[Senate Hearing 111-1115]
[From the U.S. Government Publishing Office]



                                                       S. Hrg. 111-1115
 
     INVESTIGATING AND PROSECUTING FINANCIAL FRAUD AFTER THE FRAUD 
                      ENFORCEMENT AND RECOVERY ACT

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

                                HEARING

                               before the

                       COMMITTEE ON THE JUDICIARY
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

                           SEPTEMBER 22, 2010

                               __________

                          Serial No. J-111-110

                               __________

         Printed for the use of the Committee on the Judiciary




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                       COMMITTEE ON THE JUDICIARY

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



                            C O N T E N T S

                              ----------                              

                    STATEMENTS OF COMMITTEE MEMBERS

                                                                   Page

Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa.     4
    prepared statement...........................................    82
Kaufman, Hon. Edward E., a U.S. Senator from the State of 
  Delaware.......................................................     1
    prepared statement...........................................    85
Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont, 
  prepared statement.............................................    89

                               WITNESSES

Breuer, Lanny A., Assistant Attorney General, U.S. Department of 
  Justice, Washington, DC........................................     5
Khuzami, Robert S., Director, Division of Enforcement, Securities 
  and Exchange Commission, Washington, DC........................     7
Perkins, Kevin L., Assistant Director, Federal Bureau of 
  Investigation, Washington, DC..................................     9

                         QUESTIONS AND ANSWERS

Responses of Lanny A. Breuer to questions submitted by Senator 
  Specter........................................................    36
Responses of Robert S. Khuzami to questions submitted by Senator 
  Specter........................................................    40

                       SUBMISSIONS FOR THE RECORD

Breuer, Lanny A., Assistant Attorney General, U.S. Department of 
  Justice, Washington, DC........................................    43
Khuzami, Robert S., Director, Division of Enforcement, Securities 
  and Exchange Commission, Washington, DC........................    54
Perkins, Kevin L., Assistant Director, Federal Bureau of 
  Investigation, Washington, DC..................................    91


     INVESTIGATING AND PROSECUTING FINANCIAL FRAUD AFTER THE FRAUD 
                      ENFORCEMENT AND RECOVERY ACT

                              ----------                              


                     WEDNESDAY, SEPTEMBER 22, 2010

                                       U.S. Senate,
                                Committee on the Judiciary,
                                                   Washington, D.C.
    The Committee met, pursuant to notice, at 2:06 p.m., in 
room SD-226, Dirksen Senate Office Building, Hon. Edward E. 
Kaufman, presiding.
    Present: Senators Kaufman, Klobuchar, Franken, and 
Grassley.

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

    Senator Kaufman. I am honored to call to order this hearing 
of the Senate Committee on the Judiciary. I want to thank 
Chairman Leahy for permitting me to chair this hearing.
    Today we are going to examine the efforts of Federal law 
enforcement to investigate and prosecute the financial fraud 
that contributed to our current economic crisis in light of the 
Fraud Enforcement and Recovery Act, FERA, signed into law by 
President Obama in May 2009. This is the second post-FERA 
oversight hearing that we have held. The first was December 9th 
of last year. Today the same distinguished witnesses--and I 
truly mean distinguished witnesses--who testified at that 
hearing join us to discuss these issues: Assistant Attorney 
General Lanny Breuer, SEC Director of Enforcement Robert 
Khuzami, and FBI Assistant Director Kevin Perkins. Welcome 
back, gentlemen.
    My objective for this hearing is several. The first comes 
under the heading of FERA oversight. In the time since the 
December 2009 hearing, what have the Department of Justice, the 
FBI, and the SEC done in terms of investigating and prosecuting 
fraud at the heart of the financial crisis? Do they have the 
infrastructure, personnel, and strategies in place they need to 
be successful?
    All three entities have received significant additional 
resources in part as a result of FERA, and I want to explore 
whether those resources are being deployed effectively. I will 
say right now I am frustrated. I know the Justice Department, 
the SEC, and the FBI have all been working incredibly hard--and 
I mean incredibly hard--reviewing countless transactions, 
interviewing myriad witnesses, poring over literally millions 
of pages of documents.
    And yet we have seen very little in the way of senior 
officer or board room-level prosecutions of the people on Wall 
Street who brought this country to the brink of financial ruin. 
Why is that? Is it because none of the behavior in question was 
criminal? Is it because too much time passed before the 
investigators got serious? Has the trail gone cold? Is it 
because the law favors the wealthy and powerful? Or is the 
explanation much more complex?
    Are there systemic challenges that the agencies are finding 
difficult to overcome? Is there a foundational, targeted 
strategy in uncovering those instances of actual 
misrepresentation of material facts which exist, which is a 
mountain, a veritable mountain of ``everybody was doing it'' 
mentality on Wall Street? Is the fine print exculpatory or only 
chilling prosecutorial efforts that still deserve to move 
forward?
    My second objective is legislative. Are there changes in 
the law that would make it harder for people to construct and 
sell incredibly complex financial instruments without 
disclosing their own belief that the value of these products 
will soon plummet? While I will be leaving the Senate before 
long, I would like to help my colleagues get started on making 
those changes in the law, if they are required, and if there 
are useful changes to be made.
    In the last year or so, through the work of people both in 
and out of Government, we have been learning more and more 
about the wide range of conduct that contributed to the 
financial collapse. I have said from the beginning that much of 
that behavior, though terribly misguided, inexcusable, or 
morally bankrupt, was not criminal. But I do remain convinced 
by what we have learned through a host of sources, including 
hearings by Senator Levin on the Permanent Subcommittee on 
Investigations, that appears from evidence that there was also 
serious criminal behavior on all of this.
    Let me start a discussion about the difference between 
criminal behavior and behavior that was merely misguided with a 
hypothetical example. Assume that there is a bank in the 
mortgage orientation business. During the early and mid-2000s, 
as home prices increased nationwide, the bank is able to make 
huge profits both by packaging these mortgages into bonds for 
sale to others and by holding onto them as investments. In the 
race to maximize market share and raise profits, the bank 
decides to relax its official underwriting standards to a 
greater and greater degree until a large majority of even some 
of its riskiest loans to the least qualified borrower, or so-
called liar's loans, issued without even bothering to verify 
that the income stated by the borrower is accurate. They 
literally go into a bank, ``My name is Ted Kaufman.'' ``How 
much are you making?'' ``Five hundred thousands dollars a 
year.'' And that goes on the form, and there is no further 
checking done on whether that is true or not true. It obviously 
plays a big part in what kind of a mortgage you can get.
    This behavior was unwise and dangerous, creating tremendous 
risk on many levels--to the bank extending the credit, to the 
borrowers without the means to pay, to those who bought the 
loans from the bank. More important, it also created a grave 
risk to the broader economy. As we now know all too well, 
extending credit without regard to creditworthiness can help 
fuel a speculative boom that ends only with a painful market 
correction involving crashing prices and foreclosed-upon 
homeowners.
    But without more, making loans that should never be made, 
even on a tremendous scale is not a crime, particularly if the 
quality of those loans were disclosed. Was there more? In the 
lead-up to this country's recent national housing market crash, 
did some banks and board room executives step over the line and 
commit actionable fraud? For example, what if this hypothetical 
banks knowingly issues widespread exceptions to its published 
underwriting standards while at the same time claiming to 
would-be purchasers of mortgage securities that the 
underwriting standards had been substantial complied with?
    Let me repeat that. What if a hypothetical banks knowingly 
issues widespread exceptions to its published underwriting 
standards while at the same time claiming to would-be 
purchasers of mortgage securities that the underwriting 
standards had been substantial complied with? Or suppose it 
determines that a class of mortgages that it has held for its 
own investment--held for its own investment--are likely to 
default in the near future onto third parties. That might not 
be a crime. But what if the bank has claimed to purchasers that 
it has not selected mortgages for sale based on a belief that 
they are likely to default? If criminal conduct contributed to 
the financial meltdown, then the people responsible should be 
investigated, prosecuted, and sent to prison. And I know that 
our three witnesses agree with that. If we fail to do so, we 
will lose our chance to restore the public's faith in our 
financial markets and the rule of law.
    Criminals on Wall Street must be held to account; 
otherwise, one of the great foundations of this country--our 
capital markets--will simply fade away. This is why very early 
in the Congress I joined with Chairman Leahy and Senator 
Grassley and others to help pass the Fraud Enforcement and 
Recovery Act. FERA was designed to ensure that additional tools 
and resources were provided to those charged with enforcement 
of our Nation's laws against financial fraud.
    In the year-plus since the passage of FERA, we have seen 
some important progress. The FBI, the Department of Justice, 
and the SEC have all ramped up their efforts. Last November, 
President Obama created an Interagency Financial Fraud 
Enforcement Task Force. Its mission is not only to pursue 
crimes already committed, but also to deter criminal behavior 
that might lead to another financial crisis. But despite the 
new resources and the renewed emphasis, despite the 
presidentially created task force, we are now nearing the final 
quarter of 2010 without the sort of prosecutions that I had 
fully expected we would hope to see by this time. Without 
successful investigation, prosecution, and meaningful 
punishment, deterrence is an illusion.
    So where does that leave us? That is what I want to explore 
in today's hearing. Where is the line between conduct that is 
actionable and conduct that is not? What are the disclosure 
obligations of individuals and entities that select, bundle, 
securitize, and market groups of mortgages with characteristics 
that at some point along the way foretold their failure? These 
obligations need to be strengthened in terms of either what 
must be included or in terms of how prominent the disclosure 
must be made.
    Last spring, Senator Specter and I offered an amendment to 
the Dodd-Frank bill that would have imposed on broker-dealers 
and banks the same sort of duty to customers that financial 
advisers already have. Had that amendment become law, those 
broker-dealers and banks would have been obligated to disclose 
not only their own conflict of interest, but also their 
knowledge that a particular security is likely to underperform.
    I want to get a sense from you, from the witnesses, in the 
enforcement community whether that sort of change in the law 
would make a difference in your world. Many on Wall Street have 
argued that there is no criminality in this financial crisis, 
merely a collective delirium brought about by soaring profits 
and mistaken assumptions about risks. I and others have 
disagreed. But so far I have waited in vain for the sort of 
prosecutions that we predicted would come. I hope this hearing 
will help us understand why that is so and also give us a 
better sense of what to expect in the future.
    I also want to emphasize that the existence of criminality, 
or the lack thereof, should not be our only guiding star. Our 
job is to focus on what is right and wrong, fairness and 
unfairness, and legislate accordingly. What laws do we need to 
make sure that we focus on right to wrong, fairness to 
unfairness? Law enforcement officials represented by these 
witnesses today have to ask whether the conduct they are 
investigating violated the law? If not, they move on to the 
next case. As Members of Congress, we have a different 
obligation. We have to ask whether the laws that exist reflect 
sound public policy. If not, if the law permits conduct that 
should be prohibited, then we need to change the law.
    Ours is a Government of laws rather than men, and as 
Justice Brandeis reminded us, ``If we desire respect for the 
law, we must first make the law respectable.'' Our laws are not 
a static code of received wisdom from on high. They are an 
evolving reflection of public debate and national need. Where 
laws let America down, Congress must remedy those laws so that 
they may not do so again.
    Senator Grassley, do you have something you would like to 
say at this point?

STATEMENT OF HON. CHARLES E. GRASSLEY, A U.S. SENATOR FROM THE 
                         STATE OF IOWA

    Senator Grassley. Well, first of all, I associate myself 
with the remarks you just made, and it is very important to 
have these oversight hearings, particularly within 1 year after 
FERA has been passed, to make sure it is working right; and, 
second, if it is not, as you suggested, the extent to which we 
need additional tools, because the goals of FERA are very 
important for the benefit of the taxpayers and for discouraging 
fraud.
    I have a long statement I want to put in the record. I want 
to take a couple minutes to give a view of my interest in this 
hearing.
    First of all, as a lead cosponsor for the Republicans of 
FERA, I am pleased that we are here today to hear testimony 
from the various agencies that can use it as a tool to see how 
the implementation of FERA is going. Our legislation is a very 
important key to investigating and prosecuting complex 
financial fraud that were a part of the root cause of the 
financial crisis. I am interested to hear from the witnesses 
before us how FERA has helped them hunt down criminals and the 
extent to which it will be used as a tool to bring people to 
justice. While I will not be able to stay for the entire 
hearing, I will have a number of follow-up questions for the 
witnesses.
    Specifically, I have a number of questions about how the 
Securities and Exchange Commission is implementing 
recommendations made by the SEC Inspector General following the 
failures of follow-up on investigative leads regarding the 
Madoff and Stanford Ponzi schemes. The Inspector General found 
serious deficiencies at the SEC, and I want to know whether the 
SEC is serious about fixing the problems.
    Additionally, I would like to take a moment to alert people 
from the Justice Department about this letter that I sent to 
the Attorney General this very day, so you would not have it 
yet, regarding the Department's failure to respond to serious 
allegations raised by the retiring Inspector General of the 
Department of Housing and Urban Development. The Inspector 
General is the chair of the Mortgage Fraud Committee at the 
Justice Department, and he raised concerns to the Department 
about the systematic fraud against the Federal Housing 
Administration, FHA, and whether the Department obtained the 
best settlement possible. Given the seriousness of the 
allegations, I expect an answer as soon as possible from the 
Attorney General.
    I thank you very much.
    [The prepared statement of Senator Grassley appears as a 
submission for the record.]
    Senator Kaufman. Thank you, Senator Grassley.
    Before we turn to the opening statements of Mr. Breuer, Mr. 
Khuzami, and Mr. Perkins, I ask the three witnesses to stand 
and be sworn. Do you affirm that the testimony you are about to 
give before the Committee will be the truth, the whole truth, 
and nothing but the truth, so help you God?
    Mr. Breuer. I do.
    Mr. Khuzami. I do.
    Mr. Perkins. I do.
    Senator Kaufman. Let us begin with Mr. Breuer.

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

    Mr. Breuer. Good afternoon, Senator Kaufman, Senator 
Grassley. Thank you for inviting me to speak with you today 
about the Department of Justice's efforts combatting financial 
fraud.
    Before I begin, I would like to take this opportunity just 
for a moment to thank this Committee, and particularly you, 
Senator Kaufman, for your leadership in this area of financial 
fraud enforcement.
    As you know, and as you both have said, the Fraud 
Enforcement and Recovery Act, FERA, and most recently, the 
Dodd-Frank Wall Street Reform and Consumer Protection Act, were 
signed into law. Both of those laws have provided our 
investigators and prosecutors with more robust tools and 
resources in our fight against financial fraud. We thank you 
for your support, and we intend to continue to aggressively use 
those tools and resources in the coming months and years.
    I am pleased today to be able to speak with you about the 
Justice Department's efforts in combatting financial fraud, and 
I am particularly gratified to be here today with Robert 
Khuzami of the Securities and Exchange Commission and Kevin 
Perkins of the Federal Bureau of Investigation, two of our most 
critical partners in this fight. Together with them, and our 
many other partners on the Financial Fraud Enforcement Task 
Force, the Department of Justice is committed to investigating 
and prosecuting those who defraud our citizens of their hard-
earned savings.
    Since the passage of FERA in May of 2009, the Department 
has re-evaluated the manner in which it investigates financial 
fraud, and as a result, we have significantly heightened our 
enforcement efforts. We have forged even closer partnerships 
with the many law enforcement and regulatory agencies that are 
focused on fighting fraud, and we have redoubled our efforts to 
send a strong deterrent message to would-be fraudsters by 
vigorously prosecuting these criminals and sending them to 
jail.
    Indeed, since the passage of FERA, the Department has 
prosecuted and incarcerated thousands of financial criminals, 
and we have sought stiff sentences for their crimes. Let me 
highlight for the Committee just a few of the areas in which we 
have focused our efforts.
    Fraud, of course, takes many forms, but perhaps the most 
pervasive and pernicious of these are investment fraud schemes, 
which include what we commonly refer to as ``Ponzi schemes.'' 
Those who commit investment fraud schemes often prey upon the 
vulnerable individual investors, and the resulting losses can 
be devastating to families around our country. For this reason, 
the Justice Department has dedicated significant resources to 
unearthing and vigorously prosecuting these crimes. Indeed, our 
agents and prosecutors around the country uncover and 
investigate investment fraud nearly every week. Let me describe 
for you just three examples of such prosecutions, all from last 
week alone.
    On September 15, 2010, Nevin Shapiro, the former CEO of 
Capital Investments USA, Inc., pleaded guilty in Newark, New 
Jersey, to fraudulently soliciting funds for a non-existent 
grocery distribution business. Mr. Shapiro's $880 million 
investment fraud resulted in losses of somewhere between $50 
million and $100 million to investors. Mr. Shapiro will be 
sentenced on January 4, 2011.
    On that same day that Mr. Shapiro pleaded guilty, Frank 
Castaldi, an accountant and businessman, was sentenced in 
Chicago to 23 years in prison for bilking hundreds of 
investors--many of them elderly Italian immigrants--out of more 
than $30 million.
    And just 2 days earlier, on September 13th, Michael 
Goldberg pleaded guilty in Bridgeport, Connecticut, to three 
counts of wire fraud relating to his operation of a $100 
million fraud scheme that cheated investors out of more than 
$30 million over an approximately 12-year period. Mr. Goldberg 
will be sentenced on December 2nd.
    As I mentioned, these three prosecutions, which taken 
together targeted fraud relating to over $1 billion, were from 
last week alone. The list of investment frauds, however, goes 
on and on. We stand ready to continue to prosecute the 
perpetrators of these frauds and to send them to jail.
    Our efforts to combat financial fraud, including mortgage 
fraud, have also targeted high-level executives in the most 
sophisticated of frauds. As just one example, in June of this 
year, the Department obtained an indictment in the Eastern 
District of Virginia against Lee Bentley Farkas, the former 
Chairman of Taylor, Bean & Whitaker Mortgage Corporation. TBW 
was once one of the largest private mortgage companies in the 
United States. Mr. Farkas was charged with perpetrating a 
massive fraud scheme that resulted in losses exceeding $1.9 
billion and that contributed to the failure not just of TBW, 
but also of Colonial Bank, one of the 50 largest banks in the 
United States before its collapse in 2009. This prosecution is 
just one example of our sustained efforts to reach and uncover 
fraud at every level.
    Financial fraud in its various forms has devastating 
effects on our citizens, and it deserves the full attention of 
law enforcement and regulatory communities. With the increased 
resources afforded to the Justice Department under FERA and 
other legislation, and through our close collaboration with our 
partners on the Financial Fraud Enforcement Task Force, we have 
made this fight a priority, and we will continue to do so.
    Thank you for the opportunity to provide the Committee with 
this brief overview of the Department's efforts to address 
financial fraud, and, of course, I would be happy to answer any 
questions.
    [The prepared statement of Mr. Breuer appears as a 
submission for the record.]
    Senator Kaufman. Thank you.
    Mr. Khuzami.

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

    Mr. Khuzami. Thank you, Senator Kaufman, Senator Grassley. 
Thank you for the opportunity to testify here today on behalf 
of the Securities and Exchange Commission alongside my valuable 
colleagues from the Department of Justice and the FBI.
    When I first testified before this Committee in December of 
last year, we were emerging from an economic crisis that 
threatened our financial system and tested the public's 
confidence in the institutions charged with enforcing the laws 
that govern that system. Although there is much work to be 
done, during that 9 months we have achieved significant results 
at the SEC in our efforts to enforce the securities laws, 
particularly in areas relating to the financial crisis.
    Our statistical accomplishments for year-to-date fiscal 
year 2010 are compelling, include 634 actions filed, over $1.5 
billion in disgorgement of ill-gotten gains that have been 
returned to investors, $968 million in penalties imposed, and 
nearly $2 billion in funds distributed to injured investors.
    But statistics alone do not capture the breadth and the 
complexity of the high-impact cases that we have filed since I 
last testified, and let me just give you a couple of brief 
examples.
    Boston-based State Street Bank and Trust Company agreed to 
pay over $300 million into a Fair Fund for the benefit of 
injured investors to settle our charges that it misled 
investors about their exposure to subprime investments and 
selectively disclosing more complete information to certain 
favored investors so that they could get out of those funds 
sooner during the 2007 mortgage crisis.
    We charged investor adviser ICP Asset Management and its 
founder, owner, and principal, alleging conflicts of interest 
and fraud related to its simultaneous management of multiple 
CDOs, managed accounts, and affiliated hedge funds that came 
under pricing and liquidity pressures in 2007. Mr. Priore and 
ICP collected millions of dollars in advisory fees on 
investments that were inflated as a result of that crisis and 
otherwise interposed themselves in certain trades in order to 
benefit themselves and to the detriment of their fiduciary 
clients.
    As Mr. Breuer testified, we, along with the FBI, Department 
of Justice, SIGTARP, and many others, charged Lee Farkas, the 
former Chairman of Taylor, Bean & Whitaker, in the large-scale 
securities fraud that Mr. Breuer mentioned. I mention that 
because it reflects the coordination of all of our agencies, 
both before but only enhanced by the formation of the Federal 
Financial Enforcement Task Force.
    In addition, Goldman Sachs agreed to pay $550 million to 
settle SEC charges alleging fraud in connection with the 
marketing of a synthetic CDO in which Goldman represented that 
the portfolio of securities underlying the CDO had been 
selected by a neutral, objective third party, when, in fact, 
the hedge fund investor at whose request the CDO had been 
structured and whose interests were directly adverse to CDO 
investors had heavily influenced the selection of that 
portfolio.
    We charged the former CEO, CFO, and comptroller of New 
Century Financial Corporation, once the third largest subprime 
lender in the United States, and they all agreed to pay 
disgorgement penalties and be barred from serving as an officer 
or director of public companies to settle charges stemming from 
their respective roles in the misleading New Century financial 
statements.
    And while doing these cases, we have pursued other 
traditional areas of SEC focus, including accounting fraud, 
insider trading, municipal securities, Ponzi schemes, offering 
fraud, pension fund fraud, and violations of the FCPA statute.
    We also brought charges against Dell, who paid a $100 
million penalty to settle charges that it failed to disclose 
material information to investors and used fraudulent 
accounting to make it falsely appear that the company 
consistently met Wall Street earning targets while reducing 
operating expenses from 2002 through 2006, and certain Dell 
executives, including the chairman, the CEO, the former CEO, 
and a former CFO, all agreed to pay penalties to settle our 
charges.
    But we are not just focused on wrongdoing in connection 
with the financial crisis. We are equally focused on the 
future, embracing a range of initiatives designed to increase 
our ability to identify hidden or emerging threats to our 
markets.
    Stopping misconduct as soon as possible and minimizing 
investor loss and erosion of the public's confidence in our 
markets is one of our top goals. As I detail in my written 
testimony, to accomplish this goal we have, among other things, 
established national specialized units focused on key areas of 
activity, and we are using risk-based metrics and other 
proactive measures in order to identify, for example, 
investment advisers who misrepresent credentials or performance 
returns, mutual funds who charge excessively high fees, 
suspicious pattern and relational trading in market-moving 
securities, and troubling marketing practices, improperly 
minimizing the risk to investors of complex securities. These 
efforts all involve the integration of market data, event 
analysis, and red flags to flush out those firms, individuals, 
practices, and transactions that are most likely to be engaged 
in questionable conduct. This will help our staff to shine a 
bright light on the dark corners of the financial industry.
    We are also engaged in other reforms, streamlining our 
management structure, swiftly obtaining formal orders so that 
our staff can focus on what they do best. And we are also 
integrating the new authority and responsibility granted to us 
under Dodd-Frank.
    There is much to be done, but I am confident the Commission 
is up to the task. I thank you for the opportunity to appear 
here today, and I am happy to answer any questions.
    [The prepared statement of Mr. Khuzami appears as a 
submission for the record.]
    Senator Kaufman. Thank you.
    Mr. Perkins.

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

    Mr. Perkins. Good afternoon, Senator Kaufman and Senator 
Grassley. I want to thank you for the opportunity to testify 
before you today about the FBI's continued efforts to combat 
significant financial crimes.
    Since my last appearance before you, the FBI has continued 
to uncover massive financial frauds, and there are several 
notable cases that I will discuss which clearly highlight our 
commitment to combatting financial crimes at every level.
    In June, for example, and as Mr. Breuer and Mr. Khuzami 
have mentioned in their testimony, Lee Farkas, the former 
Chairman of Taylor, Bean & Whitaker, was charged and arrested 
in coordination with the SEC and with other--SIGTARP and the 
Justice Department. I mention this case specifically because of 
the role that leveraging resources between the various 
investigative agencies plays in the fight against financial 
frauds.
    Other cases I will mention include: In June, Scott 
Rothstein, a Miami attorney, was sentenced to 50 years in 
prison and ordered to pay $363 million in restitution for 
operating a $1.2 billion Ponzi scheme, which took money from 
over 300 victims.
    In August of this year, former chief accounting officer 
Michael Rand of Beezer Homes, a former Fortune 500 company, was 
charged and arrested for his role in an alleged accounting 
fraud that manipulated the company's reported earnings. Beezer 
Homes previously agreed to a deferred prosecution agreement and 
paid a $50 million fine in relation to this fraud scheme.
    Over the past 6 months, the prosecutions of the Galleon 
insider trading case in New York and the Petters $3.7 billion 
Ponzi scheme in Minnesota continued, with guilty pleas and with 
significant sentences of top corporate executives.
    These cases are just a few examples of the thousands of 
financial fraud cases investigated by the FBI and its partners 
and conducted in conjunction with the administration's 
Financial Fraud Enforcement Task Force.
    Our message is clear: Together, the FBI, the Department of 
Justice, and our partners throughout law enforcement and 
regulatory communities will investigate and, where appropriate, 
bring charges of criminal misconduct on the part of businesses 
and business executives.
    Mr. Chairman, the wave of mortgage fraud we have 
experienced shows no sign of slowing at this point. In the last 
3 years alone, the FBI has seen the number of mortgage fraud 
cases steadily climb from 1,200 cases in 2007 to over 3,000 
cases today. Seventy percent of those investigations of pending 
cases represent losses to victims exceeding $1 million. In many 
of these cases, the losses far exceed $1 million.
    Just today, seven individuals, seven mortgage industry 
insiders, were indicted in San Juan, Puerto Rico, for their 
role in a scheme which cost victims over $21 million.
    Recently completed Operation Stolen Dreams demonstrated 
just how rampant mortgage fraud is in this country. This 
operation resulted in charges against 863 subjects who were 
allegedly responsible for more than $3 billion in losses.
    Since my last appearance before you, the FBI has also 
observed a continued rise in corporate and securities fraud 
schemes, such as the falsification of accounting records and 
the continued increase in complex investment frauds. In 
addition to the number of corrupt high-level executives that 
have been exposed during this time, we have also experienced an 
increase in the number of financial crime cases involving loan 
offenders who have defrauded unsuspecting victims of millions 
of dollars.
    For example, earlier this month, a Federal grand jury 
charged an Ohio couple, Michael and Melissa Spillan, in a 47-
count indictment, alleging that they defrauded over 50 victims 
of more than $25 million through a series of fraudulent stock-
based loan schemes.
    By using the additional resources appropriated by Congress 
with your assistance, we have continued to implement innovative 
and proactive methods to detect and combat significant 
financial frauds. Foremost is the FBI's continued development 
of the Financial Intelligence Center, established 1 year ago. 
The Center is an amalgamation of intelligence analysts and 
professional staff and provides tactical analysis of financial 
intelligence data sets to identify ongoing financial fraud 
schemes. Their work includes not only traditional financial 
fraud schemes but also those employed within health care 
frauds, contracting frauds against the Government, and money 
laundering, among others.
    Mr. Chairman, I would also be remiss if I did not emphasize 
the vital role that partnerships play in our efforts. Most 
recently, the FBI and the SEC reached an agreement to place an 
FBI agent on a full-time basis within the SEC's Office of 
Market Intelligence. This cooperative effort on the part of 
both organizations will allow for a much better coordination 
with regard to the referral of potential criminal activity 
within the securities markets.
    The FBI works closely with its Federal, State, and local 
investigative partners in efforts to combat mortgage fraud. 
Right now we have over 25 mortgage fraud task forces located 
across the country.
    Mr. Chairman, I appreciate the opportunity to come before 
you and the Committee today and share the work the FBI is doing 
to combat significant financial fraud. I look forward to 
working with you, and I am happy to answer any questions you 
may have.
    [The prepared statement of Mr. Perkins appears as a 
submission for the record.]
    Senator Kaufman. Thank you very much. We will be doing 7-
minute questions, and I will start.
    Mr. Breuer, I think it is fair to say that, maybe because 
of popular press or whatever, we thought that on Wall Street 
there would be more criminal prosecutions on Wall Street, and 
since Bear Stearns there have not been. What is your thinking 
about that? Is that something that we just misjudged it, or 
there are problems that nobody anticipated, or we are moving 
ahead but it is just taking longer to get the cases started?
    Mr. Breuer. Well, Senator, just to take a step back for a 
moment, it is always hard to know what people define and what 
their expectations are. But there really has been, as my 
colleagues have said and as I have said, a very rigorous 
enforcement effort. And so even if you look at FERA, you look 
over the last months, we have indicted, prosecuted, and 
sentenced numerous officials of public companies. Mr. Perkins 
talked about Beezer Homes, which is a publicly traded company. 
There we went after the chief accounting officer, and he was 
indicted for false revenue recognition. For the average person 
or investor of Beezer Homes, that is a very meaningful 
prosecution.
    We went after the executive vice president and the former 
risk vice president of Integrity Bank. That is a financial 
institution, and those gentlemen pled guilty for both accepting 
bribes and for insider trading.
    Aeropostale, that is another public company, Senator. There 
just a couple of months ago, the executive vice president was 
indicted for a kickback scheme.
    And so we can go on and on with publicly traded companies 
and private companies and senior executives who, in fact, have 
been prosecuted vigorously.
    With respect to the Wall Street institutions that you are 
specifically referring to, as I said last time and as I 
continue to and as the public press has talked about, there has 
been no lack of effort in pursuing fraudulent activity--and I 
know you know it--wherever it is. But there is a big difference 
between pursuing it and then concluding an investigation. If 
there is criminal activity, we will prosecute it. And if we 
cannot prove criminal activity, then we will not prosecute it. 
And, of course, we have the SEC, which, of course, has been 
extremely vigorous as our partner here.
    So my view is that, in fact, it has been a very robust 
response by the Department of Justice and by the SEC and 
others. I think we have a lot to be proud of, frankly. But 
these are, of course--the cases you are referring to, of 
course--extremely complicated cases.
    Senator Kaufman. Right. And the point I want to make, 
because I am going to have a series of questions on this, but 
really the point that we made, that I made and that Senator 
Grassley made, this is an oversight hearing, and we are trying 
to see how the funds were spent and the rest of it. But it is 
also a legislative hearing. If there are some problems that you 
are running into in prosecuting these cases because the law--I 
mean, the law, as I said in my statement, it did not come from 
on high.
    Mr. Breuer. Right.
    Senator Kaufman. We write the laws. And so we can change 
the laws. I do not want a single innocent person to go to jail 
or be criminally indicted for any reason. But are there things 
going on that really give you concern, as I said in my opening 
statement, where there are really things going on that are 
clearly wrong, but just because of the way that the law is 
being formed or the way the law is being implemented or the way 
the regulations are written, we can see that people are doing 
bad things and not being prosecuted for them.
    Mr. Khuzami, what has changed about how you identify 
higher-level targets and how you conduct resulting 
investigations? Has anything changed on that?
    Mr. Khuzami. No, I think the fundamental tools that have 
always been in place are still the ones that we use--you know, 
thorough and vigorous investigation, partnering with our 
colleagues. The Galleon case was mentioned. Of course, there is 
no substitute for the kind of wiretap work that was done in 
that case, and, you know, one of the asks I would suppose I 
would have on my list would not necessarily be for me, but it 
would be more resources for the Justice Department and the FBI 
to be engaged in those kind of undercover activities for which 
there is no substitute.
    We have developed a cooperation program at the SEC where we 
can now offer reduced sanctions in exchange for insiders who 
come forward and provide us with information. And the same is 
true with the whistleblower legislation that was part of Dodd-
Frank where we will be able to award financial incentives.
    Those last two efforts should do a lot to get us earlier 
information on the inside while a scheme is unfolding. That is 
the best way to get as high up in the organization as you can.
    Senator Kaufman. Thank you.
    Mr. Perkins, can you think of anything?
    Mr. Perkins. Sir, just as far as use of resources, Senator, 
I wanted to make note of the fact that just looking at our 
resource levels from 2007 to 2010, a notable increase in each 
of our four priorities. Right now, we utilize just over 2,000 
agents to work white-collar crime matters. That is all of 
white-collar crime. Ninety-three percent of those 2,000 agents 
work our top four priorities: complex financial frauds, 
securities and commodities frauds, public corruption, and 
health care fraud.
    Now, when you look back to 2001, it is known that, 
following 9/11, there was a shift of resources within the Bureau away 
from criminal activities in the early days because of the 
crisis the country was in. Over the ensuing 9 years and through 
the help of the Congress and through prioritization within the 
Bureau, many of those resources have come back. I am still 
about 200 agents below where I was on the white-collar side at 
9/11. The difference between then and now, however, at that 
point in time--well, at this point in time, 93 percent of our 
resources are focused on priorities. It was much less than that 
at 9/11.
    So what has happened is we have had to prioritize and shift 
our resources away from the lower-priority matters. One 
particular case in point, on 9/11 we had nearly 1,800 financial 
fraud cases where the loss suffered by the financial 
institution was less than $25,000. Today we have one. And I 
believe that is a fugitive case that is still just pending.
    So we have shifted our priorities away, and we are focusing 
the resources that have been given to us by the Congress where 
they need to be.
    Senator Kaufman. Very good. Thank you.
    Mr. Breuer.
    Mr. Breuer. Well, Senator, with respect to the resources, 
we feel we have good resources. To make a point, Mr. Khuzami a 
moment ago spoke about the fact--and I could not agree more--
that, for instance, one of the strategies that we are employing 
in these white-collar cases and insider cases is to use 
wiretaps. Well, at the Department of Justice, we have tripled--
tripled--the number of people who review wiretaps. Now, many of 
those are for violent crimes, but many of those are for white-
collar offenses. That is a very real direct result. We have cut 
down in half the time that it takes to review these. We move as 
nimbly as we can. And that is just one small example. Everybody 
knows about the prosecutors both in Main Justice and in the 
field. But that shows how deeply we are dealing with the 
situation and how nimbly we are trying to react and be as 
forceful as we can.
    Senator Kaufman. Thank you very much.
    Senator Grassley.
    Senator Grassley. Thank you, Mr. Chairman.
    Mr. Khuzami, the Ponzi scheme perpetrated by the Madoffs 
and Stanford were serious breaches of our financial regulatory 
system. Most shocking is how these frauds went undetected for 
years by SEC, despite repeated warnings and tips from various 
sources. So the SEC Inspector General issued some scathing 
reports following these frauds, finding that the SEC made a 
number of failures along the way that allowed these schemes to 
go on for so long.
    Leadership there at the Commission has said that the Madoff 
scheme happened to be a perfect storm of fraud that allowed it 
to go undetected for years. I understand that the SEC has 
agreed with a number of recommendations that the SEC Inspector 
General made and that the SEC is currently implementing these 
recommendations. However, the Inspector General's report also 
recommended that the SEC take appropriate action against 
employees that are still employed at the agency to ensure that 
failures do not happen again. It has been over a year since the 
SEC Inspector General issued the Madoff report and 6 months 
since the Stanford report came out.
    So the question: To date, has the SEC taken any personnel 
action against the SEC employees that were highlighted in the 
reports for failing to perform on the jobs? And if so, what 
sort of action was taken? And if not, why hasn't action been 
taken?
    Mr. Khuzami. Senator, in both cases you mentioned, large 
numbers of the individuals involved are no longer with the 
Commission, and, of course, we cannot discipline ex-employees. 
But for those that remain, with respect to Madoff, the internal 
review is completed, and it is my understanding that those 
decisions will be made in the very near future.
    With respect to Stanford, the same recommendations by the 
IG, that process is underway. We have a variety of rules and 
regulations we follow in these circumstances, and that is what 
we are doing.
    Senator Grassley. And that sort of punishment will be known 
to the public? Or will there be an attempt to keep it secret?
    Mr. Khuzami. Senator, I actually do not know the--I will 
get back to you. I do not know whether or not there are 
restrictions on to what extent we can disseminate that 
information.
    Senator Grassley. Well, it is along the line of what the 
Chairman said. If heads do not roll, nobody makes any changes. 
I will go on with you also on another point.
    The SEC Inspector General issued an audit report in March 
regarding the SEC's use of the whistleblower provisions that 
authorize the SEC to pay a bounty to individuals who provide 
information leading to the recovery of funds from securities 
fraud, particularly insider trading. That report found that, 
despite having the authority for more than 20 years, there has 
been very few payments to whistleblowers under the program. The 
IG noted that the number of applications for the county was 
also low and that the program was not well known either inside 
or outside of the agency. The Inspector General ultimately 
concluded that the program was not well designed and was not 
successful because of poor design.
    During the debate on the Wall Street reform bill, enhanced 
whistleblower provisions were discussed as a means to bring 
more tips to the SEC and to make the agency more accountable. 
The SEC was ultimately provided a new whistleblower program 
under the law.
    Question number one--and I have three questions. Now that 
you have the whistleblower authority that the SEC requested, do 
you believe it will fundamentally increase the productivity of 
the agencies in hunting down financial fraud?
    Mr. Khuzami. Senator, I think it is potentially extremely 
valuable. There is no substitute for insiders, and if we 
incentivize them properly to come forward, that is all to the 
benefit. The challenge, of course, is separating the wheat from 
the chaff to make sure that we cast a wide enough net so we get 
as many people as possible, but not so wide that we inundate 
ourselves with complaints.
    So we are working through it in a way to strike the right 
balance, but we are very optimistic. It was our highest 
priority under the Dodd-Frank legislation, and we are eagerly 
writing rules and moving forward.
    Senator Grassley. OK. Then a follow-up to that, but I think 
you partly answered this. Since the authority has been 
previously little used based upon what the Inspector General 
said, and the agency did little to promote or facilitate the 
program as a useful tool, why should we have faith that the SEC 
will implement this new authority in a meaningful manner?
    Mr. Khuzami. Senator, the plans are to distribute word of 
this new program far and wide--on the Internet and various 
other forums--to let people know that this exists and they 
should come forward if they have information.
    Senator Grassley. OK. I think you answered my last question 
at the same time.
    Thank you, Mr. Chairman.
    Senator Kaufman. Senator Klobuchar.
    Senator Klobuchar. Thank you very much, Mr. Chairman. Thank 
you for your work on this. We are going to miss you, I can say.
    I thank all of you for being here today. I have always been 
a big supporter of this legislation. I was proud when the 
President signed it into law, and I am mostly here today just 
to get more updates on what has been happening. I think from 
what I understand, you have had nearly 3,000 defendants 
sentenced to prison for financial fraud between October 2009 
and June 2010, and that so far the SEC has obtained orders 
requiring the repayment of $1.53 billion this year.
    So I guess one of my questions--maybe it is of you, Mr. 
Breuer--is how this compares to other years. Do you have any 
historical data of the number of convictions and the number of 
the amount of money that has been brought in?
    Mr. Breuer. Senator, I do not have at my fingertips the 
numbers of prior years----
    Senator Klobuchar. Oh, come on.
    Mr. Breuer. I know. It is shocking. But I will not lose the 
opportunity to echo what you said. I think under any objective 
criteria the results since October of 2009 really are quite 
positive. As you said, 4,300 defendants have been charged; 
3,200 defendants have pled guilty; 2,800 have received prison 
terms; and 1,600 have received prison terms of over a year. I 
think by any measure those are very, very ample and high 
numbers. Those, of course, do not include what we are doing in 
the health care area, another enormous area that I know this 
Committee cares about. They do not deal with the FCPA, so this 
is just one level of criteria.
    I will get you the old numbers, but this is, I think, a 
very robust response.
    Senator Klobuchar. OK. Very good. And then if you could get 
these numbers, that would be great.
    [The information appears as a submission for the record.]
    Senator Klobuchar. What are some of the lessons you learned 
as you took over this area in terms of what works and what does 
not work?
    Mr. Breuer. Well, clearly one of the things that works is 
that we need to employ aggressive techniques in the area of 
white-collar and financial fraud. We have to use undercovers. 
We have to use Title III wiretaps. We have to seek very 
stringent prison terms. We have to hold companies accountable 
and ensure that they have very robust compliance programs. And 
we have to get the word out. All of that really does work.
    The other thing that I think works very closely is the 
gentlemen at this table next to me are not just my colleagues. 
They have become my friends, as have their most senior people, 
and that works, because frankly what really matters in cases 
that we can pick up the phone and in a very nimble way address 
issues. And so that has worked, and the Financial Fraud 
Enforcement Task Force has, at an unprecedented level, allowed 
Federal prosecutors and investigators throughout the agencies 
to work together and, frankly, to partner with State district 
attorneys and State AGs. That really matters a lot, because 
what we need are comprehensive responses. The Federal 
Government cannot, and Federal prosecutors and investigators 
cannot, be always the answer.
    Senator Klobuchar. And I have found in this area, just from 
my past job, that those prison sentences are very important. 
Maybe I have mentioned before when we prosecuted eight airline 
pilots who were not paying their taxes in the State where they 
should have paid it, as in my State, it created a huge amount 
of money coming into our State revenue department because the 
prosecutions got a lot of attention. And I think in this area 
more than any other, going after these cases actually sets a 
precedent that people tend to follow. So I commend you for 
that.
    I also wanted to mention not only the Petters case, which 
was, I think, the second biggest case in terms of money that 
was prosecuted by the Justice Department next to Madoff in the 
last year, but also the two others that I think were in your 
testimony out of our jurisdiction. I do not know if I am 
supposed to be proud of that, but Corey Johnston pled guilty. 
It was 17 lenders, $80 million, and then you also in August of 
this year, a Federal judge sentenced Trevor Cook, who 
orchestrated a Ponzi scheme by selling $158 million in bogus 
foreign currency trading investments, to 25 years in prison. So 
I wanted to thank you for that.
    What has not worked, have you learned? Or maybe things that 
were going on before that you do not think were very helpful?
    Mr. Breuer. Well, I think the real challenge is, candidly, 
the public perception and the fact that for very complicated 
cases there are lots of different issues. So that we will 
continue to do it, and we will call it the way we see it. But, 
obviously, we have to put enormous resources in some of the 
most complicated cases. They take time. They take the review 
of, you know, sometimes thousands, tens of thousands or more of 
documents. And, of course, at the end of the day, it does work 
in the sense that if we do not think we can prove beyond a 
reasonable doubt a crime, we move away. That is the system 
working. But I understand that that also on the public frame 
can cause some level of frustration.
    So there is really no alternative to hard work and, 
frankly, as prosecutors, we could not be more delighted with 
what our friends at the SEC, and the other regulators, are 
doing because, of course, what we need as the prosecutors are 
people with deep, substantive knowledge who really understand 
these very complicated transactions, and who along with the 
FBI, which has done a stellar job, are able to bring the cases 
to us. And so that partnership has worked. But, clearly, it 
will be over a period of time that we'll really be able to 
assess the fruits of our efforts.
    Senator Klobuchar. Thank you.
    Mr. Khuzami--I am sorry. Every time I see your name, my 
staff wrote, ``Pronounce it like `tsunami.' '' And so I keep 
wanting to say that.
    Did you have those numbers on the SEC and the money brought 
in at all? Or maybe you are the best person to ask for that?
    Mr. Khuzami. I do not have them specifically. We will get 
them for you. I can tell you that certain categories have 
certainly increased. The number of TROs and asset freezes we 
have done in the last few years has increased dramatically. 
That is an intentional decision because that is the best way to 
make sure we get as much money back to investors as possible.
    Our penalty numbers are up considerably, and our Fair Fund 
numbers--that is the amount of money that actually gets 
distributed back to harmed investors--are up in the last 2 
years.
    So all in all, I think those statistics reflect 
significantly enhanced performance, but even more so, I think, 
is the nature of the cases. The list of credit crisis and 
financial crisis cases from Countrywide, to American Home 
Mortgage, to New Century, to Goldman, to the Colonial Bank-TBW 
case mentioned today, to Dell, to Ernst & Young, all of those 
cases, a great deal of time and effort goes into those. They 
are challenging cases to make. So what I am most proud of is 
that while we have been able to increase the statistics, at the 
same time or perhaps more importantly, we have taken on the 
challenging cases.
    Senator Klobuchar. OK. One last question. Mr. Perkins, 
maybe you are the right one for this. I just remember after 
Katrina there were a number of sort of disaster fraud cases. I 
wonder if you are seeing the same thing with the BP oil spill 
in the gulf.
    Mr. Perkins. We are taking some significant proactive steps 
to address those issues. We met, in fact, just last week with 
nearly all of the U.S. Attorneys from the gulf region. We went 
to the campus of LSU----
    Senator Klobuchar. You are the right person to ask.
    Mr. Perkins. Yes, ma'am.
    Senator Klobuchar. That is good.
    Mr. Perkins. Mr. Breuer and myself attended the conference, 
spoke at the conference. Mr. Feinberg was there and spoke as to 
his efforts with the trust fund. We have the National Disaster 
Fraud Center on the campus of LSU where we are operating the 
call centers. We are seeing some signs of fraud, but what we 
are trying to do is be ahead of it, and----
    Senator Klobuchar. Yes, to try to prevent it by the rules 
you have put in place?
    Mr. Perkins. It is a combination of prevention, public 
awareness. Our colleagues, for instance, from the Postal 
Inspection Service have done a great deal of media within their 
organization, pushing out to individuals in the gulf region 
that there is going to be very little tolerance to any type of 
fraud, that prosecution is going to take place. And so we are 
closely monitoring that. We will have the resources to address 
it.
    The prosecutors and the agents met at this meeting just 2 
weeks ago and spoke about what worked during Katrina, what did 
not work, and what we are going to try to do going forward.
    Senator Klobuchar. Well, that is very helpful, because as 
we know, this was a public trust issue to begin with, and I 
think now that the spill is plugged and the work is getting 
done to help people that were victims, we just want to make 
sure the money goes to the right people. So thank you very 
much. Thank you, all of you.
    Senator Kaufman. Senator Franken.
    Senator Franken. Thank you, Mr. Chairman.
    Gentlemen, I am sorry I was not here for your testimony, 
but I did read it last night. Mr. Khuzami, back in December I 
asked you a question about prosecuting credit rating agencies 
that had a clear conflict of interest when valuating 
securities. And I notice in your testimony you talked about a 
credit rating agency, LACE Financial, that you settled some 
charges against.
    Mr. Khuzami. Correct, Senator.
    Senator Franken. And that was about its conflict of 
interest?
    Mr. Khuzami. That arises out of--there were a number of 
theories there, the primary one of which is that the laws 
provided that you could not rate instruments for, I believe, an 
entity that accounted for more than 10 percent of your revenue 
in a given year. And there were some accounting shenanigans to 
make sure they did not go over that 10-percent threshold to 
allow----
    Senator Franken. Right, so for the accounting shenanigans.
    Mr. Khuzami. Correct.
    Senator Franken. Right. But it was addressing this conflict 
of interest.
    Mr. Khuzami. That is correct.
    Senator Franken. So this conflict of interest is kind of a 
big problem.
    Mr. Khuzami. Senator, we are looking--we have looked at the 
area closely, and I agree with you. And Dodd-Frank, obviously, 
as I am sure you know, addressed a number of those issues.
    Senator Franken. Well, actually, not quite as strongly as I 
would have liked. In fact, I presented an amendment that passed 
the Senate 64-35 that would eliminate this conflict of interest 
by creating a third party that would assign a credit rating 
agency to the instrument and take the conflict of interest out. 
And that has been now--that became a study, after 2 years under 
the SEC, and that is kind of what I wanted to ask you about.
    This conflict of interest is pretty serious, right?
    Mr. Khuzami. Correct, Senator. We see conflicts not just in 
the credit rating agency but in a number of areas, and each 
time it is typically a source of concern of ours.
    Senator Franken. But let us talk about it specifically in 
the credit rating agencies. I think basically what would happen 
is they would get paid to rate an instrument, and they would 
give it a AAA rating, whether it deserved it or not often. In 
fact, in your testimony you have a thing about Moody's doing 
that, right?
    Mr. Khuzami. Correct.
    Senator Franken. OK. And you say here that the Commission's 
report warned that, ``.  .  .the conduct of Moody's European 
credit rating agency Committee was contrary to the 
methodologies described in Moody's NRSRO application submitted 
to, and later approved by, the Commission.'' It sounds like 
they are in breach of the law.
    Mr. Khuzami. Well, in the Moody's case, the problem was one 
of jurisdiction.
    Senator Franken. Well, I know, and that speaks to this 
exactly, that it is ``contrary to the methodologies described 
in Moody's NRSRO application submitted to, and approved by, the 
Commission.'' You wrote that to say, however, it may very well 
be--you said, ``The report cautioned Moody's and other NRSROs 
that deceptive conduct in connection with the issuance of 
credit ratings may violate the antifraud provisions of the 
Federal securities laws.  .  .''
    So my question is why--now, didn't you at one point give 
them a Wells notice?
    Mr. Khuzami. We did, Senator.
    Senator Franken. And why did you decide not to go further 
with that?
    Mr. Khuzami. Because of the jurisdictional hurdles. As I am 
sure you know, the transactions at issue were European----
    Senator Franken. Right, OK.
    Mr. Khuzami. The ratings were done by the European entity. 
There was really no connection to the United States.
    Senator Franken. OK, even though in your own testimony here 
you write this caveat that it is in violation--it is possibly 
in violation of our laws.
    Mr. Khuzami. Correct. If we had jurisdiction over the 
conduct, absolutely.
    Senator Franken. OK. Well, maybe I do not totally 
understand your testimony, then. I am sorry. I apologize if I 
do not.
    I guess my point is that there was also testimony in 
Chairman Levin's Committee of a number of credit rating 
agencies that their e-mails basically said we better give this 
a good rating because we want their business, right?
    Mr. Khuzami. Yes, I am aware of that testimony, Senator.
    Senator Franken. OK. And it is more evidence than 
testimony. It is e-mails.
    I guess my point is that I want the SEC, after examining 
this--I would like to find some solution to this conflict of 
interest, and I do not see any other solution other than having 
some kind of third party--and it does not have to fit my 
prescription, but I would like to see some kind of way of 
eliminating this conflict of interest where the credit rating 
agency is chosen by the bank that is issuing the product and 
paid by the bank that is issuing the product.
    Mr. Khuzami. I completely agree with you, Senator.
    Senator Franken. Oh, good. I am glad you do. Thank you very 
much.
    Let us see. Mr. Breuer, thank you for being here. In a 
speech given to the American Bar Association, National 
Institute of White-Collar Crime--a terrific group, by the way--
in March 2010, you discussed that the Department of Justice 
needed to ``be more targeted, more creative, and more strategic 
in where and how we look for criminal conduct when 
investigating financial fraud.''
    What specifically has the Department of Justice done with 
FERA funds to be more creative and strategic when prosecuting 
crimes so that we are ahead of the curve? And maybe this was 
asked before, and I am sorry if it has been before I got here.
    Mr. Breuer. Senator, both at Main Justice and at the U.S. 
Attorney's Offices, numerous U.S. Attorneys have created 
securities sub-groups, or even if they have not denominated 
them specifically as that, have either selected lawyers or 
recruited lawyers to work specifically on what we will call 
securities-related kinds of cases. That is what we are doing. 
We have beefed up in our Fraud Section the number of lawyers 
who work in this area. We have recruited lawyers with very deep 
experience in the specific areas. We have recruited alums of 
the SEC who have then decided to become prosecutors. We have 
recruited lawyers from other U.S. Attorney's Offices and given 
them supervisory positions. So that is one thing we have done.
    As I said earlier, it is always hard for me to know exactly 
where the monies go, but we think very much that, given the 
kinds of cases that we need to bring, we have to be very 
aggressive in doing it. We have to have wiretaps, we have to 
have undercovers. In doing that, we have allocated more 
positions for people who review wiretap applications, because 
the ones that take the longest are the ones, frankly, in the 
very complicated white-collar cases. And I think, Senator, you 
will see in the coming period of time announcements of perhaps 
insider trading cases or others that will have been brought 
about, as had the Galleon case, from things such as wiretaps. 
We have been taking more and more aggressive steps.
    Then, frankly, we have taken these lawyers, and we have put 
them on some of the most complicated cases. In January, we will 
go to trial in the Stanford case. We, of course, brought the 
Farkas case dealing with TBW, one of the largest mortgage 
lending institutions, which led to the failure of both that and 
Colonial Bank.
    So we are taking the funds. We are hiring lawyers. I think 
probably, Senator--I do not know exactly -probably nationally 
at this point maybe, ball park, 75, 80 new prosecutors in this 
area have been hired, and probably another 70 are in the 
process of being hired.
    Senator Franken. Thank you, and I want to thank all three 
gentlemen for your service. Thank you, Mr. Perkins. I did not 
get a chance to question you, but my time is up.
    Thank you, Mr. Chairman.
    Senator Kaufman. Thank you.
    Mr. Breuer, during the savings and loan crisis, bank 
regulators played an important role in cases. Now, you used the 
term ``deep, substantive knowledge,'' and I think that is the 
real driving force. They can deliver cases that are ready to go 
to prosecution.
    Can you talk a little bit about how you are working with 
bank regulators in order to find fraud?
    Mr. Breuer. Yes, it is going very well, and, Senator, it 
is, candidly, going particularly well after FERA, and to be 
very open, after speaking with members of the Committee and 
specifically you. We in the Criminal Division and our 
colleagues have been meeting regularly with the bank 
regulators. We have been reviewing with them, after they have 
selected some, the Suspicious Activity Reports, which are in 
this day and age the equivalent of referrals. And, frankly, 
those kinds of reviews are leading to very active 
investigations.
    The task force in particular has been a terrific forum to 
get the regulators together. Just earlier this week in New 
York, for instance, the Securities and Commodities Working 
Group of the task force met. We met at the CFTC. Mr. Khuzami 
and I, and the U.S. Attorney in New York, are the co-chairs of 
that committee. And at that meeting, there were many of the 
bank regulators and others, and we spoke about these very 
issues.
    So we will continue to work. We have more to do, but 
overall I think it is a good report.
    Senator Kaufman. Great. Thank you.
    Mr. Khuzami, as you justifiably said, the SEC settles its 
highest-profile cases, such as Bank of America, Goldman Sachs, 
Barclay's, and Citi. Can you kind of go through the decisions 
you make when settling versus taking a case to court?
    Mr. Khuzami. Sure, Senator. Look, when we consider 
settlement, we consider whether or not we can achieve the 
objectives we started out in bringing the case through 
settlement. And if we can do that and avoid the litigation risk 
of an unfavorable outcome as well as the resource 
considerations--not that the resource considerations are 
paramount, but there are opportunity costs in everything we do. 
If you are working on Case A, you are not working on Case B. 
And so we look at all of that, and it is a complicated analysis 
just because you need to analyze the strength of your proof and 
what you think the remedies will be even if you prevail. And 
that is the general formula, and we do it in all of our cases.
    Senator Kaufman. Do you ever take into account what the 
message will be if somehow you go into court and you lose in 
terms of just the impact people have about whether they can 
break the law?
    Mr. Khuzami. If we lose?
    Senator Kaufman. Yes.
    Mr. Khuzami. We do worry about--I think about that in some 
context. If you are bringing a case, for example, a TRO or an 
asset freeze against a suspected Ponzi scheme, and you are 
uncertain if you have got the evidence to stop it, but you very 
much want to be able to because it may be an ongoing fraud, if 
you bring that case and lose, all of a sudden it becomes 
potentially -you know, the Good Housekeeping Seal of Approval 
that the perpetrators then say, ``The SEC tried to stop us and 
nothing was found wrong.'' And so sometimes you have to take 
that into account.
    But as a general matter, I think that you cannot be cowed 
by the possibility of losing, and we do enough good things and 
bring enough good cases that we can take a few losses if the 
cause is right.
    Senator Kaufman. Mr. Breuer, the behavior of the borrowers, 
lenders, banks during the housing boom, which ultimately led to 
the financial catastrophe, represented a continuum from 
innocent to the unwise to the criminal. What are the hallmarks 
of criminal or fraudulent behavior that you look for when 
deciding whether to initiate an investigation?
    Mr. Breuer. Well, we look, Senator, to see if we believe 
that fraudulent conduct occurred and whether or not it is the 
kind of conduct that we believe we can prove beyond a 
reasonable doubt. So if someone made a material false 
misrepresentation and we believe that that is something that is 
colorable, then that is exactly what we would investigate.
    And so working with my colleagues to my left, whether it is 
the most sophisticated or the simplest, that is the kind of 
benchmark that we follow.
    Senator Kaufman. Mr. Khuzami, how about you?
    Mr. Khuzami. In terms of what we look at?
    Senator Kaufman. Yes, look for in terms of deciding whether 
to initiate an investigation. What kind of behavior kind of 
sends a signal that it is time to start looking and investigate 
this? Not prosecute, but earlier on in the investigation phase.
    Mr. Khuzami. Well, you know, some cases come to you with 
pretty good evidence of wrongdoing, and that is an easy call. 
You look at that----
    Senator Kaufman. And the whistleblower thing is really very 
helpful in that, right?
    Mr. Khuzami. That is the----
    Senator Kaufman. And everybody agrees to that? I mean, you 
know, there is nothing like having somebody come forward who 
can tell you actually what is going on.
    Mr. Khuzami. That is correct. Potentially extremely 
valuable, both in terms of getting at the conduct earlier, 
getting at those who organize and supervise and lead an 
organization, because if you have an active scheme really of 
any kind, odds are there is just a handful of people who are in 
on it. And in order to gain access and a window into that and 
the evidence that you need to bring that case, you need 
somebody similarly trusted. And so whistleblowers and 
cooperators are the kind of people that can do that for you.
    Senator Kaufman. Yes, and we have talked about it before. I 
mean, this is not--at one time I said it is not like drug 
dealers. These folks that are involved in this kind of fraud 
have very good lawyers and accountants, and they cover up 
behind themselves very, very well. Do you want to comment on 
that?
    Mr. Khuzami. It is absolutely right. The simplest example 
is the person who is engaged in insider trading who at the same 
time they are receiving the information and executing the 
trades are searching the Internet for a few research reports on 
the particular company and stick it in their file, so when the 
cops come knocking, they point to the file and say, ``This is 
why I bought.'' And in order to be able to rebut that defense, 
you need a pretty tight case.
    Senator Kaufman. Mr. Perkins.
    Mr. Perkins. Senator, I can give you a couple specific 
examples of what we are trying to do, especially involving 
resources that we receive based upon FERA and through Congress 
over the last year. I mentioned in my opening statement in my 
testimony the Financial Intelligence Center. I also want to 
mention the usage now of forensic accountants, something we did 
not have in the past.
    We found in the past walk-ins, people that are motivated 
through whistleblower and the like, yes, those can deliver a 
lot of cases. But the best cases are the ones you can get on 
the front end where you can utilize the Title III, the 
undercover technique, and whatever the case, whether it is a 
financial fraud or any other type of criminal activity.
    What we are trying to do with the Financial Intelligence 
Center, we have intelligence analysts there who look at SARs, 
which you mentioned. When I came into the Bureau in the mid-
1980's, it was the RTC, Resolution Trust. I worked those cases. 
Today we have SARs not only from the financial institutions but 
from the securities industry. We are able with our analysts 
there to look at those, determine patterns of activity, and 
actually have identified investigations based out of that that 
no one came in the door, that we have actually referred out to 
our field offices, to follow up on that with the forensic 
accountants, again, something that 1 year ago we did not have. 
We have a position now----
    Senator Kaufman. I am smiling because I can remember that 
little accountant in ``The Untouchables.''
    Mr. Perkins. Yes.
    Senator Kaufman. The FBI accountant that found out about Al 
Capone.
    Mr. Perkins. Exactly.
    Senator Kaufman. He was gone by this time.
    Mr. Perkins. Being the one accountant sitting at this 
table, I can appreciate that, sir. But with the forensic 
accountants, we have been able to hire nearly 100. We send them 
to a 6-week class at Quantico. Our first class graduated with 
35 students just a few weeks ago.
    I will give you an idea of the quality of the people we 
have in these classes, and these are all newly hired 
employees--I am sorry, 38 students. Of the 38 students, 28 of 
them are certified public accountants; 10 of them are certified 
fraud examiners. So that is just the beginning. Multiple MBAs. 
These people are now in the field. Over half of that original 
class went to our top five field offices where these cases 
exist.
    We have another class of 40 about to start in a month, and 
we are going to keep that continuum going. So we are using 
these individuals to identify those types of cases and then to 
work those cases.
    Senator Kaufman. I think that is really what we all talked 
about. That is what FERA was all about, to try to get the 
capability to move up the chain to get to the more complex 
cases. That is why the whistleblower provisions are in Dodd-
Frank. I think this is all the ability to know you just cannot 
have two different sets of rules for people, and if you are 
powerful and you have got money and you have got good 
accountants and good lawyers, you can get away with something 
that normal people cannot.
    I would like to turn back to the hypothetical I discussed 
in my opening statement to try to define the distinction 
between actionable fraud and legally permissible behavior. Mr. 
Breuer, I described a bank that sought to increase market share 
by lending a larger and larger percentage of its loans on a 
stated-income basis, or liar loans. Over time, almost three-
quarters of the Option ARM loans and about half of the subprime 
loans were offered on a stated-income basis. Does that in 
itself give rise to actionable fraud?
    Mr. Breuer. Senator, from my perspective, it really 
depends--I hate to say it but--on what the disclosure says.
    Senator Kaufman. Sure.
    Mr. Breuer. At the end of the day, that is the difference. 
If the institution materially misrepresented what it was doing, 
if it purported to the public one thing and was doing something 
very different, materially different, then, yes, that could 
very well be criminal. But, frankly, if within the large 
disclosure of the kind of activity that they were engaged in is 
covered in some way, then that could very well pose an enormous 
burden for us and could preclude us from proceeding criminally.
    So until we read those dense disclosure materials or unless 
we have somebody from the inside telling us what was going on, 
those are the kinds of challenges that we will continue to 
face.
    Senator Kaufman. Now, if the bank takes loans itself, it is 
free to sell the loans; it is free to hold them on its balance 
sheet, right? It can do anything with these loans it wants to 
do.
    Mr. Breuer. There are others, such as Mr. Khuzami, who are 
more expert in this than I, but so far it seems as if, yes, 
they would be able to do that in your hypothetical.
    Senator Kaufman. Now, if the bank at some point decides 
that loans on its own balance sheet are likely to default and 
plummet in value, may the bank sell these loans to third 
parties without disclosing its belief that they are a bad 
investment?
    Mr. Breuer. Well, again, Senator, I mean, there are cases--
and the SEC I think is litigating some of these right now. But 
I think that there would be a question of what is being 
disclosed and what is being withheld and whether it is just an 
opinion being withheld or whether the underlying facts are 
being withheld. And, again, those are difficult issues.
    Senator Kaufman. Mr. Khuzami.
    Mr. Khuzami. Well, look, under the scenario you describe of 
a securitization, a company in the securitization business, a 
couple points.
    One, there are various theories: disclosure; the accounting 
could be bad; they could be not setting aside proper reserves 
given the deteriorating quality of the loan portfolio. That is 
a separate and independent potential violation. And there is 
the MDNA provisions of the disclosure laws which require them 
to disclose trends and uncertainties and kind of management's 
perspective of the business model. So you might look at all 
those three. In fact, in Countrywide, we brought the case based 
on an MDNA theory, not so much on the accounting or other 
aspects but the fact that they knew that the business model was 
deteriorating because the quality of the loan portfolio was 
going down, and they did not disclose that. So we try and be 
creative with the theories.
    One of the hurdles in the securitization world is that 
typically these securitization vehicles, the offering materials 
attached to them, in addition to the disclosure, every loan in 
the portfolio where you get the loan identity and geographic 
location, the average FICO score, and all the information. So a 
lot of granular level is disclosed in connection with the 
securitization that can make it difficult to make the case.
    But, on the other hand, in your hypothetical, if a company 
were to say, you know, our portfolio may consist of a certain 
percentage of liar loans and, in fact, they already do consist 
of that, you might even try to be aggressive and seize upon the 
difference between ``may'' and, in fact, ``does'' as a theory 
to proceed. And we consider those kind of theories as well.
    Senator Kaufman. And this disclosure thing, because I think 
disclosure is really the root of a lot of these problems. Is 
that fair to say? You know, one of the things I was thinking 
about--because I have been thinking about this a lot--is, you 
know, we had the truth-in-lending law which took--you know, 
everybody in America was borrowing things, and somewhere deep 
down--and it was not 100 pages like some of these prospectuses 
are, but, you know, it would be three or four pages, little 
print--would be what the interest rate was. Then we took the 
interest rate and put it right out on the front of the page so 
you cannot miss the interest rate.
    Is there something in disclosure--I mean, it just seems to 
me this is not right. This falls into the ``not right'' 
category. It may be legal that you can hide these things down 
in the body of the thing, you can put in there what the 
statements are, when all along you know what it is that you are 
selling is not a good thing.
    What can we do in terms of changing the disclosure rules so 
that it makes it easier for people who are buying, even 
supposedly, you know, the big boys, so that people know what it 
is that they are getting and how really risky it is?
    Mr. Khuzami. Well, I guess I would like to give that a 
little thought and perhaps get back to you.
    Senator Kaufman. That would be fine.
    Mr. Khuzami. A lot of the risks that are disclosed are 
typically disclosed up front in the offering materials, then 
followed on in the offering materials by more detailed and less 
important ones. So if you open up securitization offering 
material, the risks can start out, you know, the housing 
market, if that falls, these things are going to be badly 
worth; and if, you know, originators cannot make loans anymore, 
then this will be this, this, or this; or if there is an 
earthquake in Fresno, that could hurt.
    And so a lot of the stuff is identified up front, but you 
are also right that it is a big book of information and not 
always fully transparent to all buyers.
    Senator Kaufman. Mr. Breuer.
    Mr. Breuer. Well, I would say the same. I mean, obviously 
at the Department we are less the regulators, of course. We are 
the prosecutors. And so whatever the regulations and the laws 
are, we will look to see whether people violated them.
    I, too, would want to look at it. I think at its most basic 
level disclosure is a good thing, and making it simpler and 
understandable is a good thing. But, of course, in the very 
kinds of transactions that you are discussing and that Mr. 
Khuzami was referring to, many times you have very 
sophisticated parties on both sides of these very, very 
difficult and complicated transactions. And so, you know, where 
the right balance is I think is for others to probably figure 
out.
    Senator Kaufman. But I think in the end, I think you would 
all admit that these ended up being sold to very 
unsophisticated investors. I mean, a lot of people ended up--
when you go around and look at the people who--I mean, major 
institutions maybe, but not at all familiar with what it is 
that we were doing and what was going on. This was not just--
so, you know, the big boy thing, just as long as everybody is a 
big boy. But I think if you go back and look at most of these 
things, they were not big boys.
    OK. So they have the disclosure, and they said they had 
toxic securities and they sold them. But at the same time, they 
bet huge amounts of money against them in the credit default 
swap market. Mr. Khuzami, is that OK?
    Mr. Khuzami. Well, I mean, if an institution is engaged in 
legitimate hedging activities, if it looks at its overall risk 
and decides I am more long in the mortgage market than I really 
want to be and I offset some of that risk through derivatives 
or other instruments, there generally is--that is not improper. 
And, in fact, you want companies to hedge their activities.
    Senator Kaufman. But they can always hedge their activities 
by selling the securities.
    Mr. Khuzami. They can sell them, or they can--there is a 
variety of hedging tools.
    Senator Kaufman. I mean, most people, when they have 
something they do not like, they do not sell something, you 
know, as an offset, which is what the argument is. They sell 
the basic securities. But the basic securities are such that 
they know how bad they are at this point so they cannot sell 
them. So they can say that, you know, it is a hedging move. But 
if, in fact--I guess the key thing is if they know these 
securities are going south, they know that the housing market--
at some point in there, if you know the housing market is going 
south, and you cannot sell the securities because you will not 
be able to disclose--you cannot say, ``I know these are bad.'' 
You have reached that point. Is it OK to go out at that point 
and then begin to sell swaps, to buy swaps to cover that?
    Mr. Khuzami. If I understand it right, a portfolio of bad 
loans, a company decides they are in bad shape and I don't want 
them anymore, and I put them in some sort of vehicle to sell 
them to third parties.
    Senator Kaufman. Right.
    Mr. Khuzami. First off, they have to accurately describe 
what is in that portfolio, which means all the information that 
they are required to provide. If they provide any misleading 
information in connection with that, then that is clearly 
improper.
    Senator Kaufman. But if they do not sell them, they do not 
want to sell them because they cannot sell them because they 
disclosed, and what they do is they do exactly what you said. 
They leverage it by going out into the swap market and bet huge 
sums that the securities are going to fail.
    Mr. Khuzami. So that they basically go short.
    Senator Kaufman. Yes.
    Mr. Khuzami. The loans that are in their portfolio. I mean, 
the problem is that may be a legitimate hedging activity. They 
may have this risk on their books that they cannot get rid of, 
they cannot sell, they do not want the exposure. So they take 
other steps in order to protect themselves. That may not be 
improper if the counterparty to the swap sort of understands 
what it is that the underlying reference obligations are in the 
swap.
    Senator Kaufman. Got it. But to the extent that they know 
they have got a problem, at least it poses a conflict of 
interest. If they are selling some of these securities--if they 
are holding them all, no problem. But if they are selling some 
of these securities at the same time they are selling--betting 
against them, that is at the very least a conflict of interest, 
right?
    Mr. Khuzami. It could be, yes, Senator.
    Senator Kaufman. Is it legal for a firm to manufacture and 
sell securities which it knows or is virtually certain are 
going to default?
    Mr. Khuzami. Well, again, if page 1 of the disclosure 
material said here is X security, but I am virtually certain 
that these are going to default, the answer would be no. Of 
course, no one would buy them.
    Senator Kaufman. So the same thing, to the extent that you 
reach a point in a market and you have got these secured 
investments that you are selling, you are selling them to 
customers, you put the disclosure in them. But you sit down and 
have a meeting. In the meeting you say, you know, this business 
has gone south, so what I am going to do, I am going to 
continue to sell as much of these as I can, but I cannot sell 
very many, and I've got to be protected if I do not. So then I 
go out and I sell the swaps in order to offset any potential 
loss. Is that criminal behavior?
    Mr. Khuzami. Well, is it the subject of a civil enforcement 
action?
    Senator Kaufman. Excuse me. Civil action.
    Mr. Khuzami. Well, I think the point is that at some point 
the securities are in such bad shape that it is virtually 
impossible to make adequate disclosure. And so I think if you 
really had a portfolio of securities that were that bad, you 
would--you know, odds are the disclosure, if they tried to sell 
them and nobody bought them, it just would not be adequate.
    Senator Kaufman. So the key to this really is finding out--
you know, if you assume--and I think we can assume based on the 
hypothetical--that they did not actually say the housing market 
is going to fail and we are all going to fail. They said what 
they were saying before, which is if the housing market--
exactly what you said, if the housing market fails, dah, dah, 
dah, dah, dah, then you are going to lose.
    Mr. Khuzami. Yes, or if----
    Senator Kaufman. Isn't it relevant--because it is very 
difficult--for instance, in this hypothetical it would be very 
difficult if the bank never will admit that they thought the 
housing market has gone south. Once they admit the housing 
market was going to go south, they should have disclosed that, 
right? I mean, there is a difference between saying the housing 
market might go south. It is different when you know the 
housing market--you have decided as a group the housing market 
is probably going to go south. I do not think anybody disclosed 
in their disclosure, well, the housing market is probably going 
to go south, and you are going to buy this security anyway. I 
think what they said was--and correct me if I am wrong. That is 
why we are having a hearing. They said what they were saying 
all along, which was, you know, if you invest in the housing 
market, the housing market could fail. But isn't it key at what 
point they think the housing market is actually going to fail? 
And isn't that disclosure key to whether what they are doing is 
criminal?
    Mr. Khuzami. That could, although, you know, when the 
housing market is going to fail is a little more amorphous than 
more specific information about the particular security. So if 
they knew that, you know, the mortgages in Fresno were 
defaulting at a 45-percent rate and made misleading disclosures 
suggesting that they were performing adequately, that is more 
likely, were you to find the hook that you would need to bring 
an action.
    Senator Kaufman. But, remember, in this hypothetical they 
are selling--90 percent of their prime loans are liar loans. I 
mean, you cannot sit there--if this housing market is going 
south, it is hard to figure out how instruments being sold 
where over 50 percent of all their loans are liar loans, that 
you can--you know, that this is going to work. Once you reach--
that is all based--that whole philosophy of liar loans rests 
with if you believe it--although I must say the head of the 
Office of Thrift Supervision said that liar loans are anathema 
to the banking industry. Of course, the problem was he was 
overseeing a bank that was using them and did not even know it.
    Mr. Khuzami. Right. The other hook you could use here is to 
show that if you had these loans on your own books, then 
typically you would be required to disclose that the source of 
these loans were your own balance sheet, because it is one 
thing----
    Senator Kaufman. Yes.
    Mr. Khuzami. You know, it is one thing if you went out into 
the street and collected loans from everybody and then packaged 
them and sold them. If you are offloading your own risk from 
your own balance sheet, that is typically something that needs 
to be disclosed because that speaks to your----
    Senator Kaufman. But it would not--but the equivalent thing 
is selling these swaps, right? Wouldn't you have to disclose 
that, too? I mean, what is the difference between--essentially 
in the hedge case you gave, what is the difference between 
unloading stocks off your own account and going out and selling 
swaps?
    Mr. Khuzami. Buying protection. No, that is certainly true, 
and that could be a hook. I will say that certain of many 
structured products, including CDOs, often disclose that the 
underwriter or the arranger may take a short position or may be 
otherwise engaged in transactions, you know, long or short of 
the portfolio in question. So this sort of goes to your earlier 
question of whether or not that kind of disclosure is 
sufficiently prominent that people can make a decision.
    Senator Kaufman. But it goes back to what we are trying to 
say. One of the things we are talking about in the hearing, I 
mean, that kind of behavior should not be allowed--I mean, I 
know what the law is now. But isn't there something we should 
do about that kind of behavior, especially when you look back 
on what happened to so many folks after it was clear that the 
banks continued to sell these, continued to turn them out, 
continued to securitize them, mortgage brokers, appraisers 
knew, everybody knew what was going on, and they had this 
incredible conflict of interest, as you admit. I mean, there 
should be some way legally we can turn that conflict of 
interest, if you abuse it, into a crime. Anybody?
    Mr. Khuzami. Well, I mean, I think the answer is yes. 
Again, because we have a disclosure-based system, that is where 
the focus is on. If the question is we should just out and out 
prohibit that kind of activity, I think, you know, there are 
certainly some instances where we have seen where that would 
have been a better result. I would want to look at the overall 
impact that that might have before planting my feet.
    Mr. Breuer. Senator, I just want to be clear. At its most 
core principle I know, of course, you are talking about the 
CDOs and the swaps and really the kinds of very sophisticated 
transactions that the SEC in particular is focusing on and 
doing such a great job. But if we look at the kinds of cases 
that we have been bringing--and there have been many, many 
investment fraud cases, indeed many over the last months, the 
one common theme is that every one of the people we have 
prosecuted made false statements.
    Senator Kaufman. Right.
    Mr. Breuer. They made materially false statements. They 
told investors one thing, whoever they were, and they did 
something different. And they could not point to something to 
show that they, in fact, had revealed whatever it was. There 
was falsehood and there was criminality.
    And so at the end of the day--at the Department of Justice 
we are pretty simple--whether it is the simplest case or the 
most sophisticated case, that is what we are looking for, and 
that is what we need. That is what we need the regulators to 
show us. That is what we need the FBI to bring us. Those are 
the kinds of cases we look for, and at its core that is what we 
want.
    So if disclosure, for instance, as you suggest, is simpler 
and that would be appropriate for whatever the transaction is, 
then we can see what the disclosure is, and we can match it up 
to what the conduct was. And, really, that is what we look for.
    Senator Kaufman. Good. And, by the way, the only reason I--
this probably is not going to happen again. It is going to be 
some new thing that is going to happen that we have not even 
thought about. But it is the basic premise. The basic premise 
is that, you know, I do not think anybody in America can sell 
something and at the same time sell insurance, buy insurance it 
is going to fail, a product. I think in a product liability 
case, this would be a real problem, right? If you made a car 
that you knew was going to crash and then sold insurance so 
that every time everyone crashed you made money, that would be 
a conflict of interest and be criminal behavior, correct?
    Mr. Khuzami. Yes.
    Senator Kaufman. So that is the thing we are trying to get 
at. In the securities industry, where in the securities 
industry do they have a special situation that does it?
    To follow up on this, Mr. Khuzami, if the bank relies on 
the credit rating to market the security, which it knows to 
have been awarded based on faulty methodology, is that a 
problem?
    Mr. Khuzami. If the bank is aware of that and they did not 
disclose that, that could well be a problem.
    Senator Kaufman. If the bank relies on a credit rating that 
it knows to have been awarded due to a clerical error, is that 
a problem?
    Mr. Khuzami. Same thing. Again, if they know that and they 
intentionally do not disclose it or make misrepresentations 
that mislead the buyer, that is, in fact, a violation of the 
law.
    Senator Kaufman. And, Mr. Breuer, what if the bank relies 
on third-party representations such as claims by the originator 
regarding the quality of loans which it knows to be false?
    Mr. Breuer. Well, if it knows something is false, Senator, 
and it acts as if it is not false, and it represents as a 
result to third parties that that which it knows to be false is 
not, then that certainly would have the potential of being a 
criminal case.
    Senator Kaufman. And are there any cases like that? I mean, 
are you investigating cases like that? Is that a problem out 
there, or is it just hypothetical?
    Mr. Breuer. Well, no, we are looking at a whole host of 
conduct, and some of the conduct we are looking at would be 
related to the scenarios you are discussing.
    Senator Kaufman. Mr. Khuzami.
    Mr. Khuzami. Same thing. I mean, typically we focus on the 
issuers, the underwriters, and the public companies. But it is 
no defense if they know that a third party is doing something 
improper, they know that and they do not disclose it, that is 
improper. Even if they tried to disclaim complete 
responsibility--you know, no responsibility for the conduct of 
the third party, I am not sure that would cure the problem.
    Senator Kaufman. Now let us talk about some legislative 
changes to continue what I was just talking about because I 
think that is not the oversight now. What do we do going 
forward? And going back to this basic question, which is they 
are not--it is not illegal to do a number of things that I 
asked you about.
    Where the bank manufactures assets for sale to unwitting 
customers while at the same time shorting those securities, 
Congress should pass laws to fix that, I think. How would a law 
imposing a fiduciary duty on broker-dealers affect your ability 
to do your job and to catch people that are doing bad things?
    Mr. Khuzami. Well, Senator, as you know, that is a matter 
under study by the Commission now as a result of Dodd-Frank and 
whether or not to move to a uniform standard. For that reason, 
it probably would not be appropriate for me to----
    Senator Kaufman. I am just talking about it from a 
legislative standpoint. I am saying, you know, it is in there 
as one of the things to consider. But we had offered a 
proposal--and I am not going to be here so I am not doing this 
to kind of pump my----
    [Laughter.]
    Senator Kaufman. I am really trying to figure out, 
genuinely trying to figure out how we help get at some of this. 
And I am just saying I think that--let me put it this way: What 
separates what went on with that hypothetical bank and what 
most Americans view and most--is that there is this fiduciary--
there is not a fiduciary duty. In other words, the key to this 
thing is I can do anything I want, you know, as long as I 
disclose it, and I can hedge my--I can use it as a hedge, but 
basically the ``get out of jail free'' card in this, which I 
think exists only in this business, is I do not have a 
fiduciary responsibility to tell you what is actually going on 
here or to warn you about what is happening. Is that fair to 
say?
    Mr. Khuzami. Well, look, certainly a fiduciary standard is 
a heightened standard, and it would sweep into it more conduct 
that would be deemed improper. No doubt about that.
    Senator Kaufman. Mr. Breuer.
    Mr. Breuer. Senator, obviously, we really would at DOJ, I 
think, be very affected by what our friends at the SEC thought. 
So if they determined that broker-dealers should have an 
equivalent fiduciary duty, let us say as investment advisers, 
we would want to have long discussions with them. But, really, 
in the first instance, they really do have more expertise in 
that area than we, and so we would study it. But at the end of 
the day, we would probably be guided by that, and if there was 
a determination that that was appropriate, then to make it as 
simple as we can, then we would start prosecuting those cases 
when broker-dealers acted contrary to their duty.
    Senator Kaufman. Great. What about a law requiring broker-
dealers--Mr. Khuzami, what about a law requiring broker-dealers 
to disclose internal company analysis regarding securities that 
it offers for sale?
    Mr. Khuzami. I am sorry. As a proposal?
    Senator Kaufman. Yes, as a proposal. Just a thought in 
terms of how do we get at this problem.
    Mr. Khuzami. Well, I suspect one result of that is there 
would be much less internal analysis of securities that would 
be issued.
    Senator Kaufman. Yes.
    Mr. Khuzami. So, you know, I think you would want to think 
about whether or not--whatever value that has--and obviously 
firms have research departments and they issue research across 
wide ranges of topics. So I guess I would want to think about 
that.
    Senator Kaufman. Got it. I understand that the toxic CDOs 
which undermined the financial system leading up to 2008 were, 
by and large, accompanied by extensive disclosure. We have 
talked about that. The problem was that few investors bothered 
to read and study them. The economic crisis actually 
underscores one potential problem in the disclosure regime. Mr. 
Khuzami, is there a better way to regulate disclosure so that 
investors are able to more readily determine what it is they 
need to know about a security?
    Mr. Khuzami. Well, I think this goes back to your point 
earlier about perhaps you need a Truth in Lending Act for 
securities disclosure. But, again, I think some of these are 
under consideration now, including revisions with respect to 
disclosure in connection with securitization and other similar 
products. So, again, that is something I think we would 
probably have to give some thought to.
    Senator Kaufman. OK. Mr. Breuer, you testified during the 
December 2009 fraud hearing that one type of fraud that 
contributed most to the financial mortgage crisis was when 
banks lied about the mortgage underwriting standards they used 
in issuing loans. Can you tell me what progress in pursuing 
those cases since last December?
    Mr. Breuer. Senator, I think I probably said something like 
we were looking at sort of a whole host of conduct from the 
very beginning to the end without probably making a statement 
that, you know, I had come to a conclusion that they had, in 
fact, lied.
    Senator Kaufman. Right.
    Mr. Breuer. We are looking at all the codes of conduct. We 
continue to look at them. And obviously the cases that we have 
already brought suggest that. The Farkas case that we have 
talked about is a very good example of that where we look at an 
originator and we look at his misrepresentations to a financial 
institution and proceeded. And we continue to look, as do our 
colleagues throughout the country.
    Senator Kaufman. Mr. Khuzami, when the SEC conducts an 
investigation and determines that the conduct was harmful 
though not actionable, the Commission can issue a so-called 
21(a) report to publish its conclusions. Can you talk a little 
bit about a 21(a) report?
    Mr. Khuzami. Sure. The 21(a) reports can be issued in a 
variety of circumstances, including where there is a lack of 
clarity in the law and, you know, the investing public is well 
served by hearing, you know, a description or an explanation of 
what kind of conduct is improper. It gives proper notice and 
warning to institutions involved in that business to make sure 
they conform their conduct to the law. So it is a good way of 
getting the word out even if you do not have an enforcement 
action to file, so you correct behavior going forward.
    Senator Kaufman. In the case of the Moody's European credit 
rating committee, can you explain the facts of that case and 
why the SEC issued the 21(a)?
    Mr. Khuzami. Quite simple. The structures at issue were 
European. The decisions--the error with respect to the rating 
of those instruments was European. The decisions by the 
individuals not to correct the error was made in Europe. There 
was really no connection to the United States, and, frankly, in 
addition, under the previous law, there was some question as to 
whether or not we even had the ability to bring actions against 
credit rating agencies with respect to either their 
methodologies or their ratings, which has now been cured under 
Dodd-Frank.
    Senator Kaufman. Yes. You know, the 21(a)'s sound like a 
pretty good thing to me, I mean, in terms of what we are 
talking about, sending a message to the industry that, you 
know, this is bad behavior, we know what you are doing, we 
cannot bring a case. Do you ever think about issuing more 
21(a)'s? Or is there a real problem with doing that?
    Mr. Khuzami. No, I mean, we consider it on occasion. I 
cannot say I know the complete history of how many we have 
brought over the years, but it certainly is something that is 
always viewed as an alternative to an enforcement action.
    Senator Kaufman. And, again, this is not for publicity or 
anything. This is to actually turn to behavior. One of my major 
concerns is--and I have spoken of this extensively. The vast 
majority of people on Wall Street are really good people, and I 
went to school with them, you know, I really think the best of 
them. But there is a small group up there that continues to 
behave in what I would call--I mean, just totally opposed to 
what Senator--the former hear of the Fed Greenspan said, which 
was, you know, people will look out for the corporation, you 
know, they are not going to do anything really bad because they 
do not want to hurt corporation, they do not want to hurt other 
people. It seems to me coming out of this it continues to be a 
group of people who do not care about the corporation, who do 
not care about the taxpayer, who do not care about anything, 
except just maximizing--I think, again, a small percentage of 
people.
    And I think that what worries me about the difficulty of 
bringing these cases because they are so complex and because of 
the fact that we have--they are able to gain the services of 
extremely competent lawyers and accountants, that it is hard to 
bring these cases. But I do not want people sitting around in 
their office on Wall Street saying, Well, you know, we have 
kind of been doing this, and it has kind of worked for us, so 
we are going to keep doing it.
    So I think the deterrent piece of this is not to see 
someone go to jail, but a deterrent so that the next time 
something comes along--because it is going to be something 
different. It is not going to be the same thing. It is going to 
be something different. Could each one of you comment on that 
kind of thought?
    Mr. Breuer. Well, Senator, I could not agree more, and 
there, of course, will be some group of people--small, as you 
suggest--that will be willing to break the law and act in a 
criminal manner in order to benefit themselves. And what we 
have to do and what we are doing and what we will continue to 
do is have a robust and comprehensive response.
    Just last week, Senator, in New York, we completed an 8-
month trial, 8 months, where we convicted a CEO and a COO of 
insider trading and a whole host of conduct, accounting fraud, 
where they took a public company and engaged in activities for 
their personal benefit.
    We are going to continue to bring those cases, whether they 
are hard or not. We hope that that creates deterrence. We will 
continue to be as aggressive as we can be, and we will continue 
to seek very, very stern and long sentences for those who 
cannot be deterred and for those who decide that their own 
selfishness and need for material wealth is more important than 
abiding by the law. And so we will continue to do that.
    Senator Kaufman. Mr. Khuzami.
    Mr. Khuzami. Yes, I agree. You know, you want to take on a 
comprehensive effort to make sure that people do not cross the 
line into illegal behavior, and in any particular company or 
bank, there is a large number of people who work in the legal 
departments, the compliance departments, the risk departments, 
the audit departments, the control functions, the management, 
whose function it is to make sure the company operates 
properly. And you want to empower those people--they are your 
deputies--because they are the ones that are in the offices 
every day. You want to empower them in order to make sure they 
get the message out that improper activity will not be 
tolerated. So they are your allies in this fight, and to give 
them the tools they need, you do a whole host of things. You 
know, you have better quality directors and more active 
management and compensation reform and just a whole host of 
activity that collectively sends the message to the corporation 
that, in short, crime does not pay.
    Senator Kaufman. Let me ask you--Mr. Perkins, I will get to 
you in a minute--because that compensation thing--in the 
Permanent Subcommittee on Investigations, it was clear in a 
number of these places where bad things happened the 
compensation, the incentives were to behave in a very bad way. 
In other words, you got much more money to go out and find a 
subprime loan than you did, you know, a conventional loan.
    Is there any--does that play any role, is there any 
criminal--not criminal. Is there any civil or any other thing 
to deal with a company that continues to offer incentives that 
lead to bad behavior?
    Mr. Khuzami. Well, we have certain remedies, particularly 
in 304 of S-Ox, which allow us to claw back executive 
compensation for at least CEOs and CFOs under circumstances 
where there was misconduct that occurred on their watch, 
frankly even if they were not personally involved in it. And we 
have used that authority on some occasions.
    There is more compensation structures--this is not really a 
matter of regulatory action, but more compensation structures 
particularly in banks that provide for claw-backs so that if a 
trade takes home a $10 million payday but his book blows up 6 
months after he got that bonus, some of that is going to be 
clawed back, so you reduce the incentives for sort of the 
short-term gain. And I think that is a good development.
    Senator Kaufman. Good. And that is good for legislation.
    Yes, Mr. Breuer.
    Mr. Breuer. And, Senator, with respect to the Department, 
we, of course, were investigating, looking, for instance, at 
the conduct of a corporation or a large entity, there is a fair 
bit of discretion in how we are going to use our--how we are 
going to resolve the matter. Often a company is going to argue 
vociferously that they are a good company, that they have 
robust compliance programs, and that in this context they 
should not be prosecuted, or perhaps that they should have a 
deferred prosecution agreement or the like. Perverse incentives 
are certainly a factor and one of the issues we are going to 
look at, and we will look at it hard.
    Similarly related to it, Mr. Khuzami said before, we want 
to empower and encourage lawyers, accountants, and all to do as 
good a job as they can, to be as robust as they can. And on the 
other side, when they do not do that, when they act criminally, 
we think we have to prosecute those gatekeepers and prosecute 
them aggressively. And I think that also sends a powerful 
message.
    Senator Kaufman. Yes, it does.
    Mr. Perkins.
    Mr. Perkins. Yes, thank you, Senator. I think you are 
exactly right when you described the threat tomorrow is going 
to be different. There is going to be something coming down the 
track next week that will not be anything like what we are 
looking at now. With my colleagues here at the table, as we 
have described, a great deal of effort and work is going to 
address the issue at hand right now, and example after example 
has been given.
    I think the success in FERA and what it has done for the 
FBI in particular is that it has allowed us to begin to build 
our capacity to look over that horizon. One of the issues, the 
mantra we push is we want to chase the threat, not the case. We 
want to see what is coming over the horizon. And until we have 
been able to establish the Intelligence Center, the Forensic 
Accounting Program, bringing on additional agents, we did not 
have that capacity to do that. We are gaining that capacity 
now. We are building that so that we can identify that threat, 
much as we are doing in a much simpler matter on the gulf 
coast. We are trying to be ahead of what the threat is. We are 
trying to be proactive and address those things before they 
come up.
    Senator Kaufman. Thank you. And, listen, I want to thank 
the three of you for what you do, and the folks sitting in the 
row behind you and behind them and behind them and behind them. 
I mean, the people that we have, you know, fighting this fight 
is really quite impressive, and I think we are in a difficult 
war. But I am very pleased with the people we have on our side 
in the battle against people who are doing bad things.
    The thing that bothers me, I have said repeatedly in the 
Congress that the two most important things we have as a 
country is democracy and free markets. They are just key to 
maintain the credibility of our free markets. If we lose that, 
talk about not passing on to our grandchildren being 
responsible. And one of the things of our free market is making 
sure that if people use the market in a bad way or something 
like that, they pay a penalty for it.
    So it is really important. I mean, you are the police who 
make sure, you are the referees on the football field that make 
sure everybody is playing according to the rules. And that is 
really what we need. We had a period where I think we were not 
as concerned about that. We thought--I said a number of good 
people, smart people, said we do not need that anymore. But I 
think we have to have the confidence that our capital markets 
are fair, transparent. We have to make sure that capital 
formation--without capital formation, they will slow our 
growth. Widespread cheating and fraud of the sort that drove 
the speculative housing and derivatives securities bubbles are 
anathema--an anathema--to public confidence in the markets. In 
order to assure investors and the public that we have learned 
our lessons from the last disaster, we must have a full account 
of the criminality that has led us there.
    This November, I will leave the Senate, and the task of 
oversight will fall to my colleagues. I encourage each of you--
I do not think you really need my encouragement, but I am going 
to encourage you anyway--to keep up the hard work, keep digging 
in the offerings documents, e-mails, board minutes, to keep 
developing leads through whistleblowers, plea deals, and tip 
hotlines. I am confident you will, and I want to thank you and 
thank you for your service.
    The record will stay open for additional information for a 
week. This hearing is adjourned.
    [Whereupon, at 3:54 p.m., the Committee was adjourned.]
    [Questions and answers and submissions follow:]

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