[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
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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
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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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