[Senate Hearing 111-818]
[From the U.S. Government Publishing Office]
S. Hrg. 111-818
OVERSIGHT OF THE SEC INSPECTOR GENERAL'S REPORT ON THE ``INVESTIGATION
OF THE SEC'S RESPONSE TO CONCERNS REGARDING ROBERT ALLEN STANFORD'S
ALLEGED PONZI SCHEME'' AND IMPROVING SEC PERFORMANCE
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
SECOND SESSION
ON
EXAMINING THE OVERSIGHT OF THE SEC INSPECTOR GENERAL'S REPORT ON THE
``INVESTIGATION OF THE SEC'S RESPONSE TO CONCERNS REGARDING ROBERT
ALLEN STANFORD'S ALLEGED PONZI SCHEME'' AND IMPROVING SEC PERFORMANCE
__________
SEPTEMBER 22, 2010
__________
Printed for the use of the Committee on Banking, Housing, and Urban
Affairs
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
CHRISTOPHER J. DODD, Connecticut, Chairman
TIM JOHNSON, South Dakota RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York JIM BUNNING, Kentucky
EVAN BAYH, Indiana MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina
SHERROD BROWN, Ohio DAVID VITTER, Louisiana
JON TESTER, Montana MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin KAY BAILEY HUTCHISON, Texas
MARK R. WARNER, Virginia JUDD GREGG, New Hampshire
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado
Edward Silverman, Staff Director
William D. Duhnke, Republican Staff Director
Dean V. Shahinian, Senior Counsel
Levon Bagramian, Legislative Assistant
Brian Filipowich, Legislative Assistant
Hester M. Peirce, Republican Senior Counsel
Dawn Ratliff, Chief Clerk
William Fields, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
?
C O N T E N T S
----------
WEDNESDAY, SEPTEMBER 22, 2010
Page
Opening statement of Chairman Dodd............................... 1
Prepared statement........................................... 40
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 4
Senator Vitter............................................... 5
Senator Hutchison............................................ 6
Senator Johnson
Prepared statement....................................... 41
WITNESSES
H. David Kotz, Inspector General, Securities and Exchange
Commission..................................................... 7
Prepared statement........................................... 41
Robert Khuzami, Director, Division of Enforcement, Securities and
Exchange Commission............................................ 26
Prepared statement........................................... 47
Responses to written questions of:
Chairman Dodd............................................ 59
Senator Shelby........................................... 63
Carlo V. di Florio, Director, Office of Compliance Inspections
and Examinations, Securities and Exchange Commission........... 27
Prepared statement........................................... 47
Responses to written questions of:
Chairman Dodd............................................ 59
Senator Shelby........................................... 63
Rose L. Romero, Regional Director, Fort Worth Regional Office,
Securities and Exchange Commission............................. 27
Prepared statement........................................... 56
Responses to written questions of:
Chairman Dodd............................................ 67
Senator Shelby........................................... 69
(iii)
OVERSIGHT OF THE SEC INSPECTOR GENERAL'S REPORT ON THE ``INVESTIGATION
OF THE SEC'S RESPONSE TO CONCERNS REGARDING ROBERT ALLEN STANFORD'S
ALLEGED PONZI SCHEME'' AND IMPROVING SEC PERFORMANCE
----------
WEDNESDAY, SEPTEMBER 22, 2010
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:13 a.m., in room SD-538, Dirksen
Senate Office Building, Hon. Christopher J. Dodd, Chairman of
the Committee, presiding.
OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
Chairman Dodd. The hearing will come to order. Let me first
of all express my apologies to my colleagues and to our
witnesses and to those who gathered for being a few minutes
late getting started. I was just with the National Head Start
Association, which has a gathering and invited Senator George
Voinovich and I to address them and we were backed up a little
late in getting our program going this morning, so I am late
getting up here and I apologize to everyone.
I will make some brief opening comments, then I will turn
to Senator Shelby for any opening comments he may have, and my
hope is we can go right to our witnesses so we don't delay.
Obviously, we are a little behind and want to complete the
hearing if we can by noon. And so if people want to be heard,
obviously, I always give people the right to express themselves
on these issues.
Today is an important hearing. And by the way, let me thank
my colleagues yesterday, as well. I had a funeral to attend in
the morning, and I want to apologize to Richard Shelby and the
others. These things happen, and I understand it was a very
good hearing on the Infrastructure Bank issue----
Senator Shelby. It was.
Chairman Dodd. ----and I am very grateful to Senator
Merkley and Senator Jack Reed, who chaired the hearing, and my
colleagues who showed up to participate. Kay, I have been
talking about you and that Infrastructure Bank idea, and we
have talked about that possibly pilot program in that San
Antonio-Dallas-Houston triangle, and so I encourage these
Members who are going to talk about this--I said, go and see
you and talk to you about this if you have an interest in the
subject matter.
Senator Hutchison. Yes. I very much am interested in doing
something that would promote infrastructure and private sector
investments.
Chairman Dodd. Exactly.
Senator Hutchison. You started that operation. I think you
have passed the baton to Senator Kerry, and I attended a
meeting yesterday----
Chairman Dodd. Good.
Senator Hutchison. ----where we talked about some of the
concerns and parameters.
Chairman Dodd. How to make it work. Great.
Well, this morning, this is a hearing, an oversight hearing
of the SEC's Inspector General's report on the Investigation of
the SEC's Response to Concerns Regarding Robert Allen
Stanford's Alleged Ponzi Scheme and Improving SEC Performance.
And I will mention that Senator Shelby and Senator Vitter
were two of our colleagues who wanted to see this Committee
conduct this hearing, and rightfully so, in my view. We have
new leadership at the SEC, but I think it is very important to
go back and examine what happened, how did it happen, what is
presently occurring to minimize this from ever happening again,
and so it is an opportunity for us to discuss. I am grateful to
Senator Shelby and Senator Vitter for raising the spectrum of
this particular question and the hearing this morning is as a
result of their efforts.
The Banking Committee today is holding a hearing, as I
said, on the oversight of the SEC Inspector General's report on
the Stanford alleged Ponzi scheme. The Committee will review
the Inspector General's report on the Commission's failure to
stop the Stanford financial fraud in a timely manner, and we
will hear about the steps that it has taken to fix the problems
and restore investor confidence.
Last August, the Banking Committee held a field hearing on
the alleged Stanford Financial Group fraud, regulatory and
oversight concerns, and the need for reform at the request of
my colleague. Senator Vitter had a hearing in Louisiana. In
fact, he asked me if he could do that and I agreed to allow him
to do it. He did a very good job, I might point out, with that
hearing in Louisiana. It was a very well conducted hearing,
done in a very responsible manner, and I thank him for that.
Last year, we held two hearings surrounding the SEC's
failures in regard to the Bernard Madoff fraud. Those three
hearings contributed to reforms that we included in the Dodd-
Frank Wall Street Reform and Consumer Protection Act to better
empower and equip the SEC to do its job.
Today's hearing builds on those and reflects our work with
Ranking Member Richard Shelby. The hearing looks not only to
the past Commission performance, but also to future Commission
actions for improvement.
Let me review very quickly this situation. In January of
2009, the SEC charged Robert Allen Stanford and several
associates with orchestrating an $8 billion Ponzi scheme.
According to the SEC's complaint, the defendants for almost 15
years promised improbably high interest rates and
misrepresented to purchasers of Certificates of Deposit that
their deposits were safe, falsely claiming that the bank
reinvested clients' funds primarily in liquid financial
instruments.
Although the Commission examine staff found strong evidence
that Stanford was likely operating a Ponzi scheme as early as
1997, the Commission did not bring charges against Mr. Stanford
until 2009, 12 years later, only months after Bernie Madoff's
own Ponzi scheme was exposed. Both cases revealed deeply
troubling failures by the SEC.
In March of this year, the SEC Office of the Inspector
General released its report on the Commission's response to
Stanford's scheme. The report found that a central problem was
the failure of the SEC Fort Worth District Office Enforcement
staff to heed the warning of the Examination staff. The IG
report shows that the examiners at the Fort Worth District
Office raised red flags about Mr. Stanford's operation in four
exams conducted over 8 years, beginning in 1997, concluding in
each examination that Stanford's CDs were likely a Ponzi scheme
or a similar fraudulent scheme.
However, the Enforcement staff disregarded the examiners'
repeated warnings, continually turning a blind eye for nearly a
decade. We seemed to have an instance in which one side of the
agency was screaming that there was a fire and the other side
said that the fire was too hard to put out or that it didn't
exist. The Inspector General's report found that one reason
that the Enforcement Division did not want to investigate Mr.
Stanford was the perception that the case was difficult, novel,
and not the type favored by the Commission.
The report also raised a number of troubling facts about
the former Enforcement head of the Fort Worth Office, who
played a significant role in multiple decisions over the years
to quash investigations of Mr. Stanford. All these pieces paint
a picture of regulatory disconnects and mistakes that allowed
this fraud to harm families and communities all across our
Nation.
So we look forward this morning to learning to what the
Commission attributes this regulatory shortcoming. Investors in
Stanford's Ponzi scheme may have lost as much as $8 billion, as
I mentioned earlier, and the damage to investor confidence,
obviously you cannot put a number on that as a result of news
such as this one and the Bernie Madoff scam, as well.
So I look forward, as my colleagues do, to Inspector
General Kotz's insights and a discussion of his findings and I
appreciate the SEC being here with us to let us know what the
Commission is doing to correct what went wrong. I hope that
this hearing will provide the Committee, the Senate, and the
American public with a clear view of how such a large and
audacious fraud was allowed to perpetuate and to grow and what
is being done to fix the system and prevent similar frauds in
the future.
The Dodd-Frank bill was one step in a long journey to
righting this ship, giving the SEC more power, doubling its
funding over 5 years, and having periodic GAO reviews. But our
work is obviously not done. The Inspector General's report also
makes several thoughtful recommendations regarding bringing
enforcement actions in complex cases, evaluating the
performance of the Enforcement staff, coordination among SEC
offices and divisions, staff training, and other matters.
Investors deserve to know there is a cop on the beat working
hard to protect them from the scam artists like Robert Allen
Stanford and Bernie Madoff.
Restoring investor confidence and certainty in the fairness
of our financial system is vitally important as we recover from
this economic crisis. The SEC should use all of its resources
at its disposal to work toward that end.
Let me also say very quickly, before I turn to Senator
Shelby, because I always think it is important to make this
point, obviously we are going to talk about an office in Fort
Worth. We are going to talk about some people even here in
Washington who should have done a better job. But I always
think it is important in moments like this to also point out
and recognize that there are thousands of people who work in
the SEC who do an incredible job every day, and I don't want a
hearing like this, where we focus on the misfeasance or
malfeasance even of some to contaminate the hard work done by
others who do a good job every day.
So even though our remarks are tough and the questions will
be tough this morning about what happened here, I want also the
employees who are not in this room but work for the SEC to know
how much we appreciate how hard they work every day and how
determined they are to do a good job for our country. And so I
want our opening remarks to reflect those attitudes, as well,
as we go forward.
Senator Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman. Thank you very
much for holding this hearing.
The Stanford case, as you have pointed out, represents a
major failure by the Securities and Exchange Commission in
carrying out its investor protection mandate. Investors, as you
have pointed out, were defrauded of billions of dollars and
thousands of victims have had their lives shattered as a
result. One of those victims from my home State of Alabama,
Craig Nelson, testified at last August's field hearing on the
Stanford case that you referenced Senator Vitter presided over.
We now know that Allen Stanford openly flaunted the money
that he stole from his victims. He used it to buy part of a
Caribbean island, to bribe foreign securities regulators, and
fund sporting events. His victims deserve to know how this
could have happened, hence this hearing.
Last October, Senator Vitter and I sent a letter to the
Inspector General of the SEC asking him to supplement the
limited review that had been conducted of the SEC's record in
the Stanford matter. We asked him to look into, among other
things, the history of the SEC's oversight of Stanford. What we
learned was extremely disturbing.
The IG's findings, which we will get into later here today,
indicate that the SEC produced reports, as Senator Dodd pointed
out, in 1997, 1998, 2002, and 2004 that determined that fraud
was occurring at Stanford. Further, the IG found that
enforcement action was not taken following the findings, even
though the Examination staff repeatedly requested that the
Enforcement staff pursue such action at the SEC. Finally, the
Inspector General found that a particular member of the
Enforcement staff involved in making the determination not to
pursue enforcement action later sought employment with
Stanford.
Ultimately, it was not until after the Madoff Ponzi scheme
was uncovered that any action was taken in the Stanford case,
despite all these warnings. In the end, SEC inaction allowed
the fraud to grow larger and swallow the life savings of
numerous additional victims.
I believe that the SEC's gross negligence with respect to
the handling of the Stanford case involves even more
significant failures than were present in the Madoff fraud in
some ways. In contrast to Madoff, where the SEC's examiners did
not find fraud, in the Stanford case, give them credit. The
SEC's examiners were not only aware of the fraud, they
prevailed upon the Enforcement Division in the SEC to take
action and they refused.
The findings of the SEC's gross negligence in the IG's
report are not the only troubling aspect of the SEC's conduct
in the Stanford case. The Securities and Exchange Commission
chose to release the report in the height of Congressional
action on regulatory reform and on the very same day that it
announced its decision to pursue charges against Goldman Sachs.
Think about it. In many ways, it appears that the timing of the
release was intended to draw the least amount of scrutiny to
the SEC for their failures.
Today, we will hear from the SEC Inspector General, the
heads of the SEC's Examination and Enforcement programs, and
the head of the Fort Worth Office. I believe that this should
mark just the beginning of our review of this troublesome
episode. We need to know exactly why evidence of fraud was not
more thoroughly pursued. We need to know who was involved in
reviewing this evidence and why they failed to connect the
dots. Moreover, we need to examine the Commission's general
response to these findings so that we can be sure that
corrective measures are being taken to prevent a repeat of
these institutional failures. Otherwise, we will go down the
road again.
Senator Dodd, I appreciate again you holding this hearing
and look forward to the Inspector General.
Chairman Dodd. Thank you, Senator, very, very much.
I mentioned, David, before you came in that you had a very
good hearing in Louisiana, back 6 months ago, 7 months ago,
whenever it was, and I thank you for that and thank Senator
Shelby.
Unless someone would like to be heard, I am going to go
right to our witness. Yes, certainly, go ahead.
STATEMENT OF SENATOR DAVID VITTER
Senator Vitter. I won't take long, Mr. Chairman, but very
briefly, first of all, thank you and thanks to the Ranking
Member for all of your help to me and all of your leadership on
this. This is a very important matter to me for an unfortunate
reason, because so many victims live in Louisiana, and you all
have been extremely supportive in helping us follow up on this,
including that field hearing in Louisiana, including this
hearing today.
I completely concur with your comments and Senator Shelby's
comments. This isn't just one major disappointing scandal. It
is really three. It is the original Stanford Ponzi scheme
fraud, which is horrible and created so many victims, including
so many in Louisiana. On top of that, it is the inaction by the
SEC, which I think is absolutely scandalous now that we are
finally discovering all of the facts. And on top of that,
number three is this conscious effort that Senator Shelby
alluded to of the SEC to cover its tracks, to basically try to
rewrite history in terms of when it knew about the problem.
So this is very disappointing and very frustrating and we
have to ensure that this doesn't happen again. We also have to
do everything possible to properly handle the ongoing issues
with the Stanford victims.
So thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Senator Hutchison. Mr. Chairman, could I just----
Chairman Dodd. Yes, certainly, Senator Hutchison.
STATEMENT OF SENATOR KAY BAILEY HUTCHISON
Senator Hutchison. I won't belabor this long, but I also
want to add that so many of my constituents in Texas were
victims. Reading the IG report, it is stunning. It is stunning,
the times that the SEC had notice both from the Texas
Securities Board and from internal reports from within the SEC
at the field office, and yet years went on.
And so I thank you for holding this hearing. I hope that
with the IG report, we will be able to assure that there are
systems in place at the SEC that will eliminate this in the
future and go forward so that people can have confidence in
their investments with someone as big as Mr. Stanford. Thank
you.
Chairman Dodd. I appreciate that.
Senator Johnson. Mr. Chairman?
Chairman Dodd. Senator Johnson.
Senator Johnson. May I submit my statement.
Chairman Dodd. Certainly. By the way, any opening
statements that all of our colleagues have and any other data
or information will be included.
Let me just say, as well, as we will hear obviously from
our witnesses, and I suspect that we did some things in the
financial reform bill that we enacted, but as I indicated, I
think there are a lot of other areas where it may require some
legislative action, and that will be the job for Tim Johnson
and Richard Shelby and Members of this Committee. Jim Bunning
and I won't be here to be a part of it, but I suspect you have
got some----
[Laughter.]
Chairman Dodd. No, no. Well, I will regret not being here.
I have enjoyed my work with my colleagues immensely, but I
think there are some areas here that we didn't include and
cover in our legislation that may warrant some legislative
action. I will leave that to others to make the determination,
Tim and Richard in the coming months.
But this morning, I want to introduce briefly our Inspector
General--and I will also just take a minute and introduce all
of the second panel, as well, and then we will get just right
to it.
David Kotz has served as the Inspector General for the SEC
since December of 2007. He leads a very distinguished team of
auditors, investigators, administrative staff in the Office of
the Inspector General's efforts to uphold the effectiveness,
efficiency, and integrity of the SEC. He has testified before
this Committee last September, in fact, in our hearing on the
oversight of the SEC's failure to identify the Bernard Madoff
Ponzi scheme and how to improve SEC performance, and we thank
you very much for being back before us again today.
Robert Khuzami is the Director of the Division of
Enforcement of the U.S. Securities and Exchange Commission. He
joined the staff in February of 2009, and as Director, Mr.
Khuzami is responsible for the civil law enforcement efforts of
more than 1,200 SEC personnel located in 12 offices around the
country. Previously, he worked as General Counsel for the
Americas for Deutsche Bank, and before that served as a Federal
prosecutor. He also testified before the Committee last
September.
Carlo V. di Florio became the Director of the Office of
Compliance Inspections and Examinations at the SEC in January
of 2010. Prior to joining the Commission, Mr. di Florio was
partner in the Financial Services Regulatory Practice at
PriceWaterhouse Coopers, with expertise in corporate
governance, enterprise risk management, and regulatory
compliance and ethics.
Rose Romero has been the Regional Director for the Fort
Worth District Office of the SEC since March of 2006. In that
role, she oversees the enforcement and examination programs for
the region. Prior to joining the SEC staff, Ms. Romero was the
Executive Assistant United States Attorney for the Northern
District of Texas. She testified representing the SEC at the
Banking Committee's hearing last August on the alleged Stanford
Financial Group fraud. That was the hearing, David, I think, in
Louisiana that Ms. Romero testified.
So we welcome the witnesses this morning, all of you, and
again, David, we will begin with your testimony. And again, any
data and information that you and the rest of the witnesses
have will be included in the record. I will just make a blanket
acceptance of any documentation you would like for us to have
on this oversight hearing. With that, the floor is yours.
STATEMENT OF H. DAVID KOTZ, INSPECTOR GENERAL, SECURITIES AND
EXCHANGE COMMISSION
Mr. Kotz. Thank you. Good morning. Thank you for the
opportunity to testify before this Committee today on the
subject of the SEC Inspector General's report on the SEC
response to Robert Allen Stanford's alleged Ponzi scheme. I
appreciate the interest of the Chairman, the Ranking Member, as
well as the other Members of the Committee and the SEC and the
Office of Inspector General.
In my testimony today, I am representing the Office of
Inspector General and the views that I express are those of my
office. They do not necessarily reflect the views of the
Commission or any Commissioners.
I would like to begin my remarks this morning by briefly
discussing the role of my office and the oversight efforts we
have undertaken. The Office of Inspector General has staff in
two major areas, audits and investigations. Over the past 2\1/
2\ years since I became the Inspector General of the SEC, my
office has issued numerous audit reports involving matters
critical to SEC programs and operations, as well as the
investing public, including an examination of the Commission's
oversight of Bear Stearns and the factors that led to its
collapse, an audit of the SEC Division of Enforcement's
practices related to naked short-selling, complaints and
referrals, a review of the SEC's bounty program for
whistleblowers, and an analysis of the SEC's oversight of
credit rating agencies.
My office's Investigative Unit has also issued numerous
investigative reports regarding the failures by the SEC
Enforcement Division to pursue investigations vigorously or in
a timely manner, improper securities trading by Commission
employees, whistleblower allegations of contract fraud,
preferential treatment given to prominent persons, and
retaliatory termination.
In August 2009, we issued a 457-page report of
investigation analyzing the reasons why the SEC failed to
uncover Bernard Madoff's $50 billion Ponzi scheme.
On October 9, 2009, I received a letter from the Ranking
Member of this Committee, the Honorable Richard Shelby, and the
Honorable David Vitter, requesting a comprehensive
investigation of the handling of the SEC's investigations and
examinations into Robert Allen Stanford and his various
companies. Very shortly thereafter, on October 13, 2009, we
opened our investigation.
As part of this effort, we made numerous requests to the
SEC's Office of Information Technology for the e-mails of
current and former SEC employees for times pertinent to the
investigation. The Office of Information Technology provided e-
mails for a total of 42 current and former SEC employees for
time periods ranging from 1997 to 2009. We estimate that we
obtained and searched over 2.7 million e-mails during the
course of our investigation.
In addition, we sent comprehensive document requests to
Enforcement and the SEC's Office of Compliance Inspections and
Examinations, own as OCIE, specifying the documents and records
we required to be produced for the investigation. We also
sought documents from FINRA, including documents concerning
communications between FINRA or its predecessor, the NASD, and
the SEC concerning Stanford. We carefully reviewed and analyzed
the information received as a result of our requests.
We also conducted 51 testimonies and interviews of 48
individuals with knowledge of facts or circumstances
surrounding the SEC's examinations and/or investigations of
Stanford and his firms. I personally led the questioning and
the testimony interviews the witnesses in this investigation.
On March 31, 2010, we issued to the Chairman of the SEC a
comprehensive report of our investigation in the Stanford
matter, containing over 150 pages of analysis and 200 exhibits.
Our investigation determined that the SEC's Fort Worth Office
was aware since 1997 that Robert Allen Stanford was likely
operating a Ponzi scheme, having come to that conclusion a mere
2 years after Stanford Group Company, Stanford's investment
advisor, registered with the SEC.
We found that over the next 8 years, the SEC's Fort Worth
Office conducted four examinations of Stanford's operations,
finding in each examination that the CDs Stanford was promoting
could not have been legitimate and it was highly unlikely that
the returns Stanford claimed to generate could have been
achieved with the purported conservative investment approach
utilized. The SEC's Fort Worth examiners conducted examinations
of Stanford in 1997, 1998, 2002, and 2004, concluding in each
instance that Stanford's CDs were likely a Ponzi or similar
scheme. The only significant difference in the Examination
Group findings over the years was that the potential fraud was
growing exponentially, from $250 million to $1.5 billion.
The Fort Worth Examination Group made multiple efforts
after each examination to convince the Enforcement Group to
open and conduct an investigation of Stanford. However, we
found that the Enforcement Group made no meaningful effort to
investigate the potential fraud until late 2005.
In 1998, the Enforcement Group opened a brief inquiry, but
closed it after only 3 months when Stanford failed to produce
documents evidencing the fraud in response to a voluntary
document request. In 2002, no investigation was opened, even
after the examiner specifically identified multiple violations
of securities laws by Stanford. In 2003, after receiving three
separate complaints about Stanford's operations, the
Enforcement Group decided not to open up an investigation or
even an inquiry and did not follow up on the complaints.
In late 2005, after a change in leadership in the
Enforcement Group and in response to continuing pleas by the
examiners, who had been watching the potential fraud grow in
examination after examination, the Enforcement Group finally
agreed to seek a formal order from the Commission to
investigate Stanford. However, even at that time, the
Enforcement Group missed an opportunity to recommend an action
against Stanford Group Company, or SGC, for its admitted
failure to conduct any due diligence regarding Stanford's
investment portfolio, which could have potentially halted the
sales of the Stanford International Bank CDs through the SGC
Investment Advisor and would have provided investors and
prospective investors with notice that the SEC considered SGC's
sales of the CDs to be fraudulent. We found that this
particular action was not considered partially because the new
head of the Enforcement Group in Fort Worth was not aware of
the findings of the investment advisors' examinations in 1998
and 2002, or even that SGC had registered with the SEC as an
investment advisor, a fact she learned for the first time
during our investigation in January of 2010.
We did not find that the reluctance of the Enforcement
Group to investigate Stanford was related to any improper
professional, social, or financial relationship on the part of
any current or former SEC employee. We did find evidence,
however, that SEC-wide institutional influence within the
Enforcement Group factored into its repeated decisions not to
undertake an investigation of Stanford, notwithstanding staff
awareness that the potential fraud was growing.
We found that senior Fort Worth officials perceived that
they were being judged on the number of cases they brought, so-
called ``stats,'' and communicated to the Enforcement staff
that novel or complex cases were disfavored. As a result, cases
like Stanford, which were not considered quick-hit or slam-dunk
cases, were not encouraged.
We also found that the former head of Enforcement in Fort
Worth, who played a significant role in multiple decisions over
the years to quash investigations of Stanford, sought to
represent Stanford on three separate occasions after he left
the Commission, and, in fact, represented Stanford briefly in
2006 before he was informed by the SEC Ethics Office that it
was improper for him to do so.
In summary, our report concluded that the SEC's Fort Worth
Office was aware since 1997 that Stanford was likely operating
a Ponzi scheme after conducting examination after examination
for a period of 8 years, but merely watched the alleged fraud
grow and failed to take any action to stop it.
We provided our report to the Chairman of the SEC on March
31, 2010, with the recommendations that the Chairman review its
findings and share with Enforcement management the portions of
the report that related to the performance failures by
employees who still work at the SEC so that appropriate action
would be taken.
We also made the following specific recommendations to
improve operations within the SEC. One, that Enforcement ensure
that the potential harm to investors if no action is taken is
considered as a factor when deciding whether to recommend an
enforcement action.
Two, that Enforcement emphasize the significance of
bringing cases that are difficult but important to the
protection of investors in evaluating the performance of an
Enforcement staff member or a regional office.
Three, that Enforcement consider the significance or the
presence or absence of United States investors in determining
whether to open an investigation or recommend an enforcement
action that otherwise meets jurisdictional requirements.
Four, that there be improved coordination between
Enforcement and OCIE on investigations, particularly those
initiated by an OCIE referral to Enforcement.
Five, that Enforcement reevaluate the factors utilized to
determine when referral of a matter to State securities
regulators in lieu of an SEC investigation is appropriate.
Six, that there be additional training of Enforcement staff
to strengthen their understanding of the laws governing broker-
dealers and investment advisors.
And seven, that Enforcement emphasize the need to
coordinate with the Office of International Affairs and the
Division of Risk, Strategy, and Financial Innovation as
appropriate early in the course of the investigation.
My office is committed to following up on all the
recommendations made in our Stanford report to ensure that
there are appropriate changes and improvements in the SEC's
operations. We are aware that many improvements have already
been undertaken under the direction of Chairman Schapiro and
Enforcement Director Khuzami as a result of the findings and
many recommendations arising from our Madoff investigation. We
also understand that Enforcement has initiated actions on our
Stanford recommendations and are confident that the SEC will
take the appropriate steps to implement our recommendations and
ensure that fundamental changes are made in the SEC's
operations to remedy the errors and failings we found in our
investigation.
I appreciate the interest of the Chairman, the Ranking
Member, and the Committee in the SEC and my office, and in
particular in the facts and circumstances pertinent to our
Stanford report. I believe that the Committee's and Congress's
continued involvement with the SEC is helpful to strengthen the
accountability and effectiveness of the Commission. Thank you.
Chairman Dodd. Thank you very much, Mr. Kotz. I appreciate
that very much.
Let me ask the clerk, why don't you put on 7 minutes here?
We do not have a full complement here. That will give people a
chance at least to get a couple of questions in as we try and
move along.
Some of the questions I have you anticipated to some degree
in your comments, but I want to pursue a couple of them in a
little more detail, if I can, anyway. The SEC brought its
action against Stanford 12 years--12 years--after the first
reports from examiners that he was likely operating a Ponzi
scheme, a conclusion that examiners reached on four separate
occasions. Again, Senator Shelby emphasized this point. I think
a good point he made, that unlike the Madoff issue, here you
actually had examiners--Madoff, there were reports from
individuals to the SEC that they thought something was wrong,
but as I recall, it was nothing within the SEC itself--not to
excuse that behavior but, nonetheless--but in this case, here
you had four occasions of examiners over a 12-year period
making those reports. And then, of course, immediately after--2
months after Madoff confessed to law enforcement officials that
he was running a $50 billion scheme, you ended up with the SEC
acting.
So my question obviously comes: Had Madoff not confessed,
in your view, as you looked over these materials now and raised
awareness about Ponzi schemes, would the Commission have
brought this case against Stanford, in your view?
Mr. Kotz. I certainly think that there was a connection. I
mean, the SEC was investigating Stanford----
Chairman Dodd. Please turn on your mic.
Mr. Kotz. Yes, I certainly think there was a connection. I
mean, the SEC was investigating Stanford prior to the Madoff
confession. However, they were sort of at a standstill at that
point. But I think the dynamic shifted in the SEC when Madoff
confessed.
As I talked about in my testimony, there was a feeling that
you did not want to bring a novel or complex case. You wanted
to bring the quick-hit, slam-dunk case. And you might be
criticized if you came up with something that was difficult.
And because Stanford had international issues, it was a more
complicated case.
But after Madoff confessed, at that point the dynamic
shifted, and at that point, if you were holding onto a
potential Ponzi scheme case that you did not bring, you would
be criticized more for that than you would if you brought forth
a complicated case. So I do think it had an impact in that way.
Now, certainly they were investigating it. They started
finally--after many years of the examiners pushing, they
finally started investigating in late 2005. They were moving
forward with the investigation. The Department of Justice asked
them to hold off because the Department of Justice was
conducting a criminal investigation. But when Madoff hit, they
went to the Department of Justice and essentially said, ``We
are not holding off anymore. We are going forward. We cannot
have a case going on in our midst that relates to a Ponzi
scheme that we are not bringing.''
So there was certainly----
Chairman Dodd. So let me just--in your opinion, then, in
the absence of the Madoff confession, we might have then gone a
longer time before the Stanford case went forward.
Mr. Kotz. Right. I mean, I think it probably would have
been eventually brought anyway, but there was a clear urgency
at that point.
Chairman Dodd. Let me ask you, if I can--obviously, we know
about the troubles in the SEC's Fort Worth district office
regarding suspicions about Stanford's operations, but let me
ask you this: Do you believe that the Commissioner staff of the
SEC's Washington office should or could have done more to bring
an end to this fraud?
Mr. Kotz. This was a matter that really was not raised with
Washington. I mean, it is interesting because----
Chairman Dodd. They were not aware of this at all?
Mr. Kotz. Not really, no. I mean, the offices are, you
know, relatively independent. They work on matters themselves.
Certainly at a certain point in time in late 2005, when they
finally decided to bring the action, they have to go the
Commission and----
Chairman Dodd. In 1997, 1998, nothing managed to make way
up to the Washington office that something was going on down
there?
Mr. Kotz. No. There is no evidence that anyone in the
Washington office knew about the examinations that occurred in
1997, 1998, 2002, 2004, until the formal order was made.
Chairman Dodd. Let me go back, if I can, on this point on
stats and easy cases, as you point out. Your report--and I am
quoting from it here--says, ``SEC-wide institutional influence
within the enforcement did factor into repeated decisions not
to undertake a full and thorough investigation of Stanford,
notwithstanding staff awareness that the potential fraud was
growing. We found''--speaking of your report--``that senior
Fort Worth officials perceived that they were being judged on
the numbers of cases they brought, so-called ``stats,'' and
communicated to the enforcement staff that novel or complex
cases were disfavored. As a result, cases like Stanford were
not considered quick-hit or slam-dunk.''
Have you looked beyond this matter? I mean, if that is the
case, were there other matters that are now showing up
nationwide that were ``novel or more complex cases,'' that
recommendations made by enforcement officers that were not
brought because they were novel or complex and did not fit into
the--what did you call it?--the slam-dunk or quick-hit? It
seems to me like this was not sort of a narrow path between
enforcement and Fort Worth. It sounds like it was a nationwide
issue. And to what extent have you looked at or has the IG's
office looked at other offices around the country to determine
whether or not matters are lingering out there such as this?
Mr. Kotz. Well, we have not done sort of a broad audit of
the matter, but, I mean, certainly it was--there was a
competition between the regional offices to see who could get
the best numbers, and the Fort Worth office was very proud of
the fact that their numbers were very high, and so it was
something that was not limited to just Fort Worth at that time.
Now, I think that things have changed somewhat and there
have been efforts by Director Khuzami to move away from that--
--
Chairman Dodd. Some what have changed?
Mr. Kotz. Well, I think that there have been efforts made--
and he can certainly talk about it more than me--to change that
perception, for example, to change the evaluations of senior
officials so they are not evaluated on the numbers of cases
they brought. But I do think it takes time to change that
culture. When you have such an embedded culture in an agency,
you know, that you want to just bring--you want to show how
many cases you brought--I mean, there was a conversation, a
speech made by a former SEC person who said that, you know,
Worldcom was one, Enron was one. You know, those were only
counted as one case, and yet obviously they are very important,
significant cases. And there are ways where you can bring a lot
of little cases and get your numbers up. So it is a matter of
great concern, and I do think that it went beyond the Fort
Worth office.
Chairman Dodd. Well, I will be anxious to hear from Mr.
Khuzami what steps have been taken. You mentioned March 2010,
the recommendations. But, clearly, I hope there is going to be
some examination beyond this. I hate to think we are having
these hearings repeatedly as matters surface later on and we
find out these were not one-off, but this was more of a broader
problem. That is what I am getting at.
Mr. Kotz. Right.
Chairman Dodd. You do not seem to have any indication, or
at least you do not believe there is any broader problems that
we ought to be paying attention to.
Mr. Kotz. We are not aware of any specific cases. You know,
it is sort of hard to know what cases were not brought. But, I
mean, I think it is something to----
Chairman Dodd. Examiners, have the examiners, has anyone
been talking to examiners around the country to find out
whether or not there were similar problems anyplace else?
Mr. Kotz. Well, I do think that the examiners--we have had
discussions with the new head of the examination----
Chairman Dodd. What about the old ones? I know the new ones
are OK, but tell me about the old ones. Has anyone brought them
in and said, ``Did you have problems anywhere else in the
country besides Fort Worth?''
Mr. Kotz. Yes, I am not aware specifically that has been--
--
Chairman Dodd. Why didn't we do that?
Mr. Kotz. I do not know. I think that you could talk to the
head----
Chairman Dodd. Yes, but you are the IG. You are the guys
who did the report. Did you ask them whether or not--were there
any problems like this anywhere else in the country we ought to
be aware of?
Mr. Kotz. Yes, I mean, I think that generally there are
some instances where there are frustrations on the part of
examiners, but that is something that, you know, can be looked
at certainly on a broader level. We could interview examiners
all over the country.
Chairman Dodd. Well, I would hope so. It seems to me that,
otherwise, you are having a bunch of quick-hit stat kind of
approach--and it was not just the Fort Worth office. This was
sort of a systemwide approach. Then to what extent were
examiners frustrated in other parts of the country on matters
that were ``novel or more complex'' that may have involved a
lot more damage than the small cases? I presume the quick-hit,
stat numbers are that small insider trading piece or something.
I do not want to minimize the problem, but it seems to me in
the context of the damage done.
Mr. Kotz. Right. I mean, our recommendation was that they
should consider the amount of investors that was affected,
because you can have a small matter that affected five
investors, or you can have a complicated matter that affected
millions.
Chairman Dodd. Right. Others may have similar point, but I
hope you might go back. I would like to know the answer to
whether or not from examiners they had any other areas around
the country where they felt frustrated about conclusions they
were drawing and the reluctance either on the regional office
or in the national office to respond to those requests.
Mr. Kotz. Absolutely.
Chairman Dodd. All right. I have gone over my time. I
apologize. I have several more questions, but let me turn to
Senator Shelby.
Senator Shelby. Thank you, Senator Dodd.
I want to pick up on the area Senator Dodd was in, Mr.
Inspector General. Where was the SEC Enforcement Division? You
talked about there were recommendations made in the Stanford
case on, what, four or five occasions?
Mr. Kotz. Yes.
Senator Shelby. And they ignored it, basically. Was it the
atmosphere there or the working conditions, as you indicated,
for--in the metric area, how many cases we could have, we could
get the easy ones, but the difficult ones, the big ones, gosh,
they were tough, they were strong. But that is where the big
frauds are.
Mr. Kotz. Right.
Senator Shelby. Where was the leadership of the Enforcement
Division not just in Fort Worth but at the SEC here? Because it
came from here. It had to. Where were the--and are those same
people still in Enforcement?
Mr. Kotz. Yes, well, I mean, certainly----
Senator Shelby. And if so, why? Why are they still there?
Mr. Kotz. Certainly in Fort Worth, the head of Enforcement
and to some extent the head of the Fort Worth office very much
believed in this metrics approach, and they certainly perceived
that the Enforcement Division in Washington thought that
approach was important because, as I said----
Senator Shelby. Were they counting beans? In other words,
they wanted to count how many cases they had, they had solved,
but in the scheme of things, they were small cases compared to
Madoff and the case in hand, Stanford, involving billions of
dollars.
Mr. Kotz. Right.
Senator Shelby. Were they not competent enough or were they
afraid of something this big? Or was it leadership from
Washington? Leadership had to come from the SEC here to Fort
Worth or to New York or to Los Angeles, or wherever else.
Mr. Kotz. Right. I mean, certainly the fact that the Fort
Worth office thought it was being sort of graded on how many
cases it brought, that came from Washington, because that is
the way they would look at the offices and determine how good a
job they are doing.
Senator Shelby. And when they were talking about how many
cases, did they look into the substance? Just to use an analogy
to criminal cases, were they speeding cases or reckless driving
as opposed to fraud, murder, robbery, and so forth? In other
words, were these statistically minor cases compared to
complicated cases?
Mr. Kotz. Right. I mean, I think probably many of them were
more minor cases because, obviously, it is easier to do a minor
case quicker. You know, they had decisions to make about
resources, and they did not want to use the resources on
Stanford because it would take a long time to get a case. And
so they could have people working on it for a year and not have
a stat to show for it in that whole year. Well, if they worked
on other cases----
Senator Shelby. But that is no way to do business, is it?
Mr. Kotz. Absolutely.
Senator Shelby. And what did you say in your report about
doing this instead of substance, which they should have gone
after, statistical stuff?
Mr. Kotz. Right. I mean, you know, we----
Senator Shelby. What did you say in your report, you, the
Inspector General?
Mr. Kotz. We said that it is inappropriate to act that way
and that that is not the responsibility of the SEC. The SEC's
responsibility is with respect to investors. There were
investors out there who were getting hurt. The examiners knew
that they were getting hurt. Even the enforcement folks knew
that they were getting hurt. In fact, some of the enforcement
folks we talked to said, ``Oh, we thought that it was a Ponzi
scheme.'' So, I mean, they were sitting there watching a
potential Ponzi scheme go on, but making decisions, you know,
for their own betterment of stats and not looking into it and
not taking appropriate action. It is outrageous.
Senator Shelby. Well, any way you look at it, this is a
colossal failure of the SEC. I mean, let us be honest. You are
the Inspector General. This is a colossal failure to do their
job. And why was the SEC set up? To protect the investor. Is
that right?
Mr. Kotz. Right.
Senator Shelby. So they failed big time in protecting the
investor in both the Madoff and in the current Stanford case.
And in the Stanford case, as Senator Dodd says, they had all
these warnings from their own staff.
Mr. Kotz. Yes.
Senator Shelby. Did the people in enforcement in Fort
Worth--I mean, when the examiners recommended things, brought
it to the attention of enforcement, did the people in
enforcement in the regional area--when they did not do
anything, did the examiners take it further up? Is there a
chain of command they could have brought this right to somebody
like you or somebody in Washington? What the heck is going on
here? Is this a cover-up? It is obviously gross negligence if
not a cover-up and a failure of leadership.
Mr. Kotz. Right. I mean, they did not take it----
Senator Shelby. Is it not?
Mr. Kotz. Yes, absolutely. They did not take it to our
office or Washington, but they did take it up the chain. And
finally they were able to convince the enforcement group in
Fort Worth to bring it because there was a new head of
enforcement, and they went to that person and lobbied, and
there were memos back and forth and great efforts by the
examiners to convince this new leader, and this new leader
finally agreed to open the investigation.
Senator Shelby. These people that I mentioned, whoever they
are, are they still working in enforcement after such a failure
like this? And if so, why?
Mr. Kotz. Well, many of the people are different. The head
of the Fort Worth office has changed since then. The head of
enforcement in the Fort Worth office has changed since then.
Some of the line people are still there, and, you know, in our
report, we recommended that the SEC look to see if disciplinary
action has been taken.
Senator Shelby. Well, why are they there? It dumfounds me
as to why these people who failed on one of the biggest frauds
in SEC history, where they had information, did not pursue it--
not once, not twice. How many times? Four times. You are the
Inspector General, and I know you are sincere and you are doing
your job, but this just looks like the SEC failed the investor,
not once, not twice, but four times, big time.
Mr. Kotz. Yes, no, I agree. And, you know, we recommended
that action be taken as a result.
Senator Shelby. So the SEC basically broke down in their
job and responsibility, didn't they?
Mr. Kotz. Yes.
Senator Shelby. OK. Thank you, Mr. Chairman.
Chairman Dodd. Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
Mr. Kotz, it seems impossible and outrageous that it took 8
years from the time that possible fraud was identified before
the SEC spent any energy on enforcing the law. Now, the SEC's
job is to protect the investors. That is their only job. I
mean, they have got a lot of other peripheral jobs, but they
are basically paid to protect the investor.
Now, if the investigations four times said, you know, here
we have got a guy here or a company here who is running what we
think is a Ponzi scheme--and I do not care what credits you get
at the SEC in Washington. Your job is to protect the investor.
And every day that they did not do that, the scandal got
bigger. It went from hundreds of millions of dollars. It is
approximately $8 billion. We drink more than that in a week up
here. I mean, that is so outrageous that the investor has been
bilked out of $8 billion because of incompetence, because that
is exactly what it was. Or they were trying to make points with
the SEC in Washington, DC, by this scheme of metric approach.
Tell me what is going on. Tell me. Tell me how that
happens.
Mr. Kotz. Yes, I mean, I agree, you know, and our report
discusses it. It is outrageous. And, in fact, you know, one of
the issues initially that they looked at in deciding not to
bring an investigation is that there were no U.S. investors.
Ironically, had they brought an investigation at any of those
stages, they would have been potentially able to stop the
fraud, the alleged fraud, before----
Senator Bunning. Yes, and stop the losing of the money.
Mr. Kotz. Right, before any U.S. investors came in, because
initially there were no U.S. investors, and then over time
there were U.S. investors. So, you know----
Senator Bunning. Ask the people in Texas and Louisiana.
Mr. Kotz. Right. Right. And so, I mean, if they had been
able to take action earlier, they could potentially have made
it such that there would never have been U.S. investors. And,
in fact, when they did their examinations and did not
necessarily take investigative action, the investors' message
that they got was everything is OK. And as in Madoff, Stanford
used that--you know, when there would be questions about his
returns, he would say or his financial advisers would say,
``Well, we just got a clean bill of health from the SEC.'' And
the SEC would come and do an examination. They would issue
these deficiency letters, which are relatively minor, depending
on the type of deficiency, and something that a lot of folks
get in examinations. And so he would say, well, you know, we
just came, and we talked to many investors who said that if
there was any hint at all that there was a problem, they would
have stopped, absolutely.
Senator Bunning. One of the troubling parts of your report
involves the former head of enforcement at the Fort Worth
branch of the SEC. He made several important decisions over the
years about not pursuing the Stanford case. Then he left the
SEC. He represented Stanford briefly and tried to represent
them over and over again, even after being told no on three
separate occasions by the SEC Office of Ethics. He also told
the Office of Ethics that he did not remember--he did not
remember participating in decisions about the Stanford case
while he was at the SEC. Are you kidding me?
Mr. Kotz. It is stunning. It is absolutely stunning.
Senator Bunning. I mean, that to me is criminal negligence,
and the sooner they get him before a U.S. court, the better I
will like it.
Mr. Kotz. Absolutely.
Senator Bunning. I mean, to allow that to happen--I almost
fell out of my chair when I heard the reasons he gave you for
trying to represent Stanford. This is a quote from your----
Mr. Kotz. Right.
Senator Bunning. ``Every lawyer in Texas and beyond is
going to get rich over this case. OK? And I hate being on the
sidelines.''
That is the quote he gave you?
Mr. Kotz. Yes.
Senator Bunning. Well, does that look to you like a little
bit of criminal negligence or something like that?
Mr. Kotz. Yes, well, I mean, I do not want to go into the
details, but we have had discussions with criminal authorities
about whether there would be any criminal action arising out of
that.
Senator Bunning. But the SEC for 13 years has sat on their
hands. So if you do not get the Justice Department involved in
this, shame on you as the Inspector General.
Mr. Kotz. Again, we have had those discussions. You know,
to the extent that they are ongoing cases, I do not want to
talk about them specifically.
Senator Bunning. Fine. You do not have to talk about the
case specifically.
Mr. Kotz. But we have had those discussions, absolutely.
Senator Bunning. You mentioned in your testimony that his
behavior appears to violate State bar rules. Can you tell me
first whether this issue was referred to the State bar for
possible discipline; and, second, whether this was referred to
the Justice Department for possible prosecution or false
statements made to the SEC Office of Ethics?
Mr. Kotz. Yes. On both counts, essentially yes. The Ethics
Office in the SEC is the one that refers it to the bar. We
recommended they do so, and my understanding is they either
have or are in the process of doing so now. And, yes, we have
had discussions with, as I said, the Department of Justice and/
or FBI.
Senator Bunning. This is a stunning case, knowing that the
SEC has changed hands and things, that they would not jump down
this after the Madoff--Bernie--after his case hit the papers
and then they released all the documents on the one in Fort
Worth trying to say, oh, we got one but it is not as big.
Mr. Kotz. Right.
Senator Bunning. I have gone over my time, but it just is
stunning to me.
Thank you.
Chairman Dodd. Thank you, Senator.
Senator Hutchison.
Senator Hutchison. Thank you, Mr. Chairman.
How has the SEC responded to your report?
Mr. Kotz. Well, we have, as I said, those specific
recommendations. They have provided information to us
explaining how they have attempted to resolve the
recommendations. We go through a very rigorous process where we
review exactly what they provide. We are in the process of
looking at their responses. In most cases, we think they are
sufficient. In a couple cases, we have gone back and asked for
additional information. In a couple cases, we are going to ask
for them to do more. But they have been responsive to the
specific recommendations in the report.
Senator Hutchison. Could you be more specific about the
areas where you do not think they have provided enough
information? Or are there areas that have not been addressed to
your satisfaction to date?
Mr. Kotz. Sure. I mean, the first issue we are looking at
is to talk about the focus on potential harm to investors, that
that be something that be a clear factor that outweighs other
factors, such as litigation risk. And so where you have a
situation where there is some litigation risk, but on the other
side you have clear harm to investors, that you have to in some
cases value the clear harm to investors over the potential
litigation risk. That is one they have responded to us. They
have made some changes. We would like a little more clarity. We
would like it to be even clearer in their policies and
procedures that harm to investors could outweigh litigation
risk; that even if you have litigation risk, sometimes it is
worth it to bring a case, even if you are going to lose, if
there is significant investors involved.
So, for example, if you brought a case and you believe
legitimately that there was a fraud or a Ponzi scheme, the
investing community would be aware of it. And so even if there
was some possibility that you would lose, nevertheless, there
would be a benefit. So that is one that we are asking for
follow-up.
There are certain clarifying procedures that they have
showed us that we are asking for a little bit more information
in. So I would not say that they are not being responsive to
any particular one, but, you know, when we look at these
responses to our recommendations, we are very careful and very
tough, frankly, to make sure that they respond in all ways.
But I am happy that they have come back with responses, and
we do believe we are going to be able to close out all the
recommendations in short order.
Senator Hutchison. Well, let me ask you on the issues of
the bottom information getting to the top. Both the State
Securities Board in 2003, according to your report, and then
the Fort Worth regional office starting in 1997 had raised
flags. How did you feel the response was to the procedures at
the SEC in Washington to address that both the State Securities
Board and the regional office had given notice that had not
gotten up--I mean, it closed at the Fort Worth regional office
four examinations, according to your report, separate
examinations that were started, and then the State Securities
Board in 2003. So--1997. How do you feel about the response of
the SEC in assuring that information gets from these lower-
level yellow flags, at least, if not red, to Washington.
Mr. Kotz. Right, no, that was a concern, and that is
something we tried to address in our recommendations. You know,
the lower-level folks, or even some higher-level folks, in the
examination group in Fort Worth appealed to the enforcement
folks. But there was not that mechanism for them to go back to
Washington and potentially have the head of the whole program
go to the head of the enforcement program and say, ``We have
got a big problem in Fort Worth. Your folks in Fort Worth are
not taking appropriate action.''
So they felt comfortable only within the independent
office, but there needs to be better collaboration between the
examiners and the enforcers so that the examiners can go all
the way to the top, as far as they could go, to say, ``Look,
here is what is happening in our office. Our office is too
focused on stats, and so, therefore, if there is a fraud, it is
growing.'' You know, they made great efforts in Fort Worth, but
there needs to be a mechanism where they can go beyond Fort
Worth and potentially get Washington's support for their
concerns.
Senator Hutchison. But you do not see that connecting yet?
Or do you?
Mr. Kotz. Right, I mean, they are putting in policies and
procedures to reflect all this. And, you know, our view is that
is a very good thing for policies and procedures to be put in.
But we need to make sure that they work appropriately. And so,
you know, it is all well and good to put in new procedures, and
that is really all you can do now. But we need to make sure
that it works well, you know, in the actual case. And so as
these procedures are put in, we are going to then test them and
audit them to make sure that they are actually doing the job
that they are supposed to be doing.
Senator Hutchison. What about in the area of respect for,
coordination, credibility of State boards? Now, in this case
the State Securities Board was the first one to bring it up,
but in general, in your investigation did you see that there
was a respect for State Securities Boards--or what other States
call them, I do not know. But is that something that needs to
be addressed more carefully as well?
Mr. Kotz. Yes. That was one of our recommendations. You
know, first of all, there were referrals from the State
Securities Board to the SEC which they essentially ignored. At
the same time, in one case a complaint came into the SEC which
involved this Stanford matter, so it was obviously a
complicated matter involving jurisdiction overseas. They
referred it to the State Securities Board. Well, I mean, if the
SEC with its resources was not going to be able to take a case
that involved overseas issues, the small Texas State Securities
Board would not.
So one of our recommendations is to promulgate specific
procedures on that, because in some ways I believe that they
sent it to the Texas State Securities Board as a way to do
something. Well, they had to do something. A complaint came in.
And they did not want to take the case because, of course, it
was a complicated case. Well, if the SEC is not going to take a
complicated case, the Texas State Securities Board is not going
to be able to do it. And then when the Texas State Securities
Board comes back, they need to take those things seriously. So
that is one of the specific issues that we addressed in our
recommendations.
Senator Hutchison. And what about the response on that
point?
Mr. Kotz. Yes, and so, again, they have told us that they
are going to promulgate these procedures to deal with this
issue. We have not seen the procedures yet, and so until we see
them, we are not going to close them out. Obviously, we will
give them some time to put them together. So we are on the
right track. But that is another one that we have not finally
closed.
Senator Hutchison. OK. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Senator Vitter.
Senator Vitter. Thank you, Mr. Chairman. Thank you, Mr.
Kotz, for your work.
I want to go to this SEC official who later worked for
Stanford and tried to do a lot more work for Stanford.
Mr. Kotz. Right.
Senator Vitter. What was his name and title at the SEC?
Mr. Kotz. His name was Spence Barasch, and he was the
Director of Enforcement for the Fort Worth office.
Senator Vitter. And specific, Director for Enforcement for
Fort Worth?
Mr. Kotz. Right.
Senator Vitter. And what involvement did he have in the
Stanford matter as it was passed over for enforcement over and
over and over again?
Mr. Kotz. Well, as I said, initially they opened this
matter under inquiry, which is kind of a prelude to an
investigation, in 1998. He made the decision to close it. There
were also complaints that he reviewed. He participated in
decisions to refer the complaint to the Texas State Securities
Board as opposed to taking the action by the SEC.
Senator Vitter. So it is clear from your investigation that
he affirmatively made the decision to close the matter at that
time, in 1998?
Mr. Kotz. That is what we found, yes.
Senator Vitter. And he claims he does not remember any
involvement?
Mr. Kotz. Well, I mean at the time that he went back to the
SEC's Ethics Office to try to represent Stanford he claimed
that he did not remember any involvement. When we interviewed
him, it came back, and he certainly did remember some
involvement, and we discussed the fact that he was involved in
those decisions. And, in fact, he was the one who told us a lot
about this issue with stats. He explained that this is what he
was looking at, and so a lot of that information did come from
him. So when we interviewed him, he did recollect that he had
some involvement.
Senator Vitter. And have you, or any others, investigated
whether he had conversations while he was at the SEC with
Stanford about future employment?
Mr. Kotz. Yes. Well, there was no evidence of that that we
found. However, as I indicated, there are follow-up efforts
that we are doing in conjunction with other authorities, and
they are going to be looking at those issues as well.
Senator Vitter. OK. I also want to go to Senator
Hutchison's questions about the SEC's reaction to your report.
Specifically, how would you grade their reaction so far about
becoming much less of a statistics-driven culture?
Mr. Kotz. As I said, I think that the intention is there. I
think Chairman Schapiro has proven some leadership on this
issue. I think Director Khuzami has proven some leadership on
this issue. But I do not know that it has necessarily taken.
I mean I think it takes time for a culture to be changed. I
think that the clear message from the top is we are no longer
focused on stats; we are focused on important cases. I think
there have been some examples of that, but what we need to make
sure is that trickles down, all the way down the line.
Senator Vitter. OK. And about when could we expect your
written analysis about how adequate or inadequate the SEC's
reaction to your specific recommendations are?
Mr. Kotz. Yes. So I think we would have to give them, say,
a year or two potentially after the procedures are in place to
figure out whether they are actually working. But yes, I would
say in that timeframe, shortly thereafter, we need to figure
out whether it is just paper procedures or whether it is
actually having an impact.
Senator Vitter. Well before that, could we get a report
about what paper procedures they are at least saying they are
going to implement to address this?
Mr. Kotz. Absolutely.
Senator Vitter. OK. Now Mr. Kotz, you issued your report to
Chairwoman Schapiro and the rest of the SEC on March 31st. As
you know, the report was not released to the public until 3
weeks later, the day, the specific day the SEC charged Goldman
Sachs with fraud which was a bit of a news story. Do you
personally consider that timing coincidental?
Mr. Kotz. Well, I mean that is actually a matter that we
are, in some measure, looking into now. I mean we have been
requested to look at specifically the timing of the Goldman
case because there were allegations made that the timing of the
Goldman case was related to financial regulatory reform, other
allegations about that timing. So that is a matter that
actually we are looking at and we are investigating right now.
We have not concluded the investigation. So it is a little
hard for me to give a full answer, but I will tell you that we
are almost finished with that investigation. That investigation
should be completed within a couple weeks, and it will outline
the more broader issue of what led the SEC to file the Goldman
case the day it did and whether it was related to any other
factors, such as financial regulatory reform, such as to mask
the Stanford case, et cetera.
Senator Vitter. Well, that is certainly important, but I am
not asking about the timing of the Goldman case. I am asking
about the timing of the release of your report the day the
Goldman case was made public in terms of the fraud charges.
Based on what you know, do you think that timing of the release
of your report was coincidental?
Mr. Kotz. I guess certainly one would, it would strain
credulity to think it was coincidental. I cannot say that I
have concluded that for sure because we have a process we go
through when we look at these matters, but certainly it was
suspicious that the day that our report was finally issued was
on the same day as the Goldman action.
However, I would say that there was a process where our
report was redacted. There was a process that actually we were
involved in, and it took some time. So it was not suspicious
per se that it took a few weeks after we issued the report to
have the report issued.
The particular timing with the Goldman case is certainly
something worth looking into. I cannot give you a conclusion
right now because we are still looking at it, but I would
certainly say it is suspicious.
Senator Vitter. Final question about the SEC's reaction to
all this: Who at the SEC has been fired or demoted because of
this gross mismanagement of the Stanford case?
Mr. Kotz. I have not been informed that anyone has.
Senator Vitter. Thank you.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you. Before turning to my colleague
from Tennessee, I want to make a point. In the Madoff hearings,
stats, I asked for there to be reports every 3 months from the
SEC. We have received one, on the progress being made on these
matters.
Again, I am not going to be here, but others will be. This
Committee is going to want to follow this, and you are hearing
it from Members up here. So I will raise the same with the
people who follow you at the table, but it is very important
the Committee be kept abreast of exactly what is happening with
recommendations on these matters, so if you could.
Mr. Kotz. Absolutely, I agree. As I said, I think that this
Committee's involvement is crucial to ensuring that there be
improvements.
Chairman Dodd. Yes. Well again, the promise, the commitment
was made. The question I specifically raised at that hearing
was every 3 months. We have had one.
Mr. Kotz. Yes.
Chairman Dodd. Senator Corker.
Senator Corker. I actually really came to question the
second panel. I think my colleagues have done a very good job,
and I think our witness has too. But since you did mention the
Goldman report, that will be made public in 2 weeks, is that
correct?
Mr. Kotz. Well, the process that we have, and this is not
something within our office's control. Investigative reports
are internal, and then there can be request made for them to be
made public. And then there is a process where the SEC, not our
office, reviews it and redacts it and issues it. That is what
happened in the Stanford case.
So we will, we plan to, issue our report internally within
the next couple of weeks, likely by the end of next week. As
far as how long it will take for the SEC to release, that is
not something that I have any control over.
Senator Carper. OK. I will just wait for the second panel.
Chairman Dodd. Well, fine. Let me just emphasize I want get
to the second panel as well too, but I want to underscore the
point raised by Senator Bunning. I was going to raise the
question myself, regarding--Senator Vitter raised it as well, I
believe--and that is with this head of the Enforcement
Division. I mean this whole issue of then going off and trying
to represent the matter here. I mean obviously, you could spend
a whole day just on that issue alone, but it is stunning to me
in many ways and looks like it was very much a part of the
problem that went on here.
But second, I would really like to request, if I may, this
issue because I have a tendency to believe these are not sort
of one-off matters.
Mr. Kotz. Yes.
Chairman Dodd. It is a national policy or, excuse me, it is
a Commission policy, or it was anyway, to get the sort of quick
hits, the stats up. That was not just focused on the Fort Worth
office. To what extent are you looking at other offices around
the Country as to whether or not a similar conflict emerged?
Now there was a report in the Washington Post back a few, I
do not know whether days or weeks ago now. I had the question
here, that the problems still persist. The Washington Post, in
June, reported that a few years ago the SEC Fort Worth office
changed how it performed inspections, and this ``opened up a
rift between Fort Worth managers and staff that continues
today, undercutting the efforts by SEC leaders in Washington to
build the agency and promote coordination after years of
setbacks, according to current and former SEC officials and
internal agency documents including three separate reports by
the SEC's Inspector General.''
``SEC's regional offices present managerial problems,
become an obstacle to reform'' is the title of the Washington
Post article.
Can you comment on this assertion, the June report in the
Washington Post? Is this still a problem in this office?
Mr. Kotz. We have issued other investigative reports about
the Fort Worth office where we found concerns. So I do not know
if I would go as far as that article, but certainly in other
cases we have found situations there where folks had spoken
out, and when they spoke out they were disciplined. And we
issued reports recommending that action be taken against those
who engaged in that. So we have issued more than our fair share
of investigative reports regarding the Fort Worth office.
Chairman Dodd. Is it ongoing?
Mr. Kotz. Well, we look at particular issues, and those
issues are resolved by our investigation, but it is hard to
know what else is going on. We have information. We look into
it. But these other investigations were involving matters that
were relatively recent. Unlike the Stanford where most of the
time was many years ago, these were relatively recent. So they
may very well be ongoing.
Chairman Dodd. Let me just do this then with you. First of
all, I would like to get as soon as you can, and you can maybe
do it in a written form to the Committee. We do not have to
bring you all the way back here. But I would like to know
whether or not there are ongoing problems within that office
regarding conflicts between the Enforcement Division as well as
the Examination Division. If this is an ongoing problem in that
office, I want to know why and what is being done at the
national level to correct it.
And two, whether or not we are looking at other offices
regionally to determine during this period of time, when the
quick hits and the stat approach was being taken, were other
matters being reported by examiners to enforcement people where
actions were not being taken that we ought to be aware of?
Mr. Kotz. OK. Absolutely. Certainly.
Senator Bunning. May I have one?
Chairman Dodd. Senator Bunning, yes.
Senator Bunning. Let me get one thing straight. You are the
Inspector General for the SEC, correct?
Mr. Kotz. Yes.
Senator Bunning. Are you independent?
Mr. Kotz. Yes.
Senator Bunning. Then why do you submit your reports to the
SEC so they can redact anything, to prevent the public and our
Committee from knowing exactly what you said in the report?
Mr. Kotz. Again, this is not my decision, but I will tell
you that----
Senator Bunning. No, no, no. Why is it your decision to
report to the SEC and not to the public which you have an
obligation to do?
Mr. Kotz. The concern is that there may be nonpublic
information in the reports that I write, and so the----
Senator Bunning. That is up to you.
Mr. Kotz. Well----
Senator Bunning. Listen, I mean I have had inspectors
general before this Committee before, and they did not report
to their specific agency. They reported to us, what you found
out. Now are you telling us that you report to the SEC and they
can redact specific things out of your report so that we never
get to see them?
Mr. Kotz. Our office does not have the authority to make
decisions on nonpublic information by itself. That is something
we have asked for. We do not have that authority, and so
therefore if there is a concern about nonpublic information it
goes through the entire Commission.
Now we are involved in the process to try to ensure that
the information that is redacted is limited, that is only----
Senator Bunning. You need a change in the law then.
Mr. Kotz. All right. I mean we would be happy to issue the
report directly.
Senator Bunning. You have the authority to issue your
reports as you see fit. I thought that is what all inspectors
general had the authority to do. You do not have that
authority.
Mr. Kotz. Right. I would welcome that.
Senator Bunning. Thank you.
Chairman Dodd. Thank you, Senator.
Mr. Kotz, thank you.
Unless there are some other questions here, we will move to
our second panel. But I am going to leave the record open.
Obviously you may have, one, some additional questions from
Members who are here, but certainly those who could not be here
this morning I presume may want to raise some questions with
you as well. So we will leave the record open.
I appreciate very much your coming before us, and I
appreciate the work you are trying to do. I do not want you to
think our lines of questioning here are necessarily targeted
specifically at you, but clearly some of the issues I raised
about a broader look at all of this, it seems to me, are worth
the Inspector General spending a little time. Obviously, you
had to focus on Fort Worth. But, because I am getting nervous
that if you had a policy like this nationally, I do not want to
find out later as I am sitting in a different place somewhere,
reading about hearings up here because there were problems in
other offices around the Country. You get my point.
Mr. Kotz. Absolutely.
Chairman Dodd. OK. Thanks.
Mr. Khuzami, I appreciate your joining us here, and Carlo
di Florio and Ms. Rose Romero. Come on up and join us here, and
thank you all very much for your work and your efforts.
I am going to ask, if you would, we have got you, Mr. di
Florio in the middle. Mr. Khuzami, you are right there, very
good. And Ms. Romero, thank you. I will begin in the order I
have introduced you, and if you could try and keep your remarks
down to about 5 minutes or so if you can, so we can jump right
in with you on the questions. And your full statements and any
data and material that you think would be worthwhile for the
Committee to be looking at, we will include certainly in the
record as well. OK? Thank you.
STATEMENT OF ROBERT KHUZAMI, DIRECTOR, DIVISION OF ENFORCEMENT,
SECURITIES AND EXCHANGE COMMISSION
Mr. Khuzami. Certainly, Mr. Chairman, thank you. I thank
Members of the Committee for the opportunity to testify before
you today.
The Commission commends the work of the Inspector General
with respect to the Stanford matter, and the depth and analysis
of the report. They have conducted an extensive investigation,
clearly identifies missed opportunities at the SEC. We cannot
evade responsibility for the handling of the Stanford matter
and deeply regret our failure to act more quickly to limit the
tragic investor losses suffered in the case.
We are doing three things that respond directly to the
Stanford case and the IG's recommendations: first, vigorously
pursuing Stanford and others who were involved in the
misconduct, and trying to reclaim as much money as possible for
investors; two, embracing all the recommendations that the
Inspector General proposed; and three, continuing what started
prior to the report by both Mr. di Florio and I of a top to
bottom review of our respective division and offices, and to
implement new structures and processes to make sure that this
does not happen again.
You know about the details of the filing of the Stanford
case.
With respect to the recommendations, we are doing a number
of things including revising the metrics used to manage and
evaluate the performance of the division, and clarifying the
procedures with respect to coordination between the exam
program and the Enforcement Division that underlie some of the
matters in the Stanford case, and third, we have both conducted
this review over the last 18 months.
With respect to the Division of Enforcement, what has been
described as the most significant restructuring of the division
in over 30 years. That includes new training, hiring new
outside staff with market and private sector expertise,
streamlining management, putting more attorneys back on the
front lines of conducting investigations, improving risk
assessment techniques, leveraging the knowledge of third
parties, new initiatives and, most importantly perhaps, totally
revamping the way we handle our tips, complaints and referrals
of which we get tens of thousands per year.
We are also doing new initiatives, launching specialized
units focused on particular areas of the law or conduct or
transactions that are particularly relative to Stanford,
including a specialized unit focusing on investment advisors.
We are also doing risk-based investigative techniques, so
that we look at problems early on, identify red flags and move
more quickly.
Much more needs to be done. As was mentioned earlier, our
mission of investor protection demands nothing short of a full
commitment to do all that we can to minimize the chance that
another Stanford happens and we do not act as quickly, as
promptly as possible.
Now I will turn it over to Mr. di Florio.
STATEMENT OF CARLO V. DI FLORIO, DIRECTOR, OFFICE OF COMPLIANCE
INSPECTIONS AND EXAMINATIONS, SECURITIES AND EXCHANGE
COMMISSION
Mr. di Florio. Mr. Chairman, Ranking Member Shelby, and
Members of the Committee, the Inspector General's
recommendations identify the need for better coordination
between the enforcement program and the exam program. We are
committed to doing just that.
OCIE and Enforcement are working together on multiple
fronts to identify misconduct earlier and move to shut it down
more rapidly. We have introduced joint committees to
proactively evaluate potential referrals and new governance
processes to ensure early escalation of any concerns. Finally,
OCIE has undertaken a top to bottom review of our strategy, our
structure, our people, our processes and our technology. In
each of these critical areas, we are breaking down silos and
implementing significant new reforms to better protect
investors and ensure market integrity.
In conclusion, both OCIE and Enforcement are committed to
reforms that address the kind of issues that led to the
Stanford case. We would be happy to respond to any questions
you might have. Thank you.
Chairman Dodd. Ms. Romero.
STATEMENT OF ROSE L. ROMERO, REGIONAL DIRECTOR, FORT WORTH
REGIONAL OFFICE, SECURITIES AND EXCHANGE COMMISSION
Ms. Romero. Chairman Dodd and Members of the Committee,
thank you for the opportunity to testify today about the
reforms the Fort Worth Regional Office is making in response to
the issues raised in the Inspector General's report on the
office's performance in the Stanford matter.
Like Mr. Khuzami and Mr. di Florio, I regret that the SEC
failed to act more quickly to limit investor losses suffered by
the Stanford victims. All of us at the SEC share responsibility
for the handling of the Stanford matter, and we are taking
significant steps to ensure that we implement the needed
reforms.
Mr. Khuzami has summarized the status of the current
litigation, but I wanted to highlight a few additional points.
Immediately after filing the civil action, my staff worked
closely with the Justice Department to ensure that responsible
executives of the Stanford Company were brought to justice. We
aggressively continued our investigation, aided by access to
Stanford financial records and other key documents obtained by
the receiver, and access to key employees. In particular, my
staff played a significant role in securing the cooperation of
James Davis, Stanford Financial Group's Chief Financial
Officer. We also developed critical evidence in support of the
allegation that Leroy King, Antigua's head of the Financial
Services Regulatory Commission, conspired with Stanford and
obstructed the Commission's efforts to investigate Stanford
over many years.
We have recently notified several former Stanford
executives that we intend to recommend fraud charges against
them. These persons include former high level executives and
financial advisors. Our investigation of these matters is
continuing, and I have directed my staff to determine if others
at Stanford were involved in fraudulent conduct.
Over the course of the past 12 months, we have collected
and reviewed tens of thousands of documents, reviewed e-mail
communications of more than 150 former employees, interviewed
and taken sworn statements of more than 60 former employees and
other witnesses, and interviewed approximately 200 victims of
the Stanford fraud. We have worked with the Stanford Victims
Coalition, State regulators and FINRA to gather relevant
information and evidence to further this important
investigation.
Since filing the Stanford case, we have worked to minimize
receivership expenses and ensure that the receiver's efforts
are focused properly on investor recovery. As a result of our
efforts, the receiver agreed to reduce his rates by 20 percent,
and the court, at our request, has held back an additional 20
percent of the receiver's fees and expenses. We continue to
monitor the receiver's work closely.
The initiatives outlined in the remarks of Mr. Khuzami and
Mr. di Florio are, from a regional perspective, making a
significant impact upon the Commission and its staff. For
example, this fiscal year alone investigations by the Fort
Worth Regional Office have resulted in criminal charges against
14 individuals, and many members of our staff now serve as
special Federal prosecutors assisting in the prosecution of
important criminal cases in the securities area.
Since last year, the Fort Worth staff has filed 19
emergency actions in Federal court, preserving millions of
dollars for investors.
During the past 4 years, the Fort Worth Regional Office has
worked to bridge the gap between broker-dealer and investment
advisor examination staff and programs. In late 2006, it was
clear to me that we could not adequately oversee an increasing
integrated registration population unless we brought to each
examination the skills and expertise to effectively review a
firm's business activities, whether advisory, brokerage or
both. Another top priority has been to enhance collaboration
and teamwork among examination and enforcement programs. The
success of this initiative over the past 4 years is
demonstrated by the fact that the percentage of enforcement
cases stemming from examination referrals and information has
increased from 12 percent in fiscal year 2005 to 39 percent in
fiscal year 2009.
In conclusion, while I certainly believe that our efforts
have enhanced the Commission's ability to protect investors, we
will not forget the painful lessons taught to us by past
mistakes. The Fort Worth Regional Office is dedicated to
protecting investors and aggressively pursuing those who
defraud them.
I thank you for the opportunity to appear before you today,
and I would be pleased to answer your questions. Thank you.
Chairman Dodd. Well, thank you all very, very much, and let
me begin by thanking you all for the work you are trying to do.
I realize in addition to staying on top of all the other
matters that are occurring, getting into this is obviously
important as well. So at least from my standpoint I want you to
know that my line of questioning here is not to reflect
obviously the work that you are trying to do. You were not part
of all of this obviously. You are all new hires in these
matters. So again, I appreciate your efforts going back over
the time.
One is, just quickly as I say, I raised this with Mr. Kotz
earlier, and that is that we have asked for these progress
reports in the Committee in the past. We asked for it on the
Madoff matter. As I pointed out, staff informs me we have had
one report in the last 5 months. I made the request back then
on behalf of the Committee. I make it again in this matter
here. This Committee is going to want to be kept informed, and
I guarantee you in my absence Senator Shelby will want to be
informed, Senator Johnson will be, and other Members of this
Committee. So I will make that request of you.
Second, I think we would like to have you keep us posted
regarding personnel actions being taken as a result of the
performance of SEC staff. I think Senator Vitter may have
raised the question whether anyone has lost their job in any of
this, and the Inspector General indicated that he did not know
of any at this point.
But again, there are some serious questions being raised,
Ms. Romero, in that office. And it seems to me again it is not
our business here to hire and fire people at the SEC, but in
light of what went on it seems to me that people may have left
and again a little hard to understand why people have not been
fired in light of what occurred--billions being lost, lives
ruined as a result of actions and inactions taken. So I would
like to be kept informed on that if I can.
Now again I raised issues, Mr. Khuzami, before. I thought
Senator Shelby made a very good point in his opening statement,
in drawing a distinction between the Madoff case and this case,
in that in the Madoff case there were reports coming--the
gentlemen in Massachusetts who, on numerous occasions, raised
what he thought were very important matters, that the Madoff
matter was clearly a Ponzi scheme, but that was an outsider in
a sense, a knowledgeable one.
But in this case here you have had an Examination Office
bellowing fire, fire, fire in one office and an Enforcement
Division saying no fire or the fire is too complex or we have
to respond to other matters here. So this is a different set of
matters.
You talked about the perfect storm in response to a
question by Senator Schumer on the Madoff matter, describing
the perfect storm on Madoff. How do you describe this one? What
happens here? What is your quick analysis of what went wrong
here?
Mr. Khuzami. Well, Senator, I think in this case the people
in Fort Worth were focused on the issue as to whether or not
this was Ponzi scheme. It was not like Madoff when they were
trying to figure out whether or not the split strike conversion
strategy that Mr. Madoff was operating was really a Ponzi
scheme or not.
The discussion and the debate within the office was going
on. The shortcoming occurred because there was not, in my view,
sufficient follow-up to get as much evidence as we could and
then once we did that, to do, to try and proceed with perhaps a
more narrowly tailored case, not prove the full-blown Ponzi
scheme, but not proceed with the full-blown case, so that we
may have been able to start the process of alerting the world
that Mr. Stanford may have been involved in wrongdoing and
there was a problem with this product.
Now sometimes that is easier said than done because
obviously we have to go into court and have admissible evidence
to show that this was a Ponzi scheme or there was some other
violation of law. My sense is that we did not do as good a job.
We were not as creative as we should be under these kinds of
circumstances, with these red flags, to figure out what that
narrowly tailored case was and go in and try and do it even if
we had a significant risk of loss.
Now I think going in and losing a case is not a great thing
because obviously if you do that one thing that can happen is
the perpetrators of the fraud can use that as the Good
Housekeeping Seal of Approval and say the SEC has tried to stop
this, the judge rejected their claim, the investment is safe.
So you always have to be a little concerned about that.
But under circumstances where you have got high returns and
a lack of volatility, like we did here, as I sit here I wish we
had gone in with a narrower theory, a sales practice theory or
a failure to disclose commissions, or some other theory that
might have been able to do.
Chairman Dodd. Is this fairly commonplace, where you have
this kind of a debate?
I mean this were four instances over a period of years, 12
years, where your examiners, unless there was some huge debate
among the examiners which no one has indicated yet. That may
have been the case. But let's assume for a second you had a
pretty united view. They came back four different times to the
Enforcement Section. Is this commonplace, where you have had
that happen?
I could understand one time. But on four occasions over a
period of 12 years?
Mr. Khuzami. Well, it would not happen today. I can assure
you that, Senator. There is much more collaboration and
coordination and more immediate decision making on these
issues.
I will say that again the focus, as I read the report, was
whether or not they had the admissible proof--not that they did
not understand the exam team was not saying this is a Ponzi
scheme, but that they needed and wanted a level of proof in
order to go into court and make their case that perhaps was
higher than we should have. We should have been more creative
and tried to go in quicker and stop it.
Chairman Dodd. Well, that is a different answer than we got
from Mr. Kotz because he said it was more like the question of
this is the quick fix, the stats approach, rather than the
novel, more complicated case.
Then second, had the Madoff matter not come forward as it
was, he is not sure, frankly, that any action would have been
taken, even as late as it was.
You have a different point of view.
Mr. Khuzami. Look, well, certainly in light of Madoff, we
took a hard look at everything that was in the pipeline to make
sure that we were operating appropriately.
I think the other factor that happened here, of course,
that happens in many Ponzi schemes is that the economy soured.
It became more difficult to keep Ponzi schemes afloat. Fewer
investors willing to invest and more people demanding
redemptions, that puts pressure on the scheme.
Chairman Dodd. Yes.
Mr. Khuzami. We also were able to get some evidence from
insiders that we did not have before in the 2006, 2007, 2008
timeframe.
Chairman Dodd. Yes. Last, would you answer the question I
asked the Inspector General? Are you looking at other offices
where that approach of the quick fix stats number and that
other matters might have missed, whether Ponzi schemes or
others, that could have put investors at greater risk?
Mr. Khuzami. Yes. Senator, I do not see--more importantly,
I am not telling the rank and file that quick hits and numbers
are what drive the division. If you look at the course of cases
that we have brought in the last 18 months, particularly across
the credit crisis--New Century, Countrywide, Goldman, Dell,
State Street, Evergreen, ICP, CitiGroup, Bank of America--these
are hugely complicated accounting frauds, structured product
cases. We are not getting quick stats on those cases, I assure
you.
In addition, even during the 2000s, if you look at the
history of the cases--auction rate securities, market timing,
research analysts, options backdating, Enron, WorldCom there
are plenty of examples of complicated, difficult cases.
Now I am not going to say that one or more individual
offices were not focused on stats, and maybe they even came
from Washington. I just do not know. But it is not the standard
today, I assure you.
Chairman Dodd. I appreciate that.
Senator Bunning.
Senator Bunning. Thank you, Mr. Chairman.
Mr. Khuzami, what kind of actions were taken by the SEC to
discipline SEC enforcement employees who were responsible for
mishandling this case?
Mr. Khuzami. Senator, that process is underway. We have to
follow certain procedures by regulation and otherwise. The
process is fully underway.
Senator Bunning. 1997 through the present time, that is 13
years. You have not had enough chance to accumulate evidence?
Mr. Khuzami. Well, the process commenced upon the release
of the IG's report, which has been approximately 5 months, and
that is the process that we are following, to review the
information gathered by the Inspector General and to make the
appropriate decision.
Senator Bunning. OK. Now, aside from that, the Inspector
General reported to you 5 weeks ago about insider trading with
Tyco. What has happened to that report?
Mr. Khuzami. Senator, I am not familiar with that matter,
but I would be happy to get back to you and provide you
information in response to your question.
Senator Bunning. You do not know anything about the report?
Mr. Khuzami. The report----
Senator Bunning. By the Inspector General, the gentleman
who was just here, on insider trading with Tyco. He submitted a
report 5 weeks ago.
Mr. Khuzami. I am not familiar with that matter, Senator.
Senator Bunning. Well, who at the SEC would be?
Mr. Khuzami. I will find out as soon as I return to the
office and will respond to your question.
Senator Bunning. OK.
Senator Bunning. Five weeks is a pretty good time to be
able to read the report and, according to the Inspector
General, redact those things that should not be made public.
And we would like to know about that because that is--insider
trading, that also affects a lot of investors. If you bought
Tyco Industries in that time or in the past years and you had
somebody that was doing insider trading in that stock, it
surely affected your holding.
Mr. di Florio, in your opinion, does the Office of
Compliance Inspections and Examination bear any responsibility
for the spectacular failure in this case? Or should the
majority of the blame fall on the Enforcement Division?
Mr. di Florio. Senator, I think the IG's report laid out
the facts effectively. Going forward, I see that we both have
responsibility to make sure that we address the Inspector
General's recommendations, and one of those key recommendations
was that Enforcement and Exam work more collaboratively
together to ensure it does not----
Senator Bunning. How about Washington and Fort Worth?
Mr. di Florio. Correct, likewise. So we look at those
programs on a national basis and on a regional basis, and we
now have governance mechanisms, escalation protocols, and joint
initiatives across divisions and with our regions to make sure
matters like this do not happen in the future.
Senator Bunning. Do you know how much money just the two
cases have cost the--just two cases have cost our investment
public? If you take the one in the east and the one in Texas.
Mr. di Florio. Yes, Senator, and it is with that in mind
and the----
Senator Bunning. $58 billion.
Mr. di Florio. Correct.
Senator Bunning. Or right around that, give or take a few
billion here or a billion there. Do you know how long it takes
for people to save $58 billion? I mean, we can print it up
here. It is a little different for the Government. But
individual investors trying to preserve their capital and
getting taken by crooks. I think the SEC better be capable of
better things.
Mr. di Florio. Senator, we have implemented a number of
reforms.
Senator Bunning. The Chairman of this Committee has tried
to convince others how important it is to protect the investor,
and that is the SEC's job. I worked in that business for 30
years, and if I messed up, the SEC was there to tell me. They
should be there to do it and do it better than they are doing
it right now.
Mr. di Florio. Absolutely, Senator.
Senator Bunning. Thank you.
Chairman Dodd. Thank you, Senator, very much.
Senator Hutchison.
Senator Hutchison. Thank you, Mr. Chairman.
Many of the victims of this Ponzi scheme and the
misappropriation of people's funds have come to our office.
They are seeking some kind of help, and they really have fallen
through a crack in a way because there is really nothing there
for them.
One of the things that they have raised is that the SEC has
refused--I guess in 2009 they filed civil suits, but not
criminal--I am sorry, civil suits, but they did not go further
and seek bankruptcy of the Stanford companies, which many of
the victims believe would give the bankruptcy judge more
authority to go after assets. And, of course, they are trying
to go after assets.
Why did the SEC never initiate bankruptcy proceedings in an
effort to try to give all opportunities to the bankruptcy judge
for asset availability for the victims? Mr. Khuzami.
Mr. Khuzami. Senator, if you do not mind, I think I will
defer to Ms. Romero on that, who I think has been more
integrally involved in some of the details of the proceeding.
Ms. Romero. Thank you. Senator Hutchison, the court was
approached with that idea of whether or not the Stanford
receivership should be converted into a bankruptcy. At that
stage, the SEC--we came in and we disagreed with the investors
who were wanting to take it to a bankruptcy because, in our
view, in our analysis, it would have cost the estate a lot more
money. So the court had a different view, and he wanted to take
it to--what he did was he appointed an investor committee that
would serve much like a bankruptcy committee or a creditor's
committee, but it would not cost the estate any money. In other
words, they are not going to be able to charge the estate any
money where you would in a bankruptcy setting.
This committee, this investors committee was announced a
couple of weeks ago. We supported that effort. It is going to
give investors a more--they are going to have a closer working
relationship and more say in the receivership than they had
previously.
The examiner that the court appointed to protect investor
interests is also part of that committee, and we expect that
that is going to help return more monies back to investors.
Senator Hutchison. I did not understand what you meant by
``cost the estate more money'' if they did not go through
bankruptcy than if they are where they are now, in
receivership.
Ms. Romero. Right. At the stage that we were when the
bankruptcy issue came forward, there would have been costs in
terms of creditors that would have had claims perhaps in a
bankruptcy setting that they do not have in a receivership
setting, and that meant that that pot of money that we had
would have been even thinner or----
Senator Hutchison. Would have gone to creditors rather than
victims.
Ms. Romero. Exactly. And so given that, it was our view
that perhaps this investor committee, which serves like a
creditors committee, would give the investors the same type of
control, if you will, or access to the receivership as they
would if it were in bankruptcy, but without the cost.
Senator Hutchison. So is it your view--and I assume as
regional director you are being given the SEC's authority here.
And your view is that the assets are being protected to the
maximum for the victims at this time?
Ms. Romero. Senator Hutchison, we have worked very hard
over the past 18 months to make sure that the assets--that we
protect the assets, every dollar, for investors. We have taken
a number of steps to do that. We continue to oversee the
receiver's activities. We continue to work with the Justice
Department, the Office of International Affairs, and regulators
throughout the world, quite frankly, to make sure that the
assets that we have had frozen in these different foreign
jurisdictions remain there until they are repatriated here to
the U.S. for investor benefits, yes.
Senator Hutchison. One of the complaints of the victims has
been the time that it has taken, that frozen assets--that even
assets that were owned by the victims, not owned by the company
were frozen for so long and people could not get access. Let me
ask you two things.
One, how much longer will it be before frozen assets will
be able to be distributed that have not already been? And I
know some have, but--and number two--and I realize that there
are different types of investments and you cannot make a
blanket estimate, probably. But in the area that you can, how
much can victims count on or at least have some expectation of
being returned, not the assets that are already actually the
victims', but in the assets that were under management that
will be distributed, with the foreign assets as well? What
would be the timetable? And what could be the expectation?
Ms. Romero. As to your question on the timetable, there
are, like I said, assets, Stanford assets all over the world
that have been secured and hopefully will be repatriated soon.
In order to secure those, particularly those in Europe, the
Department of Justice took the lead there so that the
determination of when we get them back and when we can get them
in investors' hands is going to be made in that criminal case,
when there is a conviction in that criminal case. As you know,
that is set right now for January of this coming year, so
hopefully once there is a conviction in that case--that is why
getting a conviction in that case is so important, because a
lot of this money is tied to that.
So we expect that some time after that we would hopefully
begin the process of distribution of these monies to investors.
Senator Hutchison. I am sorry. I know I am over my time,
but just last, any type of percentage that people could expect?
Ms. Romero. It is hard for me to predict that at this point
in time. The receiver is working hard to continue to gather
assets. Like I said, there are ongoing efforts in, for example,
South America, where we cannot predict how much money there is
going to be--that we are going to be able to recover there. So
it is hard for me to say.
After we go through a claims process, we can better
determine how many victims are going to make claims, you know,
how much money they may have received during the course of the
Stanford Ponzi scheme, and then, you know, do those
calculations. It is a long and arduous process. So I am sorry I
do not have any specific numbers for you at this time.
Senator Hutchison. Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much, Senator.
Senator Vitter.
Senator Vitter. Thank you, Mr. Chairman. I am going to
continue with Ms. Romero.
Ms. Romero, just remind us, what is your full title and
general responsibility?
Ms. Romero. Yes, sir. I am the regional director for the
Fort Worth regional office, and I am charged with overseeing
the examination program and the enforcement program in the Fort
Worth office for the SEC.
Senator Vitter. OK. And how long have you been in that
particular position?
Ms. Romero. I started there in March of 2006.
Senator Vitter. In that position?
Ms. Romero. Yes, sir.
Senator Vitter. And were you at the SEC previously?
Ms. Romero. I was not. I was a Federal prosecutor for 16
years prior to coming to the SEC.
Senator Vitter. OK. You testified at our field hearing in
August 2009 in Baton Rouge, and I appreciate that, so obviously
you were in the same role then.
OK. When did the SEC first look into and investigate,
either formally or informally, Stanford?
Ms. Romero. Well, the formal investigation began October
26, 2006.
Senator Vitter. And what about anything informal?
Ms. Romero. There was an informal inquiry, which is really
a term of art at the SEC, that was opened in 2005. I believe it
was late 2005.
Senator Vitter. And that is the first time the SEC looked
into and investigated Stanford?
Ms. Romero. No, but the answer to the question whether it
was an informal or a formal investigation, given that they are
terms of art at the SEC, the formal investigation began October
26, 2006, and the informal in late 2005. I do not know the
exact date.
Senator Vitter. And when was the first look-see at
Stanford--that is my term of art--at the SEC?
Ms. Romero. OK. As you know, I came into the SEC in 2006.
From what I have reviewed, they looked at the--the SEC was
looking at Stanford back in 1997.
Senator Vitter. 1997.
Ms. Romero. Yes.
Senator Vitter. And what would you describe that activity
as?
Ms. Romero. It was my understanding that there were--the
examination program does periodic exams of various firms in the
region, and Stanford, they did four examinations between 1997
and 2006.
Senator Vitter. And that is not an investigation in any
way, even informal?
Ms. Romero. No, sir.
Senator Vitter. OK. And the name of that division is what?
Ms. Romero. The name of the examination? They are called
OCIE.
Senator Vitter. Which stands for what?
Ms. Romero. Office of Compliance and Examinations.
Senator Vitter. It is Office of Compliance Inspections and
Examinations, but they do not investigate in any way?
Ms. Romero. No, sir. I mean, they inspect and they examine
books and records of different firms. You know, so, yes--no,
they do not investigate like the Enforcement----
Chairman Dodd. They make recommendations.
Ms. Romero. Yes.
Senator Vitter. The reason I am asking--and I know you are
aware of this--is I asked you about this in Baton Rouge in
August 2009.
Ms. Romero. Yes, you did.
Senator Vitter. But apparently I did not lawyer up enough
when I asked the question. I asked, ``When did the SEC formally
begin an investigation of Stanford and exactly what provoked
that?'' You responded, ``We began the formal investigation in--
well, there was an informal investigation that began in 2004,
then the formal investigation. That is where we asked for
authority to issue a subpoena, was in 2000--end of 2005, early
2006.''
Were you aware at the time that significant activity,
inspection activity, happened well prior to that?
Ms. Romero. Yes, I was aware at the time that significant
inspection activity had happened. I was truthfully and candidly
answering your question as to when the informal and then formal
investigation began and what provoked it. I noted in my answer
that several things provoked the formal investigation,
including the tips and complaints.
That said, sir, if my answer created any confusion for you
or your staff, I sincerely apologize.
Senator Vitter. Well, in your testimony you also said, ``I
think in total we had about four tips or complaints, some were
anonymous, that were questioning the legality of Stanford
International Bank. We followed up on all of those tips, and
then that led to our informal and then our formal
investigation.''
That summary seems to leave out something pretty
significant, because you just did not have tips and complaints
from the outside. You had instance after instance after
instance of your own enforcement--excuse me. What is the name
of the Division?
Ms. Romero. Examination.
Senator Vitter. Examination Division saying this is a big
problem. Is there any particular reason you did not put that in
the summary? That is a lot different than an outside,
uncertain, anonymous tip.
Ms. Romero. As I told you, Senator, in 2009, there were
several things that provoked the investigation, the informal
and formal investigation of Stanford in 2006. Some of those
things were the tips and complaints that were received by our
office. But I also noted in my answer that there were other
factors, and I was fully prepared to describe those factors to
you during the hearing. Again, if my answer created----
Senator Vitter. Did you describe those pleas from that
division?
Ms. Romero. I am sorry, sir?
Senator Vitter. Did you, in fact, go into all of that
activity within the SEC itself starting in 1997?
Ms. Romero. No, sir, I did not.
Senator Vitter. You did not. So you were open to that, but
you did not go into it.
Ms. Romero. Well, I was prepared to. I was answering your
specific question, and if I created confusion, I again
apologize. But I was answering your specific question, yes.
Senator Vitter. OK. What was the preparation you undertook
before that testimony? Did you prepare your testimony in
consultation with other folks at the SEC?
Ms. Romero. Yes, sir, I did.
Senator Vitter. And who were they?
Ms. Romero. Members of the Stanford team, obviously, to get
facts down about the Stanford case, numbers, you know, where we
were, getting updates on the investigation.
Senator Vitter. Who in the Washington office did that
preparation include?
Ms. Romero. In Washington, there was preparation regarding
the opening--or the written submission.
Senator Vitter. Who was involved----
Ms. Romero. I am trying to think. I am sorry. There were a
number of people involved. There were lawyers from the General
Counsel involved; there were lawyers from the Chairman's office
involved; there were lawyers from the Division of Enforcement
involved. As I sit here, I cannot think of everybody's name,
but I would be happy to send that to you.
Senator Vitter. OK.
Senator Vitter. Do you remember as part of that preparation
written timelines being put together?
Ms. Romero. I am sorry. I do not understand your question.
Senator Vitter. As part of that preparation for your
testimony, do you remember putting together with the help of
others written timelines regarding SEC activity about Stanford?
Ms. Romero. Actually, Senator, the day that we filed the
Stanford case, on February 16, 2009, we began to put together a
detailed chronology of the Stanford events, beginning in 1997
through 2009.
Senator Vitter. Do you remember putting together a
chronology specifically in preparation for your testimony?
Ms. Romero. No, sir.
Senator Vitter. OK. You do not remember that being
distributed and discussed by e-mail?
Ms. Romero. No, I do not.
Senator Vitter. OK. You do not remember the original
chronology that was put together to help you prepare for your
testimony starting in 1997?
Ms. Romero. I remember that there was a--we did a
chronology the day--we started a chronology the day that we
filed the Stanford case.
Senator Vitter. Again, I am talking about specifically in
preparation for your testimony.
Ms. Romero. I do not remember that. I do not recall.
Senator Vitter. And you do not remember, as that was looked
at and discussed in preparation for your testimony, that
chronology was changed to start around 2004?
Ms. Romero. No, sir, I do not remember that. I do not.
Senator Vitter. And you do not remember the fact that that
new revised chronology is what basically you testified about?
Ms. Romero. No, sir. No, sir.
Senator Vitter. OK. In the same vein, do you remember an
SEC Commission meeting with you prior to your testimony where
Chairman Schapiro said, ``Any disclosure that is made now is
meant to be quite narrow and was not meant to expose the
agency''?
Ms. Romero. No, sir. I did not participate in any such
closed Commission meeting.
Senator Vitter. I do not know it was closed or not. Do you
remember a Commission meeting before the testimony?
Ms. Romero. No, sir.
Senator Vitter. You do not remember any such comment by
Chairman Schapiro?
Ms. Romero. No, sir, I do not, not in relation to Stanford
or any other case.
Senator Vitter. OK. Well, there is a lot of background to
this. The bottom line, which I am obviously going to, is I
think you actively misled me and the Committee. I am not
saying--I am not saying--I could have been more careful in
devising my question. Shame on me. I am a recovering lawyer. I
am saying you actively misled me and the Committee. Do you have
any response to that?
Ms. Romero. I do, sir. I have dedicated--I did not actively
mislead you, Senator. I have dedicated my life to the public
good. I am a 4-year veteran of the Armed Services. I served as
a police officer in the city of Fort Worth for 4 years. Three
of those years I worked undercover. I served as an assistant
district attorney with the Tarrant County DA's office. I went
to the Fort Worth--to the Dallas--I am sorry, to the U.S.
Attorney's Office in the Northern District, where I served for
16 years. I have earned and I enjoy the deepest respect and
reputation of excellence with the judiciary in the Northern
District, with county judges, State judges, with members of the
Fifth Circuit, and my integrity has never been--ever been
questioned. I make mistakes. I am human, and I am getting old,
quite frankly, so if that happened, I apologize. I am prepared
in this forum, Senator Vitter, or any other, briefing you or
your staff, to go into full detail about the Stanford matter as
I know it. But I did not then and I am not now in any way
misleading you, or have any reason to. The events that happened
before 2006 I was not a part of. I was not there.
Senator Vitter. OK. Well, again, you laid out a timeline in
our field hearing in August 2009 that started in 2004. The
SEC's direct knowledge of all these problems started 7 years
before that. Would you disagree with any of that?
Ms. Romero. No. No, I would not. You are right. They
started in 1997.
Senator Vitter. Do you think that is sort of a big
omission, those 7 years?
Ms. Romero. I was answering a specific question, and I am
sorry. I was prepared to go into all of that. We moved on to
other questions, and as I read the transcript, I saw that. For
my part in that, sir, again, I sincerely apologize, and I am
prepared to fully brief you in any forum that you would like
and go through the Stanford matter detail by detail.
Senator Vitter. Well, as the whole Committee and others
look at this, I think it is going to be very important and
instructive to look at the preparation that went on at the SEC
Washington office with you and others directly preparing your
testimony and specific discussion about the timeline and
specific discussion about answering everything absolutely as
narrowly as possible and using every opportunity to shorten the
timeline as much as possible.
Ms. Romero. I would be happy----
Senator Vitter. That is going to be a continuing focus of
mine. That is there. That is in e-mails. That is in writing.
That is part of the record. And that is part of the travesty of
this entire case.
Thank you, Mr. Chairman.
Chairman Dodd. Thank you very much. Let me thank our
witnesses here. I am going to leave the record open for a
number of days here so that Members can have an opportunity to
submit some additional questions. But I want to end where I
began. I have great respect for the work that people do at the
SEC, and I would not want this hearing to conclude without
emphasizing that point again. This is hard work.
I note that in our financial reform bill we call for the
doubling of the budget of the SEC. I think we go from $1.1
billion in this fiscal year to $2.25 billion by 2015. And my
hope is that additional resource capacity will provide
additional staff as necessary as we go forward. We have a lot
more we are going to be asking you to do as a result of the
financial reform bill itself, and I will acknowledge that the
heads are nodding. I am not sure you are nodding necessarily
you agree with that number. You probably want more. But I
wanted to make the record at least clear that we are
acknowledging the problems and the necessity of having a
resource capacity to do the job. And you are all new to this in
many ways, and so it falls in your lap to try and help weave
our way through this to get some right answers so we see that--
there will invariably be crises again. There will be problems
that get missed somehow. It is a human endeavor as well. But we
ought to be able to set up procedurally the ability so that
when you have a conflict such as existed in that office, there
has got to be a manner by which that can be resolved in a way
that does not leave the gaping hole and, of course, the
tremendous damage done to so many people.
So, with that, I thank you again for coming. The Committee
will stand adjourned.
[Whereupon, at 12:12 p.m., the hearing was adjourned.]
[Prepared statements and responses to written questions
supplied for the record follow:]
PREPARED STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD
The Banking Committee today is holding a hearing on ``Oversight of
the SEC Inspector General's Report on the `Investigation of the SEC's
Response to Concerns Regarding Robert Allen Stanford's Alleged Ponzi
Scheme' and Improving SEC Performance.'' Regulatory oversight is a
prime responsibility that this Committee takes seriously. The Committee
will review the Inspector General's Report on the Commission's failure
to stop the Stanford financial fraud in a timely manner and will hear
about the steps it is taking to fix the problems and to restore
investor confidence.
Last August, the Banking Committee held a field hearing on the
``Alleged Stanford Financial Group Fraud: Regulatory and Oversight
Concerns and the Need for Reform'' at the request of my colleague
Senator Vitter. And last year, we held two hearings surrounding the
SEC's failures in regard to the Bernard Madoff fraud. Those three
hearings contributed to reforms we included in the Dodd-Frank Wall
Street Reform and Consumer Protection Act to better empower and equip
the SEC to do its job. Today's hearing builds on those, and reflects my
work with Ranking Member Shelby. The hearing looks not only to the past
Commission performance, but also to the future Commission actions for
improvement.
Let me review this situation. In February of 2009, the SEC charged
Robert Allen Stanford and several associates with orchestrating an
eight billion dollar Ponzi scheme. According to the SEC's complaint,
the defendants for almost 15 years promised improbably high interest
rates and misrepresented to purchasers of certificates of deposit that
their deposits were safe, falsely claiming that the bank reinvested
clients' funds primarily in ``liquid'' financial instruments.
Although the Commission examination staff found strong evidence
that Stanford was likely operating a Ponzi scheme as early as 1997, the
Commission did not bring charges against Mr. Stanford until 2009, only
months after Bernard Madoff's own Ponzi scheme was exposed; both cases
revealed deeply troubling failures by the SEC.
In March of this year, the SEC Office of the Inspector General
released its report on the Commission's response to Stanford's scheme.
The report found that a central problem was the failure of the SEC Fort
Worth District Office Enforcement staff to heed the warning of the
Examination staff.
The IG report shows that the examiners at the Fort Worth District
Office raised red flags about Mr. Stanford's operation in four exams
conducted over 8 years, beginning in 1997, concluding in each
examination that Stanford's CDs were likely a Ponzi scheme or a similar
fraudulent scheme. However, the enforcement staff disregarded the
examiners' repeated warnings, continually turning a blind eye for
nearly a decade. We seem to have an instance in which one side of the
agency was screaming that there was a fire, and the other side said
that the fire was too hard to put out.
The Inspector General report found that one reason that the
Enforcement Division did not want to investigate Mr. Stanford was the
perception that the case was difficult, novel and not the type favored
by the Commission.
The Report also raised a number of troubling facts about the former
enforcement head of the Fort Worth office, who played a significant
role in multiple decisions over the years to quash investigations of
Mr. Stanford.
All these pieces paint a picture of regulatory disconnects and
mistakes that allowed this fraud to harm families and communities
across our country. We look forward to learning to what the Commission
attributes this regulatory shortcoming. Investors in Stanford's Ponzi
scheme may have lost as much as $8 billion, and the damage to investor
confidence may be greater still.
I look forward to Inspector General Kotz's insights and discussion
of his report's findings, and I appreciate the SEC being here with us
to let us know what the Commission is doing to correct what went wrong.
I hope that this hearing will provide the Committee, the Senate, and
the American public with a clear view of how such a large and audacious
fraud was allowed to perpetuate and grow, and what is being done to fix
the system and prevent similar frauds in the future.
The Dodd-Frank bill was one step in a long journey to righting this
ship--giving the SEC more power, doubling its funding over 5 years, and
having periodic GAO reviews--but our work is not done. The Inspector
General's report also makes several thoughtful recommendations
regarding bringing enforcement actions in complex cases, evaluating the
performance of enforcement staff, coordination among SEC offices and
divisions, staff training, and other matters.
Investors deserve to know that there is a cop on the beat, working
hard to protect them from scam artists like R. Allen Stanford and
Bernard Madoff. Restoring investor confidence and certainty in the
fairness of our financial system is vitally important as we recover
from the economic crisis. The SEC should use all the resources at its
disposal to work toward that end.
______
PREPARED STATEMENT OF SENATOR TIM JOHNSON
Mr. Chairman, thank you for holding today's hearing. Following the
release of the SEC's Inspector General's Report, ``Investigation of the
SEC's Response to Concerns Regarding Robert Allen Stanford's Alleged
Ponzi Scheme,'' I think it is crucial that this Committee continues its
oversight role of the SEC, especially the agency's responsibility to
protect investors. I also think it is important that we delve deeper
into the ``alleged'' Stanford Ponzi Scheme and the SEC response, as
there are constituents in my State who were victims.
The report highlights grave errors made by the SEC, particularly
when the examinations conducted since 1997 at SGC (Stanford Company
Group) indicated fraud, but no enforcement action was taken. The
inaction by the Enforcement Division elicits grave concern about the
priorities of the SEC in this case, especially when Americans' life
savings were lost.
While massive cases like the Madoff Ponzi scheme rightfully grab
headlines, I am pleased that we are taking a closer look at the fraud
perpetrated by Stanford, the impact on investors, the response of the
SEC, and the IG's investigation into the SEC's response to concerns
about Robert Allen Stanford.
I applaud Chairman Schapiro for the efforts she has made to reform
how the SEC regulates markets and protects investors. I also think the
Dodd-Frank bill makes some important changes at the SEC to better
protect investors. That said, it is the role of this Committee to help
determine if these are the right changes to prevent fraud, like that
which was perpetrated by Allen Stanford, from happening again, and to
ensure that these changes are working.
It is my goal to ensure that the SEC has the right tools and
appropriate resources; that investors have access, information, and
protection, and that industry participants follow the rules, while also
having certainty. I look forward to hearing more from today's
witnesses, and I look forward to working with Members of this Committee
to ensure that investors are protected from fraud before it happens.
______
PREPARED STATEMENT OF H. DAVID KOTZ
Inspector General, Securities and Exchange Commission
September 22, 2010
Introduction
Thank you for the opportunity to testify before this Committee on
the subject of ``Oversight of the SEC's Inspector General's Report on
the `Investigation of the SEC's Response to Concerns Regarding Robert
Allen Stanford's Alleged Ponzi Scheme' and Improving SEC Performance.''
I appreciate the interest of the Chairman, the Ranking Member, as well
as the other Members of the Committee, in the Securities and Exchange
Commission (SEC or Commission) and the Office of Inspector General
(OIG). In my testimony, I am representing the OIG, and the views that I
express are those of my Office, and do not necessarily reflect the
views of the Commission or any Commissioners.
I would like to begin my remarks by briefly discussing the role of
my Office and the oversight efforts we have undertaken during the past
few years. The mission of the Office of Inspector General is to promote
the integrity, efficiency and effectiveness of the critical programs
and operations of the SEC. The SEC Office of Inspector General includes
the positions of the Inspector General, Deputy Inspector General,
Counsel to the Inspector General, and has staff in two major areas:
Audits and Investigations.
Our audit unit conducts, coordinates and supervises independent
audits and evaluations related to the Commission's internal programs
and operations. The primary purpose of conducting an audit is to review
past events with a view toward ensuring compliance with applicable
laws, rules and regulations and improving future performance. Upon
completion of an audit or evaluation, the OIG issues an independent
report that identifies any deficiencies in Commission operations,
programs, activities or functions and makes recommendations for
improvements in existing controls and procedures.
The Office's investigations unit responds to allegations of
violations of statutes, rules and regulations, and other misconduct by
Commission staff and contractors. We carefully review and analyze the
complaints we receive and, if warranted, conduct a preliminary inquiry
or full investigation into a matter. The misconduct investigated ranges
from fraud and other types of criminal conduct to violations of
Commission rules and policies and the Government-wide conduct
standards. The investigations unit conducts thorough and independent
investigations into allegations received in accordance with the
applicable Quality Standards for Investigations. Where allegations of
criminal conduct are involved, we notify and work with the Department
of Justice and the Federal Bureau of Investigation as appropriate.
Audit Reports
Over the past 2\1/2\ years since I became the Inspector General of
the SEC, our audit unit has issued numerous reports involving matters
critical to SEC programs and operations and the investing public. These
have included an examination of the Commission's oversight of Bear
Stearns and the factors that led to its collapse, an audit of the SEC
Division of Enforcement's (Enforcement's) practices related to naked
short selling complaints and referrals, a review of the SEC's bounty
program for whistleblowers, and an analysis of the SEC's oversight of
credit rating agencies. In addition, following a comprehensive
investigative report related to the Madoff Ponzi scheme in which our
Office identified systematic breakdowns in the manner in which the SEC
conducted its examinations and investigations (discussed in more detail
below), we performed three comprehensive reviews providing the SEC with
69 specific and concrete recommendations to improve the operations of
both Enforcement and the Office of Compliance Inspections and
Examinations (OCIE).
Investigative Reports
The Office's investigations unit has also conducted numerous
comprehensive investigations into significant failures by the SEC in
accomplishing its regulatory mission, as well as investigations of
allegations of violations of statutes, rules and regulations, and other
misconduct by Commission staff members and contractors. Several of
these investigations involved senior-level Commission staff and
represent matters of great concern to the Commission, Congressional
officials and the general public. Where appropriate, we have reported
evidence of improper conduct and made recommendations for disciplinary
actions, including removal of employees from the Federal service, as
well as recommendations for improvements in agency policies, procedures
and practices.
Specifically, we have issued investigative reports regarding a
myriad of allegations, including claims of failures by Enforcement to
pursue investigations vigorously or in a timely manner, improper
securities trading by Commission employees, conflicts of interest by
Commission staff members, unauthorized disclosure of nonpublic
information, whistleblower allegations of contract fraud, preferential
treatment given to prominent persons, retaliatory termination, perjury
by supervisory Commission attorneys, failure of SEC attorneys to
maintain active bar status, falsification of Federal documents, and the
misuse of official position, Government resources and official time. In
August 2009, we issued a 457-page report of investigation analyzing the
reasons why the SEC failed to uncover Bernard Madoff's $50 billion
Ponzi scheme. More recently, we issued a thorough and comprehensive
report of investigation regarding the history of the SEC's examinations
and investigations of Robert Allen Stanford's (Stanford's) $8 billion
alleged Ponzi scheme. The report is discussed in detail below and is
the subject of this hearing.
Commencement of Stanford Investigation
On October 9, 2009, I received a letter from the Ranking Member of
this Committee, the Honorable Richard Shelby, and the Honorable David
Vitter requesting a comprehensive investigation of the handling of the
SEC's investigation into Robert Allen Stanford and his various
companies, including the history of all the SEC's investigations and
examinations regarding Stanford. On October 13, 2009, the OIG opened
our investigation into the Stanford matter.
Document and E-mail Review
Between October 13, 2009 and February 16, 2010, the OIG
investigative team made numerous requests to the SEC's Office of
Information Technology (OIT) for the e-mails of current and former SEC
employees for various periods of time pertinent to the investigation.
The e-mails were received, loaded onto computers with specialized
search tools and searched on a continuous basis throughout the course
of our investigation.
In all, OIT provided e-mails for a total of 42 current and former
SEC employees for various time periods pertinent to the investigation,
ranging from 1997 to 2009. We estimate that we obtained and searched
over 2.7 million e-mails during the course of the investigation.
On October 27, 2009, we sent comprehensive document requests to
both Enforcement and OCIE specifying the documents and records we
required to be produced for the investigation. We carefully reviewed
and analyzed the information we received as a result of our document
production requests. These documents included all records relating to
the SEC's Fort Worth office's examinations in 1997 of Stanford Group
Company's Broker-Dealer, in 1998 of Stanford Group Company's Investment
Advisor, in 2002 of Stanford Group Company's Investment Advisor, and in
2004 of Stanford Group Company's Broker-Dealer. These also included
investigative records relating to the Fort Worth office's 1998 inquiry
regarding Stanford Group Company and its investigation of Stanford
Group Company, which was opened in 2006.
We also sought and reviewed documents from the Financial Industry
Regulatory Authority (FINRA), including documents concerning
communications between FINRA or its predecessor, the National
Association of Securities Dealers (NASD), and the SEC concerning
Stanford, and FINRA documents pertaining to the SEC's examinations and
inquiries regarding Stanford.
Testimony and Interviews
The OIG conducted 51 testimonies and interviews of 48 individuals
with knowledge of facts or circumstances surrounding the SEC's
examinations and/or investigations of Stanford and his firms. I
personally led the questioning in the testimony and interviews of the
witnesses in this investigation.
Specifically, we conducted on-the-record and under oath testimony
of 28 individuals, including all of the relevant examiners and
investigators who worked on SEC matters relating to Stanford. We also
conducted interviews of 20 other witnesses, including former SEC
employees, whistleblowers, victims of the alleged Ponzi scheme, and
officials from the Texas State Securities Board.
Issuance of Comprehensive Report of Investigation
On March 31, 2010, we issued to the Chairman of the SEC a
comprehensive report of our investigation in the Stanford matter
containing over 150 pages of analysis and 200 exhibits. The report of
investigation detailed all of the SEC's examinations and investigations
of Stanford from 1997 through 2009 and the agency's response to all
complaints it received regarding the activities of Stanford's
companies, tracing the path of these complaints through the Commission
from their inception and reviewing what, if any, investigative or
examination work was conducted with respect to the allegations in the
complaints.
Results of the OIG's Stanford Investigation
The OIG's investigation determined that the SEC's Fort Worth office
was aware since 1997 that Robert Allen Stanford was likely operating a
Ponzi scheme, having come to that conclusion a mere 2 years after
Stanford Group Company, Stanford's investment adviser, registered with
the SEC in 1995. We found that over the next 8 years, the SEC's Fort
Worth Examination group conducted four examinations of Stanford's
operations, finding in each examination that the certificates of
deposit (CDs) Stanford was promoting could not have been
``legitimate,'' and that it was ``highly unlikely'' that the returns
Stanford claimed to generate could have been achieved with the
purported conservative investment approach utilized. The SEC's Fort
Worth examiners conducted examinations of Stanford in 1997, 1998, 2002
and 2004, concluding in each instance that Stanford's CDs were likely a
Ponzi scheme or similar fraudulent scheme. The only significant
difference in the examination group's findings over the years was that
the potential fraud was growing exponentially, from $250 million to
$1.5 billion.
The first SEC examination occurred in 1997, just 2 years after
Stanford Group Company began operations. After reviewing Stanford Group
Company's annual audited financial statements in 1997, a former branch
chief in the Fort Worth Broker-Dealer Examination group stated that,
based simply on her review of the financial statements, she ``became
very concerned'' about the ``extraordinary revenue'' from the CDs and
immediately suspected the CD sales were fraudulent. In August 1997,
after just six days of field work in an examination of Stanford, the
examiners concluded that Stanford International Bank's statements
promoting the CDs appeared to be misrepresentations. The examiners
noted that while the CD products were promoted as being safe and
secure, with investments in ``investment-grade bonds,'' the interest
rate, combined with referral fees of between 11 percent and 13.75
percent annually, was simply too high to be achieved through the
purported low-risk investments.
The branch chief concluded after the 1997 examination was finished
that the CDs declared above-market returns were ``absolutely
ludicrous'' and that the high referral fees paid for selling the CDs
indicated that they were not ``legitimate CDs.'' The Assistant District
Administrator for the Fort Worth Examination program concurred, noting
that there were ``red flags'' about Stanford's operations that caused
her to believe Stanford Group Company was operating a Ponzi scheme,
specifically noting the fact that the interest being paid on these CDs
``was significantly higher than what you could get on a CD in the
United States.'' She further concluded that it was ``highly unlikely''
that the returns Stanford claimed to generate could be achieved with
the conservative investment approach Stanford claimed to be using.
In the SEC's internal tracking database, where it recorded
information about its examinations, the Broker-Dealer Examination group
characterized its conclusion from the 1997 examination of Stanford
Group Company as ``Possible misrepresentations. Possible Ponzi
scheme.'' Our investigation found that in 1997, the examination staff
determined, as a result of their findings, that an investigation of
Stanford by the Fort Worth Enforcement group was warranted, and
referred a copy of their examination report to the Enforcement group
for review and disposition. In fact, when the former Assistant District
Administrator for the Fort Worth Examination program retired in 1997,
her ``parting words'' to the aforementioned branch chief were to ``keep
your eye on these people [referring to Stanford] because this looks
like a Ponzi scheme to me and some day it's going to blow up.''
We also found that in June 1998, the Investment Adviser Examination
group in Fort Worth began another examination of Stanford Group
Company. This Investment Adviser examination arrived at the same
conclusions that the broker-dealer examination had reached. The
Investment Adviser examiners found very suspicious Stanford's
``extremely high interest rates and extremely generous compensation''
in the form of annual recurring referral fees, as well as the fact that
Stanford Group Company was so ``extremely dependent upon that
compensation to conduct its day-to-day operations.''
In November 2002, the SEC's Investment Adviser Examination group
conducted yet another examination of Stanford Group Company. In this
examination, the staff identified the same red flags that had been
noted in the previous two examinations, including the fact that ``the
consistent, above-market reported returns'' were ``very unlikely'' to
be able to be achieved with Stanford's investments.
The Investment Adviser examiners also found that the list of
investors provided by Stanford Group Company was inaccurate, as the
list they received of the CD holders was inconsistent with the total
CDs outstanding based upon referral fees. The examiners noted that
although they did follow up with Stanford Group Company about this
discrepancy, they never obtained ``a satisfactory response, and a full
list of investors.''
After the examiners began this third examination of Stanford, the
SEC received multiple complaints from outside entities reinforcing and
bolstering the examiners' suspicions about Stanford's operations.
However, the SEC failed to follow up on these complaints or take any
action to investigate them. On December 5, 2002, the SEC received a
complaint from a citizen of Mexico, who raised the same concerns the
examination staff had raised. While the examiners characterized the
concerns expressed in this complaint as ``legitimate,'' we found that
the SEC did not respond to the complaint and did not take any action to
investigate the claims made therein.
In 2003, the SEC Enforcement staff received two new complaints that
Stanford was a Ponzi scheme, but we found that nothing was done to
pursue either of them. On August 4, 2003, the SEC was forwarded a
letter that discussed several similarities between a known Ponzi scheme
and Stanford's operations. Then, on October 10, 2003, the NASD
forwarded a letter dated September 1, 2003, from an anonymous Stanford
insider to the SEC's Office of Investor Education and Advocacy, which
stated, in pertinent part:
Stanford Financial is the subject of a lingering corporate
fraud scandal perpetuated as a ``massive Ponzi scheme'' that
will destroy the life savings of many; damage the reputation of
all associated parties, ridicule securities and banking
authorities, and shame the United States of America.
Our investigation found that while this letter was minimally
reviewed by various Enforcement staff, the Enforcement group decided
not to open an investigation or even an inquiry into the complaint. The
Enforcement branch chief responsible for the decision explained his
rationale as follows:
[R]ather than spend a lot of resources on something that could
end up being something that we could not bring, the decision
was made to--to not go forward at that time, or at least to--to
not spend the significant resources and--and wait and see if
something else would come up.
In October 2004, the Fort Worth Examination staff conducted a
fourth examination of Stanford Group Company. The examiners once again
analyzed the CD returns using data about the past performance of the
equity markets and concluded that Stanford Group Company's sales of the
CDs violated numerous Federal securities laws.
While the Fort Worth Examination group made multiple efforts after
each examination of Stanford Group Company to convince the Enforcement
group to open and conduct an investigation of Stanford, we found that
the Enforcement group made no meaningful effort to investigate the
potential fraud or to consider an action to attempt to stop it until
late 2005. In 1998, the Enforcement group opened a brief inquiry, but
then closed it after only three months, when Stanford failed to produce
documents evidencing fraud in response to a voluntary document request.
In 2002, no investigation was opened even after the examiners
specifically identified in an examination report multiple violations of
securities laws by Stanford. In 2003, after receiving the three
separate complaints about Stanford's operations, the Enforcement group
decided not to open up an investigation or even an inquiry, and did not
follow up to obtain more information about the complaints.
In late 2005, after a change in leadership in the Enforcement group
and in response to the continuing pleas by the Fort Worth examiners,
who had been watching the potential fraud grow in examination after
examination, the Enforcement group finally agreed to seek a formal
order from the Commission to investigate Stanford. However, even at
that time, the Enforcement group missed an opportunity to have the SEC
bring an action against Stanford Group Company for its admitted failure
to conduct any due diligence regarding Stanford's investment portfolio.
Such an action could have potentially halted the sales of the Stanford
International Bank CDs though the Stanford Group Company investment
adviser, and would have provided investors and prospective investors
with notice that the SEC considered Stanford Group Company's sales of
the CDs to be fraudulent. We found that this particular action was not
considered, partially because the new head of the Enforcement group in
Fort Worth was not aware of the findings of the Investment Adviser
group's examinations in 1998 and 2002, or even that Stanford Group
Company had registered as an investment adviser, a fact she learned for
the first time in the course of our investigation in January 2010.
We did not find that the reluctance of the SEC's Fort Worth
Enforcement group to investigate Stanford was related to any improper
professional, social or financial relationship on the part of any
current or former SEC employee. We found evidence, however, that SEC-
wide institutional influence did factor into the Enforcement group's
repeated decisions not to undertake a full and thorough investigation
of Stanford, notwithstanding staff awareness that the potential fraud
was growing. We found that senior Fort Worth officials perceived that
they were being judged on the numbers of cases they brought, so-called
``stats,'' and communicated to the Enforcement staff that novel or
complex cases were disfavored. As a result, cases like Stanford, which
were not considered ``quick-hit'' or ``slam-dunk'' cases, were not
encouraged.
We also found that a former head of Enforcement in Fort Worth, who
played a significant role in multiple decisions over the years to quash
investigations of Stanford, sought to represent Stanford on three
separate occasions after he left the Commission, and in fact,
represented Stanford briefly in 2006 before he was informed by the SEC
Ethics Office that it was improper for him to do so.
Our investigation revealed that this individual while working at
the SEC was responsible for decisions: (1) in 1998 to close an inquiry
opened regarding Stanford after the 1997 examination; (2) in 2002, in
lieu of responding to a complaint or investigating the issues it
raised, to forward it to the Texas State Securities Board; (3) also in
2002, not to act on the Examination staff's referral of Stanford for
investigation after its Investment Adviser examination; (4) in 2003,
not to investigate Stanford after a complaint was received comparing
Stanford's operations to a known fraud; (5) also in 2003, not to
investigate Stanford after receiving a complaint from an anonymous
insider alleging that Stanford was engaged in a ``massive Ponzi
scheme;'' and (6) in 2005, to summarily inform senior Examination staff
after a presentation was made on Stanford at a quarterly summit meeting
that Stanford was not a matter they planned to investigate.
Yet, in June 2005, a mere two months after leaving the SEC, this
former head of the Enforcement group in Fort Worth e-mailed the SEC
Ethics Office that he had been ``approached about representing
[Stanford] . . . in connection with (what appears to be) a preliminary
inquiry by the Fort Worth office.'' He further stated, ``I am not aware
of any conflicts and I do not remember any matters pending on Stanford
while I was at the Commission.''
After the SEC Ethics Office denied the former head of Enforcement
in Fort Worth's June 2005 request, in September 2006, Stanford retained
this individual to assist with inquiries Stanford was receiving from
regulatory authorities, including the SEC. The former head of
Enforcement in Fort Worth met with Stanford Financial Group's General
Counsel in Stanford's Miami office and billed Stanford for his time on
this representation. In late November 2006, he called his former
subordinate, the Assistant Director working on the Stanford matter in
Fort Worth, who asked him during the conversation, ``[C]an you work on
this?,'' and in fact told him, ``I'm not sure you're able to work on
this.'' After this call, the former head of Enforcement in Fort Worth
belatedly sought permission from the SEC's Ethics Office to represent
Stanford. The SEC Ethics Office replied that he could not represent
Stanford for the same reasons given a year earlier and he discontinued
his representation.
In February 2009, immediately after the SEC sued Stanford, this
same former head of Enforcement in Fort Worth contacted the SEC Ethics
Office a third time about representing Stanford in connection with the
SEC matter--this time to defend Stanford against the lawsuit filed by
the SEC. An SEC Ethics official testified that he could not recall
another instance in which a former SEC employee contacted the Ethics
Office on three separate occasions trying to represent a client in the
same matter. After the SEC Ethics Office informed the former head of
Enforcement in Fort Worth for a third time that he could not represent
Stanford, he became upset with the decision, arguing that the matter
pending in 2009 ``was new and was different and unrelated to the matter
that had occurred before he left.'' When asked during our investigation
why he was so insistent on representing Stanford, he replied, ``Every
lawyer in Texas and beyond is going to get rich over this case. Okay?
And I hated being on the sidelines.''
Based upon this evidence, our investigation determined that the
former head of Enforcement in Fort Worth's representation of Stanford
appeared to violate State bar rules that prohibit a former Government
employee from working on matters in which that individual participated
as a Government employee.
In summary, our report of investigation concluded overall that the
SEC's Fort Worth office was aware since 1997 that Stanford was likely
operating a Ponzi scheme after conducting examination after examination
for a period of 8 years, but merely watched the alleged fraud grow, and
failed to take any action to stop it.
Recommendations of the OIG's Stanford Report of Investigation
We provided our Report of Investigation on the SEC's handing of the
Stanford matter to the Chairman of the SEC on March 31, 2010. We
recommended that the Chairman carefully review the Report's findings
and share with Enforcement management the portions of the Report that
related to the performance failures by those employees who still work
at the SEC, so that appropriate action (which may include performance-
based action, if applicable) would be taken, on an employee-by-employee
basis, to ensure that future decisions about when to open an
investigation and when to recommend that the Commission take action are
made in a more appropriate and timely manner.
We also made numerous recommendations to improve the operations of
several divisions and offices within the SEC. Specifically, we
recommended that:
1. Enforcement ensure that the potential harm to investors if no
action is taken is considered as a factor when deciding whether
to recommend an enforcement action, including consideration of
whether this factor, in certain situations, outweighs other
factors such as litigation risk;
2. Enforcement emphasize the significance of bringing cases that are
difficult, but important to the protection of investors, in
evaluating the performance of an Enforcement staff member or a
regional office;
3. Enforcement consider the significance of the presence or absence
of United States investors in determining whether to open an
investigation or recommend an enforcement action that otherwise
meets jurisdictional requirements;
4. There be improved coordination between the Enforcement and OCIE
on investigations, particularly those investigations initiated
by an OCIE referral to Enforcement;
5. Enforcement reevaluate the factors utilized to determine when
referral of a matter to State securities regulators, in lieu of
an SEC investigation, is appropriate;
6. There be additional training of Enforcement staff to strengthen
their understanding of the laws governing broker-dealers and
investment advisers; and
7. Enforcement emphasize the need to coordinate with the Office of
International Affairs and the Division of Risk, Strategy, and
Financial Innovation, as appropriate, early in the course of
investigations.
We also referred our Report of Investigation to the Commission's
Ethics Counsel for referral to the Bar Counsel offices in the two
States in which the former head of Enforcement in Fort Worth was
admitted to practice law.
Follow-up on Recommendations
My Office is committed to following up with respect to all of the
recommendations made in our Stanford report to ensure that appropriate
changes and improvements are made in the SEC's operations as a result
of our findings. We are aware that many improvements have already been
undertaken under the direction of Chairman Schapiro and Enforcement
Director Khuzami as a result of the findings and many recommendations
we made as a result of our Madoff investigation. We note that
Enforcement has indicated that it has taken action on the
recommendations of our Stanford report, and we are in the process of
reviewing those actions to ensure that they are adequate and fully
address the OIG's concerns. We are confident that under Chairman
Schapiro's leadership, the SEC will carefully take the appropriate
steps to implement fully our Stanford recommendations and ensure that
fundamental changes are made in the SEC's operations so that the errors
and failings we found in our investigation are properly remedied and
not repeated in the future.
Similarities to Failures in the Madoff Matter
While my Office has not conducted any formal analysis of
similarities between the findings in our Madoff and Stanford reports,
we have identified some striking parallels between the two situations.
First, in both cases, the SEC received credible and substantive
complaints about possible fraud, but failed to follow up appropriately
on these complaints. Second, in both the Madoff and Stanford matters,
the SEC had in its possession ample evidence of potential fraud, which
should have triggered thorough and comprehensive Enforcement
investigations and actions. Third, and most unfortunately, in both
situations, prompt and effective action on the part of the SEC could
have potentially uncovered fraud and prevented investors from losing
billions of dollars.
Our Office intends to remain vigilant to ensure that the SEC
benefits from the lessons learned as a result of its failures in both
these cases and makes the necessary improvements to ensure that such
failures do not occur again in the future.
Conclusion
In conclusion, I appreciate the interest of the Chairman, the
Ranking Member and the Committee in the SEC and my Office and, in
particular, in the facts and circumstances pertinent to our Stanford
report. I believe that the Committee's and Congress's continued
involvement with the SEC is helpful to strengthen the accountability
and effectiveness of the Commission. Thank you.
______
JOINT PREPARED STATEMENT OF
ROBERT KHUZAMI
Director, Division of Enforcement, Securities and Exchange Commission
And
CARLO V. DI FLORIO
Director, Office of Compliance Inspections and Examinations, Securities
and Exchange Commission
September 22, 2010
Chairman Dodd, Ranking Member Shelby, and Members of the Committee,
thank you for the opportunity to testify today on behalf of the
Securities and Exchange Commission (SEC).
The Commission commends the work of the Inspector General and his
staff investigating this matter and drafting the report, Investigations
of the SEC's Response to Concerns Regarding Robert Allen Stanford's
Alleged Ponzi Scheme, OIG-526 (Inspector General Report). The Office of
the Inspector General conducted an extensive investigation that clearly
identifies missed opportunities for protecting investors, and no one
should evade responsibility for the SEC's handling of the Stanford
matter. We deeply regret that the SEC failed to act more quickly to
limit the tragic investor losses suffered by Stanford's victims.
The Inspector General Report makes important recommendations
identifying areas for improvement throughout the SEC and, as we will
discuss today, both the Division of Enforcement and the Office of
Compliance Inspections and Examinations (OCIE) have instituted various
measures to address those recommendations.
In addition to the Inspector General Report's recommendations, as
new leaders, each of us has engaged in a top to bottom review of our
respective Division and Office since joining the Commission within the
last year and a half and have implemented measures to reform our
organizational processes and improve our effectiveness. We have vastly
expanded our training programs; hired staff with new skill sets;
streamlined management; put seasoned investigative attorneys back on
the front lines; improved our examiners' risk-assessment techniques;
revised our enforcement and examination procedures to improve
coordination and information-sharing; leveraged the knowledge of third
parties; instituted new initiatives to identify fraud; and revamped the
way that we handle the tremendous volume of tips, complaints, and
referrals that we receive annually.
Despite the many changes, more needs to be done. This will require
commitment and creativity. We embrace the challenge and are confident
that our efforts will continue to enhance investor protection and the
integrity of our financial markets.
Status of the Stanford Case
In February 2009, the SEC filed an emergency civil action to halt
sales of Stanford Certificates of Deposit (CDs) and seek the return of
funds to harmed investors. Shortly thereafter, the SEC filed an amended
complaint against Robert Allen Stanford, James M. Davis, Stanford
International Bank (SIB), and others alleging a massive Ponzi scheme in
the sale of SIB CDs.
By the end of 2008, SIB had sold more than $7.2 billion of CDs by
touting the bank's safety and security, consistent double-digit returns
on the bank's investment portfolio, and high rates of return on the CDs
that greatly exceeded rates offered by U.S. commercial banks. The SEC's
complaint alleged that Stanford and Davis misappropriated billions of
dollars of investor funds and invested funds in speculative,
unprofitable private businesses controlled by Stanford. In an effort to
conceal their fraudulent conduct, Stanford and Davis allegedly
fabricated the performance of the bank's investment portfolio and lied
to investors about the nature and performance of the portfolio. The SEC
alleged that, rather than making principal redemptions and interest
payments from earnings, Stanford made purported interest and redemption
payments from money derived from CD sales.
Working in close coordination with the SEC, the Department of
Justice, on June 19, 2009, unsealed indictments against Stanford, Davis
and three other former Stanford employees, alleging that they committed
securities, wire and mail fraud and obstructed the SEC's investigation.
On June 30, 2009, the court ordered that Stanford be detained in jail
pending his criminal trial.
In June 2009, the SEC also sued Leroy King, the former
Administrator and Chief Executive Officer for the Antigua Financial
Services Regulatory Commission (AFSRC), alleging that Stanford bribed
King to help him conceal his fraud and thwart the SEC's investigation.
As alleged in the SEC's complaint, while King received bribes from
Stanford, he rebuffed SEC inquiries into Stanford's conduct by stating,
among other things, that further investigation of Stanford was
``unwarranted,'' and that his bank was ``fully compliant'' with
Antiguan bank regulations. \1\ King also permitted Stanford to, in
effect, ``ghost write'' the response by the AFSRC to the SEC, which
rejected the SEC's demand for information. Bribing King permitted
Stanford to keep his fraud alive for years. In addition to the SEC's
charges, the Department of Justice indicted King for charges, including
obstruction of justice, for allegedly accepting tens of thousands of
dollars in bribes to facilitate the scheme.
---------------------------------------------------------------------------
\1\ SEC v. Stanford International Bank Ltd., et al., No 3:09-cv-
0298-N (N.D.Tex), Second Amended Complaint at par. 88.
---------------------------------------------------------------------------
The SEC is vigorously pursuing its case against Stanford and the
others charged in this massive Ponzi scheme. In addition, the staff's
investigation into possible misconduct by others (including former
employees and third parties) is ongoing.
Status of Recovery for Stanford Investors
The SEC's focus in the Stanford matter is to hold wrongdoers
accountable while providing maximum recovery to investors harmed by
this egregious fraud. We are proceeding on several fronts:
First, after filing its civil action in February 2009, the SEC
filed a motion requesting that the district court appoint a Receiver
over the defendants' assets to prevent waste and dissipation of those
assets to the detriment of investors. Second, to complement the
Receiver's efforts, the SEC, in coordination with the DOJ, moved to
freeze SIB assets held in international financial institutions.
Freezing assets in international jurisdictions poses complex litigation
challenges, but this step was crucial to ensure the protection of
investor funds. Third, the SEC is working with the Receiver, DOJ, and
securities regulators and law enforcement agencies in the United
Kingdom, Switzerland, Canada, Mexico, and in several countries
throughout Central and South America, to identify, secure, and
repatriate for the benefit of investors over $300 million in cash and
securities held in non-U.S. bank accounts.
In a status report filed July 1, 2010, the Receiver identified
several categories of major assets for possible distribution to harmed
investors:
$80.5 million in cash on hand;
$17.2 million in private equity investments already
recovered and liquidated, with an additional $7.7 million in
proceeds from additional pending transactions expected;
$2.3 million in inventory and accounts receivable,
specifically in coins and gold bullion;
$6.4 million in real estate sale proceeds, with an
additional $11.7 million expected from sales of other
identified properties; and
$511 million in pending fraudulent transfer and unjust
enrichment claims. \2\
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\2\ This figure includes amounts claimed in lawsuits filed or
intended to be filed by the Receiver; actual recovery may vary
depending on litigation outcome.
In conjunction with the SEC, the Receiver is focused on identifying
and liquidating the largest possible pool of obtainable assets for
distribution to harmed investors.
The SEC is closely monitoring the Receiver's costs to ensure
optimal recovery for the victims of this massive fraud. We have
strongly urged the Receiver to stringently apply a cost-benefit
analysis and pursue only those legal claims that could generate maximum
proceeds for the benefit of investors while minimizing the Receiver's
legal fees and expenses. We also have cautioned the Receiver that we
are carefully scrutinizing all bills requesting payment for fees and
expenses. In fact, on at least three occasions, the SEC has formally
challenged the Receiver's bills. We will continue to do so where
appropriate.
Status of SIPC Determination in Stanford
The Commission oversees the activities of the Securities Investor
Protection Corporation (SIPC), which plays a critical role in
protecting the customers of a broker-dealer entering liquidation under
the Securities Investor Protection Act (SIPA). In the Stanford matter,
SIPC has indicated that, in its view and based on the facts presented,
there is no basis for SIPC to initiate a proceeding under SIPA. \3\ The
Commission is investigating the facts to determine whether that
determination is appropriate, including meeting with the Stanford
Victims' Coalition and reviewing documents provided in support of their
claims. The Commission will continue to monitor the issues surrounding
the Stanford matter as it relates to SIPC.
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\3\ http://www.stanfordfinancialreceivership.com/documents/
SIPC_Letter.pdf
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Enforcement and OCIE Responses to Inspector General Recommendations
On April 16, 2010, the SEC released a report by the Inspector
General concerning the investigation of the Stanford matter. The report
identified the need for reforms in the Division of Enforcement and in
the Office of Compliance Inspections and Examinations.
Division of Enforcement
The Division of Enforcement has taken action on all seven of the
formal recommendations identified in the Inspector General Report. On
July 20, 2010, Enforcement submitted a closing memorandum to the
Inspector General containing information that we believed fully
addressed all seven recommendations. We are working with the Inspector
General and hope to receive his concurrence on closing the
recommendations as soon as possible.
First Recommendation. The Inspector General recommended that we
evaluate the potential harm to investors when deciding whether to bring
an enforcement action that also may involve litigation risks. The
Division's Enforcement Manual, \4\ developed in October 2008, provides
that staff should consider several factors when determining whether to
open an investigation, including: (i) the potential losses involved or
harm to investors and (ii) the egregiousness of the potential
violation. In addition, the Enforcement Manual also states that first
among the factors the staff should consider before closing an
investigation is the seriousness of the conduct and potential
violations. As these Enforcement Manual provisions indicate, prior to
the Inspector General Report, the Division encouraged staff to
carefully assess factors such as potential harm to investors and
seriousness of potential violations when deciding whether to open or
close investigations. In response to the Inspector General Report, we
have instituted mandatory Enforcement Manual training for all Division
staff to ensure compliance.
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\4\ http://www.sec.gov/divisions/enforce/enforcementmanual.pdf
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In addition to its Enforcement Manual provisions and related
training, the Division regularly files actions in Federal court seeking
emergency temporary restraining orders and asset freezes to prevent
imminent investor harm and protect assets for the benefit of
investors--actions that often present litigation risk given the exigent
circumstances of the very early stages of an investigation. In fiscal
year 2010 to date, Enforcement has obtained 45 emergency temporary
restraining orders to halt ongoing misconduct and prevent imminent
investor harm and 56 asset freezes to preserve funds for the benefit of
investors. We believe that these measures address the Inspector
General's concern that Enforcement staff should carefully consider the
potential harm to investors when deciding to bring an enforcement
action that may otherwise pose litigation risks.
Second Recommendation. The Inspector General recommended that we
consider promulgating and/or clarifying staff and regional office
performance evaluation procedures that recognize the significance of
bringing difficult cases focused on investor protection. The
Enforcement Division has revised the metrics used to manage and
evaluate the performance of its staff. Rather than emphasizing the
number of actions filed, we focus on the programmatic priority of the
case, which reflects a consideration of multiple factors, including
whether the matter:
1. presents an opportunity to send a particularly strong and
effective message of deterrence, including with respect to
markets, products and transactions that are newly developing,
or that are long established but which by their nature present
limited opportunities to detect wrongdoing and thus to deter
misconduct;
2. involves particularly egregious or extensive misconduct;
3. involves potentially widespread and extensive harm to investors;
4. involves misconduct by persons occupying positions of substantial
authority or responsibility, or who owe fiduciary or other
enhanced duties and obligations to a broad group of investors
or others;
5. involves potential wrongdoing as prohibited under newly enacted
legislation or regulatory rules;
6. involves potential misconduct that occurred in connection with
products, markets, transactions or practices that pose
particularly significant risks for investors or a systemically
important sector of the market;
7. involves a substantial number of potential victims and/or
particularly vulnerable victims;
8. involves products, markets, transactions or practices that the
Enforcement Division has identified as priority areas (i.e.,
conduct relating to the financial crisis; fraud in connection
with mortgage-related securities; financial fraud involving
public companies whose stock is widely held; misconduct by
investment advisers; and matters involving priorities
established by particular regional offices or the specialized
units); and
9. provides an opportunity to pursue priority interests shared by
other law enforcement agencies on a coordinated basis.
We further consider in our evaluations the difficulty, complexity
and investigative challenges of the case, as well as the efficiency of
the resources used, the swiftness of the action, and the success of the
outcome.
In addition, the Division now generates a national priority case
report that identifies and tracks cases deemed programmatically
significant to ensure that appropriate resources are devoted to these
cases. Finally, the SEC's Strategic Plan for Fiscal Years 2010-2015--as
circulated for public comment--identifies the performance standards
that it will use to gauge the success of its enforcement program. Those
performance measures are not exclusively focused on the number of cases
filed per fiscal year, but rather include: (i) the percentage of
enforcement cases successfully resolved; (ii) the percentage of
enforcement cases filed within 2 years, and (iii) our success in
collecting and returning money to investors in a timely fashion. We
believe that these new procedures and metrics address the issues raised
in the Inspector General Report regarding the role that metrics played
in the Stanford matter and the need for an enhanced qualitative
assessment of staff performance.
Third Recommendation. The Inspector General recommended that we
consider promulgating and/or clarifying procedures regarding the
significance of the presence or absence of U.S. investors in
determining whether to open an investigation or bring an enforcement
action that otherwise meets jurisdictional requirements. As previously
described, the Division's Enforcement Manual identifies a number of
factors that the staff should consider when deciding whether to open an
investigation including, but not limited to, potential losses and harm
to any investor, namely: (i) the egregiousness of the potential
violation; (ii) the potential magnitude of the violation; (iii) whether
the potentially harmed group is particularly vulnerable or at risk;
(iv) whether the conduct is ongoing; (vi) the size of the victim group;
and (vii) the amount of potential or actual losses to investors. As
demonstrated by these provisions, prior to the Inspector General
Report, the Division encouraged its staff to assess victim losses and
victim impact when deciding to open an investigation. Moreover, in
response to the Inspector General Report, the Division instituted
mandatory Enforcement Manual training to ensure full compliance.
In addition, the Division currently is evaluating a recent Supreme
Court decision, Morrison v. National Australia Bank, that placed
jurisdictional limitations on securities fraud claims involving conduct
and activities outside the U.S., in light of certain Dodd-Frank Wall
Street Recovery and Reform Act of 2010 (Dodd-Frank Act) provisions
concerning the territorial scope of the Federal securities laws. In
connection with the Inspector General's recommendation, we are
assessing the impact of that decision and the related Dodd-Frank Act
provisions, and currently are working with other SEC offices to
determine whether any additional guidance should be provided to
Enforcement staff. We continue to work with the Inspector General to
address his concern that staff should evaluate the presence or absence
of U.S. investors when deciding to open an investigation.
Fourth Recommendation. The Inspector General recommended that we
consider promulgating and/or clarifying procedures regarding
coordination between Enforcement and OCIE on investigations,
particularly those investigations initiated by a referral to
Enforcement by OCIE. As a result of various Enforcement/OCIE
initiatives, there now exists a significantly increased level of
collaboration between Enforcement and OCIE staff. Enforcement and OCIE
hold regular meetings to discuss issues raised in ongoing examinations.
In addition, the many risk-based investigative initiatives undertaken
as part of the overall restructuring of the Enforcement Division
require early and frequent contact between Enforcement and OCIE to: (i)
jointly develop risk metrics; (ii) identify entities with risk profiles
indicative of the need for a risk-based examination; (iii) discuss the
findings of ongoing examinations; and (iv) discuss the scope and nature
of referrals to Enforcement for investigation.
In November 2006, Enforcement and OCIE established a process to
facilitate the tracking of examination referrals, and ensure that there
is a record of all OCIE referrals that are both accepted and declined
by Enforcement (or are accepted and later closed), and the reasons why.
This process includes referral committees at both the regional and
headquarters office. To ensure ongoing coordination with OCIE where
appropriate, Enforcement's new guidance for written investigative plans
encourages staff to carefully evaluate and reevaluate issues throughout
an investigation to minimize the risk that investigative steps are
overlooked, and to better identify issues that require consultation
with OCIE or other Divisions or Offices.
Lastly, as part of the Chairman's initiative to improve the
handling of tips, complaints and referrals (TCRs), Enforcement has
established the Office of Market Intelligence (OMI) and staffed it with
market surveillance specialists, accountants, attorneys and other
support personnel, and additional hiring is expected. OMI's mission is
to ensure that we collect all TCRs in one place, combine that data with
other public and confidential information on the persons or entities
identified in the TCRs, and then dedicate investigative resources to
those TCRs presenting the greatest threat of investor harm. OCIE's
referrals to Enforcement are tracked through this new TCR system to
ensure proper Enforcement staff assignment. We believe that these
measures will address the issues identified in the Inspector General
Report regarding poor coordination between Enforcement and OCIE.
Fifth Recommendation. The Inspector General recommended that we
consider promulgating and/or clarifying procedures regarding when to
refer a matter to State securities regulators. Prior to the Inspector
General Report, the Enforcement Manual identified factors to guide
referrals to Federal or State criminal authorities, SROs, the Public
Company Accounting Oversight Board, or State agencies, including: (i)
the egregiousness, extent and location of the conduct; (ii) the
involvement of recidivists in any suspected conduct; and (iii) the
potential for additional meaningful protection to investors upon
referral. In response to the Inspector General Report, we now require
mandatory Enforcement Manual training for all Enforcement staff.
The Inspector General recommended that we consider promulgating
and/or clarifying procedures regarding when to refer a matter to State
securities regulators. Prior to the Inspector General Report,
Enforcement had strong working relationships with our law enforcement
and regulatory partners, including State securities regulators.
Moreover, the Enforcement Manual identifies factors to guide referrals
to Federal or State criminal authorities, SROs, the Public Company
Accounting Oversight Board, or State agencies, including: (i) the
egregiousness, extent and location of the conduct; (ii) the involvement
of recidivists in any suspected conduct; and (iii) the potential for
additional meaningful protection to investors upon referral.
In addition, as indicated, Enforcement has created the Office of
Market Intelligence to oversee and coordinate Enforcement's collection,
analysis and distribution of TCRs. OMI staff has been directed to
provide relevant information and data obtained in its initial triage of
TCRs to the appropriate State or Federal agencies or other regulatory
partners. Further, in connection with our work on the Financial Fraud
Enforcement Task Force, we continue to work closely with our law
enforcement and regulatory partners, including State securities
regulators. These strengthened relationships facilitate effective
information-sharing and provide us with clear points of contact for
referrals to State securities regulators. We continue to work to
address the Inspector General's concern related to the appropriate and
timely referral of relevant investigative information to State
securities regulators.
Sixth Recommendation. The Inspector General recommended that we
consider promulgating and/or clarifying procedures regarding training
of Enforcement staff to strengthen staff understanding of the laws
governing broker-dealers and investment advisers. Newly created
specialized units in the Enforcement Division, including one dedicated
to Asset Management issues (including investment advisers) have
unveiled intensive training modules in their respective specialty
areas, which have been made available to all staff throughout the
Division. In addition, Enforcement has strengthened training both for
new hires and for existing staff, including training specifically
focused on the laws governing broker-dealers and investment advisers.
Enforcement also has created a new formal training unit led by a senior
Enforcement official. This training unit will coordinate further
training for the staff and has created a training site on our intranet
to allow staff to easily find training opportunities and materials from
prior training events. These formal training initiatives are
complemented by Enforcement staff's efforts to take advantage of
substantive expertise within other Divisions and Offices. We believe
that these initiatives address the Inspector General's concerns related
to the staff's working knowledge of the laws governing broker-dealers
and investment advisers.
Seventh Recommendation. The Inspector General recommended that we
consider promulgating and/or clarifying procedures regarding
coordination with the Office of International Affairs (OIA) and the
Division of Risk, Strategy, and Financial Innovation (RiskFin), as
appropriate, at the early stages of investigations where relevant
documents, individuals or entities are located abroad. As indicated
above, the Division has adopted new guidance concerning written
investigative plans that requires the staff to identify issues
appropriate for coordination with other Divisions or Offices, such as
OIA or RiskFin. In addition, Enforcement has established a formal
quarterly case review process to assist the staff in identifying
whether and when to consult with experts in OIA and RiskFin.
Also, both OIA and RiskFin have designated Enforcement liaisons to
serve as a point of contact for staff with questions requiring
investigative assistance. Enforcement staff regularly consults with and
seeks assistance from OIA to obtain documents and information from
foreign regulators, to locate and freeze assets abroad, and to assist
with other international enforcement issues. Moreover, OIA and RiskFin
provide training to Enforcement staff concerning their available
resources. We believe that these measures address the Inspector
General's concern that staff properly consult with other SEC Divisions
and Offices to further their investigations.
Office of Compliance Inspections and Examinations
The Inspector General Report made several recommendations relating
to coordination between Enforcement and OCIE on investigations of
potential violations of the Federal securities laws, particularly those
investigations initiated by a referral from OCIE to the Enforcement
Division. OCIE has undertaken specific policy changes and instituted
procedures to improve coordination and communication between the
Enforcement Division and OCIE.
Through a number of structural and process reforms, OCIE and the
Enforcement Division are working to identify misconduct earlier and to
move to shut it down more rapidly. OCIE and Enforcement staff and
leadership have been directed to evaluate potential referrals from the
OCIE Exam staff against Enforcement's criteria (referenced above)
regularly and determine the disposition of referrals. If there is
disagreement on a case at the regional level, Exam staff has been
instructed to escalate the matter to the attention of senior leadership
in Washington. These processes ensure that concerns can be escalated in
a timely manner to senior leadership of both the Exam and Enforcement
programs for appropriate review and resolution.
Exam and Enforcement coordination with respect to particular
matters is also the subject of periodic reviews. OCIE policy now
requires that OCIE Exam staff hold quarterly Exam Reviews, in which the
progress and status of every exam in the Regional Office is discussed
and evaluated for several factors, including evaluating any significant
issues with the firm that is the subject of the exam, determining
whether more staff resources are needed on the exam and deciding if the
exam is a potential referral to the Enforcement Division. These reviews
are an opportunity to summarize and preview findings that appear likely
to trigger possible Enforcement referrals, as well as to flag any
potential differences in the assessment of urgency, potential harm to
investors, or other issues that can then be raised at the joint
regional meetings or to OCIE senior management.
Finally, OCIE Exam staff is working closely with the Specialized
Units created recently within the Enforcement Division to identify key
risks presented by entities registered with the SEC and key risks to
the markets. This partnership with the Specialized Units has already
resulted in new approaches to joint efforts to identify risky firms
that may warrant examination or an Enforcement investigation. In
addition, OCIE recently announced the creation of several Specialized
Working Groups that will focus on areas where OCIE plans to increase
its specialization and market knowledge.
Additional Significant Enforcement and OCIE Reforms
In addition to the reforms prompted by the Inspector General
Report, we are engaged in a number of significant initiatives designed
to enhance our performance.
Division of Enforcement
The Division is embracing a range of initiatives designed to
increase our ability to identify hidden or emerging threats to the
markets and act quickly to halt misconduct and minimize investor harm.
Across the Division, we are launching risk-based investigative
initiatives, tapping into the expertise of our colleagues in OCIE and
other SEC offices and divisions, hiring talent with particularized
market expertise, and reaching out to academia, law enforcement, and
the regulated community to collect data on fraud hotspots.
One example of this new approach is our new national specialized
units, which were formally staffed and fully launched in May 2010.
These units are focused on the key areas of Structured and New
Products, Market Abuse, Municipal Securities and Public Pensions, Asset
Management, and violations of the Foreign Corrupt Practices Act. The
creation of these units further demonstrates the Division's emphasis on
the programmatic significance--rather than the quantity--of cases. To
assist them in their investigative efforts, the units are hiring
industry experts to work directly with our teams of experienced
attorneys and accountants to ensure that we stay on the cutting edge of
industry trends for the benefit of investors.
In addition to investigative work, the specialized units are
engaged in a number of initiatives with our colleagues in OCIE and
other Divisions to develop risk analytics that proactively identify red
flags for further examination and investigation. To take but one of
numerous examples, Enforcement, OCIE and RiskFin developed metrics and
risk analytics for an Aberrational Performance Inquiry to identify
those investment advisers whose operations shared characteristics of
those of a Ponzi or other illegal scheme. Specifically, working with
RiskFin's computer platform, we applied performance and volatility
benchmarks to thousands of hedge fund advisers, and those that emerged
from that analysis as outliers (e.g., those with above-market returns
coupled with an absence of expected volatility) are being subject to
further examination or investigation. This kind of proactive, risk-
based investigative approach is being duplicated across the Division.
In addition, the completion of other organizational reforms--such
as streamlining our management structure and obtaining delegated
authority from the Commission to allow us to swiftly obtain formal
orders and related subpoena power--has enabled our staff of attorneys
and accountants to focus on what they do best, investigate and stop
securities fraud. Across the Regional Offices and throughout the Home
Office, our staff has responded to challenging times by concentrating
on making smart investigative decisions, obtaining key evidence,
tracing investor funds and aggressively pursuing wrongdoers.
To support our staff's efforts, we continue to build on our already
strong working relationships with our law enforcement partners,
particularly the Department of Justice and the FBI, as well as the
banking regulators, other Federal and State agencies, and our other
partners around the world. In particular, our work as cochair of the
Securities and Commodities Fraud Working Group of the Financial Fraud
Enforcement Task Force facilitates effective communication with our law
enforcement partners nationwide engaged in parallel investigations
alongside of our own.
Finally, we are rapidly integrating the new authority and
responsibility granted to us under the Dodd-Frank Act. The Act
authorizes the creation of a Whistleblower Program, which will be
housed in our Office of Market Intelligence, and provides us with
numerous measures to further our investigations, including: nationwide
service of process; the ability to seek civil penalties in cease-and-
desist proceedings; the ability to seek penalties against aiders and
abettors under the Investment Advisers Act of 1940; and the ability to
charge aiding and abetting violations under the Securities Act of 1933
and the Investment Company Act of 1940, among other initiatives. We are
grateful that Congress included these legislative initiatives in the
Dodd-Frank Act, and we are now focused on using these new tools to
enhance our mission of investor protection.
Office of Compliance Inspections and Examinations
In addition to specific Exam/Enforcement coordination reforms, OCIE
has instituted several recent changes to its examination program and
has plans for significant additional strategic initiatives, all to
increase the effectiveness and efficiency of the National Exam Program.
Recent Changes at OCIE
OCIE has instituted significant reforms to sharpen its focus on a
risk-based examination process that also provides clear data for
coordination and decision making with Enforcement. OCIE is improving
its risk assessment procedures and techniques, to better identify areas
of risk to investors and more effectively allocate limited resources to
their highest and best use. For instance, OCIE is enhancing the
information that financial firms submit and is improving techniques to
better identify those particular firms that represent the highest risk
profiles and therefore warrant a closer look. Once we select firms for
examination using a risk-focused methodology, OCIE Exam staff are more
rigorously reviewing information about these individual firms before
sending examiners out to the field, so that we can use our limited
resources more effectively and target key risk areas at those firms
with the greatest overall risk profiles.
We also have instituted measures to improve the ability of
examiners to detect fraud involving theft of assets and other types of
violations. OCIE Exam staff across the country now routinely reaches
out to third parties such as custodians, counter-parties and customers
during examinations to verify the existence and integrity of all or
part of the client assets managed by the firm. The measures also
include expanded use of exams of an entire entity when firms have joint
or dual registrants such as affiliated broker-dealers and investment
advisers.
OCIE also has been hiring new staff with diverse skill sets to
expand its knowledge base and improve its ability to assess risk,
conduct examinations, detect and investigate wrongdoing, and focus our
priorities. We have hired new Senior Specialized Examiners--and will
bring on board more--who have specialized experience in areas such as
risk management, trading, operations, portfolio management, options,
compliance, valuation, new instruments and portfolio strategies, and
forensic accounting. We also have been hiring additional staff with
expertise in financial products and techniques--such as derivatives,
structured products and hedge fund activities. This will permit other
staffers to tap into that expertise to help them identify emerging
issues and understand the ways the industry is changing. Such expertise
can also be helpful in efforts to improve the techniques used in
examinations and the collection and analysis of data.
In addition, OCIE has instituted several measures to integrate the
activities of the broker-dealer and investment adviser examination
programs. The New York Regional Office, for example, has adopted a
protocol that integrates examination teams to make sure people with the
right skill sets are assigned to examinations. Under the protocol, a
single team of examiners, drawn from the broker-dealer and investment
management units, jointly examines selected dually registered firms to
ensure that the examination team includes those personnel relevant to
the subject of the exam. In addition, the examination program has
expanded opportunities for examiners to cross-train and increase
coordination between broker-dealer and investment management staff on
their examination plans. Finally, the examination program has begun to
include experts from other SEC divisions and offices in exams to ensure
we are leveraging SEC expertise and knowledge across the exam process.
For instance, we recently involved RiskFin colleagues with algorithmic
model experience in exams of High Frequency Trading firms.
OCIE's Ongoing Strategic Initiatives
In March, OCIE launched an intensive nationwide self assessment
program. We reviewed the OCIE Examination Program by looking at the
five components of Strategy, Structure, People, Process and Technology.
Since July, we have moved quickly to implement additional reforms from
the nationwide self-assessment.
OCIE has focused our strategy to identify the areas of highest risk
and deploy our examiners against these risks, in order to improve
compliance, prevent fraud, monitor risk and inform policymaking. We
have reinforced our strategy by developing a highly specific set of Key
Performance Indicators (KPIs) which we have shared with Enforcement,
and on which we plan to report periodically.
OCIE also has already implemented a new governance structure, which
is transforming our lines of communication and accountability. As
mentioned above, the OCIE National Leadership Team now includes
Directors of the Regional Offices, who manage both the Enforcement and
Examinations programs in each Regional Office. This strengthens the
OCIE/Enforcement partnership and speeds alerts, information hand offs,
and transitions from OCIE Exam staff to the Enforcement Division when
warranted. OCIE governance also forges interrelated bonds of
policymaking, information sharing, and communication among staff in our
Washington Home Office and our mission-critical examination teams in
the 11 Regional Offices.
In addition, OCIE has outlined a new ``open architecture''
structure for staffing exams that will enable management to reach
across disciplines and specialties to better match the skills of
examination teams to the business models and risk areas of registrants.
OCIE is also redesigning our exam team structure to redeploy the
expertise and experience of managers from office administration to on-
site exams in the field. These changes will help ensure that managers
spend additional time and attention on supervision and oversight in the
field on exams of registrants.
Our self assessment concluded that we needed not only to streamline
our processes and policies, but also to create an environment for our
staff of open, candid communication and personal accountability for
quality, in order to build on OCIE's core strengths and eliminate
repetition of the systemic flaws that may contribute to situations like
the Stanford case. Accordingly, OCIE has accelerated enrollment of OCIE
managers in the SEC's Successful Leaders Program and volunteered as the
pilot site for many of the SEC's Office of Human Resources' new
initiatives on hiring and professional development.
Finally, OCIE is placing continuous, focused attention on
technology, another area that our self assessment identified as
essential to a healthy examination program. We have developed and are
about to test a standardized examination tool across the national exam
program. We are also upgrading equipment and connectivity for examiners
to match that available to examiners and auditors at other regulatory
agencies and in the private sector.
Conclusion
The scope and egregiousness of Stanford's conduct and the resulting
injury to investors underscores that it is essential for us to push
forward with our efforts to hold the wrongdoers accountable and seek
maximum investor recovery. The Inspector General Report identified
numerous areas for reform, and we have moved aggressively to implement
these reforms. There is much more work that remains to be done, but we
are confident that we are putting in place the people and structures to
prevent another occurrence of Stanford-type problems.
Finally, we would note that both the SEC and the Department of
Justice continue to have open investigations into the Stanford matter.
Our efforts to bring potential wrongdoers to justice in this case are
still very much ongoing, and the defendants vigorously contest our
allegations. In responding to your questions today, we intend to be as
forthcoming and candid as possible and will identify when we are
concerned that disclosure of information through an answer could
compromise the Commission's ability to bring the wrongdoers to justice
or to provide maximum recovery for investors.
We thank you for the opportunity to appear before you today.
______
PREPARED STATEMENT OF ROSE L. ROMERO
Regional Director, Fort Worth Regional Office, Securities and Exchange
Commission
September 22, 2010
Introduction
Chairman Dodd, Ranking Member Shelby, and Members of the Committee,
thank you for the opportunity to testify today about the reforms the
Fort Worth Regional Office (FWRO) is making in response to the issues
raised in the Inspector General's Report on the Office's performance in
the Stanford matter.
Like Mr. Khuzami and Mr. di Florio, I regret that that the SEC
failed to act more quickly to limit the investor losses suffered by
Stanford's victims. All of us at the SEC share responsibility for the
handling of the Stanford matter and are taking significant steps to
ensure that we implement the reforms recommended by the Inspector
General.
I want to begin by saying that, from a regional perspective, the
initiatives outlined in the remarks of Mr. Khuzami and Mr. di Florio
are making a significant impact upon the Commission and its staff. A
streamlined management structure; delegation of authority to the staff;
expanded training opportunities; improvements to risk assessment and
examination procedures; specialization initiatives; and procedures to
insure coordination and information sharing are some of the critical
reforms that have greatly enhanced our capabilities.
By way of background, I served for 4 years in the United States Air
Force. I have served as a Fort Worth police officer, an assistant
district attorney and, prior to joining the Commission staff, I worked
as a Federal prosecutor for 16 years. I came to the Commission in 2006
with many objectives. Principal among them was to bring a more
aggressive, law enforcement-like focus to the way we do our job. During
my tenure, the staff of the Fort Worth Regional Office has performed
with dedication and diligence, and with an aggressiveness and integrity
that has earned for it a true partnership with its criminal agency
counterparts. In fact, the Justice Department has commended us for our
``remarkable collaboration'' with them. This fiscal year alone,
investigations by the FWRO staff have resulted in criminal charges
against 14 individuals, and many members of our staff now serve as
special Federal prosecutors, assisting in the prosecution of important
criminal cases. Since last year, in addition to their regular case-
loads, Fort Worth's 25 staff attorneys have filed 19 emergency actions
in Federal court, preserving millions of dollars stolen from investors.
While we certainly believe that our recent efforts have enhanced
the Commission's ability to protect investors, we must not forget the
painful lessons taught to us by past mistakes. The team that is leading
us now has done much and is prepared to do more. I have every
confidence that Chairman Schapiro and Directors Khuzami and di Florio
will continue to shape an agency that will stand as a bulwark for the
investing public.
Status of the Stanford Case
Mr. Khuzami has summarized the status of the current litigation. I
wanted, however, to highlight a few additional points.
Status of Ongoing Investigation
Immediately after filing the civil action, my staff worked closely
with the Justice Department to ensure that responsible executives of
Stanford were brought to justice. We aggressively continued our
investigation, aided by access to Stanford financial records and other
key documents obtained by the Receiver, and access to key employees in
Stanford's auditing and accounting departments. Our work allowed us to
understand how Stanford manipulated its financial documents to further
the scheme. In particular, my staff played a critical role in securing
the cooperation of James M. Davis, Stanford Financial Group's Chief
Financial Officer. We developed critical evidence in support of the
allegation that Leroy King, Antiguan's head of the Financial Services
Regulatory Commission, conspired with Stanford and obstructed the
Commission's efforts to investigate Stanford over many years. Our work
assisted the criminal authorities in filing a criminal case in June
2009 and was recognized by Assistant Attorney General Lanny A. Breuer
as ``resilient dedication.''
I have directed my staff to continue our investigation of the
Stanford matter to determine if other executives and employees at
Stanford deceived U.S. investors in the sale of fraudulent certificates
of deposit. Over the course of the past 12 months, we have collected
and reviewed tens of thousands of documents; reviewed e-mail
communications of more than 150 former employees; interviewed and taken
sworn statements of more than 60 former employees and other witnesses;
and interviewed approximately 200 victims of the Stanford fraud. We
have worked with the Stanford Victims Coalition, State regulators, and
FINRA to gather relevant information and evidence to further this
important investigation.
We have, through our Wells Process, notified several former
Stanford executives that we intend to recommend fraud charges against
them. These persons include former high level executives and financial
advisors. Our investigation of these matters is continuing, as are our
efforts to maximize the recovery for the Stanford victims.
Status of Recovery
Upon filing its civil action in February 2009, the SEC filed a
motion requesting that the district court appoint a Receiver over the
defendants' assets (including over 100 Stanford-related entities
operating around the world) to prevent waste and dissipation of those
assets to the detriment of investors. While a Receiver was a necessary
tool in this case, the SEC has closely monitored the receivership to
help maximize investor recovery. To complement the Receiver's efforts,
the SEC, in coordination with the Justice Department, moved to secure
assets held in international financial institutions. Securing assets in
international jurisdictions poses complex litigation challenges, and
those challenges have been magnified in this case by, among other
issues, the appointment in Antigua of a competing Receiver that has not
cooperated with the staff and that, in fact, has challenged various
steps taken by the Receiver, the SEC and the Justice Department. But,
securing international assets was crucial to ensure the protection of
investor funds and we continue to work closely with the Receiver,
Justice Department, and securities regulators and law enforcement
agencies in the U.K., Switzerland, Canada, Mexico, and in several
countries throughout Central and South America, to identify, secure,
and repatriate for the benefit of investors over $300 million in cash
and securities held in non-U.S. bank accounts.
Mr. Khuzami has set forth categories and amounts of assets
recovered for possible distribution to harmed investors. While I will
not repeat those items again here, I want to point out that we have
worked vigorously with the Receiver to recover assets in Panama,
Ecuador, Colombia, Venezuela, Peru, and Mexico.
In conjunction with the SEC, the Receiver is focused on identifying
and liquidating the largest possible pools of assets to prepare for a
future distribution to harmed investors. In addition, the SEC has
recently worked with other involved parties in the creation of an
investor committee to provide an additional mechanism for investor
input as to the receivership operations.
Throughout this case, the SEC has worked closely with a court-
appointed Examiner to monitor the Receiver's costs and ensure maximum
recovery to the victims of this massive fraud. These efforts have had
tangible benefits. For example, the Receiver and the professionals
assisting him have reduced their customary fees by at least 20 percent
and have capped the rates charged by senior lawyers. In addition, we
carefully scrutinize the Receiver's bills for fees and expenses. In
fact, in response to our objections, the district court has held back,
on an ongoing basis, an additional 20 percent from the Receiver's fees
and expenses. We have strongly urged the Receiver to stringently apply
a cost-benefit analysis and pursue only those legal claims that could
generate maximum proceeds for the benefit of investors while minimizing
the Receiver's legal fees and expenses. As with our monitoring of the
Receiver's fees and expenses, the SEC has intervened when it believed
the Receiver was pursuing inappropriate claims. For example, the SEC
challenged the Receiver's lawsuits seeking net profits from innocent
investors. Conversely, when the Receiver properly pursues assets, we
intervene in support of that effort where appropriate. For example, the
SEC recently submitted an amicus brief in the Fifth Circuit supporting
the Receiver's efforts to maintain a freeze over approximately $24
million in accounts held by former Stanford financial advisers. We will
continue to be closely involved with the Receiver's activities.
Status of SIPC Coverage
As you know, the Commission oversees the activities of the
Securities Investor Protection Corporation. Prior to the emergency
filing of the Stanford action, I directed my staff to contact SIPC,
notify them of the proposed enforcement action and consider whether
coverage under SIPA would be appropriate under the facts and
circumstances of this case. Since the filing of this action, we have
communicated with counsel for the Stanford Victims Coalition regarding
its position with respect to SIPC coverage and assisted them where
possible. My staff has also responded to informational requests and
worked with the Commission's Division of Trading and Markets in its
evaluation of the relevant facts of this case. I understand that the
Commission continues to investigate whether SIPC coverage is
appropriate for the victims of the Stanford fraud.
Reforms
In an effort to reform and improve its Programs, the Fort Worth
Regional Office has worked to integrate its broker-dealer and
investment adviser examination programs and to build strong
collaboration ties between its Enforcement and Examination staff.
Exam Program Integration
During the past 4 years, the FWRO has worked to integrate the
activities of its broker-dealer and investment adviser examination
programs. In late 2006, it was clear that we could not adequately
oversee an increasingly integrated registrant population, unless we
brought to each examination the right skills and expertise to
effectively review a firm's business activities, whether those were
advisory activities, brokerage activities or some combination thereof.
We immediately took action to: (1) break down the long-standing silos
that divided the investment adviser and broker-dealer exam programs;
(2) provide cross-training opportunities for exam staff to allow them
to expand their knowledge and experience; (3) routinely employ joint
teams of exam staff drawn from both sides of the program; (4) employ
strategic techniques to quickly assess risks to investors, especially
at firms who operate as both a broker dealer and an investment adviser;
and (5) significantly increase the level of coordination and
collaboration across the program. In 2009, the FWRO moved to a fully
integrated examination program with investment adviser, broker-dealer
and some fully crosstrained examiners working together under managers
responsible for the program as a whole rather than two distinct
programs. This formalized integration has allowed us to use staff
expertise more strategically, in conformity with the new OCIE
initiatives.
Collaboration Between the Examination and Enforcement Programs
Another top priority has been to build collaboration and teamwork
across the examination and enforcement programs, so that we are better
able to find fraud and significant problems through examinations and
quickly take action to stop the fraud and protect investors. We have
taken a number of specific actions to increase coordination between
exam and enforcement staff, starting with collaboration between senior
management across the office. The success of this increased
collaboration, as well as the integration of the examination program,
can be measured by the accomplishments we have achieved. For example,
the percentage of enforcement cases brought by the FWRO resulting from
examination referrals to Enforcement has increased from 12 percent in
fiscal year 2005 to 38 percent in fiscal year 2009.
Conclusion
The Fort Worth Regional Office is dedicated to protecting investors
and aggressively pursuing those who defraud them. We thank you for the
opportunity to appear before you today. I would be pleased to answer
your questions.
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN DODD
FROM ROBERT KHUZAMI AND CARLO V. DI FLORIO
Q.1. Dealing with managerial ``Bad Apples''. Mr. Khuzami/di
Florio, the Inspector General's report found that the former
head of Enforcement in Fort Worth, who played a significant
role in multiple decisions over the years to quash
investigations of Stanford, sought to represent Stanford on
three separate occasions after he left the Commission, and in
fact represented Stanford briefly in 2006 before he was
informed by the SEC Ethics Office that it was improper to do
so. How does your Division prevent abuse of discretion by
senior staff such as this? What are the current relevant
policies and how are they enforced?
A.1. We share your concern about ethical violations by any SEC
personnel. With respect to the conduct of the former Head of
Enforcement in the Fort Worth Regional Office, it appears that
this individual twice contacted the SEC Ethics Office and
inquired about his ability to represent Stanford. On both
occasions, he was told that such representation was not
permitted. When he contacted his former colleagues in the Fort
Worth Regional Office, they too questioned the appropriateness
of his involvement. These circumstances indicate that Fort
Worth personnel were sensitive to the ethical issues presented,
and that the Ethics Office gave the appropriate advice. The
fact that the individual, at some point in that process, may
have disregarded some or all of that advice and billed Mr.
Stanford for approximately twelve hours of representation is
unacceptable. We can never guarantee, however, that former SEC
personnel will comply with ethical advice that they have
received from the Commission. While we have not undertaken a
survey of the actions of all former SEC personnel, we are not
aware of another instance where this has occurred. We also
understand that the former Head of Enforcement in the Fort
Worth Regional Office has been referred to the proper State bar
committee based on his actions in representing Mr. Stanford.
As a general matter, all employees and members of the SEC
are bound by Government-wide postemployment restrictions based
on Section 207 of Title 18 of the U.S. Code. This statute
contains several postemployment restrictions, including a
permanent bar on representations and appearances before the
Commission on any matter in which a former employee or member
participated, personally and substantially, while at the
Commission; a 2-year bar on representations and appearances
before the Commission on matters that were under the former
employee's official responsibility while at the Commission; and
a 1-year ``cooling off'' period for former senior officials
which prohibits communicating with or appearing before the
agency on any matter on behalf of another with an intent to
influence. In addition, the SEC has enacted supplemental ethics
regulations which require former employees and members, within
2 years of leaving the agency, who are employed or retained as
the representative of any person outside the Government in any
matter in which it is contemplated that he or she will appear
before the Commission, or communicate with the Commission or
its employees, to file with the agency for clearance to do so.
In addition, the Government-wide standards of conduct
contain provisions that prohibit any current Federal employee
from working on a matter in which someone with whom he is
seeking employment is, or represents, a party to the matter.
Further, Section 208 of Title 18 of the U.S. Code prohibits any
Federal employee from working on any matter that could have a
direct and predictable effect on the financial interests of
someone with whom he is negotiating for employment.
In addition, due to the unique work of the exam staff that
requires them to spend considerable time on-site at regulated
entities, the Office of Compliance, Inspections, and
Examinations (OCIE) has in place ethics guidelines specific to
the examination program. This guidance covers various potential
personal and financial conflicts of interest, as well as
circumstances that may create the appearance of a conflict of
interest. The goal of OCIE's guidance is to ensure that
examiners do not engage in conduct that could create even the
appearance of a personal or financial conflict of interest
related to an examination. OCIE provides mandatory annual
training on its ethics guidelines to all examination staff. In
addition, OCIE managers conduct exit interviews with departing
examiners to evaluate if any potential conflicts of interest
could arise based on the examiner's new employment and to
discuss with the examiner any restrictions on the examiner's
ability to work on SEC examination matters based on those
potential conflicts.
Q.2. How will SEC funding increase impact SEC work? Mr.
Khuzami/di Florio, the Dodd-Frank Act authorizes the SEC budget
to double by 2015. That will be an increase from $1.1 billion
in 2010 to $2.25 billion in 2015. How would this large increase
in funding improve the enforcement, compliance and Ft. Worth
Office efforts to protect investors?
A.2. Although Section 991 of the Dodd-Frank Wall Street Reform
and Consumer Protection Act increases the authorized level of
funding for the SEC, the actual level of funding will depend
upon the appropriations Congress provides over the next several
fiscal years. Recently, the SEC's House and Senate
appropriations subcommittees each marked up bills that would
provide the agency with an FY2011 appropriation of $1.3
billion. If enacted, this funding level would allow us to build
out new oversight programs for derivatives, private funds,
credit rating agencies and other requirements imposed by the
Dodd-Frank Act. The funding would also help enhance the SEC's
base program capabilities. Notably, the enforcement program
would add 45 positions, a portion of which would go to
strengthen its new Office of Market Intelligence that handles
the thousands of tips, complaints, and referrals the agency
receives each year. The SEC also would hire 67 new personnel in
its examination program to augment its risk assessment,
monitoring, and surveillance functions and conduct additional
adviser and fund inspections.
It is worth noting that pursuant to the funding reforms
adopted in Section 991 of Dodd-Frank, whatever amount we are
appropriated would be fully offset by matching fee collections.
Q.3. Will staff provide ongoing progress reports to Committee?
Mr. Khuzami/di Florio, in order for the Committee to remain
apprised of efforts that the Commission is taking to improve
its effectiveness, would you provide this Committee with
reports every three months describing your efforts to prevent
problems similar to those raised by the Stanford fraud?
A.3. We are happy to provide any updates requested by Chairman
Dodd or the Committee. We understand that Chairman Schapiro
intends to coordinate with Enforcement and OCIE to provide
updates to the Committee approximately every three months until
the recommendations from the Inspector General's Report on
Stanford are closed.
Q.4. Issues from Emphasis on ``Stats''. Mr. Khuzami, the
Inspector General Report found evidence that
SEC-wide institutional influence within Enforcement did
factor into its repeated decisions not to undertake a
full and thorough investigation of Stanford,
notwithstanding staff awareness that the potential
fraud was growing. We found that senior Fort Worth
officials perceived that they were being judged on the
numbers of cases they brought, so-called ``stats,'' and
communicated to the Enforcement staff that novel or
complex cases were disfavored. As a result, cases like
Stanford, which were not considered ``quick-hit'' or
``slam-dunk'' cases, were not encouraged.
Have you conducted or will you conduct a review of whether
other cases at other SEC Offices were passed over because they
were deemed ``too difficult'' and share the results with the
Committee?
A.4. There is no reason to believe that any matter has been
declined because it was ``too difficult'' in the absence of
careful evaluation of the facts, evidence, and legal issues
presented. The Enforcement Division has a series of robust
systems and procedures in place to assure that matters receive
appropriate investigative attention. Each region has a case
review process that includes, among other things, discussions
between supervisors and members of each investigative team in
order to perform a detailed review of ongoing matters.
In addition, there is a Division-wide quarterly case review
protocol that involves an evaluation of all matters under
investigation. As part of the protocol, topics for discussion
include investigative planning, staffing considerations,
techniques to gather evidence, quality of evidence, relevant
legal theories and appropriate investigative steps. Quarterly
case reviews are conducted at the staff-Assistant Director
level; the Assistant Director-Associate Director level; and
between the Director and Deputy Director with the Associate
Directors and Regional Directors at each Regional Office and
the Home Office.
In these reviews, we discuss performance metrics with
individual senior officers, including both quantitative and
qualitative factors. We assess qualitative factors to insure
that we give proper recognition to the challenges that certain
cases present, so that staff members receive due credit and are
not penalized for taking on difficult cases. This recognizes
that there are many worthwhile cases that present unique
challenges, such that they will take longer, and more
resources, to bring, and that this fact should be taken into
account in assessing performance. The qualitative factors we
consider include (i) investigative creativity and perseverance
(overcoming unique challenges and vigorous defenses, adoption
of successful investigatory strategies that lead to resource
efficiencies or that avoid pitfalls and hurdles, persistence
that uncovers or develops critical evidence); (ii) unique or
particularly effective deterrent message in the case; (iii)
breadth of misconduct, harm and victims, including vulnerable
victims; (iv) involvement of persons occupying substantial
authority, responsibility, or fiduciary obligations; (v) case
of first impression (violative of newly enacted legislation, or
new or previously unprosecuted products, transactions or
practices); (vi) challenging coordination issues with other law
enforcement authorities; (vii) novel or complex legal issues;
(viii) large number of defendants or violations; and (ix)
number of defendants and amount of monetary recovery, bars and
other relief.
Additionally, the clear message from Division leadership is
to escalate matters of concern. We also have established an e-
mail-based suggestion box that provides a forum for staff and
managers to submit comments and suggestions if desired on an
anonymous basis. The suggestion box is monitored on a weekly
basis and provides a direct link to Division leadership.
The cases filed by the Enforcement Division in the past
approximately 18 months reflect the fact that cases are not
declined because of a fear of difficulty. They have been
complex and challenging investigations, and certainly do not
result in ``quick hits.'' Examples include investigations
involving wrongdoing in the areas of complex mortgage-related
securities and disclosure (Countrywide, New Century, Beazer
Homes, American Home Products), COOs and other structured
products (Goldman Sachs, ICP), complex insider trading
(Galleon), intricate accounting fraud (Bally/E&Y, AIG, Dell,
Diebold, GE), TARP fraud (Colonial Bank), nondisclosure of
subprime risk (Citigroup, State Street Global Advisors,
Evergreen, Morgan Keegan), interdealer market manipulations
(ICAP), municipal securities violations (State of New Jersey),
and Ponzi Schemes (Petters). Included in the list are cases
brought by the Fort Worth Regional Office, including Acxiom
(insider trading), Home Solutions (financial statement fraud
and related-party transactions), Perot Systems (insider trading
case brought in two days following tip), and Lightspeed (short
sale order violations). This list is evidence that the message
currently being communicated to the staff is that cases are not
to be avoided because they present difficult investigative
challenges.
Q.5. Emphasis on ``Stats'' and Easy Cases. Mr. Khuzami, the
Inspector General's Report found evidence of an SEC-wide
institutional influence against novel or complex cases during
the period under investigation. As a result, cases like
Stanford, which were not considered ``quick-hit'' or ``slam-
dunk'' cases, were not encouraged. This is a poor practice and
appears to mean that investors lured into more complex frauds
were less protected than others. Such a practice sends a signal
to potential fraudsters that if you veil your crime well, the
SEC will not come after you.
Please describe the genesis of the emphasis on ``quick-
hit'' and ``slam-dunk'' cases. When did the Commission stop
this practice? Please describe the current policy.
A.5. The Enforcement Division has emphasized the importance of
pursuing investigations and cases with a high deterrent impact
that involve complex schemes. Senior management designates
select investigations as National Priority investigations.
These matters involve cases of programmatic importance, where
the alleged misconduct could significantly undermine the
integrity of the U.S. securities markets, or disproportionately
harm a broad number of investors, or is of a significantly
egregious or extensive nature, or involves wrongdoing by
persons occupying positions of substantial authority or
responsibility. We are developing a series of robust metrics to
capture the quality of cases and investigations in the
Division. These metrics allow us to evaluate the workload,
productivity, quality, timeliness, and efficiency of the
Division's investigative and litigation efforts. By tracking
the progress of each ongoing matter in the Division, we are
better able to pursue matters across a broad spectrum of
potential violative conduct.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM ROBERT KHUZAMI AND CARLO V. di FLORIO
Q.1. Mr. Khuzami/di Florio, your testimony was made explicitly
on behalf of the SEC, whereas Ms. Romero did not state that she
was speaking for the SEC. Are there aspects of Ms. Romero's
testimony at this hearing or last year's hearing on the
Stanford fraud that the SEC does not stand behind? If so, what
are they and why?
A.1. On September 22nd, we each testified in response to the
September 15th invitation from the Senate Committee on Banking,
Housing, and Urban Affairs to Mary Schapiro, Chairman of the
SEC. The invitation allowed Chairman Schapiro to testify
personally, or designate individuals to testify on behalf of
the Commission. In that manner, our statements were offered as
Commission witnesses before the Committee. We understand that
Ms. Romero was a witness designated by the Minority for
invitation to the hearing, and thus testified in response to
the Committee's request for her individual testimony. In any
event, prior to the testimony, the Commission reviewed and
approved the written testimony submitted to the Committee by
Ms. Romero, as well as the written testimony submitted by us.
Q.2. Mr. Khuzami/di Florio, aside from Commission-wide reforms
you described in your testimony, have you discovered any
problems unique to the Fort Worth District Office that you are
addressing with solutions tailored to that office?
A.2. As you know, in 2010, the Division of Enforcement
completed its comprehensive internal review and subsequent
structural reforms--the most Significant in four decades.
Similarly, OCIE has undertaken a top to bottom review of OClE's
strategy, culture, people, processes, and technology.
Throughout these reviews, all members of OCIE and Enforcement,
including those in the Fort Worth Regional Office, were
encouraged to submit their ideas for enhancing the programs and
processes of OCIE and Enforcement.
One area of improvement identified by our Forth Worth
examiners is the need to enhance collaboration between
examination and enforcement staff, particularly on matters that
could give rise to an enforcement referral. As you know, the
SEC's Inspector General also identified this as an area in
which we could improve. OCIE and Enforcement are working
together to develop collaborative relationships and improve
coordination on examination referrals to enforcement.
Further, as recently reported in the press, some personnel
issues have been identified that appear to be unique to the
Fort Worth Regional Office. OCIE senior management is
continuing to monitor and evaluate the operations and culture
of the Fort Worth Regional Office to ensure the change process
includes any solutions that should be specifically tailored to
the Fort Worth Regional Office.
Q.3. Mr. Khuzami, at the hearing, you contended that the
``stats'' culture that contributed to the failure by the Fort
Worth District Office's failure to pursue an enforcement action
against Stanford is a relic of the past. Nevertheless, several
hours later, at a hearing before the Senate Committee on the
Judiciary, you touted the Enforcement Division's statistics--
634 enforcement actions brought so far this year. As you
acknowledged, cases brought by the SEC include some very
complex cases and some more simple cases. Moreover, an
incredibly complex enforcement action that is based on an
internal investigation might involve less work than an apparent
simpler case. If the head of the Enforcement Division touts
numbers of cases as a measure of achievement, how can regional
offices of the SEC be expected to assume that they will not be
measured on the numbers of enforcement actions they generate?
A.3. The clear and unambiguous message from the leadership of
the Enforcement Division has been to emphasize the importance
of high-quality investigations with maximum deterrent impact.
Managers and staff repeatedly have been assured that they will
not be evaluated simply on the basis of quantitative
statistics. We are introducing a series of metrics to capture
this principle, including metrics designed to measure the
workload, productivity, quality, timeliness, and efficiency of
the Division. In addition to these metrics, Division leadership
designates select investigations as National Priority cases.
These include, among others, cases of programmatic importance,
where the alleged misconduct could significantly undermine the
integrity of the U.S. securities markets, or disproportionately
harm a broad number of investors.
At the same time, it is important to have a vibrant and
robust enforcement program across various types of cases that
may involve large, smaller, complex, and simpler matters.
Quantitative measures are therefore not irrelevant. If by
tracking quantitative measures one learns that there has been a
sharp increase (or decrease) in the number of cases filed, or
in how long it takes to file a case, that is an important data
point to discuss with a senior officer. There may well be a
perfectly appropriate explanation for the change (an unusually
large number of complex cases, more cases than expected
proceeded to trial rather than settled, delay due to obtaining
overseas evidence, etc.), but it is important to ask the
question to understand why the change occurred. That is the
proper use of metrics--as a starting point upon which to
further inquire. What must be avoided, and what we do not do,
is to present quantitative targets or quotas. Indeed, I have
given out awards during this past year for cases that took a
great deal of time and resources to investigate, and that we
ultimately declined to pursue. That certainly sends the message
that persons are not evaluated and rewarded based on the number
or ease of cases.
My testimony was entirely consistent with this approach.
For example, I described the number of enforcement actions, the
amounts of ordered disgorgement and penalties, and the numbers
of asset freezes and emergency temporary restraining orders. I
also highlighted that the Division had, thus far, distributed
nearly $2 billion to injured investors. At the same time, I
emphasized the complex, wide-ranging and programmatically
significant casework of the Division, including descriptions of
nearly twenty cases involving mortgage-related securities,
structured products, institutional market abuses, financial
fraud, municipal securities, undisclosed executive compensation
and other types of securities law violations. I also described
our continued cooperation and coordination efforts with
criminal and other regulatory authorities; our internal process
reforms and management streamlining; our new initiatives to
identify securities fraud; and new tools provided under the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
Q.4. Mr. Khuzami, I understand that you have instituted a
number of structural changes and procedural changes in the
SEC's Division of Enforcement. Real change, however, will only
come if the culture in your division changes. People need to
know that they will be recognized for bringing good cases and
dropping bad ones. A good case might be a small dollar case
that prevents many small investors from getting defrauded down
the road. If SEC employees perceive that they will only be
recognized for enforcement matters that involve household name
companies, that is where they will focus their attention. What
are you doing to change the culture of your Division?
A.4. As noted in my answer above, throughout the Division
senior management emphasizes the importance of high-quality
investigations rather than simply the number of investigations
or enforcement actions. Similarly, the Enforcement staff works
diligently to detect, deter, and obtain strong remedies in
response to unlawful conduct regardless of the notoriety, or
lack of notoriety, of the entity involved in the misconduct. As
described above, we have instituted a robust quarterly case
review protocol that involves an evaluation of all matters
under investigation. As part of the protocol, topics for
discussion include investigative planning, staffing
considerations, techniques to gather evidence, quality of
evidence, relevant legal theories and appropriate investigative
steps. Quarterly case reviews are conducted at the staff
Assistant Director level; the Assistant Director-Associate
Director level; and between the Director and Deputy Director
with the Associate Directors and Regional Directors at each
Regional Office and the Home Office. The message within and
beyond the Division is clear: we are focused on timely
detecting and preventing securities law violations in order to
protect investors and deter unlawful conduct.
Q.5. Mr. Khuzami, the SEC's revised performance metrics do not
seemed designed to encourage enforcement staff to work on cases
like Stanford early enough to prevent investor harm. The factor
seems to push staff toward pursuing cases that involve
violations prohibited under new laws, violations that pose
systematically important risks, or violations in so-called
``priority areas'' that the SEC is emphasizing at the
particular time. Ponzi schemes are a very old form of fraud
that often target middle class investors using boring
investment products, like the supposed certificates of deposit
that Stanford was selling. These cases may not involve cutting-
edge legal arguments, but marshaling of evidence may be
difficult. What are you doing to ensure that sufficient SEC
resources are devoted to detecting and shutting down plain
vanilla frauds that target ordinary Americans before those
frauds swell to the size of the Stanford fraud?
A.5. As noted in my response above, the Division focuses on
quality cases across the spectrum of potential securities law
violations. Offering frauds and Ponzi schemes, which are
described in the question as ``a very old form of fraud,''
continue to evolve and remain an important focus of our
enforcement program. In FY2010, offering frauds comprised
approximately 22 percent of the cases brought by the
Commission. In these actions, the Commission seeks to freeze
assets, where possible, in order to maximize the recovery to
investors and prevent new investors from being harmed.
For example, in an action expedited by Enforcement's newly
created Asset Management Unit, the SEC charged a New Jersey-
based investment adviser, Sandra Venetis, and three of her
firms with operating a multimillion dollar offering fraud
involving the sale of phony promissory notes to investors, many
of whom were retired or unsophisticated investors. Venetis
falsely stated that the promissory notes were guaranteed by the
FDIC, would earn a high rate of interest and would be used to
fund loans to doctors. In April, the Commission charged a
prominent Miami Beach-based businessman and philanthropist,
Nevin Shapiro, with fraud for orchestrating a $900 million
offering fraud and Ponzi scheme involving the sale of
securities that Shapiro claimed would fund his company's
grocery diverting business, were risk-free, and had rates of
return as high as 26 percent annually. The SEC also filed an
emergency asset freeze and fraud charges against Daniel
Spitzer, a purported fund manager based in the U.S. Virgin
Islands, who perpetrated a $105 million Ponzi scheme against
400 investors. Spitzer's investors were promised that their
money would be invested in funds that would be invested in
foreign currency with annual returns that could reach over 180
percent.
Even recently, in an emergency action filed on October 6,
2010 against Imperia Invest IBC, the Commission obtained a
temporary restraining order and emergency asset freeze against
Imperia for defrauding more than 14,000 investors worldwide.
The Commission's complaint alleges that Imperia solicited
investor funds via the Internet; promised returns of 1.2
percent per day; and raised in excess of $7 million, $4 million
of which was collected primarily from deaf investors in the
United States. The Commission's complaint alleges that Imperia
took proactive steps to conceal the identity of its control
persons by using an anonymous browser to host its Web site, by
communicating with all investors via e-mail without disclosing
the identity of the control persons, and by establishing
offshore PayPal style bank accounts to conceal the identity of
the recipient of the investment proceeds. Despite these
challenges, the case was filed without the typical evidence in
an offering fraud, including knowledge of the identity of the
perpetrators. Rather than being stymied by this absence of
proof, or taking weeks or months to gather it, we developed a
theory that did not rely on this proof, and moved quickly
because we suspected that investors were being defrauded on an
ongoing basis. Even on these unique facts, the Division was
able to act swiftly to halt the fraudulent offering activity,
and seek a court order to secure assets related to the
offering.
The many things we are doing to ensure that sufficient
resources are focused on detecting and preventing Stanford-type
frauds have resulted in: improved collection, investigation and
referral of tips, complaints and referrals through our newly
created Office of Market Intelligence; increased communication
with the Office of Compliance, Inspections and Examinations
(OCIE), including joint inquiries and escalation procedures to
resolve differences over referrals; greater sensitivity in
Ponzi scheme investigations to factors such as outsized
investment returns, absence of volatility and related-party
transactions; an increased number of executed Memorandums of
Understanding with foreign governments to facilitate the
securing of evidence in foreign jurisdictions; and improved
access to ``insider'' evidence of wrongdoing, including our new
cooperation initiative and the Dodd-Frank whistleblower
legislation.
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RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN DODD
FROM ROSE L. ROMERO
Q.1. Dealing with managerial ``Bad Apples''. Ms. Romero, the
Inspector General's report found that the former head of
Enforcement in Fort Worth, who played a significant role in
multiple decisions over the years to quash investigations of
Stanford, sought to represent Stanford on three separate
occasions after he left the Commission, and in fact represented
Stanford briefly in 2006 before he was informed by the SEC
Ethics Office that it was improper to do so. How does your
Office prevent abuse of discretion by senior staff such as
this? What are the current relevant policies and how are they
enforced?
A.1. During my tenure with the SEC, I have personally
participated in the periodic review of all cases within the
FWRO. These reviews function, in part, to prevent any single
individual from having the sole discretion to close an
investigation. Also, Rob Khuzami has instituted additional
procedures that require, each quarter, that every level of
management (assistant directors, the enforcement associate and
the regional director) conduct a detailed review of all matters
being handled by their staff. Subsequent to these reviews, Mr.
Khuzami personally conducts a review of pending matters with
the Regional Director and the Associate Director of
Enforcement.
In regard to the conduct of the former head of Enforcement,
it should be noted that when the FWRO staff learned that
Stanford had retained this individual in 2006, the staff
immediately objected to the representation. Shortly thereafter,
he ceased all work in connection with the investigation. My
staff is trained each year on their ethical obligations in
connection with seeking outside employment and their duties
regarding the permissible range of post-SEC employment.
Q.2. Issues from the Emphasis on ``Stats''. Ms. Romero, the
Inspector General Report found evidence that ``SEC-wide
institutional influence within Enforcement did factor into its
repeated decisions not to undertake a full and thorough
.investigation of Stanford, notwithstanding staff awareness
that the potential fraud was growing. We found that senior Fort
Worth officials perceived that they were being judged on the
numbers of cases they brought, so-called `stats,' and
communicated to the Enforcement staff that novel or complex
cases were disfavored. As a result, cases like Stanford, which
were not considered `quick-hit' or `slam-dunk' cases, were not
encouraged.''
Have you conducted or will you conduct a review of whether
other cases at your Office were passed over because they were
deemed ``too difficult'' and share the results with the
Committee?
A.2. As noted in the answer to the previous question, the
management of our office continuously reviews matters to insure
that they are handled appropriately. I personally participated
in frequent reviews of pending matters, and have done so since
coming to the Commission in 2006. I am unaware of any matter
that was not pursued because it was perceived as ``too
difficult.'' I have attached hereto a brief description of
complex cases handled by the Fort Worth office beginning in
1998. As you review this document, you will see clearly that
the Fort Worth staff frequently has tackled difficult and
significant matters and has obtained outstanding results.
Q.3. How will SEC funding increase impact SEC work? Ms. Romero,
the Dodd-Frank Act authorizes the SEC budget to double by 2015.
That will be an increase from $1.1 billion in 2010 to $2.25
billion in 2015. How would this large increase in funding
improve the enforcement, compliance and Ft. Worth Office
efforts to protect investors?
A.3. While I am not in a position to predict the nationwide
impact of the above-referenced budget increases, additional
resources would, from a regional perspective, no doubt, enhance
the Commission's enforcement and examination programs. Simply
put, I believe that the additional resources will enhance the
Commission's ability to protect U.S. investors.
Every day, managers in the SEC's Enforcement Division and
Office of Compliance Inspections and Examinations are required
to make difficult choices about which investigations and
examinations to prioritize. Under the leadership of Director
Khuzami and Director di Florio, the Enforcement Division and
OCIE have implemented procedures designed to identify
investigations and examinations that can best protect the
greatest number of investors. That said, the scope of the SEC's
jurisdiction is daunting. And increased resources will enable
regional managers to effectively carry out their mission.
Q.4. Comment on Post article on the Fort Worth District Office.
The Washington Post, in an article entitled ``SEC's regional
offices present managerial problems, become an obstacle to
reform'' published on June 10, 2010, reported that some years
ago the SEC Fort Worth office changed how it performed
inspections and this ``opened a rift between Fort Worth
managers and staff that continues today, undercutting the
effort by SEC leaders in Washington to rebuild the agency and
promote coordination after years of setbacks, according to
current and former SEC officials and internal agency documents,
including three separate reports by the SEC's inspector
general.''
Ms. Romero, would you comment on this assertion based on
your knowledge?
A.4. During the time period referenced in the Washington Post
article, the FWRO's examination staff of 40 was responsible for
examining more than 735 investment advisers, 350 broker-
dealers, and 15,000 branch offices. This significant resource
mismatch meant that many of these registrants would likely
never be examined. Moreover, the financial services industry
and our registrant population, is becoming increasingly
integrated--with firms and individual representatives routinely
offering both investment management services and also selling
products to those same clients and acting as a broker-dealer--
presenting significant conflicts of interest and heightened
regulatory risks.
Accordingly, the FWRO examination staff, in consultation
with the OCIE's senior management at SEC headquarters,
developed a pilot, risk assessment program designed to more
efficiently assess risks to investors by obtaining basic
information about a firm's business activities and controls
through document reviews and on-site interviews of senior
officers and other key staff. OCIE's National Examination
Program now uses certain information gathering techniques based
on the principles of this pilot program to conduct risk
assessments of firms registered with the Commission to
determine candidates for examination.
Despite the market realities associated with examining such
a sizeable registrant population and the clear need for a
better approach to assessing risk, two FWRO managers strongly
objected to the program. Nonetheless, the examination staff,
working as a team with managers, put in place a highly
successful risk assessment program. Moreover, examiners and
managers have effectively broken down the long-standing
``silos'' that previously existed between the broker-dealer and
investment adviser exam teams as well as between exam and
enforcement staff. These collective efforts have allowed us to
quickly identify and halt fraudulent activities. The increase
(from 2005-2010), in the number of enforcement cases that
stemmed from examination referrals clearly demonstrates that
our efforts to build a more cohesive team have resulted in
significant improvements for the benefit of investors.
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RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
FROM ROSE L. ROMERO
Q.1. When did you first learn that there were Potential
problems at Stanford? As Director of the SEC's Fort Worth
Office, what was your role with respect to deciding whether and
when to bring enforcement actions related to the Stanford
fraud?
A.1. I first learned of potential problems at Stanford in early
2006, shortly after my arrival at the SEC from the Department
of Justice. At that time, the FWRO staff was working with the
SEC's Office of International Affairs in an effort to obtain
information from Antiguan authorities, about Stanford
International Bank, Ltd. The staff also had contacted other
Federal agencies in hopes of leveraging any information they
might have about the bank. In June of 2006, I authorized the
FWRO staff to seek formal order authority from the Commission
so that the staff could compel documents and testimony from
Stanford-related entities and individuals.
After an extensive review by the SEC's divisions and
offices, the Commission authorized the issuance of a formal
order of investigation in October of 2006. As noted in the
Inspector General's June 19, 2009, report, the FWRO staff,
following issuance of the formal order, actively investigated
Stanford's bank and its principals, including the review of
thousands of pages of documents produced by Stanford Group
Company, an SIBL-affiliated broker-dealer and investment
adviser located in Houston, Texas.
By April of 2008, the FWRO staff concluded, based on
information provided to the FWRO by former Stanford employees
and the bank's refusal to produce documents and information,
that the case was appropriate for a criminal referral.
Accordingly, I authorized the FWRO staff to contact the Fraud
Section of the Department of Justice. Following a meeting with
DOJ in June 2008, DOJ and the FWRO staff decided that DOJ was
better Positioned to uncover evidence of wrongdoing at the
Antiguan-based bank. In December of 2008, the DOJ and FWRO
staffs jointly concluded that a parallel investigation was
appropriate. As a result of our staff's efforts, I was able to
authorize the staff to seek authority to file an emergency
action in mid-February 2009.
Q.2. In advance of your testimony in August 2009 before this
Committee, were you ever asked to limit your testimony to avoid
revealing the length of time between the Fort Worth office's
original suspicions of fraud at Stanford in 1997 and the SEC's
filing of an emergency action to halt the fraud? If so, from
whom did this request come?
A.2. I was not asked to avoid revealing any information.
Q.3. The Inspector General's report describes some very
commendable performances by employees in your office and some
very poor decision making by others. Are you taking, or have
you taken, any personnel actions B positive or negative B in
response to the Inspector General's report?
A.3. In recognition of their around-the-clock efforts and
fortitude in overcoming efforts to obstruct the investigation
by Stanford and his cronies, I nominated the attorneys,
examiners and managers that completed the investigation for a
``Director's Award.'' On my recommendation, Robert Khuzami,
Director of the Division of Enforcement, issued the awards on
July 1, 2010. As to those individuals that were involved in
examining and investigating SIBL and its affiliates prior to my
arrival at the SEC, it is my understanding that a review of the
Inspector General's recommendations is being conducted by SEC's
headquarters.
Q.4. During the hearing, you mentioned the efforts that are
being made to collect additional assets for the benefit of the
Stanford victims. It appears, however, that assets collected
will fall far short of investor losses. Based on collections to
date and reasonably likely additional collections, how many
cents per dollar invested do you anticipate defrauded investors
will receive?
A.4. It is difficult to provide an accurate estimate in
response to this question, given that a variety of factors
influence the return defrauded investors may receive. For
example, while a pro rata distribution among investors is
common, the details of any distribution (including how claims
by investors will be treated in comparison to claims by other
creditors) will be known only after a claims process and
distribution process have been proposed to and approved by the
district court. Moreover, it is difficult to estimate the
amount of reasonably likely additional collections. For
example, according to the Receiver, some assets are in the form
of private equity that has a value not yet determined.
Moreover, the Receiver has reported that a significant category
of uncollected receivership assets is related to potential
recovery in litigation against third parties.
While the Receiver believes there are valid claims in that
litigation, it is simply not possible at this stage to know
with any degree of certainty what receivership assets may
result from that litigation. Additional details about that
litigation, including the amount claimed, have been discussed
in previous submissions, and I would happy to supplement this
response with more details if doing so would be helpful.
Unfortunately, regardless of the outcome of that litigation, as
you note, it appears that available assets will fall far short
of investor losses. Nevertheless, we continue to use every
effort to work help make as many assets as possible available
to defrauded investors.
Q.5. The receiver's July 2010 interim report stated that
$185,000 had been spent in April 2010 alone on responding to
the SEC, among others, in connection with Government
investigations. These expenses ultimately diminish the amount
of money available for defrauded investors. Has the SEC
considered the steps that it can take to limit the expenses
incurred by the receiver in assisting the SEC with the SEC's
enforcement work?
A.5. Throughout this case, the SEC has worked closely with a
court-appointed Examiner to monitor the Receiver's costs and
ensure maximum recovery to the victims of this massive fraud.
These efforts have had tangible benefits. For example, the
Receiver and the professionals assisting him have reduced their
customary fees by at least 20 percent and have capped the rates
charged by senior lawyers. In addition, we carefully scrutinize
the Receiver's bills for fees and expenses. In fact, in
response to our objections, the district court has held back,
on an ongoing basis, an additional 20 percent from the
Receiver's fees and expenses.
Accordingly, we have worked with the Receiver to reduce any
expenses associated with the SEC's ongoing investigations. For
example, we worked with the Receiver to allow SEC staff to
review voluminous hard copy documents stored by the Receiver
with as little involvement (and expense) from receivership
personnel as possible. We also earlier conferred with counsel
to the Receiver to help minimize costs associated with
examining voluminous electronic records that had potential
relevance to both the SEC's ongoing investigations and possible
third party receivership claims.
Recently, the staff obtained approval of a contract with
the Receiver's forensic accounting firm under which the SEC
will directly absorb the cost (rather than seeking
reimbursement out of the receivership estate) for certain
expenses incurred responding to requests for information from
the SEC's staff in connection with ongoing enforcement-related
investigations. It is our understanding that the Department of
Justice has entered into a similar contract. As we do regarding
a variety of expenses, we will continue to confer with the
Receiver and his counsel to identify ways to minimize any
expenses associated with responding to requests for information
from Government agencies.