[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]
BANK OF AMERICA AND MERRILL LYNCH: HOW DID A PRIVATE DEAL TURN INTO A
FEDERAL BAILOUT? PART V
=======================================================================
JOINT HEARING
before the
COMMITTEE ON OVERSIGHT
AND GOVERNMENT REFORM
and the
SUBCOMMITTEE ON DOMESTIC POLICY
of the
COMMITTEE ON OVERSIGHT
AND GOVERNMENT REFORM
HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
DECEMBER 11, 2009
__________
Serial No. 111-102
__________
Printed for the use of the Committee on Oversight and Government Reform
Available via the World Wide Web: http://www.gpoaccess.gov/congress/
index.html
http://www.house.gov/reform
----------
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COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM
EDOLPHUS TOWNS, New York, Chairman
PAUL E. KANJORSKI, Pennsylvania DARRELL E. ISSA, California
CAROLYN B. MALONEY, New York DAN BURTON, Indiana
ELIJAH E. CUMMINGS, Maryland JOHN L. MICA, Florida
DENNIS J. KUCINICH, Ohio MARK E. SOUDER, Indiana
JOHN F. TIERNEY, Massachusetts JOHN J. DUNCAN, Jr., Tennessee
WM. LACY CLAY, Missouri MICHAEL R. TURNER, Ohio
DIANE E. WATSON, California LYNN A. WESTMORELAND, Georgia
STEPHEN F. LYNCH, Massachusetts PATRICK T. McHENRY, North Carolina
JIM COOPER, Tennessee BRIAN P. BILBRAY, California
GERALD E. CONNOLLY, Virginia JIM JORDAN, Ohio
MIKE QUIGLEY, Illinois JEFF FLAKE, Arizona
MARCY KAPTUR, Ohio JEFF FORTENBERRY, Nebraska
ELEANOR HOLMES NORTON, District of JASON CHAFFETZ, Utah
Columbia AARON SCHOCK, Illinois
PATRICK J. KENNEDY, Rhode Island BLAINE LUETKEMEYER, Missouri
DANNY K. DAVIS, Illinois ANH ``JOSEPH'' CAO, Louisiana
CHRIS VAN HOLLEN, Maryland
HENRY CUELLAR, Texas
PAUL W. HODES, New Hampshire
CHRISTOPHER S. MURPHY, Connecticut
PETER WELCH, Vermont
BILL FOSTER, Illinois
JACKIE SPEIER, California
STEVE DRIEHAUS, Ohio
JUDY CHU, California
Ron Stroman, Staff Director
Michael McCarthy, Deputy Staff Director
Carla Hultberg, Chief Clerk
Larry Brady, Minority Staff Director
Subcommittee on Domestic Policy
DENNIS J. KUCINICH, Ohio, Chairman
ELIJAH E. CUMMINGS, Maryland JIM JORDAN, Ohio
JOHN F. TIERNEY, Massachusetts MARK E. SOUDER, Indiana
DIANE E. WATSON, California DAN BURTON, Indiana
JIM COOPER, Tennessee MICHAEL R. TURNER, Ohio
PATRICK J. KENNEDY, Rhode Island JEFF FORTENBERRY, Nebraska
PETER WELCH, Vermont AARON SCHOCK, Illinois
BILL FOSTER, Illinois
MARCY KAPTUR, Ohio
Jaron R. Bourke, Staff Director
C O N T E N T S
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Page
Hearing held on December 11, 2009................................ 1
Statement of:
Bair, Sheila C., chairman, Federal Deposit Insurance
Corporation................................................ 39
Khuzami, Robert, Director, Division of Enforcement, U.S.
Securities and Exchange Commission......................... 60
Letters, statements, etc., submitted for the record by:
Bair, Sheila C., chairman, Federal Deposit Insurance
Corporation, prepared statement of......................... 41
Connolly, Hon. Gerald E., a Representative in Congress from
the State of Virginia, prepared statement of............... 100
Issa, Hon. Darrell E., a Representative in Congress from the
State of California, information concerning daily pacing... 69
Khuzami, Robert, Director, Division of Enforcement, U.S.
Securities and Exchange Commission, prepared statement of.. 63
Kucinich, Hon. Dennis J., a Representative in Congress from
the State of Ohio, prepared statement of................... 35
Towns, Hon. Edolphus, a Representative in Congress from the
State of New York:
Letter dated December 10, 2009........................... 84
Prepared statement of.................................... 3
BANK OF AMERICA AND MERRILL LYNCH: HOW DID A PRIVATE DEAL TURN INTO A
FEDERAL BAILOUT? PART V
----------
FRIDAY, DECEMBER 11, 2009
House of Representatives, Committee on Oversight
and Government Reform, joint with the
Subcommittee on Domestic Policy,
Washington, DC.
The committee and subcommittee met, pursuant to notice, at
10 a.m., in room 2154, Rayburn House Office Building, Hon.
Edolphus Towns (chairman of the Committee on Oversight and
Government Reform) presiding.
Present: Representatives Towns, Cummings, Kucinich,
Tierney, Clay, Watson, Connolly, Quigley, Cuellar, Speier,
Issa, Duncan, Bilbray, Jordan, Flake, Luetkemeyer, and Cao.
Staff present: John Arlington, chief counsel--
investigations; Jean Gosa, clerk; Adam Hodge, deputy press
secretary; Carla Hultberg, chief clerk; Marc Johnson and
Ophelia Rivas, assistant clerks; Mike McCarthy, deputy staff
director; Jenny Rosenberg, director of communications; Joanne
Royce, senior investigative counsel; Leneal Scott, IT
specialist; Christopher Staszak, senior investigative counsel;
Ron Stroman, staff director; Gerri Willis, special assistant;
Alex Wolf, professional staff member; Jaron Bourke, staff
director, Subcommittee on Domestic Policy; Lawrence Brady,
minority staff director; John Cuaderes, minority deputy staff
director; Rob Borden, minority general counsel; Jennifer
Safavian, minority chief counsel for oversight and
investigations; Frederick Hill, minority director of
communications; Adam Fromm, minority chief clerk and Member
liaison; Kurt Bardella, minority press secretary; Seamus Kraft,
minority deputy press secretary; Christopher Hixon, minority
senior counsel; Hudson Hollister, minority counsel; and Brien
Beattie and Mark Marin, minority professional staff member.
Chairman Towns. The committee and subcommittee will come to
order. Good morning and thank you for being here.
The committee's investigation into Bank of America's
acquisition of Merrill Lynch has resulted in an unprecedented
look behind the scenes of one of the biggest bailouts in
American history. Did the Federal Government force Bank of
America to go through with the merger? Every Bank of America
senior executive involved has told the committee that the
government did not force them to go through with it. In fact,
they told us they decided to go through with the deal because
they thought it was in the best interests of Bank of America
and its shareholders. Ken Lewis also testified that no one in
the Government did anything improper during this transaction.
If there are still people who want to say the Government
forced Bank of America to go through with the deal, they are
turning a blind eye to the facts we now have before us. Over
the course of this 8-month investigation, the committee has
held five hearings, received extensive testimony from top
executives at Bank of America and senior Government officials,
conducted numerous interviews, issued two unprecedented
subpoenas to the Federal Reserve for internal records, and
reviewed nearly half a million documents.
Most importantly, public scrutiny and oversight by this
committee has produced tangible results. Two days ago, Bank of
America paid back its entire $45 billion Federal loan plus
interest. In addition, under pressure from the committee, Bank
of America agreed in September to pay $425 million to the
Treasury Department in compensation for toxic asset insurance
the bank received but never paid for.
In sum, our bipartisan investigation has resulted in the
American taxpayers receiving approximately $47\1/2\ billion.
Even in today's world, that is real money.
Every member of this committee should be proud of our
efforts, and I take the time to salute you for your involvement
and your hard work that has been great to get to this point.
While we have thoroughly examined all these issues involved
in this case, I agreed to grant the ranking member's request
for one more hearing to tie up some loose ends that he is
concerned about. This will close the committee's full, fair,
and successful investigation of the Bank of America-Merrill
Lynch merger.
On that note, I thank you; and I yield to the ranking
member of the committee, the gentleman from California,
Congressman Darrell Issa.
[The prepared statement of Hon. Edolphus Towns attached:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Mr. Issa. Thank you, Mr. Chairman, and thank you for
holding this hearing.
I have already told the chairwoman that, quite frankly, I
do believe she is the bookend of this investigation. She is the
bookend because Tim Geithner has never appeared before us. She
is the bookend because, in fact, there never really was much
there. Bank of America is a regulated bank. Moneys were made
available on an extraordinary basis and have now been paid
back.
Today, in the short time that we will take of the
chairwoman, we in the minority will ask, where do we go from
here? The security of our banks, FDIC-insured banks, the future
of banks conveniently becoming banks in times of trouble and
perhaps not being banks in other times, these are important
questions that this committee should ask not because we are the
Financial Services Committee but because we are the watchdog of
the American dollar and the American process and the laws that
are passed that the executive branch and its affiliates must
adhere to.
Mr. Chairman, I am deeply concerned that in your opening
statement you, quite understandably, said that the American
people were paid back $45 billion with interest, over $47
billion. I must caution you, the American people didn't get a
penny back. That money has not come back to the American
people. In fact, it has simply been put back into the slush
fund that was created under a Republican President with Tim
Geithner and Hank Paulson's assistance; and today, in fact, not
a penny has been paid back to the American people. That money
is being recycled into do-good causes or whatever the President
and this administration would like to do.
Mr. Chairman, I look forward to us getting the American
people's money back as it was promised. We were told that, in
fact, we would be paid back all of our money, and probably with
interest. Mr. Chairman, unless that money comes back
immediately, when you look at Chrysler, General Motors, and, of
course, $31-plus billion to AIG that Tim Geithner himself has
now said we will not get back, it is clear that even if all the
other moneys given to various organizations through a process
of buying mostly preferred debt, if in fact all of that is paid
back with interest, the offset of the money that we now know we
are going to lose would barely make us whole without
considering interest as anything other than principal payback.
So Mr. Chairman, this is the bookend. We have only a few
questions for our esteemed witness, and we appreciate your
bringing her here today. But this is not the end of protecting
the American people's money, not the end of this committee's
jurisdiction of ensuring that the intent of law becomes the
fact in law.
With that, I thank the chairman and yield back.
Chairman Towns. I thank the gentleman for his statement.
And maybe what we can do with some of this $47\1/2\ billion is
use it to create jobs and job opportunities. So maybe that is a
good way to use it.
Mr. Issa. Mr. Chairman, I would certainly appreciate a bill
authorizing that and appropriating that through the Congress.
And I look forward to working with you on such a piece of
legislation, which is our constitutional responsibility.
Chairman Towns. Thank you very much. I appreciate the
gentleman's offer and look forward to working with you.
Mr. Connolly. Mr. Chairman? Would the ranking member yield?
Chairman Towns. Actually----
Mr. Issa. The Chair certainly could.
Mr. Connolly. Would the chairman allow me to just respond
to something the ranking member said?
Chairman Towns. Very quickly.
Mr. Connolly. Very quickly. I just want the ranking member
to know there are Members on this side of the aisle who share
his view about the need to address the deficit and that the
first obligation of the repayment of TARP money or the use of
unused TARP money ought to be that.
Mr. Issa. Thank you.
Chairman Towns. Thank you very much.
As this hearing is being conducted by the Domestic Policy
Subcommittee, of course, and they have done a superb job in
working with us on this issue, I now would like to yield 5
minutes to the gentleman from Cleveland, OH, Mr. Kucinich, the
Chair of that subcommittee.
Mr. Kucinich. Thank you very much, Mr. Chairman, Mr. Issa,
members of the committee.
On December 5, 2008, the shareholders of Bank of America
voted to approve a merger with Merrill Lynch. Only 12 days
later, Ken Lewis, CEO of Bank of America, made a call to then-
Secretary of Treasury Hank Paulson, initiating a process that
led to a $20 billion bailout of the merger and a promise of
government insurance for losses of up to $118 billion.
The chronology of events strained belief. Was it true that
the financial situation at Merrill Lynch shifted so
dramatically in that short amount of time, as Ken Lewis said?
Or did top management know, or should they have known, about
the deteriorating situation at Merrill Lynch much earlier? Did
they fail to make necessary disclosures to the shareholders?
Bank of America would be in legal jeopardy if it failed to
disclose to shareholders information about large accelerating
losses at Merrill Lynch known or knowable before the
shareholder vote.
The Domestic Policy Subcommittee investigation has found
evidence of possible security law violations at Bank of
America. Bank of America unreasonably and negligently relied on
internal fourth quarter 2008 forecasts created by Merrill Lynch
that omitted any forecast of how the CDOs, CDS, and other toxic
assets would perform during the quarter. The former Merrill CFO
admitted that this forecast was not, in fact, a valid forecast.
Bank of America knew at the time that the forecast was of
questionable validity. However, Bank of America did not do any
actual financial analysis to make up for the Merrill omissions.
Instead, Bank of America merely pulled a number out of thin
air, which was recorded on a forecast as the gut feeling of
Neil Cotty, Bank of America's chief accounting officer. Bank of
America simply created an assumption that Merrill Lynch's
illiquid assets would almost break even for November, thereby
spreading October's bad results over 2 months.
The attorneys at Bank of America and at Wachtell, Lipton
recklessly did not question this financial information. They
advised Bank of America not to make further disclosures to its
shareholders based on the deficient forecast and the gut
feeling.
Within only weeks, however, reality crowded out wishful
thinking. Merrill Lynch's exotic investments continued to lose
large amounts of money, causing Merrill to lose over $21
billion in just the fourth quarter. Bank of America went
running to the U.S. Government for rescue.
When I asked Ken Lewis about this at our first hearing, he
told us that he relied on advice of counsel. Protecting
shareholders is often, in the final instance, the
responsibility of corporate general counsels and their outside
counsel. The subcommittee's investigative findings demand the
question, where were the lawyers? Where were the lawyers?
The glaring omissions and inaccurate financial data in the
critical November 12th forecasts were so obvious that they
should have alerted the attorneys to the necessity of
reasonable investigation before making a key decision on Bank
of America's legal duties to disclose. The apparent fact that
they did not mount such an investigation makes the decision not
to disclose Merrill's losses to shareholders an egregious
violation of securities laws.
The stage for these possible violations was set by former
SEC Chairman Christopher Cox. At exactly the time that CDOs,
CDSs, and other exotic instruments proliferated in financial
markets, Chairman Cox discouraged formal investigations of, and
large corporate penalties against, securities fraudsters. Bank
of America's conduct was the corporate reaction to years of
weakening enforcement at the SEC under Chairman Cox. Chairman
Schapiro has made efforts to turn enforcement policy around.
While I applaud the SEC for enforcing the law, in the case
of the nondisclosure of the Merrill bonuses, Bank of America's
failure to disclose accelerating losses at Merrill Lynch before
the shareholder vote is more significant. Indeed, those
undisclosed losses dwarf the amount of undisclosed bonuses. The
reliance on counsel defense asserted by Ken Lewis raises the
broader question will the Securities and Exchange Commission
allow corporate management to rely on the advice of counsel
defense and then allow the counsel to avoid liability for their
advice? The investing public and now this Congressman wants to
know, where is the SEC? As of yet, we don't know.
Thank you.
[The prepared statement of Hon. Dennis J. Kucinich
follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Towns. Thank the gentleman for his statement.
I now yield 5 minutes to the ranking member of the Domestic
Policy Subcommittee, Mr. Jordan, from the State of Ohio.
Mr. Jordan. Thank you, Mr. Chairman, and I want to thank
you for holding today's hearing. I look forward to exploring
the role of the SEC and FDIC in the merger between Bank of
America and Merrill Lynch.
This committee's investigation has revealed important
evidence of the abuse of power by the Federal Government in
response to the financial crisis. As I have said before, Mr.
Chairman, while the actions of the government officials took
place in a time of significant economic challenges and
uncertainty, there must be limits to government action even in
a time of crisis, and those limits must be respected.
We must also keep in mind that the actions of government
officials in this merger occurred after many of the Nation's
banks were forced to accept taxpayer money through the TARP
program. We know that in October 2008--this is from testimony
Ken Lewis gave us at the very first hearing we had on this
issue. We know at that October 2008, meeting, Mr. Paulson, Mr.
Bernanke, Mr. Geithner, and Ms. Bair brought the CEOs of the
largest private banks in America to the Treasury Department,
demanded that they accept the partial nationalization of their
banks in exchange for an amount of money of the government's
choosing. I look forward to learning more about Mrs. Bair's
role in that meeting and this entire affair.
This investigation has continued to reveal the unintended
consequences and negative implications of the government's
unprecedented intervention in the private sector. I hope the
Congress will apply these lessons as we continue to debate the
appropriate regulatory framework for our financial system as we
move forward.
And with that, Mr. Chairman, I thank you and yield back.
Chairman Towns. Thank you very much.
We now move to our witness. We have with us today the Chair
of the Federal Deposit Insurance Corporation.
Madam Chair, it is the longstanding tradition that we swear
all of our witnesses in. If you would stand and raise your
right hand.
[Witness sworn.]
Chairman Towns. Let the record reflect that the witness
answered in the affirmative. You may begin with your testimony.
STATEMENT OF SHEILA C. BAIR, CHAIRMAN, FEDERAL DEPOSIT
INSURANCE CORPORATION
Ms. Bair. Thank you, Chairman Towns, Chairman Kucinich,
Ranking Members Issa and Jordan, and members of the committee.
As requested by the committee, my testimony today will
focus on the FDIC's role and the decision----
Chairman Towns. Madam Chair, you want to pull that mic down
just a little bit there?
Ms. Bair. Sure. As requested by the committee----
Chairman Towns. And closer, too, I think.
Ms. Bair. As requested by the committee, my testimony today
will focus on the FDIC's role and the decision to provide
assistance to Bank of America.
Let me note at the outset that Bank of America is an open
institution, and the FDIC is very sensitive about any
discussion of the condition of open and operating insured
depository institutions.
In mid-September 2008, in the wake of Lehman's failure,
BofA announced that it would acquire Merrill Lynch. BofA's
acquisition of Merrill Lynch was approved by the Federal
Reserve on November 26, 2008, and was to be finalized in early
2009. However, on or very shortly before December 21, 2008, the
FDIC was told by the Federal Reserve and Treasury that BofA had
expressed reservations about completing the acquisition of
Merrill Lynch. Over the course of time, it was clear that
officials from the Federal Reserve and Treasury believed that
systemic risk would exist absent an agreement by the government
to provide assistance to BofA.
On January 14, 2009, the FDIC received from the Federal
Reserve a draft terms sheet describing an assistance package,
the principal elements of which were capital infusion in a
transaction where the FDIC, Treasury, and Federal Reserve would
share in a guarantee against certain losses, otherwise known as
a, ``ring fence,'' transaction.
The FDIC continued to analyze where and how much the
exposures were and how that specifically impacted the FDIC. The
FDIC's board ultimately was persuaded that BofA's condition
presented a systemic risk and that the ring fence transaction
would mitigate that risk and the risks to the deposit insurance
fund in a cost-effective manner.
The transaction also limited the FDIC's risk to a small
portion of the covered exposures, recognizing the fact that
most of the exposures resided within the investment bank and
not the insured depository institution.
On January 16, 2009, the planned Treasury capital infusion
and the Treasury-Fed-FDIC ring fence transaction were
announced. In early May 2009, BofA asked that the ring fence
transaction not be completed.
Moving forward, we have worked continuously with Congress,
the Treasury, and the financial regulators toward creating a
more resilient, transparent, and better-regulated financial
system, one that combines stronger and more effective
regulation with market discipline. One of the lessons we have
learned over the past few years is that regulation alone is not
enough. We need to establish an effective and credible
resolution mechanism to ensure that market players will
actively monitor and keep a firm handle on risk taking.
We commend you and your colleagues on the progress you have
made in moving toward providing the regulators with the tools
to effectively deal with any future crisis.
Thank you, and I will be pleased to take any of your
questions.
[The prepared statement of Ms. Bair follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Towns. Thank you very much for your statement.
Let me just state to the Members we are going to be really
tight on the 5 minutes today. Because 5 minutes really means 5
minutes, which means 5 minutes to ask the questions and for the
person to answer the questions. Because I promised the
chairperson that I would have her out by no later than 11:15,
11:20. So we want to respect that and try to move forward.
Let me just sort of ask one quick question. Are there steps
you think the Congress can take to avoid future bailouts of the
banking industry?
Ms. Bair. Yes. I think we have put a very high priority on
a robust resolution mechanism. We have that for insured
depository institutions. And when smaller institutions start to
fail, they are put into a very severe resolution mechanism that
requires shareholders and unsecured creditors to take a loss,
generally a complete loss.
For nonbank entities or activities outside of banks, this
resolution authority does not apply and, we think, something
very similar to the FDIC process, which is shareholders and
creditors take losses, not the government, is very important.
And we think that the House bill that is being on the floor now
moves very well in that direction, and we think they should be
very clear and that the resolution authority should
specifically ban assistance to individual institutions going
forward. And I believe that is also in the House bill.
Chairman Towns. Thank you very much.
I now yield to the gentleman from California, ranking
member, Congressman Issa. Thank you very much, Madam Chair.
Mr. Issa. Actually, Mr. Flake wanted to be recognized
first.
Chairman Towns. The gentleman from Arizona. He yields to
the gentleman from Arizona. Congressman Flake.
Mr. Flake. I yield to the gentleman from California.
Mr. Issa. The gentleman is yielding me his time in order to
be expeditious.
Madam Chair, I want to be brief, also; and I have just a
series of short questions.
First of all, from the standpoint of the FDIC looking back
now, wasn't--forgetting about whether the merger was a good
merger, the MAC, all the other things that this committee has
worked on, wasn't the underpinning of the additional money,
preferred stock as a form of loan, wasn't that in fact the most
appropriate thing for the FDIC to approve of so that the
capital worth of Bank of America would be undeniable?
Ms. Bair. Well, I think it is always hard in hindsight to
answer questions like that.
Mr. Issa. Actually, I normally find it easier in hindsight.
Ms. Bair. It may be easier in hindsight. I guess it is
easier to reevaluate decisions that were made.
I think the distinction needs to be made between the
insured depository institution that had a strong capital
position with other activities that were going on in the bank
holding company. And so I think if you are looking just to the
insured depository institution where we had the exposure, there
is a question about whether additional capital was needed. I do
think----
Mr. Issa. I am not saying whether it was needed. It is
clear that--in hindsight, it is clear they didn't need it,
because they paid it back to you essentially without it being
from actual new money in any large amount. They passed the
stress test. And they passed the stress test and said they
could pay it back. So I know that part of hindsight is clear.
Ms. Bair. Right, right.
Mr. Issa. But the real benefit of the $45 billion of loan,
and I repeat it was not--it is not--you know, we didn't bail
them out. We didn't give them anything. We bought stock. We
bought the worth of the company, and we got interest guarantee
and the ability to get our money out ahead of everyone else.
Preferred stock is not all bad.
But the effectiveness of it was to, if you will,
overcapitalize the company in hindsight. But wasn't that
essentially a good thing in that, if there was no other benefit
to TARP, the confidence of knowing that these companies,
particular banks, were extremely well capitalized, not as to
the stockholders but as to the depositors, wasn't that
effectively the good thing that came out of this arrangement?
Ms. Bair. Well, I think, yes, the capital investment
certainly created a fortress balance sheet. I think that was
the original intention of all these capital investments under
TARP.
Again, we were not--the only role that we had was on the
ring fence, not on the TARP investment. That was a Treasury
program and Treasury decision.
But yes, certainly----
Mr. Issa. But you were the beneficiary of it in a sense.
Ms. Bair [continuing]. Is absolutely going to have a
stabilizing impact, yes.
Mr. Issa. The next question is a harder one.
Ms. Bair. Uh-huh.
Mr. Issa. Many nonbanks decided to become banks
conveniently in this crisis.
Ms. Bair. Right, right.
Mr. Issa. Many entities in fact fled to the FDIC. And the
FDIC finds itself with its funds, funds which are designed to
ensure that we never have to actually put in taxpayer dollars,
those funds are stressed right now. Going forward, do you
believe that in fact in the future people should be able to run
to the FDIC, run to being a bank when it suits them, even if
they hadn't been when it didn't suit them?
Ms. Bair. No, I don't think they should be able to do that.
Mr. Issa. Is that a reform that you presently see on the
horizon that would give you that ability next time to say you
better be there early or not come at all?
Ms. Bair. Well, I think--two things. I think we need a
robust resolution mechanism so when entities get themselves in
trouble they don't get government assistance. They get put into
receivership. And I think entities asking for assistance maybe
won't ask for assistance so much if they know that is the
repercussion.
In terms of entities becoming bank holding companies and
having insured depository institutions not just for deposit
insurance but for the Fed lending facilities, we have suggested
that there needs to be a systemic risk council that would
decide and have the power to say to an entity that became a
bank holding company but perhaps later doesn't want all the
regulation that entails that they still need to subject
themselves and be subject to prudential supervision, that they
can't arbitrage just becoming a bank holding company when it
suits them and then not and escaping the regulation when that
suits them.
Mr. Issa. Thank you. I yield back to the gentleman from
Arizona, and he yields back.
Mr. Flake. I yield back.
Chairman Towns. Thank you very much.
I now recognize the ranking member--I am sorry--the
chairman of the Domestic Policy Subcommittee, yes, Mr. Kucinich
from Ohio.
Mr. Kucinich. Chairman Bair, do you have any concerns that
America may face yet another bank collapse?
Ms. Bair. No, I don't, but I think there is a lot of work
that needs to be done to continue the stabilization and the
cleanup, and I think the regulatory reform efforts going on
right now in Congress are absolutely crucial to that.
Mr. Kucinich. Do you think banks that are too big to fail
are too big to exist and ought to be broken up?
Ms. Bair. Well, I think there needs--the problem with too
big to fail is the same problem that you had with Fannie and
Freddie. There is an implied government backstop, which feeds
into risk taking. If shareholders and creditors think they have
the upside and the government has the downside, that is going
to encourage risk taking. We think that is a major factor that
drove the crisis.
And again, this is why--I hate to sound like a Johnny One
Note, but we really need--Congress needs to establish a very
robust, very severe resolution mechanism that tells
shareholders and creditors they will take losses if these
institutions go down. Right now, they are just happily, you
know, feeding, extending credit, and making equity investments,
and I fear that they are not really doing their own due
diligence in terms of looking at what is going on in these very
large institutions. Do they understand the risks? Do they
understand--is the management on top of those risks? I don't
think we have market discipline right now, and we need that.
Mr. Kucinich. Do you have any concern that banks may still
be overleveraging derivative markets?
Ms. Bair. Absolutely. Yes. I would say financial
institutions, not----
Mr. Kucinich. Pardon.
Ms. Bair. I think banks as loosely used. I would say
financial institutions, I absolutely have that concern, yes.
Mr. Kucinich. And what can you tell the American people
about the security of their bank deposits?
Ms. Bair. Their bank deposits are very secure. That is one
thing we have been very early on with a public information
campaign. The resolutions have been smooth. Everyone's deposits
have been completely protected, as they always have been. So
there is no question that the FDIC has resources to deal with
whatever may come.
Mr. Kucinich. Would you tell us what those immediate
resources are to assure security of deposits?
Ms. Bair. Right. Well, we are full faith and credit, and we
have a Treasury line and a congressional commitment to back
insured deposits. And, again, that has been in effect for 75
years. Right now, we have required prepayment of assessments
that is going to bring in another $45 billion at the end of the
year, which will bring our cash position probably in the first
quarter to around $60 billion, given what we already have and
additional moneys that we are going to be bringing in. So I
think it is a very strong cash position. We can borrow up to
$500 billion from the Treasury Department if we would need to
do that. I don't foresee any circumstance where that would
become necessary.
Mr. Kucinich. Thank you, Madam Chair.
Thank you, Mr. Chairman. Yield back.
Chairman Towns. Thank you very much.
I now yield to the ranking member of the full committee,
Congressman Issa.
Mr. Issa. Thank you, and I will be equally brief this time.
Madam Chair, you on January 9th determined it was clear
``It was clear that officials from the Federal Reserve and
Treasury believed the systemic risk would exist absent an
agreement by the government to provide assistance to BofA.''
That is really the point at which you came in. But isn't it
true that the deal was already done prior to that time to give
them the money? Isn't that what we have essentially discovered?
Ms. Bair. Right. Well, I will tell you I know conversations
already occurred between the Treasury and the Fed and Mr. Lewis
prior to the time we were contacted. I wasn't privy to those
conversations, so I don't know.
Mr. Issa. Sure. I realize we have been very unfair to you
in that you came in on the tail end of everything.
Ms. Bair. Yes, I did.
Mr. Issa. And only if something was a bank or about to
become a bank holding company.
Ms. Bair. Right.
Mr. Issa. Let me followup with this question.
Specifically in your role as FDIC Chair, if you had a
choice and you were told, what would you like to do when BofA
said we are going to invoke the MAC or give us more money? It
doesn't matter who said it, but that occurred. Wouldn't the
FDIC's position in the future be go to Congress or go to the
TARP and bail out Merrill Lynch directly? If they don't want it
and there is money needed, and obviously there wasn't new
management or consolidation in the merger at all, wasn't it
really go bail out Merrill Lynch, do whatever you are going to
do with Merrill Lynch, they are not a bank, and why should it
be clouded with me? Isn't that essentially the--you and future
Chairs' position that you would prefer?
Ms. Bair. Well, we think it is important to act as one
government, yes. But my first job and foremost job is to
protect insured depositors. And I can't, with at that time
about a $50 billion deposit insurance fund, bail out the entire
economy and everybody else with the resources that we have. And
I have to make sure that we have credibility to protect insured
depositors, first and foremost.
So, yes, investment banks are not insured depository
institutions, and it would have been nice to have other
mechanisms available. Absolutely.
Mr. Issa. So as we are Monday morning quarterbacking up
here, if there is anything--and since we have determined that
Chrysler and General Motors qualified for TARP money, if there
was any mistake made, it was this very lucrative merger that
BofA is now happy about and touting, to be honest, when faced
with the dilemma, it was a Merrill Lynch decision. Treasury,
Paulson, Geithner, they should have made a Merrill Lynch
decision relative to. Instead, what they do is they pushed it
onto a bank holding company, and a bank holding company then
had a systemic risk problem which fell to your doorstep, and
$45 billion of taxpayer money, albeit paid back, in fact was
put in play.
Ms. Bair. Well, yes, BofA was already a bank holding
company, obviously. This is a situation where Merrill Lynch was
not. So through the acquisition it got folded into the bank
holding company structure. And, yes, there were significant
benefits that accrued because of that, yes.
Mr. Issa. Now on a lighter note----
Ms. Bair. OK.
Mr. Issa [continuing]. Yesterday this committee on a
bipartisanship basis moved for a common searchable platform,
although not XBRL, which of course you use. We mandated a
common uniform platform with rigorous structures so that there
could be transparency either to those cleared or, in the case
of assets, information available normally to the public,
directly to the public. What is your experience and what would
you guide us with, in your case, XBRL and that kind of
capability that it gives you to look down and, if possible,
even allow others to look down?
Ms. Bair. Right. Well, IT is not my forte. We have been
leaders in this area. I think we have had a very good
experience, and I would certainly offer our IT people to give
you a more detailed briefing on that, if you would like.
Mr. Issa. Let me--last followup question, and I will yield
back. Do you believe that this committee is on the right track
when we insist that data bases be common, robust, searchable,
and interactive so that in fact, when appropriate, the American
people can have transparency?
Ms. Bair. Right. You may get me in trouble with other
agencies, but if I could just follow that, we have had a very
positive experience, and I would encourage others and this
committee to facilitate broader use.
Mr. Issa. Thank you, Madam Chair. I yield back.
Chairman Towns. Thank the gentleman from California.
I now yield to the gentleman from Maryland, Congressman
Cummings.
Mr. Cummings. Thank you very much, Mr. Chairman; and, Ms.
Bair, welcome, and thank you doing such a superb job.
I recognize that the FDIC's job in the Bank of America
bailout was different from that of your fellow regulators at
Treasury and the Federal Reserve. But, nonetheless, we have a
responsibility to explore all aspects of this tainted
transaction.
In your written testimony, you note that the FDIC was
notified of potential government assistance in the Bank of
America-Merrill Lynch merger around December 21, 2008. You go
on to say that over the next 3 weeks the discussion continued
about Bank of America's financial condition and the nature of
the assistance to be provided. You discussed the case with
Secretary Paulson, Chairman Bernanke, and others on January 9,
2009, and were provided a draft terms sheet on January 14th.
This is all correct, I hope, and I am working from your own
written testimony. Is that right?
Ms. Bair. That is right.
Mr. Cummings. My concern is the fact that in past hearings
in this committee we have heard about how Ken Lewis briefed his
board of directors on December 22, 2008, and again on December
29, 2008, indicating that at least $12 billion in fourth
quarter Merrill Lynch losses would be covered by the Federal
Government.
I am not asking you what happened at those meetings. I know
you weren't there. But what I would like to address is this. Do
you have any reason to believe that Ken Lewis had sufficient
basis on the structure of any potential deal to brief his board
with such certainty?
Ms. Bair. No. Again, we weren't privy to any of those
discussions, and certainly the FDIC had made no decision at
that time about whether we would participate and to what extent
we would and how that would take place or whether it was
necessary.
Mr. Cummings. Based on your testimony, the government
regulators were still reviewing the Bank of America positions
and working on whether a deal would occur well into the new
year. It certainly doesn't sound like it was a done deal, does
it?
Ms. Bair. No. And, again, I can't--we were only one small
piece of this. But certainly from the FDIC's perspective we had
committed to continue talking with the Fed and Treasury and
examine the facts and analyze to what extent assistance would
be appropriate. We had not made any decisions during that time
period, no.
Mr. Cummings. This is not you saying this. This is me
saying this. One could certainly read this as Mr. Lewis pulling
a fast one on his board to get them to approve the deal. Unless
you want to comment.
Ms. Bair. I think I will stay away from that.
Mr. Cummings. I am sorry?
Ms. Bair. I think I will stay away from that. Thank you.
Mr. Cummings. Thank you very much.
Thank you, Mr. Chairman. I yield back.
Chairman Towns. Thank you very much. I thank the gentleman
from Maryland for his questions.
Now yield to the ranking member of the committee, Mr.
Jordan of Ohio.
Mr. Jordan. Thank you, Mr. Chairman.
Chairwoman Bair, let me--I have looked at your record, and
you were a professor of regulatory policy, and--very
impressive--and I am just curious, on a broad context are you,
like I am, a bit troubled--frankly, for me, it is more than a
bit--troubled by this what I have called unprecedented
involvement by the government in the private sector?
Whether we are talking President of the United States
deciding who gets to be CEO of General Motors, whether we are
talking about the fact that we now have in the United States of
America something I thought I would never see but a Federal
Government pay czar telling private American citizens how much
money they can make, and bailouts, and TARP, and second
stimulus coming in, on and on it goes. So just as an
accomplished professional individual, are you nervous about
this general direction and, again, this unprecedented
involvement of the government in the private marketplace?
Ms. Bair. Absolutely. And we think better tools are needed
for the government to deal with this in different ways going
forward.
We are very much opposed to--and I believe the House bill
does this, prohibits capital investments in banks and financial
institutions going forward. I think government ownership of
financial institutions has created not only a lot of public
outcry and cynicism but also very difficult issues about what
should be private entities and private sector decisions, based,
obviously, on some prudential regulatory standards. But
government ownership has created a whole list of problems, and
we would like to end that going forward.
Mr. Jordan. OK. With that being said, let me take you
back--and this, again, as I pointed out in my opening
statement, was brought out when we first had Ken Lewis in front
of this committee several months ago. The meeting that took
place here in D.C. with the nine largest banks 10 days after
the TARP legislation was passed--and, again, the TARP
legislation was passed designed to go in and get these troubled
assets off the books, free up credit, straighten up these
balance sheets, et cetera.
Ten days later, the nine biggest banks were brought to the
Nation's Capital. According to Mr. Lewis' testimony, Mr.
Paulson and Mr. Bernanke and you were in that meeting; and Mr.
Lewis indicated he had no idea what the meeting was about. That
the meeting went with a piece of paper slid across the table to
the banks telling them how much money they were now going to
take from the TARP program, whether they asked for it or not,
and that they had to sign a statement saying they were in
agreement to that.
Is his recollection of that meeting accurate? Is that in
fact what took place?
Again, not 10 days after we were told--the Congress of the
United States was told that the TARP program, the money that
was made available be used for something entirely different.
Ms. Bair. Right. I was invited to attend that meeting. I
was not involved in decisions about who should come to that
meeting and who was going to get what. My role was confined to
explaining the temporary liquidity guarantee program, the debt
guarantee program. The only remarks I made were to explain that
program, and I did not opine or comment at all on the capital
investments piece. We were not involved in decisionmaking, and
we remained silent during that discussion. But, yes, these
banks were strongly encouraged to take this money.
Mr. Jordan. Going back to your answer to my first question,
though, were you troubled that day about what you saw taking
place in that meeting in light of the fact you just said--you
made two statements already today. You said you were troubled
by this unprecedented involvement of the government in the
private sector; and you also said, in an answer to Mr. Issa's
question earlier, that the government should act as one. So
were you sitting in that meeting troubled by what you saw
taking place in that meeting, again 10 days after the
legislation had been passed for an entirely different purpose?
Ms. Bair. Yes. I think--two things. I think these decisions
were made in the fog of war. These decisions had to be made
very quickly, and the situation was becoming more and more
destabilizing. And, also, there had been an international
agreement to use a combination of liquidity guarantees. We were
involved in liquidity guarantees and capital investments to
stabilize the system.
Frankly, the idea of it took my breath away, and it was
quite unprecedented in terms of the private sector system that
we have. And so I was concerned, and I have----
Mr. Jordan. Was that the first time--did you know what was
going to take place in that meeting, or did you come into that
meeting much like Ken Lewis and the rest of the other----
Ms. Bair. We were told in advance who was going to come and
that they were going to be asked to take--or encouraged to take
capital investments. We were absolutely told that in advance.
I did not weigh in one way or the other. I confined my role
to explaining the debt guarantee program. I have said in
retrospect I wish we had weighed in, because I think, again,
government ownership in banks has created a whole host of
problems.
And, by the way, on troubled asset relief, I think we still
need a program, and we would like to see maybe perhaps Congress
authorize that going forward. That still needs to be done and
has to be done.
Mr. Jordan. Mr. Chairman, real quick--I appreciate what you
said, Ms. Chairwoman. I think this has been very helpful. If I
could just ask one other question, Mr. Chairman.
Chairman Towns. Go ahead.
Mr. Jordan. The talk this week is about using TARP dollars
for stimulus, for something outside of the scope.
Ms. Bair. Right.
Mr. Jordan. Again, I think it was done already. But I
totally disagree with this. Your thoughts, if you would, on the
idea of using TARP money for a second stimulus.
Ms. Bair. Well, I think you are asking me something beyond
my pay grade, because I like to confine my public comments to
areas where I think appropriately fall within my sphere as
chairman of the FDIC.
I do think that there needs to be more focus in terms of
troubled asset relief. We still have toxic assets on the books
of banks. Particularly the smaller banks really did not benefit
from the capital investments. The smaller banks are a large
share of small business lending, but their need to continue to
work out and reserve against these legacy loans that they have
is inhibiting their ability to engage in new lending. So we do
think it would be appropriate and consistent with the Troubled
Asset Relief Program to try to deal with that problem.
But, beyond that, I would not want to opine about other
uses that others might want to make of the TARP money.
Chairman Towns. The gentleman's time has expired.
Mr. Jordan. Thank you, Mr. Chairman.
Chairman Towns. I now yield to the gentleman from Virginia,
Congressman Connolly.
Mr. Connolly. I thank the chairman.
Welcome, Chairwoman Bair. And I am going to ask you to move
your mic closer. I cannot hear you sitting here because of the
acoustics in this room.
I am listening to my friend from Ohio, and he loves to use
the phrase ``this unprecedented Federal intervention in the
financial sector'', as if we didn't have the worst meltdown in
70 years a year ago September.
Let me ask you, wearing your FDIC hat, as somebody who has
an interest in insuring deposits in depository institutions
regulated by the Federal Government, so what if we hadn't had
that unprecedented Federal intervention by a Republican
administration, by the way? What would have happened to the
banking sector in America, wearing your FDIC hat.
Ms. Bair. I think it wasn't pretty. It wasn't perfect. I
think retrospect and hindsight always has additional wisdom.
Mr. Connolly. So should we not have done anything?
Ms. Bair. No, we had to do something, and it did stabilize
the system. I absolutely agree with that. Something needed to
be done, and that was the decision that was made, and it did
stabilize the system.
Mr. Connolly. So intervention was necessary, in your view?
Ms. Bair. Intervention was absolutely necessary.
Mr. Connolly. Now, the intervention that was designed, this
came from some pointy-headed liberal academic from some Ivy
League College, right? It didn't come from a Republican
Secretary of State and a Republican administration, did it?
Ms. Bair. I am sorry, what are you referring to?
Mr. Connolly. Who proposed the idea of the TARP?
Ms. Bair. Oh, the TARP. The TARP was proposed by, yes, the
Treasury and the Fed.
Mr. Connolly. Oh. Not a pointy-headed liberal academic from
an Ivy League college? By a Republican businessman who was the
Republican-appointed Secretary of the Treasury in a Republican
administration. Is that correct?
Ms. Bair. Yes, that is my recollection of how----
Mr. Issa. If the gentleman would yield?
Mr. Connolly. No, I am not going to yield.
Let me ask you a question. In your testimony you say that
you have, wearing your FDIC hat, a direct interest in both Bank
of America and Merrill Lynch because they are depository
institutions. Is that correct?
Ms. Bair. That is right. Well, Merrill Lynch is not.
Mr. Connolly. I am sorry?
Ms. Bair. Bank of America, the bank is an insured
depository institution. Merrill Lynch was an investment bank.
Mr. Connolly. I know, but I am reading from your testimony.
Ms. Bair. Right.
Mr. Connolly. OK. And you assert that FDIC has a continuing
stake in the financial well-being of those insured depository
institutions.
Ms. Bair. Right.
Mr. Connolly. OK. So what was the view of the FDIC at the
time the Bank of America proposed to acquire Merrill Lynch? Was
that a good business decision? Was that a risky business
decision? Were you aware of the fact that they had
unprecedented losses, by the way, without unprecedented Federal
regulatory intervention?
Ms. Bair. Well, a couple of things. We are not the holding
company regulator. The Fed is. And we do not approve mergers
and acquisitions. The Fed does. We are also not the primary
regulator for Bank of America.
Mr. Connolly. I understand.
Ms. Bair. We insure them. We have backup supervisory
authority. So I think in terms of the more intimate knowledge
of that situation would come from the Fed and the OCC.
As backup supervisor, frankly, we must rely on the primary
regulator. If there starts to be troubles, then we move in. But
without red flags, no. With those caveats, I was not aware
until we got these phone calls and started looking into it that
Merrill Lynch had such significant losses in the fourth
quarter. They were quite profound.
Mr. Connolly. Let me ask you, we have a bill that is
pending before the floor of the House of Representatives today
that would constitute a major overhaul of regulation and for
the first time finally allow some oversight of the risky
derivatives market, for example, and would, in effect, extend
some Federal oversight and regulation of investment banking by
any other name, not many are left, none of which existed
previously.
In retrospect, just given your financial expertise, do you
think we made a mistake to explicitly exempt derivatives, a
multi-trillion dollar market, from any Federal regulation?
Ms. Bair. Oh, absolutely. That was a mistake. Absolutely.
Mr. Connolly. So, again, this unprecedented Federal
intervention in the financial markets, in the case of
derivatives, since there is no such unprecedented Federal
intervention at the moment, maybe in retrospect we should have
had some?
Ms. Bair. I think we absolutely should have had more
regulation in a lot of areas and particularly in OTC
derivatives. There is no question in my mind about that.
Mr. Connolly. Thank you.
And my final question, does the FDIC have a point of view
with respect to the extension of FDIC that is contained in the
bill that is pending before the House today? Is that a good
idea to extend the FDIC and finance that extension by having
the big banks have an extra fee rather than taxpayers do it?
Ms. Bair. Right. Yes, we do support. We have said that for
banks and bank holding companies that have insured depository
institutions we would like to be the resolution authority. For
nonbanks, we will let Congress decide that. And I think they
have decided they would like one entity doing it all.
And, yes, we think that this should be a very robust
resolution mechanism that provides no open bank assistance, no
conservatorship, everyone goes into receivership, their
shareholders and creditors take losses. That is the process
that we use for banks, and that is the process that works.
And so, yes, and we think the working capital needs for
this fund should be provided through a risk-based assessment on
the larger financial entities. And, again, this could be
another lever, another tool to discourage excessive risk
taking. So we do support that part of it.
Mr. Connolly. Thank you.
My time is up. Thank you, Mr. Chairman.
Chairman Towns. The gentleman's time has expired.
I now yield to the gentleman from Missouri, Mr.
Luetkemeyer.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
Madam Chairwoman, thank you for being here this morning.
I am just kind of curious, now that we have some nonbanks
that are banks and Lehman Brothers has been absorbed by BofA,
have you been in to examine that portion of BofA? Have you been
in to examine the bank itself? Have you been in to examine like
Goldman Sachs and those folks at all since this all took place?
Ms. Bair. I cannot comment on specific institutions. Let me
tell you generally what we are doing, which is, right now, we
have backup authority only for insured depository institutions.
So activities outside of insured depository institutions like
investment banking, even though they might be part of a broader
holding company structure, we have no authority there. That is
the exclusive domain of the----
Mr. Luetkemeyer. Goldman Sachs is now a bank, is it not?
Ms. Bair. No, because the insured depository institution is
only a subsidiary of a larger bank holding company structure.
This has been a problem for us.
And another positive thing that we think the House bill
does is give us backup authority over everything in the holding
company. Right now, it is only over the piece that has the
deposit insurance, which is not the whole thing.
Mr. Luetkemeyer. Do you think that there needs to be some
ability to regulate and have some oversight over some of these
off balance sheet liabilities that a lot of these folks are
involved with?
Ms. Bair. Absolutely. Yes.
Mr. Luetkemeyer. What are your plans do that?
Ms. Bair. Well, fortunately, the accountants have done a
lot of it already. We are implementing FAS 166 and 167, which
basically requires that these off balance sheet exposures now
be counted on balance sheet. So you have to hold capital and
reserves against them. So we will be finalizing rules next week
to make clear that you need to hold capital and reserves from
the regulatory capital, that we will treat those as on balance
sheet assets.
On the derivatives area, the OTC derivatives area, I think
Congress needs to act on that. Because of the Commodity Futures
Modernization Act, there is very little authority to provide
product regulation or market regulation; and we have been
working with the SEC and the CFTC to strengthen that. And we
are generally supportive of that.
Mr. Luetkemeyer. OK. You mentioned a while ago that all our
banks are in great shape, yet this last year or two we have had
almost a record number of bank failures within a short period
of time.
Ms. Bair. I don't know that I said----
Mr. Luetkemeyer. How many more failures do you anticipate
over the next year or 2 years?
Ms. Bair. I would not say--I think most banks continue to
be profitable and--but there are clearly some under distress.
And we do not publicly release our failed bank projections, but
it will continue to go up. We think it will peak next year.
Mr. Luetkemeyer. I understand. OK.
But your comment earlier was also with regards to a lot of
small banks are having to absorb some of these--they are part
of the ripple effect of some of the big guys here and are
certainly under stress at this point. Do you have any plans for
some forbearance for those folks to allow them to be able to
withstand this and to outlive some of these problems so that
they are not going to be closed as a result of some of the
actions of some of the big guys?
And while we had forbearance with the big folks and helped
them get over this, we don't have TARP funds available for the
small guys. And if we don't have forbearance for those folks,
they are the ones who are going to suffer disproportionately
compared to what the other folks have. And while it may not be
a big deal to the folks who are concerned with BofA, it
certainly is going to impact a lot of community banks in my
district and a lot of small districts around this country.
Ms. Bair. Well, Congressman, by statute, if a bank becomes
insolvent or can no longer meet its liquidity demands, it needs
to be closed. There is a very well-defined, prompt corrective
action procedure in the statute. We cannot provide open bank
assistance unless there is a systemic risk and then only if the
Fed and the Treasury and the President agrees. By statute, we
cannot provide----
Mr. Luetkemeyer. With all due respect, Madam Chair, my
question, though, is are you going to have some forbearance on
those folks because of the unusual circumstances that they find
themselves in through no fault of their own, only being a
participant in investing in some things that wound up getting
them into trouble? And they don't have the opportunity, like
you just said, for some of the TARP funds and things like this.
Is there willingness on your part to look at these
situations on a case-by-case basis and say, hey, the rest of
the bank has been profitable; it has been under good
management; just this one area is a problem; and, therefore, we
are going to deal with this and work with them on this and not
close them down as a result of that? Is there a willingness to
look at that situation?
Ms. Bair. We have done that already, I think. We released
and were able to get interagency agreement on some guidelines
recently that explicitly allow banks to do loan restructurings
with the commercial real estate loans. It needs to be disclosed
and well documented and only if you have a creditworthy
borrower that continues to make repayments on a restructured
loan. We tried do that already.
I guess my only point is, though, Congressman, once the
institution no longer becomes viable under the statutory
criteria, there is no flexibility to provide forbearance. And I
think these rules were put in place after the S&L crisis, where
there is forbearance and there is forbearance. And sometimes if
forbearance just denies the problem that exists and delays the
closing, it will end up costing the government more money,
which is what happened during the S&L days. So we do need to be
careful.
But, absolutely, for the healthier institutions that can
make it, we are trying to give them flexibility to work these
loans out.
Mr. Luetkemeyer. OK. Thank you, Madam Chair. Thank you.
Chairman Towns. The gentleman's time has expired.
I now yield 5 minutes to the gentleman from Louisiana, Mr.
Cao.
Mr. Cao. Thank you very much, Mr. Chairman; and I would
like to continue questioning concerning community banks similar
to Mr. Luetkemeyer. Because, in Louisiana, many of the banking
systems are community based banks, and they are impacted
tremendously by the financial overhaul that we are looking at
in the Congress. Madam Chair, can you provide me with the
number of banks that have failed in Louisiana?
Ms. Bair. I do not know that off the top of my head, but I
will certainly get it to you this afternoon when I get back to
my office.
Mr. Cao. OK. But probably it is either none or extremely
few.
Ms. Bair. I would really need to check. I am sorry,
Congressman, but we have had about--I think we will have about
140 failures, and it is very difficult to know State by State.
I will get that information back to you very quickly.
Mr. Cao. That is fine.
The community banks in Louisiana, they did not involve
themselves in the subprime mortgage mess; and, as such, many of
them were profitable in the past years, while some of the big
banks have failed. My question to you here is, why are we
making these small community banks, who were successful, who
operated within the boundaries of the traditional loaning
criteria, they followed the rules, why are we making them pay
for the faults of the big banks through this tremendous
overhaul process?
Ms. Bair. Well, I think--two things. I think you are right.
Community banks generally did not make subprime, they didn't
make these high risk mortgages, they did engage in commercial
real estate lending. Some of that was not prudent. A lot of it
was. They were good loans when they were made, but because of
the economy they are going bad now. And as the economic
problems continue, more and more of the failures are driven by
that.
But, again, banks must hold certain levels of capital and
loan loss reserves against their loans. And if their loans are
going to have losses that exceed their capital capabilities,
they become insolvent. Or if they can't meet their liquidity
demands, if depositors want to withdraw money and they can't
have enough cash to do that, then they need to be resolved. And
that is--again, there is a fairly well-defined procedure in our
statutes to do that.
I think this Congress, you know, again back to the
conversation about the appropriate use of TARP going forward
and troubled asset relief, I think this is a ripe area,
especially for smaller banks, to provide some assistance,
continued need for troubled asset relief for the smaller
institutions. And we would be very strongly supportive. But our
statute does not allow us to provide open bank assistance to
large or small institutions, again, unless it is under this
very narrow systemic risk exception.
Mr. Cao. It seems to me that the small banks are being
penalized for the actions of bigger banks.
Ms. Bair. I am greatly troubled, and I have spoken out
about this for a long time, of the different treatment between
large and small. And the very large get the TARP money and get
the support and the small ones get closed. I don't like that.
Going forward, I would like to close the big ones, too. I
mean, I think that is really--if we are going to have a free
market system, not a free-for-all system but a free market
system, I think going forward the resolution regime needs to be
able to work for small and large institutions, and right now it
can only work for the smaller ones.
But the immediate problem, you are right. It is not fair,
and we have said that TARP needs--we need to figure out a way
to make TARP work better for the smaller institutions. And,
again, with troubled asset relief, not so much capital
investments, I think that is a problem. But troubled asset
relief, providing support there to help them get rid of these
bad loans so they can make new loans, we are very supportive of
that and work with Treasury, work with Congress on trying to
make those programs more effective.
Mr. Cao. Can you explain to me--I agree with you that the
big bank institutions that were involved in these subprime
mortgage loans, we need to have a better mechanism of
overseeing their operations. But can you explain to me how
regulating these smaller community banks that are already
regulated by State law, how would that improve our country's
financial health when they have been profitable, when they have
been following the traditional methods of loaning? They were
not involved or did not contribute to this financial mess? How
would regulating them improve our financial health?
Ms. Bair. First of all, no Louisiana failures. My staff
just handed me a note. So no failures in your State.
I think we provide supervision, obviously, of small and
large banks because they have deposit insurance. There is a
government exposure there. If they get in trouble, we always
protect the insured depositors. So with that comes prudential
supervision, and that has been the cover for over 75 years.
I think, moving forward, my concern from a supervisory
perspective with the smaller banks is helping them diversify
their balance sheet. Because of unlevel playing fields between
large and small institutions, as well as between insured
depositor institutions and the shadow sector, the nonbank
sector, community banks have been relegated primarily to
commercial real estate lending and small business lending; and
they provide good support for their communities in those two
areas, but they don't have much diversification. They got the
mortgages taken away from them, a lot of the consumer credit
taken away from them, and I think a lot of that has been driven
through an unlevel regulatory requirement.
So, going forward, I would change that to help them further
diversify their balance sheet and get back to where we used to
be with community banking, where they were in a position to
offer a more full range of services to their communities.
Chairman Towns. The gentleman's time has expired.
Let me announce that we have 3 minutes left on the vote,
and of course we will return 10 minutes after the last vote. I
understand there are three votes.
Madam Chair, let me thank you very much for coming this
morning. We will now recess until 10 minutes after the last
vote.
The committee is in recess.
[Recess.]
Chairman Towns. The committee will reconvene.
Our second witness today is Mr. Robert Khuzami, Director of
the Division of Enforcement at the Securities and Exchange
Commission. It is committee policy that all witnesses are sworn
in. So if you would stand and raise your right hand.
[Witness sworn.]
Chairman Towns. You may be seated. Let the record reflect
that the witness answered in the affirmative.
Mr. Khuzami, you may begin.
STATEMENT OF ROBERT KHUZAMI, DIRECTOR, DIVISION OF ENFORCEMENT,
U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. Khuzami. Thank you, Chairman Towns, Ranking Member
Issa, Congressman Kucinich. My name is Robert Khuzami, and I am
the Director of Division of Enforcement at the Securities and
Exchange Commission. I became director on March 29th of this
year. Thank you for the opportunity to testify on behalf of the
SEC regarding Bank of America's acquisition of Merrill Lynch.
The committee's invitation asks about the SEC's litigation
against Bank of America. Because the enforcement action is
ongoing, discussion of certain aspects of this litigation pose
a risk of negatively affecting our case. I am happy, however,
to discuss elements of our publicly filed court papers.
The complaint in our case concerns a November 2008, joint
proxy statement that Bank of America and Merrill sent to their
shareholders soliciting shareholder approval for Bank of
America's acquisition of Merrill. The complaint alleges that
the proxy statement violated proxy solicitation provisions
because it contained material faults and misleading statements.
Specifically, we allege that Bank of America represented in
the proxy statement that Merrill had agreed not to pay year-end
performance bonuses to its executives prior to the closing of
the merger without Bank of America's consent. Bank of America,
however, failed to disclose that it already had consented to
Merrill's payment of up to $5.8 billion in discretionary year-
end and other bonuses to Merrill executives. That complaint
alleges Bank of America's omission of the information rendering
the proxy statement misleading and false.
At the time we filed our complaint, the Commission
submitted a consent judgment for the court's consideration
under which Bank of America agreed to settle on terms that
included payment of $33 million and the entry of an injunction
prohibiting it from further proxy solicitation violations. As
you know, the judge declined to approve the settlement, and the
litigation is thus ongoing.
The judge's decision has not affected our underlying case,
which is set for trial in March of next year. We stand by our
charges, and have used the additional discovery available in
the litigation to further pursue the facts and to determine
whether or not additional claims are appropriate. In
determining how to proceed, we will, as always, be guided by
what the facts warrant and the law provides.
With regard to the proposed settlement, we believe it was
reasonable, appropriate, and in the public interest, and also
properly balanced to relevant factors that must be considered
when assessing any settlement. Where a corporate issuer fails
to meet its statutory obligations, the need for deterrence is
paramount. The proposed penalty, which would have been the
second largest ever imposed in a proxy statement case, would
have sent a clear message that proxy solicitations must include
the substance of separate nonpublic documents when the failure
to do so results in material misrepresentations or omissions.
It also clearly communicated to shareholders and the public
that management had failed to keep the company in compliance
with securities laws and undercut the position now asserted by
Bank of America that there was no legal requirement to disclose
such information.
Importantly, these objectives would have been achieved in a
way that did not place an undue burden on shareholders.
Although a $33 million penalty is a significant amount, it is
not likely to have had a material adverse financial impact on
individual innocent shareholders, given the billions of shares
of Bank of America stock then outstanding.
You have also asked why our complaint did not charge
individuals. The SEC pursued the charges we believe were
appropriate based on the investigative record and applicable
law. The securities provisions that govern proxy statements are
directed to those who solicit proxies or in whose name proxies
are solicited. Here, the corporations solicited the proxies. As
such, the Bank of America had a legal obligation that we
alleged it failed to meet.
To establish that individuals aided and abetted a proxy
solicitation violation or committed frauds under the security
laws, it is necessary to prove scienter, or knowing or reckless
misconduct. Based on the record that existed at that time, we
did not believe that we could fairly and properly assert
scienter-based charges against individuals under the applicable
legal standards. We have followed and will continue to follow
any additional evidence developed wherever it leads.
I want to be clear that the proposed settlement in no way
reflects a change in the Commission's approach to pursuing
charges against individuals who violate the Federal securities
laws. The Commission has been and will continue to be
aggressive in bringing actions against individuals who violate
the securities laws and also will continue to vigorously pursue
penalties from culpable individuals, including corporate
executives. In fact, as outlined in my written testimony, the
Commission recently has filed a number of enforcement actions
against corporate executives charging violations of the Federal
securities laws and seeking extensive remedies.
Thank you for the opportunity to address these important
issues, and I look forward to answering your questions.
[The prepared statement of Mr. Khuzami follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Chairman Towns. Thank you very much.
Again, we apologize for the break, but we have to vote
around here.
Mr. Khuzami, I know you are currently preparing the case
against Bank of America. I don't want to do anything or say
anything that is going to jeopardize your case, but in general
what is the SEC--what do they believe Bank of America did
wrong? What do you think happened here that was wrong?
Mr. Khuzami. Mr. Chairman, in our complaint we allege that
the proxy materials that were sent to shareholders, which was
the basis upon which they would decide as to whether or not to
vote to approve the merger, stated that Merrill Lynch could not
pay discretionary bonuses without the consent of Bank of
America.
In fact, what the proxy solicitation did not disclose, that
there already had been an agreement that Bank of America would
allow Merrill to pay up to $5.8 billion in exactly those kinds
of bonuses. So the proxy was misleading because it suggested
that no consent had been given and no such bonuses would be
paid without such consent when in fact the consent had already
been given.
Chairman Towns. I know you are a very serious prosecutor,
and that is what we need in this day and age.
What can we expect from the SEC going forward in terms of
aggressive enforcement against corporate wrongdoers? What can
we expect from this point on? We are talking about a lot of
money here.
Mr. Khuzami. I understand.
Look, first, I would point to the recent cases that we have
brought against corporate executives. In the mortgage fraud
area alone we have charged the CEOs, the CFOs, or other senior
executives in New Century, Countrywide, American Home Mortgage,
Brookstreet Securities. We charged Hank Greenberg and another
official at AIG. Just in the recent past we have gone
vigorously after those individuals who we believe were heading
companies that engaged in one form or another of fraud or
wrongdoing, particularly with respect to mortgage and mortgage-
related products.
So I think past is prologue, and you will continue to see
that kind of approach. Under Chairman Mary Shapiro, we are
embarking on a number of internal efforts to streamline our
processes and make ourselves more responsive, but we are
reinvigorated and rededicated to that effort.
Chairman Towns. But you do feel that you have the tools to
be able to do the job that needs to be done, that no
legislation or anything is required in order to be able to move
forward with this aggressive approach? The word around here now
is robust approach.
Mr. Khuzami. Robust, yes. Yes. We have a number of
legislative proposals that we have presented, particularly
involving hedge fund registration; the creation of a central
clearing party for derivative transactions; more and better
information on exactly the kind of trading and activity that
goes on in some of these over-the-counter and opaque markets.
In addition, we have sought legislation regarding
nationwide service of process and some other things to help
make our job easier.
And last, of course, funding is a significant issue. We
have--I think the last statistics I saw--over 35,000 regulated
entities that the SEC is responsible for between issuers,
broker-dealers, investment advisors, transfer agents, credit
rating agencies; and that is before we get to hedge fund
registration.
Despite those numbers, the enforcement staff is 1,100,
total. I think that additional funding would also go a long way
toward helping us complete our mission.
Chairman Towns. Thank you very much. Thank you for your
testimony.
I now yield to the gentleman from California, the ranking
member, Mr. Issa.
Mr. Issa. Thank you, Mr. Chairman.
Mr. Khuzami, I know you were not on board on December 18th
of last year, but are you familiar with the document dated
December 10th, which was delivered to the Fed on that date,
which is called the ``fourth quarter 2008 walk-down,'' the so-
called ``walk-down document?''
Mr. Khuzami. I do not believe that I have seen that,
Congressman.
Mr. Issa. Mr. Chairman, I ask unanimous consent this be
placed in the record at this time.
Chairman Towns. Without objection.
Mr. Issa. It is already in our information, but I want to
make sure it is in the record at this point.
Chairman Towns. Without objection, so ordered.
[The information referred to follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Mr. Issa. I apologize; December 17th I believe it was
delivered.
It probably would not surprise you to know that it
actually--on page 6 it lays out those bonuses. Mr. Bernanke,
Mr. Paulson had that on those days in December.
Had you been in the room when this was delivered--in other
words you, the SEC--would you have then been aware of the
failure of the proxy in time to at least begin action at that
point in December?
Mr. Khuzami. Well, I guess you would have to know exactly
what was said in the proxy and compare that to the information
that was then available.
Mr. Issa. But you knew that. You have compliance people.
You were hand-in-hand, and you get paid to make sure that the
public is protected throughout the process of a merger.
So let me ask you the real question. We are the Government
Oversight Committee, and it is a double entendre because we
oversee the government.
We are also the government entity that oversees a number of
things that are outside the government; but in this case, the
Federal Reserve, the Treasury, and the SEC--as I understand it
through testimony again and again, the SEC was locked out of
this process during that time and did not get into the process
until January.
Isn't that correct? Your agency was not informed of what
the Fed was doing or the Treasury was doing, and you were not
at these meetings? You were conspicuous in your absence, right?
Mr. Khuzami. I understand that is correct, yes.
Mr. Issa. So from a standpoint of the Securities and
Exchange Commission, the respect the Treasury and the Fed
should show in the future, shouldn't you be at the table if
tens of billions of dollars of taxpayers' money are being
thrown in to complete a merger; and at the moment that an
executive, a party says, I'm looking at the MAC clause, I'm
looking at breaking up this because things have changed, or
things were not disclosed, or we have learned something,
wouldn't that, in your opinion, be an absolute mandate for the
Securities and Exchange Commission to be in the room from that
time forward?
Mr. Khuzami. Congressman, I think if it was a matter that
impacted on the SEC's jurisdiction or responsibilities with
respect to shareholder disclosure, regulation of the securities
markets, the answer would be ``yes.''
Mr. Issa. Now I'm going to ask you a hypothetical, but it
is not much of a hypothetical. If you'd been in the room on
September 17th, 18th, 19th, if you'd been in the room when they
said, this is not going to go forward because there have been
material adverse effects, and on top of that, you were aware of
misstatements in the proxy, would you have interjected at least
your oversight, your opinion, and your demand that compliance
to law be adhered to, which it wasn't?
Mr. Khuzami. Well, I'm not sure that I would have commented
on whether or not a MAC clause was properly invoked or not.
Mr. Issa. But we have already had testimony that if they
invoked the MAC, they have to go back to the stockholders.
Mr. Khuzami. Correct.
Mr. Issa. The Federal Government came in with $20 billion--
and there's some debate about whether it was forced on B of A
or B of A demanded it. Regardless of which one that is, at that
point when there's new money, a MAC clause, or money in lieu of
you, and on top of that, material misinformation in the proxy,
shouldn't you be in the room; and more importantly, if you are
in the room, wouldn't you have acted to at least advise--and
let's assume you're willing to take on the Fed chairman and the
Secretary of the Treasury--that, in fact, they're crossing
lines at that point that should not be crossed, they are
failing to disclose to the very stockholders, the public that
you protect?
Mr. Khuzami. If those events triggered disclosure
obligations, we would certainly communicate that.
Mr. Issa. For Christ's sake, we have had five, six
hearings. Mr. Kucinich has dedicated probably a whole wall of
his library to this very question. And you're saying ``if.''
Let's go back again. They failed to disclose these bonuses.
The Fed and the Treasury became aware of that. They also became
aware that these losses were mounting, and through a
negotiation behind closed doors in which you were locked out,
they negotiated additional money, now repaid, but additional
money to make BofA go through with this deal or to encourage
or, in fact on their demand, to have them go through.
So all of that occurred with your agency locked out of the
room. Are you going to tell me today--if there was something to
be reported, are you going to say, like Sheila Bair that was
here earlier, Yes, I would like to have been in the room, and
if I had been in the room, or when I was in the room, I wish I
had said or done more.
Which is it? Are you going to say the SEC should darn well
be in the room and be protecting stockholders, or are you going
to say ``if,'' ``if,'' ``if'' today? Which one is it?
Mr. Khuzami. Perhaps I didn't make myself clear.
Mr. Issa. I think I did.
Mr. Khuzami. Yes, you did. Very clear.
My only point was that we would certainly like to be in the
room any time there are discussions that go on that affect
shareholders and the entities and individuals that we regulate
and protect. My only point was a more modest one--whether or
not discussions about invoking a MAC clause necessarily
triggered disclosure obligations under the Federal securities
laws.
Mr. Issa. Thank you.
Thank you, Mr. Chairman, for your indulgence. I think we
made the point that Mr. Kucinich and I have both been wanting
to make, and I look forward to continuing to followup on it.
I yield back.
Chairman Towns. Right. At this time I would yield to the
Chair of the Domestic Policy Subcommittee, the gentleman from
Ohio, Mr. Kucinich.
Mr. Kucinich. Mr. Chairman, I just want to say at the
outset to my friend from California that there's a distinction
between what you're discussing and what our subcommittee has
been doing; and that is that you're talking about disclosure
events that occurred after the shareholder vote. Our focus in
this subcommittee has been about disclosure events before the
shareholder vote.
Now, Mr. Khuzami, my subcommittee investigation has found
that Bank of America relied on the November 12th forecast for
fourth quarter 2008, created by Merrill Lynch, that omitted any
forecast of how collateralized debt obligations, subprime
mortgage-backed securities, credit default swaps, would perform
in the quarter.
The former Merrill CFO admitted to staff that the November
12th forecast was not in fact a valid forecast. Bank of America
knew at the time that the November 12th forecast was of
questionable validity; it's in quotes. However, Bank of America
did not do any actual financial analysis to make up for the
Merrill omissions. Instead, Bank of America merely pulled out
of thin air a number on November 13th, which was recorded on
the forecast document as the ``gut'' feeling of Neil Cotty,
Bank of America's chief accounting officer.
The attorneys at Bank of America and at Wachtell Lipton did
not question; in spite of the omission and the explicit
reference to a ``gut'' feeling, they advised Bank of America
not to make further disclosures to its shareholders in advance
of the merger vote based on the information in the deficient
forecast and a ``gut'' feeling.
The November 12th forecast omission of any projection for
losses and the CDOs and other liquid investments and the
implication that Merrill Lynch would break even in those
investments for the remainder of the quarter was material to
the advice attorneys gave Bank of America.
Now when I asked Ken Lewis about this at our first hearing,
he told us he relied on advice of counsel. Protecting
shareholders is often, in the final instance, the
responsibility of corporate general counsels and/or outside
counsel. This subcommittee's investigative findings demand the
question: Where were the lawyers, the glaring omissions,
inaccurate financial data, and the critical November 12th
forecast so obvious that they should have alerted the attorneys
to a necessity of a reasonable investigation before making a
decision on Bank of America's legal duties to disclose. The
apparent fact they did not mount such an investigation makes
the decision not to disclose Merrill's loss to the shareholders
an egregious violation of security laws.
Mr. Khuzami, in March, GAO issued a scathing report on the
effect of Christopher Cox's leadership of the SEC in reducing
corporate penalties and formal investigations at exactly the
time that the CDOs and CDSs were proliferating. To Chairman
Shapiro's credit, she rescinded the Cox policy and appointed
you to reinvigorate the Enforcement Division.
Now I am concerned that one pernicious aspect of the Cox
legacy may have survived: the unwillingness to pursue, as GAO
wrote, ``more complicated cases, those with industrywide
implications, in favor of those seen as more routine.''
Mr. Khuzami, this is the test case. This is the case with
industrywide implications, where what is at issue is the
performance of the attorneys in interpreting the Nation's
security laws strictly or permissively. Here's the case where
the SEC's Shapiro breaks with the SEC's Christopher Cox.
Mr. Khuzami, is the SEC widening its investigation to
include the issue of Bank of America's failure to disclose to
its shareholders the mounting losses at Merrill Lynch, known or
knowable by mid-November 2008, weeks before--weeks before the
shareholder vote on the merger?
Mr. Khuzami. Congressman, we have been and are looking at
all aspects of the activity with respect to the proxy
statements, including the fourth quarter losses at Merrill
Lynch.
Mr. Kucinich. Is that a ``yes'' or a ``no?''
Mr. Khuzami. That's a yes.
Mr. Kucinich. If it's a ``yes,'' then the work of this
committee has been worthwhile, because you now have a chance to
do your job. Because we have done ours, and the information
that we have uncovered should facilitate your investigation.
I thank the gentleman.
I thank the Chair. I yield back.
Chairman Towns. Thank you very much.
I now yield to the gentleman from Missouri, Mr.
Luetkemeyer.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
Mr. Khuzami, Messrs. Bernanke and Paulson were negotiating
with Merrill Lynch and Bank of America and sort of came to an
agreement, yet they didn't disclose this. They didn't want to
put in writing the transaction that they were about to embark
on here and about to approve and had been working with. My
understanding is that once they did that, that would have been
a disclosable event that the SEC would have been able to come
into and be a part of and have some oversight over.
What is your opinion of this transaction and how it all
happened, and this unwillingness to put this in writing?
Mr. Khuzami. Congressman, what the securities laws require
is that if that understanding had solidified to a material
contract, then it would have been required to have been
disclosed under what is known as Form 8-K. So Bank of America
would have had to make a disclosure if it rose to the level of
an enforceable contract.
Mr. Luetkemeyer. But isn't this skirting the law by them
saying, We are going to have a little wink-and-nod agreement
here and let's just have a gentleman's handshake on it? I mean,
aren't they trying to subvert what really is a necessary part
of a transaction, the disclosure to all parties involved?
Mr. Khuzami. Congressman, it wouldn't be appropriate to
comment on my views of that in light of the ongoing nature of
the investigation, but certainly there can be circumstances
where there's an enforceable contract, even though it's not
formally written down, in which case it may trigger the
disclosure obligations.
Mr. Luetkemeyer. Following along that process, do you see
something that's happened here that you think needs to be
changed in existing law? Do we need to have something more
clarified by the way we have these transactions take place, so
that there's more disclosure?
Mr. Khuzami. Congressman, we sort of constantly review our
disclosure rules and regulations to determine whether or not
more disclosure or different disclosure is appropriate. That
process is ongoing now. The Sarbanes-Oxley Act required us to
consider more real-time or robust disclosure, and that is a
process that continues. We would certainly take the experience
here and determine whether or not we should change our rules
and regulations appropriately.
Mr. Luetkemeyer. You still haven't said, yes, there are
some things we need to do, and they are--can you fill in the
blank?
Mr. Khuzami. The question whether or not events such as
these should require more affirmative disclosure obligation is
something that we are considering. So, for example, contracts
or discussions short of a formal, legally enforceable
obligation, should that be disclosed even though all the terms
are unfinalized or interim results that may not rise to the
level of a material impairment of an asset, which is the
current standard, whether or not that should be disclosed.
Mr. Luetkemeyer. Are you currently looking at that with
your rules and regulations, or do we need to have some
congressional action? What do you think we need to do?
Mr. Khuzami. Congressman, that is something that we look at
on a regular basis and we are looking at now.
Mr. Luetkemeyer. As someone who has gone through this and
been in the middle of it--and we are in the process now
congressionally to try and do something with this too-big-to-
fail situation--what do you see that we are not doing with the
legislation that's proposed that you think would be
advantageous or a big aid to you, or would be something that we
could do in the future to mitigate or minimize some of the
things that have gone on?
Mr. Khuzami. Congressman, from an enforcement perspective,
which is my perspective, transparency and information are
critical. We cannot determine if misconduct is going on in
markets if we don't have complete and accurate and standardized
information about what is going on. So, for example,
registration of hedge funds, which would require better
reporting and stronger client and inspection authority, would
be highly beneficial.
Mr. Luetkemeyer. Transparency and registration is in the
bill right now. Does it go far enough? Does it go too far? What
is your opinion?
Mr. Khuzami. I'm not sure I understand the full and
complete details of what is in the current version of the bill,
so if I could have an opportunity to respond to you, I would
appreciate that.
But the same is true in the derivatives markets. We would
like that kind of information.
One case we brought, for example, recently, involved
insider trader, which typically takes place in the equity
world, in stocks, was actually going on in the credit default
swap market. Yet we don't have nearly the same kind of
information in that market as we do in the equities.
Mr. Luetkemeyer. Interesting. Thank you, Mr. Khuzami.
Thank you, Mr. Chairman.
Chairman Towns. The gentleman's time has expired.
I now call on the gentleman from Baltimore, Mr. Cummings,
who is a very active member of this committee.
Mr. Cummings. Thank you very much, Mr. Chairman.
Mr. Khuzami, I've got to tell you, as I listened to my good
friend and colleague, Congressman Kucinich, he said, ``Our work
is done.'' And I don't think our work is done. Let me tell you
why.
As you know, the SEC, in the case of the SEC v. Bank of
America, there was a settlement that was submitted to the
Federal court in New York on August 3, 2009. The settlement
agreement provided for the Bank of America to pay $33 million
in fines for making false and misleading statements in proxy
statements to shareholders. Bank of America, of course, told
shareholders that no year-end bonuses would be paid to Merrill
Lynch executives, when in fact it had been agreed that Bank of
America would pay up to $5.8 billion in bonuses to Merrill
executives.
Putting aside the fact that $5.8 billion was to be paid to
the executives of a company that was hemorrhaging money at the
time, the decision to settle the matter for $33 million struck
many of us as being a perverse outcome. Here was a company with
$45 billion in government assistance, $20 billion of which was
from this exact deal; and the Securities and Exchange
Commission let them pay a fine. And this is the piece that got
me: Pay a fine with our money, with taxpayers' dollars.
Does this strike you as fair to the taxpayer shareholders?
Does it fit your mission of protecting American investors?
To me, it's like you fine somebody and then take somebody
else's money to pay the fine. And I'm trying to figure out,
where is the punishment in that, where is the enforcement in
that? If I'm sitting back, I say, ``Oh, boy, a great day here;
got the public's money to pay the fine. Everything is fine. I
don't have to pay a dime.''
And then one of the things that I read about the
settlement--once I read about it, I fired off a letter to your
inspector general, David Coates, asking him to look into the
settlement. I just read in Mr. Coates' recent semiannual report
to Congress that he is in the midst of this investigation, and
I look forward to his conclusions.
One of the main reasons I requested the investigation was
because I would not be the least bit surprised that in the
aftermath of this crisis that further securities laws
violations are uncovered and the violations may have occurred
at a firm that has received government assistance.
In that case, what is the calculus that is used to
determine how to punish a company without penalizing the
involuntary investors in the firm, the taxpayers? I want you to
understand I'm concerned about, when we catch folks, what is
the thinking that goes into the process of how to punish them?
Because, to me, this was not punishment, and I'm glad the judge
did reject it.
I know you may not be able to talk about the case, but I
assume you can talk about what goes into your thinking as the
No. 1 guy who addresses these issues.
And the only person that you answer to is Ms. Shapiro, Mary
Shapiro; is that right? It's you and straight up to her; is
that right?
Mr. Khuzami. That's correct.
Mr. Cummings. So help me with this. As a lawyer, when I
read this, I got so upset because, I said, it makes absolutely
no sense. And I know you've got a great answer for me, and I'm
waiting to hear it.
Mr. Khuzami. Congressman, let me take each of those.
First, with respect to the amount of the fine. The
penalties that we assess have to be proportionate to the actual
wrongdoing that occurred. And here the wrongdoing was not the
payment of the bonuses. That may be excessive and wrong as a
policy matter, as a corporate governance matter, as a number of
other matters; but from a pure enforcement point of view, the
wrong was to fail to disclose to shareholders that they said
that they would not pay bonuses without Bank of America's
approval when they had already agreed to pay the money.
And so the wrong was the depravation of information to the
shareholders in deciding how to vote, not the fact that the
amount of money that was paid was illegal or improper in and of
itself. So we look at the wrongdoing.
Mr. Cummings. They had a duty to disclose; is that right?
Mr. Khuzami. Yes, they have a duty to make sure the
statements in the proxy are not misleading. So the number of
$5.8 billion, although it was $3.6 billion that was ultimately
paid, is not, I don't think, the measure of the wrong. The
wrong was that they did not tell shareholders who needed all
the information they could to decide whether or not to vote. So
that was the starting point.
Then we look at the amount. We looked at our precedent. In
the proxy violation area, the largest fine that we had imposed
was $38 million, give or take or so, in a case involving,
frankly, more egregious conduct than this because it involved
manipulation of their stock and obstruction and other things,
in addition to the proxy violation.
Next, we try and balance the benefit of the penalty versus
the burden on the shareholders. So we recognize the penalties
that we assess may come out of the pockets of shareholders who
may themselves have been wronged by the conduct. So we try and
balance. But we have to still impose the penalties because it
sends a strong deterrent message to other corporations and
other issuers that this kind of conduct will not be tolerated.
The deterrence message is critical. It tells others they
shouldn't do it. It says that if you do it, you're going to pay
a cost. It incentivizes them to fix their own problems before
we come knocking. It allows us to leverage our limited
resources so that companies voluntarily engage in corrective
measures rather than us having to go to each one of them. The
lawyers read these things, the corporate executives read these
decisions; they implement changes.
So there's many good reasons to have the penalty, but we
don't want to burden the shareholders more than necessary.
That's a balancing that we look at under our penalty
guidelines, and we come to the best determination that we can.
Mr. Cummings. I see my time is up. Thank you, Mr. Chairman.
Chairman Towns. The gentleman's time has expired. The
gentlewoman from California, Ms. Speier.
Ms. Speier. Thank you, Mr. Chairman.
Mr. Khuzami, I am deeply troubled by your description of
what took place. You said that the bank misled the
shareholders. The bank didn't mislead the shareholders. It lied
to the shareholders. It was a bald-faced lie.
Now, on a proxy statement, if you make a bald-faced lie, I
think that you should have a penalty that is so strong that you
won't ever do it again.
Now the courts seem to believe that $33 million was
insufficient. Who initiated the settlement?
Mr. Khuzami. Congresswoman, this was a settlement that
was----
Ms. Speier. Who initiated it? Did SEC go to the Bank of
America and say, let's settle this; or did the Bank of America
come to the SEC and say, let's settle this?
Mr. Khuzami. I don't know the answer to that,
Congresswoman. Typically, settlements result from both parties
coming together and discussing the possibility of settlement.
Ms. Speier. Someone initiates it. If you don't have the
answer today, I'd appreciate it if you would make that
available to the committee.
Mr. Khuzami. Certainly.
Ms. Speier. You based your decision on the fact that there
was a precedent where $38 million was fined in another setting.
Now, you know that the SEC, historically, when you were not
a member of the staff, was reducing its enforcement actions
dramatically. In fact, the recent GAO study indicated that the
enforcement actions had been reduced by some 80 percent and the
disgorgement actions I believe by some 60 percent. Presuming
those figures are indeed accurate--I may be off a little bit--
you're basing a decision on whether or not to impose a fine on
a very anemic SEC that was not doing a good job of enforcing
the law.
So I guess my real question to you is, if something is
substantive, if something is significant, if it is a lie,
shouldn't the penalty reflect that? I'm not accepting the fact
that somehow, because there was another fine issued before,
that somehow should be a measurement, when we know that the SEC
wasn't doing its job.
Finally, your argument that somehow you've got to balance
what happens to the shareholders, if that's the deliberative
process you're going to use, then the appropriate fine is never
going to be imposed on companies that do, in fact, lie.
Mr. Khuzami. As to your latter point, the harm to
shareholders who may have been victimized by the wrongful
conduct is only one factor amongst eight or nine that we take
into account, one of which is the importance of the deterrence
impact of the penalty. So I don't want to mislead you to
suggest that we only look at whether or not there's harm to
shareholders. We look at a variety of factors, including, most
importantly, the deterrent effect of the fine.
Ms. Speier. Let me ask you this. Based on what the judge
has said in this case, if you were to start over again, what
would be the fine that you believe would be appropriate for a
proxy statement that had a bald-faced lie in it, that
shareholders relied on--or prospective shareholders relied on
in terms of purchasing the stock?
Mr. Khuzami. Congressman, I think the judge's concern in
his opinion had to do more with whether or not the fine was too
high, because he felt that it was falling--the burden was
falling on shareholders who had been victimized by the wrongful
conduct, not that it was too low.
But reasonable minds can have different opinions on that
issue. My belief is the settlement that we struck was fair and
appropriate.
Ms. Speier. So in terms of further negotiations, will there
be another settlement offered up to the judge, or will this go
to trial?
Mr. Khuzami. The matter is scheduled for trial in early
March and the case is proceeding.
Ms. Speier. So there will not be any further settlement on
this case?
Mr. Khuzami. I couldn't predict the future as to whether or
not the case will settle or not. As of now, the case is
proceeding in the discovery phase and it's scheduled for a
March trial.
Ms. Speier. I just want to understand. Could you then go
back and negotiate a smaller--is what you're saying, that the
judge wants a smaller fine imposed? I find that absolutely
unbelievable.
Mr. Khuzami. No. My only point was that, in the judge's
opinion, he indicated that he was concerned about the penalty
because he thought that it was being imposed on shareholders
who were victimized by the wrongful conduct.
Ms. Speier. His opinion was not based on the fact that the
fine was too low?
Mr. Khuzami. I don't remember whether or not he used
exactly those terms, but his point was more that the fine was--
sorry to repeat myself--but the fine was falling on the
shareholders victimized by the wrongful conduct.
Ms. Speier. Or maybe his focus was that the fine should be
imposed on the executives who misled the shareholders and maybe
have it taken out of their salaries.
Mr. Khuzami. He did question why no individuals were
charged, you're absolutely right; but he didn't suggest that
the fine should be paid out of the pockets of individuals or
particular corporate executives.
Chairman Towns. The gentlewoman's time has expired.
I now yield 5 minutes to the gentleman from Ohio, the
ranking member on the subcommittee.
Mr. Jordan. Thank you.
Mr. Khuzami, were you here for Ms. Bair's testimony and
questioning earlier this morning?
Mr. Khuzami. Yes, I was.
Mr. Jordan. So you're aware of what she said in confirming
what Mr. Lewis had told this committee about the meeting that
took place in October, 10 days after TARP had passed, where the
nine biggest financial institutions were brought to this town,
including Bank of America, and told they were going to have
their bank partially nationalized, they were going to have to
accept TARP money, they had to sign a form. You heard all that
testimony that she gave?
Mr. Khuzami. Yes.
Mr. Jordan. I guess my point is or my question is--well,
let me go back to this.
Her testimony to this committee a few hours ago was that
action by the Fed, by Mr. Paulson--Treasury Secretary Paulson
and Federal Reserve Chairman Bernanke took her breath away when
she saw what took place at that meeting.
So now, as we move forward, it seems to me that--I guess
your testimony--and I apologize for not being here, I was at
another commitment. You talked about shareholders being misled.
But it seems to me that this unbelievable involvement by the
government, the e-mail we have that's been part of the record
in earlier hearings from Mr. Lacker, Federal Reserve Bank of
Richmond, where he talked about the fact they didn't want a
disclosable event so Mr. Paulson, Mr. Bernanke were not willing
to put anything in writing about the willingness to help Bank
of America with additional TARP dollars.
I mean, it seems to me that someone looking at this can
say, you know, Bank of America--what was the government's
culpability here in running the show and pushing for this deal,
particularly Mr. Paulson and Mr. Bernanke?
I assume you at the SEC are looking at--I mean, that has
to, in my mind, factor into this whole picture, this whole
scenario that we have been looking at now for several months.
Any response you would have to all that?
Mr. Khuzami. Congressman, as we look at these events, we
look at the roles of all the participants that are relevant and
all of the facts. I guess that would be my response.
Mr. Jordan. Yes or no, would potential arguments by Bank of
America that the bank and its management were not necessarily
completely liable because they were acting at the government's
directions?
Mr. Khuzami. Well, events that you're talking about I
believe occurred after the proxy, and so after the merger had
been approved. And so the question is whether or not--with
respect to the TARP money, whether or not that understanding
had become a material contract that had to be disclosed under
the 8-K rules and regulations. So that is certainly an issue.
Mr. Jordan. When did you guys first become aware of what
was taking place or the mounting losses at Merrill Lynch? When
did you first become aware of that?
Mr. Khuzami. Unfortunately, I wasn't there until March, so
I can't--I don't know the answer to that question.
Mr. Jordan. Why do you think--when we have the e-mail
saying we don't want disclosable, why do you think there was a
reluctance by the Federal Reserve not to have information be
made known to the SEC?
Mr. Khuzami. It probably wouldn't be appropriate for me to
speculate about that.
Mr. Jordan. Mr. Chairman, I yield back.
Chairman Towns. Thank you very much.
I now yield to the gentlewoman from California,
Congresswoman Watson.
Ms. Watson. Thank you, Mr. Chairman, and thank you for this
followup hearing. We have had several in the past, and after
listening to the testimony from the Bank of America CEO Kenneth
Lewis; the Federal Reserve chairman, Ben Bernanke; former
Treasury Secretary Hank Paulson; and officials at the Bank of
America, there's still strong questions. And I know the intent
of this committee, through its Chair, is to get some of these
questions answered so we will know really what took place.
We want to hear from you the role of the government and
what was played in the negotiations; the quality of the Bank of
America's due diligence process; and the motivation behind
BofA's attempt to claim a material adverse change [MAC], and
the adequacy of their disclosure to shareholders.
Can you package all that and clarify it for us? I think
this is what, the third or the fourth hearing, Mr. Chairman?
Chairman Towns. Fifth.
Ms. Watson. Fifth.
Let us hear how you would describe the roles that each one
of these sectors played.
Mr. Khuzami. Well, Congresswoman, involving some or all of
the matters that are currently under investigation, I have to
be careful about my comments.
With respect to the proxy that was sent out in connection
with the merger, as we have charged in our complaints, we
believe that the disclosure was misleading because Bank of
American did not disclose that they already had an agreement to
pay bonuses, when they told shareholders that Merrill Lynch
would not be paying such bonuses without their consent; but, in
fact, consent had already been given. That is the case we
charged and that is the case that is proceeding.
Ms. Watson. Let me stop you and I want to query these
bonuses.
Ethically, I don't see how the bonuses could even be in
contention when we are bailing out too-big-to-fail institutions
with taxpayers' moneys to try to capitalize these big
institutions so they can save people's homes, etc.
Is a bonus appropriate under the crisis conditions that
exist? I just want you to talk about bonuses, and then
continue.
Mr. Khuzami. Well, Congresswoman, again, from an
enforcement perspective, my focus is on what the law requires
and whether or not the law has been violated.
Ms. Watson. Do bonuses fall under that provision in the
law?
Mr. Khuzami. Generally not, except in this situation, where
they made a representation about what they were going to do
about bonuses, and that representation, in our view, was false.
Ms. Watson. But that was prior to the collapse, wasn't it?
When people signed their contracts, as I understand, they had
bonuses attached in there. But the whole condition has changed
now, where they have to comply with the provisions that were in
the original agreement.
Mr. Khuzami. Well, that is correct. The bonuses that were
paid in this case were paid, frankly, shortly after the merger
was approved. That's correct.
Ms. Watson. Would you continue on, please.
Mr. Khuzami. There's probably not much more. I don't mean
to disappoint you, but probably not much more I would say on
that topic. Whether or not bonuses are appropriate and the
appropriate level, and the balance between incentivizing talent
and retaining talent versus what is an appropriate compensation
is probably something that is above my pay grade.
Ms. Watson. I've heard that said, to retain talent. That
really goes beyond--I feel it's so absurd. I don't think at
this point that you couldn't find 1,000--or you could find
1,000 people out there with tremendous talent. If that talent
goes, there are people lined up.
I mean, we are really being hit hard, and I'm talking about
my district now, which is Los Angeles, Culver City, Hollywood.
And people have lost their jobs in droves, lost their
investments.
Talent is available, believe me. And so it's a phony, phony
excuse. But in putting this all together, I feel there were
tremendous failures on all sides. Would you agree to that?
Mr. Khuzami. I think there's a lot of blame to go around.
Ms. Watson. Yes.
My colleague, Ms. Speier, said it was just downright lies
that were given and possibly it was done so that government
could support BofA and give them more support in the merger. So
I'm just really thoroughly, thoroughly disappointed that the
people that were in place, particularly at the SEC, looked the
other way.
Thank you. I yield back.
Chairman Towns. The gentlewoman's time has expired.
I now yield 5 minutes to the gentleman from Missouri,
Congressman Clay.
Mr. Clay. Thank you very much, Mr. Chairman.
Thank you, Mr. Khuzami, for being here. Just a couple of
questions. At what point should action have been taken to curb
some of the activities of the big banks' involvement in the
security market? There had to be some indication to the SEC
that some investment houses were stretched too thin without the
proper reserves to cover their risk in this market.
Did red flags or alarms ever go off? What did you know and
when did you know it?
Mr. Khuzami. Congressman, I didn't arrive at the SEC until
March of this year, so I'm probably not the right person to ask
that question of.
Mr. Clay. How about the people that you work with now that
have been there for years? Did red flags go off for them?
Mr. Khuzami. Well, there were certainly systemic risks and
a bubble that had occurred in the housing market and elsewhere
that resulted in the collapse and the excessive leverage and
risk-taking that we saw.
What the Commission saw at various points along the way,
it's difficult for me to answer that question. We didn't have
regulatory authority over certain areas. It might be better if
I have an opportunity to respond to you after today's hearing,
so I can give you a more fulsome answer.
Mr. Clay. I'd love to hear from your colleagues in writing
just what alarms went off or whether the relationship was too
cozy with the big banks, that they never wanted to cite them
for risky practices.
Let me ask you in particular, why did Bank of America get
only a slap on the hand when it was cited in 2006 for
improperly marketing auction rate securities? Why were they
allowed to continue these practices of using false and
misleading information in selling these instruments, in
hindsight? Do you think the BofA was given too much leeway?
Mr. Khuzami. Congressman, I would have to familiarize
myself with that case. I'm aware generally of the auction rate
securities matter, but as I sit here, not with the particulars
of whatever action may have been brought in 2006.
I'd be happy to respond.
Mr. Clay. Would you respond to us and to the committee in
writing on that issue also?
Mr. Khuzami. Certainly.
Mr. Clay. Mr. Chairman, I have no further questions. I
yield back.
Chairman Towns. Thank you very much.
Before we close out, let me just say, Mr. Khuzami, I'm
troubled by the question the gentleman from Maryland raised,
Mr. Cummings. It seems to me that individual executives, the
ones who sign off on the proxy filings, should be the ones that
are responsible. So, therefore, why wouldn't they be the ones
that you go after, you know, fine them from the personal
standpoint? Like he said, taking our money and then paying the
fine. I'm not sure we get to where we need to go with that.
The other thing, the general feeling, in terms of the
community at large, they feel that the reason the judge sent it
back to you is that you were not aggressive enough, that you
did not pursue it in the fashion that he felt it should have
been. And, of course, that's the general feeling among people,
as they say, ``in the street,'' as to what's going on.
I don't know whether that's the case or not, but I do
believe that you really need to look at that because when I
listen to the fact that they are paying with our money, that
doesn't encourage people to do what's right.
Mr. Khuzami. A couple of responses: First, with respect to
the payment of the fine, obviously, any entity that receives
TARP funding or other money still has to pay that full amount
back, with interest. So whether or not a fine was paid with
government money, which can tend to be fungible in an
institution, but ultimately they had pay back all the money
they got from the government with interest. I would just make
that point.
Second of all, you're right, the judge expressed concern
about not charging individuals. We have shown a very aggressive
posture of charging individuals. If you look historically at
our cases, the overwhelming number of cases result in charges
against individuals and not corporations alone. I just
mentioned some earlier today.
But the particular issue in the proxy area is that the
proxy laws impose the obligation on the entity whose proxy is
being solicited or on whose behalf it's being solicited, and
those are the corporations.
To charge individuals, you need a higher level of proof.
You need to show what is called scienter, or either knowledge
or reckless conduct, meaning a significant and substantial
deviation from normal standards of care. It is that difference
in the legal standard that makes a difference in how we can
proceed. There's a higher burden of proof with respect to the
individuals; and our determination, based on the record we had,
is that we did not have the basis to charge them as
individuals.
Now as we get into the discovery process, we may get
additional information, and we will take that into account. But
I don't want to leave the impression that we do not
aggressively pursue individuals. We recognize the deterrent
impacts of charging individuals as much as corporate penalties
deter people. Nothing substitutes for charging individuals. And
we do that across the board in many, many, many of our cases.
Chairman Towns. Because the shareholders are really the
ones who suffer in a case like this.
Let me thank you very, very much for your testimony. Of
course, we really appreciate the fact that you're here and that
you shared with us.
This is the end of many, many hearings that we have had on
this. And of course we hope that we will now be able to move
and to give the kind of confidence that people really need in
order to turn the situation we now find ourselves in around. So
I want to thank you again.
This hearing is now adjourned.
[The information referred to follows:]
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[Whereupon, at 12:37 p.m., the committee and subcommittee
were adjourned.]
[The prepared statement of Hon. Gerald E. Connolly
follows:]
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