[Senate Hearing 111-613]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-613

     MORTGAGE FRAUD, SECURITIES FRAUD, AND THE FINANCIAL MELTDOWN: 
                     PROSECUTING THOSE RESPONSIBLE

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

                                HEARING

                               before the

                       COMMITTEE ON THE JUDICIARY
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

                            DECEMBER 9, 2009

                               __________

                          Serial No. J-111-66

                               __________

         Printed for the use of the Committee on the Judiciary


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                       COMMITTEE ON THE JUDICIARY

                  PATRICK J. LEAHY, Vermont, Chairman
HERB KOHL, Wisconsin                 JEFF SESSIONS, Alabama
DIANNE FEINSTEIN, California         ORRIN G. HATCH, Utah
RUSSELL D. FEINGOLD, Wisconsin       CHARLES E. GRASSLEY, Iowa
CHARLES E. SCHUMER, New York         JON KYL, Arizona
RICHARD J. DURBIN, Illinois          LINDSEY GRAHAM, South Carolina
BENJAMIN L. CARDIN, Maryland         JOHN CORNYN, Texas
SHELDON WHITEHOUSE, Rhode Island     TOM COBURN, Oklahoma
AMY KLOBUCHAR, Minnesota
EDWARD E. KAUFMAN, Delaware
ARLEN SPECTER, Pennsylvania
AL FRANKEN, Minnesota
            Bruce A. Cohen, Chief Counsel and Staff Director
                  Matt Miner, Republican Chief Counsel











                            C O N T E N T S

                              ----------                              

                    STATEMENTS OF COMMITTEE MEMBERS

                                                                   Page

Kaufman, Hon. Edward, a U.S. Senator from the State of Delaware..     1
    prepared statement...........................................    82
Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont, 
  prepared statement.............................................   111

                               WITNESSES

Breuer, Lanny, Assistant Attorney General, Department of Justice, 
  Washington, DC.................................................     3
Khuzami, Robert S., Director, Division of Enforcement, Securities 
  and Exchange Commission, Washington, DC........................     5
Perkins, Kevin L., Assistant Director, Federal Bureau of 
  Investigation, Washington, DC..................................     6

                         QUESTIONS AND ANSWERS

Responses of Lanny Breuer to questions submitted by Senators 
  Specter and Schumer............................................    37
Responses of Robert Khuzami to questions submitted by Senators 
  Specter and Schumer, letter to Senator Hatch...................    61
Responses of Kevin L. Perkins to questions submitted by Senator 
  Schumer........................................................    63

                       SUBMISSIONS FOR THE RECORD

Breuer, Lanny, Assistant Attorney General, Department of Justice, 
  Washington, DC, statement......................................    66
Khuzami, Robert S., Director, Division of Enforcement, Securities 
  and Exchange Commission, Washington, DC, statement.............    85
Perkins, Kevin L., Assistant Director, Federal Bureau of 
  Investigation, Washington, DC, statement.......................   113

 
     MORTGAGE FRAUD, SECURITIES FRAUD, AND THE FINANCIAL MELTDOWN: 
                     PROSECUTING THOSE RESPONSIBLE

                              ----------                              


                      WEDNESDAY, DECEMBER 9, 2009

                                       U.S. Senate,
                                Committee on the Judiciary,
                                                     Washington, DC
    The Committee met, pursuant to notice, at 1:58 p.m., Room 
SD-226, Dirksen Senate Office Building, Hon. Edward E. Kaufman 
presiding.
    Present: Senators Whitehouse, Klobuchar, Franken, and 
Hatch.

  OPENING STATEMENT OF HON. EDWARD E. KAUFMAN, A U.S. SENATOR 
                   FROM THE STATE OF DELAWARE

    Senator Kaufman. I call the Committee to order.
    Good afternoon, everyone. I'm honored to call this hearing 
of the Senate Committee on the Judiciary, and I thank Chairman 
Leahy for permitting me to chair this hearing.
    Today we're going to examine the contributions of financial 
fraud to our current economic crisis and to explore the efforts 
of law enforcement to bring out what happened, and bring the 
perpetrators to justice.
    I really mean this when I say three distinguished witnesses 
join us today to discuss these issues: Assistant Attorney 
General Lanny Breuer, SEC Director, Enforcement, Robert 
Khuzami, and Assistant Director Kevin Perkins of the FBI.
    Between the spring of 2007 and this past summer, the net 
worth of the United States' households dropped $14 trillion--
that's ``t'', $14 trillion, with a ``t''. Of course, an 
economic collapse of that magnitude was spurred by a wide 
spectrum of activity. Much of that behavior, though terribly 
misguided and indeed inexcusable, was not criminal.
    The honest homebuyer, enticed by the promise of perpetually 
rising home prices, took out a mortgage that he could not 
really afford, may have shown bad judgment, but did not break 
the law. In all likelihood, neither did the investment manager 
who lost a great deal of her clients' money because she failed 
to appreciate the full extent of the risk caused by mortgage-
backed securities.
    On the other end of the spectrum, however, was conduct that 
has all the earmarks of financial crime. I'm talking about loan 
originators who encouraged borrowers to lie on loan 
applications, or middlemen and banks who knew the loans were 
bad but accepted them anyway for bundling and reselling of 
securities, or investment banks that stuck with toxic assets as 
housing prices began to plummet, that consciously failed to 
disclose their true value or their risks to shareholders. These 
people should be the target of the FBI, SEC, and DOJ 
investigations, and if convicted, they should go to jail.
    If we want to restore the public's faith in our financial 
markets and the rule of law, we must identify, prosecute, and 
send to prison the participants in those markets who broke the 
law. Their fraudulent conduct has severely damaged our economy 
and harmed countless hardworking Americans.
    That is why, last May, I joined with Chairman Leahy, 
Senator Grassley, and others to help pass the Fraud Enforcement 
and Recovery Act. FERA was instrumental in ensuring that 
additional tools and resources were provided to those charged 
with enforcement of our Nation's laws against financial fraud.
    Since the passage of FERA, some real progress has been 
made, thanks to the men in this room. The FBI, Department of 
Justice, and SEC have all redoubled their efforts and 
redeployed their resources. Just last month, President Obama 
created an interagency Financial Fraud Enforcement Task Force. 
His decision to do so reflects the fact that mortgage 
securities and corporate fraud schemes not only devastated our 
economy, but also led to the widespread view that Wall Street 
does not play by the same rules as Main Street.
    I'm pleased to see the task force mission is not just to 
hold accountable those who helped bring the last financial 
crisis, but also help to prevent another crisis from happening. 
We must deter those in the mortgage industry, on the trading 
desks, and the boardrooms who, in the future, might be tempted 
to put greed ahead of the law, thus setting the stage for 
another meltdown.
    Of course, deterrence comes with successful investigation, 
prosecution, and then meaningful punishment. Successful 
investigation of these complex cases means, among other things, 
being smart about where to look and what to look for.
    At lower levels, we're starting to see the results. The FBI 
reports that mortgage fraud investigations nationwide now total 
more than 2,800. To give just one example, in northern 
California, the U.S. Attorney's Office recently secured a 53-
count indictment against seven individuals who ran a scheme 
using straw buyers, appraisers, escrow agents and notaries to 
obtain millions in fraudulent mortgages from victim banks. In 
addition, unwitting purchasers were laden with mortgages they 
had no prospect of paying in amounts that vastly exceeded the 
values of their underlying homes.
    I also read with interest, on Monday, that the SEC filed 
charges against three former top officers of New Century 
Financial Corporation for misleading investors, as New 
Century's prime sub-mortgage business was collapsing in 2006. 
According to press accounts, a parallel criminal investigation 
is ongoing.
    The messages are being sent that this sort of crime just 
does not pay, but I, like many Americans, remain frustrated 
that the responsible agencies have not yet been able to bring 
more high-level crooks to account. I understand, and I've 
talked to the three of you, unraveling sophisticated financial 
fraud is an enormously complex undertaking and these cases can 
be difficult to make, particularly when trying to prove 
criminal intent beyond a reasonable doubt from the historical 
record alone.
    But I've called this hearing because enough time has passed 
that America deserves a full accounting, though necessarily an 
interim one, from those who are tasked with enforcing our 
criminal laws. In the midst of the housing boom and bust cycle, 
did Wall Street executives and hedge fund managers commit 
financial fraud? If so, why haven't we seen any convictions 
yet? Are the agencies being smart and effective in deploying 
their resources? Do they have the absolute sense of urgency?
    Is there enough transparency in the markets for law 
enforcement even to know whether the laws are being followed? 
Many of Wall Street have argued there was no criminality, 
merely a collective delirium brought by soaring profits and 
faulty assumptions regarding risks.
    I have this recurring nightmare in which I see some people 
in Wall Street inside a burning house. They see smoke, maybe 
even a flame or two, but instead of sounding an alarm they keep 
grabbing the money, convinced they still have time to get out 
before the house burns down. Even if they make it, where does 
that leave the rest of us? I hope this hearing will provide 
answers to those questions, and more.
    What I would like to do is have testimony. Testifying 
before us today are three--and I really mean this--top Federal 
law enforcement officials. All three have highly distinguished 
backgrounds and are extremely well-qualified to lead their 
respective agencies. We're grateful for their efforts.
    Let's start with Lanny Breuer, who is the Assistant 
Attorney General for the Criminal Division at the Department of 
Justice.
    Mr. Breuer, please proceed with your testimony.
    [All witnesses were sworn prior to going on the record.]

  STATEMENT OF HON. LANNY BREUER, ASSISTANT ATTORNEY GENERAL, 
             DEPARTMENT OF JUSTICE, WASHINGTON, DC

    Mr. Breuer. Thank you. Good afternoon, Senator Kaufman. 
Thank you for your invitation to address the Committee, and for 
giving me the opportunity to discuss the Department of 
Justice's efforts to prosecute mortgage, securities, and other 
types of financial fraud related to the financial crisis.
    As the Attorney General has made clear, we are committed to 
reinvigorating the traditional crime-fighting mission of the 
Department, including redoubling our efforts to fight financial 
fraud. We face unprecedented challenges in responding to the 
recent financial crisis. Mortgage, securities, and corporate 
fraud have eroded the public's confidence in our financial 
markets and have led to a growing sentiment that Wall Street 
does not play by the same rules as Main Street.
    In the wake of the financial crisis, we must be, as you 
have said, relentless in our investigation of potential 
criminality. We must vigorously prosecute mortgage fraud, which 
appears to have been one of the catalysts of the crisis, and to 
continue to scrutinize other questionable conduct and practices 
to ferret out any crimes that may have occurred. We also must 
continue to protect investors in our capital markets by 
aggressively prosecuting securities and commodities fraud.
    We have been working very hard to carry out this mission. 
We've had numerous successes in prosecuting mortgage, 
securities, commodities, and other forms of financial fraud. We 
recognize, however, that there is much more to be done.
    Just a few weeks ago, as you said, Senator, the President 
signed the Executive Order establishing a new interagency 
Financial Fraud Enforcement Task Force, led by the Attorney 
General, to combat financial crime. The Task Force will 
strengthen our collective efforts in conjunction with our 
Federal, State, and local partners to investigate and prosecute 
significant financial crimes relating to the financial crisis.
    The Task Force will lead an aggressive, coordinated, and 
proactive effort to investigate and prosecute these crimes. We 
will marshal both criminal and civil enforcement resources to 
investigate and prosecute financial fraud cases, recover stolen 
funds for victims, address discrimination in lending and 
financial markets, and enhance coordination, cooperation, and 
information sharing among authorities responsible for 
investigating and prosecuting significant financial crimes and 
violations.
    The Task Force is, thus, an important and significant step 
forward in our fight against financial fraud. Let me assure 
you, it is a fight that we have been waging each and every day. 
To take one example, the Department has redoubled its efforts 
to uncover abuses involving mortgage fraud. At present, Federal 
mortgage fraud-related charges are pending against 
approximately 500 defendants around the Nation, and the FBI is 
working on more than 2,700 additional mortgage fraud 
investigations. As described in my written testimony, many of 
our investigations have ended with successful prosecutions.
    In addition, in recent months the Department has 
successfully prosecuted many high-profile securities fraud 
cases: the Madoff case brought by the U.S. Attorney's Office 
for the Southern District of New York the FBI and the SEC and 
the Stanford case brought by the Criminal Division's Fraud 
Section and the U.S. Attorney's Office for the Southern 
District of Texas, the FBI, and the SEC are just two prominent 
examples. The Galleon insider trading cases brought by the U.S. 
Attorney's Office for the Southern District of New York, the 
FBI, and the SEC have used court-authorized wire taps and 
demonstrate that we will be aggressive in investigating and 
prosecuting white collar crimes.
    We have numerous tools at our disposal to help us 
accomplish our mission and we will continue to use them. 
Senator, we will work as hard as we can. We will work with the 
SEC, the FBI, and with all our State, local, and Federal 
partners.
    Thank you. I look forward to answering your questions.
    Senator Kaufman. Thank you.
    [The prepared statement of Mr. Breuer appears as a 
submission for the record.]
    Senator Kaufman. The second witness is Robert Khuzami, the 
Director of Division of Enforcement at the SEC.
    Mr. Khuzami.

     STATEMENT OF ROBERT S. KHUZAMI, DIRECTOR, DIVISION OF 
ENFORCEMENT, SECURITIES AND EXCHANGE COMMISSION, WASHINGTON, DC

    Mr. Khuzami. Thank you, Senator, members of the Committee. 
Thank you for the opportunity to testify here today. Oh, sorry. 
It's on, just not close enough. Sorry.
    Senator Kaufman, members of the Committee, thank you for 
the opportunity to testify here today before the Committee.
    My name is Robert Khuzami. I'm Director of the Division of 
Enforcement of the Securities and Exchange Commission. I'm 
honored to be here today and to testify alongside my colleagues 
from the Department of Justice and the FBI regarding 
enforcement efforts against those involved in the financial 
crisis.
    As the only agency in the Federal Government focused 
exclusively on investor protection, the SEC has, and accepts, a 
special obligation to investors. Essential to that obligation 
is the aggressive and even-handed enforcement of our Federal 
securities laws. Enforcement actions address the public's fair 
expectation that those who have violated the securities laws 
and caused financial loss and hardship will be held accountable 
for their actions.
    Vigorous law enforcement efforts serve to vindicate the 
principles fundamental to the fair and proper functioning of 
our markets, including: first, that no one should have an 
unfair advantage in our financial markets; second, that 
investors have a right to truthful and accurate disclosure in 
accordance with the requirements of the securities laws; and 
third, that there is a level playing field for all investors.
    The SEC and the Division of Enforcement are moving on five 
primary fronts in response to the financial crisis and to 
further our overall mission of investor protection. First, we 
are bringing significant cases based on unlawful conduct 
related to the financial crisis.
    For example, just to take this week alone, we filed two 
such actions. On Monday, we filed fraud charges against three 
former senior officers of New Century Financial Corporation, 
once one of the largest sub-prime lenders in the United States. 
We charged them with manipulating the company's financial 
results and concealing the company's deteriorating financial 
performance.
    Among other things, the defendants allegedly failed to 
disclose to investors important negative financial information, 
including dramatic increases in early loan defaults, loan 
repurchases, and pending loan repurchase requests, all of which 
caused substantial investor losses. In fact, the company's 
stock price dropped to less than $1 when it filed for 
bankruptcy in April of 2007, down from its previous high of $50 
per share in 2006.
    The second case, brought yesterday, is against Brookstreet 
Securities Corporation, a registered but now defunct broker-
dealer in connection with the sale of unsuitable collateralized 
mortgage obligations, or CMOs, to retail customers. In this 
action, the SEC sued Brookstreet and its former president and 
CEO, alleging that he helped to create, promote, and facilitate 
an investment program through which Brookstreet improperly sold 
risky, illiquid CMOs, including interest-only and inverse 
floating rate securities to retirees and other retail investors 
with conservative investment goals. More than 1,000 Brookstreet 
customers invested approximately $300 million in this program.
    Beyond this week's actions, we have previously filed 
mortgage-related actions against Countrywide Financial and its 
CEO, Angelo Mozilo, as well as against three former senior 
officers of American Home Mortgage Investment Corporation.
    Our second initiative is to enhance our traditionally close 
working relationship with other law enforcement authorities, 
including the Department of Justice, in order to maximize the 
efficient use of government resources, as well as deliver a 
united and forceful response to those who would violate the 
Federal securities laws.
    Third, we are undergoing, in the Division of Enforcement, a 
top-to-bottom self-assessment and restructuring. We are 
establishing national specialized units that will focus 
resources and expertise to improve the Division of 
Enforcement's abilities to attack the causes of the recent 
financial crisis, as well as to address current and future 
troubling trends that may be next year's problems. We are also 
flattening our organizational structure to reduce a layer of 
management and reassigning many of these personnel back to the 
core mission of conducting front-line investigations.
    Fourth, the SEC is conducting an aggressive rule-making 
agenda to correct gaps and deficiencies exposed by the 
financial crisis, and proposing various legislative reforms to 
provide the Enforcement Division with improved tools to address 
securities fraud and related misconduct.
    Finally, in light of the magnitude and importance of the 
task of regulating and policing our capital markets and 
financial system, as well as the growing size, complexity, and 
number of market participants, the SEC is seeking to address 
the compelling need for additional resources within the 
Division of Enforcement, and throughout the SEC.
    Our mission is to vigorously enforce the Federal securities 
laws. The staff of the Division, and all of us at the SEC, are 
committed to that end, and to enhancing investor confidence in 
the Division, our agency, and the financial markets.
    I thank you for the opportunity to appear here today and 
would be pleased to answer your questions.
    Senator Kaufman. Thank you.
    [The prepared statement of Mr. Khuzami appears as a 
submission for the record.]
    Senator Kaufman. Our third witness is Kevin Perkins, who is 
the Assistant Director of the Criminal Investigative Division 
of the FBI.
    Mr. Perkins.

  STATEMENT OF KEVIN L. PERKINS, ASSISTANT DIRECTOR, FEDERAL 
            BUREAU OF INVESTIGATION, WASHINGTON, DC

    Mr. Perkins. Good afternoon, Mr. Chairman and distinguished 
members of the Committee. I want to thank you for the 
opportunity to testify before you today about the FBI's ongoing 
efforts to combat significant financial crimes.
    Mortgage fraud continues to pose a significant threat to 
lenders, investors, residential real estate values, and the 
U.S. economy. Mortgage fraud, however, is just one component of 
the recent financial crisis which has left trillions of dollars 
of losses in its wake.
    Since the financial meltdown in the fall of 2007, the FBI 
has investigated significant financial frauds on various 
fronts. For example, we have more than 2,100 pending corporate 
and securities fraud investigations across the country, many 
with losses exceeding $100 million, and several with losses of 
over $1 billion. The FBI has also prioritized its efforts to 
combat the most egregious corporate and security fraud 
offenders, which resulted in 460 convictions in fiscal year 
2009.
    The current financial crisis has not only revealed new 
fraud schemes, but has also exposed established schemes which 
have been thriving in the global financial system. These 
schemes, both old and new, highlight the need for law 
enforcement and regulatory agencies to be ever-vigilant, to 
increase the collaboration, and continue working as close 
partners.
    The FBI investigates insider trading schemes alongside the 
U.S. Securities and Exchange Commission. The recent highlighted 
success came with the indictments, and subsequent arrests, 
related to allegations of insider trading within Galleon Group. 
To date, 14 individuals have been arrested and the 
investigation is ongoing.
    The FBI has observed a rise in corporate fraud schemes, and 
trends such as failures of prominent financial institutions, 
the falsification of accounting records, and misrepresentation 
regarding the risk and valuation of complex financial 
instruments. Over the last 5 years, corporate fraud 
investigations have increased by 78 percent, to more than 590 
open investigations.
    Numerous corrupt executives and accounting fraud schemes 
have also been exposed in more companies experiencing liquidity 
and cash-flow problems. This is evidenced in recent 
investigations, including the deferred prosecution agreement 
obtained against Beazer Homes, an Atlanta-based national home 
builder.
    Market manipulation, or pump-and-dump schemes, are based 
upon the manipulation of lower volume stocks purchased on 
small, over-the-counter markets. These schemes generate an 
estimated $6 billion in losses each year and have the ability 
to significantly impact investor confidence. The FBI currently 
has 109 related cases. In fiscal year 2009 alone, 62 
individuals were charged in market manipulation schemes 
following FBI investigations.
    Foreclosure rescue scams are particularly egregious because 
fraudsters take advantage, and illegally profit, from the 
misfortune of others. As foreclosures continue to rise across 
the country, so have the number of foreclosure rescue scams 
targeting unsuspecting victims.
    High-yield investment fraud schemes have many variations, 
all of which are characterized by offers of low-risk 
investments guaranteeing an unusually high rate of return. The 
most common form of these frauds is the Ponzi scheme, which 
uses money collected from new victims rather than profits from 
underlying business ventures to pay the high rates of returns 
promised to earlier investors.
    In fiscal year 2009, the FBI realized a 105 percent 
increase in the number of high-yield investment fraud cases 
over fiscal year 2008, to a total of 314 pending 
investigations, many of those with losses exceeding $100 
million. The most significant of these is the $64 billion Ponzi 
scheme perpetrated by Bernard Madoff, which resulted in the 
longest prison sentence in the history of financial crime, 150 
years. Similarly, Robert Allen Stanford of Houston stands 
charged in an alleged billion-dollar Ponzi scheme, while just 
recently Thomas Petters of Minneapolis was convicted of 
defrauding investors of $3.5 billion.
    In addition to nearly tripling the number of FBI special 
agents who investigate mortgage fraud cases in the field, the 
FBI has invented and implemented a number of innovative and 
proactive methods to detect and combat mortgage fraud. Foremost 
is the FBI's development of the Financial Intelligence 
Component, established in September of 2009.
    For its part, the Department of Justice is initiating a 
mortgage fraud initiative that will utilize, among other tools, 
Financial Intelligence Component analysis in the prosecution of 
its cases. Another proactive approach was the development of an 
analytical computer application to identify property-flipping 
transactions. The original concept has since evolved into a 
national FBI initiative.
    Some of the best tools in the FBI's arsenal for combatting 
financial crimes are its longstanding partnerships with 
Federal, State, and local law enforcement and regulatory 
agencies. Currently, there are 16 mortgage fraud task forces 
and another 61 working groups nationwide. We are also a member 
of the newly formed Financial Fraud Enforcement Task Force, and 
we work closely with the Special Inspector General for the TARP 
to guard against fraud in the $700 billion program.
    Mr. Chairman, members of the Committee, I appreciate the 
opportunity to come before you today and share the work that 
the FBI is doing to combat significant financial crimes. I look 
forward to working with you and I'm happy to answer any 
questions you may have.
    Senator Kaufman. Thank you very much.
    [The prepared statement of Mr. Perkins appears as a 
submission for the record.]
    Senator Kaufman. Chairman Leahy cannot be here this 
afternoon, but he asked that I enter his statement in the 
record, which we'll do, without objection.
    [The prepared statement of Chairman Leahy appears as a 
submission for the record.]
    Senator Kaufman. Let's start with the questions.
    Mr. Breuer, what do you believe are the top four or five 
types of financial fraud that related to the meltdown?
    Mr. Breuer. Senator, I think, in looking at what has 
occurred, we really have to run the gamut of the conduct. So in 
the first instance, I think we have to look at those who 
defrauded the financial institutions, such as the banks. So 
mortgage fraud that was perpetrated by professionals, whether 
it was lawyers, appraisers, loan officers, those who, in the 
first instance, helped those get loans and mortgages that they 
should not, perhaps those who worked with straw buyers to buy 
mortgages.
    I think if you go from there, Senator, then we have to look 
at those who made misrepresentations in their underwriting 
standards, or those who claimed that, at banks or other 
institutions, mortgage originators, that they had certain 
standards, and that they relaxed those standards purposely and 
misrepresented what they were doing. I think we have to look at 
those as well, and those who created these mortgages and 
claimed that the people at the mortgages and the mortgages that 
they had represented something other than what they were.
    Then I think they, of course, sold their mortgages and 
misrepresented, in many instances, those who securitized the 
mortgages. I think we have to look at that part of the line-up. 
We have to see what the securitizers themselves did. What, in 
fact, did they represent to those who were purchasing these 
structured vehicles? What did they say about the underlying 
mortgages, and what did they say? We think that there, too, we 
have to look hard at the underlying process and determine what 
was represented.
    And then, last, those who bought those vehicles, those 
securitizations, those CDOs, the institutions; what did they 
say to their investors about the value of what they were 
purchasing? So, Senator, when we look at it, we see it as a 
continuum from the very beginning until the very end, and I 
think it's that gamut of activity that we're investigating and 
that we want to pursue, and where we find criminal wrongdoing, 
prosecute.
    Senator Kaufman. OK.
    Mr. Khuzami, following on that, in the securities fraud 
area, what do you think are the main potential sources of fraud 
in the securities area, in your area?
    Mr. Khuzami. Senator, I agree generally with Lanny. You 
know, the SEC is primarily focused on accurate disclosure.
    Senator Kaufman. Right.
    Mr. Khuzami. So when we look at the problem, we focus both 
from the shareholders' perspective, did they get proper 
disclosure with respect to the companies that they had invested 
in? So were companies, particularly as the mortgage business 
began to fail, properly disclosing business trends, prospects, 
liquidity, the reasons for poor results?
    Second, from the perspective of those who invested in the 
financial products, there's questions about whether or not the 
risks were suitably disclosed, the status of their investments, 
what kind of risks there were, what were the reasons for 
losses, for redemptions. The valuation of assets is a troubling 
area because of a fair degree of discretion in certain types of 
illiquid investments; accounting fraud, whether or not the 
accounting rules were followed with respect to the valuation of 
assets.
    A large number of offering frauds and Ponzi schemes, 
because in a booming market many investors were seduced into 
making investments that turned out to be improper, as well as 
hedge fund activity, which we are particularly focused on. So 
from our perspective, we look at all those kinds of practices 
in each of the product areas, whether or not they be companies 
involved in the mortgage business, those who securitize the 
mortgage, or those who created structured products.
    Senator Kaufman. Great.
    Mr. Perkins, do you have any thoughts about areas that you 
think are fertile to be looking for in terms of financial fraud 
beyond----
    Mr. Perkins. Yes, Senator. I, first, have to say that I 
concur wholeheartedly with my colleagues and the descriptions 
they've given. We're engaged in what I refer to as a multi-
front battle, multiple types of fraud schemes, as Mr. Breuer 
mentioned, starting with basic mortgage fraud cases and working 
our way right up the chain, from Main Street to Wall Street and 
beyond. We have resources deployed in each one of these areas 
and we prioritize cases in each of these areas depending upon 
dollar losses, their impact on the integrity of the market 
itself, the number of victims, and the like. But I concur with 
Mr. Breuer's statement.
    Senator Kaufman. You know, look. You're sitting there, 
you're trying to figure out the priorities on these different 
cases. Clearly, it's like a lot of other things you deal with, 
like the drug area. I mean, it's easy to pick up somebody 
that's got, you know, two ounces of marijuana or something like 
that, and it's very hard to get the people that actually 
engineered the whole thing, the drug kingpins.
    So in this case, how do you decide between picking the low-
hanging fruit and going after the cases which, we admit--I 
mean, the toughest--I mean, some of these cases, going after 
some of the people at the top, some of these things, if in fact 
there was fraud, are extremely well-financed. They have great 
representation and it's going to be a very complex case. It's 
going to be hard to do. I mean, how do you--can you just kind 
of go through the process--start with you, Lanny--on how you 
kind of measure, you know, I want to get the big guys, but it's 
a lot easier to get the little guys. How do you go through 
that?
    Mr. Breuer. Senator, it's a great question. It's a very 
tough issue. I'll tell you what we do, and there's no one right 
formula. Some of our prosecutors look at the beginning of the 
continuum, and so we have, for instance, right now, a mortgage 
fraud initiative where we're working with the U.S. Attorneys, 
and we're working to send prosecutors to various areas around 
the country where we think have particularly high rates of 
mortgage fraud. We try to bring cases in very real time, much 
in the way we have very successfully done in the health care 
fraud area, and so we put pressure on those.
    And then we have other prosecutors, candidly, who are 
working on higher parts of this continuum. In part, my goal is, 
if we put pressure on the lower folks and then they feel the 
pressure, they're going to talk about the people above them. So 
if we talk about the people who misrepresent to the banks, they 
may have information about the banks, or the mortgage 
originators. They, in turn, may have information about those 
who did the securitizations and what they said. And one of our 
goals, frankly, Senator, is that. We also look for tips. We 
look for whistle-blowers, we look for filings, we look at 
everything we can. But in doing that, we have different 
prosecutors sort of focusing on different aspects along this 
continuum.
    Senator Kaufman. OK. Let's just hold the thought, Mr. 
Khuzami, Mr. Perkins, and we'll come back to that when I get to 
my next round of questioning.
    Senator Hatch.
    Senator Hatch. Well, thank you, Mr. Chairman. I'm grateful 
that you'd take the time to do this hearing, and grateful for 
your leadership in this area.
    I just have a few questions for you that I hope will be 
helpful. I'd like to kind of limit my questions to deliberate 
abusive short selling. I'm a firm believer that short selling 
is a legitimate and worthwhile correction and approach toward 
the market, but deliberate abusive short selling is a real 
problem.
    Mr. Khuzami, in your testimony you stated that the SEC has 
brought enforcement actions in a wide variety of areas, 
including market manipulation. Of those cases involving or 
pertaining to market manipulations, how many of those cases 
target short selling activities of all kinds?
    Mr. Khuzami. Senator, I don't have the exact number at my 
fingertips.
    Senator Hatch. Approximately.
    Mr. Khuzami. We've brought cases with respect to those 
firms that have violated Regulation SHO and the rules regarding 
Locates and Fails to Deliver, who have concealed the failure to 
comply with those rules through various exceptions. We have 
also brought cases regarding those that short stocks in advance 
of public offerings and then use the stock that they obtain in 
those offers to cover the short positions, which are also a 
violation of the rules.
    We have a very active investigation arising out of the 
financial crisis, particularly focused on the financial 
institutions in 2008 who were the subject of a great deal of 
downward pressure on their stock prices, where we have some 
very extensive investigative efforts going on. So we look at 
short selling across the spectrum and have brought cases in all 
of those areas.
    Senator Hatch. You have? Regulation SHO allows short 
sellers to make a short sale if they've borrowed or located the 
shares to be sold short, as I understand it, or if they merely 
have a ``reasonable belief'' that they'll be able to locate the 
shares prior to the settlement date.
    Now, there have been, in my opinion, extremely few 
enforcement actions brought under Regulation SHO, even though 
the volume of Fails to Deliver reached levels as high as 2.35 
billion of shares on June 22, 2009, and 19.77 billion on 
September 23, 2009.
    Now, do you believe that one of the reasons for the lack of 
Regulation SHO enforcement is that the ``reasonable belief'' 
standard is vague and subjective so as to make successful 
enforcement actions all but impossible, and would the 
elimination of the reasonable belief standard make enforcement 
easier for the Commission than others?
    Mr. Khuzami. Well, Senator, I guess I would answer the 
question by saying, what's good for enforcement isn't 
necessarily the right thing from a market structure 
perspective. You are absolutely right that a different standard 
would be easier to prosecute from an enforcement point of view. 
If you required persons to actually have borrowed the stock 
before a short sale, then you wouldn't have to get into 
questions of someone's reasonable belief or what they intended 
to do. But ultimately that's a tradeoff with what----
    Senator Hatch. Do you have any suggestion as to how we 
might make that standard better than it is?
    Mr. Khuzami. Well, I think that ultimately it depends on 
your view of the value of short selling or not. If you think 
that----
    Senator Hatch. I want your view.
    Mr. Khuzami. I'm sorry?
    Senator Hatch. I want your view. I think short selling may 
be valuable. I don't think that negative short selling that's 
abusive is valuable. I think it's destructive. And I think we 
have too much of it, and I don't think that the regulatory 
bodies really do much to correct it.
    Mr. Khuzami. Well, the current rules require----
    Senator Hatch. Including the SEC.
    Mr. Khuzami. The current rules, Reg. SHO, which was passed 
earlier, and then revisions to Reg. SHO require that a party 
actually has to locate the stock and then close out the fail 
within, I think, trade date plus four. And as a result of those 
two rules, my understanding is that the level of fails have 
dropped very considerably, both in the area of equities, as 
well as ETFs.
    Senator Hatch. They're still way too high.
    Mr. Khuzami. I'm sorry?
    Senator Hatch. They're still way too high.
    Mr. Khuzami. Well, with respect to the fail rates?
    Senator Hatch. Uh-huh.
    Mr. Khuzami. My understanding is, they've come down quite 
considerably, Senator. I'm happy to re-check those statistics.
    Senator Hatch. I'd like to have those figures. Look, I 
don't think it's the right thing to allow people to negatively 
short sell, especially when they do it to a company and knock 
its stock way down deliberately, and that's part of the process 
and part of the problem. And although there are some people who 
may be a little more anxious about that than I am, it's still 
something that I think is a real problem. And Regulation SHO--
do you think Regulation SHO has really worked that well?
    Mr. Khuzami. Well, I think it's done a good job of bringing 
down----
    Senator Hatch. Better than nothing.
    Mr. Khuzami. Bringing down the rate of fails. I think it's 
done a very good job at that. Now, just because there are fewer 
fails doesn't mean you still don't have people falsely 
representing whether or not they have the locate necessary for 
the short sell, and we are undertaking various studies to 
figure out whether or not something more should be done in that 
area.
    Senator Hatch. Well, I hope you really--and Lanny, I hope 
you guys in the Justice Department will really look at this 
too, because I know too many companies that I think have been 
abused because of negative short selling.
    Mr. Khuzami. We've seen it across the spectrum as well. In 
addition to the short sellers--I mean, if you talk to them, the 
short sellers say that the company is misrepresenting its 
financial information, or they've issued unregistered shares so 
there's many more shares out there in the marketplace than the 
public thinks. So when you see these huge sale volumes, it's 
because there are more shares in the float than are publicly 
registered, because some issuers have improperly issued stock. 
So what is our obligation to do, is to dissect the various 
views and figure out who it is that's engaged in the wrongful 
conduct.
    Senator Hatch. Well, do you have any tools that you'd like 
to get from us that might help you in this endeavor? Any of the 
three of you could answer that question. What would you like us 
to do?
    Mr. Khuzami. I'm sorry? Like I said----
    Senator Hatch. What would you like us to do? Because there 
are abuses in this area.
    Mr. Khuzami. Uh-huh. What I think would be very helpful, is 
we're engaged in various efforts to try and simply get better 
audit trail information about actual trading, better underlying 
data so that we can determine exactly what is the source, and 
the volume, and the amount of this kind of trading. So that's 
one of the efforts that we're taking so that we can make 
better-informed rules and better-informed enforcement 
decisions.
    Senator Hatch. Mr. Chairman, I want to thank you for your 
energetic leadership in this area. I want to thank the three of 
you for the work that you do. But I'd like to see more advice 
to us up here on what we might do to help you to keep the 
crooks out of the business as much as you can. It's very 
difficult. But I'm very concerned about this abusive short 
selling approach. That's only one of the things that I'm upset 
about, but that's about all I can ask about today.
    Thank you so much. We appreciate your testimony, appreciate 
you being here.
    Thanks, Mr. Chairman.
    Senator Kaufman. Senator Franken.
    Senator Franken. Thank you, Mr. Chairman. I also appreciate 
all you gentlemen being here today.
    I had a question. During all your testimony and in response 
to what kind of crimes contributed to the financial breakdown 
or meltdown, one of the things I didn't hear was rating 
agencies. I'm wondering to what extent--there are a lot of 
securities that were given AAA ratings that turned out to be 
complete disasters. And it seems to me, from what I've read, 
that there were rating agencies that were sort of compromised 
in that they were receiving business from the people they were 
rating. That seems to me to be not kosher and illegal. So I'd 
like to know, to what extent--and this is opened up to anybody, 
but especially Mr. Breuer and Mr. Khuzami, to what extent are 
rating agencies in your cross-hairs?
    Mr. Khuzami. Senator, let me start with that. We are 
looking very closely at credit rating agencies, for the reasons 
that you've indicated. Prior to the passage of legislation in 
2007, to bring a case against a credit ratings agency, you had 
to prove that they knowingly or recklessly issued their 
ratings, essentially. You had a fraud standard.
    That can be difficult to show and a challenge, particularly 
when, while it's clear that the ratings agency may have gotten 
things very wrong with respect to the diversification of 
portfolios and how they arrived at their ratings, historical 
assumptions about default rates that proved to be very wrong 
given what happened; a fraud knowledge and intent standard can 
be difficult.
    As a result of the legislation in 2007, we now have more 
tools because now we can bring actions based on false 
statements in an application and certain types of conflicts of 
interest that you identify, where they're issuing a rating for 
a company that may provide more than 10 percent of their 
revenues, for an example, or an analyst is rating the 
securities for a company that he or she serves as a director on 
and has some relationship with.
    So we are focused on that area. You know, there's not a lot 
of disclosure with respect to credit rating agencies, so it's 
hard to go on a disclosure theory, that they said they were 
going to do X, Y and Z with respect to their rating and they 
didn't, so what you're left with is a theory that they had 
knowledge about wrongdoing and didn't update their models, or 
they had certain conflicts of interest. We're looking at those 
areas.
    There's some ambiguity in the legislation, and I think 
we've proposed that it be cleared up because the legislation 
that was passed in 2007 actually says that we cannot bring 
actions based on, I believe, the methodology or the ratings 
themselves. It says we can't regulate that area. There's an 
ambiguity as to whether or not that means we simply can't 
regulate it, or whether or not we can't actually bring an 
enforcement action. So we've asked for some clarification in 
that area, but it's something that we are focused on and we 
hope to be successful in.
    Senator Franken. Mr. Breuer.
    Mr. Breuer. Senator, taking off from what Rob said, in the 
first instance, one of the challenges, of course, from the 
point of view of the Department of Justice, is that the fee 
structure that you described, of course, was known. It wasn't 
surreptitious; it was widely known how the rating agencies were 
charged, and at least under the--it has been--my understanding 
is it's been permissible in the past.
    Second, rating agencies themselves have always had a First 
Amendment privilege in their ratings, and they've claimed that 
when they've been challenged in court. But we are looking at 
them, and we support the SEC and the SEC's suggestions and ways 
of changing legislation. Obviously the record of the credit 
rating agencies has been troubling, and it's something we're 
all looking at, but there are challenges.
    Senator Franken. I'm thinking about what you've learned 
from looking into this. We are--not this Committee, but another 
committee--going to be changing its way of regulating the 
financial industry. From what you have learned from this--I 
don't know how you're confined in your testimony because of 
your roles--what should we be doing, different, to regulate 
these financial institutions?
    Mr. Khuzami. Well, from my perspective, Senator, with 
respect to enforcement-related regulation, we have some various 
proposals, including hedge fund registration, for starters, 
which would allow us to have additional oversight, examination 
authority, and better transparency into the activities of hedge 
funds. The same is true with derivatives. I think the proposal 
to have a central clearing party for derivatives, as well as 
require registration of the firms--which would again allow us 
to have better access to----
    Senator Franken. Should we have an exchange for 
derivatives?
    Mr. Khuzami. I think my view is, as long as we have a 
central clearing party who stands in the shoes of the counter 
parties, from an enforcement point of view, that is a very 
significant improvement over the current situation. I'm a 
little reluctant to answer the question on the exchange-related 
basis. I don't know if the Commission has announced a view on 
that particular proposal, so I want to be careful.
    Senator Franken. I hate to put you in that position.
    I'll put you in that position, Lanny.
    Mr. Breuer. Senator, I was going to go and continue from 
what Rob said. One, is that I think we should be supportive of 
that which increases transparency. I mean, it's just vital.
    And second, these structures, some of them, are just, 
candidly, remarkably complicated. Some of the smartest people 
we know were involved in this for years and years. From a law 
enforcement perspective, that requires, now, remarkable 
resources to figure out what was done, and to figure out who 
did them. To reconstruct them is hard, so anything that can be 
done to both increase transparency and to give resources to the 
regulators, and then, candidly, to law enforcement to follow up 
would be helpful. We are following up, but to state the 
obvious, these are great challenges.
    Senator Franken. OK. I hope we'll get to a second round.
    Thank you, Mr. Chairman.
    Senator Kaufman. Senator Whitehouse.
    Senator Whitehouse. Thank you, Chairman Kaufman. Thank you 
for your interest in this topic and for the, I think, very 
helpful legislation that you have proposed.
    I have a number of different questions, and so if there is 
a second round, I hope to stay for it also. But let me start by 
asking Mr. Khuzami, obviously the tail-end of the Bush 
administration, and perhaps the entire Bush administration, was 
not the SEC's finest hour; whether it became a fully captive 
regulator of the industry or just became a neutered regulator, 
it certainly fell down on some very, very important 
responsibilities.
    What are the telltales that we should be looking for that 
give us some assurance that the SEC is back on its feet, 
energetically doing what the public trusts it to do?
    Mr. Khuzami. Well, Senator, I think since my arrival in 
March, as well as the appointment of Chairman Shapiro earlier 
this year, I think both the pace of enforcement activity, as 
well as the rulemaking agenda, I think, sends a very clear 
message that the Commission is reinvigorated toward its primary 
goal of investor protection.
    Just quickly, three things. I mean, the statistics bear out 
a very significant increase in numbers of temporary restraining 
orders, opening of investigations, returning money to harmed 
investors. In addition, as I indicated in my opening statement, 
a real thorough self-assessment of how we do our operations. I 
think that's probably the single biggest piece of evidence that 
shows that we recognize that it's our obligation to do our job 
as best as we can and we need to restore investor confidence.
    So within the Division of Enforcement, we are creating 
specialized groups, streamlining management, reducing 
bureaucracy and decentralizing authority, creating whistle-
blower--seeking whistle-blower legislation, new offices to 
handle tips and complaints, new tools, like the criminal 
authorities for being able to offer formal cooperation 
agreements to inside witnesses. So, a whole host of reforms on 
the kind of organizational and structural side.
    Senator Whitehouse. Aside from the organizational and 
structural side, what can you tell me about the personnel of 
the agency? I think it's a fairly common observation that when 
a regulator becomes captive to a particular industry and fails 
to meet its responsibilities, that is very discouraging to a 
lot of the better, more energetic, more honorable employees who 
have given up a lot to serve in public service.
    And if the goal of--if the psychic reward of feeling that 
you're doing the right thing isn't being met, they tend to 
drift away, and so you're left with the slackers and the 
careerists and people who just want to get their ticket 
punched. Is that a problem at the SEC? I don't--I didn't mean 
that as a criticism of the SEC, because I don't know enough.
    I just know that, in general, that kind of thing happens. 
When a regulatory agency goes rotten, it's very hard for 
honorable people to stay in a rotten regulatory agency. How 
would you assess the extent to which that took place in the 
SEC, and what needs to be done if it did take place?
    Mr. Khuzami. Well, Senator, since I've arrived I have not 
seen evidence of rot or being captive to the industry; quite 
the opposite. I've seen a team of people in the Enforcement 
Division who are as committed as I could have hoped for when I 
arrived at the Division, as committed as my colleagues in the 
Department of Justice, when I was a prosecutor in New York. The 
ability to attract talent has only increased.
    The kinds of resumes that we get for open positions has 
been just incredibly great talent. I see people energized, I 
see people committed to their cases. I see people excited about 
the opportunities that are being introduced by a result of our 
streamlining for more autonomy, less bureaucracy, more ability 
to bring their cases.
    Senator Whitehouse. So you're comfortable that, both from a 
process and personnel point of view, the SEC is back?
    Mr. Khuzami. Absolutely.
    Senator Whitehouse. Very good. I'm delighted to hear it.
    Mr. Khuzami. And stronger.
    Senator Whitehouse. I'd like to ask both Assistant Attorney 
General Breuer first, and perhaps you'd like to chime in as 
well, the question of the honest services standard is about to 
be before the United States Supreme Court. As a former U.S. 
Attorney and Attorney General who has looked at cases under 
that standard, I can very clearly see the concerns that the 
Supreme Court has and that the opponents of the legislation 
have.
    What would you consider to be the critical elements that 
you need to see preserved under that standard, either in an 
argument to the court that you might be recommending to the 
Solicitor General, or if we have to address this again in 
legislative language, what are the kind of high points that you 
think most need to be defended to keep this an effective tool 
in your arsenal against white collar criminals?
    Mr. Breuer. Well, Senator, I was fortunate enough to go to 
the argument yesterday and heard our Deputy Solicitor General 
argue Wyrock and Black. And you're right, these are essential 
tools for us. I'd like to come back to more specific issues, 
but I do think it's essential that in an honest services case, 
that we have some latitude here, because there are in fact 
cases, Senator, right now, where--for instance, public 
officials in particular--I think the real central issue is, we 
care about everything, but the public official is really what 
we care about. We need an ability to prosecute a public 
official who surreptitiously has an interest, doesn't disclose 
that interest, purports to be doing the public's bidding, but 
in fact is privately and secretly benefiting from that.
    We need to be able to pursue those kinds of cases, so that 
the public has confidence in their public officials, and we 
need to be able to do that, even if there is not a specific 
State statute that, for instance, may require disclosure. That, 
to me, is one of the core conducts that is essential.
    There's more, and I'd be delighted to chat with you. We now 
also have the Skilling case, so it'll be interesting to see how 
far they go. It looks like the court, the different justices, 
have different views. But at its core, that's the conduct that 
we care the most about.
    Senator Whitehouse. My time has expired, but I look forward 
to continuing the discussion.
    Thank you, Chairman.
    Senator Kaufman. Back, Mr. Khuzami, to where we left my 
questions, which was the whole idea of, how do you make the 
tough decision between the relatively easy cases, the low-
hanging fruit, and the problem you get into if you really go 
after the big guys because of their incredible resources and 
the complexity of the cases. How do you kind of make that 
decision in SEC enforcement?
    Mr. Khuzami. Well, Senator, there's no shortage of 
eagerness by SEC personnel, in the appropriate case, to follow 
the evidence and go as far up the chain as the evidence will 
permit. I think that one thing that I've tried to do, is we are 
trying to come up with alternative metrics that rely less on 
quantitative measures of performance so that we de-emphasize 
the number of cases brought and try and refocus some of our 
evaluation and criteria on the quality of the cases, the 
programmatic priority, and the deterrent effect, and the 
timeliness, some other factors that I think better capture how 
effective an enforcement program we're running.
    But in terms of the investigative steps, it's a standard 
process: you start with your evidence, you start where it 
leads, and you work your way up the ladder. There is typically, 
push comes to shove, individuals find themselves in the cross-
hairs of an enforcement action or criminal investigation, will 
identify others who are involved in the wrongdoing and we will 
follow that chain up the ladder. We are also seeking, as I said 
earlier, whistle-blower legislation and these cooperation tools 
to better help us get to insiders in organizations. But it's an 
issue we think about in every case that we bring.
    Senator Kaufman. So the vast majority of cases, you start 
at the bottom and work your way up? It isn't like someone comes 
in--unless you have a whistle-blower or someone like that who 
comes in the door at the highest levels, you have to--on the 
mortgage thing, you start with maybe a mortgage broker, finance 
company, or something like that and work your way up to the 
people that securitized the mortgages?
    Mr. Khuzami. Well, it's not quite that. I mean, one, you 
start where the evidence leads you.
    Senator Kaufman. Right.
    Mr. Khuzami. But, two, there's nothing to stop you from 
starting an investigation based on information you've received 
at the highest levels. That may not be the smartest 
investigative approach----
    Senator Kaufman. Right.
    Mr. Khuzami [continuing.] But you can start virtually 
anyplace. What you want to do is start where your evidence is 
the strongest.
    Senator Kaufman. OK.
    Mr. Perkins, do you have any thoughts on this?
    Mr. Perkins. Yes, sir. Thank you.
    We consider--the FBI considers a number of different 
factors when we're looking at prioritizing what cases we take 
and which direction we go with them. I mentioned earlier, 
dollar loss is one particular item. The number of individuals 
who have been victimized across the board is another one. The 
actual impact on market integrity or the community at large. 
There are other things we look at to see if a case should be 
given a priority status, such as, is there organized crime 
involvement, is there an organized group or criminal element or 
is this a one-individual type of deal?
    We've actually become good at that simply because we have 
to focus our limited resources on cases that have the highest 
impact. A good example: 85 percent of our mortgage fraud cases 
today are focusing on cases that have losses in excess of $1 
million. So, frankly, I have to take my resources and go where 
the largest dollar impact is.
    There's another side we look at too, and we've been very 
fortunate. I've mentioned resources. In the last several 
cycles, we have been very fortunate to receive additional 
resources to work these types of cases. They've been put to 
work, many of them, in the intelligence area, as far as 
gathering and doing analysis on these types of cases.
    We try to look, both from a tactical and a strategic 
standpoint and actually try to identify cases before they're 
actually reported to us through various methods of looking at 
information, whether it's from confidential human sources, wire 
intercepts, and the like. So we use that information to also 
try to bolster these investigations and send out packages to 
our field offices.
    Senator Kaufman. You know, kind of taking a different 
approach and looking at, where was the money? The old Willie 
Sutton, you know, rob banks because that's where the money is. 
Where was the big money lost? Obviously the mortgage are and 
the mortgage-backed securities was where a lot of money was 
lost, but there was a lot of money also lost in credit default 
swaps.
    I'm just saying, from the standpoint of--you know, when a 
lot of money is lost there's always the possibility that there 
was fraud somewhere involved in that. Do you have any thoughts 
on that, starting with you, Mr. Khuzami, on credit default 
swaps and a potential there for financial fraud actions?
    Mr. Khuzami. Well, Senator, we're seeing some types of 
securities fraud where credit default swaps are being used as 
one of the means by which the fraud is occurring. So, for 
example, we've seen insider trading cases where, rather than 
buying an equity security based on material nonpublic 
information, someone might go into the derivatives market and 
buy protection or buy a credit default swap on a bond issued by 
a company in anticipation of the value of that credit default 
swap rising when a certain announcement takes place.
    We've also seen allegations that individuals had been 
buying credit protection so that the price rises, so that then 
those who hold equity will think that the company is in 
trouble, that will cause downward pressure on the price, and 
then if you have a short position you can profit under those 
circumstances. So, we've seen it as a means to other frauds.
    With respect to the market itself, I don't know what the 
sort of informed thinking is with respect to the credit default 
swap contributing to the financial crisis. A lot of people lost 
money on those markets, that's for sure. The question is 
whether or not they lost it because they bet wrong and sold 
protection for a bond or a credit instrument that then went 
into default for legitimate reasons and they had to pay up on 
their contract.
    What we would like is better transparency into all of these 
markets so that you can see who's making these trades and what 
the terms are, because now it's an over-the-counter market 
where the evidence exists in the files of the parties to the 
contract and really not anywhere else, and that's not good for 
anybody. So we're hoping, through regulation of credit default 
swaps, that we'll be able to have better access to that 
information and better be able to answer that question.
    Senator Kaufman. Let me just ask, one of the things that 
I've--a lot of people talk about how important liquidity is in 
the market, and the rest of it. But is it fair to say that you 
can't have regulation if you don't have transparency? I mean, 
it's almost like, you don't have to spend a lot of time. If 
there's a market and there's something going on in an area, any 
kind of market or any kind of area and you don't know what's 
happening, I mean, it seems to me like axiomatic that you can't 
regulate. Is that fair to say, or is there an exception to 
that? Can you think of----
    Mr. Khuzami. I think as a general maxim that's absolutely 
right. We're a disclosure agency, so that principle is our holy 
grail and we completely agree with that. You can't--if you 
don't know what's going on, you don't know where to target your 
resources. There may be circumstances where there are other 
values that you want to protect, and so something short of full 
transparency is appropriate. But as a general matter, that's a 
good maxim to live by.
    Senator Kaufman. Great. Thank you.
    Senator Klobuchar.
    Senator Klobuchar. Thank you very much, Senator Kaufman, 
Mr. Chairman. Thank you for holding this important hearing 
today. I was pleased to work with both you and Senator Leahy on 
passing the Fraud Enforcement and Recovery Act. As a former 
prosecutor, I saw firsthand how difficult some of these white 
collar cases are to go after the resources that they take on 
the investigative side, Mr. Perkins, and then the prosecution 
side as well. So we hope it gave you some more tools.
    I've often said, when you look back at the last few years, 
I picture some of these guys that were involved--mostly guys--
in these high-flying deals, taking their Ferraris down Wall 
Street while the government was chugging behind in a Model T 
Ford, and it is time to catch up and start to be as 
sophisticated as the people that are committing the crimes.
    I hope that these tools will help. Clearly, meeting with 
the Director at the FBI to see some of the change in resources, 
understandably, after 9/11, and then trying to regain that 
investigative power, because one of the things that I 
experienced, having done some of these white collar cases, was 
that there is a huge prevention element here, that if you send 
a clear message you're going after these con men and these 
fraudsters, you can really prevent a lot of crime, even more 
than in some other areas of the criminal justice system.
    My favorite story was when we went after some pilots who 
had decided they could pretend that they lived in post office 
boxes in Florida--when they had actual big homes in the Twin 
Cities--so they wouldn't have to pay the State taxes. We ended 
up getting, I think, six, seven convictions in that area.
    The Treasury Department in the State of Minnesota literally 
had millions of dollars that were sent in during that time as 
people realized that they were going to get in trouble if they 
didn't pay their taxes. So I think you can have a major effect 
by bringing these cases, and I want to thank you for making 
this such a priority.
    My first questions actually are for you, Mr. Perkins, just 
along these lines. Based on your testimony, it's clear that the 
FBI is taking financial fraud seriously. I appreciate your 
efforts. You mentioned the case, the recent white collar case 
in Minnesota, which I think was one of the biggest Ponzi 
schemes after the Madoff case. Is that right?
    Mr. Perkins. That's correct.
    Senator Klobuchar. At least, we say that in Minnesota. I 
don't know if that's a claim to fame.
    Mr. Perkins. Yes, ma'am. It's one of the top three.
    Senator Klobuchar. And the good work that was done in that 
investigation. But I'd just like to know what kind of resource 
needs you have, what we could be doing with this upcoming 
financial regulation that we're working on, the financial 
regulation bill, if there are things in there. You maybe won't 
have all your wish list right now, but to keep that in mind as 
we go ahead with these investigations.
    Mr. Perkins.
    Mr. Perkins. Yes, Senator. Thank you. Excellent question. 
I'll start by saying I'm very grateful, both personally and on 
behalf of the FBI, for the resources that have come our way in 
recent cycles. They have been well put to use and are doing the 
people's business as we go forward.
    One of the things we learned after 9/11, and as everyone 
knows, we lost a significant number of criminal resources 
shortly after 
9/11 to answer the call and the crisis that we were facing at 
the time. One of the things that did was cause the FBI to re-
focus what it was doing on the criminal side and focus on only 
the highest priority matters. We'll take that down a level and 
look into what we were doing in white collar crime, for 
instance.
    In the years shortly after 9/11, we had to eliminate the 
lower dollar loss cases. Many of those were staples. Growing up 
as a young agent myself, I was hired during the last savings 
and loan crisis in the mid-1980s, and I really cut my teeth on 
cases like that. Unfortunately, we don't have the luxury to do 
that now. State and local authorities have stepped in and do a 
very admirable job, and no one has really missed a beat.
    As resources begin to come back to us and as they're being 
focused back into these areas, we're not going back to those 
types of cases. We have begun to use those resources in a 
better way, whether it's setting up the financial intelligence 
component where we can do both tactical and strategic analysis, 
something we were never able to do before, to focus our 
resources on the highest-dollar cases, the ones that have the 
highest impact on the community. So as we take these resources 
going forward, we're looking very closely on where we can have 
the biggest impact.
    For instance, instead of one and two agents and analysts 
going across the country, we've done an awful lot of analysis 
that focuses on where the biggest problems are so we can make a 
big impact to that particular agent in charge of that 
particular division. We may send three, four, five agents to 
that particular division so that they can have almost an 
immediate impact on the crime problem going forward. I 
appreciate the support of the President's budget, the 2010 
budget, and as we go forward I appreciate the support that we 
get in all of our white collar needs. Yes, ma'am.
    Senator Klobuchar. OK. Thank you.
    Mr. Breuer, again, congratulations again on that same case 
for the Department of Justice. I was reading an article today 
about the lead prosecutor, a young guy on the case, Mr. Dixon, 
and he is so careful not to toot his own horn. The reporter 
asked him, ``How are you feeling today'', after the big 
victory, and he said, ``Is this off the record?''
    [Laughter.]
    Senator Klobuchar. In any case, I just want to congratulate 
you on that. I know it was a major case. I'd just ask about the 
issue that I raised in my first remarks here about prevention, 
and how you see this fitting in, especially in the mortgage 
area. I know that DOJ is launching a mortgage fraud initiative 
that will focus resources on the prosecution of high-impact 
mortgage fraud cases, but will also try to deter future 
mortgage fraud crimes through increased real-time enforcement. 
Talk about that and how you see prevention fitting into your 
efforts.
    Mr. Breuer. Well, Senator, it's exactly that. It's got to 
be a comprehensive approach. So we look at the mortgage 
initiative: it really takes a page from what we've done with 
the Medicare Task Force. In the Medicare Task Force, what we 
did, as Kevin was referring to, was to use data. So we sent 
prosecutors to places around the country where Medicare billing 
was disproportionately high.
    To give one example, we worked with the U.S. Attorney's 
Office in southern Florida. We started prosecuting people right 
away: doctors, health care professionals. As a result of those 
real-time prosecutions, billings immediately--billings in the 
Medicare program in one county, one county in Florida, went 
down by $1 billion.
    Senator Klobuchar. Unbelievable.
    Mr. Breuer. That's a billion. So that's our goal with 
mortgage fraud.
    Senator Klobuchar. You're making Senator Kaufman and I 
really get going, because we've got--he has, and I do, this 
bill to go after--give you more tools on Medicare fraud and 
medical fraud that we'd like in the health reform bill.
    But continue on.
    Mr. Breuer. So that's what we're doing. We're trying to 
find high-impact cases. And how do we do it? We do it through 
data. I probably meet with Rob at least once a week, and with 
Kevin about once a week, as well. So we're trying to compare 
notes about, given the resources that you have been generous 
enough to give us, how can we, in the most targeted way, deal 
with it? So that's what we're trying to do.
    Now, of course, some of those cases, again, as Senator 
Kaufman said in the beginning and as I did, tend to be sort of 
more on the local level and they tend not to be the highest end 
frauds, because those are the ones sometimes we can identify 
with the data. Our challenge is then how to build our way up. 
That's what I want us to do, and in that we need greater 
transparency. We need as many incentives as we can for people 
to come forward when they know about wrongdoing and to inform 
us. It's through that that we're building cases on all 
different levels.
    Senator Klobuchar. Thank you very much.
    Senator Kaufman. Senator Franken.
    Senator Franken. I want to pick up on one of the things 
that my colleague from Minnesota talked about, which is how 
proud we are in Minnesota to be home of the third largest Ponzi 
scheme.
    [Laughter.]
    Senator Franken. Let me ask this, Mr. Perkins. Isn't it 
kind of true that these Ponzi schemes came to light because of 
the financial collapse? I mean, in other words, isn't it easier 
to keep one going when, I'm getting you 20 percent return, I'm 
getting you 20 percent return? Every year, I'm getting you 20 
percent returns, and you should put more money in. Gee, this 
year the market just collapsed. How are you getting me 20 
percent, and why should I put more--I don't want to put more 
money in now. I mean, isn't that really what happened? Is there 
really anything--are there a lot of Ponzi schemes now?
    Mr. Perkins. Yes, Senator. You are exactly correct. These 
things come to light. I often use the analogy of a lake during 
a drought. When the drought comes and the lake level drops, it 
once was a pristine-looking, beautiful place, and then suddenly 
you start seeing the stumps and the old buildings and other 
things that had been covered over by the lake. That's exactly 
what happens in this case.
    As the market collapses, it exposes these types of schemes. 
I've been in this position--Director Mueller put me into the 
position of the Criminal Division Assistant Director about 6 
months ago. I get, on a weekly basis, a summary of various 
cases. The first few Ponzi schemes I saw, the first week I was 
there, I thought, wow, this is amazing. This is a $14 million 
loss, this is a $20 million loss. I don't pay--well, I don't 
want to say that. I do pay attention to all of them, but they 
pale in comparison right now.
    A week doesn't go by that I don't see some case brought 
against an individual or learn of a new case being opened in a 
Ponzi scheme type situation. Obviously, Madoff and others are 
the ones that hit the headlines, but that's exactly the case. 
As the market recedes, we see these cases. We've had, I 
believe--the exact number escapes me now--nearly a 100 percent 
increase, and I think it actually exceeds a 100 percent 
increase, in the number of cases in the past year.
    Senator Franken. Exposed?
    Mr. Breuer. Yes, sir.
    Senator Franken. OK.
    I'm also going to pick up on another theme of Senator 
Klobuchar's, which is prevention. It also--along with the theme 
of Senator Kaufman's, which is--he was talking about low-
hanging fruit, and picking--I kind of like picking off low-
hanging fruit, especially in mortgage fraud.
    So, Mr. Breuer, to what extent do prosecuting the garden 
variety crook, who gave a predatory loan to somebody, does that 
create a deterrent to these kind of people if they see other 
people like them going to prison?
    Mr. Breuer. Senator, I think it does. That's what we have 
to do, and that's why we are doing it. We're prosecuting those 
cases around the country. We have now, because of the Attorney 
General's direction, a Federal/State partnership.
    I, in fact, am co-chair with the Attorney General of 
Missouri, Attorney General Coster, where we are exactly 
pursuing that. These are cases where it may not always be the 
case that it's the Federal prosecutor who brings a case. It 
might be a great District Attorney who's bringing those cases. 
But I agree with you, I'm a big believer in getting low-hanging 
fruit. We want to get the other fruit, as well. But I do think 
these are deterrents, and we are aggressively doing just that.
    Senator Franken. I noticed when you said great prosecuting 
attorney, you pointed to my colleague, Senator Klobuchar.
    Mr. Breuer. But she wasn't looking up at the time, Senator.
    Senator Franken. I know. That's why I pointed it out.
    Mr. Breuer. Right.
    [Laughter.]
    Senator Franken. She was making notes.
    Here's a question, and I'll just throw it open: what is 
legal? Because sometimes the biggest--the worst stuff is what's 
legal. What is legal that you'd make illegal? Anybody? Mr. 
Breuer.
    Mr. Breuer. I'm going to cop out. I'd like to get back to 
you. I think there are things we'd like to do, but I know that 
in my Department of Justice, they'd want me to come back to 
you. What I'd like to do is send you something.
    Senator Franken. OK. I understand.
    Mr. Breuer. OK.
    Senator Franken. Mr. Khuzami, same thing?
    Mr. Khuzami. I mean, we have a number of legislative 
proposals. It's not necessarily the situation where it's 
something that's legal we want to make illegal, but it is 
activity now that is unregulated or unexposed that we would 
like to have much more information about, and that involves 
hedge funds, derivatives, and similar situations.
    Senator Franken. OK.
    One last question. What are we doing now to make sure 
there's no fraud in terms of the stimulus package? Anybody? 
Because that's a lot of money.
    Mr. Perkins. Yes, sir. One of the things we're trying to do 
is actually through some lessons learned in the Katrina crisis, 
when a lot of money went to that part of the world to try to 
fix and build. We tried to stay ahead of the curve there and we 
had a good deal of success in convicting--or prosecuting and 
convicting individuals who were defrauding the Federal 
Government at that point.
    What we've done within the FBI, is each one of our 56 field 
offices is focusing efforts on identifying the stimulus money 
that's coming to their particular area of operation, 
determining where that money is being spent, what the process 
is, looking at individuals, working informants and the like to 
determine particular contractors who may be getting funding for 
particular projects, what their criminal background possibly 
might be.
    So there's work ongoing in those areas so that we can try 
to stay ahead of the curve. We worked very closely with the 
various Inspector Generals and others who are involved in those 
matters. We have joint task forces with them and with the 
prosecutors in each one of those districts.
    Mr. Breuer. Senator, if I can just add to what Kevin said. 
The stimulus money, of course, is through the Recovery Act. The 
chair of that is Earl Devaney, someone who's been an Inspector 
General for many years, initially at the Interior Department, 
who has really a remarkably robust web site right now that's 
really quite extraordinary, where he follows all the money.
    Some of our great lawyers in the Fraud Section go there 
repeatedly literally to look at what is going on. In the 
Financial Fraud Enforcement Task Force that the President began 
through his Executive Order and that the Attorney General is 
principally leading, there is actually one working group that 
is doing nothing but looking at the stimulus money and ensuring 
that, to the degree there is fraud, we go after it. I know that 
Mr. Devaney immediately refers cases to IGs the moment he sees 
a problem, and that they in turn send them to prosecutors when 
they identify an issue.
    Senator Franken. Because in the reconstruction in Iraq and 
in Katrina, it was amazing, the lack of oversight we had and 
the billions and billions of dollars that were wasted through 
waste, fraud and abuse. I'm glad to hear that.
    Mr. Breuer. Right. And you know, Senator, I couldn't agree 
more. Every day now, or every week, with respect to Iraq, we in 
the Criminal Division, and throughout the country, are 
announcing prosecutions of people who did exactly what you're 
describing.
    Senator Franken. Thank you.
    Thank you, Mr. Chairman.
    Senator Kaufman. Senator Whitehouse.
    Senator Whitehouse. Thank you, Chairman.
    Mr. Khuzami, I read with considerable interest the scalding 
decision by Judge Rakoff that emerged out of a settlement that 
the SEC had proposed after the Merrill Lynch-Bank of America 
merger and the disclosures that were made about promises 
concerning bonuses to the acquired entity.
    It raised the interesting conundrum that the SEC was 
proposing to remedy the injury that was done to the victims of 
that alleged fraud, i.e., the shareholders, who were not given 
a fair report of what the agreements were by charging them 
another several tens of millions of dollars of shareholder 
money, so that, in effect, the victims were being asked to bear 
the burden of the penalty for the act of which they were the 
victims. I know that that case is still ongoing and so I 
cannot--you probably cannot talk about that in any kind of 
concrete or detailed way.
    But I'm wondering if it gives you any--if it causes you to 
draw any broader conclusions. Is this just a one-off decision 
and one case that will go away when that case is ultimately 
resolved, or do you think it's a case that stands for a broader 
point that is something that the SEC should be attending to, 
you know, across its entire regulatory regime? If so, what 
steps are you undertaking to respond to it, if any?
    Mr. Khuzami. Well, Senator, the issue of corporate 
penalties, in general, is something that, you know, is 
discussed on the criminal enforcement side, on the civil 
enforcement side, across the enforcement spectrum. As a general 
matter, we recognize that in some circumstances requiring a 
corporate penalty is going to come at the expense of those 
shareholders who may have been injured by the conduct, and so 
you have to balance that.
    Our penalty guidelines that we go through with an analysis 
leads us right through that analysis. But fundamentally, there 
are important law enforcement and deterrent impacts to 
corporate penalties. One, it sends a very strong message, I 
think, to the rest of the industry that the wrongdoing won't be 
tolerated and there's a financial cost to it.
    Senator Whitehouse. Yes. I understand the theory. My 
question wasn't the baseline, but rather, what changes to that 
baseline, if any, you might be considering as a result of the 
judge's decision.
    Mr. Khuzami. Well, I think that we will continue to weigh 
the factors between the benefits of deterrence and the burden 
on shareholders and come up with the best balancing that we 
can. That's a debate, an analysis, we've done before the 
decision and we will continue to do it after the decision.
    Senator Whitehouse. Do you need any further authority to 
pursue individuals who might have been more responsible for the 
conduct within the corporate structure rather than allowing the 
corporate structure to bear the penalty exclusively if there 
are managers/lawyers/advisors/consultants to whom the conduct 
can be attributed?
    Mr. Khuzami. Well, as a general matter the answer is no, 
although in the particular area of proxy solicitation in which 
this case arose the obligations on proper disclosure fall on 
the entity on whose behalf the proxy is being solicited. That's 
the corporate entity, so in this particular area of the law it 
is the corporate responsibility; to prove individual liability 
for that, you have to fall back on the higher fraud standard.
    Senator Whitehouse. OK. I'm sorry. So presently, even if 
culpability for this rests with clearly distinguishable, 
nameable individuals, it is still the SEC's policy, for that 
reason, to stick the penalty at the corporate level?
    Mr. Khuzami. No. It's--the question is, in this particular 
area of proxy solicitation, you have a higher standard.
    Senator Whitehouse. In this particular area of proxy 
solicitation.
    Mr. Khuzami. Yes. You have a higher standard for the 
culpability of individuals, as the law generally will require 
you to prove knowledge or recklessness.
    Senator Whitehouse. Yes.
    Mr. Khuzami. And so the question is, do you have the 
evidence to make that case?
    Senator Whitehouse. OK. Understood. That's helpful.
    Mr. Perkins, in the wake of the mortgage fraud that has 
taken place, there has been an enormous amount of human 
distress and there has been a secondary wave of fraud to 
capitalize on that distress: foreclosure rescue scams, debt 
resolution scams. Could you tell me how high a priority those 
are for you and what, if anything, we can do to be helpful? 
It's particularly galling to me because now you are--these are 
scavengers who are going after people who have already been 
hurt, and so they're really the lowest of the low. I would love 
to find ways to escort as many of them to the custody of our 
State and Federal incarcerative facilities as possible.
    Mr. Perkins. Yes, Senator. And I appreciate that offer. We 
do consider them a very high priority. We have seen them in 
certain areas of the country where we have open investigations, 
several areas. They are--they are part of that, what I 
mentioned earlier. Approximately 1,900 of our mortgage fraud 
cases have over a million dollars in losses. They are part--
they are considered part of the mortgage fraud in general.
    Senator Whitehouse. So they're a part of this initiative.
    Mr. Perkins. Yes, sir. Absolutely.
    Senator Whitehouse. An agent gets credit for meeting 
initiative effort requirements----
    Mr. Perkins. Oh, absolutely.
    Senator Whitehouse [continuing.] By hitting on those debt 
service and foreclosure----
    Mr. Perkins. Absolutely, Senator. I personally, and as an 
organization, we share the same feelings you have as far as 
being the lowest of the low in these types of things. They're 
going after the people who can really least afford--these are 
people who are, you know, days from losing their homes and may 
scrape together what little they have left, thinking that 
they're rescuing themselves, and then in turn have nothing. 
It's just unconscionable, what's happening in these types of 
cases, and we're very aggressively pursuing these.
    Senator Whitehouse. Does that include looking at who's 
advertising what and being proactive rather than waiting for an 
injured person to come in?
    Mr. Perkins. Oh, absolutely, sir. Without going too far 
into that, there are proactive means that we can use to seek 
out those predicated individuals who are doing this, and we've 
had some success with that.
    Senator Whitehouse. Good.
    Last words on that, Mr. Breuer.
    Mr. Breuer. Yes, Senator, I couldn't agree more. It's 
particularly galling, and it's even more galling, because often 
it's professionals, lawyers and others, who purport to be 
helping those who are in the most dire of straits.
    This was one of the great motivations of the Task Force I 
talked about, the State/Federal task force with the State 
Attorney Generals, and that's a focus. It's also a focus where 
we're working with the FTC, and they're very involved in this. 
So, this is very much on the mind of all of us and we're 
pursuing it.
    Senator Whitehouse. Good. Well, I thank you for your 
efforts. There are some very good feelings that one gets after 
a successful prosecution, and I would expect that this is an 
area in which there's plenty of room for that kind of good 
feeling.
    Thank you, Mr. Chairman.
    Senator Kaufman. All three of you talked about going up the 
chain, and Mr. Khuzami especially mentioned the idea of getting 
someone to come forward. Could each one of you just spend a 
couple of minutes and talk about how we encourage--how you 
think we can encourage--how you think people can come forward, 
but also what we can do in the Congress, with legislation or 
anything else, to encourage people, like whistle-blowers and 
the rest, to come forward? Why don't we start with you, Mr. 
Breuer.
    Mr. Breuer. Well, Senator, I think we have to deploy our 
resources as efficiently as we can to work our way up, and of 
course I said that before. As my colleagues know, I was 
thinking out loud. I know right now they're all going to be 
petrified of what I'm about to say; I realize that in other 
scenarios, in other fora, of course, one of the ways that we in 
the government learn about wrongdoing is through the False 
Claims Act. Of course, that only works when you're making a 
claim. In some of these areas, of course, we don't have that.
    But I think what we all need to do, and we're going to do 
it and go back to the Congress, is figure out every incentive 
we can to make people come forward. In the first instance, I 
want people to come forward, because if they don't come 
forward, it'll be that much tougher on them when we discover 
them. Second, obviously, when we go from the low-hanging fruit 
and work our way up, then hopefully people who are already 
discovered are going to come forward.
    But any way that we can explore these issues, such as the 
hearing today, we're going to put pressure wherever we can for 
folks to come forward. That's what we're doing. And then when 
they don't come forward, it just takes a long time. We've 
spoken about that, Senator. We have our prosecutors right now 
looking at these. Of course, we work with our remarkable 
partners, the regulators, such as the SEC, who are really 
expert in the area. But there's no quick fix, of course.
    Senator Kaufman. Mr. Khuzami.
    Mr. Khuzami. Well, as I said, internally we're developing 
these cooperation tools. I treasured them when I was a 
prosecutor and I miss them now, and I hope to soon have them 
back again.
    We've proposed whistle-blower legislation which will allow 
us to pay persons for information under certain circumstances, 
and to be able to pay them significant amounts. Lastly, I 
think, frankly, general, aggressive enforcement where 
individuals look to their left and to their right and see 
people similarly situated who are the subject of prosecution 
and are being sued and going to jail, as that noose tightens, I 
think you also get more people who come forward because they 
fear for their own well-being and they realize that law 
enforcement is getting close and they're more likely to talk. 
So just the general ability to put more resources into 
enforcement and do our job better will also encourage more 
people to come forward.
    Senator Kaufman. Mr. Perkins.
    Mr. Perkins. Yes, Senator. The FBI's greatest assets are 
its agents, and what they do is talk to people every day. When 
we talk about taking the low-hanging fruit, we put those skills 
to work. Actually, we recently, in a couple of areas of the 
country, put initiatives forward, surge initiatives where we've 
gone after the low-hanging fruit for the purpose of jamming 
these folks, sitting down with them, talking to them, 
interviewing them, convincing them to flip, and then moving 
forward. That's a long proven tool the Bureau's been able to 
use successfully. We're using it in the mortgage fraud area.
    Secondly, I believe, as I'm a strong proponent of jail 
sentences for individuals, I've seen it over my career, 
countless times where someone is looking at a significant 
sentence, it is a motivational tool and they come forward. I've 
had countless successful prosecutions over my career using that 
very tool, and I know that's been duplicated throughout the 
Bureau.
    Senator Kaufman. And also I know, Lanny--Mr. Breuer--you 
said you were going to come forward, any ideas you have for 
legislation. I know the SEC wants legislation. I think I'd 
support anything to do with that. But to kind of go back to 
finish, can each one of you, starting with Mr. Perkins, talk 
about kind of, what's the impact of criminal prosecutions and 
prison time versus civil actions and fines?
    Mr. Perkins. Yes, Senator. It's really a combination of 
both. We obviously are very successful on the health care fraud 
side where we have civil remedies that we utilize each day in 
our investigations there, but again, I'm a very strong 
proponent of criminal prosecutions that involve serious jail 
sentences for white collar criminals.
    It is a huge deterrent. I've seen it over the years. I know 
that from my own personal experience, going and interviewing 
individuals, white collar criminals who are doing jail time, 
going and talking to them on various occasions. It is a huge 
deterrent. It's something that we have to have going forward to 
make this work.
    Senator Kaufman. Mr. Khuzami.
    Mr. Khuzami. Senator, yes. There's no deterrent that's a 
substitute for jail time. I miss the cooperation tools and I 
miss the sentencing guidelines even more. But there is a very 
significant role for the civil regulators as well, simply 
because, because of the standard of proof of beyond a 
reasonable doubt and the necessity of convincing 12 jurors of 
the guilt of someone, the criminal authorities, by definition, 
cannot, and should not, capture the whole field of wrongdoing.
    So what you'll often see, is criminal authorities focused 
on the core wrongdoers, and we may cast a wider net--because we 
have a lower standard of proof, cast a wider net amongst those 
involved in the wrongdoing as well. In particular, there's lots 
of wrongdoing that goes on that doesn't rise to the level of 
criminal intent, all sorts of activity across regulated broker-
dealers, and investment advisors, and others where, if you can 
at least make it unprofitable so that they have to give back 
the money they wrongfully got, pay a penalty, perhaps suffer 
time out or lose their license, that, too, has a significant 
impact.
    Senator Kaufman. Mr. Breuer.
    Mr. Breuer. Senator, obviously, as Rob says, a 
comprehensive approach is essential. Civil remedies are 
essential. But I've had many years in the private practice, and 
I've had many years when I represented individuals. I can tell 
you, Senator, in a white collar case there is nothing--there is 
nothing--like an individual who feels as if he or she has been 
sort of the center of their community, is well-respected and 
has had a comfortable life, realizing that they're facing jail 
time. The terror in their eyes is like nothing else, and 
there's simply no deterrent like it.
    Senator Kaufman. I think I know the answer to this, but I 
think it would be good to be on the record. Starting with you, 
Mr. Breuer, why haven't we seen more, you know, board room 
prosecutions?
    Mr. Breuer. Senator, these are complicated cases. Don't for 
a moment think that they're not being pursued and investigated, 
but they're complicated, they take a long time and they take 
enormous resources. The folks who perpetrated a lot of these 
crimes, to the degree they were crimes, took a long time in 
hatching and developing, and bringing the cases will take a 
long time, but they will be brought.
    Senator Kaufman. Mr. Khuzami.
    Mr. Khuzami. Senator, in the mortgage area, I think we have 
brought a number of cases targeted right at senior executives, 
so in the Countrywide, New Century, American Home Mortgage 
cases, we've done exactly that, but we continue to pursue these 
cases. As Mr. Breuer says, they are complicated. There's lots 
of levels between somebody who executes a trade or structures a 
product and the CEO or the CFO, and they may well not have 
known the full extent of what's going on, in which case 
prosecution is not appropriate, or they may have. It takes time 
to get there.
    These are complicated cases. White collar cases, I think, 
are distinguishable from terrorism or drug crimes for the 
primary reason that often people are plotting their defense at 
the same time they're committing their crime. They are smart 
people who understand that they are crossing the line, and so 
they are papering the record or having veiled or coded 
conversations that make it difficult to establish wrongdoing. 
But we are focused on that and we will bring the cases where 
we--where it's appropriate.
    Senator Kaufman. Mr. Perkins.
    Mr. Perkins. Yes, Senator. And I concur with both Mr. 
Khuzami and Mr. Breuer in that these are complex matters, they 
do take time, they are resource-intensive. And as Mr. Khuzami 
refers to, they are worthy adversaries. Throughout the course 
of the crime, many times they are developing defenses as they 
go along and it takes us time to unwind those, work our way 
through those.
    Where we can get in early and where we can employ proactive 
investigative techniques, these cases go quicker as opposed to 
historical document review, labor-intensive type cases. So any 
opportunities we can have to get in early on cases like that, 
it's a very good thing for us.
    Senator Kaufman. Do you think the Financial Fraud 
Enforcement Task Force will help build some urgency in bringing 
some of these cases?
    Mr. Perkins. Yes, sir, I certainly do. I think what it's 
going to do--we have a good bit of liaison already in place. We 
work closely with our partners in these--that are all members 
of these groups, whether it's the Postal Inspection Service, 
whether it's the SEC, whether it's Internal Revenue Service, 
CID, whoever the case may be, we work very closely with all 
these people. It will force us to work even more closely 
together, share information, and employ that sense of urgency.
    Senator Kaufman. Mr. Khuzami, do you want to add anything?
    Mr. Khuzami. I agree. It is more forces joined in the 
fight, working together. Through these task forces, you find 
out people have expertise, knowledge, contacts that you might 
not have otherwise have known that make your cases just go more 
efficiently.
    Senator Kaufman. Mr. Breuer.
    Mr. Breuer. Absolutely, Senator. A concrete example: 
because of the Task Force, Mr. Khuzami and I, and many others, 
will be in New York on Friday to discuss these very issues, to 
compare notes and figure out, what are the different levels of 
expertise to go forward. It's essential. We feel a real sense 
of urgency, and everybody is very motivated.
    Senator Kaufman. If we come back a year from now and we're 
having this hearing, how much progress do you think we'll have 
made on the main objective of getting folks who were involved 
in the financial fraud and the top players?
    Mr. Breuer. Well, Senator, what I can tell you, is I am 
very hopeful. We will devote a lot of time, let you judge in a 
year from now. You can be the judge for the progress. But I'm 
very optimistic. We're working very hard. All of us are working 
hard throughout the government, and my sense is we will have 
good progress.
    Senator Kaufman. Mr. Khuzami.
    Mr. Khuzami. I agree. You'll see more cases and continued 
devotion in this area, and hopefully also more regulatory 
reform in other areas that will also reduce the chances of 
anything like this happening again.
    Senator Kaufman. Mr. Perkins.
    Mr. Perkins. Yes, sir. The infrastructure and resources 
we're putting in place now, and have been putting in place over 
the last several months, will bear a great deal of fruit in a 
year from now.
    Senator Kaufman. Mr. Breuer, last month we saw a jury 
acquit the two Bear Stearns hedge fund managers accused of 
misleading investors about the value of their funds. Are there 
lessons we can learn from that verdict, or is that just a one-
off?
    Mr. Breuer. Senator, I'm a big believer in the jury system 
and juries are going to do what juries feel are right. At the 
Department of Justice, we're going to bring cases when we think 
they're appropriate. We will live with the jury's decision, and 
we're going to move forward. It shows, of course, these are 
tough cases, but we're going to continue to bring them. It's 
not a deterrence at all. We're marching forward.
    Senator Kaufman. Great.
    Last month, the Attorney General--Ohio Attorney General 
filed suit against three of the largest credit rating agencies, 
Moody, Standard & Poors, and Fitch, alleging those firms gave 
high ratings to investments they knew were unsafe. What do you 
see as the role--I want to ask each one of you: what do you see 
as the role of States' Attorneys General in this area, and how 
do you plan to coordinate to work with them?
    Mr. Breuer. Well, I think the role of States' Attorneys 
General is incredibly important. I think whether we're talking 
about the credit rating agencies, whether we talk about 
mortgage fraud, frankly whether we're talking about dealing 
with the Mexican cartels on the southwest border, I've talked 
with Attorneys General about all of those issues. They're a 
vital component in our comprehensive approach. I think it's got 
to be a State, local, Federal approach to going after these 
kinds of crimes, so they're vital players.
    Senator Kaufman. Mr. Khuzami.
    Mr. Khuzami. Agree completely. I find the State Attorneys 
General are often, you know, very close to the investor on the 
street and often hear about problems or the breadth of problems 
early. Through better communication and coordination, we can 
both benefit from each other's involvement.
    Senator Kaufman. Mr. Perkins.
    Mr. Perkins. Senator, States' Attorney General offices 
across the country are very key members of many of our mortgage 
fraud task forces. They leverage the resources that we have in 
place and they bring a unique perspective to the table, again 
in a partnership role. They're very valuable to us.
    Senator Kaufman. Mr. Khuzami, we talked earlier about 
transparency. One of the things that I have become very 
concerned about is high-frequency trading and the potential for 
them to engage in manipulation, that they've created kind of a 
structured way for front-running orders. High-frequency traders 
buy proprietary data straight from the exchanges, co-locate 
their computers, use algorithms that permit them to trade ahead 
of quotes everyone else sees by just a few milliseconds.
    The mutual fund industry and the pension funds are 
beginning to share my concern and wake up to the fact that 
high-frequency traders may--and I say ``may''--be picking their 
pockets to the tune of billions of dollars per year. The high-
frequency trading industry defends itself by saying they bring 
liquidity to the markets. I am big for liquidity. I think 
liquidity is really, really important. But I think that when 
liquidity comes up against fairness and transparency, that 
fairness and transparency trump liquidity. Currently, as you 
said earlier--I mean, you didn't say this about high-frequency 
trading, but you said about transparency, there is no 
transparency.
    No one at the SEC, as far as I know--or anyone else, 
really--knows what actually goes on in the market centers where 
we're engaged in high-frequency trading. And now with high-
frequency trading up to between 60 and 70 percent of all market 
transactions, sometimes things get too big to fail, sometimes 
things get too big to even look into. So it seems to me we have 
a basic case here of a lack of transparency, no one knows 
what's happening, a lot of money, and the potential--no 
regulation because you can't see what's going on.
    Can you just talk a little bit about that and your 
concerns, or lack of concern, or how we should propose on that?
    Mr. Khuzami. Senator, the Commission is concerned about 
these developments, high-frequency trading, trading in dark 
pools, flash trading, and other sorts of high-tech programmatic 
trading activity. In general, across all of these developments, 
it is the concern about a two-tiered market where favored 
investors may get a sneak peek at trades or orders in advance 
of the rest of the public, and so we have--and the Chairman has 
indicated--that we're going to study various aspects of this 
and make various proposals. There's already a proposed ban on 
flash trading.
    Senator Kaufman. Yes.
    Mr. Khuzami. With respect to high-frequency trading, we're 
looking to develop some additional disclosure regarding those 
who engage in high-frequency trading above certain threshold 
levels and require enhanced reporting so we can have a 
telescope into that activity and get a better sense of whether 
or not it really is creating the kind of two-tier market that 
we fear, and additional efforts to create, as a general matter, 
consolidated audit trails that will just give us better trade 
data across the board, which will allow us to better regulate 
the markets.
    We have working groups within the SEC looking at this and 
related activity on the exam side, as well as the enforcement 
side. So we're looking across these areas to make a 
determination as to whether or not there's more harm than good 
that's going on here, and then have the appropriate response.
    Senator Kaufman. You've been very good over the years 
since--not years, but since you've been the head of the 
Enforcement Division, to point out that your job is to enforce 
the rules as made--the law and rules made by the Securities and 
Exchange Commission. So this is a very complex area. I do not 
mean to simplify this in any way, but I think the one area that 
I kind of zero in on, and you've raised it today, and that is, 
this is going to be very complicated.
    There's a lot of things we have to consider here, but it 
seems to me that--I'd just like to ask you, how can you enforce 
the fact, how can you demonstrate, how can you prove there's no 
manipulation if, as a first step, you don't come up with a 
method to find out--not telescope in, but literally know what's 
going on in these transactions?
    Mr. Khuzami. Well, I mean, you have the tools to do it now 
with respect to going into firms and dissecting their trading 
and determining--following the audit trail through from the 
order all the way through the trade and see what's happening. 
It is a laborious task, don't get me wrong, but we have the 
ability to do some of it now. It will be greatly enhanced with 
some of these possible additional sources of information.
    Senator Kaufman. In some of these markets, if there is not 
an actual transaction that takes place, there is no record kept 
of what happened. The allegations here are that high-frequency 
traders are sending out messages and then pulling them back at 
the last minute, and then going to another market and doing it.
    So the idea that you can do an audit trail on transactions 
will not tell you what's going on inside of these dark pools 
and at times in these markets where they have high-frequency 
trading. So, you know, unless you know what's happening, what 
is actually happening--I mean, you couldn't do it--the New York 
Stock Exchange, when I was starting up, you know, you saw every 
trade that came across the ticker. It just seems to me that 
coming up with a method that allows you to track everything 
that goes on in the area is the only way you're ever going to 
get at the manipulation.
    As I said before, there are people now holding seminars on 
how to make sure that you're not manipulated in a dark pool, so 
clearly there's people that are very, very concerned about 
this. And again, I don't mean to simplify how difficult it is 
to deal with these market structures and the rest of it, but it 
seems to me that one area that we really can deal with quickly 
is, how do we do transparency? We can't do it--I mean, you're 
right, you can't do it by just laboriously going through every 
single trade. When you're doing 2,000 or 3,000 trades in a 
second, you won't have time for low-hanging fruit, you won't 
have time for high-hanging fruit, you won't have time for 
anything else.
    There's got to be a better method to it, and I'd just 
encourage you to do it, because it's been my experience, and I 
think it's been all of our experiences, where you have a lot of 
money in a place, you have a lot of change--basically, a high-
frequency trade is going from 30 to 70 percent, where you have 
no transparency and no regulation, because you can't have 
regulation without transparency. You said that earlier, and I 
totally agree with you--that's when the bad things happen.
    And I think I want to see us follow up on all these things 
that happened during the financial crisis; that's the reason we 
passed FERA and that's why we're interested in it. But I really 
do think that we have potential here. Again, using this thing 
of, you know, lots of money, lots of change, no transparency 
and no regulation, that something very bad could happen very, 
very shortly. Sometimes, you know, it's almost like I feel--
when I talk about this, it's like the ``too big to fail.'' It's 
like, this is so big that nobody kind of wants to look at it, 
because it's just so big.
    But it's all new and it's happened during a period where we 
didn't have much regulation going on anyway. So I'm just saying 
I--I just urge you. I know Mary Schapiro has sent me a number 
of letters that are very, very good. I think it's all been laid 
out. I just, as you can tell, maybe feel a little bit more 
urgency than everyone else does, that at least we've got to do 
this--we've got to deal with this transparency problem. There's 
billions of dollars being traded and we do not know what's 
going on there. So I just encourage you to do that.
    Mr. Khuzami. Yes. I can assure you, Senator, you're 
absolutely right. There's no hesitancy to do this because it is 
widespread or too big to fail. It is, you know----
    Senator Kaufman. Yes.
    Mr. Khuzami [continuing]. An effort to make sure that we 
strike the right balance and have the proper information.
    Senator Kaufman. No, I don't think it's that, but I think 
it is so--it's like, it's so big that, OK, how bad can it be? I 
mean, it isn't--I absolutely agree with you. But how do you 
take this thing on when--I mean, how do you go to the market 
and say, we're going to do something that's going to affect 70 
percent of the trading in the market.
    How do you say that? Well, we've got to be very careful, 
and I think we should be very careful. But it's there. It's so 
big that we cannot wait for a couple of years, I think, just 
based on the past. The regulators have got to get into it and 
we've got to find out what's happening, that's all. I don't 
think there's any reluctance on the part of the SEC to do it. I 
am absolutely sure there's no reluctance on the part of you to 
do this, but we've got to get about doing it.
    The first step is, I want your people to be able to figure 
out and see what is actually going on in this area and then 
say, OK, hey, Kaufman, Senator Kaufman, you know, look, there 
could be a problem here, but we know it's not that big and we 
know that we're not going to have that much potential for 
just--but until we have some transparency, and I mean--by 
``some transparency'' I mean some real idea what's happening 
here, that just concerns me.
    But it's not that I feel there's any reluctance by anybody 
or anybody's not doing it or anything like that. It's just that 
it's so big to get your arms around it, I can't imagine going 
to SEC meetings and saying, OK, here's what we're going to do 
today, we're going to go after--you know, where 70 percent of 
the market stocks are being traded.
    We come back to what I really think is the important thing 
here, and that is, you know, we talk about Main Street and Wall 
Street, and we talk about all the things that are going on, we 
want to put people away. The reason I got started in this 
thing, I'd never--when I became a Senator I never thought this 
is what I was going to be doing. I'm not on the Banking 
Committee. But, you know, it just--our credit markets--
democracy and free markets are the two things that make 
America.
    I mean, if you look at the core of why America is a great 
country, it was democracy and free markets, the way both of 
those operate. That's why we have such--you know, that's why 
we're great. And if our free markets go through another thing 
like what happened last year, we're all in deep trouble. We're 
all--it won't be just, you know, the billions of dollars lost. 
That will be awful.
    But if, in fact, America's markets become the ones that are 
not credible, where people don't think it's a serious thing, 
when you look at where we have to be and where we want to go, 
where we want to take our kids--when people talk about our 
grandchildren--when I--when I think about my grandchildren--
I've got seven grandchildren--I think about, are our markets 
going to be the best markets in the world when they get to be 
my age? That's really key to their success, just like a lot of 
other things that are going on.
    So, anyway, I just want to thank the three of you for what 
you do. The one thing I'd like to do, and I think we've covered 
this but I don't want to leave without asking, is there 
anything that you can think of that we can do in the Congress, 
any resources, any laws, anything--and by the way, this is an 
open question. You don't have to answer the whole thing now. 
But to the extent that you can, it would be good to just tell 
us what those are. I'll start with you, Mr. Breuer.
    Mr. Breuer. Senator, candidly, you should continue doing 
what you're doing. I mean, your comments weigh heavily on us, 
and we couldn't agree more. FERA gave us more strength, and we 
are using the resources you gave us. Obviously, we are always 
happy to get additional resources. Let's keep this dialog 
going. We're pursuing it.
    I do think whatever we can do to increase the transparency, 
which Mr. Khuzami talked about, and you've talked about, I 
think we have to do. If we can encourage whistle-blowers to 
come forward in some way or another, I think that will be very 
supportive and we'll continue to have this dialog to ask for 
more. But we have a solid foundation, and with what we have, 
Senator, I think you'll see we'll continue to do a lot. We've 
done a lot and we'll continue to do a lot.
    Senator Kaufman. Thank you.
    Mr. Khuzami.
    Mr. Khuzami. Senator, I agree completely. Your interest and 
knowledge in these areas is very helpful and keeps us thinking. 
With respect to Congressional help, funding is obviously 
critical. One result of what's happened this year, is we've 
gone back and looked at some of our numbers. The SEC regulates 
over 35,000 public companies, broker-dealers, investment 
advisors, transfer agents, credit rating agencies, and the 
like. We're 1,100 people in the Enforcement Division and we 
have authority--enforcement obligations with respect to that 
group, as well as anybody in the world who might consider 
committing securities fraud, even if they don't work for a 
regulated entity. So the task is big.
    We are attempting to use our resources as efficiently as 
possible, but additional resources, particularly in the areas 
of IT, document management, specialized skills, trial 
attorneys, would be greatly appreciated, as well as some of the 
legislative initiatives, hedge funds and derivatives regulation 
in particular, which, if passed, will only add to that number 
of 35,000, of course.
    Senator Kaufman. Thank you.
    Mr. Perkins.
    Mr. Perkins. Yes, Senator. Again, we're very grateful for 
the support that you and the Committee have provided to us in 
the past. My pledge to you is that we will use those resources 
that you have provided to us, focus them on where they will 
have the greatest impact across the board. We're taking the 
agents, the analysts, the forensic accountants, the staff 
operations specialists, all of whom you on the Committee and 
the Congress have made available to us, and placing them in the 
appropriate slot so that they can serve the public.
    Senator Kaufman. Let me just make a little statement I 
wanted to make here. In the boom-and-bust cycle brought about 
by the speculative housing bubble and all of its attendant 
fraud, the average American paid an enormous price, as we 
talked about. Millions lost their jobs and nearly $14 trillion 
in household wealth has vanished. As we only begin to climb out 
of this deep, dark hole, we must not lose sight of the lessons. 
The first one is: we can never let this happen again. We have 
to break the mentality of grabbing the money before the house 
burns down.
    The only way to do that is, first, through effective 
regulation, and second, through effective law enforcement. For 
those of you on Wall Street who have information about the 
sorts of financial fraud we've been talking about I say this: 
now would be a great time to pick up the phone and call one of 
today's three witnesses. I know they'd love to hear from you.
    I want to thank the witnesses again for their participation 
and great work. I feel very good about having the three of you, 
in your jobs, doing what you're doing.
    The record will remain open for one week.
    The hearing is now concluded.
    [Whereupon, at 3:49 p.m. the Committee was adjourned.]
    [Questions and answers and submissions for the record 
follow.]

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