[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]
EXAMINING THE SETTLEMENT PRACTICES
OF U.S. FINANCIAL REGULATORS
=======================================================================
HEARING
BEFORE THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED TWELFTH CONGRESS
SECOND SESSION
__________
MAY 17, 2012
__________
Printed for the use of the Committee on Financial Services
Serial No. 112-128
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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
James H. Clinger, Staff Director and Chief Counsel
C O N T E N T S
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Page
Hearing held on:
May 17, 2012................................................. 1
Appendix:
May 17, 2012................................................. 57
WITNESSES
Thursday, May 17, 2012
Alvarez, Scott G., General Counsel, Board of Governors of the
Federal Reserve System......................................... 6
Galvin, Hon. William F., Secretary, Commonwealth of Massachusetts 44
Khuzami, Robert, Director, Division of Enforcement, U.S.
Securities and Exchange Commission............................. 8
Osterman, Richard J., Jr., Deputy General Counsel, Federal
Deposit Insurance Corporation.................................. 10
Painter, Richard W., Professor of Law, University of Minnesota
Law School..................................................... 46
Rosen, Kenneth M., Professor of Law, University of Alabama School
of Law......................................................... 48
Stipano, Daniel P., Deputy Chief Counsel, Office of the
Comptroller of the Currency.................................... 11
APPENDIX
Prepared statements:
Alvarez, Scott G............................................. 58
Galvin, Hon. William F....................................... 66
Khuzami, Robert.............................................. 74
Osterman, Richard J., Jr..................................... 84
Painter, Richard W........................................... 95
Rosen, Kenneth M............................................. 101
Stipano, Daniel P............................................ 109
Additional Material Submitted for the Record
Posey, Hon. Bill:
Written responses to questions submitted to Richard J.
Osterman, Jr............................................... 122
Written responses to questions submitted to Daniel P. Stipano 125
Watt, Hon. Melvin:
Letter to Senator Jack Reed from SEC Chairman Mary L.
Schapiro, dated November 28, 2011.......................... 127
EXAMINING THE SETTLEMENT PRACTICES
OF U.S. FINANCIAL REGULATORS
----------
Thursday, May 17, 2012
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 10:02 a.m., in
room 2128, Rayburn House Office Building, Hon. Spencer Bachus
[chairman of the committee] presiding.
Members present: Representatives Bachus, Hensarling,
Manzullo, Garrett, Neugebauer, Campbell, McCotter, Pearce,
Posey, Luetkemeyer, Huizenga, Hayworth, Renacci, Hurt, Dold,
Schweikert, Grimm, Canseco; Frank, Waters, Maloney, Velazquez,
Watt, McCarthy of New York, Miller of North Carolina, Scott,
Green, Cleaver, Ellison, Himes, and Carney.
Chairman Bachus. The committee will come to order.
Today's hearing of the Financial Services Committee is
entitled, ``Examining the Settlement Practices of U.S.
Financial Regulators.'' Our first panel consists of: Mr. Scott
Alvarez, General Counsel of the Board of Governors of the
Federal Reserve System; Mr. Robert Khuzami, Director of the
Division of Enforcement for the U.S. Securities and Exchange
Commission; Mr. Richard Osterman, Deputy General Counsel of
Litigation and Resolution for the Federal Deposit Insurance
Corporation (FDIC); and Mr. Daniel Stipano, Deputy Chief
Counsel of the Office of the Comptroller of the Currency.
I would like to welcome all you gentleman, and we
appreciate the good work you do on behalf of the United States.
At this time, we are going to have our opening statements,
and I will begin.
Under our system, Federal agencies that initiate
enforcement actions against alleged bad actors have the option
of settling their cases before going to trial. Typically, these
agencies elect a settlement in order to quickly impose a
monetary fine or institute remedial action, rather than proceed
with lengthy trials that can have unpredictable outcomes.
Often, the fines and penalties assessed against the
defendants are returned directly to the investors who have
allegedly been harmed, sometimes months or years before any
funds would have been distributed if the case had gone to trial
instead.
It is common practice at many Federal agencies, some of
which are represented at today's hearing, to permit defendants
to ``neither admit nor deny'' wrongdoing or liability when
settling the government's claims. This allows the defendant to
avoid providing ammunition to private plaintiffs in suits
related to the same conduct at issue in the Federal case, and
facilitates settlements where the government concludes that its
interests are better served by avoiding the expense and
uncertainty of lengthy legal proceedings.
Late last year, their practice came under scrutiny when
Federal District Judge Jed Rakoff rejected a $285 million
settlement agreement between the SEC and Citigroup Capital
Markets in a case involving Citi's marketing of certain
mortgage-backed securities. In rejecting the settlement, Judge
Rakoff stated that it was neither fair nor reasonable nor
adequate nor in the public interest, because the proposed
settlement did not include an admission of wrongdoing.
The SEC and Citigroup jointly appealed this decision and in
March of this year, the Second Circuit Court of Appeals
temporarily stayed Judge Rakoff's order. The Court of Appeals
stated that it had no reason to doubt the SEC's representation
that the settlement it reached is in the public interest and
that it was ``commonplace for settlements to include no binding
admission of liability.'' It is not the function of Federal
courts to dictate policy to executive administrative agencies.
The appellate court concluded that, ``The SEC and Citigroup
have a strong likelihood of success in their joint effort to
overturn the district court's ruling.''
While this is a complex issue, I believe that on balance,
the appellate court's analysis was the correct one, a policy
that has judges micromanaging Federal agencies' exercise of
their enforcement authority and requiring the government to
engage in lengthy and expensive trials in every instance would
not serve the best interests of taxpayers or investors.
As a former trial attorney, I can assure you that the
results of a trial are never certain. They are also exhausting
in both resources and energy. It therefore makes more sense, in
my view, to leave the judgment of whether to try a case or
attempt to settle it largely to the agency's discretion rather
than shifting that responsibility to Federal judges.
The agency is most knowledgeable about the merits, value,
and difficulty of the case they are bringing. One can always
second-guess but should do so with caution when second-guessing
one in a better position to make that judgment call.
Having said that, I realize that some have raised concerns
about these settlement practices, and I am pleased we are able
to examine this issue today in a bipartisan way. I thank the
ranking member for working in a collaborative way to put this
hearing together, and I will recognize him at a later time.
But at this time, I will recognize Congresswoman Waters,
the ranking member of the Capital Markets Subcommittee.
Ms. Waters. Thank you very much, Mr. Chairman, for holding
this important hearing today.
Last November, when Judge Rakoff rejected a negotiated
settlement between the Securities and Exchange Commission and
Citigroup, it captured the attention of the public and really
focused us, in Congress, on just how frequently our financial
regulators enter into ``neither admit nor deny'' settlements
with the firms they regulate.
These settlements, as you know, result in the defendant
paying a fine but not admitting any wrongdoing. I understand
that the Commission is constrained on how many cases they can
prosecute because of budget concerns. I know that the SEC is
often outgunned in terms of resources when they go up against
the industry, and I know that Chairman Schapiro has advocated
for legislative changes to empower the SEC to collect
additional fines against recidivist offenders.
Finally, let me be clear in saying that I will continue to
fight for the SEC to have the resources it needs. But with that
said, I remain concerned about the frequent use of the
``neither admit nor deny'' settlements. While I know the SEC
sometimes has a strong interest in settling cases quickly in
order to get money into the hands of defrauded investors, the
Commission also has a broader responsibility to enforce the
rule of law.
Settlements should never be viewed as just another cost of
doing business, and I fear that could be the case. When no
wrongdoing is admitted, it encourages repeat offenses. In fact,
a recent New York Times analysis of enforcement actions brought
by the SEC during the last 15 years found at least 51 cases in
which 19 firms had broken antifraud laws they previously had
agreed never to breach.
Finally, to address our banking regulator settlement
practices, let me note that I am concerned about the mortgage
servicing concept orders the OCC and the Federal Reserve Board
entered into with 14 banks and mortgage servicers, and I am
eagerly anticipating the results of a GAO study that I
requested on this topic.
I look forward to exploring this topic more fully today and
hearing our regulators' perspective on this important issue, as
well as the views of the other witnesses, and I thank you.
Mr. Chairman, I yield back the balance of my time.
Chairman Bachus. Thank you, Congresswoman Waters.
At this time I recognize the chairman of the Capital
Markets Subcommittee, Mr. Garrett, for 2 minutes.
Mr. Garrett. I thank the chairman, and I thank the panel
also for coming today. Although I will say this, I am a little
bit skeptical as to what the actual motivation is for holding
today's hearing. I understand that the Minority wanted to have
this hearing to use it as a forum, if you will, to try and
pressure the SEC not to exercise its legal discretion to enter
into settlement agreements with banks because they think that
those cases should be tried in court instead.
This strikes me as nothing more than political opportunism,
if you will, especially when one considers that these same
individuals on the other side never miss a chance to voice
their opposition when Republican bills try to curb any
discretion by the SEC in the rulemaking process.
Is this a double standard? I think it is. I think
suggesting that Congress interfere with the SEC discretion to
determine whether to spend taxpayer money on protracted
litigation or to settle a case based on the facts that the
lawyers in the Division of Enforcement have evaluated is
irresponsible.
According to a Harvard Law School article, over 95 percent
of lawsuits in the U.S. courts settle before they go to trial.
Why is that? Because trials are time-consuming, expensive,
risky, and unpredictable.
The SEC understands this reality, and it acts in the best
interests of investors and taxpayers when it settles those
cases, despite what some other people might think. The fact
that my colleagues on the other side of the aisle are even
considering putting pressure on the SEC to use taxpayer money
to go to trial instead of trying to reach settlements makes me
question the actual motive, as I said at the start.
Do they want to bleed the SEC of funds so that they can
come back and justify spending more money elsewhere, or are
they letting the trial attorneys know that, well, they haven't
been forgotten. Or is this really some sort of a gimmick
designed to appease the base of their party that blames all
society's ills on the banks?
Whatever the reason, the suggestion that this body should
substitute its judgment for the judgment of the SEC lawyers who
are privy to the facts and the circumstances of each individual
case involving complex financial transactions, in my opinion,
is completely misguided.
With that, I yield back.
Chairman Bachus. Thank you. Mr. Khuzami, since he has been
in such a supportive mood of the SEC, you ought to the ask him
for some more money.
Mr. Khuzami. Can we have some more money?
Mr. Garrett. You are doing such a good job in this area, I
think that--
Chairman Bachus. Thank you.
I now recognize Mrs. Maloney, the ranking member of the
Financial Institutions Subcommittee.
Mrs. Maloney. Thank you, Mr. Chairman, and welcome to the
witnesses today.
While many agree that investors are entitled to restitution
as a result of agency actions against institutions, there are
still concerns about how to make those investors whole and how
to ensure they help prevent future wrongdoing.
One particular case has drawn the committee's attention to
this issue and serves as the basis for this hearing, the
rejection by the U.S. District Court of an SEC settlement in
which there was no admission of wrongdoing. While I believe
that admissions of guilt are more likely to be a deterrent, we
must keep in mind the needs of investors who have been harmed
in their ability to be made whole.
Agency settlements return money to harmed investors quickly
and allow the SEC to continue suits against individuals it
believes have been fraudulent. However, I am sympathetic to
Judge Rakoff's view that we do not want these settlements to be
viewed as ``a cost of doing business,'' and that they have
little impact on future behavior.
There are many who believe we should follow Judge Rakoff's
lead and require companies to admit wrongdoing in these cases,
but I will be interested to hear from the witnesses today
whether they believe this could lead to fewer settlements and
could do a disservice to investors. The reality is that the
budget this Congress has allotted the SEC is not enough to fund
lengthy legal battles.
Settlements, which happen much more quickly with an
expenditure of fewer resources, are often the only available
route for the Commission to take. And I would underscore that
the SEC's budget has been cut and they have been given greater
responsibilities under Dodd-Frank, and they have not even
completed the rulemaking that they are required by law to do.
So they definitely need more resources to handle the challenges
ahead of them.
I look forward to the perspectives of the witnesses today
on this issue, and I thank you all for being here. And I thank
you for calling the hearing, Mr. Chairman.
Chairman Bachus. Thank you. At this time, I recognize the
gentleman from Illinois, Mr. Dold, for 1 minute.
Mr. Dold. Thank you, Mr. Chairman. I certainly appreciate
it, and I want to thank the witnesses for your time, your
testimony, and your experience. I appreciate that.
To say the least, I think that most in the legal and
regulatory community were surprised when the district court
rejected the SEC settlement with Citigroup because Citigroup
did not admit wrongdoing as part of the settlement. Of course,
nearly all formal regulatory proceedings result in a voluntary
settlement with the defendants not admitting to liability. So
this district court ruling seems unprecedented.
As I see it, a legal standard that requires wrongdoing
admissions from the defendant as a condition of settling
regulatory proceedings will diminish the number of settlements
to something very close to zero. And the implications of a
significant reduction in the number of voluntary settlements
would seem to have some meaningful negative implications for
all concerned: the victims; the taxpayers; the regulatory
agencies; the courts; and the litigants themselves.
So I look forward to hearing from our witnesses today as to
what the implications are going to be.
Mr. Chairman, I yield back.
Chairman Bachus. Mr. Canseco for 1 minute.
Mr. Canseco. Thank you, Mr. Chairman. Mr. Chairman, the
mission of the SEC is to maintain fair, orderly, and efficient
markets and to facilitate capital formation.
Needless to say, there remains a serious question as to
whether the agency settlement policies help fulfill this
mission. Yet, there is a greater question about the direction
the SEC has taken over the last several years. Almost half of
the agency's budget goes towards enforcement and examination
and, in turn, it appears that the agency believes pursuing
headline-grabbing settlements is the best way to protect
investors.
The measure of a Federal agency's success should not be how
much enforcement revenue it brings in after wrongdoing has
already occurred; rather, in the case of the SEC, it should be
whether fair, orderly, and efficient markets are being
maintained.
And with that in mind, I look forward to hearing from our
witnesses today on this matter.
I yield back.
Chairman Bachus. Mr. Green is recognized for up to 4
minutes.
Mr. Green. Thank you, Mr. Chairman. I assure you I will not
use the entire 4 minutes. I thank the ranking member as well.
And I thank the witnesses for appearing.
I think that we are at a point where we have at least one
question that has to be answered: Are we going to allow
megabusinesses to build into their bottom line acts that
constitute violations of the law? A settlement is a good thing,
but the question is, are we at a point now where businesses can
simply sit and plan and conclude that we will have ``X'' number
of settlements, ``X'' amount of damages possibly, and as a
result, let's prepare for this knowing that we can cover and
move on? There has to be some means by which businesses that
settle these lawsuits also see themselves as being held
accountable for wrongdoing. Wrongdoing cannot take place and
become a part of a bottom line.
I look forward to hearing the witnesses explain to us how
we can prevent wrongdoing from being a part of the bottom line,
and I yield back the balance of my time.
Chairman Bachus. Are there any other Members on the
Democratic side who wish to be recognized? If not, we will hear
from our witnesses. Each of your written statements will be
made a part of the record, and you will be recognized for a 5-
minute summary.
We will begin with you, Mr. Alvarez.
STATEMENT OF SCOTT G. ALVAREZ, GENERAL COUNSEL, BOARD OF
GOVERNORS OF THE FEDERAL RESERVE SYSTEM
Mr. Alvarez. Thank you. Chairman Bachus, Congresswoman
Waters, and members of the committee, thank you for the
opportunity to discuss the Federal Reserve's enforcement
program.
Authority to take enforcement actions is one of the
important tools that Congress has provided the Federal Reserve
to require financial institutions under its jurisdiction to
address serious problems or risks and comply with the banking
laws.
The Federal Reserve employs a variety of formal and
informal tools for addressing supervisory concerns found at
financial institutions under our jurisdiction. The backbone of
our supervisory tools is the examination process. Many problems
are identified and corrected during the course of regularly
occurring examinations while our examiners are still on-site at
the institution.
Improper conduct that cannot be immediately addressed may
also be noted in the institution's examination report or in a
supervisory letter as a matter that requires management's
attention and corrective action. If a problem requires a more
detailed resolution or is more pervasive at an institution, the
Federal Reserve may enter into a memorandum of understanding in
which the board of directors commits to specific corrective
actions. These informal tools comprise the most common methods
for identifying and addressing unsafe and unsound practices and
correcting alleged violations of the banking laws.
On occasion, the Federal Reserve has also confronted
situations where financial institutions management refuses to
correct an improper practice or to comply with applicable laws
or where the practice or alleged violation is so serious that
normal recourse to informal supervisory methods is not
appropriate or sufficient.
In these cases, the Federal Reserve will enter into a
formal written agreement or impose a formal order directing the
financial institution to cease and desist from engaging in the
improper or prohibited conduct. These formal agreements and
orders also require the institution to take specified
corrective action and, where appropriate, to make restitution
to third parties harmed by the wrongful conduct. We may also
assess a civil money penalty against the offending party.
Finally, the Federal Reserve may remove an individual from
the banking institution and prohibit that individual from
participating in banking at other financial institutions.
Over the past 10 years, the Federal Reserve has taken
nearly 1,000 formal public enforcement actions. This includes
more than 600 written agreements and 100 cease-and-desist
orders against institutions subject to our jurisdiction. It
also includes the permanent ban of more than 80 individuals
from the banking industry. More than 100 of these actions
involved imposing civil money penalties and restitution
payments totaling more than $1.2 billion.
The vast majority of the Federal Reserve's formal
enforcement actions are resolved upon consent. The Federal
Reserve typically sets out summary recitations of the relevant
facts in whereas clauses. However, like our fellow banking
regulators, it has not been our practice to require formal
admissions of misconduct.
Requiring admissions of guilt as a condition of entering
into a consent action we believe would have a deleterious
effect on our supervisory efforts by causing more institutions
and individuals to contest the requested relief in formal
administrative proceedings, which typically take years to reach
resolution. That would substantially impede and delay
implementation of necessary corrective action and potentially
harm the financial institution and the financial system.
Moreover, safety and soundness concerns typically do not
give rise to third-party claims. Thus, the effectiveness of the
regulatory framework established for financial institutions
does not depend on actions brought by third parties to enforce
their rights under the regulatory scheme. In those few cases
where an enforcement action cannot be resolved by consent, the
Board may issue a formal notice of charges that sets forth the
factual basis for the remedies sought by the Board.
The respondents in these cases are then accorded the
opportunity to request a formal trial-like hearing before an
administrative law judge. Only 11 of the nearly 1,000
enforcement actions taken by the Federal Reserve in the last
decade were challenged by an administrative law judge. Only one
of these actions has been contested in court.
The Federal Reserve works closely with other Federal and
State banking regulators as well as Federal and State law
enforcement agencies on enforcement matters that raise issues
that straddle our respective jurisdictions.
We also refer matters to other appropriate Federal and
State agencies, including law enforcement authorities. The
Federal Reserve's enforcement authority is a critical component
of our ability to encourage safe and sound banking practices in
compliance with the banking laws, and I thank the committee for
the opportunity to provide this information. I am happy to
answer any questions.
[The prepared statement of Mr. Alvarez can be found on page
58 of the appendix.]
Chairman Bachus. Thank you. Mr. Khuzami, before I call on
you, let me say this: I am aware that we have a panel with
three safety and soundness agencies and one disclosure agency.
So there are some differences there. But while we are
discussing this, there are also many similarities, so we have
put the panel together but there are differences, which I
recognize.
Mr. Khuzami?
STATEMENT OF ROBERT KHUZAMI, DIRECTOR, DIVISION OF ENFORCEMENT,
U.S. SECURITIES AND EXCHANGE COMMISSION
Mr. Khuzami. Thank you, Chairman Bachus, Ranking Member
Waters, and members of the committee. Thank you for the
opportunity to testify on behalf of the United States
Securities and Exchange Commission on the subject of our
settlement practices.
The Division of Enforcement recommends a settlement to the
Commission only where we believe the settlement agreement that
we have negotiated after months or years of painstakingly
detailed investigative work is within the range of outcomes
that we reasonably could expect if we litigated the case. In
making that decision, we consider many factors, including the
strength of the evidence and the potential defenses, the delay
in returning funds to harmed investors caused by protracted
litigation, and the resources required for trial, including the
opportunity costs of litigating rather than using those
resources to investigate other cases and protect other victims.
This approach serves the goals of the Commission's
enforcement program by first protecting investors, by returning
their money with increased speed and certainty, and by more
quickly getting bad actors out of the business by imposing bars
that prohibit them from continuing to work in the industry or
serving as an officer or director of a public company.
Second, it enhances deterrence and accountability because
we outline publicly in detail both the wrongdoer and the
wrongdoing, which the wrongdoer is prohibited from denying, by
obtaining large sums of money in disgorgement and penalties, by
frequently barring wrongdoers from working in the industry, and
by imposing, where appropriate, business reforms to prevent
companies from engaging in future wrongdoing, all accomplished
while the misconduct is fresh in the public's mind as opposed
to years later after a trial.
This package of sanctions leaves little, if any, doubt in
the public's mind that the securities laws have been violated
and that other would-be violators should think twice before
crossing the line. In our view, going the further step of
requiring admissions of liability in every case from defendants
would come at a high cost of delay: delay in bringing
wrongdoers to justice; delay in returning funds to harmed
investors; and delay in investigating other frauds and
protecting other victims, all for a purported benefit that we
believe is largely already achieved through our settlements.
For example, in the Citigroup settlement, the Commission
obtained most of what it could have obtained after a successful
trial, including injunctive relief, business reforms, charges
against the person responsible for the transaction, and a $285
million payment to be returned to harmed investors, an amount
which represented 81 percent of what we could have gotten in
the best case had we prevailed at trial and been awarded full
remedies.
And the bank issued a statement in connection with the
settlement saying, in effect, that, ``We hope to be a stronger
bank with better risk management controls in the future.''
Given that statement and given the totality of the settlement,
it is not clear to me what an admission would add or whether it
would be worth the cost of delay and resources.
Nonetheless, the district court rejected our proposed
settlement because it claimed we lacked facts obtained by
admissions or by trial. But in granting our motion to stay the
proceedings, the court of appeals ruled that it knew of no
precedent for requiring admissions, that the SEC correctly
considered the value of the settlement, the perceived
likelihood of obtaining a still better settlement, the prospect
of coming out better or worse at a trial, and the resources it
would need to be expended in that attempt, and that it saw no
reason to doubt that the Citigroup settlement was in the public
interest.
Whether in the Citigroup case or in any of our other
financial crisis cases, where today we have filed actions
against 102 individuals and entities, including 55 CEOs, CFOs,
or senior corporate officers, and we have obtained orders of
more than $2 billion in disgorgement, penalties, and monetary
relief, we will recommend a settlement only where it makes
sense and it serves the public interest, not because we lack
options.
If the settlement doesn't reach our standards, we will not
recommend it or the Commission will simply reject it. In either
case, we will litigate.
In our financial crises cases, 75 percent of our cases
against individuals were filed as litigated matters. Since June
2011, our trial unit in Washington has seen an increase of over
50 percent more actively litigated matters.
And when we litigate, we typically prevail. Our record in
litigation victories--we have prevailed in over 80 percent of
our trials since the beginning of Fiscal Year 2011--sends a
strong message to defendants and enhances our settlement
negotiating posture.
However, litigation requires resources. The cost of trials,
both in terms of the thousands of staff time hours and other
out-of-pocket costs such as expert witnesses, can be
exorbitant. That is why we believe it is wiser to save our
resources by demanding settlements approximating what we could
expect to achieve at trial and spending those saved resources
on fighting other frauds or litigating when a settlement does
not meet our standards. With this approach, more investors get
more protection more of the time.
Thank you, and I would be happy to answer any questions.
[The prepared statement of Mr. Khuzami can be found on page
74 of the appendix.]
Chairman Bachus. Thank you. And let me apologize, I am
always calling you ``Khuzami,'' instead of ``Khuzami,'' and my
staff corrects me every time. Obviously, it didn't do any good.
I will practice in front of a mirror before the next hearing.
Mr. Khuzami. That is all right. It happens a lot.
Chairman Bachus. Mr. Osterman?
STATEMENT OF RICHARD J. OSTERMAN, JR., DEPUTY GENERAL COUNSEL,
FEDERAL DEPOSIT INSURANCE CORPORATION
Mr. Osterman. Good morning, Chairman Bachus, Congresswoman
Waters, and members of the committee. Thank you for the
opportunity today to testify on behalf of the Federal Deposit
Insurance Corporation about our settlement practices.
In my testimony today, I will discuss the FDIC's approach
to enforcement and the tools we have available, as well as the
public interests benefits derived from our enforcement policies
and procedures. The core mission of the FDIC is to maintain
stability and public confidence in the Nation's banking system.
As recent events have reminded us, the financial condition
of banks influences the economy in direct, substantial, and
often immediate ways. Mindful of this, the FDIC's supervision
of insured depository institutions focuses on promptly
correcting unsafe and unsound practices, violations of law, and
breaches of fiduciary duty.
Among the banking regulators, the combination of FDIC's
responsibilities as supervisor, insurer, and receiver is
unique. As supervisor, the FDIC is the primary Federal
regulator for approximately 4,100 State nonmember banks, as
well as over 400 State-chartered savings associations, and
ensures the FDIC has backup enforcement authority for the rest
of the over 7,000 FDIC-insured depository institutions.
In addition, the FDIC acts as receiver for all failed
insured depository institutions, and under Dodd-Frank we have
substantial responsibilities for large, complex financial
companies that may pose a systemic risk to our financial
system. The FDIC, like the other Federal banking agencies, has
been given very strong enforcement powers under Section 8 of
the Federal Deposit Insurance Act. These powers are used when
corrective action is needed to protect the public interest.
The vast majority of our cases are resolved through
stipulated settlements which achieve our statutory
responsibilities and protect the public interest without
admissions of liability. Indeed, requiring a respondent to
specifically admit the alleged conduct in a settlement may have
the unintended consequence of delaying prompt relief and
corrective action.
One of the corrective actions Congress has granted the
agency is the authority to remove and prohibit individuals from
banking when warranted under statutory authority. Under this
authority found in Section 8(e) of the Federal Deposit
Insurance Act, the agency has issued hundreds of removal and
prohibition orders against insured affiliated parties who were
determined to have dishonestly or recklessly engaged in
violations of law.
An AE order prohibits the individual from participation in
any manner in banking under a lifetime industry ban. This
powerful tool serves to address past conduct while also
protecting the industry as a whole. Furthermore, a person
subject to stipulated removal and prohibition is precluded from
participating in banking immediately upon the order's issuance.
Stipulated civil money penalty orders often accompany
removal and prohibition actions as a means of further
deterrence. The FDIC uses its enforcement authority to assess C
and Ps against institutions and institution-affiliated parties
where we have found violations of law and unsafe and unsound
practices or breach of a fiduciary duty, under a progressive
increase in the penalty amount based on the egregiousness of
the conduct involved.
Cease-and-desist orders are used as another enforcement
tool for corrective action. For example, when banks are in
troubled conditions, such orders allow us to quickly implement
a detailed corrective program, which serves as a virtual
roadmap for the institution to follow to correct practices and
to raise capital to return the institution to a safe and sound
condition. We believe that prompt action in such cases is
essential to avoid loss to the insurance fund and cost the
communities into the economic system as a whole that arise when
a bank fails.
Additionally, we have the power through cease-and-desist
actions to order affirmative relief, including ordering an
institutions or an institution-affiliated party who has
unjustly been enriched to make restitution. And the power to
seek restitution can be particularly important when an
institution or institution-affiliated party violates consumer
protection laws and regulations.
In these consumer cases, orders for restitutions are
vehicles for consumer redress and the FDIC has an interest in
issuing such orders as quickly as possible.
The FDIC also brings professional liability cases as a
receiver for banks that have been closed by Federal or State
regulators where our investigations uncover facts that support
such actions. These cases, which promote good corporate
governance and discipline, serve a very different purpose than
the enforcement cases that I have addressed thus far.
The professional liability cases are civil tort and
contract actions and are intended to maximize recoveries for
the receivership at stake in keeping with the statutory
priorities set out by Congress.
In conclusion, we believe the FDIC's process accomplishes
its statutory responsibilities and purpose while ensuring that
actions it takes serve the public interest promptly and
effectively.
We would be happy to answer any questions. Thank you.
[The prepared statement of Mr. Osterman can be found on
page 84 of the appendix.]
Chairman Bachus. Thank you.
Mr. Stipano?
STATEMENT OF DANIEL P. STIPANO, DEPUTY CHIEF COUNSEL, OFFICE OF
THE COMPTROLLER OF THE CURRENCY
Mr. Stipano. Thank you, Mr. Chairman, and members of the
committee.
I welcome the opportunity to appear before you today to
discuss the OCC's supervisory and enforcement authorities and
process.
The OCC vigorously uses its authorities to protect the
safety and soundness of national banks and Federal savings
associations and to ensure fair treatment of customers. The OCC
and the other Federal bank agencies have a broad range of
supervisory and enforcement tools to achieve this purpose.
My written statement today covers the OCC's activities and
perspectives on enforcement in three areas. The first is our
overall approach to enforcement. The OCC's enforcement process
is intertwined with our supervision of the institutions we
regulate. These institutions are subject to comprehensive,
ongoing supervision that, when it works best, enables its
examiners to identify problems early and obtain corrective
actions quickly.
Once problems or weaknesses are identified, we expect
management and the board of directors to correct them promptly,
and institutions usually take the corrective steps necessary to
address problems or weaknesses before they develop into more
serious issues problems that adversely affect their financial
condition or their responsibilities to their customers.
That is not always true, however, and in some cases the
seriousness of the problem requires a heightened enforcement
response. In those circumstances, we have a range of
enforcement tools at our disposal, from informal enforcement
actions such as a commitment letter or memorandum of
understanding to formal enforcement actions such as a formal
agreement, cease-and-desist orders, or removal and prohibition
order.
We use all of these tools, depending on the circumstances,
to swiftly and forcefully require correction of unsafe or
unsound practices and violations of law. These include actions
taken to address a wide range of issues including capital
adequacy, managerial competency, asset quality, earnings, and
fair treatment of customers.
The second part of my testimony describes the process we
employ to initiate and resolve enforcement actions. When
circumstances warrant enforcement actions, it is important that
the OCC take such actions as soon as practical. Prompt and
effective action is critical to ensuring that institutions take
immediate corrective and remedial measures to ensure safety and
soundness and protect depositors and customers. The OCC follows
a well-established process for initiating and resolving
enforcement actions that promotes its supervisory goals.
In resolving cease and desist, civil money penalty, and
removal in prohibition actions, it is the OCC's long-standing
practice to present the actions in the form of a proposed order
or a proposed order and stipulation in the case of C&D. A
proposed order or stipulation includes the Comptroller's
findings supporting an action and a statement that the
institution or individual neither admits nor denies wrongdoing.
In the vast majority of cases, OCC enforcement actions are
resolved by consent. However, in those relatively rare cases
where a negotiated settlement cannot be reached, the OCC will
initiate an administrative proceeding by serving a notice of
charges on the institution or individual.
Permitting the institution or individual to settle the case
without admitting or denying wrongdoing facilitates the
imposition of an enforceable order at a point where, in many
instances, the problems are still manageable and can be
corrected.
If the OCC were to insist on an admission of wrongdoing, it
would prolong settlement negotiations and increase the number
of respondents who choose to litigate the merits of the action.
Even if the OCC is successful in litigation, it could be
several years before an order is issued.
In the meantime, the institution's condition could continue
to worsen and the institution might ultimately fail if the
institution continues to engage in unsafe or unsound practices,
or in a consumer protection case restitution owed to victims
could be substantially delayed while new victims arise each day
that the violation goes uncorrected.
In either case, resources of an institution that could have
been used to fix the problem are instead diverted to financing
litigation.
The third part of my statement describes how the OCC
coordinates with State and Federal regulatory agencies and with
law enforcement agencies in enforcement cases. As further
explained in my statement, the OCC coordinates closely with
many Federal agencies and regularly shares information with
State and Federal agencies pursuant to interagency information-
sharing agreements.
Thank you very much. I will be happy to answer any
questions you may have.
[The prepared statement of Mr. Stipano can be found on page
109 of the appendix.]
Chairman Bachus. Thank you. I would like to compliment the
entire panel for your opening statements. I thought they were
very educational.
Mr. Khuzami, can you give me an estimate of the length of
time between bringing an action and a consent settlement and
then the amount of time between bringing an action and, if it
is litigated, and the final judgment?
Mr. Khuzami. The time from opening an investigation to
completing it and coming to a settlement is largely a function
of the complexity of the case. But leaving aside those matters
that we bring on an emergency basis to halt ongoing fraud or
wrongdoing, it is typically in the 1- to 3-year range, I would
suspect.
If you file it as a litigated case, the time from that
point through trial, I think that we are in the range of the
general stats for civil cases generally, which tend to be more
in the 2- to 4-year range, which does not include appeals.
Chairman Bachus. And with the appeals, how much does that
prolong recovery by the investors?
Mr. Khuzami. If the appeal was taken, that typically can be
another year to 3 years as well.
Chairman Bachus. So the investor recovers much quicker in
the case of a settlement, consent settlement, in most cases, in
two comparable cases in complexity?
Mr. Khuzami. That is absolutely right.
Chairman Bachus. How about the cost of enforcement or the
cost of obtaining a consent settlement as opposed to the cost
of litigating just in two similar cases?
Mr. Khuzami. Obviously, you would have to spend the
resources to get the settlement, but if you didn't, you chose
to litigate rather than settle, we don't quantify it in that
way, but I can tell you that it is thousands of hours of staff
time in a complicated matter, expert witness fees, which are
just one expense in the litigation, particularly in complicated
financial transactions. It is not unusual for that to cost
seven figures, and I can tell you that there are probably
better metrics on the defense side where I have seen statistics
that indicate the defendants can spend $5 million or $10
million or $15 million litigating a case. So it is a
considerable expenditure of resources. If it is a small case
with half a dozen witnesses in a 3-day trial, obviously it
would be less.
Chairman Bachus. What are the factors in deciding whether
to settle an enforcement action or procedure?
Mr. Khuzami. As I indicated, it really comes down
fundamentally to whether we can get in a settlement everything
that we reasonably could hope to get if we were to go to trial
and win, taking into account, as we must, the strength of the
evidence, the defenses, the judge and all the other factors.
And it is only when we meet that standard, really, do we settle
a case.
If we don't meet that standard, we will litigate, because
obviously if you don't have a legitimate trial threat, if you
don't communicate to the targets of your investigation that you
are prepared to go to trial, then you can be exploited,
defendants will simply hold off for a softer settlement and not
fear the alternative. But in our case, we are fully prepared to
litigate, and we are doing more of it.
Chairman Bachus. All right. Thank you. Congresswoman
Waters?
Ms. Waters. Thank you very much, Mr. Chairman.
Mr. Khuzami, I would like to ask you about the Residential
Mortgage-Backed Securities Working Group. There is some more
information in the newspapers, I guess as of today, where
Elizabeth Warren expresses no confidence in the current bank
accountability measures. On April 26th, I led about 40 Members
of Congress in writing to you and the other co-chairs of the
Residential Mortgage-Backed Securities Working Group about my
concerns that this important task force was stalled, that you
didn't have the resources you required, and about the need for
a strong executive director, to be clear. Does the RMBS Working
Group have the resources you need to carry out your mission?
Can you tell me as part of this RMBS task force work what--
can you say whether if SEC will enter into these ``neither
admit nor deny'' settlements. With the firms you are
investigating, I believe that it is important for the SEC to
litigate some of these cases under the umbrella of this task
force, given the commitment to justice and the promises that
were made about this task force when the President made his
State of the Union Address.
Are you concerned that the task force still has not
appointed an executive director? When can we expect an
announcement on this? Your budget justification requested a
total of 56 new full-time equivalent provisions in your
Enforcement Division. Are any of these positions being
specifically assigned to this task force and are any of the
existing SEC employees being shifted to exclusively work on
this task force?
The reason I am pressing on this is that we have had this
subprime meltdown in this country which created this recession.
We have all of these foreclosures, and we don't have loan
modification standards that services are employing. We are
trying to keep homeowners in their home. We want to know what
went wrong in many of our financial institutions.
We have been making a lot of promises. What is happening
with this task force? Is it working? Where is the executive
director? Can you explain to me what is going on?
Mr. Khuzami. Sure, Congresswoman. First, from the
Securities and Exchange Commission's perspective and, as you
see from our statistics, we have brought a significant number
of financial crisis-related cases, 101 entities and
individuals, 55 high-ranking CEOs and officer--
Ms. Waters. Yes, but now you are part of a task force.
Mr. Khuzami. Understood. I just want you to know that there
is a record of productivity.
Ms. Waters. Yes, but I want you to know I only have so much
time.
Mr. Khuzami. Okay. With respect to the task force, we have
a significant amount of resources. The five agencies that make
up the task force have all contributed significant resources.
We have a 40 to 50 member Structured and New Products Group,
large portions of which are dedicated to these cases. Resources
are being supplied by the Department of Justice and the New
York State Attorney General. We have just hired a coordinator
to help coordinate some of this activity. There is a lot of
activity, a lot of investigation.
Ms. Waters. What is happening with the executive director?
Do we have one coming soon?
Mr. Khuzami. Congresswoman, I think we are preparing a
draft to respond to a letter that you sent. We hired a
coordinator, but most of the investigative work being done here
is not really being done by a staff that belongs to the task
force; it is being done by the individual investigative groups
that make up the task force.
Ms. Waters. So, are you going to proceed with some
investigating that is going to lead to some litigation, or are
you going to continue to work in ways that will allow those who
are being accused to ``neither admit nor deny'' and just keep
settling and settling and settling as usual?
Mr. Khuzami. Like I said, if we get offered a settlement in
this or any other case that comes close to what we could hope
to get in the best-case scenario at a trial, then I think we
would be unwise not to settle under those circumstances. If we
don't, then those cases will be litigated. We will follow the
same procedures in all of our cases that we do for the RMBS
task force, at least as far as the SEC is concerned. The other
agencies may take a different view.
Ms. Waters. Since you are here today, for all of the others
who are involved in the task force, I think it would be wise to
share with them that a lot of people are watching to see what
is happening with this widely announced task force that is
supposed to do all of these investigations and bring about some
justice for many of these homeowners who got into mortgages
they couldn't afford because they were all exotic and they were
products that really could lead only to disaster.
But let the task force know. We anxiously await what they
are going to be able to accomplish and we think it is taking
too long for them to get up and going and showing us what they
can do.
I yield back the balance of my time.
Mr. Garrett [presiding]. The gentlelady yields back. The
gentleman from Texas is next, I believe, for 5 minutes.
Mr. Hensarling. Thank you, Mr. Chairman. I think one thing
that is obvious is that if this proposal actually becomes
policy to force those subject to enforcement actions into
admissions, there will be an explosion of litigation, civil
litigation, litigation by our regulatory agencies.
So when I first heard of this proposal, knowing that the
Administration, both the worst employment record since the
Great Depression, my immediate thought was, well, this was a
trial attorney's relief act and that maybe this is another
failed jobs program so that we can somehow reemploy trial
attorneys.
But, Mr. Chairman, as I look before me and I see the
representatives of these agencies, I believe the head of every
agency has either been appointed or reappointed by the
President, in which case that is clearly a false conclusion
because what I think I heard from all four witnesses and on
behalf of their agencies, is they would oppose this policy.
Mr. Chairman, I think I have just a few simple questions to
make sure what I thought I heard, I actually heard, and so the
first question I have for our panelists is, in your
professional opinion, on behalf of your agency, will
enforcement be more effective or less effective if you are
forced in your enforcement actions to have parties admit guilt?
Mr. Alvarez, less effective or more effective?
Mr. Alvarez. I think it would be less effective.
Mr. Garrett. Mr. Khuzami?
Mr. Khuzami. I agree.
Mr. Garrett. Mr. Osterman?
Mr. Osterman. It would definitely be less effective.
Mr. Hensarling. Mr. Stipano?
Mr. Stipano. I agree with my colleagues.
Mr. Hensarling. Okay. Well, then, my ears did not deceive
me.
The next question I have is, in your professional opinion,
would investors that you consider to have been wronged--do you
believe if this becomes policy, that investors would end up
with more resources or fewer resources to redress their
grievances? Do you have an opinion on that, Mr. Alvarez?
Mr. Alvarez. Sir, of course, the banking agencies look at
things not from the investor point of view, but from the safety
and soundness of financial institutions, so we are considering
customers of the banks, depositors of the banks, the taxpayers
who stand behind the deposit insurance.
Mr. Hensarling. Let's go to the SEC, then. Mr. Khuzami.
Mr. Khuzami. I think that while there might be some cases
where they would get marginally more, that it would come at the
cost of delay and at the cost of our inability to investigate
other cases and bring money back to other victims.
Mr. Hensarling. Let's go back, Mr. Alvarez, to safety and
soundness.
My guess is that, again, those who are being asked to admit
to guilt, frankly, are going to be very loath to do so in an
enforcement action.
I think what I heard in your testimony, and I don't wish to
put words in your mouth, is that--and I think I might have
heard it from you, too, Mr. Osterman, that in enforcement
actions, particularly dealing with safety and soundness, that
it is quite often important to move quickly. Litigation is
something that doesn't move quickly historically.
So will our financial system be more safe and sound or less
safe and sound? Should this policy be enforced upon you to
require parties in enforcement actions to admit wrongdoing?
Greater safety and soundness or less safety and soundness?
Mr. Alvarez.
Mr. Alvarez. Oh, I think our system would be safer and
sounder if we had the flexibility--
Mr. Hensarling. If you had the flexibility. Therefore the
flip side of the coin is less safe, less sound if you did not
have the flexibility.
Mr. Alvarez. I think that is correct.
Mr. Hensarling. Mr. Khuzami, same question.
Mr. Khuzami. Yes.
Mr. Hensarling. Which of the two, since Mr. Alvarez kind of
restated it?
Mr. Khuzami. Again, we are less about safety and soundness
than we are about investor protection. But if we were required
to have the admissions, I do think that we would have more
delay and fewer victims would get their money back.
Mr. Hensarling. Mr. Osterman?
Mr. Osterman. Yes, I think the system would be less safe
and sound if we required an admission of liability, because we
wouldn't be able to take the corrective actions as quickly.
Mr. Hensarling. Mr. Stipano, take a full 12 seconds to
answer the question.
Mr. Stipano. I have the same view. If we required an
admission of wrongdoing, that would delay the imposition of an
enforcement action that could adversely affect safety and
soundness.
Mr. Hensarling. Thank you, gentlemen. I yield back my 1
second.
Mr. Garrett. The gentleman yields back. Mrs. Maloney is
recognized.
Mrs. Maloney. Thank you, Mr. Chairman.
Mr. Khuzami, you said in your testimony that your decision
to settle is based on whether or not you believe the settlement
is equal to what you would achieve with a trial.
I would like to ask you to elaborate on how the
appropriations process and your funding level impacts on your
decision, and would you be more likely to initiate more actions
if you had independent funding and more resources similar to
other banking regulators?
Mr. Khuzami. Oh, I think independent funding would help us
greatly across the Enforcement Division. We would be able to
litigate more cases. We would be able to investigate more
cases. We would be able to have better technology which would
make us more efficient, and more trial lawyers. It would help
us across-the-board.
Mrs. Maloney. One of the persistent criticisms is that many
people belief that the SEC's penalties do not deter bad actors.
And one of the criticisms is that the settlement penalties
amount to pocket change or, as the judge said, ``the cost of
doing business.'' And how does such a penalty deter bad actors?
Mr. Khuzami. Congresswoman, candidly, I don't agree with
those assessments at all. Within the statutory limits that we
have with respect to penalties, we impose significant and
substantial penalties.
The Goldman Sachs case was identified as one where the
penalty was deemed to be insufficient. In fact, the company
paid 37 times what they expected to make in a fee for that
single transaction and a penalty.
So our penalties are substantial, they send a strong
message, but they are limited by the transaction at issue. When
we impose a penalty for financial crisis-related conduct, we
can't assess a penalty based on all the wrongs arising out of
the financial crisis. It has to be based on the evidence of the
particular transaction at issue.
And second of all, we can't get investor losses as a
penalty. We are limited to disgorgement, which is the amount
the company earned on the transaction and a penalty equal to
the amount of the disgorgement. We can't get the investor
losses. So if a company only earned $20, we can get that $20 in
disgorgement and another $20 in penalty, but we can't get the
$100 that the investors might have lost. That is why Chairman
Schapiro has written Congress and asked for expanded penalty
authority.
Mrs. Maloney. Okay, so basically you are limited by
statute, the penalty that you can charge, is that correct, you
are limited, and it is outlined? So would you describe some
legislative changes that would permit the SEC to levy larger
penalties?
Mr. Khuzami. Chairman Schapiro proposed that we have
various penalty mechanisms. The first is sort of a tiered
approach, and Tier 3 is the most substantial penalty category.
It currently is $725,000 per violation, per institution. She
proposed that it be increased to $10 million.
She also asks that we could use investor loss as a gauge to
measure penalty or 3 times the gain. And that is really for
those situations--it wouldn't come into play in every case, but
there are some cases where the investor loss so dwarfs the
amount of disgorgement and the gain that we could get that you
would like some more authority.
We also asked for authority to add additional penalties in
the case of recidivists, those who have been previously
convicted of a criminal violation or an SEC order or decree and
those who violate injunctions. Those remedies would help us a
great deal.
Mrs. Maloney. Thank you. And the bank regulators--in one of
your testimonies, you noted that consent agreements allow the
banking regulators to enforce compliance with banking rules and
make corrections that can prevent a bank failure.
So if the banking regulators were prevented from allowing
the defendant of an enforcement order to ``neither admit nor
deny'' the allegations in the order, how would enforcement
change for the banking regulators?
Any banking regulator who wants to answer?
Mr. Alvarez. Congresswoman, as I mentioned in my statement,
I think that it would substantially delay our ability to get
effective changes at the organization and put in jeopardy,
then, the safety and soundness of the institutions themselves,
and put the taxpayers at greater risk.
Mrs. Maloney. Would anyone else like to add anything?
Mr. Osterman. I would just add that we do have several
tools in our arsenal on the enforcement front, including
removal and prohibition. So if we do see continuous action or
egregious action, we actually can remove the individuals from
banking, which doesn't require them to admit or deny any
wrongdoing.
Mr. Stipano. The only think I would add is just that the
consequence, the primary consequence of requiring admission is
delay. So our enforcement documents, which are remedial
documents in nature, they are designed to rehabilitate the
institution, would not get in place very quickly or as quickly
as they do now, and that could affect the safety and soundness
of the institution.
Mr. Garrett. Thank you. The gentlelady's time has expired.
The gentlelady yields back. I recognize myself.
First of all, just very quickly, Mr. Khuzami, with regard
to the practices and enforcement and settlement practices that
you are talking about today, these are current practices that
you are discussing?
Mr. Khuzami. That is correct.
Mr. Garrett. But these are also longstanding practices at
the SEC as well?
Mr. Khuzami. The ``no admit, no deny policy'' goes back to
the 1970s.
Mr. Garrett. So if the SEC had been funded at the level
that the President has requested in Fiscal Year 2013, would
these longstanding practices change in any way, shape or form?
Mr. Khuzami. With respect to ``no admit, no deny'' in
settlements?
Mr. Garrett. Yes.
Mr. Khuzami. The practices wouldn't change, we just would
be able to bring more cases.
Mr. Garrett. Did the SEC enforcement actions change? Did
the practices themselves change or were they any different when
the Democrats controlled the House?
Mr. Khuzami. No. We had the same policies in place.
Mr. Garrett. Thanks. So what we are talking here in general
is about enforcement of when financial institutions are accused
of breaking specific rules and regulations. So maybe I was
going to go a little bit off from that but just talk about some
of the new rules and regulations that are currently being
proposed and developed out there.
Mr. Alvarez, I will turn to you on that. One is in the area
of money market funds. There are new proposals to deal with
them and it is in summary reports, in the paper, that if the
SEC fails to act in this regard, to provide additional
regulations with regard to money market funds, the Fed, FSOC,
may step in and engage in that process and supersede the SEC's
regulatory authority and basically exert its authority over the
industry individually or designate the entire industry as
systemically important.
When I read those reports, one of the things that came to
mind, and what I have seen in some of the papers on this, is
that regulating the money market funds would be one way to
basically put money market funds effectively out of business
and then to have the funds in that segment of the economy flow
from them, and where else would they go but to the banking
institutions, which would be a way for them to backfill some of
the banks that are out there, which would be a way to then
provide for additional capital for them to make them more safe
and sound, which of course is what you have been saying is,
rightly so, the responsibility of the Fed.
Is that the avenue or the approach that the Fed takes to
this regulation?
Mr. Alvarez. Sir, I read a lot of things in the newspaper,
too, and sometimes I believe them and sometimes I don't.
Mr. Garrett. So I shouldn't believe any of those reports?
Mr. Alvarez. I think that the FSOC has made clear that
money market mutual funds are an area that requires attention.
That was in the report issued last July. The FSOC made some
recommendations in that area, and the SEC is moving forward on
taking steps to improve the safety and soundness and the
strength of money market mutual funds, and we all, I think,
await the SEC's action on that. That is as far as the Federal
Reserve has made any statements or participation at this point.
Mr. Garrett. Let's look at one other area. The area of risk
retention which Dodd-Frank talked about, but outside of Dodd-
Frank and some of the proposals that are out there that was not
contemplated in Dodd-Frank is the PCCRA, which is the Premium
Capture Cash Review Account, many people state, again in
reports but I agree with these reports, that if this is
implemented, it would basically put capital on the sideline, it
would freeze up the markets, the securitization markets which
are already frozen and basically keep the Federal Government on
the hook as far as providing financing for the marketplace, the
housing marketplace. Mark Zandi estimates that the cost of this
would be 1 to 4 percent in additional financing costs for
consumers, which I have read and agree with.
Now, Chairman Bachus and myself have written to the Fed
twice asking, are those numbers correct, or more specifically,
has the Fed done a cost-benefit analysis or any analysis on the
cost? I think my last letter was back around March 26th. So I
will ask you a couple of questions along those lines. Has the
Fed done such an analysis? Does the Fed intend to reply to
either one or both of the letters that Chairman Bachus and
myself sent to the Fed inquiring about this?
Mr. Alvarez. Obviously, we will reply to your letter.
Mr. Garrett. That is good.
Mr. Alvarez. The question of premium capture--as you
recall, the risk retention rule is not a Federal Reserve rule
alone. This is a multiagency rule.
Mr. Garrett. My time is short. What is the Fed doing? Will
you reply? And will you reply with an analysis?
Mr. Alvarez. We will reply as best we can during the
comment period. We have gotten a lot of comments on the premium
capture accounts and the concerns people had with how the
proposal was designed. And so we are analyzing your comments,
as well as other comments.
Mr. Garrett. Have you done an analysis yet?
Mr. Alvarez. We are in the process of doing an analysis.
Mr. Garrett. And when is the completion date on that
supposed to be?
Mr. Alvarez. We are working on that as best we can.
Mr. Garrett. Do you have an estimate on the completion date
on that?
Mr. Alvarez. I do not.
Mr. Garrett. Like this week? This month? This year after
the elections?
Mr. Alvarez. It will not be this week. I am sorry,
Congressman. That is the best I can do at this time.
Mr. Garrett. It will be done before the rule goes out?
Mr. Alvarez. Absolutely.
Mr. Garrett. We will be anxious, I think the chairman and I
will both be anxious to hear back to either one or both of our
letters.
With that, I yield back. And I recognize Ms. Velazquez.
Ms. Velazquez. Thank you, Mr. Chairman.
Mr. Osterman, the U.S. District Court for the Southern
District of New York rejected a proposed settlement between the
SEC and Citigroup and specifically criticized the SEC policy in
consent judgment, stating the policy does not serve any
interest other than those of the party. How would the FDIC's
enforcement and compliance process be affected if you were
prevented from allowing institutions to enter into consent
decrees without having to admit or deny any allegation?
Mr. Osterman. I think the decision would have a negative
effect on our ability to carry out our statutory functions. As
has been discussed by several of the panelists, if we were
required to get an admission or denial of liability, the other
side is quite likely not going to agree to that without a long
litigation and possibly until after a judgment has been
entered. They may not agree to it at all. And so, we could be
talking about rather than getting the corrective action taken
care of within a matter of months or a shorter period of time,
looking at years.
Ms. Velazquez. How do you address the troubling aspect for
average Americans who are watching this proceeding, and how
would you discourage or be a deterrence if people know that
they don't have to admit guilt?
Mr. Osterman. I think the process actually has been
working. The fact is we have been able to effectively police
the industry and to make corrective actions through this
policy. If you look at our actions in the last 5 years, we have
brought over 2,000 enforcement actions, and we have removed 377
individuals from banking who had engaged in improper
activities. We have issued over 753 civil money penalty orders.
And so, I think the process is working as it is. We are not
afraid, and we are certainly ready to litigate if that is
necessary. But one of the things about our powers is that our
process works through administrative process, so when we issue
the order, it is effective immediately.
Ms. Velazquez. So what is the criteria for you to determine
when it is necessary?
Mr. Osterman. The criteria is, has our statutory mission
been achieved? Has the action that was improper been corrected?
Ms. Velazquez. Thank you, Mr. Chairman.
Mr. Garrett. And the gentlelady yields back. Mr. McCotter
is recognized.
Mr. McCotter. Thank you, Mr. Chairman, I have a couple of
questions. I hope that they are not repetitious. If they are, I
apologize.
When structuring a settlement, do we address the concerns,
as colleagues like my colleague Representative Green have
raised, where you make sure that an entity that is entering a
settlement does not net out a profit despite the fact of the
payment? Because you would hate to have a situation where
someone is engaged in an act that you have taken them to court
over, and at the end of the settlement process, the bad act
still nets out a gain for the entity? Is that something you
factor into when deciding how the settlements go?
Mr. Khuzami. From the SEC's perspective, the first thing we
are entitled to obtain in a settlement or in a trial is
disgorgement, which means all of the ill-gotten gain can be
obtained by us. So if you get all of the ill-gotten gain, then
you have eliminated that issue, and then you get a penalty on
top of that. That way, you make sure that it is not a wash from
the defendant's point of view. These are additional amounts
that they are paying to be punished, if you will, for engaging
in the misconduct.
Mr. McCotter. So on your part you do consider that a
factor?
Mr. Khuzami. Yes.
Mr. McCotter. You want to make sure they don't net out at
the end of the day the cost of business argument?
Mr. Khuzami. That is correct.
Mr. McCotter. Where does the money--would anybody else like
to address that? You all do the same thing?
Mr. Alvarez. At the Federal Reserve, we do the same thing
with one variation. We don't have express authority to achieve
disgorgement of the profit. We have a specific statutory
schedule of fines that we are allowed to impose, but we take
into account the amount of the profit that is made in assessing
how to employ those fines and we do the best we can to ensure
that there is no profit-taking from illegal activity.
Mr. McCotter. Where do the proceeds of the settlement go,
again? I am sure it was asked and I might not have been
cognizant of it. Generally, where do they go?
Mr. Khuzami. From the SEC's perspective, we obtained the
so-called Fair Fund authority under Sarbanes-Oxley, so we are
now able to take the disgorgement and the penalties and return
them to harmed investors.
If there are no harmed investors, or more amounts are
obtained than there is harm, then it goes to the U.S. Treasury.
Mr. McCotter. Does that hold true with everything else?
Mr. Alvarez. For the Federal Reserve, we are required by
law to provide the fine portion of an assessment directly to
the Treasury. However, we also have authority to require
restitution to customers, and we do that as well.
Mr. McCotter. The reason I ask this is, and maybe this is
not necessarily in your instance but there have been reports of
other instances where you have had bad acts reported by an
entity, voluntarily, prior to the government being aware of
them. They would then go into a settlement with the agency they
were involved with, and the money would remain within the
agency's budget.
I am not saying, and again, I take you at your word, I
believe you that yours is not the agency I am discussing. So I
am just glad to see that from you individuals and from your
agencies' entities that we have not gone from a point where
these banks are no longer just too-big-to-fail; they have
become ``too-big-to-jail.'' And I thank you for that.
I yield back.
Mr. Garrett. The gentleman yields back.
Mrs. McCarthy is recognized for 5 minutes.
Mrs. McCarthy of New York. Thank you, Mr. Chairman, and I
thank the panel. It has been very interesting clarifying--I am
one of those who, over the years when I would read in the paper
about the settlements, and to be very honest, why didn't
somebody go to jail? I have a better understanding from all of
your testimony. I just want to follow up because I have almost
the same question as Mr. McCotter.
On the Citi settlement, it was $285 million. So no money
went back to your agencies to pay for what it cost to bring the
settlements to that point?
Mr. Khuzami. We have absolutely no ability to use the money
that we obtain in fines, penalties, or any other monetary
sanctions and use that money for our own purposes. It either
goes to investors or it goes to the Treasury.
Mrs. McCarthy of New York. So technically, the American
taxpayer is paying you to go against the bad guys, but we don't
get any money back.
Mr. Khuzami. The Treasury gets money back but we--the SEC
does not. We then get appropriations, obviously.
Mrs. McCarthy of New York. What does the Treasury do with
the money?
Mr. Khuzami. I am not quite sure. You would have to ask
them.
Mrs. McCarthy of New York. Obviously, we are not sure
either.
And one other question to you, after settlement and after
the court cases but before the Second Circuit came to their
decision, on January 7, 2012, you modified settlement language
by bringing in language for cases involving criminal
convictions where a defendant has admitted violations of the
criminal law, and if the defendant has been convicted in a
parallel criminal proceeding, the SEC will no longer allow that
defendant to settle the SEC enforcement action without
admitting wrongdoing.
Could you explain that a little bit more to me on how that
works and how is that going to affect what you said earlier in
your testimony and from the beginning of this hearing that
sometimes it is better to settle than to prosecute?
Mr. Khuzami. Sure. We constantly review all of our
policies, and that change was a result of our review, and those
circumstances are where there is a parallel criminal case, and
in the criminal case, the defendant has either pled guilty or
been convicted at a trial. So there already exists, if you
will, an admission, and then he or she settles the SEC civil
case. Under those circumstances, extracting the admission makes
perfect sense because the admission has already been obtained,
and by us demanding the admission we are not causing delay or
more litigation or any of the other evils that we are trying to
prevent through the ``no admit, no deny policy.'' So it just
makes sense because the admission has already been obtained. It
doesn't apply in that many cases because there are not criminal
convictions or criminal pleas in a large majority of our cases.
Mrs. McCarthy of New York. Okay. And just one more question
to all of you, when proceeding with enforcement action against
an institution engaging in wrongdoing, is there ever a time
when ``neither admit nor deny'' is not an option?
Mr. Khuzami. The whole range of options are already there.
We can choose to stray from our policy and demand admission. It
is our view that the best approach is to use the ``no admit, no
deny'' approach for the reasons I have stated today. But it is
not a law that we are required to use; it is an informed policy
that we choose to use.
I will also say that, just to keep in mind for ``no admit,
no deny,'' everyone focuses on the ``no admit,'' but there is
also a ``no deny'' aspect, which means in our settlements,
individual entities can't then after the settlement get on the
courthouse steps and say, ``We deny liability.'' There are
other Federal agencies including the FTC, the Department of
Justice--the FTC just settled cases with Facebook and with
Skechers yesterday, I think, and DOJ settled a civil case with
Countrywide and Fair Lending where it is only a ``no admit''
policy, which means the defendants can deny liability. We do
not permit that, and we monitor that very closely because we
think that would undermine the integrity of the process and the
deterrent impact.
Mrs. McCarthy of New York. Thank you, and I yield back the
balance of my time.
Mr. Garrett. I thank the gentlelady, and I thank you for
that point. I had not ever recognized that.
Mr. Posey is recognized for 5 minutes.
Mr. Posey. Thank you very much, Mr. Chairman. I dDefinitely
believe there is a place for consent decrees, no doubt about
it, but I think when we have consent decrees where nobody
admits any guilt and they only pay a relatively minor fine,
that it will not change bad behavior.
I think when you prosecute people and the penalty is
severe, that changes behavior. Under the RICO laws, you don't
just fine the company $40 million for $40 million worth of bad
behavior. You fine them $80 million for $40 million worth of
bad behavior, you take the Mercedes, you take the office
building, you take the Rolex watch, and that changes behavior.
The only way you change behavior more than that is when you put
somebody in jail. That really is a game changer. I don't see
anybody going to jail. With all the criminal activity we have
seen from Wall Street, I just see a real lack of accountability
and prosecution.
I don't expect any of you to be able to answer this today,
so with the chairman's permission and the other Members'
permission, I would like to ask each of you to please submit in
the next week information to us about how many criminal
prosecutions for wrongdoing you have actually pursued and how
many convictions you have. We have some notations in here. Some
of you submitted that but they didn't get that explicit.
I would like to know how many stipulated settlements you
have had, I would like to know the amount of the settlements,
and also the amount of damages that the settlement was
pertaining to or been established. Please do not send me any of
those stupid brochures that the public relations department
does for you guys that talks about how great you are and just
highlights a couple of wonderful things that you did. All I
want is the facts, simple, pure, nothing more, nothing less and
nothing else. I think the other Members would appreciate that
too.
Mr. Stipano, I think overregulation is a problem. I think
when your regulators go into a bank and they say, we are going
to put this loan on nonaccrual because the parents made the
payments while the kids were unemployed, I think that is
improper. When they say, we are going to put this loan on
nonaccrual because it was modified, it was renewed, and the
interest rate was changed, I think that is bad behavior. The
most egregious thing I have ever heard is when your regulators
go into the bank and say, we don't think these people should be
able to make their payment given this economy even though the
loan has been in existence for 7 years and they have never been
more than one minute late, they found a way to make the
payment.
I think it is egregious when your regulators break the
rules provided by the Fed that says you shouldn't mark down a
loan or put a loan on nonaccrual just because the appraisal is
upside down. We have a lot of bad behavior by regulators, too,
and I would like to know who holds them accountable? The old
appeal used to be to their boss. But I want to know if there is
an outside agency that objectively looks at abuse by
regulators, because I think that is happening. We have talked
about it in here. We have nodding of heads from the Secretary
of the Treasury, the Chairman of the Federal Reserve, and the
former Chairwoman of the FDIC. So this is not something that we
are all imagining up here. That is just the reality outside the
Beltway where a lot of people in the real word have to live and
make a living every day despite what is happening in
Washington.
So I would like to know if any of you have investigated any
investigations or compensation committees who have awarded the
prima donna CEOs multimillion dollar bonuses as they have the
helm of the sinking ship all at the stockholders' expense. I
think it was Andrew Jackson who said something to the effect
of, it should be a crime when people profit by investors' money
and gobble up the proceeds in their own bonuses and then turn
around and stick the stockholders, the investors with the
losses. They don't count those.
And I would like to know, also put in your reference to us,
how many compensation committees you have investigated for
impropriety in abusing stockholders' money.
I have actually been involved once with a false charge, and
the other side attempted to intimidate me, so that even though
it may have been wrong, it would cost me so much in legal fees,
and for 25 percent of that, they would be glad to settle. And I
basically told them, at the end of the day you are going to own
everything I have or you are going to have nothing, and they
didn't have a good enough case to pursue it. But I can't think
that I am an exception to the rule; I am sure there are a lot
of people being shaken down across America every day,
wrongfully shaken down. I want to see some wrongdoers go to
prison. I think it is an obligation of yours to see that
happens because it is the best way, the surest way we are going
to change the process, we are going to change the paradigm, we
are going to change the behavior of people who have been
getting away with wrongdoing for way too long in this country.
And I thank you, Mr. Chairman.
Mr. Khuzami. If I could just respond briefly, we will pass
your request along to the Department of Justice but we don't
have criminal authority; we can't put anyone in jail and I
don't believe my colleagues here can, either. That is the
province of the Department of Justice, but I will be happy to
pass along your request.
Mr. Posey. Mr. Chairman, I have asked the Department of
Justice for the exact same information I have asked you for,
and I am having difficulty getting it from the Department of
Justice. So you should know what referrals you have given to
the Department of Justice and what the outcome of that referral
is. And I should be able to get that information from you even
if the Department of Justice has not been that forthcoming so
far.
Thank you.
Mr. Garrett. The gentleman yields back.
Mr. Miller?
Mr. Miller of North Carolina. Thank you, Mr. Chairman.
Mr. Khuzami, I think you said all the right things about
the decision to settle cases. And I know just about every
lawyer who actually goes into court says that a bad settlement
is usually better than a good trial.
But you also said the right thing, that if your reputation
is of being unwilling to try cases, you will never get a decent
settlement, and that was also my observation in practicing law.
It is hard to measure, it is really hard from our
perspective, without being submersed in the facts of the law as
you are, which obviously cannot possibly happen to decide, to
determine whether you are settling cases on the right basis or
settling for enough or going after the right people.
The Inspector General of the FHFA, the Federal Finance
Housing Agency, reviewed the settlement of Freddie Mac with
Bank of America and Countrywide, it has probably been a year,
and issued a very critical report that they had settled too
cheaply, they had settled on the wrong basis for the wrong
reasons, their emails suggested that they wanted to protect the
business relationship with Bank of America and pushing too hard
might damage their relationship, like they aren't the entire
market for buying mortgages. Is there anyone who can review or
has reviewed your settlements?
Do you have an Inspector General? Is there some third party
who can review the settlements that you have entered into?
Mr. Khuzami. We do have an Inspector General. The position
is currently vacant. But we will have one shortly. There hasn't
been an overall review of settlements. Settlements have been
reviewed, I think, episodically. But I will tell you there is a
great deal of scrutiny and review within the Commission, not
just from the Enforcement Division. When we investigate a case
and come up with a recommendation, that recommendation is the
defense counsel gets all the opportunities to put all their
information--
Mr. Miller of North Carolina. But the idea behind an
Inspector General, which I have come to admire, is that there
is an independent watchdog within agencies that have Inspectors
General that report to the head of the agency and to Congress,
and I think they give a slight headstart to the head of the
agency, but they report both to Congress and the independent
agency. So, they have an open transom for any employee to tell
them about things at that agency that someone should look at,
and it is a pretty useful management tool both for Congress and
for the executive agencies, and it was certainly very useful, I
think very useful, that the IG at the FHFA is examining their
litigation to make sure that they are not being settled too
cheaply or not being pursued as vigorously as they should be,
and they are independent.
I understand that you have a lot of eyes within the SEC
looking at these cases, but do you have anyone independent, who
will provide a fresh set of eyes that may be critical?
Mr. Khuzami. No. There is no ongoing general review of
settlements.
Mr. Miller of North Carolina. Okay. And I know that you do
not have criminal authority, but--and a lot of the calls for
putting people in jail have sounded like Judge Roy Bean, the
Old West judge, who said, ``We'll give the man a fair trial,
and then we'll hang him.'' I understand that there is due
process. But I think there has only been one criminal
prosecution for conduct that was really part of the financial
crisis. I am not talking about prosecuting a homeowner or a
broker for exaggerating income on their application, but I am
talking about actually in the securitization process, and those
are the two guys at Bear Stearns, which resulted in an
acquittal.
Have there been others? And there have been referrals from
the Levin commission, the Levin committee, to the Department of
Justice, the Financial Crisis Inquiry Commission also made
criminal referrals. Do you know if anything has come of those
and have you made other criminal referrals?
Mr. Khuzami. There have been some other prosecutions. There
are indictments of high-ranking traders at Credit Suisse for
mismarketing their subprime portfolio. There was successful
prosecution of Colonial Bank for mortgage-related fraud. We
have made referrals and, look, I was with the Department of
Justice for 11 years as a prosecutor in New York. I can tell
you the Department is focused and committed to these cases and
is looking very hard at them. They are challenging criminal
cases to make for a variety of reasons, primarily because the
securities laws are premised on disclosure, and if you sell a
RMBS security or a CDO and it has dozens of pages of risk
disclosures and someone buys it nonetheless, you have to be
able to prove that what was concealed from an investor was
something that was not disclosed.
They are just challenging cases to make for a variety of
reasons, but that shouldn't be taken as evidence of a lack of
commitment on the Department of Justice, from what I see.
Mr. Garrett. The gentleman's time has expired. Mr. Dold is
recognized for 5 minutes.
Mr. Dold. Thank you, Mr. Chairman, and I certainly want to
thank you all again for your time and your testimony today. I
just have a series of questions and it should be pretty quick.
For the entire panel, what percentage of your case load is
settled before trial? Just a rough idea, just a quick--
Mr. Alvarez. About 99 percent.
Mr. Dold. About 99 percent. Mr. Khuzami?
Mr. Khuzami. I think about one-third of them are litigated,
so about two-thirds are settled.
Mr. Dold. So 66 percent. Mr. Osterman?
Mr. Osterman. High 90 percent.
Mr. Stipano. Ninety-eight, 99 percent.
Mr. Dold. If this policy is put in place where it is
required that wrongdoing must be determined or admitted in a
settlement, do you think the percentage of settlements is going
to go up or down?
Mr. Alvarez?
Mr. Alvarez. The percentage of settlements would definitely
go down.
Mr. Khuzami. They would go down.
Mr. Osterman. They would go down.
Mr. Stipano. Fewer settlements.
Mr. Dold. I have put in my opening statement that I think
it is going to go down significantly.
Does anybody think it is not going to go down
significantly?
Mr. Khuzami. I think they will go down significantly. I
think what you also would see is settlements may eventually
happen, but there would also be a significant amount of delay
even if they ultimately settle.
Mr. Dold. In your various agencies, will you be able to
handle more cases or less cases if this policy were to be put
in place?
Mr. Alvarez?
Mr. Alvarez. We would likely require much more staff to
handle the same amount of cases.
Mr. Dold. So, ultimately, if you had the same amount of
staff you have right now, you would be able to handle less
cases, right, is that right?
Mr. Alvarez. I think that is right.
Mr. Khuzami. I think that is right, fewer cases.
Mr. Osterman. It definitely would tie up staff, and we
would be able to handle fewer cases.
Mr. Stipano. We would operate less efficiently, we would
need more staff.
Mr. Dold. Less efficiently, fewer cases. Okay. So will
victims, the taxpayers, the litigants themselves be better of
or will they be set back if this policy were to go into place?
Mr. Alvarez?
Mr. Alvarez. Sir, I think from our perspective, the
taxpayer and the depositors' financial institutions would be
less safe and sound than they are under the current policy.
Mr. Khuzami. I think the investors would receive not as
much by way of funds in exchange for their losses, and they
would get it on a much delayed basis.
Mr. Osterman. Institutions and depositors would be much
less safe and sound. We wouldn't be able to take as many
actions.
Mr. Stipano. The safety and soundness of our institutions
could be compromised. Also, I think there would be substantial
delays in some cases, and less restitution paid to consumers
who are victims.
Mr. Dold. And I certainly agree with my good friend and
colleague that we are looking to make sure that those who have
done illegal things, we want to make sure that they are held
accountable, that they are put away, in those instances going
to jail, because I do think that does send a shock wave in
terms of wrongdoing.
Another question for the panel is, do you think you have
competent staff attorneys who work for the agencies?
Mr. Alvarez. Absolutely.
Mr. Khuzami. I think they are highly professional and
competent and dedicated, and I am proud to be associated with
them.
Mr. Dold. I am glad to hear that.
Mr. Osterman. Yes.
Mr. Stipano. Yes, sir.
Mr. Dold. So good, competent staff attorneys. In your
opinion, do you think they understand the complexities in the
implications of settlement?
Mr. Alvarez. Yes, I think we do.
Mr. Khuzami. Yes.
Mr. Osterman. Yes.
Mr. Stipano. Absolutely.
Mr. Dold. Are you forced, does anybody force your staff
attorneys to take a settlement? So in the implication, you say,
you know what? We really want to take this one to trial, this
is a big case, we have to take this to trial. Is anybody
forcing them to take the settlement if it is not the right mix
or it is not right for the agency?
Mr. Alvarez. No, we only settle cases in the way that we
think is appropriate for the action and gets the kind of
remedial action that we think is appropriate.
Mr. Khuzami. No, we have internal debates and discussions
about the strength of the evidence and evaluate the case, but
no one is forcing a settlement.
Mr. Osterman. No one is forcing a settlement. We look at
the merits of the case and decide to go forward where it is
appropriate.
Mr. Stipano. No, we only settle cases when it achieves our
supervisory goals.
Mr. Dold. And so, at least I am glad that I heard you all
properly. I thought that was the case, and so I am just trying
to get a better handle on the policy.
If this policy were to move forward, it seems to me that we
are going to take an enormous step backwards, a step backwards
for the taxpayers, for the litigants, for everyone. And we have
competent staff attorneys out there who are weighing the pros
and cons and whether they want to settle. I certainly
appreciate your comments here today, and I hope that we have
shed a little clarity for those who are watching all across the
country.
Mr. Chairman, I yield back.
Mr. Garrett. The gentleman yields back. The gentleman from
Massachusetts is recognized for 5 minutes.
Mr. Frank. Thank you, Mr. Chairman. I apologize, I had a
previous engagement that I had to deal with at the World Bank.
And I am grateful to Chairman Bachus. I had asked him if we
would have this hearing because this is a case where there are
important public policy questions that needed to be addressed.
And I apologize if I am being--I will try not to be repetitive.
I will say once again, and I gather my colleague Mrs.
Maloney asked Mr. Khuzami about this, given the Federal budget,
the enormous amount that is spent in so many other areas, I
think it is deeply regrettable that fiscal constraints drive
some of this, and when people are critical of the agencies they
ought to factor in what is inadequate funding on the part of
the Congress. Money is a lot or a little depending on the
context. When we talk about hundreds of millions of dollars for
the Securities and Exchange Commission or the Commodity Futures
Trading Commission, which isn't represented here, for their
carrying out law enforcement, we sometimes call that a lot of
money. Of course in another context, specifically JPMorgan
Chase, with $2 billion, we are told there is nothing to worry
about, and I think maybe there is a happy medium there.
Mr. Khuzami, I take it you have said that one of the things
you have to factor in, in deciding whether to prosecute or
settle is financial constraints, is that correct?
Mr. Khuzami. That is correct. If you are doing case ``A,''
you are not doing case ``B,'' and so there are opportunity
costs with everything.
Mr. Frank. There obviously is not an infinite amount of
money, but I think there is more money out there that we should
make available to the SEC. I think if in fact we were to make
some more money available, even an increase of a couple hundred
million dollars, which again in the context of--we are talking
about the defense budget today. I read a New York Times article
the other day that said a $500 million investment in teaching
Iraqis how to be policemen turns out to have been largely
wasted and it is going to be aborted. That is, of course, far
more in total than the budget of the CFTC, and half of that
would have gone a long way in enforcing this.
The other question I have is--and again if it has been
asked, just tell me that, and I will apologize, but one of the
things that has frustrated people is seeing people promise not
to do it again for the second, third, fourth or fifth time. Is
there reasonable doubt, the three strikes and you are out rule,
not out but three strikes and you can't settle again, and how
do you address all of those who are frustrated by the repeat
offenders who for the fifth time say, I am sorry, I won't do it
again, and that is the end of it?
We will start with you, Mr. Khuzami.
Mr. Khuzami. I would say first that our recidivism rates
for individuals are extremely low. That is anecdotally, just
based on cases that I see, but there are very few repeat
offenders who are individual persons, and when they do, those
are most often the ones that we would work closely with the
Department of Justice--
Mr. Franks. What about entities?
Mr. Khuzami. Institutions are a different story. Although
even then, to understand whether or not an institution that has
had more than one violation deserves a higher sanction because
of the second violation, it is a little--
Mr. Frank. You make a distinction there that some people in
our society don't accept; you are distinguishing between
individuals and institutions. But there are those who believe
that corporations are people, in which case the distinction you
are making wouldn't hold. But, please continue.
Mr. Khuzami. I understand. All I am saying is if in year 1,
you had a mortgage violation in Seattle in an institution, and
in year 3, you had a currency violation with the peso in Mexico
in year 3, whether or not that is deemed to be a recidivist
institution, you have to look to see whether or not there are
common links between the misconduct there. But your point is
well-taken. That is why Chairman Schapiro has asked for
additional penalty authority for recidivists.
Mr. Frank. Do we have to give you that? Is that statutory?
Mr. Khuzami. Yes.
Mr. Frank. I hope we will take that up. And then let me say
finally, I understand that if it is a different part of the
entity, it is a different type of thing, it is not 100 percent
repeat, but neither is it zero. And an institution that does
one thing wrong in one place one year and 2 years later does
another thing wrong in another place, that ought to be at least
a percentage; the recidivism shouldn't be all or nothing. But I
appreciate that and I will be working with the staff on our
side and will be talking to the chairman. I would hope that
people who have been at all critical of you would agree that
giving you the power to increase the penalty for recidivism,
appropriately defined, would be a very important thing to do.
Thank you.
Mr. Garrett. The gentleman yields back. Mr. Luetkemeyer for
5 minutes.
Mr. Luetkemeyer. Thank you, Mr. Chairman.
I am just kind of curious, gentlemen, whenever your agency
is proposing new rules, do you do a cost-benefit analysis on
each one of those rules?
Mr. Alvarez?
Mr. Alvarez. Yes, we do. There are certain kinds of cost-
benefit analysis that we are required to do by statute, the
Regulatory Flexibility Act for example, the Paperwork Reduction
Act we do particular analysis there, but in addition to that as
part of our rulemaking process, we consider various alternative
approaches to implementing the rules and the relative costs and
benefits of those different alternatives.
Mr. Luetkemeyer. Mr. Khuzami?
Mr. Khuzami. Congressman, in the Enforcement Division we
really don't have rules, in Dodd-Frank we had--
Mr. Luetkemeyer. I understand. I have someplace to go with
this.
Mr. Khuzami. Okay.
Mr. Luetkemeyer. Generally, you don't, though?
Mr. Khuzami. We don't. We have the whistleblower rule in
Dodd-Frank. That was it.
Mr. Osterman. We do consider the costs and benefits in
looking at--we are statutorily required to do so.
Mr. Luetkemeyer. For every rule?
Mr. Osterman. We do look at alternatives and the way things
can be done, yes.
Mr. Stipano. I am not normally involved in the rulemaking
function at my agency, but my understanding is that we do
consider the costs and burdens to the industry of specific
rules.
Mr. Luetkemeyer. Quite frankly, I sit on this committee, I
have been here a long time now, and all of your colleagues have
been coming through here, and I have gotten different answers
from them on that particular issue. And it is disturbing
because you can do a cost-benefit analysis on your cases to
decide when you need to go, when you don't need to go, who you
need to go after, when you need to settle. So you can do it,
but you don't do it on every single rule that you promulgate.
That is a problem, and I am frustrated with that because quite
frankly especially with the smaller institutions, they can't
survive with this continued onslaught of rules and regulations
that you are promulgating that are really not necessary and yet
they are costing them an arm and a leg to comply with. And I am
frustrated with that.
But moving on, I am just kind of curious. You believe that
each one of you has enough authority, I know, Mr. Khuzami, you
have mentioned a few things already that you would like to see
more flexibility with and more things.
What about the other three of you? Do you see some things
that you would like to see where you would have more tools in
the toolbox to be able to go after the bad guys spoke, so to
speak?
Mr. Alvarez. No, I think at this point we think Congress
has already addressed many of the concerns we have had.
Mr. Luetkemeyer. Mr. Osterman?
Mr. Osterman. I would agree. We have quite a few tools in
the toolbox, which we talked about in our testimony.
Mr. Stipano. At this stage, it is a very big toolbox.
Mr. Luetkemeyer. It is a very good toolbox. Thank you. I
think you are doing a good job. I don't have a problem with
what you are doing I am just a little frustrated with some of
the other things.
Do you believe that by having all the tools that you have,
that your enforcement presently is adequate, or do you need to
do more or do less? Are you okay where you are at? What do you
think? Do you think that--as we go through and somebody has a
problem, like JPMorgan lost some money the other day but
obviously a bank is in business to take risks. And the first
thing everybody does is run out and ask, has somebody done
something wrong? Is the penalty too far? Are we doing enough
investigation? What do you think?
Mr. Alvarez. During the 4\1/2\ years of the financial
crisis, beginning in 2008 up to the present, we have done 3
times more formal enforcement actions than the 5 years prior to
that. And that is driven, I think, a lot by the behavior of the
institutions and the concerns that are raised at the
institutions.
My hope is not so much that we will raise the number of
enforcement actions to try to achieve a certain number, but
that the industry will get back to a better, more coherent and
more safe and sound and compliant mode.
Mr. Luetkemeyer. Mr. Khuzami?
Mr. Khuzami. I think we could certainly use more. We
understand the importance of using what we have efficiently and
appropriately because it is taxpayer money. But having said
that, the SEC oversees 35,000 registrants, investment
investors, broker dealers, public companies, transfer--
Mr. Luetkemeyer. You think we need to go after more people?
Mr. Khuzami. I think we need to be able to investigate and
survey the landscape more thoroughly and bring more cases.
Mr. Luetkemeyer. Mr. Osterman?
Mr. Osterman. You can always improve processes but I think,
as with my colleague at the Fed, our enforcement actions have
increased substantially. I think that is as a result of what
has been happening in the industry, but I think we do have the
tools necessary to address these issues that we are doing.
Mr. Luetkemeyer. Mr. Stipano?
Mr. Stipano. The OCC has taken about 2,200 enforcement
actions in the last 4 years. We think that those actions,
coupled with our supervision, our supervisory actions, help
promote the safety and soundness of the system and improve
compliance with the law.
Mr. Luetkemeyer. Thank you all for trying to squeeze in one
more question quickly. With regards to Mr. Osterman, one of the
things that the FDIC has is an insurance fund to back up and
pay for some of the wrongdoings or the misgivings of some of
the institutions. Right now, the investment banks are being
merged into the depository banks. Do you feel that is a threat
to the insurance fund?
Mr. Osterman. It is certainly something that we would need
to look at very carefully. To any extent that you have exposure
of the insurance fund, it creates a risk. And so, it is
something that we would have to be concerned about.
Mr. Luetkemeyer. I see my time is up. Thank you very much.
Thank you, Mr. Chairman.
Mr. Garrett. And the gentleman yields back.
Mr. Watt is recognized for 5 minutes.
Mr. Watt. Thank you, Mr. Chairman. I had to step out, and I
lost my place in the queue.
Mr. Garrett. So, never step out is the rule.
Mr. Watt. Don't ever step out of the room, that is the
lesson to be learned from that. But in a sense I am kind of
glad I did because I had the opportunity to hear Mr. Posey's
line of questions and was relieved that he blew up the theory
that Mr. Garrett had advanced that this was somehow; this
hearing was somehow a Democratic conspiracy and that there is
somehow some partisan position on this issue.
This is a very difficult issue, the extent to which we
require people to litigate or settle, or oversee settlements.
My views on this are informed by 22 years of practice of law, I
guess, in which I both litigated numerous cases and settled
numerous cases and never walked away from a case not having
second thoughts about whether I did the right thing or the
wrong thing whether I litigated it or settled it. It is a very
complex set of things that go into that, having to do with the
cost of litigation, the prospects of winning or losing, the
whole myriad of issues. And I don't think there is any partisan
position on that, as Mr. Posey has in his comments indicated.
Mr. Alvarez, you were kind enough to make the distinction
between your job as the Fed's job is protecting the safety and
soundness of institutions versus protecting customers, which is
a lot different, I take it, from what the SEC's responsibility
is, and I appreciate you making that distinction.
Mr. Khuzami, you mentioned that the SEC has the right to
require disgorgements of profits that were obtained improperly,
but there are some limitations on the extent to which you can
recover lost investor investments as a result of wrongdoing.
Can you elaborate on that and tell us a little bit more about
the request that the SEC has made for additional authority in
that area?
Mr. Khuzami. Certainly. We are entitled to obtain
disgorgement, which is ill-gotten gains, plus a penalty equal
to the amount of that disgorgement. And so, to take a simple
example--
Mr. Watt. Tell me what you are not entitled to do.
Mr. Khuzami. What we can't do is look at how much the
investors lost in a transaction and get that amount as a
penalty.
Mr. Watt. And can you give any of that disgorgement or the
penalty back to investors?
Mr. Khuzami. We can give it all back, but there are cases
where it falls short of what they lost.
Mr. Watt. Okay, and so what is the remedy, the additional
authority that you have requested?
Mr. Khuzami. Chairman Schapiro has requested that our
penalty authority be increased in a couple of different ways;
one, just using up to the amount of the investor loss as an
amount that we can obtain in a penalty. As an alternative, to
get 3 times the gain as a penalty if it turns out that that
amount might be greater than the investor loss and it would be
appropriate to get it. And third, to increase the tiers, which
are the statutory ways that we can get penalties on an
alternative calculation.
Mr. Watt. And to complicate this even further, that would
be as an alternative to some kind of private right of action in
which individuals would be able to go in and do their own
enforcement actions, I take it, is that correct?
Mr. Khuzami. That is correct, although a private plaintiff
who won at trial and lost $100, if they had received $50 of it
from the SEC as part of our distribution presumably would only
be entitled to get the remaining $50 in the private litigation.
Mr. Watt. My time is about up. But I will just say that
this is a very tricky area here that we are dealing with and if
there is some partisan Republican position on this, I hope you
will communicate it to your colleagues on the Judiciary
Committee because they have been all over the lot on whether
settlements are appropriate, regulatory enforcement is the
appropriate remedy, private rights of action they hate with a
passion, I don't know how they sit on the Judiciary Committee
and take that position, but posturing this as a partisan issue
is I think not a good thing to do, Mr. Garrett. I am directing
that comment to you.
Mr. Garrett. And I appreciate that.
The gentleman's time has expired.
The gentlelady from New York is recognized.
Dr. Hayworth. Mr. Chairman, I am happy to yield to 2
minutes to you or--
Mr. Garrett. I appreciate that. I won't use all that. Just
two quick points. Mr. Khuzami, during the panel you mentioned
on at least a couple of occasions with regard to the issue of
civil penalties and the potential for changing that--my
understanding is that Chairman Schapiro has written to Congress
on that suggesting that it should be done, but the request on
that letter has only gone to the Senate and has not been
directed to the chairman of the committee or myself, is that
true? And if so, is there a reason why we are not in the loop
on this?
Mr. Khuzami. I believe that is the Senate--the letter was
addressed to Senator Reed. I am sure we would be happy to send
it along here as well.
Mr. Garrett. The ranking member brings it up, and others
have brought it up as well, but if it is a legitimate position
that the agency is looking for, we would certainly like to be
included on that.
And the second point is with regard to the funding issues
and what have you. I just remind--the ranking member is not
here on this--but I believe Chairman Schapiro asked for a
funding level at $1.6 billion, but for some reason the
Administration came in at $1.5 billion. So if the issue were,
as the other side argues, one of funding, then you would think
that they would be asking for the complete funding that
Chairman Schapiro was asking for. I am mindful of the fact that
the President's budget, of course, has come through both Houses
now and apparently has not received a single vote in either
House, so that may be part of the rejection from both, from the
other side of the aisle, that they disavow anything to do with
what the Administration is suggesting in their funding for this
program and other programs as well.
And with that, I yield back to the gentlelady from New
York.
Dr. Hayworth. Thank you, Mr. Chairman. And I thank our
panel for the most informative perspective on challenges you
face in cost-effectively and efficiently enforcing the law
without unnecessarily disrupting the services that the American
public needs.
With that, I think just summing up what we have been
talking about, the American public needs assurance that your
approach is working and that you are not missing out on
appropriate deterrent measures, which is what punishment is
supposed to be, in order to expedite processes.
If each of you could in about 30 seconds, and I apologize
for the restriction, but just give the best argument that we
can give to the American public for continuing to pursue
enforcement under the methodology that you have now?
Mr. Alvarez?
Mr. Alvarez. It allows us to most quickly and efficiently
require institutions to change their behavior and to provide
resources to customers who have been harmed.
Dr. Hayworth. Mr. Khuzami?
Mr. Khuzami. I think if you look at the entire package of a
settlement, which is a substantial financial penalty, a
detailed complaint laying out the allegations, business reforms
where appropriate, individuals charged, people barred, all of
the legal costs, reputational damage, client concerns,
shareholder concerns, everything that is packaged up in a
settlement both as a result of the agency's action as well as
simply the consequence of the wrongdoing, all told it really
has a powerful deterrent message.
Mr. Osterman. It allows us to accomplish the purposes of
our statute and meet the public interest in an efficient and
effective way and avoids protracted long-term litigation which
may actually lead to less effective regulation.
Mr. Stipano. We have taken a large number of enforcement
actions in recent years. It is really only a small part of what
we do when you consider the corrective action that is obtained
through the examination process. And once we put an action in
place, we are not done. Our examiners monitor for compliance
through the exam process, and if those actions are violated, we
can take progressively severe actions against the institutions.
Dr. Hayworth. Thank you. Mr. Chairman, could I possibly ask
for 1 additional minute? I have one more question.
Mr. Garrett. You still have time.
Dr. Hayworth. Would each of you tell us, is there some
modification you might make, if possible, that would be even
more productive in terms of the way in which you pursue your
protective actions for the public?
We will start with Mr. Alvarez.
Mr. Alvarez. Our policy is to not require admission of
guilt. In some cases more recently, we have also prohibited
folks from denying guilt. That is a practice the SEC does
regularly, and we are considering whether we should adopt that
regularly.
Mr. Khuzami. For us, it is more about resources and the
enhanced penalty authority.
Dr. Hayworth. Thank you.
Mr. Osterman?
Mr. Osterman. We believe our practices are working quite
efficiently.
Dr. Hayworth. Thank you.
Mr. Stipano. We are comfortable with our present approach.
Dr. Hayworth. Thank you all. And thank you, Mr. Chairman.
Mr. Garrett. And I thank the gentlelady very much.
Mr. Scott is recognized for 5 minutes.
Mr. Scott. Thank you very much. First, let me yield 10
seconds to the gentleman from North Carolina, Mr. Watt.
Mr. Watt. Mr. Chairman, I just wanted to ask unanimous
consent to put into the record a copy of the letter that was
written by the SEC to Jack Reed, the chairman of the committee
and in it, in the first paragraph, it does say why it is
addressed only to the Senate as opposed to the House, because
it was in response to a hearing that was being held there and
was requested by the Senate.
Thank you.
Mr. Garrett. Thank you. Without objection, it is so
ordered.
Mr. Scott. Thank you, Mr. Chairman. Let me ask a question
about the investors, when they can and cannot bring a lawsuit.
Mr. Khuzami, does an SEC settlement preclude or not preclude an
investor from bringing action against a defendant?
Mr. Khuzami. It does not preclude.
Mr. Scott. And would you please describe how the SEC's
settlement does not preclude that?
Mr. Khuzami. An injured investor or a shareholder is
entitled to bring their own private cause of action
irrespective of what the SEC does.
Mr. Scott. And what are the types of cases where the SEC
can bring a case against a defendant?
Mr. Khuzami. All sorts of accounting violations, disclosure
violations, registration violations, everything that is
actionable under the securities laws, the Foreign Corrupt
Practices Act violations, et cetera.
Mr. Scott. And in such cases, does the fact that an
investor cannot bring an additional action change the decision-
making process for determining whether it is appropriate or not
to settle with the defendant?
Mr. Khuzami. No. In general, we are going to follow the
same guidelines that I outlined previously.
Mr. Scott. Okay, and let me ask you about repeat offenders.
Are they treated differently? How does the SEC identify and
pursue repeat offenders?
Mr. Khuzami. With respect to individuals, if we see repeat
offenders, that is more likely to result in a criminal referral
and us working with criminal authorities to bring criminal
sanctions to bear on the individual. Otherwise, we take past
violations into account in setting our penalties. We have the
same ceiling that I described earlier, but within that ceiling
we have discretion, and it would be standard and appropriate
for us to extract higher penalties for recidivists.
Mr. Scott. And does the SEC consider previous settlements
by a defendant with either the SEC or another regulator when
considering bringing an enforcement action against a defendant?
Mr. Khuzami. We would consider the previous violation, not
necessarily the settlement. If we knew that somebody had
violated the law, particularly in a similar way to what we are
currently looking at, we would most assuredly take it into
account.
Mr. Scott. Would an admission of guilt in a previous
settlement or a trial change how the SEC considers future
actions against defendants?
Mr. Khuzami. No, not necessarily. No, I don't think it
would because when we conduct our investigations and arrive at
a settlement, our view is that what we have found in that
investigation is accurate and correct and true, as a result of
months, if not years of investigations.
So we settled the prior violation. Even without an
admission, we know what that person or that entity did
previously, and we take that into account.
Mr. Scott. And do you believe that the infrastructure that
you have in place now, the process, the procedures, is this
sufficient moving forward to protect the markets, to protect
investors, to protect everyone? In other words, do you feel you
have all the necessary tools that you need or is there
something else we need to do here in Congress to help you do a
better job?
Mr. Khuzami. From the enforcement perspective, we did the
largest restructuring in the history of the Division of
Enforcement in 2009 and 2010, created specialized units, cut
out a layer of management, created a COO, upgraded tips and
complaints, did a lot of things, but still, we have a strong
need for IT resources so that we can better collect all of the
information we get and search it, better monitor our cases.
We need additional trial lawyers, and we need additional
private sector experts to help us in very technical fields, so
it is really those kinds of resources that would be most
helpful to our effort.
Mr. Garrett. I thank the gentleman. The gentleman's time
has expired. The gentleman from Arizona is recognized for 5
minutes.
Mr. Schweikert. Thank you, Mr. Chairman, and as you always
worry sometimes when you see the empty chairs, understand you
are never not in front of a television camera, so when we are
running between offices, you are on all these screens around
the building.
In the types of--let's just take a year's worth of
different settlements for the last couple of years. Would I
ever find a case where the decision was bifurcated, where the
firm entered into a settlement agreement and said, we are going
to change our practices, but an individual in the firm was
referred to criminal action?
Are there any cases like that, where it has provided you
flexibility to even sort of break up saying, I have an
individual bad actor over here but the firm didn't have certain
control mechanisms and that was their failure. That was more
worthy of a settlement, this needed a criminal referral?
Mr. Khuzami. Yes. There are many cases where the entity may
settle the matter. The individual employee may continue to
litigate with us and may be referred to criminal authorities as
well.
Mr. Schweikert. And do your settlements always cut off
private rights of action?
Mr. Khuzami. No, they don't cut off private rights of
action at all.
Mr. Schweikert. Okay, I am sorry, that was partially
because I heard--I may have misheard. I thought I heard someone
on my other side say that, so I wanted to come back to you.
Mr. Khuzami. There are some laws that we can proceed under
that private plaintiffs can't, but our actions don't cut them
off. In fact, our actions help them because when we file a 20-
or 30-page complaint laying out all of our evidence and emails
and meetings, plaintiffs can use that.
Mr. Schweikert. And, Mr. Chairman, this would be for
whoever would have this expertise. Okay, you do a settlement.
How much of the discovery work of that settlement is public?
Mr. Osterman. When we do a settlement, all of our orders
and settlements are public. They are required to be, under the
law.
Mr. Schweikert. So in that case, you have actually done
much of the research for--if there was some private right of
action, you have actually done much of the work for it.
Mr. Osterman. The work that has been done internally would
be our work product. But in terms of the actual settlement
itself, it is a public document. It has to be published.
Mr. Schweikert. I am just sort of curious, and this one I
probably shouldn't go to, but how much of the work product goes
immediately public and how much of it is discoverable, either
through a Freedom of Information request or other court action?
Mr. Stipano. I think one problem for us as bank supervisors
is that our enforcement actions are really based on findings of
our examinations, which by regulation are confidential.
Mr. Schweikert. And if you were to think about it, over the
last 12 months, how many settlements have there been, and I
won't hold you to an exact number.
Mr. Khuzami. In Fiscal year 2011, we filed 735 cases. About
two-thirds eventually settled, some before litigation, some
during litigation.
Mr. Schweikert. If you were to take a sort of a guess, how
many of those, from both rumor to facts--and I am not going to
hold you to a number--do you think also had other legal actions
moving either after or in parallel? And I know that is a little
ethereal.
Mr. Khuzami. That is speculation.
Mr. Schweikert. Okay, jump on to another one. How many of
those did you have, my sort of earliest scenario, which is sort
of a bifurcation, where a bad actor was referred to either
criminal or other types of litigation where the firm was
separated out with a settlement to clean up its practices?
Mr. Khuzami. Again, I would have to--I don't know off the
top of my head.
Mr. Schweikert. Okay, but it is a scenario that does
happen?
Mr. Khuzami. Yes, although candidly, most of the time, if,
because, because corporations have liability because of the
acts of their employees, if the company is under scrutiny and
the individual is under scrutiny, it is likely to be both under
criminal scrutiny and SEC scrutiny. It is not so often that one
would go to one place and one would go to the other. Because if
the individual engaged in something that might be criminal, the
criminal authorities are also going to be interested in the
entity.
Mr. Schweikert. Okay, and I note in my last 14 seconds, and
you have already touched on this once before, okay, 700-some
cases last year, if you were in an environment where you had to
litigate everything, what happens to you? What happens to
compliance, what happens to the mechanics out there?
Mr. Khuzami. I think you have to shift a substantial amount
of your resources from your investigative staff to your trial
staff, which means investigations are not getting done, which
means there are a lot of people who did bad things who are
running around out there who are not being caught, and a lot of
investors lost money who are not being compensated.
Mr. Schweikert. Thank you. Thank you, Mr. Chairman.
Mr. Garrett. Thank you. Mr. Ellison is recognized.
Mr. Ellison. Thank you, Mr. Chairman. And let me thank the
panel. There has been some questioning around what would happen
if you had to try every case or what would happen if no
settlement could include a nonadmission provision. Has there
been such a proposal made as that?
Is there an existing proposal, are there agencies that
offered a proposal which said you must try every case, or if
you do settle a case, it can only be settled with an admission
of responsibility or guilt?
So this discussion that we have had about not being able to
settle cases, while interesting, doesn't really bear out any of
the proposals that you all have made. Am I right about that?
Mr. Khuzami. Not in our proposal, and other than Judge
Rakoff's opinion, which has now been questioned by the Second
Circuit, there is no proposal that I am aware of.
Mr. Ellison. Yes, okay, okay. Because I am an old trial
lawyer myself, and I can't imagine a situation where you could
make a prophylactic rule prohibiting nonadmission clauses. I
think these things have to be done on a case-by-case basis.
But here is another question related to that, and this is a
question that I know comes with some risk for anybody who
answers it perfectly candidly, but I am just going to throw it
out there anyway. Do you believe, based on resource issues or
lack of resources, that you have had to settle cases that you
would rather have gone forward and prosecuted, or do you
believe you have settled cases that should have included some
admissions but didn't simply because it would just cost too
much and take too much time and energy and resources to demand
that you would get results? Do you understand my question?
Mr. Khuzami. The resource issues don't dictate whether or
not we require admissions. We have a policy that I have
described, and we follow it regardless.
The lack of resources can affect cases in a more indirect
way. There is some category of cases that you are going to
pursue to the ends of the Earth, regardless. There are others
where maybe you are going to narrow the theories, so you don't
need an expert witness, or you are going to maybe charge only
two defendants rather than four.
Mr. Ellison. Yes.
Mr. Khuzami. And more, it manifests itself more in those
kinds of decisions.
Mr. Ellison. Mr. Stipano, do you want to address that?
Mr. Stipano. The only thing I would add is that we don't
initiate cases that we aren't prepared to litigate, and I think
if we departed from that we would have a much harder time
settling cases. I think one of the reasons why we are able to
settle them so efficiently is that the respondents on the other
side of the case know that we are prepared to litigate it all
the way through the Court of Appeals if necessary.
Mr. Ellison. Exactly, and it is those other cases that I am
worried about. For example, there are numerous companies
existing in America today who can drown you guys. They can just
drop buckets of interrogatories, requests for admissions,
depositions, et cetera. I know you can imagine that there are
some corporations it would be tough to tangle with. Can you
imagine a scenario where you wouldn't charge them because even
though you think they are wrong, you just can't handle them?
Mr. Khuzami. We punch above our fighting weight.
Mr. Ellison. Okay. I like to hear that. That is the right
spirit, Mr. Khuzami. Thanks.
Mr. Alvarez. The other thing the banking agencies have that
helps us quite a lot is we examine the institutions that we
regulate on a very regular basis.
Mr. Ellison. Okay, so you walk in there with a certain
advantage?
Mr. Alvarez. Yes.
Mr. Ellison. In terms of discovery?
Mr. Alvarez. And they know they have to deal with us on a
regular basis.
Mr. Ellison. Yes, right.
Let me ask you a few questions that kind of have something
to do with the whole JPMorgan thing. I just want to get your
views on it. I am asking you because I want you to know what I
am getting at, as if it wouldn't be obvious, but I am not
asking you specifically about that case. So I am not asking
about that case, but my motivation for asking you is because of
that full disclosure, okay?
And let's start with you, Mr. Stipano.
If a federally-insured bank was investing in credit default
swaps that could result in them losing as much as 3 months of
profit, would you expect that to be disclosed to investors?
Mr. Stipano. I think that is really a question that
involves interpretation of the Federal securities laws, and I
am not in a position to answer that.
Mr. Ellison. Okay. Does anybody want to answer that? No?
Okay.
Mr. Khuzami. There are various rules that require
disclosures of various kinds and various risks, so it would
depend on the other variables as to whether or not that was the
case.
Mr. Ellison. So, if a federally-insured bank, again we are
talking about federally-insured money, the public's money,
would you expect that if such a bank was invested in CDS, that
could result in the loss of 3 months of profit that regulators
would be informed that these trades were going on, or do you
think you are regulating to a degree that you would know that
this was going on?
Again, I am not asking, I am not trying to pin anybody here
with any wrongdoing. I am just asking theoretically, what kind
of activity, when we are dealing with federally-insured money
needs to be disclosed to either investors or regulators?
Mr. Stipano. We should know about it. Under our exam
authority we have access to all the books and records of the
institution.
Mr. Ellison. Okay. My time has expired. Let me say thank
you to all of our witnesses and good luck on all your work.
Mr. Schweikert [presiding]. Mr. Ellison, I would never
think of you as an old trial attorney. I recognize Mr. Carney
for 5 minutes.
Mr. Carney. Thank you, Mr. Chairman. And thank you to the
panelists. When you get to me, you know it is almost done, you
have 5 minutes left. I want to thank you for all the
information that you have provided us with today, your answers.
You have obviously done a good job of explaining the rationale
for your settlement practices.
And I think there is really kind of a fundamental
disconnect. The reason, I suspect, that gave rise to this
hearing today was the perception that people who have done
wrong, who created a very serious financial crisis in our
country is that there hasn't been adequate accountability. I
think I heard my colleague from the other side of the aisle say
that people didn't go to jail, and we have heard that from a
number of Members.
And I agree with Mr. Watt that this isn't a Democrat
concern, a Republican concern, whatever. I hear it from
Democrats, Republicans, and Independents in the district I
represent, which is in the State of Delaware.
You talk about your responsibility--and I am not a lawyer,
so I have learned a lot today about legal processes--and you
don't have the authority to put anybody in jail; is that
correct?
Mr. Khuzami. That is correct.
Mr. Carney. So that really maybe we got the wrong panel
this morning. Maybe we should have DOJ up here, because I think
that is what people really are focused on and concerned about.
Is part of your consideration, prudential regulators, it is
safety and soundness, Mr. Khuzami, it is investor protections
or recovery, is deterrence or punishment part of your
consideration in these actions and enforcement actions to take?
If you would just go right down the line, starting with Mr.
Alvarez.
Mr. Alvarez. Yes, certainly deterrence is and punishment is
as well a concern for us. Most importantly, it is correcting
the problem that we have observed, and that is our first
priority. But we have a variety of ways of ensuring deterrence
and getting the policies and procedures out to the world,
informing the world of the kinds of judgments that we want to
make.
Mr. Carney. But correcting the problems for the safety and
soundness of the institution is primary?
Mr. Alvarez. It is the first priority.
Mr. Carney. Mr. Khuzami?
Mr. Khuzami. Yes, deterrence is a strong part of what we
do. You are much better off preventing the wrong before the
fact rather than trying to pick up the pieces afterwards.
Mr. Osterman. Yes. Deterrence is certainly a big part of
what we are doing in terms of the enforcement.
But as my colleague at the Fed said, we are really focused
on safety and soundness of the banking industry. In terms of
punishment, we do have powers through civil money penalties to
seek penalties and we do that quite often when it is
appropriate.
Mr. Stipano. As my colleagues said, the primary focus of
our enforcement action is remedial in nature. We are trying to
address unsafe and unsound practices and violations of law that
we find in the institutions. We do think there is a deterrent
effect to our actions, both for the institution or the
individual involved, as well as for others in the industry.
Mr. Carney. The perception that we are dealing with is that
these perpetrators haven't been punished adequately. Do you
believe that what you have done in these settlements--part of
the problem is just the ``no admit, no deny policy'' just
sounds pretty soft to me, and I know it sounds pretty soft to
my constituents.
I understand your explanations completely and how you get
to the settlements and it helps you achieve your objectives.
But do you feel like what you have gotten in these settlements
actually accomplishes what your considerations are for
punishment and deterrence, again starting with Mr. Alvarez?
Mr. Alvarez. Yes, I do. I think we have been able to be
more effective in improving the safety and soundness of
institutions. But, remember, that also means that we are
protecting depositors and taxpayers. We have had a number of
actions that provide restitution to customers, so it is a
broader array of folks that we are trying to deal with and
punishment or retribution is not as high a priority.
Mr. Carney. Mr. Khuzami?
Mr. Khuzami. For the SEC, I think our record in financial
crisis cases is strong, as I said earlier--over 100 entities
and individuals, 55 CEOs and CFOs, I think sends a strong
message.
Mr. Carney. By the way, I don't know in the context whether
those numbers are impressive or not. It sounds pretty big, but
I don't know relative to who might have committed these
offenses.
You specifically, though, have asked for higher penalties,
so that suggests that you are not completely satisfied with the
punishment aspect of it.
Mr. Khuzami. What it means is there are some circumstances
where more authority would be appropriate.
Mr. Carney. Fair enough. I only got a--
Mr. Osterman. And I think we--the deterrent factor is
definitely there. As we said before, we are there in the
institution supervising it. We have cease-and-desist order
authority, which we use quite often to address and remediate
issues, and we do have civil money penalty authority to
actually penalize.
And the ultimate penalty, frankly, is the removal and
prohibition authority. We can remove an individual from banking
for life, and we have done that.
Mr. Carney. It is a pretty big stick, I would say.
Mr. Osterman. Yes.
Mr. Stipano. Rich just made the point I wanted to make. But
I think the broader point is that when we take enforcement
actions, they are often part of a broader package. So civil
money penalties, for example, may be coupled with restitution
action, may be coupled with a removal and prohibition. There
could be an action on an institution as well. And I think
together, when it is viewed that way, it is very effective.
Mr. Carney. Again, thank you very much, and thank you for
fighting above your weight class.
Mr. Schweikert. Thank you, Mr. Carney.
All right, I think we are out of questions.
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.
With that, this panel is dismissed. Thank you, gentlemen.
Will our second panel please be seated?
Welcome, gentlemen, and, actually as a courtesy, Mr. Frank
would like to make an introduction.
Mr. Frank. Thank you, Mr. Chairman. I want to introduce a
man who has been before this committee before at my request,
the Secretary of the Commonwealth of Massachusetts, William
Galvin. By virtue of being elected Secretary of the
Commonwealth of Massachusetts, he is our securities regulator
and he has used that power--and it hasn't always been used by
the incumbent in that office--in a very creative way and he is
a good example of how you can use the prosecutorial authority,
the civil prosecutorial authority, which he has, effectively.
And, there are sometimes complaints that people who bring these
charges, particularly those in an elected office, grandstand
from time to time. Mr. Galvin has a long record of bringing
enforcement cases, and I can't think of a time when he was
repudiated by a higher authority, by judicial authority, or
whether he--no accusation of overreach has come forward. So I
am very pleased that he accepted our invitation to come here,
because he is somebody who does this very well.
He also is a reminder that the administration of the
securities laws and protection of the investors, protecting the
stability of the economy is like other things in this country a
shared Federal-State responsibility. And I have always tried
to, as a member of the committee, be fully protective, frankly,
of the role of the States when there have been some who wanted
to make them go away.
And Mr. Galvin and others--and in a bipartisan way, because
I think he is here--I don't know if he is here on behalf of the
North American Securities Administrators, which is a very
effective American-Canadian agency of State and provincial
authorities who have been very helpful to us. So I thank you
for that opportunity.
Mr. Schweikert. Thank you, Mr. Frank. Actually with that
glowing introduction, how can it get any better. Mr. Galvin?
STATEMENT OF THE HONORABLE WILLIAM F. GALVIN, SECRETARY,
COMMONWEALTH OF MASSACHUSETTS
Mr. Galvin. Thank you, Chairman Schweikert. And Ranking
Member Frank, thank you very much for those kind words.
Thank you for this opportunity to discuss regulatory
settlements in the financial services industry. As you now
know, I am Bill Galvin, Secretary of the Commonwealth and the
chief securities regulator of Massachusetts.
Regulation without effect of enforcement makes such
regulation little more than political rhetoric and, worse,
leads to a false sense of financial security for our citizens.
We are not here today to compare bureaucracies or records
of bureaucracies. I believe we all share a common goal of
restoring confidence in the financial marketplace. For too many
Americans, their recent experiences in the market have
consisted of shattered retirement plans, broken promises, and
broken dreams. They cannot understand and will not accept a
regulatory system that holds none of the major actors
accountable.
My Securities Division carries out an active program of
civil enforcement in order to detect and stamp out securities
fraud. These enforcement actions have returned over $400
million directly back to defrauded investors in Massachusetts.
I have long spoken out against the established pattern in
Federal settlements of allowing respondents to enter into
settlements where they ``neither admit nor deny'' the
allegations in the administrative complaint for the enforcement
action.
In 2003, I had the opportunity to testify before a
subcommittee of the United States Senate on Government Affairs.
I said at that time, that too often the guilty ``neither admit
nor deny'' any wrongdoing and routinely promise not to cheat
again until they come up with a more clever method to do what
they just said they would not do again.
I repeat those words today with an even greater sense of
urgency as events of recent years and days have shown. One of
the priorities of my Securities Division is the firms and
persons who have violated the law should be required to
acknowledge what they have done. Permitting a firm to enter
into a settlement where it pays a fine but ``neither admits nor
denies'' that it has done anything wrong permits that firm to
avoid basic culpability for its actions.
In some instances, we have seen firms enter into regulatory
settlements, pay large fines, and also issue press releases
saying the firm settled the matter to avoid the distractions
created by prolonged litigation. Permitting firms to take this
kind of posture allows the firm to avoid acknowledging any
misconduct and permits such firms to publicly take the stance
that such settlements are part of business as usual.
If we intend to reform the worst practices in the financial
industry, then the firms that have violated a law must
acknowledge what they have done is wrong. In many cases there
is a thin line between arriving at a satisfactory settlement
and failing to reach any settlement at all.
I think it is very important that the most important aspect
of a settlement, and in many cases the best resolution, is to
require an issuer of securities or securities broker to repay
defrauded investors and make them whole. One of the greatest
satisfactions of my role is getting restitution for investors
and preventing the operators of financial fraud from simply
walking away from their victims with their ill-gotten profits.
Our enforcement actions also seek other sanctions. We have
imposed significant fines, we have also served as a warning, we
have secured agreements about future practices. For instance,
in 2011 my Securities Division settled the Goldman Sachs
``analyst huddles'' case which involved the practice of Goldman
Sachs giving its best research recommendations to preferred
customers in order to attract more business from those
customers, while denying it to others.
Goldman Sachs settled this case by agreeing to reform its
practices and by paying a $10 million fine. In the settlement,
Goldman Sachs admitted the factual allegations in the consent
order, which we believe will deter Goldman and other firms from
engaging in the same sort of conflicts in the future.
Between 2003 and 2012, total investor restitution of $404
million was paid directly to investors in Massachusetts
securities cases, and this does not include auction rate
security cases. We have also suspended the local licenses of
many bad actors.
The Massachusetts Securities Division analyzed the 82
consent orders it has entered into since 2003, and based on
that analysis, the respondents admitted to the facts alleged in
the administrative complaints in more than 40 percent of the
cases. The Securities Division has placed a high priority on
getting restitution for the defrauded investors and sometimes
that results in a variation. So when you do get restitution you
may well not get an admission, but the goal should be to try to
get an admission.
Much of the testimony I have heard here today suggests that
these are opposite goals. They are not. If the system was
working so well over the last 9 years, I don't think we would
be seeing the repeat offenders we have seen over and over
again. Much of the testimony I have heard today suggests that
these are two unachievable goals. I disagree.
I believe that it is important that regulators ought to
seek admissions if they can get them and certainly should not
be required to get them if they can get a better result for
investors, but at the same time the idea that somehow we should
defer all results and avoid getting any admissions is a far too
cosy relationship that has not protected the American people
and has not led to a safer and better system for our country.
And so I hope that as a result of this hearing, and some of
the changes I have heard discussed here this morning, there may
well be a change of heart on this issue.
Thank you for this opportunity.
[The prepared statement of Secretary Galvin can be found on
page 66 of the appendix.]
Dr. Hayworth [presiding]. Thank you, Mr. Secretary. Next,
Mr. Richard Painter, professor of law at the University of
Minnesota Law School.
STATEMENT OF RICHARD W. PAINTER, PROFESSOR OF LAW, UNIVERSITY
OF MINNESOTA LAW SCHOOL
Mr. Painter. Thank you very much, Madam Chairwoman and
Ranking Member. I have worked in securities law, I have taught
securities regulation for almost 2 decades, and for 2\1/2\
years I was the chief ethics lawyer for the White House under
President Bush.
I agree with the Second Circuit's view on the settlement in
the Citigroup case, and that is for several reasons.
One, the SEC has very limited resources, as we all know,
and, by the way, I would strongly urge Congress to seriously
consider an increase in the budget of the SEC. I think it would
be a good investment. But that being said, they have a very
limited budget, and they need to be able to make the
enforcement and investigation decisions.
And every time they investigate a case, they don't
investigate another. Every time they litigate a case, they may
have to spend resources there that could have been spent
investigating other frauds, and they need the discretion to
decide how to spend those resources.
Second, when you have a large settlement, such as you did
with Citigroup, there is a clear message they did something
wrong--$285 million is a lot of money. We all know they did
something wrong. Exactly what they did wrong, which statute
they violated, may not be so clear, but they clearly did
something wrong.
Third, there often is legal ambiguity.
For example, Goldman Sachs--there was a settlement of a
case with Goldman Sachs that involved securities that may not
have been sold in the United States. And after the Supreme
Court's decision in Morrison v. National Australia Bank, it
might very well be the case that some of those transactions
might not even be covered under the Federal securities laws.
There is ambiguity on that question. And the SEC settled
that case with Goldman Sachs and then ran into that very
ambiguity in litigation against an executive of Goldman Sachs,
Fabrice Tourre, in the Southern District of New York. So there
is often a reason to settle in order to not have to deal with
legal ambiguity with respect to interpretation of statutes,
even though there is clearly a situation of where the company
did do something.
And the SEC sometimes will have a situation where if they
take an ambiguous case into the courts and get a disfavorable
decision and they lose, they not only lose that case, but bad
facts make for bad case law, which could frustrate the SEC's
enforcement agenda in other areas and a range of other cases.
Now, that being said, I do have two concerns that I want to
express to this committee. One is that some of these
settlements also involve waivers of specific regulatory--
specific rules that provide that lenient regulatory treatment
in a range of areas is not provided to entities that have
entered into these types of settlements and SEC consent
decrees. And what the SEC does is then goes and waives those
provisions so that favorable regulatory treatment intended for
companies that have been behaving themselves is still given to
those companies that have not, and this is in a range of
different areas that I have discussed in my written testimony.
I do not categorically disagree with those waivers, but I
think that serious thought needs to be given to whether
companies that have not complied with the law ought to be
permitted, for example, to take advantage of favorable
regulatory treatment given to so-called well-known seasoned
issuers: Lehman Brothers; Bear Stearns; and Merrill Lynch; all
well-known seasoned issuers--perhaps not as well-known and as
seasoned as we thought.
And my last concern is that we need to focus on the
individuals who are responsible for the conduct, not just the
institutions. If $285 million, which might not mean a lot to
Citigroup, but if that money were taken out of the bonuses of
the individuals, not only who were responsible for the conduct
but who supervised the entity, we might get a very different
result with respect to repeat conduct.
And for this reason, I have suggested that we need to go
back, in the investment banking area we need to go back to the
system of personal liability of senior investment bankers for
the debts of their firms, and that is the way it was when
Salomon Brothers, Lehman Brothers, Goldman Sachs, Morgan
Stanley--those were general partnerships and they were jointly
and severally liable for the debts of their firms, and they did
not take the types of risks that those firms take today.
My grandfather was an investment banker. He had a small
shop, it folded, and he paid back the creditors. He paid back
every single penny. And then when he was a partner of a larger
firm, the same thing. They were jointly and severally liable,
and they didn't behave the way they do today.
And that is why I proposed in some materials described in
my written testimony that we need to take very seriously the
need for personal responsibility, and that may mean personal
liability for the people who are in charge.
[The prepared statement of Professor Painter can be found
on page 95 of the appendix.]
Dr. Hayworth. Thank you, sir. And now Mr. Kenneth Rosen,
professor of law at the University of Alabama School of Law.
STATEMENT OF KENNETH M. ROSEN, PROFESSOR OF LAW, UNIVERSITY OF
ALABAMA SCHOOL OF LAW
Mr. Rosen. Thank you, Madam Chairwoman, and Ranking Member
Frank. I appreciate the opportunity to testify on the use of
settlements by financial regulators.
Settlements constitute a crucial part of the enforcement
process, especially as regulators seek to allocate limited
resources in fulfilling their missions. Accordingly, it is
critical that regulators retain flexibility to settle the cases
that they pursue.
My testimony will focus on the practices of the United
States Securities and Exchange Commission, where I previously
served as a Special Counsel. However, the issues and concerns
that I raise also might prove relevant to enforcement efforts
of other regulators.
Settlements constitute a longstanding part of the
enforcement process. Driving settlements are calculations by
litigants about their potential to win and lose cases. For
regulators, settlements may be especially attractive when the
alleged violator of the law accepts conditions that give the
agency comfort in ceasing litigation. When actions are settled,
monetary and nonmonetary consequences may be significant. Of
course, requisite for successful settlement negotiations is
that notwithstanding such serious consequences, the alleged
offenders also view it in their best interests to settle.
Possible motivators for such action might be how exactly the
language of settlements is phrased, especially as it relates to
acknowledgment of legal violations.
Notwithstanding the tradition of settlements, settlements
are not without controversy. Last November, in SEC v. Citigroup
Global Markets Inc., a United States District Judge rejected
the Commission's efforts to settle a case and sought to proceed
to trial. In granting the SEC's motion to stay the proceedings
below, the Second Circuit rightly recognized multiple flaws
with the District Court's opinion.
The Second Circuit warned, ``the scope of a court's
authority to second-guess an agency's discretionary and policy-
based decision to settle is at best minimal.''
The Court's observation is wise because government
authorities pursuing supposed wrongdoers must harness limited
resources to pursue an agenda that is fair to the parties
involved and that secures both goals of punishment and
deterrence of future violations. The calculation of how best to
serve the public interest is a difficult one, and great
deference to the agency seems merited as it pursues its
mission.
Although a District Court might view individual settlements
as ``pocket change'' to large financial institutions, others
certainly can view payment of hundreds of millions of dollars
as significant, and as a punishment for potential future
violators to avoid.
It also seems useful to note that avoidance of an admission
of guilt in a settlement does not necessarily equate to
avoidance of reputational harm for the institution that
settles.
Although frustration with the economic crisis might lead
some to seek more restrictions on financial agencies' abilities
to enter settlements, discretion to settle remains an important
regulatory tool. Indeed at a time of rapidly shifting
regulatory landscapes in light of the crisis, such discretion
may be more important than ever.
Informing an agency's decision to consider settlement might
be genuine concern about the understanding of what constitutes
a violation as rules rapidly change. Settlement may permit
agencies to ameliorate the consequences of confusion during
regulatory transitions. While some might seek rigid outcomes or
language in settlements related to new rule violations, efforts
to impose such rigidity might incentivize odd results. Agencies
might opt out of pursuing violations when results would be
dictated in a settlement process related to such violations.
This might further fray investor confidence.
The enforcement process certainly remains subject to
possible improvements. However, if enforcement efforts seem
inadequate, one should focus on the effectiveness of efforts to
detect wrongdoing and the actions of officials actually charged
with pursuing wrongdoers. Review of settlements in individual
cases seems a second-best solution for changing how the
enforcement process generally operates.
Moreover, enforcement is only one of a modern financial
agency's many difficult tasks. As limited resources are taxed
by other legislatively mandated actions, agencies may, by
necessity, have to pull back on some enforcement efforts.
Settlements likely will remain a vital tool for agencies to
have some regulatory impact without expending the full
resources involved with taking all enforcement actions to trial
or administrative completion.
Thank you again for the opportunity to testify, and I
welcome the chance to answer your questions.
[The prepared statement of Professor Rosen can be found on
page 101 of the appendix.]
Dr. Hayworth. Thank you, sir. The Chair yields 5 minutes to
herself.
Secretary Galvin, the recidivism rate that you would cite
would be what, roughly?
Mr. Galvin. I think in terms of the firms, many of the
large firms are constantly coming in with different types of
violations. I think more than the firms themselves, the
fundamental problem that we keep seeing reappearing is
treatment of customers unfairly in different ways. For
instance, in my testimony I cited the settlement we just
reached last year with Goldman Sachs on the so-called huddles,
where, in effect, they were distinguishing between their
preferred customers, giving them better information than their
other customers.
Go back to 2003 when we had the market timing on mutual
funds. It was really the same thing.
Dr. Hayworth. Okay, but--
Mr. Galvin. So essentially, the firms are doing the same
thing. They see no deterrent in having paid fines and being
caught doing it before.
Dr. Hayworth. But would you say it is occurring at a rate
of more than 50 percent?
Mr. Galvin. I would say so, yes. We don't find, very
rarely--I have a wide range of entities that are licensed,
obviously many smaller ones who are less likely to return
because the effect of this would be much more damaging to them
if they have to pay damages. But the larger firms frequently
are coming back with situations.
And the attitude doesn't change. That is the problem. That
is my concern about the idea that they admit or deny is
something that is acceptable.
Dr. Hayworth. Or perhaps the nature of the penalties could
change or, as Mr. Painter says, joint and several liability
mechanism might be appropriate.
Mr. Galvin. I agree with him.
Dr. Hayworth. But another question, do you think in terms
of the whole issue of admission--and this is for each of you,
maybe we will start with you, Professor Rosen, since there is
this question of secondary lawsuits or proceedings, civil
liability that might be crippling, do you think that would act
as a deterrent from admitting wrongdoing and thereby prolong a
process that might lead to litigation instead of settlement?
Mr. Rosen. Yes, I think that is really a concern. It is
interesting if you look at the text of Judge Rakoff's opinion.
One of the things that seems to give him great concern about
the language is the fact that when one puts that language in,
one doesn't essentially estop future use of that particular
case from private litigations; but ultimately, that might make
it attractive to the defendant in the SEC's case to engage in a
settlement.
Once you take that away, you are starting to limit the
upside. And, again, settlement has to be viewed as something
that is mutually recognized by both parties to be in their
interests.
Dr. Hayworth. Right, and it is essentially. It is a
compromise, as we have said in the Second Circuit's opinion and
that makes sense. Professor Painter?
Mr. Painter. Right. An admission of guilt is an admission
to plaintiff lawsuits, and that is one of the biggest problems
I have with requiring the SEC to insist on an admission of
guilt. It drags the SEC into a battle between the large banks
and other defendants and the plaintiffs' bar. And it is a
battle that is extremely expensive and the SEC has very limited
resources to deal with it. The defendants will dig their heels
in, and they will burn up the SEC's resources fighting these
cases.
Dr. Hayworth. And Professor Painter and Professor Rosen
have both mentioned SEC resources in specific ways, if you
will, Professor Painter, with regard to funding, you feel that
the level of funding is not adequate to cover what the SEC
needs to do in this world, and Professor Rosen, you have said
we need better detection.
So do you think that if we could devote resources to
detection, certainly it comes into play. And when we think
about the eponymous law for our ranking member, many people
have said if we had better detection and enforcement of
antecedent law prior to Dodd-Frank, then we might have been
able to deter some of the consequences that some of us fear
from that law.
Your comments, Professor Rosen?
Mr. Rosen. Yes, I think that detection is really such a
critical thing in this particular instance. In fact, one of the
things that was interesting in the prior panel of looking at
the different types of regulators, is that the SEC versus the
prudential-type regulators, the SEC actually has a compliance
office as well, OCIE, which conducts examinations and thinking
about those issues is important.
I would be worried that in some ways, our focus on the
exact language of settlement becomes a distractor to try to
better address those kinds of inspections issues and also the
issues with enforcement at the Enforcement Division, which as
Mr. Khuzami pointed out has really changed how it goes about
enforcement quite drastically in the last year or so.
Dr. Hayworth. And our technology keeps changing so we have
better tools. I yield to the ranking member.
Mr. Frank. Thank you. Let me ask, obviously you have a
decisionmaking any given day and then you have to look at the
whole system. Sometimes you may decide to try to change the
behavior--even if it would be a cost in the short term--
basically what I have in mind is what would you guys all think
about, in one egregious case where the SEC was pretty sure to
respond--in the case of bankers you are exactly right, you
don't want to bring a case that is going to set you a bad
precedent, that is very clear--but what about in a very clear
case if they are recalcitrant, go after them. Let them sue if
you think you can win, and that might be setting a precedent
for the future, that is, is there something to be said for
picking a very strong case in where you can't get what you
think you should get, including admissions, I think an
admission--and I understand the points about reputation, but
the admission can be very important. What about saying to the
SEC, look, pick a strong case and make an example of somebody,
not in a negative way, because you wouldn't do it unless you
had a strong case and they had done things wrong and they were
significant--what about that kind of approach? Say, yes, we
know it is going to cost us something, but we think if we can
bring this strong case and win, that can have a good impact on
potential settlements going forward.
Mr. Galvin?
Mr. Galvin. I definitely think so. One of the concerns I
have, and this goes to the prior question from the lady from
New York, I believe, I think the system is inverted when it
doesn't put the investors first. In other words, I heard the
testimony of Mr. Khuzami about how they used some of the
results of the settlements. I think the SEC needs more
authority to put money directly back in the hands of the
investors. I don't think the experience with the so-called fair
funds event have been that effective.
Secondly, as far as the financing of the agency, I would
also suggest that the SEC should be able to retain some of the
revenue that they get as a result of fines and employ--put
costs on some of these they have to pursue. Why shouldn't the
violators pay for some of the costs of enforcement? It seems to
me--
Mr. Frank. Let me respond to that. The SEC, of course, does
levy fees and they make money for the Federal Government. I
appreciate, Professor Painter, your point about raising the
fee. But I would say to the Secretary, he will know, when I
talk about New Bedford, that our problem with some of that is,
if you give an enforcement agency the ability to levy fines and
then spend some of them, I do worry about the incentive in that
situation.
Mr. Galvin. With scrutiny.
Mr. Frank. Let me add--Professor Painter, I very much agree
with--let me ask, what about the scenario of saying okay, this
is a strong case, and we are going to take it and we understand
it is going to spend some resources, but we think winning this
case will be helpful in the future in terms of their attitude?
Mr. Painter. I think they should do that. When they have a
strong case, they should fight that case and win when they are
very confident they can do that. But there are a number of
these cases where there are ambiguities.
Mr. Frank. I agree with that. Mr. Rosen--
Mr. Painter. But the second point I want to make clear is
that they need to hold the individuals responsible. For
Citigroup shareholders to pay $285 million may not be what we
need to do. We need to take it out--
Mr. Frank. Let me ask you and then I will go to Professor
Rosen, because on that point, I very much appreciate your
testimony. The waiver point is a very strong point, and I
intend to write to the SEC and say they ought to be very strict
about the waivers. I appreciate that. That is one of those
things where experts help us.
On the individual responsibility, I very much again
appreciate that point. I note you say in the testimony--and I
would ask you not to do anything right now--I would ask you to
take a look at this, not off the top of your head.
We did include in the financial reform bill a provision
that instructed every regulator of the financial institution to
require that they have compensation practices that had good
facts, that said that you would end the situation of a bonus in
which heads, I win, and tails, I break even.
Is there some way to use that authority not to prescribe
anything by the Federal Government but for the regulators to
give a very strong incentive to the institutions to do the kind
of individual responsibility. That is, is there some way to say
under that authority you should say in the compensation package
that an individual executive or a group who are responsible for
that kind of a serious loss ought to bear some of the financial
pain themselves?
Mr. Painter. I believe to some extent they could if it is a
claw back of the bonus that is covered by the specific
provision that you are talking about. My concern is that may
not be enough and, as I said, these investment banks in the old
days were general partnerships.
Mr. Frank. I appreciate that, and that might be a start on
that and I think that might be--Professor Rosen, what about the
scenario of saying, ``Okay, this is one strong case, so we are
going to fight you, we are going to spend a little money, but
we think that may help for the future?''
Mr. Rosen. Yes, I don't disagree with that. In fact, in
talking today about the need for the discretion of the SEC and
other regulators to settle, I think they also need the
discretion to go forward with cases where they see they are
relevant, and, in fact, I think that having served at the
Commission, the folks who are there are very strategic in
making those decisions and trying to get those proper
precedents out there.
Mr. Frank. I think we all agree that greater resources
would give them the flexibility to make that kind of a
decision.
Mr. Schweikert [presiding]. Thank you, Ranking Member
Frank.
Mr. Rosen, can I come straight to where you just--doesn't
the SEC still have that discretion to pursue a settlement or to
say, this one is so egregious that we are going after them
criminally?
Mr. Rosen. Yes, absolutely. I guess the point--
Mr. Schweikert. It was just your tone, I just wanted to
make sure I wasn't--not being burdened with a law school
education.
Mr. Rosen. Sure. I think that sometimes, like I said, the
danger of this discussion of the settlements is it is almost a
distractor from everything else that is out there and it is
important to remember that discretion as well, to actually
bring the cases when necessary.
Mr. Schweikert. Thank you. For anyone on the panel, have
any of you engaged in a case over the last couple of years
where there was settlement action at the SEC level but from a
State level or an individual actor that the decision was we are
going to go after them either civilly or criminally on a
separate track?
Mr. Galvin?
Mr. Galvin. We often work with the SEC. Usually, we try to
coordinate our activities and we do, but sometimes we choose to
go on cases that the SEC has passed on or perhaps has not
gotten to yet. I can think of a number of instances where we
initiated an issue and the SEC later joined in.
So I don't think it is always necessarily that--the range
of possibilities is broad. As I said in my formal testimony, we
try first and foremost to get restitution for our investors who
have been defrauded. We do try to get an admission, and we
succeed in many instances. We would sacrifice an admission if
we thought it would help get restitution, so it is not a hard
and fast rule.
My concern, and I voiced this earlier, was that to the
extent that the discussion seemed to be with the earlier panel
that there were alternatives that could not be mixed, I
disagree with that. I think no one is suggesting, at least I am
not suggesting, and I don't know of anyone who is suggesting,
that in every case the SEC must get an admission; that is not
the issue. The issue is, in my opinion, the that this has been
too easy in denying admissions or seeking admissions.
Mr. Schweikert. Mr. Painter, your observations of what you
have experienced?
Mr. Painter. I have seen cases pursued by the State that
are not pursued by the SEC. Often, they involve a smaller
number of investors, and I believe that the State enforcement
is critical, a critical supplement to what the SEC is doing.
And in Minnesota we benefit from what Secretary Galvin is doing
in Massachusetts. It is important to the whole country that
there be effective State enforcement.
Mr. Schweikert. Mr. Rosen?
Mr. Rosen. Yes, I will go a little bit into professorial
mode here.
Mr. Schweikert. Uh-oh.
Mr. Rosen. And one of the things that I stress in my course
in securities regulation is not to forget the States. I think
sometimes folks become so fixated on the Federal regulatory
system that they forget that the States do have this authority,
particularly as it relates to antifraud actions.
Mr. Schweikert. Your specialties and what you see happening
from an academic standpoint and what is actually happening in
the States, Mr. Galvin, I almost heard you sound as if
sometimes you will do a triage decision, saying, look, the SEC
is doing this, they are not pursuing this person, you are going
to go after this bad actor. Was I reading more into what you
were saying?
Mr. Galvin. No, it may be the same, it could be multiple
companies or multiple entities doing the same thing. They may
choose to go after a large national company, we may choose to
go after local actors. Obviously, the trigger for us is that in
general our State, investors from our State have been affected.
But in working with the other State regulators, we often
trigger national efforts. For instance, I mentioned the auction
rates securities matter, which is more a matter of liquidity
than anything else, but it was the States that really led the
way there in terms of taking action to get liquidity for its
investors.
The SEC was very helpful because you do need a national
regulator. I am a firm, I am very concerned about the SEC's
ability to do what it needs to do. I think that is very
important. States can't substitute themselves for the SEC. On
the other hand, the States can be supplementary, and I think in
many instances, we are.
Mr. Schweikert. Mr. Painter?
Mr. Painter. I strongly agree.
The work at the States is very important, particularly in
light of the restricted budget of the SEC.
Mr. Schweikert. But my scenario, we know the SEC is going
after these national players, you may have someone who has
committed similar acts. Will you sort of triage who you pursue
and say, look, they are going after them, I have other States
and we have the same player. I am just sort of trying to
understand the decisionmaking at the State level.
Mr. Painter. I think that is the approach, and it would
make sense to have coordination. The problem is a lot of
different factors may feed into whether a State decides to
pursue actions or the SEC, so you may have both at the same
time. You may have overkill in some cases and in other cases
nothing happens.
Mr. Schweikert. With unanimous consent, I am going to give
myself another 2 minutes.
No one argued.
I have two other questions. Forgive me for keeping you
longer. How often will a decision to pursue at the State level
be because you see coordinated action amongst a number of
States or States within a certain region? Particularly for
where you are, if your neighboring States are pursuing
something, will that often be what draws you in?
Mr. Galvin. Not necessarily. Usually, it is an investor
from Massachusetts or a case we become aware of.
Mr. Schweikert. You beat me to the second half and that was
how often will it be an investor or private action taking place
that hits your radar that also draws you in?
Mr. Galvin. It is primarily, sometimes it is our national
practice we become aware of, like I mentioned, the auction rate
securities situation. However, most often, it is an individual
investor who comes to us with a specific issue or complaint.
We also do books and records examinations of companies. So
we do some additional work where we discover things in the
course of our books and records examinations as well that lead
us to investigations.
Mr. Schweikert. Mr. Painter?
Mr. Painter. I do not know specifically what is being done
in the States on that, but I believe that what Secretary Galvin
is saying seems consistent with what I have heard is happening
in other States.
Mr. Schweikert. Mr. Rosen, your perception from even some
of the research and things that hit your desk, is it because
they see motion in other States or there is a complainant or a
filed complaint at the State level? What do you see draws much
of the State regulators in?
Mr. Rosen. Again, on some levels, it is sort of more
speculation, not actually sitting in the offices with those
regulators, but I think that what Mr. Galvin is saying makes
sense and I think all of the above really can come into play. I
think that as a typical matter, when regulators decide to
pursue issues, some of those issues are ones that they generate
through their own investigation, which is why I think that
investigation is so important, but others are where they read
the Wall Street Journal also and find it. And particularly now
that we see a movement towards greater I think situations of
universal settlements and so forth, once the bandwagon starts
rolling along, there might be more prominence given to what is
going on in particular litigation that might attract attention
from other State regulators.
Mr. Schweikert. Gentlemen, I have to say ``thank you'' to
you and to the previous panel. This actually has turned out to
be a much more interesting day than I ever expected it to be.
So I have learned some things.
Now, I have to read the script.
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.
And with that, this hearing is adjourned. Thank you
gentlemen.
[Whereupon, at 1:05 p.m., the hearing was adjourned.]
A P P E N D I X
May 17, 2012
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