[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
THE STANFORD PONZI SCHEME:
LESSONS FOR PROTECTING
INVESTORS FROM THE
NEXT SECURITIES FRAUD
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
OVERSIGHT AND INVESTIGATIONS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
__________
MAY 13, 2011
__________
Printed for the use of the Committee on Financial Services
Serial No. 112-30
----------
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Washington, DC 20402-0001
HOUSE COMMITTEE ON FINANCIAL SERVICES
SPENCER BACHUS, Alabama, Chairman
JEB HENSARLING, Texas, Vice BARNEY FRANK, Massachusetts,
Chairman Ranking Member
PETER T. KING, New York MAXINE WATERS, California
EDWARD R. ROYCE, California CAROLYN B. MALONEY, New York
FRANK D. LUCAS, Oklahoma LUIS V. GUTIERREZ, Illinois
RON PAUL, Texas NYDIA M. VELAZQUEZ, New York
DONALD A. MANZULLO, Illinois MELVIN L. WATT, North Carolina
WALTER B. JONES, North Carolina GARY L. ACKERMAN, New York
JUDY BIGGERT, Illinois BRAD SHERMAN, California
GARY G. MILLER, California GREGORY W. MEEKS, New York
SHELLEY MOORE CAPITO, West Virginia MICHAEL E. CAPUANO, Massachusetts
SCOTT GARRETT, New Jersey RUBEN HINOJOSA, Texas
RANDY NEUGEBAUER, Texas WM. LACY CLAY, Missouri
PATRICK T. McHENRY, North Carolina CAROLYN McCARTHY, New York
JOHN CAMPBELL, California JOE BACA, California
MICHELE BACHMANN, Minnesota STEPHEN F. LYNCH, Massachusetts
THADDEUS G. McCOTTER, Michigan BRAD MILLER, North Carolina
KEVIN McCARTHY, California DAVID SCOTT, Georgia
STEVAN PEARCE, New Mexico AL GREEN, Texas
BILL POSEY, Florida EMANUEL CLEAVER, Missouri
MICHAEL G. FITZPATRICK, GWEN MOORE, Wisconsin
Pennsylvania KEITH ELLISON, Minnesota
LYNN A. WESTMORELAND, Georgia ED PERLMUTTER, Colorado
BLAINE LUETKEMEYER, Missouri JOE DONNELLY, Indiana
BILL HUIZENGA, Michigan ANDRE CARSON, Indiana
SEAN P. DUFFY, Wisconsin JAMES A. HIMES, Connecticut
NAN A. S. HAYWORTH, New York GARY C. PETERS, Michigan
JAMES B. RENACCI, Ohio JOHN C. CARNEY, Jr., Delaware
ROBERT HURT, Virginia
ROBERT J. DOLD, Illinois
DAVID SCHWEIKERT, Arizona
MICHAEL G. GRIMM, New York
FRANCISCO ``QUICO'' CANSECO, Texas
STEVE STIVERS, Ohio
STEPHEN LEE FINCHER, Tennessee
Larry C. Lavender, Chief of Staff
Subcommittee on Oversight and Investigations
RANDY NEUGEBAUER, Texas, Chairman
MICHAEL G. FITZPATRICK, MICHAEL E. CAPUANO, Massachusetts,
Pennsylvania, Vice Chairman Ranking Member
PETER T. KING, New York STEPHEN F. LYNCH, Massachusetts
MICHELE BACHMANN, Minnesota MAXINE WATERS, California
STEVAN PEARCE, New Mexico JOE BACA, California
BILL POSEY, Florida BRAD MILLER, North Carolina
NAN A. S. HAYWORTH, New York KEITH ELLISON, Minnesota
JAMES B. RENACCI, Ohio JAMES A. HIMES, Connecticut
FRANCISCO ``QUICO'' CANSECO, Texas JOHN C. CARNEY, Jr., Delaware
STEPHEN LEE FINCHER, Tennessee
C O N T E N T S
----------
Page
Hearing held on:
May 13, 2011................................................. 1
Appendix:
May 13, 2011................................................. 49
WITNESSES
Friday, May 13, 2011
di Florio, Carlo, Director, Office of Compliance Inspections and
Examinations, U.S. Securities and Exchange Commission (SEC).... 9
Kauffman, Stan, victim, Stanford Financial Group Ponzi scheme.... 32
Ketchum, Richard G., Chairman and CEO, Financial Industry
Regulatory Authority (FINRA)................................... 11
Robert Khuzami, Director, Division of Enforcement, U.S.
Securities and Exchange Commission (SEC), accompanied by
Michael Conley, Deputy Solicitor, SEC.......................... 8
Kotz, H. David, Inspector General, Office of the Inspector
General, U.S. Securities and Exchange Commission (SEC)......... 6
Preuitt, Julie, Assistant Regional Director, U.S. Securities and
Exchange Commission, Fort Worth Regional Office................ 29
Rawl, Charles W., former employee, Stanford Financial Group, and
Stanford Financial Group whistleblower......................... 31
APPENDIX
Prepared statements:
Harper, Hon. Gregg........................................... 50
Luetkemeyer, Hon. Blaine..................................... 52
di Florio, Carlo............................................. 54
Kauffman, Stan............................................... 70
Ketchum, Richard G........................................... 78
Robert Khuzami............................................... 54
Kotz, H. David............................................... 86
Preuitt, Julie............................................... 105
Rawl, Charles W.............................................. 112
Additional Material Submitted for the Record
Cassidy, Hon. Bill:
Statements from constituents who have been affected by the
Stanford Ponzi scheme...................................... 118
Harper, Hon. Gregg:
Statements from constituents who have been affected by the
Stanford Ponzi scheme...................................... 199
THE STANFORD PONZI SCHEME:
LESSONS FOR PROTECTING
INVESTORS FROM THE
NEXT SECURITIES FRAUD
----------
Friday, May 13, 2011
U.S. House of Representatives,
Subcommittee on Oversight
and Investigations,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 11:22 a.m., in
room 2128, Rayburn House Office Building, Hon. Randy Neugebauer
[chairman of the subcommittee] presiding.
Members present: Representatives Neugebauer, Fitzpatrick,
Pearce, Posey, Hayworth, Canseco; and Capuano.
Ex officio present: Representative Bachus.
Also present: Representatives Harper, McCaul, and Cassidy.
Chairman Neugebauer. Good morning. The committee will come
to order.
I would like to thank everyone for being here today.
I know that we have a number of visitors in the gallery
today, and we appreciate you being here; we just would remind
folks who are in the gallery that you are an observation team
only and that we would ask not to have any placards or any
verbal shows of support for or against the testimony.
This is a very important hearing on a very important issue.
We want to have plenty of time for members to give this panel
appropriate questions. We want to hear from the panelists, as
well.
We want to remind everyone, particularly the members who
are here, that you can submit an opening statement for the
record, and that will be made a part of the permanent record.
We have four Members who are not currently on the
subcommittee or on the committee who have asked to join us
today. And so I ask unanimous consent that Mr. McCaul, Mr.
Cassidy, Mr. Harper, and Ms. Schwartz be a part of the panel
today.
What I am going to do here is, I am going to have one
Member who is going to make a brief statement and then going to
submit his questions for the record. And so, I am going to go
ahead and yield 2 minutes to the gentleman from Texas, Mr.
McCaul, for a statement.
Mr. McCaul. Thank you, Mr. Chairman. Thank you for holding
this hearing today and allowing me to participate.
Many of my constituents were hurt by the fraud committed by
the Stanford Group, and I am pleased to see that Congress is
investigating the reasons why this fraud was allowed to
continue for so long after the SEC received initial warnings
that something was wrong.
In addition to learning from past mistakes and correcting
them to prevent another case like this, we must also do what we
can to help the investors and the victims in this case recover
what they can. I believe, as in the Madoff Ponzi scheme, that
the Stanford investors should be covered by the SIPC, and I
would like to work with this committee and the SEC to see that
this gets done.
Unfortunately, due to my flight schedule, I will not be
able to stay for the entire hearing. So, Mr. Chairman, with
your consent, I would like to submit questions in writing for
the witnesses.
Chairman Neugebauer. Without objection, it is so ordered.
Mr. McCaul. Once again, Mr. Chairman, thank you for letting
me participate. And I yield back my time.
Chairman Neugebauer. Thank you.
I am going to yield myself just a few minutes here.
This is a very important hearing. And I think as we go
through the hearing today, we are going to see some very
alarming facts: that here was a Ponzi scheme that really
started off from the very beginning as a Ponzi scheme and that,
along the way, very early in the process, people were trying to
call attention to the fact that this was, in fact, a Ponzi
scheme.
We are going to put a chart up on the screen here in just a
minute. But, basically, what we see is, in a very short period
of time, really from 1995, where we were starting off with a
fund that had a very limited number of investors, around $200
million, at the end had nearly $7 billion. And all along the
way, where you see the little stars, were opportunities where
people were saying that this fund was a fraud, was a Ponzi
scheme, and yet people ignored those warnings and let the fund
get larger and larger. And then, of course, when you look at
2005, as with all Ponzi schemes, the larger they get, the
larger the appetite for more funds, and so the more pressure to
bring more money in.
I had the opportunity recently, when I was back in Texas,
to meet with some of the victims. And what I think we will
learn is that a good number of the victims were people who came
in here at the end. It is just egregious that so many points
along the way would have saved so many billions of dollars but
not--I want to take the dollar signs off of it--and saved the
life savings of a number of people.
And so the questions are going to be tough today, because
we had people trying to make others act on the fact that this
was, in fact, a Ponzi scheme and yet they were ignored by not
just one agency, but two agencies.
I hope that several things will come out of this hearing.
One, it is important for regulators to do their job. And
one of the things we are going to hear today is that, even if
we would have had Dodd-Frank in place, it wouldn't have
prevented this from happening; the resources were there, the
infrastructure was in place, and yet people just didn't do
their job. So when people call for more regulations in a lot of
cases, it is sometimes when we find government not living up to
its expectations. And, unfortunately, the Washington answer
generally has been, we just need more people and we need more
regulations. This is a case where more people and more
regulations wouldn't have solved it. What would have solved
this problem is if we would have had regulators actually doing
their job.
And I think it also points out the importance of what
happens when regulators don't do their job, particularly in
these agencies where the people in our country have--expecting
these agencies to have integrity inside the agencies and to
address these issues, and yet we have seen a fairly systemic
failure.
In many ways, I don't want to minimize the Madoff issue,
but this is a case different from Madoff, in that Madoff was--
toward the end, people realized that was a Ponzi scheme. But
what is so egregious about this is, from the very beginning,
people realized that this was a Ponzi scheme, and yet it went
unanswered.
And so, I look forward to having a very robust hearing
today.
And now it is my pleasure to yield to the ranking member,
Mr. Capuano.
Mr. Capuano. Thank you, Mr. Chairman. Thank you for having
this hearing.
And for the victims who are in the audience listening to
this, I can only tell you that, as part of the government, I
apologize. I agree with what the chairman said, that the
government failed you in this situation.
But I also think that it is indicative of the situation
that was going on for the last 15 years. This country has
continuously let itself believe that the lack of regulation or
the lack of enforcement of regulations, somehow everything
would just take care of itself. And it was endemic, across-the-
board, which, in my opinion, caused the economic collapse that
we witnessed in the last 10 years.
This is certainly a part of it, and I agree with the
chairman that no laws can stop illegal behavior. But the
attitude that is endemic upon all of us for the last 15, 20
years, that somehow regulation is not necessary, somehow a free
and unfettered market, free of any oversight, would police
itself and everything would just be okay is wrong. This is more
proof that it is wrong.
Regulators must regulate. Enforcers must enforce. And when
we don't, we owe an apology to the people who have been hurt
and we owe them our best efforts to make it right.
With that, Mr. Chairman, I yield back.
Chairman Neugebauer. The Chair now recognizes the gentleman
from New Mexico, Mr. Pearce, for 2 minutes.
Mr. Pearce. I think the chairman.
Any time a nation makes a promise that it does not keep,
the entire nation loses confidence in itself and in its
capabilities, especially when middle-class and just working-
class families are affected.
So I appreciate the chairman calling the hearing today, and
we are listening with interest to the comments that are made
from the people whom we asked to be in charge. We appreciate
your service, but we also have questions about why it arose.
Thank you very much. I yield back.
Chairman Neugebauer. I thank the gentleman.
And I now yield 2 minutes to Mr. Harper, the gentleman from
Mississippi.
Mr. Harper. Thank you, Mr. Chairman. I appreciate very much
you holding this very important hearing, something that is
extremely important to our office and to many of our
constituents.
And I think about all of the natural disasters that my
State of Mississippi has and is enduring, but at least we had
warning. At least we had a little early detection on what was
going on there so you could take action to protect your
families. But the Stanford financial Ponzi scheme and the lives
it shattered in my home State stands in stark contrast to those
natural disasters. For years, while this calamity was brewing,
there were many warning signs and reliable forecasts that could
have been given by our government but were not.
Mr. Chairman, by and large, these were not wealthy
investors. On the contrary, these were hardworking people--
parents, grandparents, factory workers, school teachers,
retired individuals--who lost their life savings. Eighty
percent of those victims invested less than $500,000. Of the $7
billion in total losses, $2 billion was lost by over 5,000
victims in the United States. Of those, 125 that we know of
were from my State of Mississippi alone, totaling over $64
million.
From many meetings that we have had and research that has
been done, there was a monumental breakdown within our
regulatory and enforcement agencies. From what I have seen, the
SEC's own Inspector General uncovered problems as far back as
1977, when the first examinations were conducted and when there
was only $250 million in deposits with Stanford. And yet,
investors were not warned, and investments continued until
2009, when deposits totaled $7.2 billion.
I find that absolutely unbelievable, how this could happen.
How could it go unnoticed by the SEC? Why did former SEC
employees receive jobs in the Stanford company? Why did the SEC
hesitate? Why weren't investors alerted years earlier? Indeed,
how could this happen in our country? And what do we do now?
It is my understanding that the SEC's own forensic
accounting investigators determined that none of the invested
funds ever went to purchase a security. This is absolutely
amazing, the lavish and extravagant lifestyle that was done by
these Stanford leaders.
It is quite clear that there is a very hyper-technical
dispute on whether these victims warrant coverage by the
Securities Investor Protection Corporation. So we have to ask,
if they failed to do their job, then why would these victims'
investments not be covered by SIPC?
Mr. Chairman, I thank you for holding this very important
hearing. We need closure and a final resolution by the SEC and
their government.
Mr. Chairman, I have in my possession a document here
representing over 80 Stanford Financial constituents' stories.
And I ask unanimous consent that it be entered into the
permanent record of this subcommittee.
Chairman Neugebauer. Without objection, it is so ordered.
And I thank the gentleman.
Mr. Harper. Thank you, Mr. Chairman.
Chairman Neugebauer. And now the gentleman from Louisiana,
Mr. Cassidy, for 2 minutes.
Mr. Cassidy. I thank the chairman and the ranking member
for holding these hearings and allowing me to join.
It is estimated that 1,500 Stanford victims live in
Louisiana, with more than $500 million in assets lost. But ``an
asset lost'' is kind of a nice way of saying ``a human
tragedy.'' The typical person in my district worked in a
petrochemical plant, and saved a lifetime so their kids could
go to college and have a better life. They paid their mortgage,
and then they sacrificed a little extra so that after
retirement, they could live independently. That said, after
they retire, they took their savings, put it with Stanford,
and, poof, it is gone--a lifetime of work not there.
You can imagine how they feel, particularly when the IG's
report looked at the SEC and found that, as early as 1997,
there were indications that something was wrong. Double-digit
returns on these CDs could not be possible, it was said.
But it wasn't pursued, presumably because--or at least,
according to the IG's report, because that Fort Worth office
preferred slam-dunk cases, as opposed to complex things.
Unfortunately, this was complex--unfortunately, for the victims
in my district.
But the level of victimization doesn't stop there. It is
perceived that the court-appointed receiver was more interested
in billable hours than in pursuing the best interests of those
victims. And, lastly, there is one more level of victimization:
They don't qualify for SIPC, supposedly because they were given
CDs which had a value. But the value of that CD was fictitious.
We cannot make these people whole most of the time, but
about 80 percent of them were teachers, petrochemical workers,
blue-collar folks who did it right, planning for independence.
What we can do is extend them the SIPC coverage to allow them
to have a second chance at that for which they worked a
lifetime.
With that, I ask for unanimous consent to enter these
reports from my constituents on their personal fraud, and I
yield back. Thank you.
Chairman Neugebauer. I thank the gentleman.
That concludes our opening statements. And I will remind
members that their full statements will be made a part of the
record, and we will hold the record open.
At this time, I will introduce our first panel:
Mr. H. David Kotz, Inspector General, Office of the
Inspector General, U.S. Securities and Exchange Commission; Mr.
Robert Khuzami, Director, Division of Enforcement, U.S.
Securities and Exchange Commission; Mr. Carlo di Florio,
Director, Office of Compliance Inspections and Examinations,
U.S. Securities and Exchange Commission; and Mr. Richard
Ketchum, Chief Executive Officer, Financial Industry Regulatory
Authority, or FINRA.
Welcome.
Mr. Kotz?
STATEMENT OF H. DAVID KOTZ, INSPECTOR GENERAL, OFFICE OF THE
INSPECTOR GENERAL, U.S. SECURITIES AND EXCHANGE COMMISSION
(SEC)
Mr. Kotz. Thank you for the opportunity to testify before
this subcommittee. I appreciate the interest of the chairman,
the ranking member, and the other members of the subcommittee
in the SEC and the Office of Inspector General.
On October 13, 2009, we opened an investigation into the
handling of the SEC's investigation into Robert Allen Stanford
and his various companies. In the course of our investigation,
we obtained and searched over 2.7 million e-mails from a total
of 42 current and former SEC employees for pertinent time
periods from 1997 to 2009. We also conducted 51 interviews of
individuals with knowledge relating to the SEC's examinations
and investigations of Stanford.
On March 31, 2010, we issued to the Chairman of the SEC a
comprehensive report of our investigation in the Stanford
matter, containing over 150 pages of analysis and 200 exhibits.
The report found that the SEC's Fort Worth office was aware
since 1997 that Stanford was likely operating a Ponzi scheme,
having reached that conclusion merely 2 years after Stanford
Group Company, Stanford's investment advisor, registered with
the SEC in 1995.
We found that, over the next 8 years, the SEC's Fort Worth
examination group, including Julie Preuitt, who is a witness in
this hearing, conducted four examinations of Stanford's
operations, finding in each examination that the CDs Stanford
was promoting could not have been legitimate and that it was
highly unlikely that the returns Stanford claimed to generate
could have been achieved with their purported conservative
investment approach. The only significant difference in the
exam group's findings over the years was that the potential
fraud was growing exponentially, from $250 million to $1.5
billion.
We found that the Fort Worth examination group, and
particularly Ms. Preuitt, made multiple efforts after each
examination to convince the enforcement group to conduct an
examination of Stanford. However, no meaningful effort was made
by the enforcement group to investigate the potential fraud
until late 2005.
Even in 2005, the enforcement group missed an opportunity
to bring an action against Stanford Group Company for its
admitted failure to conduct any due diligence regarding
Stanford's investment portfolio, which could have potentially
halted the sales of the Stanford CDs and also could have
provided investors and prospective investors with notice that
the SEC considered such sales to be fraudulent.
In our investigation, we found evidence that SEC-wide
institutional influence with enforcement factored into its
repeated decisions not to undertake a full and thorough
investigation of Stanford. We found that senior Fort Worth
officials perceived that they were being judged on the number
of cases they brought, so-called ``stats,'' and communicated to
the enforcement staff that novel or complex cases were
disfavored. We found that because Stanford was not going to be
a quick hit, it was not considered to be as high a priority as
other easier cases.
We also found that the former head of enforcement in Fort
Worth, who played a significant role in multiple decisions over
the years to quash investigations of Stanford, sought to
represent Stanford on three separate occasions after he left
the Commission and, in fact, represented Stanford briefly in
2006 before he was informed by the SEC's ethics office that it
was improper for him to do so.
We provided our report of our investigation on Stanford to
the SEC Chairman, with numerous recommendations to improve the
operations of the SEC. We have followed up with those offices
and Divisions, and they have all been implemented and closed to
our satisfaction.
In addition, we recently completed an audit of the process
by which the compliance group refers examination results to
enforcement in all of the SEC's regional offices to determine
if the concerns about the Fort Worth office existed in other
offices. Our audit found that examiners across the regional
offices are generally satisfied with actions taken by
enforcement in response to exam-related referrals. We further
found that where there was dissatisfaction with the referral
process, the level of concern dramatically dropped over time
and particularly in 2010. We also found that the large majority
of examiners in these other offices do not believe that
enforcement will only take referrals that involve high-dollar
amounts; and, in addition, even those who did, believed that
this approach was more evident in the past.
In September 2009, we completed another investigation
involving the SEC's Fort Worth office and Ms. Preuitt. In this
investigation, we found that Ms. Preuitt and a former colleague
in the Fort Worth office voiced their differences at a planning
meeting about management's initiative to begin conducting a
certain type of examination. Shortly thereafter, Ms. Preuitt's
supervisor called her into several meetings and admonished her
for opposing the office's exam initiative. And a few months
later, Ms. Preuitt's supervisor issued her a letter of
reprimand. Eventually, Ms. Preuitt was involuntarily
transferred to non-supervisory duties.
Ms. Preuitt's former colleague, who also voiced opposition
to the new exam initiative, complained to senior management at
SEC headquarters about the initiative and about the treatment
of Ms. Preuitt. Shortly after he sent his complaint, he was
issued a performance counseling memo. And less than a month
later, he was issued a letter of reprimand for discussing,
``unfounded and inaccurate allegations with senior
management.''
Our investigation concluded that it was improper for Fort
Worth management to take action against employees for voicing
opposition to program initiatives and for complaining. Based on
our investigative findings, we recommended the consideration of
performance-based or disciplinary action against the two senior
officials.
In conclusion, I appreciate the interest of the chairman,
the ranking member, and the subcommittee in the SEC and my
office and, in particular, in our investigative reports. Thank
you.
[The prepared statement of Mr. Kotz can be found on page 86
of the appendix.]
Chairman Neugebauer. Thank you.
Excuse me. I think, Mr. Khuzami, you have someone with you
that I didn't introduce. As you make your opening statement, if
you would introduce--
Mr. Khuzami. I will, Mr. Chairman.
Chairman Neugebauer. Thank you. You are recognized.
STATEMENT OF ROBERT KHUZAMI, DIRECTOR, DIVISION OF ENFORCEMENT,
U.S. SECURITIES AND EXCHANGE COMMISSION (SEC), ACCOMPANIED BY
MICHAEL CONLEY, DEPUTY SOLICITOR, SEC
Mr. Khuzami. Thank you.
Chairman Neugebauer, Ranking Member Capuano, and members of
the subcommittee, thank you for the opportunity to testify on
behalf of the Securities and Exchange Commission.
I have served as Director of the Division of Enforcement
since March 2009. Prior to that, I was a Federal prosecutor in
New York doing criminal securities fraud prosecutions in the
U.S. Attorney's Office for the Southern District of New York
and as chief of the Securities and Commodities Fraud Task
Force. Prior to that, I also served in the Office of
Counterterrorism Unit, where I was involved in the prosecution
of the ``blind sheik,'' Omar Ahmad Ali Abdel-Rahman, and nine
codefendants for operating an international terrorism
conspiracy responsible for, among other things, the 1993
bombing of the World Trade Center. I previously served as
general counsel for the Americas for Deutsche Bank AG and as
the bank's global head of litigation and regulatory affairs.
Mr. di Florio, who is Director of Compliance, and I are
joined today by Michael Conley, who is the Commission's Deputy
Solicitor for the Office of the General Counsel. Mr. Conley is
involved in the Commission's analysis of the issues surrounding
a potential liquidation of the Stanford Group Company under the
Securities Investors Protection Act. He is here to answer any
questions you may have in that regard.
The Commission commends the work of the Inspector General
and the staff investigating the Stanford matter and in their
April 2010 report. Their investigation clearly identifies that
the SEC missed opportunities in the Stanford investigation. We
did not do our job. We did not protect the Stanford investors
as we should have, as our mission of investor protection
requires us to do. We cannot evade responsibility for this
failure, and we deeply regret our failure to act more quickly.
We cannot undo the past; what we can do is to act as a
responsible agency going forward, which means, in this case, to
take steps to prosecute those who perpetuate the fraud, to
maximize recovery for the victims, and to change the way we
operate in order to minimize the chance of this happening
again. That is happening in four ways.
First, we are vigorously pursuing Mr. Stanford. In February
2009, we filed an emergency civil action to halt sales of the
Stanford CDs and to seek return of funds to harmed investors.
We later filed an amended complaint against Stanford and other
perpetrators, alleging a massive Ponzi scheme. We also sued at
that time Leroy King, the former CEO of Antigua's Financial
Services Regulatory Commission, whom we alleged accepted bribes
to conceal Stanford's activities. Our investigation of the
Stanford fraud continues, and we are closely focused on the
conduct of others connected to the fraud, while also working
closely with the Department of Justice, which has filed
criminal charges against Stanford. And that trial is scheduled
for September 12th.
Second, we are working with the Stanford receiver, the
criminal authorities, and others to recover assets for the
Stanford investors. That includes assets in Switzerland,
Canada, and the United Kingdom which are subject to government
restraints. For example, in April 2010, we worked with the
receiver and Panama's regulatory authorities to secure millions
of dollars from the sale of certain Stanford-related entities
located there.
Third, the Inspector General's report identified a need for
reforms in the Division of Enforcement and the Office of
Compliance Inspections and Exams, seven of which related to the
Division of Enforcement. They included: revamping the way we
handle the tens of thousands of complaints and tips and
referrals we get every year; improving coordination between
enforcement and examination; adopting written investigative
plans that make sure we coordinate with other experts in the
AG, including those in the Office of International Affairs and
the Division of Risk, Strategy, and Financial Innovations; and
enhancing our procedures for opening and closing
investigations. All seven of these have been deemed closed to
the satisfaction of the Inspector General.
And, fourth, in the 2 years I have been with the
Commission, we have undertaken a top-to-bottom review of our
Division in what has been described as the largest
restructuring in the history of the Enforcement Division. We
have hired experts from the private sector with extensive
knowledge of complex products, transactions, and practices;
streamlined management; put attorneys back to the front line of
conducting investigations; improved coordination; initiated new
steps to prevent fraud; and improved our training.
Despite the many changes in the Division, more needs to be
done. This will require commitment and creativity, and that I
commit to you we will do. It also requires that we not forget
how and why we fell short in the Stanford investigation.
We thank the Stanford Victims Coalition, the Official
Stanford Investors Committee, the examiner, and others for
their help and assistance, and hope and expect to work
cooperatively with them in the future.
Thank you.
[The joint prepared statement of Mr. Khuzami and Mr. di
Florio can be found on page 54 of the appendix.]
Chairman Neugebauer. Mr. di Florio?
STATEMENT OF CARLO di FLORIO, DIRECTOR, OFFICE OF COMPLIANCE
INSPECTIONS AND EXAMINATIONS, U.S. SECURITIES AND EXCHANGE
COMMISSION (SEC)
Mr. di Florio. Thank you, Chairman Neugebauer, Ranking
Member Capuano, and members of the subcommittee. Thank you for
the opportunity to testify today on behalf of the U.S.
Securities and Exchange Commission regarding the lessons
learned from the Stanford Ponzi scheme.
As Mr. Khuzami said, we deeply regret that the SEC failed
to act more quickly to limit the tragic investor losses
suffered by Stanford's victims.
I joined the SEC last year, in January 2010. Prior to that,
I was a partner with PricewaterhouseCoopers in New York in the
financial services regulatory practice. Since joining the SEC,
I have initiated a top-to-bottom review of the exam program to
strengthen our effectiveness and our efficiency.
The SEC's examination program helps protect investors to
ensure market integrity by examining for fraud, monitoring
risk, informing policy, and promoting compliance as the eyes
and ears of the SEC in the field. Our exams assess whether
registrants are treating investors fairly or whether they are
engaged in fraud, such as insider trading, market manipulation,
Ponzi schemes.
In the Stanford matter, examiner Julie Preuitt showed the
kind of determination that we encourage in all of our skilled
and dedicated examiners, and I commend her. Unfortunately, Fort
Worth leadership at that time did not act on the concerns about
Stanford raised by Ms. Preuitt and the exam team. Those
individuals are no longer with the SEC.
The SEC's Inspector General's recommendations identify the
need for better coordination between enforcement and
examination, and we are committed to doing just that. OC and
enforcement are working together on multiple fronts to identify
misconduct earlier so we can shut it down more rapidly.
During 2010 and 2011, nearly 200 enforcement investigations
were opened and significant cases brought as a result of good
exam work. We have introduced joint referral committees to
proactively review referrals at a very senior level and a new
governance process to ensure early escalation of any issues or
concerns about how referrals are being handled.
Our new tips, complaints, and referral system helps ensure
that we have one system of record for logging, tracking,
escalating, and resolving referrals from the exam program to
the enforcement program across the country.
More broadly, over the past year, we have been engaged in a
top-to-bottom review of our exam program, taking a critical
look at our strategy, our structure, our people and skills, our
processes, and our technology. This has resulted in
comprehensive improvement initiatives to become more effective
and more targeted.
For example, we have implemented a new national governance
process that breaks down silos and facilitates coordination,
consistency, effectiveness, and accountability across the
country, across Divisions, and across regulatory partners,
including FINRA. We have implemented a new central Risk
Analysis and Surveillance Unit to enhance our ability to target
those firms, individuals, practices that present the greatest
risk to investors and our capital markets. We have begun to
recruit experts and launch new specialty groups that will bring
deep technical knowledge and experience to our exam program in
critical areas. And we are working to implement a new certified
examiner training program across the country that raises
technical training and certification standards.
As the Inspector General noted, he has also recently noted
a report on an audit of the process by which examination
findings are referred to enforcement. I am pleased that the
report was generally positive and found satisfaction among
examiners with enforcement's responsiveness to exam referrals,
particularly over this past year. The IG's audit report also
made some very valuable recommendations, which will further
improve our process and which we are currently working to
effectively implement.
In conclusion, both OC and enforcement are committed to the
reforms that strengthen our programs and address the lessons
learned from the Stanford fraud. Thank you, and I welcome your
questions.
[The joint prepared statement of Mr. Khuzami and Mr. di
Florio can be found on page 54 of the appendix.]
Chairman Neugebauer. Thank you.
I assume, Mr. Conley, you don't have an opening statement?
Mr. Conley. That is correct, Mr. Chairman.
Chairman Neugebauer. Thank you.
And now, Mr. Ketchum.
STATEMENT OF RICHARD G. KETCHUM, CHAIRMAN AND CEO, FINANCIAL
INDUSTRY REGULATORY AUTHORITY (FINRA)
Mr. Ketchum. Thank you, Chairman Neugebauer, Ranking Member
Capuano, and members of the subcommittee. I am Richard Ketchum,
chairman and CEO of the Financial Industry Regulatory
Authority, or FINRA. On behalf of FINRA, I would like to thank
you for the opportunity to testify today.
Unfortunately, we are here today because of a massive fraud
that had tragic results for many investors. No regulator can
feel good about its performance regarding Stanford. FINRA
clearly could have done better, and we deeply regret that we
did not.
In the wake of Stanford, we took a hard look at our
regulatory programs and approaches and searched for ways to
more effectively uncover misconduct, especially fraud, and
enhance our programs to better protect investors. In early
2009, the FINRA board of governors established a special
committee to conduct a review of FINRA's examination program as
it related to the detection of fraud and Ponzi schemes,
including the one Alan Stanford is charged with perpetrating.
The committee, which was chaired by former U.S. Comptroller
General Charles Bowsher, found that FINRA missed opportunities
to investigate the Stanford firm's role in this scheme
involving offshore CDs. First, FINRA's Dallas office curtailed
a 2005 investigation because of a concern that offshore CDs
were not securities regulated under Federal securities laws.
Second, FINRA procedures at the time did not set forth criteria
for escalation of a matter to senior management or the use of
especially trained investigators based on the gravity and
substance of fraud allegations. Finally, during this period,
FINRA did not have a centralized database that gave examiners
direct electronic access to all relevant complaints and
referrals associated with the firm. As a result, no single
FINRA staff member was aware of the totality of information our
organization had relating to the Stanford firm.
Following its review, the special committee made a series
of recommendations intended to enhance the effectiveness of
FINRA's examination program by increasing its ability to detect
fraud. FINRA approached the special committee's recommendations
with the utmost seriousness and immediately instituted a plan
to address each of them. FINRA has either implemented or is in
the process of implementing all of the recommendations that did
not require action by the SEC or Congress.
One of the first initiatives FINRA undertook to implement
the committee's recommendations was the creation of the Office
of Fraud Detection and Market Intelligence, or OFDMI, in
October 2009. This group is responsible for the centralized
intake and triage of regulatory filings and investor
compliance. In 2010 alone, OFDMI referred more than 550 matters
involving potential fraudulent or illegal conduct to the SEC or
other Federal law enforcement agencies for further
investigation.
FINRA's Office of the Whistleblower, first established in
March 2009 and now part of OFDMI, received and triaged over 390
substantive calls and e-mails in 2010.
FINRA also enhanced its examination programs and procedures
in a variety of ways intended to help us better detect conduct
that could be indicative of fraud:
First, we are focusing resources on the highest-priority
matters. In response to the special committee report, FINRA's
staff created an ``urgent'' designation of those regulatory
matters posing the greatest potential for substantial risk to
the investing public. The committee also identified that the
lack of a formal mechanism for the escalation of policy issues
created risk within the organization. FINRA issued new
procedures to enhance the process for escalation and
documentation of complex legal and policy issues.
Second, we have undertaken efforts to enhance the expertise
of our regulatory staff. We have increased the number of staff
in district offices tasked with realtime monitoring of business
and financial changes occurring at the firms we regulate.
Third, we have enhanced our use of third-party information
to inform our regulatory programs. We have established
procedures for third-party verification of customer assets.
Finally, we have established a multiyear technology
enhancement program to strengthen our programs.
In addition to the internal initiatives I have described,
FINRA has increased communication and coordination with the SEC
relative to our programs. FINRA and SEC staff meet routinely to
share details about strategic design and tactical delivery of
information to our regulatory programs, as well as risk
assessment, including models to measure risk for broker
dealers, branch offices, and registered representatives.
The special review committee's report and recommendations
provide an important roadmap for FINRA to enhance our ability
to quickly identify and investigate conduct that could indicate
fraud or other serious customer harm. I assure this
subcommittee that I am fully committed to continue making the
necessary changes to strengthen our programs and raise the
level of protection for all investors.
Again, I appreciate the opportunity to testify today and I
would be happy to answer any questions you may have.
[The prepared statement of Mr. Ketchum can be found on page
78 of the appendix.]
Chairman Neugebauer. I thank the panel.
I would like for the folks to put our chart back up. I
think some of you have a copy of the chart, but let's put the
chart back up.
Mr. Kotz, you mentioned that in 2005, there was a very
significant event that happened that was not executed on, in
your testimony. Do you want to go back over and just kind of
frame what happened in 2005 where there was a real opportunity
there, an opportunity missed?
Mr. Kotz. Sure.
So, over time, even before that, this issue was raised. And
then, finally, in 2005, the Enforcement Division in the Fort
Worth office decided to take on the case. But instead of going
forward with sort of emergency relief and immediately taking an
action, they spent more time investigating and doing research
and didn't actually bring an action until many years later.
And we found that there was a possibility, even though we
didn't have enough evidence of any alleged fraud at that point,
to bring an action based on the lack of due diligence. Stanford
Group Company was an investment advisor, and they were
referring and getting referral fees for folks to invest in the
CDs for Stanford International Bank. But they didn't have
information about why they were able to achieve these returns,
what they were getting the fees for.
So there was certainly a strong argument to be made that
you could have brought an action saying that Stanford Group
Company didn't perform appropriate due diligence. If that
action had been brought, then, even if it hadn't been
successful, it would have triggered for the investors out there
that the SEC believes that there is a potential fraud in
Stanford Group Company.
There are always difficult cases, and sometimes cases take
a long time to fully go forward with. But if you are in a
situation where you realize in 2005 that there has been a fraud
growing for 8 years, then you need to take action immediately,
even if you lose in court eventually.
Nevertheless, we did interviews and we spoke with lots of
victims, and we did a survey, and an overwhelming percentage of
those folks said if they had heard any whiff of a problem with
Stanford, even any lawsuit that was brought, they would have
immediately taken out their money. So--
Chairman Neugebauer. Thank you.
Mr. Kotz. --we believe that there is an obligation on the
part of the regulators to do something to let investors know
that there are issues, even if you don't have enough evidence,
necessarily, to go forward with a full-blown Ponzi scheme case.
And we believe that that opportunity was in 2005.
Chairman Neugebauer. Okay.
I want everybody to look up at this chart. This is
basically the fund balance of Stanford through the process. And
I think the thing that is so discouraging and really incenses,
I think, a lot of members of this panel today is, had--of
course, there were other opportunities, there were four other
opportunities that were missed there, but in 2005, what we see
is the amount of money flow increased exponentially.
So who was the head of enforcement in the Fort Worth office
during this time?
Mr. Kotz. There was an individual named Degenhardt and then
Addleman over time, depending on the periods of time.
Actually--I am sorry--the enforcement head was a man named
Spencer Barasch, who, as we indicated in our report, after he
left the SEC and had been involved in efforts to not allow the
SEC to go forward with the Stanford case, made efforts to
represent Stanford against the SEC and, in fact, was able to
represent Stanford for a short period of time.
In fact, Julie Preuitt, as she was trying to push the SEC
to go forward and bring this case, actually prepared a memo and
waited for Spencer Barasch to leave the agency because she
knew, while Spence Barasch was there, they were never going to
go ahead with the case.
And immediately after the decision was made to go forward
with the case because Spence Barasch had left, then Spencer
Barasch wanted to try to represent Stanford in the case on the
other side.
Chairman Neugebauer. Now, in your report, I think if I am
correct on this, did you refer your report to the SEC's Ethics
Counsel for referral to the Texas bar?
Mr. Kotz. Yes. And there was a referral to both the Texas
Bar and the D.C. Bar. Both of them are continuing to actively
look at that matter. We also referred it to the U.S. Attorney's
Office and the FBI, and there is an active matter on that, as
well.
Chairman Neugebauer. Mr. Khuzami, do you agree that Mr.
Barasch engaged in unethical and improper professional conduct?
Mr. Khuzami. Congressman, the rules clearly prohibited him
from representing, in my view, my personal view, prohibited him
from representing Mr. Stanford. That was a matter under his
control and management at the time. So my personal conclusion
would be, certainly the evidence appears to be the case.
I will say one thing. He called the Fort Worth office twice
and asked about representation, and both times the people in
the Fort Worth office told him, no, you cannot do that. He
called a third time to the ethics office, who gave him the same
advice. And then, he later went ahead and represented Mr.
Stanford, I believe, for, I think the records show, 10 hours or
so thereafter.
So my only point is that I think the ethics office and the
Fort Worth people gave him the right answer in this case.
Chairman Neugebauer. But when he violated that, is there
any kind of action that the SEC would take to prohibit him,
then, for future opportunities? What is the policy on that?
Mr. Khuzami. I think the problem here was we did not know
that he represented Mr. Stanford for that period of time. Had
we known, we would have made the same referrals that were made
in this case years later when that fact became apparent.
Chairman Neugebauer. So now that you know that, what kinds
of action have you taken?
Mr. Khuzami. Against Mr. Barasch? He is no longer an
employee, since 2005. So the referrals have been made, and the
criminal authorities and the ethics authorities are conducting
their investigations.
Chairman Neugebauer. But could he represent a client before
the SEC today?
Mr. Khuzami. He has a permanent ban on any matter in which
he was personally or substantially involved in while he was an
SEC employee, so I think the answer is ``no.''
Chairman Neugebauer. But, today, he can actively represent
clients before the SEC?
Mr. Khuzami. He is permanently banned from anything he was
involved in.
Chairman Neugebauer. But what about things he was not
involved in?
Mr. Khuzami. Without speaking to the particulars, in
general, SEC employees who leave are subject to a 1-year
cooling-off period; they can't represent anything. After 2
years, they can't represent a client in any matter that they
managed or were involved in. And, like I said, a permanent ban
on anything they were personally and substantially involved in.
Chairman Neugebauer. I understand that the ban currently is
such that I can advise a client, that I might have had an
enforcement or something, but I can't represent that client. Is
that correct?
Mr. Khuzami. You can't represent the client before the
Commission, which means you can't appear, you can't sign
papers, and stuff like that.
Chairman Neugebauer. But you can advise them.
Mr. Khuzami. You could advise them, that is correct,
subject to, I believe--I have to get back to you on that. I am
not sure whether or not the 1- or 2-year prohibitions prevent
even that kind of conduct.
Chairman Neugebauer. I think one of the things that
hopefully comes out of this is some title rules on that and
where we have seen this kind of behavior for that individual to
be able to continue. I understand that Mr. Barasch is still
practicing law. In fact, I think on his firm's Web site, he is
listed as the leader of corporate governance in the securities
enforcement team. So, obviously, that is very alarming.
I have gone way over my time, so we will now go to Mr.
Fitzpatrick.
Mr. Fitzpatrick. Thank you, Mr. Chairman.
Mr. Kotz, in your opinion, did the SEC have the authority
and the resources at their disposal to prevent the Stanford
Ponzi scheme from occurring?
Mr. Kotz. I do believe that they certainly were aware of
the possibility of a Ponzi scheme back since 1997, and they had
the manpower to be able to bring an action to attempt to stop
the alleged Ponzi scheme from going forward. So I don't think
that this was a question of lack of resources, no.
Mr. Fitzpatrick. If you had to pinpoint the failure, where
was it? Not resources.
Mr. Kotz. It was an attitude failure. It was that the
office at Fort Worth, at that time, was concerned about
numbers. They wanted to show that they brought more cases than
other offices. And in order to bring more cases than other
offices, you have to bring easy, slam-dunk, quick-hit cases. If
you brought a case like Stanford, which was complicated and
complex, involved Antigua, foreign issues, the question of
whether the CD was a security, etc., that wouldn't give you a
number very quickly. It would take a long time.
It would have saved investors billions of dollars, but, at
that time, their focus was on the numbers. And that, we
believe, was the primary reason.
Mr. Fitzpatrick. And so, would the enactment of the Dodd-
Frank legislation have prevented the Ponzi scheme?
Mr. Kotz. I don't believe that Dodd-Frank or either the
procedures involved or the resources would have made a
difference, in this case.
Mr. Fitzpatrick. Mr. Kotz, I believe that this case and the
Madoff case have demonstrated that more resources were not
needed at the SEC, that more regulations were not needed. What
we needed were the regulators to just do their job. Yet, the
SEC has been before this committee asking for further
appropriations after repeatedly failing investors in this
country.
Along those lines, I am aware of a report that you are
working on related to the SEC's decision to lease $400 million
of office space without a competitive bidding process. And that
occurred just 2 weeks after the Dodd-Frank Act passed, an act
which authorized lawmakers to double the agency's budget to
2015.
Can you elaborate on your findings of that report thus far?
Mr. Kotz. We are looking at that. We haven't completed it
yet. We are almost near completion. We actually plan to issue
that report very, very shortly. But we are looking into the
whole circumstances of how the SEC got to a point where they
obligated the Federal Government for over $550 million with
respect to that lease. And so, we will get that report to you
shortly and be able to give you a full reckoning of what
happened.
Mr. Fitzpatrick. Are you able to elaborate on any of the
details of the report at this point?
Mr. Kotz. I would rather not get into too many details. I
can say that some of the things we are finding are quite
disturbing, in terms of what the SEC's actions were in this
case.
Mr. Fitzpatrick. I have nothing further.
Chairman Neugebauer. I thank the gentleman.
Now, the gentleman from New Mexico, Mr. Pearce.
Mr. Pearce. Thank you, Mr. Chairman.
Mr. di Florio, you mentioned that the managers are no
longer with the SEC. Did you recommend any punitive action? Did
you terminate them? Or did they just quit and look for greener
pastures?
Mr. di Florio. These were the enforcement managers who were
involved in not accepting the referral at that time, and I
believe that they left the SEC.
Mr. Pearce. I am asking, did you terminate them or did they
leave?
Mr. di Florio. I believe they left. I don't believe they
were terminated.
Mr. Pearce. So you had two managers. Who were the managers
during that period of time?
Mr. di Florio. I believe that was Spencer Barasch,
principal.
Mr. Pearce. Only 1 for 10 years?
Mr. di Florio. Was there another Director of Enforcement?
Mr. Khuzami. Mr. Barasch was the Enforcement Director until
2005. An interim Director was there from 2005 to 2006.
Mr. Pearce. How about from 1997 on? If you would put that
chart back up there, that is kind of an effective chart showing
that things are happening all around and somebody is ignoring
it.
And so you only had two managers then, temporary managers,
from 1997 on?
Mr. Khuzami. No, no, I am sorry. Mr. Barasch was there, I
believe, from about late 1997-1998 through 2005. Then for 1
year, there was an interim manager and then a permanent manager
in 2006.
Mr. Pearce. Okay. Now, somewhere in that period of time,
someone wrote a letter of reprimand, did I hear that, on Ms.
Preuitt?
Mr. di Florio. Congressman, if I could--
Mr. Pearce. Who wrote that letter of reprimand? And they
wrote the letter of reprimand because she kept insisting that
the agency do its job, right?
Mr. di Florio. Correct, Congressman
Mr. Pearce. And so who wrote that letter of reprimand?
Mr. di Florio. I believe that was the letter written in the
2008 timeframe, and it was written by the Associate Director
for Examinations in the Fort Worth regional office.
Mr. Pearce. He was uncomfortable that she kept pressing the
envelope here, wanting some action, and he said that is
inappropriate on her part, is that right? Is that the basic
context of the letter? He didn't like that she was pushing the
deal?
Mr. di Florio. My understanding, Congressman--this was
before I was at the SEC, obviously--was that there were
circumstances and facts regarding behavior that the Associate
Director was--
Mr. Pearce. Having to do with Stanford?
Mr. di Florio. Not having anything to do with Stanford.
Mr. Pearce. Nothing to do with Stanford?
Mr. di Florio. Nothing to do with Stanford.
Mr. Pearce. So the Fort Worth office was an anomaly; they
were more concerned about numbers. Who reviewed the stuff up
above? Surely those four instances on the chart there, surely
those four red stars on the chart got reviewed by somebody
above Fort Worth. Did it ever get reviewed by anybody above
Fort Worth?
Mr. di Florio. Congressman, I believe that one of the
points that is made in the Inspector General's report that is
disturbing is that it was not escalated outside of Fort Worth
and reviewed above.
Mr. Pearce. Who would have been responsible to review that
on a higher level?
Mr. di Florio. On a higher level--
Mr. Pearce. What department, what office?
Mr. di Florio. If there was any concern in Fort Worth that
a matter wasn't being addressed effectively, I would expect and
certainly under my leadership today that would be escalated
directly to my attention.
Mr. Pearce. Are those people who were in that office still
employed at SEC?
Mr. di Florio. No, they are not, Congressman.
Mr. Pearce. Were they terminated or did they quit?
Mr. di Florio. They left, Congressman.
Mr. Pearce. Have you brought official actions against
anybody from Mr. Barasch on up? In other words, have you
brought proceedings against them to--
Mr. di Florio. We don't have authority over folks once they
leave the SEC, so we have--
Mr. Pearce. You don't have a Web page that describes the
actions of people while they are in your employ so that people
could come on and take a look and see what your report is? Did
you prepare any final report on that so that people who would
want to know, people who were going to hire him as a lawyer?
Did you ever do anything like that?
Mr. di Florio. Congressman, I believe, if we take action,
we do make that public so people are aware, if they want to
hire that individual or they want to do business with that
individual, that individual has an action.
Mr. Pearce. Mr. Khuzami, you gave us your four-point plan.
Which exact item--you said you are fixed, it is all okay now.
Which item on your four-point plan, if it were in place before,
would have stopped the circumstances from moving forward, would
have made sure that manager did not have the ability to push
the stuff under the rug? Which point would have stopped this?
Mr. Khuzami. Congressman, first, we are never done. We have
done a lot, and we are going to keep ongoing.
Mr. Pearce. No, I want to know which point. Because I don't
believe, myself--I don't think that the agency is going to
change much, because I don't see anything where people are
being held accountable and responsible. So I am suspicious that
your four-point plan is mostly just a little bit of eyewash,
and we warmed it up and we shined it up.
But I would like to know which point in your four-point
plan would have stopped this thing from moving forward so that
any of those stars at any point would have been pushed further
and so that you would have had somebody at a higher level say,
something is not right down there. Which point in your four-
point plan?
Mr. Khuzami. We do quarterly reviews, and we review every
case that each senior officer has within their docket, and we
discuss problems, roadblocks, investigative challenges,
theories. We have more expertise available across the Division.
We have escalation of the process so that if an exam personnel
does not get satisfaction in how their referral is being
treated by the Enforcement Division, that gets escalated.
And, in fact, the Inspector General's report, which he just
indicated, showed that, in the last couple of years, the level
of dissatisfaction in that regard has dropped dramatically.
Mr. Pearce. I am not convinced.
Thank you, Mr. Chairman. My time is up.
Chairman Neugebauer. I appreciate the gentleman.
The gentleman from Florida, Mr. Posey.
Mr. Posey. Thank you, Mr. Chairman.
Mr. di Florio said that some of the individuals involved in
this are no longer with the agency. And Chairman Schapiro
shared that with us, about the 50-some investigators and
examiners who are culpable in the Madoff crimes, as well. That
doesn't do anybody a whole lot of good, to know that they are
no longer with the agency.
A question that always begs for an answer is, where are
they now? Are they examining or investigating for somebody
else? And now, we have learned that this guy is actively
involved in a law practice, apparently.
We have said that the authorities were given a referral.
What authorities, and when were they given the referral? Can
you share that with us?
Mr. Khuzami. I believe Mr. Barasch was referred to both the
State ethics boards of Texas and the District of Columbia, as
well as criminal authorities.
Mr. Posey. What about the Justice Department, racketeering?
Mr. Khuzami. I am sorry. By criminal authorities, I meant
the Justice Department. I am sorry.
Mr. Posey. Thank you. When?
Mr. Khuzami. Shortly after the release of Mr. Kotz's report
in April of 2010, I believe.
Mr. Kotz. Yes, and we have been working with the Justice
Department and the FBI on the ongoing case against Mr. Barasch.
Mr. Posey. Okay.
In regard to the IG's report that is forthcoming, we were
all privy to the opportunity to look at the Madoff report,
which was very incriminating, wasn't quite as bad as Mr.
Markopolos' book, but it was still very incriminating. Over 50
examiners and investigators botched it. The IG was kind of
silent on the head management people who were culpable, but
obviously, there were some.
Can you tell us, at this point, the depth to which we have
examiners and investigators who failed to do their job in the
Stanford investigation?
Mr. Khuzami. I am sorry. The extent to which they are out
there working in the industry, is that the question?
Mr. Posey. How many of them failed to do their job? We know
there were over 50 in the Madoff case. Are we finding a similar
depth in this case?
Mr. Khuzami. Congressman, in my opinion, the failure here
was largely the result of the senior management. The staff who
were working the case on the enforcement side are the same
staff who eventually brought the case in 2009. So, from my
personal opinion--
Mr. Posey. Okay. That is good.
Mr. Khuzami. --just primarily the managers who refused to--
didn't let the case go forward.
Mr. Posey. The next question. Have we canonized Julie
Preuitt yet?
Mr. di Florio. Congressman, as I said in my opening
statement, I publicly commend Julie Preuitt. She did a terrific
job, exactly what we expect and hope from our examiners in
uncovering this fraud, in referring it and trying to
persistently--
Mr. Posey. Have we done anything to thank her? Has she been
promoted? She probably should be running the agency.
Mr. di Florio. Congressman, we are working closely with Ms.
Pruitt right now to structure a portfolio of responsibilities
that we think will let her demonstrate her talents to their
fullest potential and include not only critical issues like oil
and gas fraud in the Southwest region but also examines issues
of national significance and importance.
Mr. Posey. My point is we should reward her foresight and
courage and dedication to her job with more than a mere ``thank
you.'' It should be something to be recognized for decades,
something that other employees should look up to and seek to
emulate.
Most importantly, my concern is with the rightful
compensation of the victims.
Mr. Posey. I have written the chairman as recently as April
27th. She has responded--actually, her response is April 27th--
and said, I expect the Commission will make final decisions on
whether the Securities Investor Protection Corporation should
initiate a civil proceeding as soon as all this information has
been thoroughly reviewed, which should occur in the near
future. It has only been 3, 4 years now. Are we at a point
where we can make a call on this and get this on the table and
see if the acceptances are valid and the rejections are invalid
and this can be debated?
Mr. Conley. Congressman, this matter is now with the
Commission, and we do anticipate that there will be a decision
in the very near future.
Mr. Posey. Could you define ``near future'' for me?
Mr. Conley. I would say within the next few weeks we will
have an answer from the Commission on this question.
Mr. Posey. Very good.
Next of all, what type of enhanced restrictions on
employment do you foresee--any of you, feel free to speak up on
this--as necessary to stop the revolving door of regulators to
exploiters. I look at this current financial crisis. You are
aware of the players from top to bottom. You are aware of the
key positions in the highest levels of government that people
have gone from regulator to profiteer to manager when it was
convenient and a good reason to sell off their stock and take
profits and run. What do you think we should do, in your
professional opinions, to tighten up the regulations, to stop
the revolving door from regulator to exploiter or profiteer or
whatever you want to call it?
Mr. di Florio. Congressman, I would note that, under
Chairman Schapiro's leadership, we have started to undertake a
top-to-bottom review of the ethics and compliance function at
the SEC to make sure that we do have appropriate controls
around the revolving door. So under Chairman Schapiro's
leadership, she has appointed the first ever Chief Compliance
Officer for the SEC, a new Senior Ethics Council that has
embarked on looking at how to strengthen those controls and
make sure that there aren't revolving door issues.
We have put in place a system that is one of the leading
systems in the Federal agency--among the Federal agencies--
concerning conflicts of interest and managing those conflict of
interests. So I think there are a lot of positive steps under
Chairman Schapiro's leadership that have been taken.
In addition, GAO is looking at the revolving door. We are
working closely with them and their report is due out soon. We
expect that there will be good recommendations there on how we
can further strengthen those controls and make sure there
aren't those conflicts of interest. And we will certainly
implement those recommendations.
Mr. Posey. Thank you for your forthright answers.
Thank you, Mr. Chairman.
Chairman Neugebauer. Thank you.
I am going to change order here and have the gentleman from
Mississippi, Mr. Harper.
Mr. Harper. Thank you, Mr. Chairman.
I thank each of the witnesses for being here in a very
difficult situation and to those in the Stanford Victims Group,
our hearts go out to you. This matter is not over. And I
certainly admire and all of us admire your diligence and your
persistence in staying in the fight.
Mr. Kotz, I want to say, first of all, thank you for your
hard work, your very long but very detailed and revealing
report. And so I just wanted to express on my behalf that we
really appreciate the effort that you made in putting this
together.
Mr. Kotz. Thank you very much, sir.
Mr. Harper. Now, Mr. Ketchum, when we look at this issue
and we look at the things here, we look at the efforts of
FINRA, did FINRA review-- and I have a few of their marketing
materials--these materials, your agency?
Mr. Ketchum. FINRA reviews advertising materials that
specifically go to the sale of products, yes. They don't review
every material that broker-dealers put out.
Mr. Harper. But you do review most or at least you make an
effort to review?
Mr. Ketchum. We review products that in one way or another
try to sell securities.
Mr. Harper. Do you request those materials from them or do
they send them to you on a voluntary basis?
Mr. Ketchum. No. They are obligated by rule to send them to
us.
Mr. Harper. When you look at many of these, it says here in
the fine print in most of these that security products and
services in the United States are offered through the Stanford
Group Company, member FINRA and SIPC. Would the average
investor conclude from reading that that there was SIPC
coverage?
Mr. Ketchum. It is difficult without seeing the full thing
there and what they say about the CDs that were being sold. But
clearly, Stanford cynically used the broker-dealer to create
the impression there was going to be coverage, yes.
Mr. Harper. I guess if this hearing underlies the
contention that the victims believed that they were indeed
purchasing registered securities and, in fact, they were not
and that the SEC failed to do its job, then the question for
all of the victims here and for us is, why would these victims'
investments not be covered by SIPC?
Mr. Ketchum. I think that is a fair question, though
fairly, I think I properly should defer that to the SEC that
has the oversight responsibility with respect to SIPC.
Mr. Harper. Tell me what efforts FINRA made to protect the
investors, the Stanford investors.
Mr. Ketchum. As I indicated in both my written statement
and oral statement, clearly not enough. We as well missed red
flags that indicated concerns. We, as well as the SEC, became
overly intimidated by the jurisdictional issues and the issues
as to whether the CDs were securities and didn't focus on the
fundamental exposure and risk to investors. And that was
unacceptable behavior and unacceptable from the standpoint of
how we responded.
Mr. Harper. When this is being reviewed and you are looking
at information--go back to 2007. When it is determined that SGC
had an almost $3 million overdrawn account in 2007, what did
FINRA do in response to that?
Mr. Ketchum. I am sorry. I don't know exactly what you are
referring to with respect to the $3 million over--
Mr. Harper. In the investigation looking at--maybe it is a
question that one of the other witnesses could answer better.
But did FINRA take any action--when was the first action that
FINRA took to protect investors?
Mr. Ketchum. Our actions were cooperative with the SEC from
the standpoint of the investigation that finally led to the
actions of 2009. We also commenced investigations, just as the
SEC does, in part from a Dallas/Fort Worth referral with
respect to the case that did not lead to actions other than a
minor action with respect to advertising that Stanford put out.
Mr. Harper. Mr. Chairman, I thank you.
And with that, I yield back my time.
Chairman Neugebauer. Thank you.
Now we go to Mr. Cassidy. I am sorry.
I messed up there.
Mr. Canseco, after you have been so polite--exactly.
Cassidy, Canseco, you know. The gentleman from Texas.
Mr. Canseco. Thank you, Mr. Chairman.
And, gentlemen, thank you very much for appearing here
today. Just before I get started with questioning, I do want to
say several things. It is a little disconcerting to sit here
today and see how for over a decade, employees of the SEC
continuously notified their superiors and the enforcement group
that something needed to be done with Stanford. And for a
number of reasons, they were ignored. Nobody in a position of
authority seemed interested in drawing outside the lines,
whether it was because SIB was located outside of the United
States or because the SEC was only focused during that time on
taking on cases that could be quickly resolved.
Nobody seemed to step back from the situation and say,
something doesn't look right here. And as a consequence, people
were hurt, investors were hurt. And I want to point out someone
from my district--one of the ones who was hurt from my
district, Mr. Barney Hallman from Alpine, Texas, wrote to me.
And I am just going to read a little excerpt from it. He said,
``I went to the SEC and FINRA's Web site and checked the
history of the FA as well as the history of Stanford Group
Company. Both Web sites reported no allegations, no fines and
no discernible problems with either.''
And he goes on to say, ``At that time, I had no idea that
the SEC had been investigating SGC for 10 years since 1997, nor
did I know that the Fort Worth's regional office per the OIG's
Investigative Report 526 clearly believed that SGC was part of
Stanford's Ponzi scheme. I also didn't know that for over a
decade, the SEC knew investors who used their Web site and
FINRA's to base their critical decisions would lose their money
with certainty.''
It highlights what fell between the cracks here. And it is
particularly disconcerting given the fact that recent
legislation has thrown new burdens on the SEC and other
agencies without allowing for structural problems to be fixed
first. The worst part about this is even if Dodd-Frank bill had
been in place beforehand, its provisions still wouldn't have
stopped the Stanford case. The laws were there. The regulators
were there, but the regulators failed. And so now, the honest
companies in the industry are paying the price for Stanford, as
well as the good citizen investors who invested with Mr.
Stanford.
It is a travesty that these companies need to pay the price
and that these individuals need to pay the price of the SEC and
FINRA's failures.
Let me start by asking Mr. Kotz, in your March 31st report
from your office, you noted that by early summer of 2003, you
say, ``It had been approximately 6 years since the SEC
examination staff had concluded that SIB CDs were likely a
Ponzi scheme. During that period, the SEC had conducted three
examinations resulting in two enforcement referrals. An
enforcement inquiry had been opened and closed with no
meaningful effort to obtain evidence related to the Ponzi
scheme. It would take almost another 6 years, another
examination and enforcement referral and the collapse of the
Madoff Ponzi scheme before the SEC acted to shut down
Stanford's Ponzi scheme.''
Are enforcement personnel who were involved--and this is
the question--in the Stanford matter still employed by the SEC
and in what capacity?
Mr. Kotz. The managers who made the ultimate decisions left
the SEC some time ago.
Mr. Canseco. And have any SEC personnel been disciplined
for missing the Stanford fraud?
Mr. Kotz. Not to my knowledge, no.
Mr. Canseco. Okay. I still have some time.
Mr. Khuzami and Mr. di Florio, the SEC in the Fiscal Year
2010 report notes that the Division of Enforcement completed
structural reforms that were the most significant in 4 decades
and noted that the Office of Compliance, Inspections, and
Examinations established a new national governance structure.
But absent in the Fiscal Year 2010 report, it seems, is any
description of how these two Divisions are going to improve
their communication and work with one another. The divide
between the two was at the heart of the Stanford matter. What
are your two Divisions doing to improve your work with one
another?
Mr. Khuzami. From the Division Enforcement's perspective,
Congressman, we are doing a lot. We have much better
integration between the two Divisions. We meet early on in
investigation cases. We educate ourselves about the particular
registrant that might be under examination. There is much
better communication. We track referrals. We have an escalation
approach to make sure the referrals are properly handled by the
Enforcement Division, and we have expertise that we have hired
in each Division to deal with particular types of market
practices that might be under scrutiny.
All in all, I think, a change of culture and, frankly, also
due to the change in personnel who understands the value of the
examination staff and what they bring.
Mr. Canseco. Thank you. We are short on time.
Mr. di Florio?
Mr. di Florio. I would just endorse what Mr. Khuzami said.
I think it starts with the tone at the top. And we have a
commitment to a culture of teamwork and collaboration, starting
with the chairman setting that tone. We meet regularly. Our
staff meet regularly. We have put in place governance processes
that bring us together to talk about cases earlier, raise
concerns earlier, think about ways we can collaborate to stop
fraud and rapidly shut it down. So there are a number of
mechanisms, and I think we are very competent here today that
this kind of situation wouldn't occur, we would nip it in the
bud, we would have mechanisms in place to ensure that it got
escalated and addressed.
Mr. Canseco. Thank you. Mr. Chairman, may I have one more
question, sir?
Chairman Neugebauer. Quickly.
Mr. Canseco. Yes, sir.
Mr. Ketchum, have the rules and regulations promulgated by
Dodd-Frank--would they have helped solve the situation at
Stanford?
Mr. Ketchum. No, no. This was a matter from all of our
agencies' standpoint of being able to identify and push through
a difficult situation and ensure that a serious fraud didn't
continue. This wasn't about rules and regulations. We had the
rules and regulations on our books.
Mr. Canseco. Thank you very much, sir.
I yield back, and thank you for my time.
Chairman Neugebauer. And now the gentleman from Louisiana,
Mr. Cassidy. Thank you.
Mr. Cassidy. Thank you, Mr. Chairman. The goal of my office
has been to ensure an effective, transparent, and compassionate
response.
Frankly, it seems as if all three have failed. Not to point
fingers, because none of you were involved, again, Mr. Kotz, if
anyone else was supposed to be made a saint, it so should be
you because the only transparency has come from your office.
For example, my office, as well as eight or nine other
Members of Congress, Senate, and bipartisan, bicameral,
requested the chance to look at an unredacted copy of the IG's
report. Some of the redactions seemed to have pertained to
someone's name, but others are just redacted. I have no clue
what is behind there. We sent that letter sometime ago and have
never received a response. Asking committee staff, an
unredacted report has not been sent nor made available. Why
can't we get a chance to look at an unredacted report?
Mr. di Florio. Congressman, I don't know the answer to
that. I don't know whether or not there are Privacy Act
restrictions that come into play.
Mr. Cassidy. I am willing to look at it in a room without
windows with you standing behind my back to make sure that I
don't take notes. But as I try to ensure a transparent response
to people for whom transparency has been totally lacking,
except for Mr. Kotz, why not?
Mr. di Florio. I don't know. I will find the answer out for
you, Congressman. My understanding is that a lot of their
redactions have to do with maybe the ongoing investigations or
other sensitive matters, but I will get back to you with a
response.
Mr. Cassidy. Sounds great.
FINRA apparently or your predecessor in September of 2003
sent a letter to SEC suggesting that this may not be on the up
and up.
Mr. Ketchum, did FINRA, your predecessor, send it to the
Fort Worth office, or did they send it to the D.C. office?
Because it seems like, if you will, blame is being put on the
gentleman who was in charge of Fort Worth--and again, the lack
of transparency has made me a little bit concerned. Do we know
that higher-ups were not culpable and/or negligent? So I am
asking, that report sent from September of 2003, to whom did
that go?
Mr. Ketchum. The communications between the SEC and FINRA
were done at the Dallas and Fort Worth offices. I think
actually the letter you are referring to or at least the
primary letter you are referring to was a letter from the
Dallas/Fort Worth SEC office to FINRA providing a partial
referral to the thing.
But, no. Part of the problem I think on both of our sides
was an absence of escalation. It stayed at the two offices.
Mr. Cassidy. One of you, maybe Mr. Conley, I understand
that SIPC will cover Madoff because the stock transactions were
fictitious but the underlying value of the CDs was fictitious.
So why does the fictitious nature of the stock transaction of
Madoff qualify for SIPC coverage but the fictitious value of
the CDs does not?
Mr. Conley. Congressman, this is one of the questions that
the Commission is now looking at. The victims in this case
through the Stanford Victims Coalition have made the argument
to the Commission--they have met with the staff and made the
argument and also in letters to the Commission that they
believe that the CDs in this case should qualify as fictitious
and, therefore, they should be--assuming they are customers,
they would have an argument that they were entitled to the
money that they invested. And that is a question that the
Commission is looking at currently.
Mr. Cassidy. I understand the Commission so far has been
negative regarding that argument. Is that true or not?
Mr. Conley. There has been no determination made by the
Commission at this point. That is something that is currently
under review by the Commission.
Mr. Cassidy. Let us assume that they rule against. I am a
physician, and I know that if a physician does something bad,
something negligent, there is other recompense. Frankly, this
is bureaucratic agency negligence. We have heard that. Is there
sovereign immunity, or will there be civil cases allowed
against the SEC for frankly totally failing their
responsibility? Does the SEC have sovereign immunity?
Mr. di Florio. As a general matter, I believe there is
sovereign immunity, and I believe there have been some lawsuits
filed. I don't know the current status of them.
Mr. Cassidy. Can you let us know that?
Mr. di Florio. Certainly, Congressman.
Mr. Cassidy. Let us see. Also with the receiver. Now, I
actually know some of those broker-dealers. They said that they
showed up for work one day, and they were told to go home. The
receiver was there. He hacked into their account, and he paid
some IT people a lot of money to pull up lists that if they had
stood behind him, he could have opened his account; they could
have checked the documents he pulled down against the Pershing
account and all of those billable hours that Janvey racked up
are gone. So more money would have been there to compensate
victims. I know the courts had told Janvey to downgrade his
charges. The court was offended by the number of charges. Going
forward, is there going to be a review of the procedures used
to instruct receivers so that they can't maximize billable
hours when there are shortcuts to the same thing?
Mr. di Florio. Congressman, we vigorously check bills of
receivers and, in this case, in fact, on a number of occasions,
have achieved reductions in those bills.
Mr. Cassidy. I understand that. But my fundamental question
is, there was an easier way to do it. You just stand behind the
guy as he opens it up, and you stand behind and have an IT guy
there to make sure that maybe he opens up a similar computer
with the same password so somebody who knows about computers
can make sure there is not a game going on, and boom, you have
all the accounts.
And you don't take 2 months racking up IT--I am sure $200
forensic accountants, etc., when you say here is the Pershing
account data that Stanford is using, here is what you showed
me. Why don't we do it that way and save a heck of a lot of
dough?
Mr. di Florio. I think that is entirely appropriate and
that should happen. As the SEC, we don't control the receiver,
and to some degree, the court is responsible ultimately for
dictating how and in what method the receiver approaches his
task. But we have been doggedly following his expenditures and
suggesting ways he can do things more efficiently, including
not spending money chasing assets that are overseas that are
already subject to freeze orders.
Mr. Cassidy. So it sounds like--it is understood that this
particular receiver is problematic. I guess my question is,
what does Congress have to do--I am not on this committee, and
it is by the indulgence of the Chair that I am here--what does
this committee or Congress need to do so that receivers operate
within certain guidelines? I keep returning to this, but the
perception is the guy is just racking up billable hours. It is
a gold mine. I am sure he has made partner. The fact is that
there are cheaper ways to do it. Are there guidelines that can
be promulgated to help the fellow do so?
Mr. di Florio. Congressman, I am not sure that is something
that Congress could promulgate, but we will take a look at it
and get back to you.
Mr. Cassidy. You have been indulgent. Thank you. I yield
back.
Chairman Neugebauer. I thank the gentleman. Good questions.
All good questions.
I just have a quick follow-up. It is my understanding, Mr.
Khuzami, is that the Texas State Bar has not received any kind
of referral, and I think you testified that you had referred
it, a formal complaint, to the Texas Bar on Mr. Barasch; is
that correct.
Mr. Khuzami. My understanding was that there was a referral
made to both Texas and the District of Columbia, but I could be
mistaken that it was one or the other and not both. That was my
understanding. We can certainly confirm that and get back to
you.
Chairman Neugebauer. Would you think it would have been
appropriate to refer to both?
Mr. Khuzami. It depends on where he is registered to
practice. So wherever he is registered, there should have been
a referral.
Chairman Neugebauer. Were you aware that Mr. Barasch had
business before the Commission last Friday?
Mr. Khuzami. I was not aware of that.
Chairman Neugebauer. Should he be allowed to do that?
Mr. Khuzami. Congressman, again, the government-wide ethics
rule would say that if it is not something that he wasn't
personally involved in, he is not permanently barred from
representing clients in front of the SEC.
Chairman Neugebauer. But I want to understand this. You
said that you referred charges to--criminal charges; is that
correct?
Mr. Khuzami. We made a reference to the criminal
authorities, correct. But there has been no result of that. If
Mr. Barasch is ultimately criminally charged, then he could
lose his license and not practice anywhere.
Chairman Neugebauer. Another follow-up question. I think it
was in the IG's report that there was a recommendation to
discipline the supervisors whom I think most people think
unfairly disciplined Ms. Preuitt. Have you taken any action
against them?
Mr. di Florio. Congressman, again, this was before I joined
the SEC. But my understanding is that there was a review done
when the Inspector General's report came out regarding the
retaliation and the need to follow up with regard to those
senior managers. The findings of that review apparently were
that those senior managers had sought the consultation of
counsel and experts on human resources throughout the process
of developing their discipline, and so it was inappropriate to
discipline them for following the procedures we encouraged them
to follow. That is my understanding of how that occurred.
Chairman Neugebauer. Do they have the facts that we all
have now, that in fact, people were ignoring her, and in fact
demoted her because she kept raising this flag? Do they have
that information?
Mr. di Florio. Congressman, what we have done since we have
came on board, Mr. Khuzami and I, is when we learned of further
concerns regarding treatment of Ms. Preuitt, we assembled a
very senior team of our most senior deputies and sent them down
to Fort Worth to do an independent review so that we could take
appropriate action if there were circumstances that remained
inappropriate. And as I mentioned earlier, we are working very
closely as a result of that review with Ms. Preuitt to make
sure that she has an appropriate opportunity to show her
talents and to be able to work effectively in our mission.
Mr. Posey. Mr. Chairman?
Chairman Neugebauer. Yes, Mr. Posey.
Mr. Posey. Can I follow up along that same line?
Chairman Neugebauer. Sure.
Mr. Posey. And it is mainly--probably we should invite Ms.
Preuitt to come here.
Chairman Neugebauer. She is here. She is on the next panel.
Mr. Posey. Okay. Good.
Chairman Neugebauer. I agree with you. We do.
I would close--do any other members have any follow-up
comments that they want to make? I would recognize members--
because we are about to dismiss this panel, and I don't want
members to come away and say, I wish I had more time.
Everybody good?
I think the take-away here hopefully to both FINRA and the
SEC is this was--this is not even defensible and that the
American people deserve better than this. I can assure you as
chairman of the Oversight Subcommittee, we are going to work
extremely hard to make sure that the cultures in both of these
organizations have changed in such a way that this doesn't
happen again.
When you go back and you look at the history on the number
of occasions in both agencies where this thing should have been
shut down when it was less than a billion dollars, really when
it was in the millions of dollars and yet when we look and--at
the escalation from the chart of how much money from 2005,
almost $6 billion additional dollars, went into that--and this
has been brought up; you have to personalize that. In many
cases those were peoples' life savings, and it is extremely
disturbing that we had a culture in agencies that demand high
levels of disclosure and integrity that within, that very
agency there wasn't the similar amount of integrity inside
those agencies. It is inexcusable.
And so I hope that I am hearing--I have met with Mr.
Khuzami and Mr. Ketchum, and I hear them talking the talk, but
we are going to want to see them walk the walk. And with that,
we thank you for being here. And this panel is excused.
We want to welcome our second panel. I don't think the
first person needs any introduction after the conversation
during the first panel, but Ms. Julie Preuitt, who is Assistant
Regional Director of the U.S. Securities & Exchange Commission,
Fort Worth regional office.
Ms. Preuitt, welcome.
And Mr. Charles Rawl, who is a former employee of Stanford
Group Company.
I would now like to yield to my colleague, Mr. Fitzpatrick,
for the introduction of our third panelist.
Mr. Fitzpatrick. Thank you, Mr. Chairman.
I am very pleased indeed to introduce Mr. Kauffman, who
traveled here to the Nation's capital from our home State of
Pennsylvania. He and his wife Linda reside in a community right
next to my community of Bucks County. Mr. Kauffman was a public
school teacher in the City of Philadelphia where he educated
some of the State's most disadvantaged children, making a real
difference in the lives of many of them.
Mr. Chairman, Mr. Kauffman retired 6 years ago, which is
right around the same time that FINRA and the SEC were going
back and forth about who had the authority do something about
Stanford. The Kauffmans sought a safe and secure investment for
their life savings and eventually chose CDs in the Stanford
International Bank to invest their retirement savings.
The tragedy of losing their life savings was only
compounded by the fact that they were both diagnosed with
cancer in 2009.
Thankfully, they are both survivors, and Mr. Chairman, Mr.
Kauffman is here today to share his story and to raise some
very legitimate questions.
So, sir, thank you for coming to the Nation's Capital. We
look forward to your testimony.
Chairman Neugebauer. I thank the gentleman.
And now, Ms. Preuitt, you are recognized. Thank you for
being here.
STATEMENT OF JULIE PREUITT, ASSISTANT REGIONAL DIRECTOR, U.S.
SECURITIES AND EXCHANGE COMMISSION, FORT WORTH REGIONAL OFFICE
Ms. Preuitt. I want to thank you for the opportunity to
testify before the subcommittee today. I have been asked to
discuss my work for the Securities and Exchange Commission as
it relates to R. Allen Stanford and his affiliated companies,
as well as my experience as the whistleblower within the
Commission.
I am representing my personal views, which do not
necessarily reflect the views of the staff, the Commission or
the Commissioners.
First, I really would like to note that I am just a
representative of the many highly skilled experienced examiners
who have done their best to protect all investors, including
those defrauded by Stanford. I know this may not provide
comfort. It certainly doesn't lessen Stanford victims' losses
in any way, but I and the examination staff truly care about
being an advocate for the investor. And behind the public and
personal face of a large institution like the SEC are many
individuals who truly, truly mourn their losses.
The intertwining of my career with Stanford starts simply
enough. In August of 1997, I selected Stanford's broker-dealer
for examination because of the high-risk nature of its business
model. That examination resulted in enforcement referral for
the likelihood Stanford was engaging in a Ponzi scheme.
Enforcement declined to open a formal investigation.
In July of 1998, Fort Worth's investment advisory
examination group also found concerns with Stanford.
Enforcement also declined to pursue their referral.
In November of 2002, the investment advisory examination
group conducted another examination of Stanford. This time the
Associate Director for Enforcement decided to refer their
findings to the Texas State Securities Board.
In approximately September of 2004, the Associate Director
for Examinations asked me to conduct a fourth examination of
Stanford. As expected, the fourth examination supported
examination staff's belief that Stanford was engaged in a
fraudulent scheme. The only difference is that the size of the
scheme had gone from several hundred million to $1.5 billion.
Again, enforcement did not want to pursue the findings from the
fourth examination.
That began a battle which went from April of 2005 until
November of 2005 when I was able to extract a commitment from
enforcement to pursue the investigation. It was still another
11 months from that time until enforcement completed the
process to get a formal order and to get subpoena authority and
to kick the investigation to high gear.
Much has been said about the SEC-wide institutional
influence that created a disincentive to pursue matters that
were resource-intensive and whose outcome was less than
certain. And Stanford was certainly such a matter. There is no
question that during the early Stanford timeframe, Fort Worth
senior management firmly believed that the office's success was
measured strictly by the number of cases filed each year.
Unfortunately, the mentality that motivated managers in
Fort Worth to sometimes ignore the best interests of the public
into a race for numbers has not been limited to the enforcement
program. In 2007, a new Associate Director for Examinations in
Fort Worth wanted the broker-dealer examiners to conduct a new
type of examination which would consist of only a half day of
interviews.
The sole purpose of these examinations was to boost
examination numbers, even if it was at the cost of legitimate
examinations, such as the ones conducted on Stanford.
After 8 years of fighting the shortsighted mentality that
kept enforcement from an opening an investigation on Stanford,
I now had to battle with a similar mentality in my own program.
I expressed my concerns to local senior management, but my
concerns were met with hostility.
I contacted headquarters regarding this new type of exam,
and headquarters was unaware of this new initiative and also
concurred with my belief that it was inappropriate. They
ultimately stopped these mini-examinations from going forward.
Unfortunately, I paid a very heavy price for complaining. I
was given a letter of reprimand that actually cited my lack of
support for the Associate Director's program initiatives and
for contacting headquarters to complain about them.
Two months later, I was transferred out of my position. My
new position did not come with any supervisory responsibilities
or any clearly assigned duties. The goal seemed only to
convince me to leave the Commission.
After finding no one within the Commission hierarchy
willing to speak with me, much less help me resolve the
situation, I complained to the IG. And even after the IG
concluded in 2009 that there was merit to my retaliation claim
and suggested discipline for the perpetrators, no discipline
has occurred to the perpetrators. Further, no substantive
actions have been taken to correct my situation.
Many have asked me why I haven't left the Commission over
the course of the last several years. And my answer is
unwavering: I am passionately committed to the mission of the
SEC. Thank you.
[The prepared statement of Ms. Preuitt can be found on page
105 of the appendix.]
Chairman Neugebauer. Thank you.
Mr. Rawl?
STATEMENT OF CHARLES W. RAWL, FORMER EMPLOYEE, STANFORD
FINANCIAL GROUP, AND STANFORD FINANCIAL GROUP WHISTLEBLOWER
Mr. Rawl. Chairman Neugebauer, Vice Chairman Fitzpatrick,
Ranking Member Capuano, and members of the subcommittee, it is
an honor and a privilege to appear before you today, to speak
about my experience as a Stanford Financial Group advisor and
my experience with the SEC and FINRA as a whistleblower.
Thank you for inviting me to testify.
My name is Charlie Rawl, and in December of 2007, my
business partner, Mark Tidwell, and I resigned from Stanford
Financial Group because of the company's unethical and illegal
business practices. We fought an incredibly difficult 15-month
battle against Stanford and were labeled by Stanford as
disgruntled employees as management attempted to discredit the
very serious allegations we made when we left the firm and
filed a lawsuit.
Once the SEC filed its civil suit against Stanford alleging
massive ongoing fraud, we became known as the whistleblowers.
Our testimony and evidence were used to support the SEC's civil
lawsuit against Stanford to take a global network of companies
into receivership on February 17, 2009.
Mark and I believe Stanford would still be operating today
if we had not come forward to the SEC and FINRA. I would not be
here today if we had relied solely upon the present regulatory
rules and procedures.
I am in business today thanks to a strong business partner,
Mark Tidwell, and an important third partner, my friend,
client, and one of our attorneys--Mike O'Brien. It took the
three of us to survive the past 3 years.
Shortly after we resigned from Stanford in mid-December of
2007, Stanford sued Mark and me in FINRA arbitration. Our worst
fears became reality as we quickly learned that the FINRA
arbitration process was in Stanford's favor. We later have
learned that as many as 30 other FINRA arbitrations had taken
place with other former Stanford employees, all alleging
fraudulent business practice. FINRA had sided with Stanford in
every single one of those cases, including at least one case in
which a former employee alleged Stanford International Bank was
a Ponzi scheme.
It is an understatement to say that the regulatory process
failed us. After realizing Stanford would likely crush us in
arbitration, we accelerated our efforts to ask other regulators
and law enforcement for help. We came first to the SEC. The
allegations we brought to the SEC's attention did not appear to
be a high priority, and nothing really happened until Madoff
confessed in December of 2008. Then, the SEC had a sudden sense
of urgency for taking action against Stanford. We proceeded to
work closely with the SEC, providing testimony and evidence
that was crucial to the SEC's suit against Stanford. We helped
the SEC craft its legal strategy, legal tactic to implicate the
U.S. broker-dealer Stanford Group Company.
Despite the significant contributions we made to the SEC's
fight against Stanford, the SEC failed to deliver on its
promises to protect us, and we were ultimately sued by the
receiver the SEC put in place to administer the Stanford
estate. The regulatory process had failed us a second time.
It is very important to note that while we learned of many
red flags and collected evidence of unethical and illegal
business practices while working at Stanford Group, we did not
know that Stanford was a Ponzi scheme when we resigned. It was
only after an FBI agent told me he thought Stanford was a Ponzi
scheme in August of 2008 that I considered that that might be
true.
We just knew there was fraud and that the investors were
not being protected. We never imagined the magnitude of the
fraud or the level of the devastation that resulted that all
could have been prevented.
In conclusion, I would like to say that the Stanford
Financial Group scandal has left an enormous footprint in this
country. The devastation it has caused has ruined lives. I have
met victims who are literally on their deathbeds, who have lost
their homes, who can't afford their medical care. By and large,
these are middle class people who needed the protection of this
country's regulators. The SEC and FINRA have failed them, and
they continue to fail them.
Chairman Neugebauer and members of the subcommittee, I
thank you for allowing me to be here today, and I thank you for
the attention you are giving the very serious regulatory issues
that have come to light in the Stanford Financial Group fraud.
[The prepared statement of Mr. Rawl can be found on page
112 of the appendix.]
Chairman Neugebauer. Thank you.
And, Mr. Kauffman.
STATEMENT OF STAN KAUFFMAN, VICTIM, STANFORD FINANCIAL GROUP
PONZI SCHEME
Mr. Kauffman. Good afternoon, ladies and gentlemen. I would
like to thank Chairman Neugebauer, Vice Chairman Fitzpatrick,
Ranking Member Capuano, and the honorable members of the House
Financial Services Subcommittee on Oversight and Investigations
for holding this hearing today and for looking deeper at what
is surely one of the most inconceivable acts of financial
regulatory failure in our Nation's history.
I thank you also for allowing me the opportunity to tell my
story.
My name is Stan Kauffman. I live in Blue Bell,
Pennsylvania, and I am 63 years old. In 2005, I retired from
the Philadelphia Public School System where I taught science
for 31 years. When I retired, I withdrew my retirement
contributions from the Pennsylvania public school employee's
retirement system, and my wife Linda and I sought a safe,
conservative investment to protect our savings.
Based on a referral, we met with the Stanford Group Company
broker-dealer financial advisor. We saw that he had 30-plus
years of experience with many of the large financial firms and
was a member of FINRA. We explained to him that we did not want
to take big risks with my teacher's retirement as well as our
life savings.
He told us about the Stanford International Bank CDs. He
explained the bank was heavily regulated and that the deposits
were insured. The rate we were offered was a mere 2 percent
higher than other banks at the time and that the difference was
justified and the details are in my submitted testimony. We
were told that the Stanford CDs were safer than a U.S. bank,
and we invested our savings of $500,000 in these safe CDs,
including my teacher's retirement.
Now, I am not a savvy investor, and I absolutely relied on
the professional expertise of a FINRA-licensed and SEC-
registered representative who had a fiduciary duty to recommend
the most appropriate investments for my needs.
He explained to me the Stanford Financial Group was based
in Houston, Texas, and that all the company's operations were
managed in the United States. Knowing Stanford's operations
were in the United States and subject to U.S. laws made me
comfortable with my decision.
And that is how I ended up with Stanford Group Company and
investing in bogus CDs. From 2005 to 2009, we watched as the
company grew exponentially with more than 30 offices in the
United States. We saw Stanford international bank grow by
billions of dollars in deposits. We saw photos of our Senators
and Congressmen with Allen Stanford. We even received a copy of
a letter from President George W. Bush applauding the Stanford
Financial Group in 2008.
My written testimony goes into further detail about my
decision to invest with Stanford. But in short, we had zero
reason to doubt the company's stability, but we did not know
what the government regulators knew.
On February 17, 2009, our world was turned upside down when
we learned that Stanford had been accused of a massive ongoing
fraud. Massive ongoing fraud. We watched the news coverage in
shock as we realized our government regulators failed us in an
unprecedented manner and that all of our life savings were
gone.
I would like to briefly share with you what my wife and I
have faced in the last 2 years. My wife lost a job she had for
over 11 years due to downsizing as a result of the economic
downturn. We were forced to put our house up for sale, and I
had to go back to work.
And then we got the bad news: In 2009, my wife and I were
both diagnosed with cancer and had to undergo multiple
surgeries and treatments.
Fortunately, we are survivors, but the stress of Stanford
has taken its toll. The devastating reality that our government
regulators have failed us has taken its toll as well. There are
thousands of victims like myself. We are not wealthy people,
but honest, hard-working Americans. These are everyday, middle-
class citizens who were preyed upon by a criminal enterprise
with a sales force of 200 of the most qualified professionals
in the industry. These are people who were looking for a safe
place to protect their savings and should have been protected.
The insult added to injury here is the reality we have been
victimized a second time, as the SEC has seemingly gone out of
its way to not order the protection we feel we legally
qualified for from the Securities Investor Protection
Corporation, SIPC. We were sold securities that never even
existed, and the receiver's forensic accountant has provided
testimony saying our money didn't even go to Stanford
International Bank and that it certainly didn't go to purchase
the CDs we were sold. Our money sat in U.S. bank accounts and
was used to pay previous investors for bankrolling the Stanford
Financial Group's expansion and Allen Stanford's lavish
lifestyle.
SIPC was created to protect investors from a broker-dealer
stealing its customers' funds. The SEC has accused Stanford of
stealing our funds in a massive Ponzi scheme. When it comes to
repairing the damage of the SEC's aborted attempts to protect
us in the first place, we are being told our money was stolen
the wrong way.
I think it is important to note we are not seeking SIPC
protection for a foreign bank product. We are seeking SIPC
protection from a registered broker-dealer and a SIPC member
who stole our funds instead of buying the offshore bank CD.
Our government regulators have abandoned thousands of
America's seniors who have been struggling to get by as they
wait month in and month out for the SEC to finally respond to
an 18-month old request to initiate a SIPC liquidation of
Stanford Group Company.
Chairman Neugebauer, Vice Chairman Fitzpatrick, Ranking
Member Capuano, and honorable members of the subcommittee,
please do not allow the SEC and FINRA to get away with what has
transpired in this case. We need your help to get our lives
back. Stanford stole our savings, but the SEC and FINRA held
the door wide open. Please don't stand for that door to now be
slammed shut in our faces. Thank you for your time and your
attention.
[The prepared statement of Mr. Kauffman can be found on
page 70 of the appendix.]
Chairman Neugebauer. Thank you, Mr. Kauffman.
We have been joined by the chairman of the full committee,
Mr. Bachus from Alabama. And I would yield 5 minutes to him for
questions.
Chairman Bachus. Thank you. We had many Members of Congress
just in the past several months who brought this to our
attention, that there were some--that this was truly a horror
story, and when we decided to have this hearing, I had no idea
until I saw the testimony how widespread this was and what a
monumental failure of our regulators to catch this fraud.
And obviously, there were many innocent victims, including
SEC employees, and former Stanford employees, as well as
thousands of people who invested. And it really is depressing
even to hear about it. I cannot imagine what you have been
through, and I am disappointed that you haven't been protected
and that you have really been treated not only unjustly, but
even after all of the facts were out, there has been no attempt
to right those wrongs.
You have been made so many promises that I hesitate to make
another one because you have been let down so many times. But I
can tell you that this won't be the end of this here. I know
Mr. Posey asked one of the questions I was going to ask. And
that is whether the SEC employee in Fort Worth who had taken
actions since he has left which indicate a real conflict of
interest and ethical misbehavior, whether that had been
referred to the Justice Department. And Mr. Posey was told that
it had.
Do any of you have any knowledge as to where that
investigation is? Has there been an indictment brought?
Ms. Preuitt. Probably none of us would probably be privy to
what is happening with that, but I understand there is
currently no indictment.
Chairman Bachus. Thank you.
Obviously, our staff has investigated this in the past few
weeks, but we want to continue to work with you to see that
your actions, which are exemplary and ought to be encouraged by
others, that what has happened to you, that we try in every way
we can to right that wrong, because there is also a strong
message if that doesn't happen, that others shouldn't step up.
And a lot of the testimony by the first panel was, we know
about this now, and we are going forward. I was encouraged by
the Inspector General and some of the acknowledgements, but Ms.
Preuitt, what is your present situation? Are you with the SEC?
Ms. Preuitt. I am with the SEC. I am still in the Fort
Worth office. I still don't have a staff. My duties are still
vague. They have currently discussed with me working out some
kind of an arrangement where I will report to somebody in
another office, and they might let one or two people work with
me. But that is subject to the enforcement--or not--the
Associate Director who disciplined me in the first place as to
whether or not she would let Stanford--
Chairman Bachus. And they are still in charge of that
office?
Ms. Preuitt. The head of the office who was noted for
retaliating against me just recently retired. The Associate
Director for Examinations is still there.
Chairman Bachus. Who disciplined you?
Ms. Preuitt. And she has not been disciplined.
Chairman Bachus. Has she apologized to you?
Ms. Preuitt. She has not apologized to me. They still
firmly believe that, apparently, that she has not done nothing
wrong because not only has she not been disciplined, she was
actually elevated. They talked about Mr. di Florio. There is a
National Exam Program. They created an executive committee for
that. And last summer, she was put on the executive committee
for the National Exam Program.
Chairman Bachus. Pretty incredible testimony. It is not
often that we hear of such a devastating failure of regulation
and no acknowledgement that they were wrong, that they had
treated all three of you shabbily.
I will yield back the balance of my time.
Chairman Neugebauer. I thank the chairman.
One of the things that we have been trying to do is ensure
that we open up the ``People's House'' and the ``People's
Congress'' to their participation.
So we have initiated a ``You Witness'' question program and
people can go online, and they can submit questions for
hearings. And I think this is going to be--this question that I
am going to use this morning is our very first question. And it
comes from Cassie Wilkerson in Austin, Texas. She said, ``My
question is to Ms. Preuitt. As Allen Stanford's alleged Ponzi
scheme began to rapidly grow and it was apparent that losses to
the investors would be massive, was there ever any conversation
with supervisors in your department about the impact that this
was going to have on the investors' lives and what the SEC's
responsibility is to the investors? If so, whom did you speak
with and what was the outcome of that conversation?''
Ms. Preuitt. I am thrilled to get to be the first recipient
of a question that is a novel way. There were many
conversations. That was a constant nonstop discussion both
among the examination staff, who truly worried about it
tremendously. Those conversations with enforcement staff
obviously didn't go very well.
I many times encouraged them, even if you don't think we
can do this at this level, it needs to be elevated to the
Commission, and let them decide if this is too difficult of a
case to follow up on. Because so many investors are being
affected, and it is just growing rapidly, and there appeared to
be no end in sight.
It was truly a stressful time. But I cannot say how much
the examination staff truly cared, and we really tried to find
ways to make it happen.
Chairman Neugebauer. And so the culture there was, if we
couldn't get a blue ribbon here pretty quick, we just don't
mess with it.
Ms. Preuitt. Yes. To me, I could never really find an
acceptable reason or answer as to why we weren't going forward
with it. There was no reason. There was a variety of different
ways that we could approach it. And I was actually, I think,
considered a pest in enforcement because I was constantly
nagging them and pushing them forward. And many suggested,
``Why don't you just drop it? This isn't going to fly.'' And in
case you hadn't noticed, I am a rather tenacious person and
didn't drop it.
Chairman Neugebauer. Yes. It is extremely discouraging. I
guess it begs the question, why have an examination force if
you are not going to enforce it?
Mr. Rawl, so, basically, you were in the business--how long
have you been in the investment advisory business?
Mr. Rawl. Since 1995.
Chairman Neugebauer. What were you doing prior to that?
Mr. Rawl. I was a commercial banker and lender.
Chairman Neugebauer. I am sorry?
Mr. Rawl. A commercial banker and lender. I have been in
financial services since I got out of college in 1981.
Chairman Neugebauer. Okay. And so you went to work. Were
you recruited to come to Stanford? Did they actively recruit
you?
Mr. Rawl. Yes, sir, I was recruited to Stanford. That
process started in December of 2004.
Chairman Neugebauer. And what was the arrangement when you
came to work for them? Did they pay you a bonus to come to work
for them?
Mr. Rawl. Yes, sir. As was common in the industry, a fairly
standard recruiting deal, which included a bonus to come, would
be given over a period of time, 5 years in my case. I earned
different bonuses by achieving different levels of success as I
brought my book of business to the company. This is common in
the industry.
Part of is to make up for what we left behind at the prior
firm, deferred compensation, etc. And, unfortunately, part of
it, in my opinion now, is to tie you to the gaining firm. And
it creates an incredible conflict of interest for the advisor,
particularly where, as in our situation, we saw that there was
a lot wrong, and yet we had an employment contract and we owed
money back if we were to leave prematurely.
I hope that this type of practice and this methodology of
recruiting advisors, that I said before is common, I hope that
it is outlawed because it creates a conflict that is
intolerable. That is why it was so difficult to leave. We knew
we would be sued when we left, and we knew we would be sued by
a deep-pocketed plaintiff.
We tried to sit down and pay back a good portion of that
money which we had saved for that purpose, but, in this case,
we could never get to the bargaining table.
Chairman Neugebauer. As I understand it, looking at your
testimony, what brought something to your attention that
something was awry? I think you testified a while ago that you
didn't really think that there was a Ponzi scheme that was
going on, but you were concerned about the returns that were
being advertised and the returns that were being delivered to
your clients, is that right?
Mr. Rawl. Yes, sir. I was concerned about the advertised
returns of the traditional managed account program at the
broker-dealer. I never dreamed that the regulated managed
account program, that the numbers would not be able to be
substantiated. So that was one concern.
But there were many other concerns. And it started,
unfortunately, not long after I arrived at Stanford. The
advisors were called into the manager's office to talk about
these inquiry letters the SEC had sent to many new customers of
the bank.
That began a time, over the next couple of years, where I
just continued, my partner and I as well as other advisors,
continued to dig up things that didn't make sense. We didn't
understand the way management would handle certain issues we
brought to attention. Decisions were made not for good business
reasons. We learned that certain Treasury regulations were not
being followed with respect to the investments in the offshore
CD. We accumulated a long list of what I call red flags, and
these accumulated over time. We dug and we dug, and we were
known for due diligence, and we didn't forget. We pressed
management. Generally, we were dismissed, lied to, covered up.
Finally, these things became untolerable. My partner, Mark
Tidwell, and I both decided that we had to figure out how to
leave, because we were very concerned about the well-being of
our clients. So we started--
Chairman Neugebauer. So here is my final question. With a
banking background--I was in the banking business for a while,
and the CD business is a competitive way to attract funds for
banks and financial institutions. And, the spread was--maybe
bank ``X'' was 25 basis points more. Maybe if they were trying
to really recruit some funds and manage--there might be a 35-,
40-basis-points difference.
But when you look at some of the numbers, how much were the
spreads over what you could offer your clients a domestic U.S.
CD?
Mr. Rawl. That is a very good question, and it has been the
subject of a lot of confusion.
The CDs did not offer exorbitant returns, themselves. From
my experience, the CDs were priced at typically 200 or 300
basis points above what you could get in the United States. And
Stanford had a very well-orchestrated answer to that, that did
make sense: the bank being located in Antigua, domiciled in
Antigua, where there is no corporate income tax. That is a huge
multiplier to the bottom line.
There were a lot of reasons. I feel gullible to some
extent, of course, for ever going there. But it was a well-
orchestrated fraud that had been--the bank had been around 25
years.
And there have been media comments about the CDs and these
exotic returns. It is not true that the returns were not
exotic. It was the investments behind them that we have learned
were--those were the fraudulent returns.
Chairman Neugebauer. I see my time has expired.
I yield to the vice chairman of the committee, Mr.
Fitzpatrick.
Mr. Fitzpatrick. Thank you, Mr. Chairman.
I appreciate the testimony of all three witnesses. Your
testimony is incredible, to say the least.
Ms. Preuitt, I want to associate myself with the laudatory
remarks of Mr. Posey earlier. You described yourself, in your
opening testimony here, as just another examiner at the SEC. I
think that is rather humble of you. I think that you have set
the standard for public servants, not just in the Commission,
but across all Federal agencies, I hope.
Now, we were led to believe by the previous panel that the
SEC is working very closely with you to put all of your talents
to use at the SEC. Is that a fair description of what is going
on right now in the Fort Worth office and your employment
relationship with the Commission?
Ms. Preuitt. They are trying to work with me to make things
better. However, it seems to be based on the notion, still,
that there is to be no--not to restore me to my full position
that I was before and, also, under the notion that they still
should not discipline the person who inappropriately retaliated
against me.
In doing so, although I may get partially better than where
I was before, my talents are still very limited. It also sends
an incredible message to the staff. It says, ``Don't speak
up,'' and it says ``We will tolerate misbehavior on the part of
senior management.'' And as long as that is the case, I don't
think that the situation in Fort Worth is going to be resolved.
Mr. Fitzpatrick. Is it true that you were one of the first,
if not the first to identify the potential of a Ponzi scheme in
connection with the Stanford investment program?
Ms. Preuitt. Yes. I was just going through the annual
filings, and I noticed that it looked impossible, their
business model. And so I suspected that there had to be a
fraudulent scheme.
Mr. Fitzpatrick. And so you had referred to enforcement on
a number of occasions, and those referrals were rebuffed,
correct?
Ms. Preuitt. That is correct.
Mr. Fitzpatrick. Looking back on it, have you made
recommendations about ways to better coordinate today and going
forward between the exam group and the Enforcement Division, at
least in the Fort Worth office? Have you made those
recommendations? And, if so, what has happened?
Ms. Preuitt. I have not made those recommendations because,
in many ways, this was not a process issue. This was managers
who were not being held accountable for poor decision-making.
So, in that sense, I have grave concerns that a process will
not be better. There has to be, instead, a system that holds
managers accountable for poor decision-making and for placing
their own interests above the needs of the investing public.
Mr. Fitzpatrick. And was one of those managers, the one who
retaliated, the same manager who was promoted?
Ms. Preuitt. Yes.
Mr. Fitzpatrick. Mr. Rawl, over the course of your
employment with Stanford, when did you first suspect fraud at
the organization? When was that in the timeline?
Mr. Rawl. In mid-2006, I became suspicious of the
literature that was designed to promote the registered managed
account program at Stanford. It took 9 months to push and push
and push management to do a study and come back and report on
that. And on March 28, 2007, management admitted that they
could not substantiate the numbers and that there was a
problem. That was one of those red flags, so to speak.
Mr. Fitzpatrick. And when did your FINRA arbitration occur?
Mr. Rawl. We resigned from Stanford in December of 2007,
and Stanford sued us immediately. And the FINRA arbitration
process started in January of 2008.
Mr. Fitzpatrick. And what was the result of your
arbitration?
Mr. Rawl. Unfortunately, there has been no result. We have
a nice case with--most of our bullet points and charges have
been proven out, but I think the technical term is that it has
been ``abated.'' I can't proceed in our arbitration against
Stanford--of course, there is nothing to proceed against--but
the receiver can still proceed against me in the meantime.
Mr. Fitzpatrick. Were you familiar with this fellow,
Barasch, who was the head of enforcement at the Fort Worth
office while you were at Stanford?
Mr. Rawl. I was not. I certainly knew the name, but I did
not know him.
Mr. Fitzpatrick. You had not met him?
Mr. Rawl. No, sir.
Mr. Fitzpatrick. Mr. Kauffman, what did employees at the
Stanford Investment Group, what kind of information or
assurances did they give you, as an investor, that your
investments would be safe?
Mr. Kauffman. We were told that the investments were
insured by Lloyd's of London. We were told that their expenses
were less since they didn't have a brick-and-mortar presence in
the United States, and that made the investment a good
investment.
Mr. Fitzpatrick. Can you describe for the committee how
this incredible financial loss has affected you and your
family?
Mr. Kauffman. It has been difficult psychologically knowing
what we have lost, knowing all of the hours I put in. I always
worked a second job for 31 years. Being a schoolteacher, I had
the time. And I was proud of the fact that I could put away the
funds for retirement.
I didn't anticipate getting sick, and neither did my wife,
but when we were slammed with that, as I like to say, the funds
that would have been there to make it a little bit easier for
us were just not there. So we have had to cut back, in our
expenses and such. We don't eat out that much anymore.
Mr. Fitzpatrick. Okay. Thank you.
Chairman Neugebauer. I thank the gentleman.
The gentleman from Florida, Mr. Posey.
Mr. Posey. Mr. Chairman, my microphone doesn't work. May I
move down?
It seems like the SEC has been doing some maintenance on
the microphone over there.
Mr. Chairman, I am really sad to say that I expected to get
some better answers here today. After we heard the last panel,
I thought we would hear from this panel and it would be
encouraging that we are on the right track and seeing things
going in the right direction. But this is really appalling, to
hear what we have heard today. The more we hear, the worse it
gets.
And, first of all, on behalf of all my constituents and the
others who were victimized, before you leave today, I would
like to shake your hand, Ms. Preuitt.
And, Mr. Brubaker and Ms. McClure, would you raise your
hand?
I want you to get with them, please, before you leave today
and give them your contact information, because I would like to
stay in touch with you, just have some idea of what kind of
reality goes on down in the real world.
Mr. Chairman, I assume that is okay? With your permission,
I would like her to feel free to communicate with us--actually,
request that she communicate with us, maybe give us a monthly
status report, an inside view of what is going on down there.
I could not possibly have understood your answer correctly.
It seemed like you said, in response to somebody's question,
that the person who trashed you before for trying to do your
job is still your boss. Tell me that isn't so.
Ms. Preuitt. She is not technically my boss. There have
been times when they have--the person who did retaliate--there
were two who retaliated against me, the head of the office and
the Associate Director. And I was reporting to the head of the
office who had retaliated against me for the last several years
until she retired just last month.
To get any sort of staff to work with me, to work on
projects, they are going to have go get the staff from the
person who retaliated against me who is still with the
Commission. So I am still, in some way, subject--
Mr. Posey. That is just incredibly hard for me to accept
and to understand. So, excuse me for being a little bit at a
loss for words. It seems that SEC management is more interested
in protecting rotten employees, or too interested in that, at
the expense of recognizing or rewarding good behavior. And it
seems like it is backward, from this perspective. I don't know
how you could see it otherwise.
In the real world, people perceive justice is that if
somebody steals a television set and sells it to somebody else,
that when a thief is caught, the thief goes to jail. If there
were any other bad people involved in the process who were
culpable, then they have some kind of punishment. And then they
go recover the TV set, or what is left of it, and they give
that back to the rightful owner.
That is just a rough illustration of how I think the public
generally perceives justice in the case of a theft. And none of
that, Mr. Chairman, seems to be working here. None of that
seems to translate to this little bit more complex issue we
have before us.
What I wanted to talk about more--and I realize we have
time constraints, and I am not going to be able to do that--
and, at some point, maybe if you would like to respond in
writing, any of you or all of you, what you think would help in
the reorganization of the SEC, any idea that any of you may
have for the reason it has taken years to determine whether or
not the victims qualify under SIPA--I mean the Securities
Investor Protection Act.
I think the investors deserve a timely ``yes'' or ``no''
answer: yes, to anticipate something good might happen; no, to
be able to come to grips with the reality that nothing good is
going to happen or get some closure or to have a grounds
challenge the decision, either one. But I think just keeping
them in the dark year after year is just adding insult to
injury and totally inexcusable.
If any of you know--and I would have liked to have heard
from your panel before the last one--how aggressively we are
pursuing the recovery of assets and why we are not utilizing
the clawback efforts that we did with Madoff?
And, when there are no consequences for bad behavior, it
encourages bad behavior. We had a similar case with a life
insurance company called TRG in Florida. They wrote policies in
49 States, Mr. Chairman. They were based in Indiana. They wrote
policies in every State but their own State because nobody had
ever crossed State lines to prosecute white-collar insurance
fraud before.
We did that. And to make a long story short, 13 different
agencies collaborated over State lines, and those two guys went
to prison. And we went from having two dozen companies doing
that in our State to having none of them doing it. When there
are consequences, people behave better. And there is just no
evidence that there is any consequences for all the bad
behavior in the agency.
So any insight that the three of you may have on that
issue, I would appreciate that, as well.
And I thank all of you for appearing here today and sharing
your insight with us. I am truly sorry for the hardships you
have suffered for doing the right thing.
Thank you, Mr. Chairman.
Chairman Neugebauer. I thank the gentleman.
And now the gentleman from Texas, Mr. Canseco, is
recognized for 5 minutes.
Mr. Canseco. Thank you, Mr. Chairman.
Mr. Kauffman, I gather you represent the group who is here,
some of my constituents too. And I congratulate your courage,
coming here before this committee. We don't bite, but we are
here to listen with you and sympathize with your situation and,
hopefully, help to solve it.
Now, if this SIPA were to come across with some funds, is
that going to help your situation out?
Mr. Kauffman. Congressman, if SIPA would come to fruition,
approximately 80 percent of the victims of the Ponzi fraud
would be made whole. And we would be one of them, yes.
Mr. Canseco. Okay. Are you in line in any way with regards
to the trustee who is handling right now the assets of
Stanford?
Mr. Kauffman. The receiver has about $70 million today. He
had $80 million when this started, and he has billed for $70
million.
Mr. Canseco. All right. So a lot of that is going into
administrative costs of the receivership or trustee, whatever
that is.
Mr. Kauffman. Yes, sir.
Mr. Canseco. When it should be really going towards paying
all of the victims of the Ponzi scheme. Is that correct?
Mr. Kauffman. Unfortunately, that is true.
Mr. Canseco. And do you know the name of the receiver?
Mr. Kauffman. I believe it is Ralph Janvey.
Mr. Canseco. Okay. And do you keep contact with the
receiver's office?
Mr. Kauffman. Not on a personal level. There is a Web site
you can go to see what is happening. But, no.
Mr. Canseco. Is there a procedure in place for making your
claim with a receiver?
Mr. Kauffman. There is a procedure, but we haven't gotten
back any information. We submitted it originally when this all
took place. It is so long ago, we just haven't heard anything.
Mr. Canseco. Again, I sympathize with your losses, all of
you. And I would also welcome you to be in touch with my office
and see how we can help you.
Brian O'Shea, would you raise your hand?
I represent Texas, but I represent all of you too. So
please make sure and contact us on that.
Mr. Rawl and Ms. Preuitt, I congratulate you for your
bravery. I know that you all stuck your necks out, and, to a
certain extent, it has been chopped. And I regret that
happened, and it shouldn't happen.
Mr. Rawl, you have mentioned that your cases with Stanford
and the arbitrator have been held in abeyance. Is there a
reason for that?
Mr. Rawl. I guess it is kind of pointless to prove Stanford
wrong in my case. It is already a foregone conclusion. There is
much bigger, exciting, more newsworthy cases, namely the
Ponzi--the unfortunate Ponzi scheme, than whether I am to
prevail in my allegations of fraud against the company.
But it is still open, and we have had a very valid
counterclaim and claim. And that is, of course, never to be
heard. We would never want to take money from the pool of money
that would go to the victims, in any case. So we would like it
to go away.
Mr. Canseco. Do you have an opinion as to why FINRA ruled
the way they did against you?
Mr. Rawl. Against the previous folks?
Mr. Canseco. No, against you.
Mr. Rawl. FINRA hasn't ruled.
Mr. Canseco. Why they sided with you in this--
Mr. Rawl. The arbitration process is unfair, and it is
biased toward the broker-dealer. The entire process favors the
broker-dealer, and there is no doubt about it.
The private nature should be questioned. And, certainly, if
there is an arbitration between a registered rep or advisor
like me in the firm, why should that be kept private? That can
be a good red flag to the public and give warnings and be a
good view into the firm to see if there is an inordinate amount
of potentially fraudulent business practices going on. I think
that would be a great way to warn the public.
But we sued in State court. That court case got remanded
back to the arbitration. And, unfortunately, all that did was
keep this hushed for a long time.
Mr. Canseco. Thank you very much for your bravery.
Mr. Rawl. Thank you.
Mr. Canseco. Ms. Preuitt, is there a reason why you think
that you are being shut off there in your department?
Ms. Preuitt. I think that management wants to support
management. She was more senior than I.
Nobody has really, from the Commission, discussed with me
what all happened, all the events leading up to my removal from
my position. And if they are basing their decisions mostly on
the person who retaliated against me, as to whether or not I
deserved it, it just strikes me as shortsighted, obviously.
Mr. Canseco. Again, thank you very much for your bravery,
and for being a whistleblower.
I yield back my time.
Chairman Neugebauer. I thank the gentleman.
And now the gentleman from Louisiana, Mr. Cassidy.
Mr. Cassidy. Again, as you all heard me say, first, I
congratulate you all and I commiserate with you all, on behalf
of all those in Louisiana who have either benefited or have
been penalized, such as you, Mr. Kauffman.
And, again, the theme of our office has been to have an
effective, transparent, compassionate response. I continue to
hear from each of you that none of those three measures have
been achieved.
Ms. Preuitt, you sent an investigator down to Houston, and,
in a half a day, that investigator can sense that this is a
Ponzi scheme. You are looking at their business model and the
stuff that they have publicly submitted, and you are saying,
this is not for real.
Why was it so complex that the office could not take it?
Ms. Preuitt. I have never really gotten a good answer to
that. Many different things were brought up to me, but none of
them seemed like a really good reason. So I think that the best
answer we ever could come up with was just that it was going to
be difficult.
Part of the reason that it was going to be difficult was,
if you wanted to pursue it only as a Ponzi scheme, that would
mean actually being able to prove where the money is going.
Since much of the money went to, supposedly, Antigua and the
Antiguan bank refused to give us the records, it was very
difficult to track all the money. We simply could get no
response from them regarding it.
Mr. Cassidy. But Mr. Kauffman--and I have heard this
before--said that a lot of the banks--was it a Memphis bank,
Mr. Kauffman?
Mr. Kauffman. Houston.
Mr. Cassidy. A lot of the money never left the United
States. Did the SEC not know that?
Where was the bank, Mr. Kauffman?
Mr. Kauffman. Houston.
Mr. Cassidy. Houston? I also thought there was also a
Tennessee bank.
But, anyway, that said, apparently a lot of the money
didn't--I should have asked before the other panel left, but
the SEC was clueless, or they ignored that, or that seemed
incidental?
Ms. Preuitt. No, the SEC was not aware, because the SEC did
not get a subpoena to take all the actions that it needed to
look to see what was happening at the firm.
Mr. Cassidy. Okay. What is kind of hanging out there is
whether Mr. Barasch engaged in criminal activity, whether he
was--let's just put it out there. It may not be true, but,
certainly, in my mind, I am wondering, did Stanford have a
protector?
Mr. Rawl, you got one heck of a resourced, researched
statement. Now, you mention that Stanford had employed as
general counsel a former head of the Fort Worth SEC office,
Wayne something. Oh, looking through the IG's report, I didn't
see that. I am thinking, ``Man, Rawl has done a great job.''
And I don't have his name down here, but, I am sorry,
Wayne--
Mr. Rawl. Wayne Secore.
Mr. Cassidy. Did Secore and Barasch have a personal
relationship? Do they play golf every Sunday?
Mr. Rawl. I do not know.
Mr. Cassidy. Okay. I just thought I would ask because,
again, I am sitting here thinking, it appears that Stanford was
being protected. Was there something beyond a fear of taking on
a complex case, which apparently an accountant can figure out
in a half an hour was something fishy? So I am looking for
another reason.
Mr. Rawl. In my written testimony, you will see that, at
the latest days, even weeks before the SEC filed suit, they had
problems--their problem was jurisdiction over a bank in
Antigua. That was one of the excuses that they used.
But, to be more responsive to your question, there are
different entities, and the U.S. Government had been
investigating different things over different periods of time.
There are a lot of questions as to what might be being covered
up.
Mr. Cassidy. Okay. And I don't mean to interrupt, but I
don't have much time. So I am going to--again, I have such
admiration for you.
The other agents--you mentioned there were about 30 folks
over time who complained and filed complaints against Stanford.
I think a lot of people want to know, should their agent have
known? Did you have a particular position that allowed you to
see that the business structure was not right? Or should
anybody working for Stanford have known that?
And I address that both to you, Ms. Preuitt, and to Mr.
Rawl.
Mr. Rawl. I was a financial advisor. I was not in
management. I was, once upon a time, fairly well-liked amongst
management and a lot of people at the firm, so I had friends in
all different departments. And those were the folks I gathered
intel from over time.
Mr. Cassidy. So you were a connector. So the person in the
front office, as in the retail office--somebody walks in and
says, ``Hello, how are you?'' I say, ``I am Mr. Smith; I am
going to help you today''--that person may not have known, but,
rather, your position as a connector kind of gave you that
ability. Is that you are saying?
Mr. Rawl. I gained a lot of information because of
friendships, more than most other advisors.
Mr. Cassidy. Okay.
Now, Ms. Preuitt, again, just to repeat, we heard from the
first panel a real effort to change the culture of the SEC.
What we are hearing from you, at least in your experience, is
that those efforts may not be bearing fruit.
Ms. Preuitt. I think that many of the efforts they are
making are certainly of value. But if you really want to get
the trust of the staff and the trust of the public that you are
making changes, then you have to make some tough decisions, and
one of those is actually holding people accountable for
inappropriate behavior. And that has not happened in this
situation. So, although I applaud many of the changes they are
trying to make, none of those will be of value.
Mr. Cassidy. Is it a question of due process? Is the person
on administrative leave, or are they, frankly, going scot-free
so far?
Ms. Preuitt. They are not only going scot-free, like I
said, they have been promoted. Additionally, right after the
report came out that there was retaliation against me, I
understand that both the people who retaliated against me
received a large bonus.
Mr. Cassidy. And can I have one more question, please?
Mr. Kauffman, I mentioned to the first panel--you are not
an attorney, but you are obviously a smart man. You know a heck
of a lot more about this than I do. So if you can answer this,
it is fine, but if not, that is okay.
The Commission is trying to decide whether or not there
will be SIPA coverage. And you pointed out that, as regards the
CD, the argument against giving SIPA coverage is that there was
an underlying asset, and so it is just that the asset was
overvalued, and that makes it different than the Madoff case,
where there actually were no assets.
But you have pointed out that there was a group of folks
who sold CDs for whom there was no underlying asset. If you
will, that is exactly the same as in the Madoff case.
Is the Commission treating those two sets of ``CD holders''
differently, i.e., those who had an asset with a fictitious
value versus those for whom there actually was no underlying
asset?
Mr. Kauffman. There is absolutely a difference in how they
are treating the two victims. We are being denied the coverage.
Mr. Cassidy. You are one of those guys who had no
underlying asset. Are you also being denied coverage?
Mr. Kauffman. Yes.
Mr. Cassidy. And what is the legal rationale for that?
Mr. Kauffman. We are waiting for an answer.
Mr. Cassidy. I yield back.
Chairman Neugebauer. I thank the gentleman.
I just have one follow-up question with Ms. Preuitt.
So you are in the Fort Worth office, and I believe your
title is--
Ms. Preuitt. My title is Assistant Regional Director.
Chairman Neugebauer. Where is your boss?
Ms. Preuitt. In the last couple of weeks, they have now
assigned me to a supervisor in Denver.
Chairman Neugebauer. So how is that working?
Ms. Preuitt. I am obviously--I don't feel like this is a
good resolution.
Chairman Neugebauer. So, you are in the Fort Worth office,
but they have just kind of fenced you off. Basically, you don't
have any responsibilities in the Fort Worth region at this
point in time.
Ms. Preuitt. Nothing that is defined. I have been searching
for work and finding projects that I can pitch in on, but, no,
I don't have any clearly defined--
Chairman Neugebauer. And so, what would you say that--how
do the other employees in that Fort Worth office relate to you?
Ms. Preuitt. Some have been afraid to relate to me. At
least one, in particular, after she was noted speaking with me,
she then was harangued for an hour about, in part, her
association with me. So some staffers are afraid to deal with
me.
I have had another very dear friend who was--we were so
close, she was actually there with me when my husband died,
some years back. We had a very close relationship. And she told
me that she felt like she was getting pushback for our
friendship and has essentially withdrawn her friendship because
she felt like it would place her in an uncomfortable position
at work.
It has been very difficult, very stressful.
I do have many supporters, though, and many examiners who
still seek me out for counsel and who would like to work with
me if I had supervisory authority and responsibilities again.
Chairman Neugebauer. Obviously, it doesn't send a signal
that, when you find an inequity in the organization, there is
reward in that, does it?
Ms. Preuitt. No. No, it doesn't. And I am proud of what I
have done. So it is very, very difficult to be treated this
way.
Chairman Neugebauer. This is a great panel.
I want to just ask any Members--oh, Mr. Cassidy.
Mr. Cassidy. Ms. Preuitt, while I was talking, my staff was
researching something and just handed this to me, and I just
want to speak with you.
This says that you testified at one point--let me see, I am
going to read this. This is from a blog, and blogs are a little
bit, they may be true, they may not be true, kind of like
Democratic Party press releases.
This says that the first referral by an SEC examiner was
sent to Barasch in 1998. According to the testimony of Julie
Preuitt, who authored the request, Barasch declined to
investigate after discussing the matter with Stanford's legal
counsel at the time, former SEC Fort Worth District
Administrator Wayne Secore.
Is that true?
Ms. Preuitt. I asked Mr. Barasch in--I think it was the
summer of 2009 why he had never pursued the case, because it
was never clear to me. And he told me it was that Wayne Secore,
who was representing Stanford at the time, and had told him
that there was nothing there.
Mr. Cassidy. I did not see that in the IG report. Now, I am
not criticizing the IG report--
Ms. Preuitt. It is in the IG report.
Mr. Cassidy. It is in the IG report. So I just missed that.
Okay.
Thank you again.
Chairman Neugebauer. Mr. Canseco?
Mr. Canseco. If I may just follow up with one question?
Chairman Neugebauer. Sure.
Mr. Canseco. Ms. Preuitt, was there ever any doubt in your
mind that the product sold by Stanford was a security?
Ms. Preuitt. No, I never doubted at all it was a security.
I would like to say Mr. Stanford liked to just misname things.
Because he called it a CD didn't mean it was a CD. Because he
called it a bank didn't mean it was a bank. It is sort of like,
I have a doghouse in the backyard, and instead I believed it
was a Ferrari. It doesn't matter how often I went out there, I
would never find the ignition switch, so--
Mr. Canseco. Why was there so much handwringing by FINRA,
for years, before they actually got involved in this?
Ms. Preuitt. I have never understood it. I had written up a
fair amount of information related to why I believed it was a
security and shared it with the SEC. I don't know that I ever
shared that information with FINRA.
But the reality was, it was not a bank. By Stanford's own
admission, the bank was not behaving any banking activities.
So, therefore, it would not meet the definition of a bank under
the 1940 Act. I also don't think it would have qualified as a
bank underneath Federal court cases that had come out that had
discussed when a CD was a CD or not, and one of them was it had
to be from a bank under a regulatory regime.
But the bank was not engaged in any banking activities, so
it was just--I never understood. It was a play on words. He
also said they didn't pay Commissions; he said it was just
referral fees.
Again, it was a nonsensical statement that he was making.
And why it would cause so much consternation, to me, seemed a
small interest in pursuing it. It is potential, maybe, that a
court would take a different view, but that should not stop you
from pursuing the case.
Mr. Canseco. Thank you very much.
Thank you, Mr. Chairman.
Chairman Neugebauer. I thank the panel. It has been a great
panel.
I thank the members.
And the Chair notes that some members may have additional
questions for this panel which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 30 days for members to submit written questions to these
witnesses and to place their responses in the record.
This hearing is now adjourned.
[Whereupon, at 2:20 p.m., the hearing was adjourned.]
A P P E N D I X
May 13, 2011
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