[House Prints 111-B]
[From the U.S. Government Publishing Office]
111th Congress } { Committee
1st Session } COMMITTEE PRINT { Print 111-B
_______________________________________________________________________
MEETING ON
ASSESSING THE MADOFF PONZI
SCHEME AND THE NEED FOR
REGULATORY REFORM
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
January 5, 2009
111th Congress } { Committee
1st Session } COMMITTEE PRINT { Print 111-B
_______________________________________________________________________
MEETING ON
ASSESSING THE MADOFF PONZI
SCHEME AND THE NEED FOR
REGULATORY REFORM
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
January 5, 2009
______
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HOUSE COMMITTEE ON FINANCIAL SERVICES
BARNEY FRANK, Massachusetts, Chairman
PAUL E. KANJORSKI, Pennsylvania SPENCER BACHUS, Alabama
MAXINE WATERS, California MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina RON PAUL, Texas
GARY L. ACKERMAN, New York DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California WALTER B. JONES, Jr., North
GREGORY W. MEEKS, New York Carolina
DENNIS MOORE, Kansas JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts GARY G. MILLER, California
RUBEN HINOJOSA, Texas SHELLEY MOORE CAPITO, West
WM. LACY CLAY, Missouri Virginia
CAROLYN McCARTHY, New York JEB HENSARLING, Texas
JOE BACA, California SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia RANDY NEUGEBAUER, Texas
AL GREEN, Texas TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois JOHN CAMPBELL, California
GWEN MOORE, Wisconsin ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota KENNY MARCHANT, Texas
RON KLEIN, Florida THADDEUS McCOTTER, Michigan
CHARLES WILSON, Ohio KEVIN McCARTHY, California
ED PERLMUTTER, Colorado BILL POSEY, Florida
JOE DONNELLY, Indiana LYNN JENKINS, Kansas
BILL FOSTER, Illinois CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana ERIC PAULSEN, Minnesota
JACKIE SPEIER, California LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York
Jeanne M. Roslanowick, Staff Director and Chief Counsel
C O N T E N T S
----------
Page
Meeting held on:
January 5, 2009.............................................. 1
Appendix:
January 5, 2009.............................................. 85
WITNESSES
Monday, January 5, 2009
Frankel, Tamar, Professor of Law, and Michaels Faculty Research
Scholar, Boston University School of Law....................... 62
Goldstein, Allan, retiree and investor, Bernard L. Madoff
Investment Securities.......................................... 60
Harbeck, Stephen P., President and CEO, Securities Investor
Protection Corporation (SIPC).................................. 21
Kotz, H. David, Inspector General, U.S. Securities and Exchange
Commission..................................................... 17
Metzger, Leon M., Adjunct Faculty Member, Columbia University,
Cornell University, New York University, and Yale University... 64
APPENDIX
Prepared statements:
Frankel, Tamar............................................... 86
Goldstein, Allan............................................. 96
Harbeck, Stephen P........................................... 99
Kotz, H. David............................................... 102
Metzger, Leon M.............................................. 114
Additional Material Submitted for the Record
Kanjorski, Hon. Paul E.:
Written statement of the Investment Adviser Association...... 132
Bachus, Hon. Spencer:
Letter to Chairman Barney Frank, dated December 17, 2008..... 137
Hinojosa, Hon. Ruben:
Complaint, ``United States of America v. Bernard L. Madoff,
Defendant.''............................................... 138
Assorted newspaper articles.................................. 143
Goldstein, Allan:
Account statements of Bernard L. Madoff Investment Securities
LLC........................................................ 154
Harbeck, Stephen P.:
Letter to Hon. Gary L. Ackerman, dated January 12, 2009,
providing additional information for the record............ 163
ASSESSING THE MADOFF PONZI SCHEME
AND THE NEED FOR REGULATORY REFORM
----------
Monday, January 5, 2009
U.S. House of Representatives,
Committee on Financial Services,
Washington, D.C.
The committee met, pursuant to notice, at 2:08 p.m., in
room 2128, Rayburn House Office Building, Hon. Paul Kanjorski
presiding.
Members present: Representatives Frank, Kanjorski, Maloney,
Watt, Ackerman, Sherman, Meeks, Capuano, Hinojosa, McCarthy of
New York, Lynch, Miller of North Carolina, Scott, Green,
Cleaver, Hodes, Klein, Perlmutter, Donnelly, Foster, Speier,
Childers; Bachus, King, Paul, Manzullo, Biggert, Capito,
Hensarling, Garrett, Neugebauer, McCarthy of California, and
Heller.
Mr. Kanjorski. [presiding]. The committee will come to
order. Without objection, the rules of the House and of the
Committee on Financial Services for the 110th Congress will
apply to today's proceeding. The committee is meeting today to
discuss assessing the Madoff Ponzi scheme and the need for
regulatory reform. Without objection, all members' opening
statements will be made a part of the record.
Mr. Bachus. Mr. Chairman, reserving the right to object, I
do not intend to object. And I am glad you raised the issue of
process because the 110th Congress has officially concluded and
the new Congress will not be sworn in until tomorrow. Today's
proceeding is being held in what I would call a parliamentary
grey area because the Financial Services Committee as a
technical matter does not exist. Any record of today's
proceedings will not count as an official record of the
committee. And while all of us want to get to the bottom of the
Madoff scandal as quickly as possible--and I commend the
chairman for calling for this hearing.
In fact, immediately following the stories breaking about
it, I asked Chairman Frank to hold a hearing as soon as
possible after the 111th Congress convened. And we all also
want to follow regular order if at all possible and operate in
a way that does not cast doubt on the legitimacy of our
proceedings. For that reason, I wish we had waited until after
tomorrow's swearing-in of the new Congress and for the formal
organization of the committee to hold this hearing.
But having said that, I don't object to conducting today's
proceeding as if it is an official hearing of the committee,
and I therefore withdraw my objection to the committee's
unanimous consent request.
The Chairman. Mr. Chairman, I reserve the right to object,
although if--I am not sure of the procedure, given what the
gentleman said. Reserving the right to object would appear to
be in a positive sense with just a bunch of guys talking, and
women. But I am glad we are because that is important.
First of all, I don't see any possible harm that could come
from having this meeting. I don't see even the suggestion of
procedural irregularity. The gentleman said regular order. We
are a group of members, we are voluntarily members. Those who
don't want to participate can leave. He says that the record
will have no formal role. Frankly, I haven't seen that it has
had yet, even though we have hearings. I am not sure what it
would be unless you were trying to prosecute someone for
perjury, and we have never sworn people in during the
chairmanship here.
The other thing I would say is this, as the gentleman said,
wait, here is the real point I wanted to make. In January of
2007, we were not officially constituted as a committee with
our new members until January 31st; that is, we would not have
overcome the obstacle the gentleman raised to it being the
regular committee if we had waited until tomorrow or the day
after because the swearing-in of the members does not
constitute the committee under the rules of the House. We don't
yet know who the new members will be on our side. I am not
sure--I am told on the Republican side they may not pick their
new members until next week. So I want to say this was the
initiative of the gentleman from Pennsylvania who was chairman
of the Capital Markets Subcommittee in the last Congress, and I
will go on and predict will be chairman of that subcommittee in
the next Congress, although I acknowledge that is an open
question.
I don't want to prejudice things, but I think he is well in
the lead now for that job. And if we had not done it today at
his initiative, we would not have been able to do it for
several weeks, possibly, to meet that requirement. So for that
reason, I just wanted to say that I think what the gentleman
from Pennsylvania did was very appropriate, and nothing here
will prevent us from reconvening at a later time or convening
as the official committee for whatever we want to do.
Mr. Watt. Would the gentleman yield on his--
The Chairman. Yes.
Mr. Watt. I would just observe that everybody else here is
overdressed for this occasion. It is obvious that I thought it
was less than formal, so--
The Chairman. Taking back my time, could I get a testimony
from the gentleman, in writing, that I showed up overdressed?
Mr. Watt. I think I would ask unanimous consent that we
recognize that.
The Chairman. I thank the gentleman and I withdraw my
reservation.
Mr. Bachus. Yes. Mr. Chairman, I would like unanimous
consent to introduce my letter of December 17th calling for a
hearing, not a meeting. But having said that, I think the
meeting is great.
Mr. Kanjorski. Without objection, it will be entered into
the record.
But a little note on the gentleman from Alabama's question.
It is the intent of the Chair that, as soon as our committees
are constituted, to make the appropriate motions to incorporate
by reference this meeting today to make it have the full force
and effect of a committee hearing. I think that is possible
under the rules. So we were aware of the fact, but quite
frankly and in all honesty, I was hoping we didn't lose the
time, that there seems to be a great deal of information that
could be gained now and a lot of insight if we start very
early. That is why we took these unusual steps.
I think we are also proving to the American people that the
Congress has the capacity to work even when we are not
officially constituted as a body or as a committee.
Mr. Bachus. Thank you. Mr. Chairman, all I was pointing out
is that technically, the hearing is just not a hearing.
Mr. Kanjorski. It will be in the future.
Mr. Bachus. And I commend the chairman for calling this
meeting.
Mr. Kanjorski. Thank you. We meet today to begin to
understand how Bernard Madoff allegedly swindled thousands of
innocent investors, effectively stole billions of dollars and
evaded securities regulators already tipped off about this
unprecedented alleged Ponzi scheme.
The allegations that Mr. Madoff stands at the center of a
$50 billion scam simply shocked the conscience. These deeply
disturbing events have raised even more troubling questions
about the effectiveness of our regulatory system. I have long
stressed a need for pursuing comprehensive regulatory reform
and I have convened hearings to advance these initiatives in
the past. But before we act on legislation in the 111th
Congress to restructure the regulatory system for the financial
services industry and enhance investor protection, we need to
understand how Mr. Madoff organized his many business
operations and how he perpetrated his alleged fraudulent acts.
Today, we will hear from experts in the financial world,
including the Inspector General, the head of the Securities
Investor Protection Corporation, and academics. They will help
Congress begin to unravel this tangled web. We will also hear
from a Madoff victim to help us all understand the dire
implications this ruse has had for individual investors,
charitable organizations, and pension funds.
This meeting to discuss the Madoff affair will also be the
first of several public proceedings. At future hearings, we
will hear from senior officials of the Securities Exchange
Commission and from Harry Markopolos, who has asked us to
temporarily postpone his testimony so that he can better
prepare for our questions.
We will need to hear from other financial services
regulators as well. We also need to hear from auditors and
their overseers to this elaborate Ponzi scheme that fell
through the cracks of our regulatory system. From what we have
all learned in the press, it now appears that regulators should
have detected the Madoff wrongdoing earlier because of red
flags raised by others. Authorities received information about
potential problems when outsiders like Mr. Markopolos could not
create a model that matched the results of Mr. Madoff's
purported strategy. Others published articles as early as 2001
raising questions about Mr. Madoff's firm. Other red flags
included unrealistically steady investment returns and an
auditor the size of a mouse examining a fund the size of an
elephant.
Perhaps most shocking, after Mr. Madoff misled government
examiners and after he was then forced to register as an
investment adviser, the Commission did not conduct any
subsequent inspections. Moreover, in its prior examinations,
the Commission failed to effectively use its subpoena powers to
obtain any records other than those voluntarily offered.
In the wake of this unprecedented financial crisis, we now
know that our securities regulators have not only missed
opportunities to protect investors from massive losses from the
most complex financial instruments like derivatives, but they
have also missed the chance to protect them against the
simplest of schemes, the Ponzi scheme. Clearly, our regulatory
system has failed miserably and we must rebuild it now.
As we resurrect our regulatory structure we must ensure
that regulators have the resources they need to get the job
done. A former Chairman of the Commission, Arthur Levitt, has
noted that the agency's enforcement unit is chronically
understaffed. Whereas it had 433 people in the Office of
Compliance and Examinations, looking at 8,000 advisers 2 years
ago, today it has 400 people looking at 11,000 advisers and
thousands of mutual funds. Moreover, the number of investment
advisers subject to the Commission's oversight has doubled
since 1997.
While we do not know if the Commission's oversight in this
case can be blamed on a lack of resources, we can certainly
work to make sure adequate staff and powers are available in
the future.
As an adjunct to that comment, may I point out--and this is
done for the purposes of our recognition--that sometimes our
overzealousness has caused us a major problem. And that
overzealousness was caused in 2001 when this committee
entertained legislation and adopted that legislation at the
committee level, sent it to the House and passed it, where we
cut appropriations and fees paid to the Commission over 10
years of $14 billion when it was said by the Majority at that
time that these funds were not necessary, that there was
sufficient staffing at the Securities and Exchange Commission
and now we see that is not the case.
I point that out not from a blame standpoint or a political
standpoint, but I point it out that all of us better check our
memories and remember what we did these last 10, 12 or 15 years
and how this committee, perhaps even the Congress, but
certainly some people who are responsible for oversight and
control, perhaps missed the boat in this situation. I hope we
don't do that again and that is the reason I want us to
consider that.
We must also take action to better protect all investors,
from elderly widows to sophisticated market participants. There
are many ideas on how we can accomplish this objective. The
Congress will review these options. In the Madoff case, legal
authorities will be tasked with finding a way to help the
aggrieved investors.
Finally, it is important to note that this is a real crisis
with real victims. I for one was saddened to learn of a
gentleman who, because he lost the money of his family and his
clients in the Madoff financial scandal, took his own life.
Life is always more precious than money. I therefore hope we
will see no more tragic fallouts from this messy sort of
affair.
In closing I thank our witnesses and my colleagues for
joining me here today. Together, I hope that we can learn from
this terrible event, figure out how we can improve our
regulatory structure and undertake the most substantial rewrite
of the laws governing the U.S. financial markets since the
Great Depression.
The gentleman from Alabama is recognized for 5 minutes.
Mr. Bachus. I thank the chairman for convening this meeting
to begin the committee's examination of an alleged $50 billion
Ponzi scheme perpetrated by Bernard Madoff. The Ponzi scheme
designation in connection with his activities is not a recent
coinage. It was first used by Harry Markopolos some 10 years
ago in a complaint to the SEC. And it would have only taken one
staffer pursuing that claim to have uncovered quite a lot of
fraud.
Let me respond to one thing that the chairman said and that
is about a reduction of money for the SEC. There was no
reduction of money for the SEC. That money had been diverted by
the Appropriations Committee to the general fund. So the money
was not getting to the SEC. It didn't get to the SEC before
that action. In fact, the year after that action, the SEC
received greater funding than they did the year before that
action.
So this is not a question of funding. One thing we do know
about the Madoff affair and one agreement that I have with the
chairman and the chairman of the full committee is that the
Madoff affair is yet another indication that what is needed is
a statutory and regulatory structure for the 21st Century. We
don't have that. If we had that in place, I think we may not
have been having this hearing today. And I hope this hearing
will not only be about the Madoff affair, but it will also be
about a new regulatory structure.
As we learned earlier this decade when the Enron episode
was followed in short order by WorldCom and other corporate
scandals, events like Mr. Madoff's scam do not typically occur
in isolation. More recently, the troubles at Bear Stearns were
indicative of similar troubles at other investment banks. We
were told it was a one-firm event. It obviously wasn't, and
there is no reason to think that this time is different. It
seldom is, and therefore there is every reason to believe that
other cases of fraudulent investment schemes may exist.
At a time when the government is trying to stabilize
markets, the Madoff affair and concern that other similar
frauds lurk over the horizon or under the surface threaten to
further undermine investor confidence. It is for that reason
that I wrote Chairman Frank 4 days after the scandal broke to
request that the committee convene hearings early in the 111th
Congress to examine the effectiveness of government in self-
regulatory efforts to protect investors and police fraud. And
every day brings more news of devastating impact of the Madoff
affair on charities, private foundations, and government
entities as well as individual and corporate investors.
Although every detail about the Madoff scandal has yet to
emerge, enough is known at this time to conclude that the
factor that allowed his alleged fraud to continue as long as it
did was the differential regulatory treatment of broker-dealers
and investment advisers. The Financial Industry Regulatory
Authority, FINRA, inspected Madoff's broker-dealer which
supported his market making and proprietary trading operations
at least every other year beginning in 1989. But because
FINRA's jurisdiction is limited to broker-dealers, it had no
authority to inspect his affiliated investor adviser, and that
shop is where the fraud was perpetrated and operated from. And
while the SEC has authority to inspect investment advisers it
typically inspects only a small percentage of the 11,000
federally registered firms in any given year. In fact, Mr.
Madoff's firm was never subjected to such an examination. And
that is despite the fact that Mr. Markopolos had in some detail
described to the SEC the operation as a Ponzi scheme.
And in the Blueprint for Regulatory Reform issued last
March, the Treasury Department highlighted, ``The rapid and
continued convergence of the services provided by broker-
dealers and investment advisers and the resulting regulatory
confusion due to a statutory regime reflecting the brokerage
and investment advisory industries of long ago''--and they
asked for change in statutory changes from this committee and
from others.
Independent studies have reinforced this conclusion,
finding that many investors simply cannot distinguish between
the obligations and responsibilities of brokers, investment
advisers, financial planners, financial advisers or
consultants.
As part of its consideration of reforms to our financial
regulatory structure, this committee should examine whether the
Madoff scandal argues for harmonizing the regulation of broker-
dealers and investment advisers so that schemes such as the
Madoff scheme do not go undiscovered, and are limited in their
scope, before causing such catastrophic consequences. All
parties must commit to making every good-faith effort to see
that this alleged fraud of epic proportions is not repeated.
Chairman Cox should be commended for immediately
commissioning an investigation into the SEC's handling of this
matter. And we look forward to hearing today from the Inspector
General who is conducting that probe. One of the Inspector
General's tasks will to be assess the performance of the SEC's
Office of Compliance, Inspections and Examinations, which
appears to have missed several red flags that might have led to
earlier detection of the alleged fraud.
The fact that the accounting firm responsible for auditing
Madoff's $50 billion enterprise of complex trading activities
was a three-person shop operating out of a suburban New York
storefront should have been one very large red flag.
Let me conclude, Mr. Chairman, with a word of caution.
While the failures of regulatory and private sector due
diligence exposed by the Madoff matter are obvious, they do not
lead me to conclude at this stage of the inquiry that what is
needed are broad new legislative or regulatory mandates on the
rest of the securities industry. What we may have in the Madoff
case is not necessarily a lack of enforcement and oversight
tool, but a failure to use them. What we certainly have is yet
another indication, as I said in my earlier statement, that
what is needed is a statutory and regulatory structure for the
21st Century, one that the Minority has urged for 2 years now.
I thank our witnesses for being here today. We look forward
to your testimony.
Mr. Kanjorski. Thank you very much. Now, we will hear from
the chairman of the full committee, Mr. Frank of Massachusetts.
The Chairman. Thank you, Mr. Chairman-to-be. I would note
that since we are into procedural regularity here, I have in
fact been selected by the Democratic Caucus as the chairman of
the committee, even though I will concede that I do not at this
point technically have a committee to chair, but I anticipate
one very soon in the regular order.
First, I want to elaborate on the position of Harry
Markopolos, who appears to be the hero in this, who is a man
who early on notified the Boston office of the Securities and
Exchange Commission of the problem. And maybe with a little
provincial pride on behalf of my fellow New Englanders on the
panel, I will note that Mr. Markopolos reports that the Boston
office responded appropriately, that they took him seriously
and forwarded it on, and at some point later on there was a
failure.
I also want to say, because I have spoken to people who are
in the enforcement division of the SEC in the Boston office and
elsewhere, no one should infer from this terrible situation
that the working personnel at the SEC were at fault. There is
no suggestion that any of them were less than diligent. There
were some structural flaws here, but in my experience it would
not be appropriate to blame any of them. And we will be talking
further about the funding situation.
I will note that in 2003, when I became the ranking member
on the Minority side of the full committee, we had just passed,
and President Bush had signed into law, the Sarbanes-Oxley bill
which came out of this committee under the chairmanship of Mr.
Oxley, and we felt there wasn't adequate funding for it. And we
had, frankly, some partisan fights on the Floor in 2003 and
2004 in which several of us tried to add funding for SEC
enforcement. We were defeated a couple of times.
Finally, I believe in 2005--Mr. Wolf was then the chairman
of the appropriations subcommittee with jurisdiction here--
agreed. So there was then a further move up. I also just want
to note that we invited, of course, Mr. Markopolos to be here,
and he had originally said he was going to do it. And I will
frankly say that I was pleased that he indicated that he
thought coming to this committee to have these conversations
was a useful way to advance his interest, that he felt that we
would be a hospitable and useful forum for the conversations.
And as my two colleagues have mentioned, our focus here is not
so much to find out who is to blame for what happened--there
will be other institutions of the government that will do that.
Our main job is to do what we can to see that this doesn't
happen again.
We are a legislative body and our goal will be in part to
see whether the mistakes--and you have to look at why it
happened to be able to prevent it from repetition. But that is
what we are working on. But Mr. Markopolos did write back and
say, first of all, that he is understandably physically a
little bit worn down. We will release his letter. He has been
through a great deal of stress.
He also has been talking to lawyers and this is a very
complex subject, and he asked for more time to prepare.
Actually, the staff of the gentleman from Pennsylvania did
respond to him to assure him that we would be completely
cooperative in meeting these conditions.
As I read Mr. Markopolos' letter and our conversations, he
will be testifying. And I want to make that clear. This is not
a refusal to testify. But on a subject of this importance, he
wants to make sure that he is in good condition himself and
that he has been able to do the appropriate amount of
preparation.
Finally, I will say that there had been arguments
previously in our public policy that investor protection could
be confined to people of lower income, not directly relevant,
but analogous. When we talked about hedge funds for example,
the main defense we have had in place legally regarding hedge
funds has been the requirement that you had to have at least $1
million to invest to be eligible to invest in hedge funds. That
was an SEC rule. Mr. Cox explained that. The theory was for
others, the principal caveat investor could apply if people had
more than a million dollars. What we have seen here and we saw
it also--sadly, although not in nearly as negative an impact in
the auction rates securities market, that it is not simply
people who have less than $1 million to invest who need to have
rules put in place by the government that ensure fairness.
Investors are at risk and they have to make judgments about
what is or isn't a good idea. But it is not reasonable to
expect them in every individual case to be the detectors of
fraud.
So there is a requirement, I believe, if the system is to
work, for the government to act. And I will just add, finally,
this Madoff situation is an example of why regulation done
properly is very pro-market. The Madoff damage inflicted on so
many innocent people, and in turn on many of the causes that
many of these innocent people who were very charitable tried to
help out--clearly we have people who are worried about
investing anywhere. This country will not work if we are not
able to restore the confidence of investors, that there are
places that they can put their money that will be both
remunerative to them and productive to the society, allowing
the money to be put in productive places. So this is one more
example of why we need to adopt in this coming Congress a set
of rules that will give investors in America the confidence
that many of them have lost, unfortunately, because of these
scandals, and which has to be restored if we are to have a
return to the prosperity that the market functioning well can
give us.
Mr. Kanjorski. I now recognize the gentleman from Texas for
2 minutes, Mr. Paul.
Dr. Paul. Thank you, Mr. Chairman. The ranking member made
some important points early on about the timing of these
hearings, but nevertheless I am glad we are having these
hearings because it gives me an opportunity to make a few
points regarding this whole system and the tragedies that we
have faced here in this past year especially. And, of course,
symbolically the Madoff scandal is a glaring example of
something seriously wrong. But unfortunately, I don't think too
many people will gather the same answer from this problem that
I and others have gotten. And that is for a good many years now
since the 1930's, every time a problem like this comes up, like
in the Depression, we think that it is a lack of regulations.
We introduce regulatory agencies like the SEC. And like after
Enron, that was a major problem. So we appropriate more money
and hire more people. It doesn't do any good. But this
circumstance I think really makes my point that the approach is
completely wrong, that the regulatory agencies and preempting
people from doing bad things just doesn't work. There are
millions and millions and millions of transactions; you can't
do it. All they do is give a false sense of security. This is a
perfect example of it.
The SEC was involved with Madoff over the last decade. And
that sort of gives the stamp of approval: Oh, it must be okay.
So everybody's guard is let down. This creates the moral hazard
that allows people to make these mistakes and not to assume
responsibility for themselves.
Does that mean that we should ignore the problem? No. The
problem comes because people commit fraud and fraud laws are on
the books. All the people involved with Enron were prosecuted
under State laws of fraud and the market took care of the
stocks. But just adding on new regulations and spending
millions and millions if not billions of dollars on regulating
enterprise doesn't do any good. It contributes to it. It is the
problem. We should look more to how the atmosphere is created
by the Congress.
If you look at the principle of fractional-reserve banking,
that in a way is a Ponzi scheme. This gets people doing things
and building a mountain of debt. Debt on debt is done in this
manner. Also, if you really want to look at a big Ponzi
scheme--and it is said too often that people end up doing what
governments do if we set examples--and believe me, everybody
knows that the Social Security system is a Ponzi scheme. So,
yes, $50 billion is horrendous. But what about an $8 trillion
loss in the stock market? So what do we do? We rush and pump in
$8 trillion. Where do we get the money? We create it out of
thin air.
Furthering this whole idea of moral hazard and believing
that we can create an unmanageable system is not the fault of
the individuals at the SEC. They have an impossible job and
they have to pretend they are doing something to feel relevant,
the same way we do here in the Congress. We have to feel
relevant in this. Instead of saying what we need is the market
to work, we need to get rid of the bad policies, the monetary
system and these mountains of debt. We say, we are relevant
because we are going to hire more bureaucrats and we are going
to appropriate more money that we don't have and we are going
to solve all our problems. We have been doing this for 78 years
and we will do it again. But believe me, this will not solve
our problems.
We need to think about eliminating this whole regulatory
process. And actually, we don't need the SEC at all and we
could thrive even better and we would dwell on self-reliance,
self-policing, and the idea that people can't commit fraud but
that the government should not commit fraud either. We should
not set an example. I yield back.
Mr. Kanjorski. The gentleman from New York, Mr. Ackerman,
is recognized for 2 minutes.
Mr. Ackerman. Thank you, Mr. Chairman, or whatever you are.
Bernard Madoff's victims collectively paid hundreds of millions
of dollars in Federal and State taxes. Yet the Federal
Government did not use any of this tax or any other tax dollars
to properly oversee or discover any deceitful, fraudulent
activity in the Madoff empire in time to mitigate potential
losses or to protect investors. In fact, the government stands
to become the ultimate beneficiary of ill-gotten gains.
After having failed to protect the American public from Mr.
Madoff's scheme, while simultaneously taxing the phantom
profits on unreal investments by real people and charities,
many whose life savings, whose actual lives and dreams are now
in ruins. So you thought your brokerage account was insured for
$500,000? Wrong. With the collapse of Madoff's Ponzi scheme,
thousands of investors lost that half-million dollar bet along
with their life savings, and along with millions of others of
Americans, their trust in their government.
Under SIPC's liquidation plan, claims related to Madoff's
fraudulent scheme may be limited to only those investors who
can prove they sent money to Madoff after December 11, 2007.
The SIPC plan is simply inadequate.
Forget the Steven Spielbergs and Kevin Bacons who are not
worrying that the bank is going to foreclose on their house at
the end of the month. What about people like Allan Goldstein
who is testifying before our committee today? The Allan
Goldsteins of our country, who lost everything to Mr. Madoff,
aren't billionaires with seaside villas or tropical islands or
more money than anyone could spend in a lifetime. The Allan
Goldsteins of this country put their entire life savings, their
diversified--they thought--account for years, dependent on
their dividends that they received to pay for their mortgages
and their medical bills.
Mr. Chairman, the inability of the SEC to detect any
wrongdoing at Madoff Securities for well over a decade
undoubtedly has had a significant impact on investor confidence
at an already difficult time in our financial markets. The
SEC's failure and the inequity of SIPC's plan, the refusal or
the inability by SIPC or the Federal Government to provide
comprehensive fair insurance to the victims of the fraud will
only serve to exacerbate cynicism among the investors and
further discourage our economy and its recovery.
I thank you for calling this meeting today and I look
forward to hearing from all of our witnesses. I yield back the
balance of my time.
Mr. Kanjorski. The Chair thanks the gentleman from New York
and will now hear from the gentleman from Illinois, Mr.
Manzullo, for 2 minutes.
Mr. Manzullo. Thank you, Mr. Chairman. As I go over and
review exactly what happened here, at least what I think
happened, there are plenty of red flags. There are plenty of
indications that there were problems going on, but somebody
just didn't do their job. You can add resources and personnel
and money, but when the red flags were there and people weren't
doing their jobs, how do we know they will do their jobs in the
future if you just throw money at the situation? You can't
create competence by spending money. That is not the issue.
Perhaps the issue here, or the larger issue, is with a
myriad of organizations and commissions, government entities
that are supposedly involved in protecting the investor.
Perhaps we need to take a look at the big picture from the eyes
of the investor and not from the eyes of the investment house
to see how the protection of the investor can be made paramount
to trying to accommodate the investment houses, even though it
is possible to do the same.
So I hope that we have the opportunity in this committee or
meeting, or whatever we want to call it today, to begin a new
look at how we do the regulatory process. And that is all we
need on top of the fact that we have a crushing economy, 11\1/
2\ percent unemployment in the largest city of my congressional
district; the Chrysler plant that really is smarting, with
thousands of people who look to Washington for guidance each
day. Perhaps we can straighten this out in a matter consistent
with the fundamentals of free enterprise and also protect the
small investors who are out there.
Mr. Kanjorski. The gentleman from California, Mr. Sherman,
is recognized for 2 minutes.
Mr. Sherman. Thank you, Mr. Chairman. The Madoff scheme
would still be in operation today and perhaps for decades into
the future had it not been for the meltdown on Wall Street that
brought it to public notice.
Chairman Arthur Levitt announces that the SEC should be a
law enforcement agency or have a law enforcement agency. This
is a proposal that he resisted when he was Chairman of the SEC
and all of his successors continue to oppose. Four-fifths of
the Commissioners in the SEC insist upon staying on, even after
the SEC failed with regard to mortgage-backed bonds and now has
failed with regard to Madoff. You would think that all the
members of the SEC would at least offer President Obama a
resignation and have him decide whether this agency needs a
complete change.
There is a myth that Madoff's only falsehoods were on the
17th floor in its investment adviser business. Nothing could be
further from the truth. His broker-dealer business filed
financial statements with the SEC and with FINRA every year and
they were off by about $17 billion. The SEC has briefed me
privately and has said for many years, the Madoff broker-dealer
operation filed annual statements with both the SEC and FINRA.
These financial statements showed $17 billion in assets, and a
one-man accounting official. That means that if somebody
glanced at that statement for even a couple of minutes, the
fraud is there on its face, because there are ethics rules
dealing with public accountants that say that if they are going
to be regarded as independent public accountants, they can't
get more than 5 or 10 percent of their revenue from any one
client. So to look at this financial statement, you would have
to believe that somebody can audit a $17 billion enterprise,
one guy can do it in a couple of weeks. Either that is true or
the statements are fraudulent on their face. But the SEC never
bothered to read the financial statements, not even for half an
hour. Neither did FINRA.
SIPC is with us today. They are well known because you go
into your broker's office and you see that you are protected by
SIPC up to half a million dollars. I know that for many of the
Madoff clients that may be a problem, but I have investors in
my district, $10,000, $20,000 or $30,000 at the broker-dealer.
What they are not told by that decal is that SIPC has virtually
zero net worth. You are insured by an insurance company that
has nothing in the safe. Because while they had $1.5 or $1.6
billion, virtually all of that is going to be wiped out by the
Madoff claims. And, of course, if some individual investors are
able to claim it, the SIPC may owe them many billions more. I
yield back to the chairman.
Mr. Kanjorski. The gentleman from New Jersey, Mr. Garrett,
is recognized for 3 minutes.
Mr. Garrett. And I thank the chairman for holding this
important hearing this afternoon. I also want to thank Ranking
Member Bachus for his diligence in requesting that this hearing
be held as soon as this issue came to light. I think it is safe
to say that Mr. Madoff put together the largest Ponzi scheme in
history. I doubt that even the Ponzi scheme's namesake, who is
Charles Ponzi, ever foresaw that someday somebody would be
hoodwinking investors to the tune of $50 billion. Maybe it is
appropriate that due to the breadth, size and longevity of the
scheme, we change the name of the Ponzi scheme that we all use
in the future to the ``Madoff scheme.''
Unfortunately, the media has portrayed the story as one
that has only affected the wealthy, multi-millionaires and
those who socialized with the Madoffs at lavish charity events
and such. As we heard before and will hear today at this
committee hearing, that is unfortunately not the case. And I
have heard it personally at home as well.
On Friday, I received a call from a constituent. Her 86-
year-old mother suffering from illness has had her life savings
invested with Mr. Madoff. Now, due to how long it may take to
unwind this matter, she faces the very real possibility of
never receiving any of it. And what is most unfortunate is that
the SEC regulators had numerous chances to uncover the scheme
and that they continually either didn't see the multiple
warning signs, didn't follow up on them, or simply chose to
ignore them.
I think there are three takeaways that you can take from
what is about to happen in the committee in going forward in
Congress on this. First of all, to those who will advocate that
there is a need for increased Federal regulations in the hedge
fund industries from this occurrence, let me remind them that
there were a number of hedge funds that did in fact become
victims of this. So I think it is a stretch to believe that the
same SEC regulators who were directly tasked with overseeing
Mr. Madoff's firm would have been able to uncover this scheme
had they been simply reviewing the books of those very same
hedge funds.
Furthermore, to those who advocate, as we have heard here
already, for more regulation and increased budget and increased
spending--you know there was an article just the other day in
the Wall Street Journal that addresses this. They say in there,
how can it be that if the two sons of Mr. Madoff apparently did
not become aware of this, despite the fact that they were
working in the firm for some 2 decades, if they were not aware
of it, how then can we call for increased regulations and think
that some outside regulator would have been able to become
aware of it?
The third takeaway is from the comment made by the chairman
of the committee when he says that he finds no fault with SEC
personnel, specifically with regard to this situation. While I
certainly sit here and hope that is not the case, quite
honestly I think it is premature for any of us to jump to any
conclusions as to who is or who is not responsible for failure
to act on the red flags that came up numerous times.
In conclusion, I look forward to our witnesses' testimony
today and learning more on this scheme and how it was able to
continue for so long. But also, very importantly, I look
forward to figuring out just how we can help those people,
those poor--not poor, but those middle-class people such as the
elderly lady I mentioned, how they can recoup as much as they
can as quickly as possible. I yield back the balance of my
time.
Mr. Kanjorski. Thank you. The gentlelady from New York,
Mrs. Maloney, is recognized for 1 minute.
Mrs. Maloney. Thank you very much.
In contrast to the seeming ease with which Bernard Madoff
vastly overstated the contents of his clients' account, it
would be almost impossible to overstate the pain his scheme has
caused. The loss accrues not only to Madoff's client, but to
literally millions of others, who in one way or another had
depended on the false promise of his financial stewardship.
I just came back from meeting with unions that invested
their pension funds. I would like to place in the record
letters from constituents who lost their entire life savings,
investors large and small.
Two have taken their lives and I--my sympathy really goes
out today to one of our witnesses, Mr. Goldstein, a retired New
Yorker who also lost his life savings. I believe that markets
run as much on confidence as they do on capital and this is a
serious blow to investors' confidence at a critical time in our
economic challenges. I thank you for holding this hearing and I
look forward to working with you for better oversight and
regulation.
Mr. Kanjorski. Thank you, Mrs. Maloney.
The gentleman from New York--or I am sorry. The gentleman
from Nevada, Mr. Heller, for 3 minutes.
Mr. Heller. Thank you very much, Mr. Chairman, and to the
ranking member for holding today's meeting and focusing our
attention on this issue, the Madoff scandal.
This scandal has serious effects, not only on affected
investors, but the enforcement and oversight failures also
rattled the confidence of investors everywhere when our
financial system is already racked with problems.
I see three major failures here. First, clearly, the SEC
had a major failure of huge proportions. According to
testimony, the SEC was warned about this problem and ignored it
for years if not decades. In fact, I took a look back at their
highest profile investigation for 2008, and it was a $750,000
inside trading case; $750,000 was the biggest case that I am
aware of or at least the highest profile case for the SEC last
year. That versus a $50 billion Ponzi scheme was the decision I
can only assume someone on the SEC does not like the Dallas
Mavericks.
Second, State regulators. They call themselves the local
cops on the beat. They like to take a tremendous amount of
credit for the work they do. And some of them--and most of them
do a great job, but they also failed. And my question is, why
were they not doing their job?
And finally, not all individual investors did their due
diligence. Manners and expensive suits do not necessarily
equate to honesty and integrity, and we must always trust but
verify, and clearly, that failed.
Like all Ponzi schemes, this one crashed, even if it took
decades. I would like our witnesses to suggest how these three
levels--Federal, State, and individuals--can work to prevent
scandals like this one in the future.
Thank you. I look forward to the testimony, and I yield
back.
Mr. Kanjorski. Thank you very much, Mr. Heller.
The gentleman from New York, Mr. Meeks, is recognized for 2
minutes.
Mr. Meeks. Thank you, Mr. Chairman. I thank you and the
ranking member for conducting this hearing today. I guess we
can call it a hearing.
To me, what we are confronted with today is a situation,
first of all, when we talk about the Madoff scandal, what we
are really dealing with is a crook. We are dealing with an
individual who took people's money and lost it. He is a crook.
He deserves to go to jail. And to the degree that we can make
any individuals whole who lost their money, as in any other
fraud case, we need to figure out how we get that done. That is
the bottom line here.
Now, in the course of that investigation, and what I am
looking to hear and why I think these hearings that we are
having are tremendously important, is, what can we learn from
it? As in any kind of crime that has been committed, there
should be something that we can learn from it so that we can
prevent it from happening again and to make sure that we shore
up our rules and laws and regulations if it will help prevent
it. You don't get rid of the laws. If somebody commits bank
robbery, you don't say, okay, we are going to get rid of all
the laws with reference to bank robberies. We don't do that. We
figure out how we make them stronger so that we don't have
another bank robber. And that is what we are dealing with here
today.
We have to figure out and listen. Now, if there is an
investigation and we find that someone within the SEC was
complicit with it, then that person is a crook and needs to go
to jail. But if we find that there is some other--that they
were not properly trained or they were inexperienced or we
didn't put the appropriate amount of money in there, then it is
our job as Members of the United States Congress to fix that.
If we find, through the hearing and listening and learning from
people, what takes place, that there are new rules and
regulations that we can put in place so that no one else is
scandalized again, it is our jobs to do that. And the only way
to do that, because I know I am not the ultimate expert, is to
have the kind of witnesses that the chairman has decided is
necessary to be here today so that we can listen, we can learn,
we can evaluate, and we can do something intelligent to try to
make sure that a crook like Madoff can't get away with it
again.
I yield back.
Mr. Kanjorski. The gentleman from Missouri, Mr. Scott.
Mr. Scott. Thank you very much, Mr. Chairman. I am
delighted you are having this meeting.
I think the fundamental issue has to be, what went wrong,
how it went wrong, and what we are going to do about it. But I
think that we have to look at these red flags that just came:
First, the stability of getting 10 to 12 percent of return when
the economy is going up and down. The fact that they use
relatively obscure small auditing firms when most sizable
brokerages use auditors that are sanctioned by the public
accounting oversight, another red flag. Mr. Madoff himself kept
several books, false documents. He even lied to regulators when
they questioned him in previous examinations of his firm.
Why did investigators never use subpoena powers to obtain
truthful information? Instead, they only relied upon the
information voluntarily produced by Mr. Madoff. That is sort of
like asking a thief if he is stealing. The thief is going to
tell you, no, I am not stealing. It just begs the question of
time after time after time when the SEC was looking at these
things, even the case down in Florida with two accountants that
had called, there was a possibility of a $400 million fraud
case there. They looked at it, gave a wink and a nod, and it
was gone. We have a credibility problem with the SEC. We have
to find out exactly what happened.
The American people are expecting the confidence.
Confidence is the key buzzword going forward. We have to get
confidence and reclaim our economic system. And this is a way
to start, Mr. Chairman. I appreciate this hearing, and I look
forward to the questions as we go forward.
Mr. Kanjorski. Thank you very much, Mr. Scott.
The gentleman from Florida, Mr. Klein, is recognized for 2
minutes.
Mr. Klein. Thank you, Mr. Chairman, and I thank the ranking
member for holding this committee meeting today and certainly
reflect on a lot of the good comments that have already been
made.
I come from a part of the country, south Florida, which was
hit particularly hard. Mr. Madoff spent a lot of time down
there and preyed through his social engagements on a lot of
people who bought into what he was doing and, unfortunately, a
lot of charitable organizations. We had a large group called
the Picower Foundation that had over a billion dollar of assets
that funded everything from educational philanthropies, school
systems, science, all the things that everyone in this country
believes in and knows that government can't do everything, but
we rely on philanthropy to help with that; it is now closed.
And there are many other organizations which I think we are all
familiar with.
And I think the question is, not what was lost, we
understand that or are beginning to understand that, but why,
what went wrong? I think, as you have already heard, and I
certainly agree with this and my background is as a securities
lawyer, there were red flags that were presented to the SEC,
probably red flags to investors as well. The question, of
course, that has been raised is, why did the SEC not follow up
on these? The SEC has admitted that it received credible
allegations about fraud 9 years ago, but nothing was really
done with them.
So if there is anything we have learned from the Madoff
scandal, we certainly know that in a global economic crisis as
we have right now, we need smarter regulation and greater
oversight to restore confidence of investors in the market.
This doesn't mean that government will be checking up on every
move of every investor or every seller of an investment, but
this does mean that someone like Madoff should never, ever, be
able to get away with this type of activity again.
And finally, there is the human question of how much money
can Bernie Madoff's victims expect to recover? A couple that I
know from Boynton Beach, Florida, who lost their retirement
savings from Madoff and now have only enough money to live on
by Social Security, they are saying, how much, and when? These
are obviously scary times, and I think we do need to get to the
bottom of this, not only for what went wrong in the past, how
much money can be recovered and how much money can be given
back to the people who lost it in the charitable organizations,
but also what we can do to prevent it in the future.
Thank you, Mr. Chairman.
Mr. Kanjorski. Thank you, Mr. Klein.
Now, the gentleman from Texas, Mr. Green, is recognized for
1 minute.
Mr. Green. Thank you, Mr. Chairman, for hosting this
hearing.
Mr. Chairman, I don't know what should happen to members of
the SEC. But I do know what would happen to members of the
District Attorney's Fraud Division, Welfare Fraud Division, if
welfare mothers were able to perpetrate a similar kind of
circumstance. My suspicion is that members of the Welfare Fraud
Division, not having caught welfare mothers perpetrating fraud,
they would be dismissed.
I don't want to prevent investors from investing. I don't
want to make it difficult for them. I do want to make it
difficult for criminals to steal. We make it difficult for
welfare mothers to steal. I think we have to make it difficult
for people who perpetrate these kinds of fraud to do it.
I yield back the balance of my time.
Mr. Kanjorski. Thank you very much.
And now, finally, for 1 minute, Mr. Perlmutter of New
Hampshire.
Mr. Perlmutter. Thanks, Mr. Chairman.
In Colorado, we had--our fire and police pension fund was
one of the entities that lost money, and they were an investor
through Fairfield Greenwich. So when Congressman Paul was
talking about the enforcement side of this doesn't make sense
and we really don't need it, lots of money from many, many
individual investors, policemen, firemen from Colorado into
another fund into this and without an enforcement mechanism
that is really solidly in place, the confidence, as Mr. Heller
said, in the system as a whole is shot.
Now, obviously Mr. Madoff was a confidence man. He gained
the confidence of many investors and he gained the confidence
of the regulators. The regulators have to have the tools, and
they have to be no-nonsense, and they have to be regulators,
and they can't be conned, as we see so many other entities
were. So I hope the testimony we are going to hear from you
gentlemen today talks about putting some teeth back into this
regulatory system so people aren't conned in the way they were
this time.
With that, I yield back.
Mr. Kanjorski. Thank you, Mr. Perlmutter.
I just want to assure you that I know you are from
Colorado, but I got confused on the great skiing in New
Hampshire.
Mr. Perlmutter. New Mexico is a nice State, too.
Mr. Kanjorski. The gentleman from New Hampshire, Mr. Hodes.
Mr. Hodes. Thank you, Mr. Chairman. And I thank you and the
ranking member for holding this hearing.
Ponzi schemes aren't new and neither are crooks and
shysters. What is new, I think, are the conditions under which
this Ponzi scheme occurred. We have the complexity of modern
securities markets and an explosion of global wealth combined
with our regulators, who over the past few years haven't been
doing their jobs.
Arthur Levitt in the Wall Street Journal argues
persuasively today that risk assessment must be central to the
SEC's efforts. There has to be robust oversight and inspection
capability and effective enforcement, which requires a
commitment of appropriate resources.
And without going into the numbers of what those
appropriate resources are, I am interested to hear my
colleagues on the other side of the aisle apparently arguing
that we don't need more regulations or oversight. I don't know
what world they might be living in because in the world we are
living in with the global financial collapse, people who have
lost their life savings, the Madoff scandal is really like the
cherry on a bad sundae. And it is time that we have a 21st
Century regulatory scheme for the 21st Century.
So I look forward to the testimony which will enlighten us
about how and what we need to do in the SEC, and then we are
going to move on to what we need to do for the rest of the
financial markets.
Thank you.
Mr. Kanjorski. I thank the gentleman from Colorado.
I think that is fair.
Mr. Hodes. New Hampshire, New Mexico, Colorado, they all
have snow, Mr. Chairman.
Mr. Kanjorski. The chairman makes the point, Mr. Obama
carried them all.
I will now introduce the panel and thank you all for
appearing before the committee today.
Without objection, your written statements will be made a
part of the record. You will each be recognized for a 5-minute
summary of your statement.
First, we have Mr. David Kotz, Inspector General of the
U.S. Securities and Exchange Commission.
Mr. Kotz.
STATEMENT OF H. DAVID KOTZ, INSPECTOR GENERAL, U.S. SECURITIES
AND EXCHANGE COMMISSION
Mr. Kotz. Good afternoon. Thank you for the opportunity to
testify today before this committee on the subject of assessing
the Madoff Ponzi scheme as the Inspector General of the
Securities and Exchange Commission.
I appreciate the interest of the chairman as well as the
other members of this committee and the SEC and the Office of
Inspector General. In my testimony today, I am representing the
Office of Inspector General, and the views I express are those
of my office and do not necessarily reflect the views of the
Commission.
I would like to begin my brief remarks this afternoon by
discussing the role of my office and the oversight efforts that
we have undertaken since I was appointed as the Inspector
General of the SEC approximately 1 year ago in late December
2007. The mission of the Office of Inspector General is to
promote the integrity, efficiency, and effectiveness of the
critical programs and operations of the SEC. I firmly believe
that this mission is best achieved by having a vigorous and
independent Office of Inspector General to investigate and
audit Commission activities and to keep the Commission and
Congress informed of significant issues and findings.
The office has staff in two major areas: audits; and
investigations. Our audit unit conducts, coordinates, and
supervises independent audits and evaluations relating to the
Commission's internal program and operations. The office's
investigative unit responds to allegations of violations of
statutes, rules, and regulations and other misconduct by
Commission staff and contractors.
I am proud to report that, notwithstanding a small staff,
the Office of Inspector General at the SEC has issued numerous
reports over the past year involving issues critical to SEC
operations and the investing public. Two examples of recent
audit reports are an analysis of the Commission's oversight of
the SEC's Consolidated Supervised Entity Program, which
included Bear Stearns, Goldman Sachs, Morgan Stanley, Merrill
Lynch, and Lehman Brothers, that provided a detailed
examination of the adequacy of the Commission's monitoring of
Bear Stearns, including the factors that led to its collapse,
and a review of the Commission's Broker-Dealer Risk-Assessment
Program.
We also have a vibrant and vigorous investigative unit that
is conducting or has completed over 50 comprehensive
investigations, several of which involve senior-level
Commission employees and represent matters of great concern to
the Commission, congressional officials, and the general
public.
It is with this background in mind that I wish to discuss
our planned efforts to investigate matters related to Bernard
Madoff and affiliated entities.
On the late evening of December 16, 2008, SEC Chairman
Christopher Cox contacted me and asked my office to undertake
an investigation into allegations made to the SEC regarding Mr.
Madoff going back to at least 1999 and the reasons that these
allegations were found to be not credible.
The Chairman also asked that we investigate the SEC's
internal policies that govern when allegations of fraudulent
activity should be brought to the Commission, as well as staff
contact and relationships with the Madoff family and firm and
any impact such relationships had on staff decisions regarding
the firm.
Early on December 17, 2008, we opened an official
investigation into the Madoff matter. Since then, we have been
working at a rapid pace to begin this important work. On
December 18, 2008, we issued a document preservation notice to
the entire agency, informing them that we had initiated an
investigation regarding all Commission examinations,
investigations, or inquiries involving Bernard Madoff and any
related individuals or entities. We formally requested that
each employee and contractor in the Commission preserve all
potentially responsive electronic and paper records in their
original format.
Over the next few days, we met with senior officials from
the Commission's Division of Enforcement and the Office of
Compliance Inspections and Examinations, known as OCIE, to
ensure their cooperation in our investigation and our ability
to gain access to their files and records. We also met with the
Chairman's office to seek information and documentation
relevant to the investigation.
On December 24, 2008, we sent comprehensive document
requests to both the Division of Enforcement and OCIE,
specifying the documents and records we required to be produced
for the investigation. In addition, we made several formal
expedited requests to the SEC's Office of Information
Technology for searches of the e-mails of former and current
employees for information relevant to the investigation, both
at headquarters and at the New York and Boston regional
offices, and have already received and are in the process of
reviewing these e-mails.
We have also begun identifying the particular issues that
need to be investigated and are reviewing and updating daily
the list of witnesses that we plan to interview. We intend to
begin conducting these interviews immediately and, for example,
have already scheduled a meeting with Harry Markopolos for
later this month for an in-depth interview on the record. We
have also already met and spoken with numerous individuals
informally as part of our initial investigative efforts.
It is our opinion that the matters that must be analyzed
may go well beyond the specific issues that Chairman Cox has
asked us to investigate. And we believe our oversight efforts
must include an evaluation of broader issues regarding the
overall operations of the Division of Enforcement and OCIE that
would bear on the specific questions we are examining and
provide overarching and comprehensive recommendations to ensure
that the Commission fulfills its mission and goals.
At this early stage, I thought it would be useful to
identify the specific issues related to Bernard Madoff that, as
a preliminary matter, we intend to investigate or review.
Obviously, as the investigative efforts are just beginning, I
am not in a position to provide any conclusions or findings
with respect to the allegations that have been raised and do
not wish to make any preliminary judgments before we have had a
chance to analyze all the information. In addition, as
underlying evidence could also be relevant to the pending
criminal or SEC investigations into possible violations of the
securities laws, I am being mindful not to comment on anything
that may affect or interfere with those investigations.
The following are specific issues that we currently intend
to investigate:
One, the SEC's response to all complaints it received
regarding the activities of Bernard Madoff. We plan to trace
the path of these complaints through the Commission from
inception, reviewing what, if any, investigative or other work
was conducted with respect to these allegations and analyze
whether the complaints were handled in accordance with
Commission policies and procedures and whether further work
should have been conducted.
Two, allegations of conflicts of interest regarding
relationships between any SEC officials and members of the
Madoff family and whether such relationships in any way
affected the manner in which the SEC conducted its regulatory
oversight of Bernard Madoff.
Three, the conduct and examinations and/or inspections of
Bernard Madoff's firm by the SEC and an analysis of whether
there were red flags that were overlooked by SEC examiners that
could have led to a more comprehensive or timely examination.
And four, the extent to which the reputation and status of
Bernard Madoff and the fact that he served on SEC advisory
committees, participated on securities industry boards and
panels, and had social and professional relationships with SEC
officials may have affected Commission decisions regarding
investigations and examinations of his firm.
In addition to these specific issues and depending upon the
information that we learn during the course of our
investigation, we plan to consider analyzing the following
broader issues, as well:
One, the complaint handling procedures of the Division of
Enforcement, including a review of how complaints are
processed, internal incentives that may affect the decision
whether to take action with respect to a complaint, an analysis
of which complaints are brought to the Commission's attention,
and whether tangible and specific complaints are actually being
reviewed and followed up on appropriately.
Two, the OCIE examination and inspection procedures,
including an analysis of what policies and procedures were then
and are currently in place, whether these policies and
procedures are being followed, and/or whether there are gaps in
these policies and procedures relating to operations involving
private investment pools such as hedge funds because they are
subject to limited oversight by the SEC and whether any such
gaps may lead to fraudulent activities not being detected.
And three, the relationships between different divisions
and offices within the Commission and whether there is
sufficient interagency collaboration between the agency
components to ensure comprehensive oversight of regulated
entities.
Obviously, this is an ambitious investigative agenda, but I
firmly believe that the circumstances surrounding the Bernard
Madoff matter may very well dictate a more expansive analysis
of Commission operations.
Moreover, it is my view that at the end of these
investigative efforts there needs to be more than just the
potential identification of individuals who may have engaged in
inappropriate behavior or potentially failed to follow up
appropriately on complaints, but rather an attempt to provide
the Commission with concrete and specific recommendations to
ensure that the SEC has sufficient systems and resources to
enable it to respond appropriately and effectively to
complaints and detect fraud.
Of course, even with the limited staff and many of our
auditors and investigators already engaged in ongoing matters,
I understand that it is critical that our investigative efforts
be conducted expeditiously. I fully understand that it is
crucial for the Commission, the Congress, and the investing
public that answers be given to the very serious questions
regarding the SEC's efforts relating to Mr. Madoff in a prompt
and swift manner.
For this reason, I am mobilizing additional resources to
ensure that our office makes every possible effort to conclude
our investigations and reviews as soon as possible. We are
considering preparing reports on a rolling basis, assuming that
we can identify discrete issues that may be resolved separately
and expeditiously, so that some conclusions may be provided
very shortly.
Finally, I can assure you that our investigation and review
will be independent and as hard-hitting as necessary. While we
approach these efforts with an open mind, and at this stage of
the investigation we have not reached any conclusions or made
any findings, the matters that have been brought to our
attention require careful scrutiny and review. We will conduct
our work in a comprehensive and thorough manner. And if we find
that criticism of the SEC is warranted and supported by the
facts, we will not hesitate to report the facts and conclusions
as we find them. I think that if you review the reports issued
by our office over the past year, you will see that, where we
have found that criticism of the SEC or SEC officials was
warranted, we have reported our findings and concerns in a
frank manner.
In conclusion, we appreciate the chairman's and the
committee's interest in the SEC and our office. I believe that
the committee's and Congress' involvement with the SEC is
helpful to strengthen the accountability and effectiveness of
the Commission. We intend to conduct our investigative efforts
promptly and thoroughly.
Thank you.
[The prepared statement of Mr. Kotz can be found on page
102 of the appendix.]
Mr. Kanjorski. Thank you very much, Mr. Kotz.
And next, we will hear from Mr. Stephen P. Harbeck,
president of the Securities Investor Protection Corporation.
Mr. Harbeck?
STATEMENT OF STEPHEN P. HARBECK, PRESIDENT AND CEO, SECURITIES
INVESTOR PROTECTION CORPORATION (SIPC)
Mr. Harbeck. Thank you, Mr. Chairman.
Chairman Kanjorski, Chairman Frank, Ranking Member Bachus,
and members of the committee, thank you for the opportunity to
appear before you today to discuss the work of the Securities
Investor Protection Corporation, which is known as SIPC.
My name is Stephen Harbeck, and I have been the president
and CEO of SIPC for the last 6 years. I have worked at SIPC for
33 years and was general counsel prior to becoming the
president and CEO.
SIPC was created by an act of Congress, the Securities
Investor Protection Act of 1970; it is known as SIPA. It
provides financial protection to customers of failed broker-
dealers. Although created by a Federal statute, SIPC itself is
not a government organization. The statute provides that we are
a membership corporation, the members of which are all
brokerage firms, virtually all brokerage firms, which are
registered as such with the Securities and Exchange Commission.
Membership is not voluntary; it is required by law.
In terms of our funding, we currently have a fund of $1.6
million of Treasury obligations. We have a commercial line of
credit. And we have a $1 billion line of credit with the United
States Treasury, which we have never used.
SIPC has no authority to examine or investigate its
members. We receive information from the Securities and
Exchange Commission and from FINRA. And when either one of
those organizations or, for that matter, a State regulator
informs us that a brokerage firm has failed to meet its
obligations to customers, we initiate a very specialized form
of bankruptcy. SIPC uses funds to replace cash and securities
missing from customer accounts within statutory limits. We can
advance up to $500,000 per customer, of which as much as
$100,000 can be based upon a claim for cash.
I think it is important to note that no customer funds are
ever used for payment of administrative expenses, lawyers'
fees, accountants' fees, or the fees of a trustee in one of
these specially narrow-focused bankruptcies.
2008 was unlike any previous year in SIPC's history. In
addition to starting three small brokerage firm liquidations,
we initiated the liquidation of Lehman Brothers. The holding
company for Lehman Brothers filed for bankruptcy on September
15th. The holding company owned the SIPC-member brokerage firm
Lehman Brothers, Inc. And on September 19th, in order to
facilitate the transfer of customer accounts to other brokerage
firms, including Barclays Bank's brokerage firm arm, SIPC
initiated a liquidation proceeding for Lehman Brothers, Inc.
I am very pleased to report that, over the weekend--we
initiated the proceeding on a Friday. The matter was
immediately removed to a bankruptcy court for the Southern
District of New York. And we transferred, over the weekend,
pursuant to a bankruptcy court order, $142 billion worth of
customer securities. And those customers had a rather seamless
event, with respect to the failure of Lehman Brothers. Much
remains to be done, but I am very proud of the initial opening
situation there.
With respect to Madoff, the situation could hardly be more
different. Where Lehman Brothers began as a result of a
systemic failure in the subprime securities markets, the Madoff
failure is theft, pure and simple, and nothing more, nothing
less. As a result, no transfer of customer accounts, as
occurred in Lehman Brothers, was possible.
I am pleased to report the trustee and SIPC have
collaborated and published a claim form and a notice, which are
available today, to the customers who have been victimized in
the Madoff situation. Those claim forms are available on the
trustee's Web site, at SIPC.org, on our Web site, and we urge
customers to fill them out and return them to the trustee
immediately.
This fraud was of a completely different order of magnitude
of anything in SIPC's history. We won't know the extent or the
call on SIPC's resources for some time. The trustee has
identified $29 million which he has recovered from a bank and
further identified an additional $830 million that he seeks to
recover in fairly short order. I can assure the committee that
SIPC and trustees appointed under the Securities Investor
Protection Act are exceedingly aggressive in recovering assets
from wrongdoers.
With respect to the claim form in the Madoff case, I would
like to speak specifically to Congressman Ackerman, because he
mentioned something that was widely reported in the New York
Post, and that report was in error.
When we went to the United States Bankruptcy Court for
permission to publish a notice and send a mailing to customers,
we received what we call a housekeeping order which grants us
authority and instructs the trustee to make a mailing to every
customer who had done business with the firm during the last
calendar year.
It was first reported in the New York Post and later
misreported once again that there would be a limit on returns
to customers only to people who did business with the Madoff
firm in the last 12 months. That is absolutely incorrect, and I
just wanted to assure you and your constituents that is the
case.
The effects on SIPC of the Madoff case will be profound. I
look forward to working with Congress and keeping Congress in
touch with what we perceive as the ongoing matters in the case.
And I would be pleased to take any questions from the
committee.
[The prepared statement of Mr. Harbeck can be found on page
99 of the appendix.]
Mr. Kanjorski. Thank you very much, Mr. Harbeck.
I will start the questions. In some respects, I may be a
little too reserved here. I think I speak for all my colleagues
on the committee, and I certainly speak for my constituents.
They are absolutely shocked by this scandal. They want action.
And I think I speak for that, too.
Mr. Kotz, I applaud your methodical approach. You have
analyzed what has to be done and the schedule on which it will
be done.
And, Mr. Harbeck, you sort of talk of it that way too.
But I am not sure that, with a $50 billion price tag, with
literally tens or hundreds of thousands of people who will
suffer--but not only those directly that have lost their money.
Think about all the charities that aren't going to finance
their research at labs and universities all over this country
to cure everything from Alzheimer's to cancer and, ultimately,
the thousands of people who will suffer or die because of this
activity. It seems to me, it seems to me what is being asked
for is out of regular order, that they don't expect the cop on
the beat to take the normal process.
And let me give you an example of what I am speaking to.
The other day, I had the occasion to talk to one of our
enforcement agencies on the environment. And there is an
illegal occurrence going on somewhere in this country that was
brought to my attention by affidavit form. So it was my
obligation to forward it to the agency to see how this could be
handled.
After they had it for a few days and I hadn't heard from
them, I called the person who had the complaint, and I said,
``How long will it take you to examine this and determine what
is there?'' He said, ``I think we will have an answer in 2
years.'' And I don't know if that is what I am hearing from
your agencies. I think, under normal order, we will have a real
bound volume of a study, an examination made 6 months or a year
from now or 2 years from now. But really, gentlemen, I want to
impress upon you, I don't think the American people are going
to want that. I, myself, don't want that.
The question I am directing to you, what can this Congress
do to give you additional authority or additional funds to get
this thing done as quickly as possible? And how fast is that
``quickly as possible?'' When do you think you can adequately
complete these examinations so that we can start knowing what
happened and when it happened?
Because I think the ranking member pointed it out, and I
fundamentally believe it, that if it were done in this instance
when the water of the recession is still going down, the flood
is going down, we are going to find a lot of disasters across
this country. And it will be a lot more people, probably not as
wealthy a group of people, who will be seriously hurt. We have
to find out what is there, so that we can do our jobs, as Mr.
Meeks pointed out earlier, and make sure that the laws and the
authorities are in place and the funding is in place to see
that this never happens again.
Mr. Kotz, what is your answer to that?
Mr. Kotz. Sure. Certainly with respect to my area, which is
looking at the SEC, looking at the potential red flags that
were in place and how these things could have been missed, I
absolutely agree that this matter has to be dealt with very
expeditiously. There is nothing ordinary or normal about it,
and we are acting in that manner. We are bringing in new people
simply for this task.
In terms of those issues, looking at the SEC's different
divisions, looking at the enforcement division as to complaints
that came in, looking at the compliance division as to
examinations, I believe we can do that with the resources we
have in a swift manner. I would not think it would take 2 years
to come up with some large--
Mr. Kanjorski. What do you think it will take?
Mr. Kotz. I am hesitant to give you an exact amount of time
because we just started the investigation. We have come up with
a very long list of potential witnesses, we have a lot of
documents to review. It has only been a couple of weeks. But I
would hope that we would be able to get something out in a
matter of months, certainly not years.
As I said, we are looking to try to issue reports on a
rolling basis, so that if we can identify a particular discrete
issue, we can have a report on that issue without waiting for
something that is 500 pages that comes out years from now.
Mr. Kanjorski. As you get these issues resolved, very
quickly I assume, will you provide that information to this
committee and to the Congress so we can act to close those
loopholes or those problem areas or enforce and provide the
funding for better enforcement at the SEC?
Or do you anticipate that we are going to have--most
studies--I have to be honest with you. I have been in Congress
a few years now. Most studies come back that we make requests
on urgent material, and it takes several years for us to get
the study back to find out what the Congress is expected to do
to solve the problem. I don't think the American people will
tolerate that.
Mr. Kotz. I agree with you, absolutely. That is not the
case in my office. It hasn't been the case in the reports we
have issued previously. That won't be the case here. So,
absolutely, as we can identify issues and we can thoroughly
investigate them and come to a conclusion, we will absolutely
issue a report.
So I understand, definitely, that this is not something
that can sit and we can work on for years and years and years
and then issue some 500-page report many years down the road. I
understand absolutely that this is a matter that has to be
dealt with immediately.
I think we have made progress already in 2 weeks, given
that those 2 weeks included the week between Christmas and New
Year's. So I understand very much this matter has to be looked
at very carefully but also very quickly, and we intend to do
that.
Mr. Kanjorski. Okay. I know my time has expired. But to
both of you gentlemen, are you appointees of the President, and
will the change of Administration affect your position? Or can
we rely on the fact that you will be there?
Mr. Kotz. No, I am not. The change in Administration won't
affect my position.
Mr. Kanjorski. Mr. Harbeck?
Mr. Harbeck. SIPC is not a government organization, and I
will be here as long as the board of directors allows me to
serve.
Mr. Kanjorski. Very good.
So I am going to turn it over to our hound dog from
Alabama, the ranking member.
Mr. Bachus. Thank you.
Inspector General, let me ask you about four areas for
investigation. The first one, to me--I described it as a three-
person shop but it is actually only one accountant who is
employed by the auditor for Madoff. Will you be looking at
whether that should have been a red flag?
Mr. Kotz. Absolutely. That is one of the most central
issues here that we have to look at, which is, was that
information known to SEC officials? And, if so, what did they
do about it? How could it possibly be that they became aware of
that--there have been certain reports about just Googling it
would be able to find out that information. So that is
something that we will absolutely look at very carefully and
try to figure out how it could be possible that, if they were
aware of that information, that wouldn't have been a matter
that they would have acted upon immediately.
Mr. Bachus. I appreciate that, because you couldn't have a
fraud of this magnitude without involvement of auditors or
accountants.
You have asked for document and e-mail preservation not
only by Madoff but also by their contractors and related
parties. Would that include the auditors?
Mr. Kotz. We are initially asking for SEC documents, so SEC
employees and contractors. But, yes, we would certainly look to
obtain other documents--
Mr. Bachus. Yes. I would ask you--again, I would urge you
to, as soon as possible, to expand that to contractors, related
parties or associates.
Mr. Kotz. Sure, absolutely.
Mr. Bachus. Because that can obviously get away from you in
a hurry.
The custodial relationship was very odd, in that you had
the same person functioning as a broker-dealer and as an
investment adviser. Is that a red flag?
Mr. Kotz. Yes, that is something that we have to look at as
well. There were forms that were filled out that identified
specific information, including information related to that,
from what I understand, and we need to look at to see whether
those were something that should have immediately jumped out at
you and required further review based on the examination work
that was done.
So, that is something, again, that, it seems on its face to
be something that requires very careful scrutiny.
Mr. Bachus. It appears that is a red flag. And then when
you couple that with the fact that, although he was an
investment adviser obviously known to everyone, that he was
managing billions of dollars worth of assets, he didn't
register, although he was managing, by public information,
hundreds of times the assets which would have required him to
register.
So my next question was, is that not a red flag when you
catch someone who has failed to register, although the
operation would dictate him to register, obviously? Is there
not an audit or examination at that time by people who failed
to register?
Mr. Kotz. I think the issue of aggressive oversight, was
there aggressive oversight in place such that, if information
was brought to the attention of the examiners and auditors,
action was taken immediately, the question of whether they took
this individual's word for it or whether they followed up
appropriately.
And, as I indicated, we are also going to look at whether
Mr. Madoff's stature and reputation had any impact. Was there a
question of, ``This is Bernard Madoff, and so we don't have to
worry about him not following up and giving us the
documentation?''
Mr. Bachus. Right. I guess that would be my last red flag,
in that Madoff claimed to do something that very few people
claimed publicly to do, and that is a guaranteed high rate of
return. And yet the SEC had people who actually laid out to
them that this was impossible to do. And if you look at it,
just the number of puts and calls that he was utilizing, the
whole flow or the whole market for him was insufficient to have
minimized a downturn.
Are there people at the SEC who have the expertise and
maybe what we might call ``trading expertise'' to realize that
what he was claiming is impossible if you just looked at those
documents published every day or those facts published in the
Wall Street Journal on a daily basis?
Mr. Kotz. In my personal view, there should be folks at the
SEC who have that expertise. And, as we look at it, we may look
at the issue of whether there is that expertise or training in
place and perhaps make recommendations for further training and
to ensure that expertise.
There has to be a situation in the SEC where those folks
would be able to see the information that was provided and make
determinations. And so we will look carefully, following
complaints that were brought to the SEC's attention and looking
at how the SEC dealt with it, who dealt with it, what was the
expertise level of the individuals who dealt with it, and why
the actions that were taken or not taken happened.
Mr. Bachus. I appreciate that.
Do you have the authority to contact former employees as
well as former Commissioners or Chairmen of the SEC? Or are
your powers only to interview those people who are presently
with the SEC?
Mr. Kotz. We could certainly contact and have on many
occasions contacted former employees. We don't have subpoena
power per se to require them to appear like we do with current
employees. But, generally, folks have been willing to
cooperate. And there are certainly investigative methods you
could use to ensure their cooperation.
Mr. Bachus. I hope you will, because some of this would
extend back at least 10 years.
Mr. Kotz. Right.
Mr. Bachus. Mr. Harbeck, have you been able to identify any
legitimate documents which are going to allow you to help
process claims in this matter?
Mr. Harbeck. One of the first things that we did with
respect to this was to modify our standard claim form to make
sure that we asked the claimants themselves what evidence they
had in terms of money in and money out, because that is going
to be one of the critical factors. In one of these situations
where the books and records are completely unreliable, that is
our best source. So we have urged people to give us as much
documentation as they can.
Mr. Bachus. Have Madoff or his associates or the firm
supplied you with what you would call legitimate documents?
Mr. Harbeck. The trustee has taken over the books and
records of the brokerage firm. And, by the way, the investment
adviser and the brokerage firm were one legal entity. So we
have the records of what was actually in the securities
inventory, and we also have some semblance of an idea of what
the customers thought they had, at least in aggregate figures
if not in individual accounts.
Mr. Bachus. When they are one entity, does that create some
opportunities for mischief?
Mr. Harbeck. I am not an examiner; I am a bankruptcy
attorney. I think you may be right, however.
Mr. Bachus. Okay. Thank you.
You have a $1 billion line of credit with the Treasury?
Mr. Harbeck. Yes, we do.
Mr. Bachus. You have had that since 1970, obviously. Is
that--
Mr. Harbeck. Adjusted for inflation--the number has never
changed since 1970. Adjusted for inflation using the Consumer
Price Index, that number would be somewhere in the vicinity of
$4.3 billion. When you take into account the vast expansion of
the securities markets themselves since 1970, that is certainly
something we will look at as we determine how deep into SIPC's
resources this event will take us.
Mr. Bachus. Thank you.
Mr. Kanjorski. Thank you very much.
Something the ranking member brought up, the broker-dealer
being required to register, they were using an auditing firm
that is registered with the PCAOB, expired on December 31st of
last year. I understand now that the broker-dealer must be
audited by a registered firm, but there is no enforcement
authority by the PCAOB for auditors of nonpublic broker-
dealers.
Are you aware of this, Mr. Kotz? And, if so, what do you
think about it?
Mr. Kotz. Yes, I know that there has been an issue that has
been raised of the limited authority of the PCAOB. And that is
something that we would look into, as well.
Mr. Kanjorski. Isn't this the very point, though, that the
three-man auditing group that Mr. Ackerman talked about, that
if they had to be registered, they wouldn't have been allowed
to be a party to this thing?
Mr. Kotz. Yes, it would certainly seem that, if the PCAOB
had this information, that they would have been able to take
action--
Mr. Kanjorski. But the SEC gave an exemption since 2003
three or four times.
Mr. Kotz. Right. No, absolutely there is an issue there
about: number one, what was the reason for that rule; but also,
number two, whether the SEC, even without the PCAOB, should
have been able to see these red flags and take appropriate
action.
Mr. Kanjorski. I understand. But what I am not gathering
is, if you or your predecessor knew of this, isn't the
Inspector General supposed to notify the Chairman of the
Commission that there is a failure here in the law as it is
drafted and it will allow some important parties to escape
registration? And if no action is taken or no request for
additional change or authority of the Congress, wouldn't you
come to Congress and say, we have a gaping hole here, we have
people with billions and billions and billions of dollars who
don't have a registered auditor?
Mr. Kotz. I can only speak for the time I was the Inspector
General. But I agree that, certainly, if, in the context of
this investigation and our audit that we conduct, we identify
gaping holes like that, we would certainly put that in our
report, and that would be brought to Congress' attention. So I
agree with you.
Mr. Kanjorski. But this gaping hole has existed for 5
years, and an exemption has been given 3 times, and nothing
ever happened until this thing hit. If it had been changed, if
the exemption weren't there, it seems to me this couldn't have
happened.
Mr. Kotz. Yes, we have not looked carefully at that
specific exemption issue, so it is difficult for me to comment.
But I do agree with you that we need to look carefully at the
regulatory gaps. And if there are regulatory gaps that we have
looked at carefully and we have reviewed and find that they
exist, that it would absolutely be incumbent upon us to bring
that to your attention.
Mr. Kanjorski. The gentlelady from New York, Mrs. Maloney.
Mrs. Maloney. Thank you very much.
My district is home to many of Madoff's victims. And as a
Representative from a State with millions of jobs dependent on
the financial sector, I am mindful that protecting this
industry's reputation and integrity from predators and thieves
like Madoff is absolutely crucial to maintaining our country's
economic leadership.
Some of our country's most sophisticated investors were
duped by Madoff. This leads me to ask you a few questions.
Madoff's firm was unusual in that it performed custody,
trade clearing, and statement generation functions in addition
to managing clients' funds. If custodial clearing and statement
reporting were done by a reputable third party or parties,
would this not have made it far more difficult for Madoff to
dupe his clients and to fool regulators?
Mr. Kotz. Yes, I think that is something that we would look
at very carefully as part of our review. I don't know that I
could answer that question today before having completed the
audits and investigations. But that is something, certainly,
that must be carefully scrutinized.
Mrs. Maloney. Also, it has been suggested that Madoff's
tiny and little-known auditor was a red flag. What minimum
standards should we set for qualifications of accountants to
the money management business?
Mr. Kotz. Yes, I understand the point. And, as I indicated,
we are going to look not only at the specific situation, but
what rules we could recommend or policies such as you mentioned
to ensure that where there are red flags potentially or
information that is out there that they are responded to
immediately. So I agree with you.
Mrs. Maloney. Now, additionally, many people threw up red
flags. One of them was that Madoff's returns typically hovered
between 10 and 12 percent. People even wrote articles about
``Don't Ask, Don't Tell,'' raising concerns about his
investment strategy. One in May 2001 by Erin Arvedlund, which
was in Barron's, it should have thrown up a red flag to
investigators, to the SEC, to the general public. Why didn't
these questions that she raised alert the regulators?
In addition, Harry Markopolos, he was in regular
communications with the SEC, raising red flags, asking
questions. He contacted them in 2000. In 2005, he sent the SEC
a 19-page report entitled, ``The World's Largest Hedge Fund is
a Fraud.'' Why in the world didn't anyone respond to his
allegations? What happened to his report? And did the SEC
investigate his allegations?
Mr. Kotz. Yes, that is exactly what I intend to find out.
Certainly, the articles that you mentioned initially are things
that we have to look at to see if the SEC examiners were aware
of the articles, reviewed the articles, how they viewed the
articles, and whether they factored that into their
determinations. Or if they weren't aware of the articles, why
weren't they aware of the articles?
And certainly Mr. Markopolos, who, as I said, I am meeting
with later this month, we need to trace that complaint through
the different offices that it went to, to determine what
individuals dealt with that, what were their determinations
that were made, why was it that they took the action they took.
So I will tell you that my investigation and audit efforts
will get to the bottom of exactly those issues.
Mrs. Maloney. And when the key regulator is totally asleep,
even when whistleblowers are calling and trying to alert them,
as was the case before us with the Madoff case, we would like
to think that there were some checks and balances in our
complex regulatory system that would alert other regulators,
the Administration or Congress. Why did that not happen in this
case?
Mr. Kotz. Yes, absolutely. We need to look at what was the
information that the individuals within the SEC were aware of,
and why was it that they took or didn't take the appropriate
actions. So that is going to be the focus of my efforts.
Mrs. Maloney. Many of us have lost confidence in the SEC.
It is pretty pathetic when a major newspaper, major
periodicals, when whistleblowers issue reports and warnings
when they have a system that they won't explain to anyone and
an auditor that no one ever heard of, that this should be
raising some concerns.
So my question is, for those of us who don't trust the SEC
anymore, what additional authority should be given to other
regulators to provide a better safeguard against the sort of
agency failure that occurred with the SEC?
What is so frustrating about this, we could not do anything
as a government to prevent 9/11. We could have prevented this
if we responded to whistleblower complaints, articles raised by
other investment bankers, and a model that no one understood
and an auditor that no one ever heard of.
So where can we go to get the proper oversight? I do not
believe we got it in the past from the SEC. I don't have trust
in them for the future.
Mr. Kotz. I can certainly understand the concerns. And my
efforts will be to find out exactly what happened, how it could
be that where it was spelled out in such a way, the world's
biggest Ponzi scheme, that wouldn't be sufficient information
to look into a potential Ponzi scheme.
So I can understand the concern about the credibility. All
I can do is find out what happened, report back in terms of
what failures were caused in this case, and then determine or
make recommendations about what action should be taken as a
result.
Mrs. Maloney. I look forward to your report--my time has
expired--on why no one read the report on the world's largest
Ponzi scheme and now we have the world's largest Ponzi scheme.
Mr. Kanjorski. Thank you, Mrs. Maloney.
And now, we will recognize the gentleman from Texas, Mr.
Paul.
Dr. Paul. Thank you, Mr. Chairman.
I would like to follow up on my opening comments to Mr.
Kotz. The contention is that the system didn't work. It didn't
work. I don't think there is any argument about it. But I go
one step further, and I maintain it can't work because it is a
flawed system.
The argument goes that, if we have to use a system, what we
have to do is get more money, more people, and more efficiency.
So the money will come, the people will come, and you will
promise more efficiency, and the Congressmen will say we have
to be more efficient.
But my argument is that the approach is completely wrong.
There is always a cost that we don't talk about. There is a
money cost, but of course there is a cost to regulation that
injures businesses. In the Depression, the SEC actually helped
prolong the Depression. Sarbanes-Oxley didn't do anything to
prevent this from happening. And we have been in a slump for a
long time. So regulations aren't the solution.
But does that mean that we have to be soft on fraud? No.
Fraud we have to really crack down on, which we seem to ignore.
But too often we have these regulations out there that sort of
protect us, that say, ``Oh, the SEC will take care of us. We
don't really have a responsibility.''
A good analogy to this is where people are safe is in their
homes. The least safe place in this country is where the most
laws are and the most policemen are, in the inner city. The
people who are the safest are the ones who assume
responsibility for themselves, have their own weapons in their
home and live in rural areas, and there is no policemen within
miles. So that whole attitude is completely different.
But the point I want to make and get you to respond on is,
in some areas, we don't do it this way. We don't preempt with
regulations. If we deal with habits or religious cults or
intellectual pursuits, we are very protective of the first
amendment and say, ``Oh, yes, a lot of harm can come of it, but
we are never going to regulate you.'' When it comes to the
press, the press can do a great deal of harm to any one of us.
And frequently, politicians suffer from libel and slander. But
we never go and say, ``What we need is prior restraint to make
sure that nobody is ever injured.'' We don't do that. We assume
there is a recourse, and we don't because there is a cost:
There is a loss of liberty, in that sense. Because if we have
people snooping around on everybody's habits and anticipating
it, then we have lost something.
But on economic issues, all of a sudden we say, ``Oh, this
is okay. We can do this, and there is never a downside.'' But
what I don't understand is, why don't we treat economic liberty
the same as we do with personal liberty and religious liberty,
intellectual liberty? We even have the first amendment split in
two. We talk about intellectual freedom of speech. But
commercial freedom of speech needs regulation. Why is this not
a unit?
And so my question to you is, don't you have any doubts
whatsoever that regulations aren't the answer? Why is it that
we couldn't monitor ourselves and our system with a
determination to prevent fraud and deal with the fraud and the
corruption and the Ponzi schemes within our own system?
And pyramiding debt contributes to this, the financial
system that we manage is--our fiat system contributes to it.
All of the insurance programs that we have, it teaches people
that it is okay and that we allow this moral hazard to occur.
So instead of this being the answer, I see this as the
problem, the cause, and not in a personal sense because I think
people who work at the SEC are probably as determined as
anything, but I think you have an impossible task. You might
say, ``Oh, no,'' and you might be able to come up with some
examples: ``We did A, B, C, and we protected such and such.''
But we could do that if we monitored religion and said, ``Look
at what we prevented.''
Do you have a comment on this and why we couldn't treat
everything equally?
Mr. Kotz. Sure. I don't go into this with any preconceived
notions that increased regulation or increased resources or
increased individuals is the answer. What we need to look at is
a holistic and comprehensive view as to whether the SEC can
respond appropriately.
So I certainly wouldn't go into the process thinking that
the answer is a particular matter, whether it is increased
regulation or increased individuals. We need to look at the
process, as you say, and see if the SEC is able to do the job
that it needs to do.
Dr. Paul. The budget for the SEC probably doubled in the
last 7 or 8 years. I think in 2001 it was about $400 billion,
and now it is over $900 billion. And the personnel went up
about 20 percent, but we had, like, a 100 percent increase in
the budget.
Where did that money go if we didn't hire more people? Do
you have a general idea on where most of that money went if it
wasn't for hiring more personnel?
Mr. Kotz. I am not that familiar with the overall budget of
the SEC. I could talk more about our office. But, certainly, we
need to look at where money went and whether there were
additional people or what was used with the resources.
Dr. Paul. Do we do contracting out? Could that have been
hiring individuals where they were not called government
employees? Do you think that might have been part of it?
Mr. Kotz. There is some contracting out in the SEC, yes.
Dr. Paul. I yield back. Thank you.
Mr. Kanjorski. Thank you, Mr. Paul.
The gentleman from North Carolina, Mr. Watt.
Mr. Watt. Thank you, Mr. Chairman.
Mr. Kotz, were you in the Inspector General's office prior
to becoming the Inspector General?
Mr. Kotz. No.
Mr. Watt. Okay. Is there anything that you, during your
tenure, or your predecessor could have done that you can
suggest to us that might have prevented this?
Mr. Kotz. I am not aware specifically. Obviously, I think
it is the job of the Inspector General to be aggressive in
their oversight and to be vigilant to the agency. And there
have been reports that we have issued over the past year that--
Mr. Watt. Yes, but on this issue, is there anything that
you or your predecessor could have done? For example, could you
have made sure that Mr. Madoff and his company didn't exercise
these exemptions that they were getting from the Investment
Advisors Act?
Mr. Kotz. Yes, I don't believe--
Mr. Watt. Would that have been an appropriate role for the
Inspector General?
Mr. Kotz. I am not--I don't believe that there is something
specifically we could have been done. Now, we could have done
an audit of a particular area, and if we had done an audit of a
particular area, we could have made recommendations regarding
that area.
Mr. Watt. Okay. I am not trying to blame you for any of
this, but it just seems to me that everything that you have
talked about today is kind of ``I am going to take a look at
the horse after the horse is gone from the barn.'' And I am
trying to find out what somebody could have done to have
stopped this from happening.
Mr. Harbeck, I take it that your agency is pretty much like
the FDIC of brokers?
Mr. Harbeck. There are analogies, and there are also
differences.
Mr. Watt. Okay, I understand that. But you get appointed by
the members that you supervise, right?
Mr. Harbeck. No. First of all, we do not supervise anyone.
Mr. Watt. Who is on your board?
Mr. Harbeck. Our board of directors is composed of seven
individuals, five of whom are Presidential appointees. Three
must be in the securities industry; two are not permitted to be
in the securities industry. There are also representatives
from--
Mr. Watt. Okay. Is there anything that came to your
attention over the last 5 to 10 years about Mr. Madoff's
operation? Do you all do any audits of the people that you
insure?
Mr. Harbeck. No, sir, we do not.
Mr. Watt. You are not required to do any audits--
Mr. Harbeck. We are not permitted to.
Mr. Watt. --or you are not expected to do any audits?
Mr. Harbeck. We are not expected to or permitted to under
the statute we administer. That role falls to the SEC and to
FINRA.
Mr. Watt. Okay. What happens if you exceed the $1 billion
in--I think you testified that you have $1 billion in a
Treasury account and a line of credit of $1.5 billion. What
happens if the extent of the claims exceed that amount?
Mr. Harbeck. I believe this committee would be among the
first to know that. But we have $1.6 billion in treasuries. Our
commercial line of credit is currently $1 billion. And then we
also have a line of credit with the Treasury. We will not
know--
Mr. Watt. I am not asking you how much the claims will be.
I know you don't know that. But if you exceed the amount of
assets that you have, what will be the recourse that you have?
Mr. Harbeck. Speaking to your point about who is on our
board of directors, we also have a director from the Treasury
and from the Federal Reserve. And we--
Mr. Watt. That is not the question I asked you, Mr.
Harbeck.
Mr. Harbeck. --will go there.
Mr. Watt. That was the prior question. I am asking you a
new question now. What will happen if the legitimate documented
claims exceed the assets that you have?
Mr. Harbeck. We will come to Congress.
Mr. Watt. And so the taxpayers will end up being
responsible for whatever that overage is on the claims, is that
correct?
Mr. Harbeck. That would be the case if we did come to
Congress. We have not done so for 38 years and have never used
government funds.
Mr. Watt. Okay. But under the statute, is there either an
explicit or an implicit guarantee by the Federal Government of
what you do?
Mr. Harbeck. There is nothing explicit beyond the $1
billion line of credit with the Treasury that is currently in
the statute.
Mr. Watt. Is there anything implicit or has anything been
written about that over the years?
Mr. Harbeck. There really has not, and the reason is that
this event is such a remarkable outlier in terms of its
expense. We have liquidated 317 brokerage firms over 30 years--
Mr. Watt. I appreciate you volunteering all that
information, but I am trying to--would it be a good idea to
give your agency audit authority or some kind of authority
since you are writing the check if somebody ends up doing
something like Mr. Madoff did, you have to write the check to
cover it? What would be the downside of giving your agency the
authority and responsibility for going in and policing these
accounts? Doesn't FDIC have that authority?
Mr. Harbeck. Yes. And they are a regulator.
Mr. Watt. Okay. All right. So is there a downside that you
see to doing that?
Mr. Harbeck. The question you have asked was asked in
1970--
Mr. Watt. I didn't ask you that now, Mr. Harbeck. I am
already out of my time. I am saying, can you articulate for me
a downside of doing what I just suggested?
Mr. Harbeck. I don't think we could do any better job than
the people who are currently assigned to do it. We would hire--
Mr. Watt. Which is the SEC? You are saying you couldn't
have done a better job, even though your money and taxpayer
money was on the line, you couldn't have done a better job in
this case than the SEC did?
Mr. Harbeck. I would have hoped anybody could have done it.
But I am not confident, since it is outside our current area of
expertise, that we could have done it.
Mr. Watt. Thank you, Mr. Chairman. I yield back.
Mr. Kanjorski. Thank you, Mr. Watt.
Mrs. Biggert?
Mrs. Biggert. Thank you, Mr. Chairman.
Mr. Kotz, looking over the number of the years that
something came up, from 1999, 2004, again in 2005, and then
November of 2005, and then in 2006, it really troubles me. We
have that the SEC investigators in New York meet with Harry
Markopolos and has a 21-page presentation, which then seems
like nothing happens to that. I think it troubles me and
probably others that, how could we be sure that the SEC is
really going to be able to accomplish an investigation now?
Is there something in the protocol where if there is
somebody outside of the examiners looking into a--or when they
are looking at a group such as this, that they don't take into
account the outside information?
Mr. Kotz. I think we need to look at both of those issues.
First of all, how could it have been that this information was
brought to the SEC's attention, to trace it throughout the
process but also to look at what the policies and procedures
were?
I do think it is important to look at what were the
policies and procedures in place at the time, were they
violated. If they were violated, clearly we have to take action
with respect to that. And if they were not violated, then the
question is, why weren't the policies and procedures different
at the time in order to ensure that this be done correctly?
Mrs. Biggert. In your testimony you say that, ``Where
allegations of criminal conduct are involved, we notify and
work with the Department of Justice and the FBI as
appropriate.''
Wouldn't you think that the--first of all, do the FBI and
the Department of Justice have the expertise to investigate and
prosecute securities funds?
Mr. Kotz. When I mentioned that, I was talking about my
office, the Office of Inspector General. For example, if we
were to do this investigation that we are currently undertaking
and we were to find criminal conduct on the part of someone in
the SEC, vis-a-vis the Madoff matter, we would follow up with
the FBI and the Department of Justice.
I do believe that the Division of Enforcement, which is the
entity that does investigations, such as what was brought to
their attention by Harry Markopolos, does also coordinate with
the FBI and the Justice Department. I couldn't speak to what
they do vis-a-vis the Justice Department and the FBI.
Mrs. Biggert. Do you think they should be more involved in
this investigation then? Wouldn't it help if it seems to be
that we have talked about you don't have the people to do it,
they don't have the expertise.
Mr. Kotz. The investigation that the SEC Division of
Enforcement is undertaking with regard to the criminal case
against Mr. Madoff, certainly the FBI and the Department of
Justice should be more involved.
With respect to our investigation that we are undertaking
with respect to what the SEC did or didn't do when the Madoff
allegations came in, we would certainly bring them in if there
was a criminal-type issue that they would be able to assist us.
I certainly would like to get assistance from whoever I could
to try to unravel the situation.
Mrs. Biggert. Thank you.
Mr. Chairman, may I suggest that we invite the FBI and
Department of Justice to testify before this committee about
their efforts related to securities fraud as well as other
forms of financial fraud? For example, mortgage fraud last year
grew by 42 percent. Since 2000, it has grown by an astounding
1,200 percent. I think that this might be something that would
be of value to us, and I would request that.
Mr. Kanjorski. I think that is an excellent suggestion, and
we will certainly take it under consideration.
Mrs. Biggert. Just one other question. The focus about the
relationship between the SEC staff and Mr. Madoff and his
family, does the SEC have current rules and procedures
governing permissible relationships and standards of conduct?
Mr. Kotz. Yes, I believe they do. And we have to look very
carefully at those rules to see if any rules were violated; and
again, even if rules were not violated, to see whether those
rules must be supplemented.
There are allegations in this case regarding potential
conflicts of interest, and one of the areas that we will look
at very closely is were there conflicts of interest, were the
rules in place sufficient to deter those conflicts of interest,
and whether further rules are necessary?
Mrs. Biggert. Thank you.
I yield back.
Mr. Kanjorski. Thank you very much.
And next, Mr. Ackerman of New York.
Mr. Ackerman. Thank you, Mr. Chairman.
I am trying to figure out what we have here. We have the
president of the Securities Investor Protection Corporation. He
has been that for the last 6 years, Security Investor
Protection. It seems to me he hasn't protected any of the
security investors. And we have the Inspector General of the
Securities and Exchange Commission, which is the inspector of
the watchdog agency that didn't watch out for anything, which
makes you the Jacques Cousteau of the Keystone Cops. And
looking at this whole program that we and so many investors
thought that they had some modicum of protection, with some
official eyes upon it with something called the Securities
Investor Protection Corporation, I want to know who is
responsible for protecting the security investor? Because I
want to tell that person or those people whose job it is that
they suck at it. So whose job is it to protect the security
investor?
Mr. Harbeck. Congressman, the Securities Investor
Protection Corporation becomes involved only after it has been
determined that a brokerage firm has failed. We have no role
prior to that.
Mr. Ackerman. So you are not protecting the consumer; so
you are not protecting the security investor is what you just
told me. And it was not until Mr. Madoff turned himself in or
had his children turn himself in that you discovered that
people were being defrauded and one of the members of the
corporation that you are the president of this, whatever it is.
Mr. Harbeck. With respect, I disagree with your
characterization that we are not protecting--
Mr. Ackerman. I have $50 billion of investors who would
disagree with you, but go ahead.
Mr. Harbeck. And we will use the maximum extent of the law
to return funds to them.
Mr. Ackerman. What funds?
Mr. Harbeck. From SIPC funds.
Mr. Ackerman. How much money is there in SIPC?
Mr. Harbeck. We have $1.6 billion.
Mr. Ackerman. I have $50 billion to cover. How are you
going to do it? Do you have a scheme?
Mr. Harbeck. A great deal of those funds are false profits
that never existed.
Mr. Ackerman. False profits?
Mr. Harbeck. Yes, sir.
Mr. Ackerman. So the government has been taxing people on
false profits?
Mr. Harbeck. I think your point is very well taken, and I
believe there are tax remedies for people who pay taxes on
those funds. I am not a tax expert.
Mr. Ackerman. Mr. Inspector General?
Mr. Kotz. Yes. I could certainly understand what your
concern is, and I am going to ask those very same questions. If
the facts are as--
Mr. Ackerman. What do you do before the Bernie Madoffs and
the mini-Madoffs turn themselves in?
Mr. Kotz. We need to make sure that the SEC has enforcement
and examination divisions in place.
Mr. Ackerman. Do they?
Mr. Kotz. That is what my investigation will determine.
Mr. Ackerman. You don't know that they have it or not?
Mr. Kotz. I don't know.
Mr. Ackerman. You have been doing this for over a year, and
someone else has been doing it for a year before you and years
and years before that, and we still don't know if they have the
ability do what we are paying them to do with taxpayer dollars?
Mr. Kotz. I can certainly say that if the allegations are
as they say, then there is great concern that they do, I will
report that back and--
Mr. Ackerman. After the fact, we will know if you were able
to do your job all these years and the SEC was able to do their
job.
This is worse than a nail in the coffin; this is a spike in
the heart of investment communities that makes America run at a
time that we can ill afford it. Confidence in government and
its agencies are at stake here.
Now, you had Mr. Madoff turn over a list of all of his
assets. There are people with $50 billion worth of claims.
Whether these are false profits or not, they are certainly real
investments that built up to $50 billion, maybe more, maybe
less. We don't know the extent. This may be the tip of the
iceberg besides how many other icebergs that might be floating
that you won't know about until someone confesses to the crime.
Now, in the assets that you had him turn over on December
31st, at midnight, while much of America had no champagne
bottles to pop, how much assets did he turn over that you have
sealed, and why haven't you turned that over to the bankruptcy
court so that people can see what is happening as in normal
bankruptcies?
Mr. Kotz. I didn't have anything to do with the
instructions about the assets. That was the--
Mr. Ackerman. Good. Would you turn that over to this
committee?
Mr. Kotz. I don't have that information. But certainly
everything that will be in my report I will seek to--
Mr. Ackerman. Mr. Harbeck, do you have it?
Mr. Harbeck. I know that the Securities and Exchange
Commission has it. SIPC itself does not have the--what I can
tell you, sir, is that the trustee will work with the SEC and
get those assets, and we are very aggressive about liquidating
assets.
Mr. Ackerman. Will you turn it over to this committee? The
public has a right to know. There is a bankruptcy which is a
very public thing. There are legitimate investors who have a
right to know what this is, what they might reasonably expect
to have if they can do the math and divide by the number of
them and the number of dollars.
Mr. Harbeck. I can promise to you that if it is the
committee's pleasure to have that report, I will get it to you
as soon as I receive it.
Mr. Ackerman. I am making that request. Will you get it to
me and the committee as soon as you can?
Mr. Harbeck. Yes, sir.
Mr. Ackerman. Can you do that in a week, or have you turned
it over to the court already?
Mr. Harbeck. If the SEC has not given it to me, they will.
Mr. Ackerman. And you will give it to us within a week?
Mr. Harbeck. Yes, sir.
Mr. Ackerman. Now, what happens to this clawback thing that
is making a lot of people petrified? Why is there a difference
between an investor who invested 6 months ago or 8 months ago
and an investor who invested 6 years ago? Are we going to see
the government go after them? I represent the north shore of
Long Island, made famous in many novels as the gold coast, and
I probably represent more people than--I know dozens of people
who are absolutely destitute now who were the biggest
philanthropists in this country, making the world of charity
work, who now don't know what to do. One guy called me up with
tears in his eyes, his wife is dying of cancer, his kid has a
debilitating disease. He is going to get through this somehow,
but what is going to happen to the hospital he promised $12
billion to in his next contribution, a children's hospital?
Mr. Harbeck. Your question with respect to clawbacks is
that under the law, all customers participate in what is known
as a pool of customer property. It is the trustee's duty to
expand that pool and distribute it equitably. If a customer has
received many times more than the customer put in, he is far
more advantaged than someone who, for example--and this is a
true example--someone who put in $10 million last week.
Mr. Ackerman. My constituent put in $10 million the day
before Mr. Madoff turned himself in, and people are telling him
it doesn't exist anymore. Does he get his money back?
Mr. Harbeck. He is part of that common pool, and
unfortunately, he will not get his $10 million back any more
than someone who put it in--
Mr. Ackerman. Is there a government clawback for his $10
million?
Mr. Harbeck. No, those funds are already in the Madoff
enterprise.
Mr. Ackerman. The insurance that people have with SIPC, the
$500,000 insurance that they think that they have, if they have
put in $500,000, regardless of when, can they expect their
money back? And you are going to hear a witness--if you care to
stay here after you testify, you are going to hear a witness
who can't pay his mortgage next month.
Mr. Harbeck. I have heard many such stories. The answer to
your question is--
Mr. Ackerman. Two and a half years.
Mr. Harbeck. No, faster than that.
Mr. Ackerman. Can he make his mortgage payment before he
loses his house and has to go live with his children and
grandchildren?
Mr. Harbeck. If he can demonstrate that he put money in and
did not take money out, we will get money back--
Mr. Ackerman. I ask unanimous consent with the witness-to-
come's permission, which I have, to put his statement of this
last month in the record in its entirety.
Mr. Kanjorski. Without objection, it is so ordered.
Mr. Ackerman. I yield back whatever time I may have.
Mr. Kanjorski. The gentleman from Nevada, Mr. Heller, for 5
minutes.
Mr. Heller. Thank you very much, Mr. Chairman. And I want
to thank the witnesses for attending. I know this can't be easy
at times.
Inspector General, could you explain what a split-strike
conversion strategy is?
Mr. Kotz. That is unfortunately not in my area of
expertise.
Mr. Heller. Do you anticipate someone in your agency would
know what a split-strike--
Mr. Kotz. Absolutely. There are certainly the areas within
the agency, not the watchdog office, that would be involved in
those matters, but unfortunately that is not me.
Mr. Heller. Because I believe this is the basis of it. I
can't ask you the question then if you don't understand the
strategy. Let me move in another direction.
Besides marrying into the family, are you aware of any SEC
employees who ever worked for Madoff Security Investments?
Mr. Kotz. I am not at the moment, but again, that is
something we need to look at in the investigation and determine
whether that happened. So that is something that is certainly
within the list of matters we are going to look into.
Mr. Heller. Are you aware if there is a cool-down period
for SEC employees working in the industry?
Mr. Kotz. I believe that the standard rules, standards of
conduct apply to SEC employees like every other employee in the
Federal Government. I am not specifically aware of special
rules for the SEC; I am not an ethics officer. One of the
things that we do need to look at, and one of the things that
we already looked at, is that relationship between SEC
employees when they leave SEC and when they go into private
industry and the questions of whether their relationships
caused by that have an impact on what the SEC folks do.
And so as I said, we are going to look at the stature of
Mr. Madoff, whether his reputation had any effect on the
actions that were done here, and whether the different
employees within the SEC had any expectations or even wished to
go to private firms that could have impacted their decisions.
Mr. Heller. Right. I appreciate that comment, and I would
hope that you would take a good, close look at that.
I want to talk about your auditing process. What do you, in
your opinion, consider to be an ideal period of time between
audits of an investment adviser or a securities firm? Is it
every 2 years, every 4 years? Does the SEC or does your office
have a goal?
Mr. Kotz. Our office is the watchdog Office of the
Inspector General, so we don't do audits of investment advisory
firms. I know that there is an issue in this matter about the
frequency of those audits and examinations. One of the things
we are going to look at is how does the office that does those
audits and examination--what is their frequency; and is that an
issue of resources, that they don't have enough resources in
order to do more frequent examinations, but also whether these
examinations are done appropriately, so that even if you have
further resources and you could do more examinations, if the
examinations aren't yielding the results, then additional
examinations aren't done.
So that is not something our office does, but it is
something we will look at to see what is the frequency of the
audits and whether the frequency should be changed and the
audits should be changed.
Mr. Heller. You are anticipating that you would propose
some level of audit standards or frequency of audits in the
future?
Mr. Kotz. Yes. We would make recommendations regarding the
office's policies potentially about the frequency of audits if
we determined that those examinations or audits are fruitful.
First, I think we need to determine that the examinations would
find what they were supposed to find, and then if that becomes
the issue, that it is just a matter of frequency, then we would
make recommendations that they increase the frequency.
Mr. Heller. Thank you. I yield back.
Mr. Kanjorski. The gentleman from California, Mr. Sherman.
Mr. Sherman. Thank you.
Mr. Harbeck, I want to thank you for pointing out that we
are dealing with one legal entity, because there is this myth
that the 16th floor was cool; the 17th floor was where the
fraud was going on. The fact is it is one entity, one
fraudulent entity, and that entity was filing financial
statements with the SEC and with FINRA every year for many
years. Those financial statements were obviously false on their
face because they involved large amounts of money being
reported by a tiny accounting firm or tiny auditing firm. And
so I want to thank you for pointing that out.
A number of my colleagues are questioning why you didn't do
the enforcement job. And as I understand it, you are basically
like my life insurance company. You are not going to keep me
alive, but if I die, you are supposed to pay off.
Mr. Harbeck. That is correct, sir.
Mr. Sherman. In contrast, it is FINRA and the SEC that are
supposed to be doing the enforcing. They are the ones who
received these financial statements that were obviously false
on their face. They are the ones that the intelligent tipsters
went to. They didn't come to you and say, hey, there is fraud
going on at Madoff. They were sophisticated enough to know they
should go to the SEC.
I look forward, Mr. Chairman, to bringing the SEC
enforcement people and FINRA before this subcommittee.
But, Mr. Harbeck, the one thing I count on my life
insurance company to do is to stay solvent so they can pay off
when I do die. I look to other people to keep me alive.
Now, mentioning your lines of credit, but the right to
borrow money is not net worth. Your net worth is about $1.5
billion, minus what you lose on this Madoff case. And do you
have any reason to think that--we talked about this earlier.
You are going to lose, under even a conservative estimate, a
billion dollars off the Madoff case.
Mr. Harbeck. It all depends on the claims we haven't yet
received, Congressman.
Mr. Sherman. But everybody who has one of these statements
where they directly invested in Madoff, and they are secure--
and the positions are here listing the securities they are
supposed to have--is insured up to half a million dollars,
correct?
Mr. Harbeck. They are protected. We don't use the word
``insurance'' because of the fact that we don't protect against
the underlying value of a securities portfolio.
Mr. Sherman. But you do perform an insurance company
function, and any insurance company regulator in this country
who looked at the fact that you are standing behind well over a
trillion dollars worth of accounts, and you have after this
Madoff thing well less than a billion dollars, would close you
down in a second as being an undercapitalized insurance
company. There is no more obvious fraud than somebody selling
insurance or claiming to be providing insurance who doesn't
have any capital to pay anybody off.
Should your members put an asterisk by that decal that they
all have on their in window saying, yes, SIPC Corporation
provides the protection, but there is virtually no net worth.
And we can argue here whether your net worth is $500 million or
$800 million or negative $17 billion. Your net worth is trivial
or negative compared to the well over a trillion dollars of
security that you are supposed to be providing the investors in
all of our districts, right?
Mr. Harbeck. We look at the issue of our solvency every
board meeting, and what I can tell you is--
Mr. Sherman. I am not asking for solvency, I am asking for
your net worth, your assets minus your liabilities, including
the liabilities you have on the Madoff situation. Your net
worth is less than a billion, and we have over a trillion
dollars of accounts with securities brokers here in the United
States, and I am only counting the ones under the half-million-
dollar limit.
Mr. Harbeck. The answer to your question is that
historically these frauds have been found before it cost SIPC
net $1 million in any given case.
Mr. Sherman. That is ancient history. Now we are in the new
history. The history of thousand-point drops in the markets on
occasion, the history of Madoff at $50 billion losses to
investors. And you have decals all over the 27th district
telling my constituents that they have protection. And I am not
asking you to be a law enforcement agency, that is other
agencies; but you are supposed to write the checks to protect
them, and your net worth is under a billion dollars.
Mr. Harbeck. The first thing that happens when our fund
falls below $1 billion is we automatically institute
assessments on the securities industry based on their net
operating--
Mr. Sherman. But you haven't done that yet even though you
are clearly going to lose at least $500 million out of this
Madoff thing. You are below a billion dollars, you just haven't
told your members that.
Mr. Harbeck. I would expect our board will move on that in
January, sir.
Mr. Sherman. In January. Okay. Let me shift to Mr. Kotz.
You are going to write this great report, and it will take you
months or years to do it, but a couple of things are already
obvious. One is that the SEC did not do a good job when it got
tips from outsiders, very sophisticated tips. And zero percent
of the tips about Madoff were handled correctly. What
assurances do you have as Inspector General that at least half
of the tips that the SEC receives are handled correctly?
Mr. Kotz. That is right. And we are planning to not just
look at the tips in the Madoff case, but the whole process.
Mr. Sherman. We don't know whether half of them are handled
correctly or maybe zero percent. Right now, you don't know.
Mr. Kotz. Right, and so we need to look at all the tips and
the process.
Mr. Sherman. Do you know whether the SEC even today is
giving an extra half-hour scrutiny to financial statements
where the auditor is not a PCAOB audit firm?
Mr. Kotz. I don't know.
Mr. Sherman. I would sure like to find out.
I yield back to the chairman.
Mr. Kanjorski. The gentleman from Alabama.
Mr. Bachus. Thank you.
Mr. Harbeck, I want to compliment you on good work over a
very difficult year, first with Lehman and now with Madoff.
I think it is important--you don't insure against market
loss.
Mr. Harbeck. That is correct.
Mr. Bachus. And a lot of what has been lost as far as
assets by investors will be due to market loss; will it not?
Mr. Harbeck. We are looking at this as a missing asset
case, because assets were put in; the assets aren't there. So
that is the kind of thing that we can protect people against.
What we can't protect people against is a 99 percent decline in
any particular stock.
Mr. Bachus. He has acknowledged that he actually stole
money from investors.
Mr. Harbeck. Yes, he has.
Mr. Bachus. I think it is going to be very difficult and
complex because you have no records. You don't have accurate
records. That is almost acknowledged in this case; is it not?
Mr. Harbeck. Certainly, the records don't match one hand
with the other in terms of the actual securities inventory with
what the customers expect to receive.
Mr. Bachus. Do you have auditors or forensic experts on
staff?
Mr. Harbeck. The trustee has hired forensic accountants and
computer experts and attorneys who specialize in this kind of
asset recovery to make sure that we know exactly what we have
and what went where.
Mr. Bachus. All right. I guess it is going to be very hard
in just a matter of weeks to start processing claims; is it
not?
Mr. Harbeck. It will be hard, and we are going to do it.
Mr. Bachus. What?
Mr. Harbeck. It is going to be hard, and we are going to do
it. That is why I certainly have urged customers to give us as
much information as they can. If they do that, we will be able
to move very rapidly.
Mr. Bachus. So there is some expectation on your part that
some can start getting reimbursed within a matter of weeks?
Mr. Harbeck. We have a meeting with the Securities and
Exchange Commission Division of Trading and Markets later in
the week to hammer out exactly how best to do this, because I
want their support as well.
Mr. Bachus. Small investors may actually have more promise
of getting at least all or a greater percentage of their
investments?
Mr. Harbeck. The investors who are going to have the
easiest trail are the people who have been in the scheme for
the shortest amount of time.
Mr. Bachus. Okay. And let me close by asking you this: Mr.
Ackerman asked you to share records with us, but this is a
judicial proceeding that you are involved in akin to
bankruptcy; is that right?
Mr. Harbeck. It is a bankruptcy, and certainly if it is
filed under seal, I cannot produce them.
Mr. Bachus. Not only that, but I think you also couldn't
produce it to us before you produce it to the court; could you
not?
Mr. Harbeck. I don't know under what terms the Securities
and Exchange Commission was given the authority to receive this
report.
Mr. Bachus. I will point out the fact that the judicial
proceeding is going to limit you somewhat, I would think.
Mr. Harbeck. I will get it to the committee as soon as I
legally may.
Mr. Bachus. Thank you.
Mr. Kanjorski. Mr. Meeks, the gentleman from New York.
Mr. Meeks. Thank you, Mr. Chairman.
Let me find out from Mr. Kotz. I was recently looking, and
we saw that Bayou Management, a Connecticut hedge fund that
collapsed in the scandals of 2005, as well as Enron and others,
they used nearly 900 offshore entities, mostly in the Cayman
Islands, to conceal bogus trades and accounting fraud. And I
know that some Federal prosecutors are looking more and more at
some of the offshore business to see whether or not this is a
mechanism that makes it easy or easier for individuals to
conduct schemes to defraud the public.
So I was wondering if, in fact, you could let us know or
let this committee know whether or not the SEC has the
capacity, first, to monitor the use of offshore fund
operations, and also as to your knowledge of how many
enforcement and oversight actions the SEC has taken to ensure
investor protections from the manipulation of offshore fund
operations since 2001.
Mr. Kotz. I can certainly look into what the SEC does vis-
a-vis these offshore operations, and that is--I appreciate the
information in order to follow up on that. But I could
determine whether in this case the Enforcement Division had any
issues related to offshore operations, or whether generally the
Enforcement Division of the SEC treats accordingly and
appropriately those kinds of issues.
Mr. Meeks. But you can't--have you done any internal
investigations thus far of the SEC with how they are currently
monitoring some of the offshore funds and whether or not--
giving them any guidelines or guidance to looking into whether
or not they are doing it correctly, whether they are
undermanned, or whether they have the proper training or not?
Have you as the Inspector General done that at all?
Mr. Kotz. I have not looked at that specific issue, no, but
I certainly can.
Mr. Meeks. You are saying that is something you will do in
the future, but it hasn't happened in the past?
Mr. Kotz. Right.
Mr. Meeks. Also, if you look at the SEC's annual report,
the SEC cites that there have been 671 enforcement actions in
Fiscal Year 2008. Insider trading actions increased by 25
percent, and market manipulation actions increased by 45
percent. And between 2004 and 2008, the SEC has ordered $12.9
billion of penalties and disgorgements. The largest group of
this 3,500 employees assigned to enforcement, and then after
that compliance, and then corporate compliance with Federal
securities lawsuits.
Given the explosive growth of the financial sector in both
the United States and abroad, and the level of global financial
market interconnectivity, and the rise of infractions and
fraud, can you give us your opinion on whether the SEC is
adequately prepared to face the challenges of the new
millennium marketplace?
Mr. Kotz. I can't today as we are sitting here. Part of the
process of the investigation and audits that we are going to
undertake is to look at the overall complaint procedures and
the enforcement operations and to determine that very question,
whether it is a question of resources, that they simply don't
have sufficient resources in order to look at all those issues
given the multiplication that you indicated, or whether the
process simply is broken such that, even with additional
resources, it wouldn't make a difference.
Mr. Meeks. So all of this will be what you are looking at
now, and you will come back with us, Mr. Sherman has indicated,
but we don't know when, whether it is a month or 2-year
process, because this is the kind of information, I think, that
I know that we need in trying to determine whether or not there
needs to be some new resources or what kind of regulation we
should be putting in place. We need that kind of information.
What about the fact that you look at the interconnecting
individuals from various firms that go from one firm to
another. Some say because of the status of Mr. Madoff, because
he was the former this or--that had something to do with that
people just accepted his reports without looking any deeper
than they should have. Have you as the Inspector General looked
into any interconnectiveness with reference to people in the
industry who have gone from one position to the other and
whether they just check off because they know somebody
personally?
Mr. Kotz. That is an issue that has come up in other
specific investigations, and that is an issue that has to be
looked at very carefully. I think that is a great concern about
the relationship of certain individuals. But there have been
situations where we have issued reports where we have felt like
the reputation of individuals had an impact on how the SEC did
its job. We have reported that. We recommended action in those
types of cases. And if we find that in the Madoff case, we find
that generally we will do the same thing.
Mr. Meeks. One last question, Mr. Harbeck. I know that in
your testimony you have indicated that because of the Lehman
Brothers holding, you discussed the liquidation and how you
have protected a lot of the people that they control their
portfolios. But as you know that in the Lehman Brothers
procedures, there are still over--some say $700 billion stuck,
because it hasn't been so smooth in London where United States
citizens and various funds are stuck there. Have you--and I am
asking--I sent letters to the SECs inquiring about them because
there are a number of individuals who have invested whose money
is still stuck in London. Have you looked into that, or do you
have any suggestions or recommendations how they can get access
to their portfolio in London in that bankruptcy proceeding?
Mr. Harbeck. The bankruptcy proceedings of LBIE, which is
the European subsidiary of Lehman Brothers, are completely
different and separate, but the trustee for Lehman Brothers,
Inc., and the trustee for Lehman Brothers Holding meet
frequently with the Lehman Brothers European branch
conservators, I believe they are called, to try to iron this
thing out.
Those offshore funds were simply not under the control of
either the Lehman Brothers holding company or the Lehman
Brothers brokerage firm. So I don't have a lot of hope that
they can untangle the British scheme as fast as we were able to
untangle the American.
Mr. Kanjorski. The gentleman from Texas, Mr. Hinojosa.
Mr. Hinojosa. Thank you, Mr. Chairman. Chairman Kanjorski,
I want to thank you for holding this meeting. And I would like
to take the opportunity to acknowledge all the work that your
staff has done over the years to try to ensure that our capital
markets remain vibrant and strong. I particularly want to thank
you for holding this meeting in a solid effort to determine
what changes your subcommittee or the full committee should
make to the financial services regulatory system to ensure that
this type of Ponzi scheme is detected much sooner than that of
Mr. Madoff and his company.
At this point, Mr. Chairman, I ask unanimous consent to
enter into today's record a copy of the complaint of the United
States of America against Bernard L. Madoff.
Mr. Kanjorski. Without objection, it is so ordered.
Mr. Hinojosa. I would also like to insert into the record a
copy of today's Bloomberg, Wall Street Journal and Financial
Times articles on this Ponzi scheme.
Mr. Kanjorski. Without objection, it is so ordered.
Mr. Hinojosa. Thank you.
I have a question for Mr. David Kotz. Does your Office of
Inspector General need extra Federal funding to ensure that
this type of scheme is detected sooner rather than later?
Mr. Kotz. Our office is the one that looks at what happened
with respect to whether these things were detected
appropriately. So we don't feel that I have asked for and I
have received additional resources for our office to conduct
the investigation. One of the things that we will determine in
our investigation is whether the Division of Enforcement would
require additional funds in order to detect these things, or
whether the compliance divisions of the SEC would require
additional funds in order to identify issues, or whether it is
a question of the processes that are in place that are simply
broken and such that additional resources wouldn't help.
So in my office, in terms of my investigative component, we
don't need additional resources to conduct the investigation.
With respect to whether the SEC as a whole needs additional
resources in order to do its job, that is something we would
look at in our report.
Mr. Hinojosa. I am sure you will do a good job, but as my
colleagues pointed out, it will take time, maybe several
months. It is odd that the organization, the entity that
dropped the ball, which is the SEC, is investigating itself.
How can we rely on them investigating themselves? Tell me about
that.
Mr. Kotz. Sure. I think if you look at the track record of
my office, Office of Inspector General, over the past year, you
will see we issued critical reports where appropriate. There
have been numerous occasions where we have issued reports that
were very critical of the SEC; audit reports about the CSE
program, Consolidated Supervised Entity programs, that found
that there were flaws in the process involving the Bear Stearns
collapse, that there were red flags that were not followed up
on by the SEC. We have issued investigative reports that were
very critical of the SEC employees and officials.
I think if you look at what we have done over the years,
you can be assured our office does not pull any punches. Our
office is very aggressive, and our office issues candid and
sometimes very critical reports.
At the next stage, the effort will need to be to ensure
that the SEC follows appropriately with respect to the reports
that we issue, but our track record is very strong in terms of
the reports we have issued that have pulled no punches and
simply told the facts as we found them. And that is what we
intend to do in this case. I can assure you that we will report
the facts exactly as we find them. Then it will go to the SEC
in order to implement those.
Mr. Hinojosa. At this point, Mr. Kotz, since you have
already seen some of the information, are you aware of any
collaboration between the SEC employees and Mr. Madoff that
resulted in him managing to conduct his business as usual
despite it being a Ponzi scheme?
Mr. Kotz. Yes. We haven't gotten to the stage of the
investigation that I can say definitively either way. I can say
that is an issue that we will look at very carefully to see
what the potential collaboration there was between SEC
employees and Mr. Madoff's firm. And if we find that was the
case, we will recommend the strictest form of disciplinary
action, potentially criminal action if we find that
appropriate, whether it is existing employees or former
employees.
So these matters are very serious. We take them very
seriously. We will not hesitate to recommend termination, refer
matters for criminal prosecution, follow up on criminal
prosecution to ensure, if the facts warrant, those who engaged
in inappropriate actions pay for what they did.
Mr. Hinojosa. My time has run out, and I yield back.
Mr. Kanjorski. Thank you very much.
Mrs. McCarthy of New York.
Mrs. McCarthy of New York. Thank you, Mr. Chairman.
Mr. Kotz, the question I want to ask you is--because an
awful lot of questions I was thinking of have already been
asked and answered to some extent--how large was the
corporation of Madoff? How large of a corporation was it?
Mr. Kotz. I wouldn't know the answer to that question.
Mrs. McCarthy of New York. Ten, fifteen, twenty employees?
Mr. Kotz. I wasn't involved in any of the issues relating
to any actions taken against Mr. Madoff.
Mrs. McCarthy of New York. All right. With that being said,
say it was a fairly large corporation, being that it seems to
have an awful lot of money and customers, are there any SEC
rules about the ruling of an accounting firm doing an
accounting of the firm itself?
Mr. Kotz. Yes--
Mrs. McCarthy of New York. From what I understand, he only
had a small firm with one or two people.
Mr. Kotz. I think there are some serious questions about
whether the information about the accounting firm was known to
the SEC officials, and, if that was the case, why they didn't
take any action. So absolutely, as I said, we are going to look
into how it could possibly be that such a large entity
involving so many dollars, high-level volume of dollars, could
have an accounting firm that was so small without there being a
red flag that would be clearly obvious to all who could see
that it was an issue that needed to be further investigated.
And if we find that, we will certainly report, as we have done
in the past, that the SEC failed to follow up on a red flag.
Mrs. McCarthy of New York. I want to say thank you for your
patience in front of this committee, and to the second
committee, second panel that will be coming up. Unfortunately,
I will have to leave, but the testimony of Mr. Metzger is
excellent, and I advise people to actually read it.
So basically both of you actually come in after the fact;
after a crime has been done or a fraud has been done, you come
into the investigation at that point.
Mr. Kotz. That is correct. The Office of Inspector General
looks at matters after they have occurred to try to find
lessons learned to ensure these things don't happen again.
Mrs. McCarthy of New York. I think what is going to be
interesting as we go forward, my husband worked for a brokerage
firm most of his life. He was actually in compliance for a long
time, and one of his biggest beefs was as he went around the
country looking at the different brokerage firms is how much
corruption was going on. His feeling was nobody should get a
commission; pay them a good salary, but the commissions make
you buy and sell and actually cheat the investor one way or the
other.
One of the other things which is common sense is if it
sounds too good, it usually is too good. So you had an awful
lot of smart people investing in this firm. When he was talking
about 9, 9.5 percent constantly, no one, especially the SEC who
had to know that he was giving out these particular amounts of
money, saw or even felt there was something wrong?
Mr. Kotz. Right. Absolutely, that is a very significant
issue, and one could look at an investor perhaps not wanting to
ask too many questions, not finding information. But certainly
the SEC's job is to find that information. The SEC's job is to
look at things that are too good to be true and to make that
determination that if it is too good to be true, we have to
audit, examine, and investigate it to determine that it is
truly true.
So it is something that is logically hard to understand,
and that is why we need to look very carefully to see how the
facts are as they say; how it could have happened that these
returns, that this information which was--to the extent it was
brought to the SEC's attention, how could it have not have
triggered an immediate, full-blown, full-scale investigation,
audit and examination, all the tools that the SEC has in order
to see how this could have happened.
Mrs. McCarthy of New York. My concern is being that this
went on for so many years, how many other organizations, firms
are actually doing the same thing and just haven't gotten
caught yet?
Mr. Kotz. Yes. As was indicated, the market collapse
obviously had a lot to do with the circumstances at the end. So
clearly--which is why we need to not just look at the Madoff
matter, but we need to look at whether this situation could
replicate itself. And if a situation like this that seemingly
on its face was obvious in terms of red flags, we need to look
at if there were other problems that occur as well.
So we plan to do a comprehensive overview of both the
enforcement division and the compliance unit to ensure that we
don't just at the end of the day say--have some findings with
respect to Mr. Madoff, but that we look at the whole system in
place to see if it can adequately detect fraud.
Mrs. McCarthy of New York. I think that also, as we go
forward on the full committee and the subcommittees, obviously
the SEC, even Wall Street and the investors, I don't even think
anybody knew the extent not only of this particular case, but
the whole collapse. It looks like we are going to have to
modernize or somehow look at the whole financial system,
because nobody expected this, nobody.
I yield back.
Mr. Kanjorski. The gentleman from Massachusetts.
Mr. Lynch. Thank you.
With the greatest respect for my colleagues, let me just
pick up from that point that nobody saw this coming, we have to
modernize. The short sellers saw this coming. The short sellers
saw this coming, and they invested in it, and they made
billions.
What is troubling here is that--and as you say, Mr. Kotz,
it is the SEC's job to find the information. In this case,
though, in this case the SEC was given the information. The SEC
had repeated reports. The SEC had a whistleblower with a very
long analysis. We had repeated attempts to contact the SEC, and
the analysis was all given to it, but in the end they really
did nothing until it was too late. I don't think you have to
stay up late to figure out whether or not there were other
occasions of this.
There was a case earlier in the year, within the last year,
so while you were there, Gradient Analytics came up and
reported about Washington Mutual's problems. They pointed out
that WAMU, over a year before it got in trouble, was not
setting aside sufficient assets. A lot of short sellers came
into the market, bet against them. AIG, their own auditor,
Pricewaterhouse, again, long before problems developed there,
they reported that the company had ``significant shortcomings''
because of the way they were valuing their credit default
swaps. They reported it to the SEC. It was public information.
That is the most troubling aspect of this for me. The cops
were informed, the law enforcement was informed, and yet
nothing happened. That is the difficult part.
I am wondering, I have met with former SEC officials to ask
them what is the real problem here. Some have suggested to me
that they are overlawyered at the SEC, and they don't have
enough financial people.
The short sellers, financial people, were able to diagnose
this, bet on it in significant ways, and make a killing here,
billions of dollars. And yet the SEC, with the same
information, refused to act, and that is troubling.
Some former SEC officials also suggested to me that in many
cases the investigators are right out of school, very new,
inexperienced, and they were simply--in this case with Mr.
Madoff, they were overmatched. The guy was on the SEC Advisory
Board. That must be very intimidating for those newer
investigators coming into that situation.
Now you have been there a year and have seen how the
investigation goes, you know the personnel, and you know who is
doing the investigations and how much experience they have. Are
they lacking in experience? Is this one of the shortcomings we
have? Do we have to shore this up? God knows there will be
drastic change here. The SEC will be totally reformed, or maybe
it is going to go away or will be merged with something else,
because it is just inexcusable. Is that something that we have
to look at? Are these investigators inexperienced, and is that
costing us in the long run?
Mr. Kotz. I think that is absolutely something we need to
look at. That is a major issue that we are going to consider
ourselves, which is the expertise level: Are they equipped, and
do they have the expertise and the training and ability to keep
up with this? And it is very alluring sometimes to be dealing
with somebody who is on this panel and that panel, very famous,
very rich. One aspires to be like that person. The person is a
junior-level SEC attorney, he sees this very impressive
individual, and it is very easy to even subconsciously think
this guy couldn't be lying to me, this guy is a great man, he
has made all this money, he is a genius. And so we need to look
at whether they are equipped to ask the tough questions.
Mr. Lynch. Let me ask you one other thing, Mr. Kotz. In
your investigations, a couple of weeks ago, we had five
billionaires sitting at that table. A lot of them had made a
lot of money, Mr. Paulson and others, on short selling against
these type of deals. They recognized the weakness in the market
in these firms and basically through credit-default swaps were
able to make a killing.
Have you thought about pulling in short sellers? They are
really much more informed and seem to be investigating the
strength of these firms to a level of detail that I wish the
SEC was investigating them. Did you ever think of pulling some
of these people in? I am sure they would cooperate. Some of
them would. Some of them are making too much money, but I am
sure some of them we could lure away to help us strengthen this
market, because we have lost our credibility here. This is all
about restoring trust in the markets. That is your job, and
that is our job.
I do want to say I thank you for your patience in coming
before the committee and helping us voluntarily, because this
isn't an official committee hearing. I do appreciate both of
you gentlemen coming to help us with our work.
I yield back, Mr. Chairman.
Mr. Kanjorski. Thank you very much, Mr. Lynch.
Mr. Scott of Georgia.
Mr. Scott. Thank you, Mr. Chairman.
Mr. Kotz, I have been sitting here trying to get my hands
around what really seems to me to be the big problem, and that
is the credibility of the SEC. It is amazing for anybody to sit
here and think that there is not some level of complicity in
this with the SEC. This is plain as the nose on your face. You
have a situation here where 29 red flags came up, not one or
two, but over and over again. This guy has been examined 8
times in the last 16 years, and every time you go in, you ask
questions about this. You ask him a question, are you stealing?
No, I am not stealing. And there is no further investigation of
this. He knows the loopholes. He says he is a hedge fund
operator and not a business investment adviser, and you accept
that. He trades on foreign markets at certain amounts of time.
You say, oh, yes, that is true, too. Okay, that is fine.
How sure are you that it is not some complicity with an
inside person or persons at the SEC that has enabled this man
to do this?
Mr. Kotz. Yes, I am not sure, absolutely not. And that is
something we will look at. I can tell you that when we complete
our investigation, I will have the answers to those questions.
But you are right; on its face, it certainly looks as if there
may be that possibility. That is something that we have to look
into. We have to look into the question of how it was that it
seems as though the word of Mr. Madoff was taken; what were the
tools that were used; why wasn't subpoena power used, for
example; why was it all voluntary, and whether that was because
of his reputation or simply lack of aggressiveness or perhaps
complicity, as you say. Those are answers that I am looking to
provide.
Mr. Scott. Also in each of the reports, when the SEC looked
at some of this stuff, none of that was made public.
So I think that there is something with this. I think
that--and I would hope--I think one of the greatest justices
that you can do at least--we may not be able to get all of the
money back, and I want to ask you about that in my follow-up
question, Mr. Harbeck, about the money--but there needs to be a
singular effort to get the heads that enabled this guy to do
this at the SEC. He could not have done it without some
complicity with some people who work at the SEC. It goes in
line with the greed of Wall Street that has been one of the
primary factors as to why we are in the economic condition that
we are in now. That needs to be the first order of business of
the SEC to get the confidence of the American people: Get the
culprits. You have some folks working for you in the SEC who
worked with Mr. Madoff to allow this to happen. Their heads
have to roll.
Now, Mr. Harbeck, let me ask you about the ability of
trying to get some restoration for the investors. Is it an
accurate figure of $50 billion? Is that an accurate figure?
Mr. Harbeck. It is far too early to say. We believe the $50
billion figure includes the inflated profits that Mr. Madoff
said. The best example I can give you is that Yeshiva
University put $14 million into this scheme. This is publicly
available knowledge. And the records that they had indicated
that they held a securities portfolio of $110 million. So there
is a gigantic gap between when was put in and reflected on the
statements. Of course, the longer you were in this deal, the
bigger that gap was.
So having said that, and having said that the $50 billion
figure is probably quite high, whatever it is, we will find it.
The administrative expenses of that will not come out of
customer property to find those assets, to find the accurate
dollar amount, and then we will go try to get whatever we can.
Mr. Scott. So we are talking about ill-gotten gains. We are
talking about loss and gains that to some degree may be fakes.
In the Ponzi scheme--I want to get this right--what happens is
that he takes one investor's money and uses that investor's
money to give some return to the investment on the other
fellow's money without it going through a trading process. Is
that--
Mr. Harbeck. That is correct. And the way this was
perpetuated for so long is people did not withdraw their funds
from this Ponzi scheme. They just kept letting him roll over
the supposed profits into even further supposed profits.
Mr. Scott. Now, there is a management firm for what is left
of these assets. There is somebody that you have engaged or
somebody is engaged to determine these, and I think the figure
that is put on that expense has been about $28 million.
Mr. Harbeck. No. The trustee has received $29 million back
from a bank account. Some of that will be used for
administrative expenses, but if that is determined to be
customer money, SIPC will reimburse it.
Mr. Scott. Is this the recovered liquidation cost?
Mr. Harbeck. Yes. And that is not all costs that have thus
far been incurred. That is more than what is thus far.
Mr. Scott. So that is a false figure that is out there.
Mr. Harbeck. It is somewhat correct in that is the amount
of money that has been returned to the trustee from a bank
account.
Mr. Kanjorski. Mr. Scott, your time has expired.
Mr. Scott. Thank you, sir.
Mr. Kanjorski. The gentleman from Texas, Mr. Green.
Mr. Green. Thank you, Mr. Chairman. Again, I thank you for
hosting this event.
Mr. Kotz, permit me to ask you a few questions, and I want
to say from the outset I have had an opportunity to peruse your
resume. It is quite impressive. You were with the Peace Corps
before coming to this current position, and you have an
outstanding record as a scholar and student of jurisprudence.
Let us start, if we may, with your comment that you
investigate after the fact. I think you need to bring some
clarity to what ``after the fact'' means because you received a
letter from Senator Grassley on April 2nd asking that you look
into Bear Stearns, and there has been no arrest or reported
crime as it relates to Bear Stearns; is this correct?
Mr. Kotz. Yes. We were asked to do an audit of Bear Stearns
to determine whether the SEC missed red flags in their
oversight of Bear Stearns.
Mr. Green. Exactly. Which means that you can receive
intelligence from sources about inappropriate conduct at the
SEC, and as a result you can look into whether or not the SEC
is properly conducting itself, true?
Mr. Kotz. Right.
Mr. Green. Is it true or not true that your office received
some degree of intelligence prior to the arrest of Mr. Madoff
with reference to reports that were sent to the SEC concerning
the so-called Ponzi scheme?
Mr. Kotz. No, to my knowledge it is not true. There was
never a complaint. We actually searched our records going back
years beyond when I was there. There is no record of any
complaint filed with our office about Madoff. In fact, the
investigation that was begun, from what I understand, was not
brought to the Commission's attention. But certainly, nothing
was brought to our office's attention.
Mr. Green. The investigation that was begun with respect to
Mr. Madoff was never brought to the attention of the SEC?
Mr. Kotz. There is an enforcement investigation, not an
investigation that our office does.
Mr. Green. I understand, but you said that the
investigation that was begun with reference to--and I am adding
``with reference to''--Mr. Madoff was not reported to the SEC,
meaning the SEC Commissioners?
Mr. Kotz. Right. What the Chairman stated in his request
for me to conduct an investigation was the concern--one of the
things we have to do is determine whether that is true--but the
concern that he had that the Madoff matter that was looked at
by the Enforcement Division had been not been brought to his,
the chairman, and the other Commissioners' attention.
Mr. Green. And the Enforcement Division of which you speak
is one other than the Enforcement Division that you happen to
head?
Mr. Kotz. Yes. I have the Office of Inspector General. That
is separate from the Enforcement Division.
Mr. Green. So the Enforcement Division of the SEC received
its complaint, made its investigation, but did not give a
report to the Commission itself.
Mr. Kotz. That is the allegation that the Chairman asked me
to look into and what we will confirm, if it turns out to be
the case, in our report.
Mr. Green. So the allegation is made by whom?
Mr. Kotz. The Chairman of the SEC. When he asked me to
conduct the investigation, he stated that one of the things he
wanted me to look at was why or whether if the information--
Mr. Green. There is a difference between ``why'' and
``whether.''
Mr. Kotz. You are correct, sir.
Mr. Green. Which was it?
Mr. Kotz. Why. He asked why was it--in his view he did not
believe that the information regarding the Madoff investigation
conducted by the Enforcement Division was brought to his
attention and therefore the other Commissioners' attention. So
he asked me to look at this specific question in the Madoff
case, and in general why enforcement cases are decided not to
be brought to the larger attention of the Commissioners and the
Chairman.
Mr. Green. To your knowledge, has there been any report or
complaint, I should say, against the SEC with reference to the
Madoff scheme that was forwarded to your agency?
Mr. Kotz. Yes, certainly there have been reports that Mr.
Markopolos met with folks from the SEC to report information
about Mr. Madoff.
Mr. Green. And did Mr. Markopolos give his report--his
report forwarded to your agency?
Mr. Kotz. To the agency in which I work, yes. Not my
office, but agency.
Mr. Green. This is not about you personally. It came to the
attention of your office.
Mr. Kotz. The agency.
Mr. Green. Your agency. All right, I am sorry. I will get
my diction correct, because sometimes it is not superb.
If it came to the attention of your agency, and all of
things that you today contend were red flags for the SEC, why
were not these things red flags for the watchdog of the
watchdog? You are the watchdog for the SEC. The SEC is the
watchdog for the public, the investors.
Mr. Kotz. Right.
Mr. Green. Why were they not red flags for your office or
your agency?
Mr. Kotz. Because we were never made aware of them. In
other words, the SEC can't undertake action--
Mr. Green. You said that you received the report--the same
report that we are contending the SEC should have acted upon,
you have just indicated that your agency received that same
report.
Mr. Kotz. My office never did.
Mr. Green. Not your office, your agency.
Mr. Kotz. Right. It is a large agency. Because a particular
division of the agency received a report wouldn't mean that
anyone in my office received it. The watchdog of the watchdog
wouldn't receive something before it happened. Once a complaint
is brought to our attention, we can look into it.
Mr. Green. So your office never received a report from
Mr.--
Mr. Kotz. No, we didn't receive it until now.
Mr. Ackerman. Could I ask unanimous consent that the
gentleman have 1 more minute so that the witness can clarify
and make a distinction to us and the public the difference
between the Inspector General's Office and the enforcement
office, because I think that is what we all assumed you were,
or some of us assumed. You are not the enforcement office?
Mr. Kotz. Correct.
Mr. Ackerman. It went to the inspector--
Mr. Green. I will yield that 1 minute that you have asked
that I receive to you.
Mr. Ackerman. I was just following up on your excellent,
excellent question. So when you say your office, your office
has nothing to do and the Inspector General doesn't ever see
these complaints?
Mr. Kotz. Right. Right. No, we are not the enforce--
Mr. Ackerman. So they go to the enforcement, which is
something completely different, which is basically an in-
house--you are the outside auditor. Is it fair to characterize
it, you are the outside auditor?
Mr. Kotz. Yes.
Mr. Ackerman. And the enforcement guys are inside players
with the SEC?
Mr. Kotz. Right.
Mr. Ackerman. And they can decide to just bury the darn
thing and not show it to you?
Mr. Kotz. Right. We would never see a document that
suggests that there was securities fraud or a violation of
securities laws. That would never come to us. That would come
to the enforcement division, which is a very large, several
thousand people division.
Mr. Ackerman. Mr. Chairman, I would suggest that there is
confusion here on the committee, that we would hope that you
would initiate some legislation that could possibly require any
complaints that are made in house to the inspectors, because
the public doesn't know who to complain to. Obviously they
complained to somebody who had no interest, because they found
nothing wrong in a $50 billion scheme until the guy who did it
confessed to it, that they share it with the outside auditors
in effect and share that with the Inspector General's office.
Mr. Kanjorski. I think it is a very good point taken, Mr.
Ackerman.
Mr. Ackerman. I yield the gentleman back his time.
Mr. Green. Thank you. And I would adopt the comments of the
gentleman. I have one final question, Mr. Chairman, just to
make this absolutely clear. Your office, by whatever name,
never received any report from Mr. Harry Markopolos?
Mr. Kotz. Right. Not that I--no. That is correct. We have
now because we have initiated the investigation.
Mr. Green. But prior to this investigation, Mr. Harry
Markopolos or no other person concerning the Ponzi scheme of
which we are here to investigate or look into today, no one
ever gave--sent to your office any information concerning that?
Mr. Kotz. That is my understanding, right.
Mr. Green. Thank you.
Mr. Kanjorski. The gentleman from Missouri, Mr. Cleaver.
Mr. Cleaver. Thank you, Mr. Chairman. Most of the questions
that I was going to raise have already been raised. Actually,
the follow-up was by Mr. Ackerman to Mr. Green's comments is
exactly where I was going to go with regard to some clarity.
Though I understand that--and I think the frustration you hear
is because people out in the world are angry and we actually
probably would be better if we had SEC members in here instead
of the Inspector General. But you are here and so this is the
frustration of the public. P.T. Barnum once said, there is a
sucker born every minute. And I am not a linguist, but that
seems a little unfair.
He is saying the victims are suckers and in most instances,
particularly with Wall Street, the victims are the suckees and
the Madoffs are the suckers. And we are trying to find out why
the SEC seems soft on suckers. And it is not going to be
answered by you. We need them here and it creates at least some
frustration for me because they are not here to answer the
question. And I don't know--neither of you can probably answer
the main question that I want to ask, which is do you believe
that all of the SEC members ought to resign? I understand. Next
question. You mentioned--is it Mr. ``Kotz''--
Mr. Kotz. ``Kotz.''
Mr. Cleaver. We need a holistic and comprehensive approach,
you said earlier. Give me an alternative for what you think.
You are there, you have been looking at what is going on. What
do we need? If there is one thing you would like for Congress
to do to empower someone, you or someone to do something
differently that might eliminate the damage done to the
suckees?
Mr. Kotz. I would rather be able to answer that question
after conducting my investigation and review. I think once I do
that, I will come up with more than one matter that could be
done. I think we need to look very carefully at what happened.
We need to look very carefully at the whole operation of the
SEC and then make determinations. It is a little premature at
this stage--the investigation just began 2 weeks ago--to make
that determination.
Mr. Cleaver. How long do you think the investigation is
going to last? Of course, I guess it is difficult to know how
long it is going to last because what I am curious about is how
do you do an asset search on in this issue?
Mr. Kotz. Yes. I understand the need for the investigation
to be conducted very quickly, and so I do plan to do that. It
is hard to give you a definitive timeline on how long our
investigation will take place. Our investigation will yield
recommendations about the SEC. Reviewing the assets would be
what the enforcement division would do and for that I couldn't
speak to.
Mr. Cleaver. Mr. Harbeck, do you have any idea how you
assess the assets? It seems to me like that is almost like
unraveling these subprime loans.
Mr. Harbeck. One of the first things the trustee for the
liquidation did was get subpoena power for a wide variety of
witnesses who will be testifying as to what happened to the
assets. He has received these subpoenas and he has sent them
out.
Mr. Cleaver. How do we find out who is owed what?
Mr. Harbeck. On the who is owed what, the best source of
information is the claimants themselves.
Mr. Cleaver. All right. Thank you, Mr. Chairman.
Mr. Kanjorski. Thank you very much Mr. Cleaver. The
gentleman from Colorado, Mr. Perlmutter.
Mr. Perlmutter. Thanks, Mr. Chairman. Mr. Harbeck, the
question was asked of Mr. Kotz whether he knew what a split
strike strategy was. Do you know what a split strike strategy
is?
Mr. Harbeck. The only options trading I am familiar with is
covered calls. So the answer is no.
Mr. Perlmutter. I guess kind of what we are talking about
here and Mr. Paul sort of talked about personal responsibility.
There is the personal responsibility piece, there is the
government oversight piece. I am a bankruptcy lawyer as you
are. And a lot of times people come up with terms. I have been
hearing terms these last few weeks on this committee that I
have never heard of before. So you have to say what is that,
really, that is the personal responsibility side of this. Am I
just getting a bunch of gobbledygook and they are quoting some
kind of gambling strategy with some kind of terminology that
nobody really understands which is what a Ponzi scheme is.
I have a little black box, I am not going to tell you what
is in the black box, but boy, it has great returns and the
money comes out the other end. And that is what this Ponzi
scheme was about. So there is a personal responsibility piece,
but Mr. Ackerman, he has his retiree who is in trouble, I have
firefighters and police officers who may have lost substantial
amounts with respect to their pensions. I don't know what the
exact amount is. And my firefighters may be fighting with his
retiree to take from this pool that your bankruptcy trustee is
going to try to gather and then spread it out evenly among
everybody. In your bankruptcy--and I know you didn't have a
specific amount, but I saw some numbers in there. Do we have
any idea at this point what the liquid assets were that are in
the bank that could be taken by the trustee and then any other
kind of portfolio stocks that could be liquidated?
Mr. Kotz. The liquid assets, as far as we know, are in the
neighborhood of $830 million to $850 million. Those have not
yet all been secured, but the trustee is working on that. After
that, it becomes a job of hunting them down to see source and
application funds.
Mr. Perlmutter. And just let us talk about the claw back
and then I would like to move to Mr. Kotz really quickly.
``Claw back'' meaning if somebody--let us say they put $100,000
into Mr. Madoff's investments and they received over time
$50,000 back. Is the claw back going to take that $50,000 away
from them even though they haven't even gotten their investment
back?
Mr. Harbeck. The fraudulent transfer preference and the
insider preference provisions of the Bankruptcy Code apply to
that fund of customer property. So to take a more extreme
example, someone who put in $1 million and took out $5 million
over time may, within the statute of limitations, be called
upon to pay back so that someone who put in $1 million and got
back nothing would have something to share. It is a matter of
equity. That has been the law since the case of Cunningham
versus Brown which was the original Ponzi scheme case on
fraudulent preferences and transfers.
Mr. Perlmutter. So my firefighters who got nothing back--I
don't know what the status is. Let us say they got zero back.
Mr. Ackerman's constituent to--this retiree has received
payments over time may end up being at odds?
Mr. Harbeck. That is what the law is. The statute of
limitations helps those retirees in one respect and the rule of
reason also applies as well.
Mr. Perlmutter. All right. Next question. Does your agency
ever talk to the SEC about fears that you see from an
underwriting kind of a context about wait a second, what is a
split strike strategy? We never heard of this stupid thing.
Mr. Harbeck. In that particular instance, that didn't come
to our attention. I know that for example, in the Bayou
Securities Ponzi Scheme, when you read the description of the
investment strategy and you see the incredible returns that
were theoretically made, those were red flags that a layman
could see. The reason this scheme went on as long as it did, at
least at first blush is that Mr. Madoff did not try to hit a
home run. He tried to be a doubles hitter. He kept--he kept
himself looking like a steady hand rather than a spectacular
winner.
Mr. Perlmutter. But here is where the SEC--we are all
saying the same thing, is falling down on the job terribly.
This return went on, this 8 to 19 to 12 percent went on
forever, which is unlikely in good times and bad and the SEC
didn't pick up on it. And where I believe where Mr. Paul is
just dead wrong is that my firefighter in Colorado or his
retiree along the Gold Coast, they don't know because they are
sort of investing through other people or whatever. That is
where the SEC comes in. And I am just curious why nobody
brought this to anybody's attention. That is what you are going
to find out, Mr. Kotz?
Mr. Kotz. Yes.
Mr. Perlmutter. Should the Bear Stearns incident have
brought this Madoff kind of thing to anybody's attention or are
they just so different that the SEC problems are that different
and then I would yield back, Mr. Chairman.
Mr. Kanjorski. Thank you very much, Mr. Perlmutter.
Mr. Kotz. Yes, I think they are different. Although we did
find in the Bear Stearns case that there were red flags that
were not followed up on, albeit different red flags. If we were
to determine that there were red flags that weren't followed up
on, then I think that would represent some sort of pattern,
although it would be different types of issues.
Mr. Perlmutter. Okay. Thank you.
Mr. Kanjorski. Thank you. Next we will have the gentleman
from Indiana, Mr. Donnelly.
Mr. Donnelly. Thank you, Mr. Chairman. Mr. Kotz, as the
Inspector General for the SEC, you keep an eye on their
operations, make sure they are doing things by the book. Do
they, when they go into a firm, the enforcement arm, is there a
checklist that they use where they say check, accounting
situation makes sense, check, custodial relations makes sense.
Is there any set form they use when they go in? Obviously, they
are going to look at a number of things, but is there any list
of, hey, here are the things we are at least going to make sure
we check these 10 things?
Mr. Kotz. That would be that particular office. But as part
of our investigation and audit, we would look at exactly that.
I do believe there are policies in place, there are procedures.
I don't know if it is a check list per se, but certainly
procedures as to what should be reviewed for different types of
situations. What we plan to do is analyze what they were,
determine whether they were triggered in this case; if they
were triggered, why wasn't the resulting action taken? And if
there was nothing that was triggered, then why weren't those
triggered mechanisms put on the policies?
Mr. Donnelly. I guess that is where I am leading to. We
heard talk that the custodial relations didn't make sense here,
that the accounting relations did not make sense, that there
was no registration. At what point if there--if these are being
checked, do they look up and say five of these are completely
out of whack. We have to go much deeper into this?
Mr. Kotz. In my view, it would be any one of those.
Mr. Perlmutter. Right. And here we see one after another,
after another and this goes on for year after year and is not
found by the SEC, but by the fact that there is no money left.
Mr. Kotz. So if that is the case, either there are problems
in terms of how the forms are being used or the forms are
problematic. But there is a significant issue.
Mr. Donnelly. And as Inspector General, how would we find
out as Congress, what forms there are, and we would love to get
copies of those.
Mr. Kotz. We will certainly, as we produce our reports,
incorporate the forms, cite them and analyze them to see what
were the potential issues that one would look at and provide
all of that information in our reports.
Mr. Donnelly. I guess part 2 of this question is what other
organizations that the SEC audits, enforces also may not have
had these different checkmarks ticked off? Who else has an
accounting situation in and as the Inspector General, I hope
that is--and I am sure it is, one of the things you are looking
into now is where else are there red flags? So that no other
person, in my home State of Indiana or any other State who
works so hard to put a few bucks away that they are not going
to put it in next week and get burned by another organization?
Mr. Kotz. No. We need to look at the forms that are
problematic such that they need to be revised or whether the
way the forms are reviewed is problematic such as we need to
deal with that issue. So, yes, we are planning to look at way
beyond just the Madoff situation because as you say, if the
form was not appropriately used in that case, then it would be
not appropriately used in many other cases, and in that way, we
can actually see things that are coming in the future rather
than what is often the case with an Inspector General office
which your only ability is to see things after it was brought
to your attention.
Mr. Donnelly. Right. It would seem that we almost have to
go right back to ground zero with every organization that the
SEC works with.
Mr. Kotz. I certainly think we need to look at how the SEC
deals with those organizations, what is their process for
examining or auditing or reviewing those organizations and
figure out whether that process works. If this information is
correct, it seems it didn't work at all in this case. If it
didn't work in this case, then it likely doesn't work in any
case. So we need to look at that and suggest, recommend reforms
to make sure that it does work.
Mr. Donnelly. I think--I know on my--personally for me, I
would love to get a copy of what the SEC does for each of the
inspections that they do, what steps are followed, what do they
look into so that we can get an in-depth idea of that and Mr.
Chairman, thank you for your time.
Mr. Ackerman. Mr. Chairman?
Mr. Kanjorski. Yes.
Mr. Ackerman. Could I just share some information before
this panel leaves? I know Mr. Foster is yet to have his turn.
Mr. Kanjorski. Yes.
Mr. Ackerman. Something that I think that is of critical
importance at this junction based on our colleagues' questions,
if I could have 1 minute, you are talking about red flags. Up
until now, nobody has seen any of the monthly statements that
Mr. Madoff sent out. And I think these will be made available
by the law firm that is representing the witness that we will
hear from. But for the sake of Mr. Kotz and the committee,
people got these detailed statements at the end of the month.
Mr. Madoff turned everything into treasuries, and we believe he
did this with every account or almost every account.
At the end of the reporting period with everything in
treasuries, he did not have to report to the SEC. He escaped
the scrutiny of your agency and perhaps nobody was watching him
and the question that should be asked of all of the members of
SIPC, all of the brokerages, how many of them at the end of the
month show that they have turned every account into treasuries
and aren't reporting? There may be many other people who have
come across this brilliant way of flying under the radar and
basically reporting forms to no one owner we are holding
treasuries and not securities. Thank you, Mr. Chairman.
Mr. Kanjorski. The gentleman from Illinois, Mr. Foster.
Mr. Foster. Thank you. Inspector General Kotz, I was
interested in a related question, but it has to do with whether
the SEC has systematic written procedures for just dealing with
complaints like Mr. Markopolos generated, that when one of
these is received, are there written procedures for cataloging
these, for assigning responsibility for follow up, for tracking
them and eventually dispensing with these type of complaints?
Mr. Kotz. Yes. I believe the Enforcement Division does have
procedures in place and what I am going to look at is whether
those procedures are working, whether these procedures need to
be revised or whether those procedures are simply not being
utilized appropriately.
Mr. Foster. And you will be getting us copies or references
of just how you handle complaints so we can see where it got
dropped in this?
Mr. Kotz. Absolutely.
Mr. Foster. In Mr. Markopolos's November 7, 2005, complaint
or tip to you guys, they had the sentence here that says ``due
to the sensitive nature of the case I detail below, its
dissemination within the SEC must be limited to those with a
need to know,'' which must be a very common situation because
of the obvious effect on markets and so on. Do you have any
idea of the order or magnitude of the number of people inside
the SEC that were actually privy to the details of this?
Mr. Kotz. I don't know that right now, although I would say
it certainly seems as though there were sufficient people who
knew about it, who were in a position to do something about it.
So I don't think it was a question about not enough people
became aware of it. It seems as though it was brought to the
right place and that was the place that has the responsibility
follow up. I don't know exactly how many people. We will
obviously talk to every person who became aware of it and find
that out. But it certainly seems as though it was brought to
enough people that action could have been taken.
Mr. Foster. So this was more than 10 people and less than
100 as a guess?
Mr. Kotz. Yes. I don't know for sure. But I would think
that would be the case.
Mr. Foster. Okay. I guess--oh, one other question. What is
the scope of your e-mails that you are looking into here? Are
these limited to official SEC e-mails by current and former
employees or do they include the private e-mails of current and
former employees and so on?
Mr. Kotz. Initially, we requested all the public e-mails,
the SEC computer e-mails. And you would be surprised how much
information is on a government e-mail. Now, as we further gain
information, we can try to take steps to get personal e-mails
as well. And that may be something we need to do in a couple of
cases here.
Mr. Foster. All right. And you have the authority to do
that?
Mr. Kotz. We can. We have in the past dealt with different
Internet providers and gotten the information that we have
needed, yes.
Mr. Foster. Thank you. I yield back.
Mr. Kanjorski. Thank you very much, Mr. Foster, and now
this panel is concluded finally. Thank you, gentlemen, very
much. We are holding up a panel of three more and they have
been kind enough to remain here and be available. May I ask the
question, is there any travel difficulties with the next three
panelists? The three witnesses, do you have any travel
difficulties at all?
Mr. Metzger. I have a 7:00 train.
Ms. Frankel. I missed this plane, but the question is
whether I could go to another one.
Mr. Kanjorski. Both to New York, the two trains?
Mr. Metzger. Boston.
Mr. Kanjorski. Boston? Oh, my. Okay. We will try to get
this completed as soon as we can. Let me get right on and
welcome you to the committee.
And let us get to the testimony first of Mr. Allan
Goldstein, who is an investor with Bernard L. Madoff Investment
Securities. Mr. Goldstein.
STATEMENT OF ALLAN GOLDSTEIN, RETIREE AND INVESTOR, BERNARD L.
MADOFF INVESTMENT SECURITIES
Mr. Goldstein. Good afternoon, and thank you for the
opportunity to testify today on my experiences with Bernard L.
Madoff Securities, the impact that Mr. Madoff's actions have
had upon my family and myself. My name is Allan Goldstein and I
am a human face of this tragedy. I speak not only for myself,
but for the many people who have lost everything because of
this Ponzi scheme. I held an IRA retirement account with Mr.
Madoff's firm for approximately 21 years. I am 76 years old and
until my retirement, I worked in the textile trade buying and
selling fabrics for use in women's apparel. My wife Ruth and I
have been married for 52 years. For the past 16 years, we lived
quietly in the Taconic Mountain region of New York State. At
this stage of our life, I could never have envisioned the
financial devastation we are now suffering following the arrest
of Mr. Madoff last month. In the blink of an eye, savings that
I struggled my entire life to earn have vanished. Like many of
Mr. Madoff's victims, we are hardly super rich. I was born and
raised in the Flatbush section of Brooklyn in a one-bedroom
apartment with my parents and sisters.
I worked my way through New York University with two jobs
to pay tuition. After school, I spent 2 years in the Army,
including 16 months in Korea. Ruth and I married in 1956. Our
first home was a furnished basement apartment. My first job
selling drapery fabrics paid $200 a month. With my scant
savings accumulated over several years, I co-founded a textile
company that became fairly successful through the 1970's and
1980's. Throughout that time, I always remained very
conservative with my money, investing it prudently and keeping
a good deal of it in money market funds. By the late 1980's, I
managed to accumulate approximately $1.8 million in my IRA.
My accountant took note of the slow returns from the money
market fund and recommended me to Madoff securities. He told me
that Madoff generally achieved an 8 to 12 percent return per
year and he employed a conservative proprietary hedging
strategy that moderated market risk. In the late 1980's, I
transferred $1 million from my IRA to Madoff. I received
account statements every month, showing gains of 8 to 12
percent annually. As this conservative strategy offered me
peace of mind, I was willing to forego outside gains in boom
years in favor of greater security. In the mid-1990's, I moved
the rest of my IRA savings to Mr. Madoff, approximately another
million and a half dollars.
Since retiring in 2001 at the age of 69, we have used our
savings at Madoff to pay our mortgage, taxes, and general
living expense.
By November 2008, our Madoff account had reached
approximately $4.2 million in stated value. Ruth and I thought
we were living the American dream. Our dream, as well as so
many others, has turned into a nightmare. We had considered
Madoff securities not a get rich scheme, but a buffer against
risk. We entrusted Mr. Madoff with all we had and now
everything I worked for over a 50-year career is gone. I have
been forced to cash in my life insurance policies to pay my
mortgage. We are forced to sell our home and with the real
estate market the way it is, we probably will not find a buyer
and be forced into foreclosure. I sit before you a broken man.
Throughout my life, I always believed the American system
of capitalism was the best regulator in the world and could
safely be relied upon by investors like myself. But the Madoff
scandal and the SEC's inability to detect it despite repeated
written and other warnings tells me that is not the case. I
believe my government has failed us and we have suffered
tragically as a result. As with many other Madoff investors,
the past several weeks have been a difficult waiting period for
my family and myself. The media has covered the scandal
zealously but there are no real details on how and when
investors will see any recovery. For me, even 5 or 6 months
would be too late.
We simply do not have years to wait. Our current reality
has nothing to do with profligate spending or undue market
risks. We conducted our affairs in good faith in the belief
that the SEC would never allow this sort of scheme to be
conducted. I pray that Congress will come to understand our
plight and enact some emergency legislation to allow SIPC to
loosen its standards and distribute funds as soon as possible,
as well as establishing a restitution fund for the Madoff
victims.
We are not trust funds, hedge funds or banks. We are
ordinary people who are victims of an incomprehensible crime
who have had their lives turned upside down. We are turning to
our government, our only help for relief and help that we
desperately need. Thank you.
[The prepared statement of Mr. Goldstein can be found on
page 96 of the appendix.]
Mr. Kanjorski. Thank you very much, Mr. Goldstein. It is
certainly a horrible situation.
Professor Frankel.
STATEMENT OF TAMAR FRANKEL, PROFESSOR OF LAW, AND MICHAELS
FACULTY RESEARCH SCHOLAR, BOSTON UNIVERSITY SCHOOL OF LAW
Ms. Frankel. Thank you. Mr. Chairman, and committee
members, thank you for the opportunity to speak about Ponzi
schemes, trusting the securities market, and the need for
regulatory reform. I want to emphasize that Ponzi schemes are
common and they are common in the United States as well. In
2002, court cases, just court cases covered $9.6 billion of
these schemes. So we have them. What is amazing in this case is
the amount.
Mr. Bachus. I am sorry. Mr. Chairman--
Mr. Kanjorski. Yes. Could you pull your microphone just a
little--
Mr. Bachus. Pull the microphone--
Ms. Frankel. I am sorry.
Mr. Bachus. It's not you. Just if you can pull the
microphone towards you, it might be--
Ms. Frankel. Okay. Can you hear me now?
Mr. Kanjorski. Yes.
Ms. Frankel. It is the amount that was so enormous and this
really raises concerns. How did Mr. Madoff gain the trust of
sophisticated people who knew how to read and write or knew how
to ask questions? I would say first it is his personality,
second he paid relatively higher returns, just as was described
here. Third, he targeted trusting groups, affinity groups and
that is the way it done. That is the kind of fraud this is.
Fourth, he conducted a business similar to legitimate
businesses. It looked like a brokerage after all. He looked
like that.
And fifth, he drowned the truth in details. And that made
the discovery tremendously costly and this is what happened,
and I went through about 700 of these cases just in the United
States--by the way, there are other places too--and found this
kind of pattern. So the difficulty is verification. The
difficulty is finding out, out of all of these details, what is
missing. And that is how he created undeserved trust.
Let me say two words about trust. Trust is not gullibility.
Trust must be reasonable. Trust is a reasonable belief that the
other person is telling the truth, that the other person will
abide by his promise and reasonable belief requires some
verification. But this is what the investors in the Madoff
situation failed to do and others are likely also not to
succeed because of the costs of verification and therefore let
me add one more thing. During the last 30 years, we have really
dismantled the financial structure that we used to have. So we
have regulation here about financial structure that doesn't
exist, that is very different. And he could combine a variety
of structures together, which made the regulation also very,
very difficult.
So what kind of regulatory reform would help restore
investors' trust in the market which we must have. We must have
this. We need deterrents and we need verification. I want to
focus on verification. We heard a lot about deterrents. So
first, we do not necessarily need more rules, especially not
now. Rules deter, but they don't really verify. And I was very
happy to hear the questions here were about verification, not
about rules, additional rules. And besides--and this is one of
the problems, what would be the future, fraudulent activities,
we don't know. And preventive rules may prevent innovations,
may prevent necessary flexibility.
So I would not focus on rules now. The second one, do we
need more prosecution? Sure. We need to prosecute. But
prosecution doesn't enhance trust, especially when it gives the
impression that everybody in the financial business is a crook,
which isn't true. It isn't true. So I would suggest that we
need prosecution, but we should focus on verification. So first
of all, we should verify. The investors cannot verify. The
private sector gatekeepers do not verify. We have seen that
time and again. The lawyers, the accountants, the rating
agencies not now, they don't verify. So we are left with the
government. The government must verify. So let me ask who
should be examined and how. And here I reach the point that I
have said before. I believe that all financial actors that can
affect the financial market regardless of what you call them
and whether they are registered or not registered, all of them
must be examined. The main test should be the amount that they
hold, not necessarily whether they are broker-dealers or this
or that or the other because we don't have any more of the
structure that we used to have.
Annual examinations, I think, should be mandatory, but also
flexible, subject to exemptions and changes. Examiners should
be highly qualified, they should be well paid, they should be
sheltered from influence by the regulated entities which will
be large. And they should be interdisciplined or in
collaborated groups of experts. They should find out how these
large institutions work and how they profit. I would not
necessarily suggest that they should become the FDIC and decide
whether they profit rightly or wrongly, but just how.
Government verification can be effective to support investors'
trust.
If you look at the FDIC, it is effective. If you look at
the Internet, the verification by banks, by e-trust, by good
housekeeping works. It is effective. So the very existence of
examiners like the police on the beat may also enhance trust.
The emblem that the person--that these institutions may have
examined by the SEC might also be desirable by them and
therefore given the resource, the SEC can contribute to
bringing trust back into the markets. Not necessarily people
into the prison, but also back into the markets.
There are other benefits of examinations. They do not
require restructuring the government. They are less expensive
than verification through the courts. The problem is, I don't
think the SEC has today the amounts that are necessary to
examine and maybe also the talent that is needed. We need
people who really know the ins and outs of the market. And most
importantly, we don't have much time. I think mistrust, like
trust, can become part of the culture and it is very hard to
change. So congressional support of examinations can be
introduced in a relatively short period of time and we need
hands-on government policing fairly soon. And this is what we
can achieve now. Thank you.
[The prepared statement of Professor Frankel can be found
on page 86 of the appendix.]
Mr. Kanjorski. Thank you very much, Professor.
Mr. Metzger is an adjunct faculty member at Columbia
University, Cornell University, New York University and Yale
University. Mr. Metzger.
STATEMENT OF LEON M. METZGER, ADJUNCT FACULTY MEMBER, COLUMBIA
UNIVERSITY, CORNELL UNIVERSITY, NEW YORK UNIVERSITY, AND YALE
UNIVERSITY
Mr. Metzger. Mr. Chairman, Mr. Ranking Member, and
distinguished members, thank you for inviting me to speak. I
commend you for conducting a meeting on regulatory reform of
the financial services industry. In these remarks, I wish to
stress two things: first, the need for top-notch internal
controls; and second, that operational risk is the great
unspoken-about danger. With the chairman's permission, I would
like to submit my written statement for the record and
summarize my principal observations and oral remarks.
Mr. Kanjorski. Without objection, it is so ordered.
Mr. Metzger. My written statement includes the following 10
specific recommendations for new legislation or regulation:
One, there should be separate market-stability and market-
integrity regulators.
Two, certain financial institutions should provide complete
and timely disclosure of positional information to a market-
stability regulator.
Three, the government should develop a model due-diligence
questionnaire for investors.
Four, advisers should be required to remind their clients
that the volatility of returns or the absence thereof is not
necessarily the sole or even appropriate measure of risk.
Five, Members of Congress should mute the criticism of FAS
157.
Six, all financial intermediaries should be required to
disclose how they diversify both financial and operational
risks.
Seven, advisers should offer greater transparency to
investors.
Eight, an independent third-party custodian should be used
by all investment advisers.
Nine, accounting firms that audit broker-dealers should be
peer reviewed.
And ten, the government should review whether investors
benefit from soft-dollar arrangements.
Studies of hedge fund failures have concluded that the
majority of them folded because of a failure to manage
operational risk, not because of a failed investment strategy.
If investors could be given the tools for evaluating non-
financial aspects of investments and could be convinced to use
those tools, I am certain that vastly fewer of them would fall
prey to investment fraud.
Unfortunately, for many investors, due diligence begins and
ends with reviewing the performance record. There is a tendency
for investors to ``chase returns'' and to assume that past
performance guarantees future results.
The payoff for many hedge-fund strategies is a high
probability of a small profit, and a low probability of a huge
loss. Investment advisers use financial leverage to amplify
returns. A manager with an impressive performance record may
have achieved that success, not because of his investing
skills, but because of his tolerance for risk taking.
Increased transparency allows for better due diligence and
monitoring. It can help the investor identify excessive
contributions in her portfolio when she aggregates her
investment, and any style drift by the investment adviser.
One of the arguments made by the investment advisers who
oppose transparency is that it could allow competitors to
reverse engineer proprietary trading algorithms. I do not have
much sympathy for those who assert this concern. Too many
managers generate ``fake alpha'' by delivering early above-
average returns when the expected return over a longer period
is much lower.
Investors should be given enough information so that they
can accurately asses the risk to their portfolio.
Eliminating risk is impractical, because without risk there
cannot be any reward. The aim should be to achieve an
appropriate balance between risk and return.
Diversification of assets and strategies, which reduces the
risk of excessive concentration, is a necessary part of risk
management, which must also address low-probability events.
While we may not be able to undo the damage of the past, we
should resolve: first, to contribute to the development of
legislation and regulation that will protect investors from
Ponzi schemes and other fraud.
Second, to inform and educate investors regarding the
dangers of making investment decisions solely on the basis of
past performance, ignoring the importance, understanding the
investment strategy, disregarding best internal control
practices and piggy backing on smart money;
And third, to inform and educate investors regarding the
benefits deriving from diversifying both investment and
operational risks and conducting proper due diligence.
Consider the extent of our contribution if, because of
today's meeting, investors will walk away from the next multi-
billion-dollar fraud, avoiding the embarrassment and financial
pain that inevitably follows.
Regulatory reform of the financial services industry should
be a high priority. Thank you for your leadership in this
important matter and for inviting me to speak. I stand ready to
assist you, and welcome any questions you may have.
Mr. Kanjorski. Thank you very much, Mr. Metzger.
[The prepared statement of Mr. Metzger can be found on page
114 of the appendix.]
Ms. Frankel. I join my friend. I also would like to assist.
Mr. Kanjorski. Thank you, Professor. Professor Frankel, I
didn't get to introduce you. You are a faculty member of the
Boston University School of Law and have been a witness before
this committee on several past occasions. We welcome you back
and sought your expertise on this particular issue. Maybe we
could take Mr. Goldstein's experience here and then look at
your evaluation and opinion as it affects him. Why can we
assume--first of all, let me say, in a capitalist system, there
has to be risk. Do we all concede there is going to be risk?
Ms. Frankel. That is right.
Mr. Kanjorski. Then the question of due diligence. Where
does it lie, does it lie with the investor or does it lie with
someone else? And I come to the conclusion it really is with
the investor. Now, on the other hand, listening to Mr.
Goldstein's story, I am absolutely shocked in terms of an
experienced businessman, successful, hesitant when you took
some of your money from your IRA and gave to the Madoff
investment but you retained half of it for a decade or so. What
was the compelling reason? Was it the advice of your
accountants that made you select the Madoff outfit or did you
individually check them out in some way? How did you get to
them? I am curious.
Mr. Goldstein. It was on the advice of my accountant.
Mr. Kanjorski. The advice of your accountant? Is there any
relationship? Was he a finder, your accountant, for Mr. Madoff?
Mr. Goldstein. No.
Mr. Kanjorski. He just heard from other people who--
Mr. Goldstein. I think he invested money with Mr. Madoff
also. I was prepared for risk. I wasn't prepared for fraud.
Mr. Kanjorski. Isn't fraud a potential risk factor, though,
to be considered?
Mr. Goldstein. To my mind, no, because the securities
industry is regulated by the Securities and Exchange Commission
to prevent that kind of thing, in my mind.
Mr. Kanjorski. So you believe when someone--there is a Good
Housekeeping seal of approval, if securities are issued and
people say the Securities and Exchange Commission approved the
issuance, you don't have to go any further, you don't have to
look at the character, the personality of the people involved
or their track record?
Mr. Goldstein. These weren't securities. These were--my
statements showed only Dow Jones components every month. There
weren't any auditables--
Mr. Kanjorski. And part of your testimony was a looking
forward to some sort of relief, potentially from the
government?
Mr. Goldstein. Yes.
Mr. Kanjorski. If you had purchased General Motors stock 3
years ago and it fell from $80 to $2, do you believe that the
United States Government should compensate you for that?
Mr. Goldstein. Absolutely not.
Mr. Kanjorski. Why not?
Mr. Goldstein. Because it is a risk that I took.
Mr. Kanjorski. What kind of risk did you take, stupidity
over fraud, is it?
Mr. Goldstein. I am really having difficulty answering that
question. If I bought a stock, let us say General Motors with
the expectation that it was going to burn money and continue to
go up and it didn't, then possibly I didn't, do my due
diligence, or possibly the market was adverse to me and I would
understand that and accept that readily. But this was a fraud.
These people took my money.
Mr. Kanjorski. Okay. How about you are walking down 5th
Avenue and I sort of like the cut of your clothes, so I pull my
little gun out and I say Mr. Goldstein, give me your wallet, do
you want the government to recompensate you?
Mr. Goldstein. No.
Mr. Kanjorski. Aren't you entitled to believe that you
should live in a safe place and it wouldn't have happened
except that a thief is allowed to carry on in the streets of
New York?
Mr. Goldstein. I also would expect that the police force or
the law would protect me to the best of their ability.
Mr. Kanjorski. And they obviously didn't because you were
robbed.
Mr. Goldstein. That is right.
Mr. Kanjorski. So should the State of New York or the
government pay you for whatever you were robbed of?
Mr. Goldstein. Possibly not, but possibly my insurance
company would.
Mr. Kanjorski. You can insure against that I see. Couldn't
you have insured against dealing with fraudulent people? Isn't
there some insurance? I am not aware of what the insurance--
Mr. Goldstein. I don't have anything like that, but I
always thought that SIPC would do that.
Mr. Kanjorski. What I am curious about, though, is that,
having listened to some of the testimony today and having read
the press reports of this, I am astounded not by you, Mr.
Goldstein, I think you fall within the range of really less
sophisticated than some of the people who were taken. We are
talking about banks that got taken for billions of dollars and
they have the responsibility of investing other people's money
and due diligence and they have regulators that come in and
look at their accounts. That is the thing that shocks me. Do
you see where my trend of examination, Professor, is going? Can
we afford to represent that the United States Government or any
government can stand behind people who are defrauded?
Ms. Frankel. First, I want to say a word. Banks, there were
eight banks that were caught in a Ponzi scheme, not very long
ago, a few years ago. So even banks can fall within such a
scheme. But the question was whether we can afford to be
protected. What exactly--I am sorry. Maybe I didn't follow.
What was the question?
Mr. Kanjorski. Is it reasonable to rely that the government
will stand behind all fraud situations in a loss or is that
concomitant with the risks of investment?
Ms. Frankel. Not all. But fraud I agree. And the question
is the cost. How costly is it to really find out the fraud. The
government does have resources that investors don't. It has the
ability to force people to tell the--
Mr. Kanjorski. Let me stop you right there, Professor. Some
of the people who had the fraud, some of these banks had
billions of dollars and the SEC only has $900 billion to carry
out all of its functions as a regulatory agency. So really some
of these people who were defrauded have far more money than the
government agency.
Ms. Frankel. The banks, those people who were--had the
money and also were regulated, they should not expect, I think,
payment by the government. Taxpayers shouldn't support them.
But the person like this gentleman, who did his best, but--let
me say one thing. We are a specialized community. We must
depend on each other. If each of us has to become an expert in
law, in medicine and so on, we won't have the society we are
having today. So we must rely on others. And if the cost of
supervising and the cost of finding out frauds are too high, we
won't be able to have a financial system. That is what people
are doing now. They are taking their money and running away.
That is because they can't supervise that much so it is a
question of measure.
Let me add one more thing: There are three building blocks
to the financial system. One of them is morality and that is
self-regulation, self-limitation of the people who hold other
people's money. The other one is forced morality and that is
the law. The third one is protection. What we have done in the
last 30 years is we have moved everything to self-protection
and that is what we get.
Mr. Kanjorski. I would love to go on, but I am taking too
much of my allotted time. The gentlelady from West Virginia.
Mrs. Capito. I want to thank the witnesses. I want to
particularly thank Mr. Goldstein for coming before the
committee today. I know it is a particularly difficult time for
you and you have put a human face on this. And I have just a
couple of specific questions, and then just generally a couple
of questions. Did you actually interact personally with Mr.
Madoff at all during any of these transactions?
Mr. Goldstein. Never met him.
Mrs. Capito. Never met him. Were you in a circle of friends
or anything who other folks were investing with him and so you
were aware of other larger profits that were being made and
that type of thing?
Mr. Goldstein. I knew of no one in Madoff when I first put
my money in except my accountant who had money there. But over
the course of years, I have come across a lot of people who are
friends of mine who had money there also.
Mrs. Capito. And during the course of the 10 years, your
money was in this--
Mr. Goldstein. 21 years.
Mrs. Capito. Excuse me. 21 years. Did you draw out and
receive dividends and benefits all those kinds things in a
regular manner that you would have expected from another
investment account?
Mr. Goldstein. Yes. Since I have retired, I took out living
expenses. I didn't take out any huge sums of money.
Mrs. Capito. Okay. Thank you. I would like to ask--I am
kind of getting a conflicting message from the other two
panelists, because Ms. Frankel says no more rules and Mr.
Metzger is saying more regulation. Are you agreeing or
disagreeing or is a regulation different than a rule? And how
is that, in your minds, divergent or together?
Ms. Frankel. May I say something? I don't suggest that we
don't need regulation or rules. They are the same as law. I
think they should be the second or third in line, which would
be done now should be examinations rather than rules. I am
concerned about rules that would limit the ability to develop.
So now the rules that Mr. Metzger suggested are different.
Mr. Metzger. Yes, I am talking about rules of disclosure. I
don't think those are heavy-handed rules. I think also the way
our society has developed, the lines of separation between
certain types of financial products at one point were quite
clear but now they are blurred. The approach toward regulation
should change. I am not saying we have to have additional
regulation, but I think that there ought to be a market-
integrity regulator and there ought to be a market-stability
regulator. Right now, information that the market stability
regulator ought to have, that regulator doesn't receive. So, I
don't think that this is a major change in regulations. These
are just slight modifications that I think will improve things.
Mrs. Capito. And I will agree with that in I think the
sophistication of the financial instruments that are at work
here are well beyond somebody who is reading their monthly
statement can begin to imagine, much less how to regulate or
keep track of what is actually going on. So I think that we
need something that can move quickly and can adjust from time
to time probably more quickly than we have been able to adjust
at this point. Would that be an accurate statement--
Mr. Metzger. Yes, it is. And I would also say that some of
my legislative suggestions relate to education of investors as
opposed to regulation of investors.
Mrs. Capito. I think that is an excellent suggestion as
well. Going back to Mr. Goldstein as an individual investor, he
was basing his very intelligent decisions on the fact that
things that were before him were true, that the standards that
Mr. Madoff had and the certifications that he had and the
bond--or the ratings that he had, that all of these things in
fact represented a true and honest portrayal of an honest
professional. And I am sure the law is going to figure out how
dishonest or whatever, but it is so difficult I think from an
advised's point of view when the SEC and other regulators have
come in and said, okay, okay, okay, you trust in that and then
when you find out that is all a fraud, you really, I think--I
think you just have to throw your hands up and be so frustrated
by that because as an individual, it would be very difficult to
unwind that on your own. And so--
Mr. Metzger. May I respond?
Mrs. Capito. Yes.
Mr. Metzger. In my written testimony, I referred to a due
diligence questionnaire that the Alternative Investment
Management Association has produced. I think if investors were
to look at this DDQ and then question prospective investment
advisers and have them respond to the survey, they would learn
so much more, and it is likely that there would be far fewer
frauds of this type.
Mrs. Capito. But the fact of the matter is a crook is a
crook, and if somebody is going to lie, they are going to lie.
Mr. Metzger. No. There is a question of who is your
custodian and the adviser says, ``I am the custodian,'' there
you go.
Ms. Frankel. And if the adviser says the custodian is in
the Cayman Islands and in the Virgin Islands, what would you do
then, go--
Mr. Metzger. That is a red flag.
Ms. Frankel. That is a red flag and what do you do next?
Mrs. Capito. There were a lot of red flags in this case
unfortunately, and I yield back.
Mr. Kanjorski. The gentleman from North Carolina, Mr. Watt.
Mr. Watt. Mr. Chairman, I think I am going to yield my time
to Mr. Ackerman since he has a constituent who has been
directly impacted by this.
Mr. Kanjorski. Mr. Ackerman, go to it.
Mr. Ackerman. Thank you very much. Mr. Watt. Thank you very
much, Mr. Chairman. Actually let me state for the record that
Mr. Goldstein is not a constituent, he is not one of those very
wealthy people to whom I refer. He does not live in my
district. But of the many, many cases that I heard of, many of
whom are constituents, a number of whom have lost over half a
billion dollars and some of whom can keep their life together
and move on after that kind of thing, even though the public
has no great sympathy for somebody who has lost at least a
million dollars, I want to tell you that Mr. Goldstein is the
typical American dream to whom everybody aspires to be. And
that is where the problem lies and that is why I suggested him
as a witness, Mr. Chairman.
Mr. Goldstein's statement--and people have asked and a
colleague of ours mentioned if it seems to good to be true, it
is probably not true. And other people have said people should
do due diligence and they should look into these things and
they should be smart and these people have so much money, why
aren't they that smart and we should have no sympathy for them.
If one looks at Mr. Goldstein's statement--and I am sure now a
lot of people will now that it is part of the record--you will
see a conservative prudent person.
The first generation Americans grew up in one bedroom with
sisters and parents all in one bedroom and scrimped and saved
in what we used to call the into the day he could help his
children and help his grandchildren and now find that he might
lose his house because he is going to be underwater pretty soon
if he doesn't find a buyer and then can put the house on the
market. If no help comes--because he has already taken--Mr.
Goldstein, how much do you have left in cash value in your life
insurance?
Mr. Goldstein. None. I have taken it all out.
Mr. Ackerman. You took it all out for what purpose?
Mr. Goldstein. To pay my mortgage, to pay my living
expenses.
Mr. Ackerman. Closer with the microphone.
Mr. Goldstein. I have none left. I took it all--
Mr. Ackerman. A little closer, please. Turn it on.
Mr. Goldstein. I took out all the money from my life
insurance policy since it was only my only liquid asset. I use
it to pay my mortgage, to buy food--
Mr. Ackerman. What month are you paid up to on your
mortgage?
Mr. Goldstein. My mortgage is paid through January.
Mr. Ackerman. What is your mortgage payment a month?
Mr. Goldstein. About $5,900 a month.
Mr. Ackerman. Can you pay it next month, can you pay it the
following month, can you pay it for the next 3 months?
Mr. Goldstein. I think that I can pay my mortgage for the
next 2 months, February and March.
Mr. Ackerman. Then what happens to your April payment?
Mr. Goldstein. I just can't make it. I don't have any
money.
Mr. Ackerman. And if you sell your house, where does that
money go?
Mr. Goldstein. If I sell my house, it will pay the
mortgage. But I don't know I will be able to sell. There is no
market right now for homes where I live. I live in upstate New
York.
Mr. Ackerman. And then you pay the mortgage company if it
covers the mortgage. And then where do you live? You just sold
your house.
Mr. Goldstein. My daughter in California has told me that
she would put my wife and myself up in her house.
Mr. Ackerman. How does that make you feel?
Mr. Goldstein. At this stage of my life, the thought of
living in my children's home is not humiliating but it is very
sad. It is terrible. Terrible. So I have to end up my life
living off the benefits of my children.
Mr. Ackerman. When your statement from Mr. Madoff that you
have scrutinized every month--and I have only spoken--I have
just met you today, spoke to you for a few minutes before the
hearing. But looking at your statement, thank you for allowing
us to make this public. And I appreciate your wife's
willingness, although she could not be strong enough to be with
us today, that she has allowed--
Mr. Goldstein. My wife is going through severe emotional
problems because of this.
Mr. Ackerman. I am sure. And we appreciate her and the fact
that you are willing to do this so that we can bring public
light to this. But your statement shows a prudent investor.
This is the face of somebody who has invested everything over
50 years starting from zero in things like Fidelity Spartan,
Wal-Mart, Exxon, Intel, Johnson & Johnson. This is this month.
JPMorgan, Coca-Cola, McDonald's, Merck, Microsoft, Oracle,
PepsiCo, Apple, Pfizer, Abbott Laboratories, Procter & Gamble,
AmGen, Philip Morris, Bank of America, Qualcomm, Citigroup,
Slumberjay, Comcourse, AT&T, Conoco Phillips, United Parcel,
Cisco Systems, on and on and on, for ages.
Mr. Kanjorski. May I ask a question? Is that Mr. Madoff's
statement?
Mr. Ackerman. No.
Mr. Goldstein. This is Mr. Madoff's statement, my monthly
statement from Madoff.
Mr. Kanjorski. Telling you what you are investing in?
Mr. Ackerman. This is Madoff's statement to Goldstein, to
Mr. Goldstein. This is his IRA, this is his nest egg, this is
his grandchildren's tuition to college that he is going to get
closer to than he ever thought he would be, fortunate or
unfortunate and tragic although that may be. But this shows a
prudent investment. Mr. Madoff, the thief that he is, was
brilliant at what he did, people should understand. He showed
you what he gambled on and what you won after the fact because
he sent you a statement after the trading day was over. If he
bought Exxon and you were flying high on the 14th, he knew the
price that you bought it at, put it down and sold it at the
15th, knew the profit you made. If Mr. Goldstein checked out or
anybody else checked out their statements, to the penny this
checked out. At the end of the month, swept all of this money
all--whatever it adds up to, $4 million or somewhat less, swept
it into treasuries. How does a man--I will ask the other
witnesses. They are the sophisticated professionals. Is there
any way that the Mr. Goldsteins of this world, and there are
numbers of them. They are more than the high profile--and I
won't name the people. You can read them in the paper who they
are--that any of these people, sophisticated or average people,
could have checked. The Inspector General is at a loss. He is
just starting an investigation and he is scratching his head in
front of us. He is talking about the Enforcement Division
investigating this of the SEC. The SEC is supposed to--who was
watching? If none of them could find this, how could Mr.
Goldstein?
Mr. Goldstein. I must add to this that on more than one
occasion, I took my statement, and I sat down with the stocks
index of The New York Times, and it checked out.
Mr. Ackerman. Of course it did. He told you you were
betting on a horse race after the race was over.
Mr. Kanjorski. Let me ask the next question. He converted
to treasuries every month?
Mr. Ackerman. He did nothing. He took Mr. Goldstein's
money, the $4 million that Mr. Goldstein thought he had saved
with all his dividends, interest, etc., and he then paid
everybody their 8 percent or 10 percent a year, and then he
went to Mr. Jones and said, have I got a deal for you. Look, I
got this guy and that guy and all these names of all these show
business people and everybody--
Mr. Kanjorski. But you said to avoid some sort of
inspection that would have been triggered by the SEC?
Mr. Ackerman. Yes. What he did, at the end of the month--
Mr. Kanjorski. At the end of the month he converts
everything--
Mr. Ackerman. He took all these stocks that he never
bought.
Mr. Kanjorski. Right.
Mr. Ackerman. These stocks don't exist. You can't check it
out. They are in nobody's name. They are not in the street
name, in Madoff's name. Maybe Madoff had some stocks in his
street name. We don't know that. But for the most part we think
what is going on here, he just paid you off in new money that
he took in. That is the Ponzi scheme. He got 10 million
investors. He wouldn't touch you. And every once in a while, he
took one of these wealthy people who are all in the same
country clubs in Palm Beach and the Gold Coast of Long Island.
This guy is making 10 percent for 20 years. You would be stupid
not to invest. That is the track record that you checked out
with everybody who is brilliant, with everybody who is making
money.
And I have spoken to constituents of mine who had millions,
who aren't blinking an eye. They lost it and so what. This one
guy says, I called up to check it out one day and I said
Bernie, I need $500,000. He said, I will wire it in your
account. He said the next morning, there was $500,000. He says,
the next morning, I ran to the bank so quick to put it back in.
Why should I lose 10 percent? I checked it out. The money is
there. This guy was brilliant. And at the end of the month all
of this stock that you thought you had, he then shows you at
the end is in treasuries. Sold everything, put it in
treasuries. You can't check out treasuries. How many people say
they should have checked? I said, where is your money? They
said, I am in treasuries. I said, how do you know it is in
treasuries? Because I told them to buy treasuries. I said, what
if you sent it to X, Y, Z, name the 10 biggest brokerage houses
you know and they are all crooks. They are not, but let's say
they are. And you sent them $10 million and said, put in
treasuries. Did you ever see a treasury bill? You get a
statement that says he has a treasury bill. All of the Mr.
Goldsteins of the world got statements. They got all of this
paper that said they have treasury bills. At the end of the
month, he figures I can take out $4 million. I have it in
treasuries, or whatever it is.
Mr. Kanjorski. So let me just interrupt you for a second.
This is like reporting the race after it is run. If you ran
through all this stock and took the day he claims that it was
sold when in fact it really wasn't, it would add up to the
amount he purchased through treasuries and it would show the
profit.
Mr. Ackerman. To the penny. But thousands of people. We
don't know the number. Maybe 3,000 or so people. That Mr.
Madoff could do this scheme himself, he had to be a lot smarter
than the genius that some people think he was. The mad genius,
the evil genius. That is part of what the Inspector General and
the other law enforcers are going to find out. But it is not
Mr. Goldstein's fault. This is not a case where you can blame
the victim for not doing due diligence. There is nothing
anybody could have done.
Mr. Metzger. This was a sophisticated fraud. Most
sophisticated investors would not have been able to detect
that.
Mr. Ackerman. The SEC couldn't detect it, the watchdog, the
watchdog of watchdogs, couldn't figure out what the crime was.
Mr. Metzger. This was not a garden-variety case of alleged
fraud.
Mr. Ackerman. No. But we don't know how many mini-Madoffs
there are out there. We don't know how many people sweep all of
their money into treasuries. And hopefully Mr. Kotz is going to
ask that question because they don't have to report to his
agency. They say, I am holding those securities or I am holding
very few securities. I don't have to report it to you because
it is all in treasuries. This is the dilemma of Mr. Goldstein.
Mr. Goldstein, who is not a cop, he is not an investigator, he
is not a very sophisticated investor but he is a smart man who
saved and did the prudent thing. And this is the face of the
investors that we are talking about.
But he did think that he had one thing. He had the
confidence, as he has told us, in his government, that his
government made sure that this has a seal of approval to at
least $500,000. At my college, you know what we did and we
insisted that Mr. Paulson do when people we wanted them to have
confidence and not have runs on the bank because they had more
than that? We raised it to $250,000. So we insured those
accounts for $250,000 so people with that kind of money thought
that they at least had that kind of protection and they should
move the money into different accounts. Right? With brokerage
accounts, some people said why am I in a bank with $250,000 if
I have $300,000? I will put it in a brokerage account instead
of my banker's account and I am insured for $500,000. Mr.
Goldstein is one of the thousands of people who were told that
seal of approval, as it was called, that is given by our
government, that is backed up presumably by people who are
watching, the real cops, the real enforcers, or so we thought--
and I did mean Inspector Clouseau instead of Jacques Cousteau.
Forgive me, Jacques. So I thought it was guaranteed that if Mr.
Goldstein can get his $500,000 worth of insurance and so many
other people, at least they would have a temporary lifeline
plus the rest of the assets that might be there.
Mr. Kanjorski. Thank you very much, Mr. Ackerman. I will
now recognize the gentleman from Alabama for 5 minutes.
Mr. Bachus. Thank you, Mr. Chairman. Mr. Goldstein, your
wife is obviously emotionally torn up by this. I am sure it has
affected your health and hers. When you watch TV and you
realize that Mr. Madoff is still going home every night to his
luxury apartment, how does that make you feel?
Mr. Goldstein. I have to answer that. The first 2 or 3 days
after the disclosure, I was very, very angry, very angry. And I
decided to myself that the only way that I could survive this
as best I could was to get rid of the anger. So I don't care if
Mr. Madoff goes to jail. I don't care if he sits in his
apartment. It doesn't--it won't affect my life one way or the
other.
Mr. Bachus. That is a good--I get a good lesson in
forgiveness, although I am not sure that he should be spending
the night in his luxury apartment. I am not sure what message
that sends to other folks who would do this type of thing.
Mr. Ackerman called him an evil genius. Basically what he
did, he made this stuff up every month.
Mr. Goldstein. I don't think one man made all this up,
however.
Mr. Bachus. Oh, I agree. I agree. I think if he were in
jail, he may be more likely to cooperate. But maybe that is not
true.
Mr. Metzger, you said it is not a garden variety type of
fraud. A lot of people who have committed much less of a crime
than this are in jail today, and went straight to jail. Does it
bother you that Mr. Madoff is free on bond?
Mr. Metzger. I don't know why the government reached that
decision. I cannot defend the government's--the way the
government negotiated with him.
Mr. Bachus. How about you, Ms. Frankel? Or Professor.
Ms. Frankel. I don't think it makes that much of a
difference. I would like to see him in jail. On the other hand,
I don't want to pay for his food and keep. What I would like is
to make him live the way the other people--I would like his
money rather than his discomfort. And then the discomfort will
come.
Mr. Bachus. You know we don't seem to apply that standard
to other people who steal much less than that. We don't just
ask for the money back.
Ms. Frankel. Then maybe we should start. We should start if
we take other people's money--the point is this, he took other
people's money and then they are--he should be trustworthy.
Mr. Bachus. They are suffering worse tonight than he is. I
guess that is my point. I am not--
Ms. Frankel. He is ruining or he has helped continuously to
ruin a very important part of this country.
Mr. Bachus. Including charities and schools.
Ms. Frankel. The whole financial system.
Mr. Bachus. I for one am outraged that this man continues
to walk the street and go home at night, and I consider myself
a pretty forgiving person. But I think that the message it
sends about law enforcement and the even-handedness and equal
protection of laws is a dangerous message.
Ms. Frankel. I agree.
Mr. Bachus. Thank you. You know we are talking about what--
Mr. Goldstein what you did and whether you should have done
something different. I wrote down some of the things that I
would have done. One of them, I would have found a good
investment adviser with a good track record, and that was Mr.
Madoff. In fact he appeared to be about as good of--had a great
track record, was--and then you know I, like you, I would have
looked at my statements to see if he was investing it wisely
and if I was getting a good return. And every month it would
be--I would--I would have the opinion that I had done the right
thing, and that would be reinforced by these made up
statements. And you did that, too. You looked at them. And
obviously he was investing in what I have heard other people
say, and you, a lot of index funds which is diversification.
Ms. Frankel. That is right.
Mr. Bachus. And treasuries, which is, what is safer than
treasuries? So yes, I can't really--it is hard to understand
that you could have this massive of a fraud for this period of
time and have complaints come before the regulators and yet
them not discover it. It just blows my mind.
Mr. Goldstein. I would just like to say one thing. I never
thought of fraud in this. It was an investment. It looked
perfectly fine. I was getting a return. But somewhere inside of
me was the thought that this was a regulated industry, and the
government was behind the regulation. And it wasn't. It wasn't.
The red flags, the warnings, the letters were just pushed
aside. So the end result was people like myself are suffering
because of that.
Mr. Bachus. I agree. Thank you very much.
Mr. Goldstein. Thank you very much.
Mr. Kanjorski. Thank you very much now. Do you have that
train to catch at 6:30? Is that correct?
Mr. Metzger. Mine is at 7:10.
Mr. Bachus. I think you have already missed it.
Mr. Kanjorski. The question is--
Mr. Metzger. I am willing to stay.
Mr. Kanjorski. Professor?
Ms. Frankel. I am willing to stay.
Mr. Kanjorski. And Mr. Goldstein?
Mr. Goldstein. Yes.
Mr. Kanjorski. It would be very helpful because this does
put a human face on a problem. And it is shocking. So I am very
pleased we will be able to get--I will even start with Mr.
Scott, give him the first 5 minutes.
Mr. Scott. Thank you, sir. I appreciate that. First of all,
let me thank you for your patience and waiting. You have been
here since 2:00 and it is good to see that you have stayed
because, in fact, yours is probably the more important of the
panels from my perspective.
Mr. Goldstein, let me just talk with you for a second. How
much money are we talking about that you have invested with--
Mr. Goldstein. I invested with Madoff two different times.
The total--this was 20-some odd years ago. But the total was
approximately $2.5 million.
Mr. Scott. That is the total leading up after 20 years of
investment of your money. So you had a 20-year relationship
with Madoff?
Mr. Goldstein. Yes, sir.
Mr. Scott. And if I may ask, how did you get into this
relationship? Were you referred? Did you know him?
Mr. Goldstein. I was referred by my accountant, who also
had an account with Madoff.
Mr. Scott. Okay. Your accountant wasn't by any chance their
auditor?
Mr. Goldstein. No, no, no, no.
Mr. Scott. So this $2.5 million that you had invested and
lost with him over a 20-year period, now what did you see from
this over this 20-year period? Did you engage in any selling
and buying with him? Were you able to see--of the $2.5 million
that you invested, what was a gain to you? What did you see for
that?
Mr. Goldstein. I had a yearly return, which was give or
take 10 percent.
Mr. Scott. Okay.
Mr. Goldstein. It was so steady. Over the years there was
never any hint of impropriety. What I did was, I mortgaged my
house, lived on that money, and let the Madoff money just
increase in value and the account got bigger. From my $2.5
million, I have $4.2 million on my November statement.
Mr. Scott. 4.2 million in your November statement.
Mr. Goldstein. Yes. That is what he told me I had.
Obviously I didn't have it.
Mr. Scott. You didn't have that because of the scheme. Let
me ask you, Ms. Frankel, if I may, moving forward, you made a
recommendation and I would like for you to just expound on it
for a moment. When you said that rules, the regulations, I
think the heart of your testimony was that we should verify.
Can you explain what you are talking about when you say verify
and how we would do that? Are you Ms. Frankel?
Ms. Frankel. Yes.
Mr. Scott. Yes, Ms. Frankel.
Ms. Frankel. The government has a right to demand proof.
And in this case, that is the way mutual funds, for example,
are regulated. They are--there is a whole slew of rules. And it
is not merely that you have the money in a certain--with a
certain bank. But you have all sorts--you have requirements for
the--you have a requirement for the insurance of the employees.
You have a lot of requirements. As a matter of fact, the
Investment Company Act of 1940 and the Investment, even the
Investment Advisers Act of 1940 have rules. But these--Mr.
Madoff was a broker. Brokers are not subject to many of these
rules. And they were not--that is--that is number one. Number
two, I think we should have more examination. In other words,
not merely they are saying, yes, we did put the money in the
bank. But somebody should come there and examine and say, show
me. Yes. I was at the SEC for just a year and a half. I was on
loan. And I went to these examinations. They were for other
things, yes, they were for soft dollars. We went in. We said
hello, hello. And then we said, show us, yes. And we asked
questions and the people there said for about 2 years.
Mr. Scott. Let me ask you this--
Ms. Frankel. Sorry.
Mr. Scott. What do you think a step in that direction would
be if we in one part of the process, if we brought broker-
dealers, regardless of their size, make sure that they are
audited by auditors that come under the jurisdiction of the
Public Accounting Board?
Ms. Frankel. Broker-dealers now even assert that they are
not fiduciaries even though they hold other people's money.
Yes? And I think the regulation of broker-dealers ought to
change. And it is more complicated but it ought to change.
Mr. Kanjorski. Thank you, Mr. Scott. Mr. Sherman, for 5
minutes.
Mr. Sherman. Thank you, Mr. Chairman. Mr. Goldstein, your
investment was directly in Madoff. And so as I understand the
position of SIPC, you stand to--you have a good claim for
$500,000.
Mr. Goldstein. God willing.
Mr. Sherman. Yes. On the other hand, filings have been made
on behalf of those who invested indirectly, where you know a
fund manager would take the money of 20 people and put it into
one Madoff account, and the old-fashioned position on that was
those 20 people are all going to have to share $500,000. People
in that situation have gone before the courts to say, no, we
are 20 people. Treat us as 20 people and not as one account. If
that happens, SIPC is way bankrupt.
Are you and the direct investors taking any position with
regard to the claims of the indirect investors?
Mr. Goldstein. Not that I know of.
Mr. Sherman. Okay. Ms. Frankel, I will go a little bit
outside the Madoff situation because sophisticated investors at
least go with a guy who looks like he is a broker or an
investment adviser. A lot of people in my district may invest
in a variety of other flim-flams where--most people in my
district don't know what a private placement memorandum is
supposed to look like.
Ms. Frankel. Right.
Mr. Sherman. The SEC takes the position that they will surf
the Web looking for problems. But they will never send an e-
mail to someone who is offering an investment unless they say,
hi, we are the SEC. We are investigating you. But they won't
pose as a potential investor. So would it make sense for the
SEC to pose either in person or online or both as a prospective
investor and hear the pitch not from the people who are
registered investment advisers, registered companies with the
SEC but with the folks who are stealing from the less
sophisticated?
Ms. Frankel. This is a criminal law question of entrapment.
The question is, to what extent are these people entrapped?
Mr. Sherman. It is hardly entrapment to say--the problem we
have is the SEC says, we don't want to be a law enforcement
agency, which begs the question, who? It certainly is not
entrapment if you see something online, ``double your money in
6 months, e-mail me now and find out how'' to say, hi, my name
is Jack Smith. I would sure like to double my money in 6
months. But these hearings are going to create--I think it was
Mr. Paul, whom I usually don't agree with, who said that one of
the functions of the SEC--one of its effects is to create an
image in the society that things are safe. Go try to find the
right investment. And of course things are particularly unsafe
for those who are not investment purveyors.
Ms. Frankel, what is your comment on that? Or, excuse me,
Mr. Metzger.
Mr. Metzger. I wasn't following the question. Do you want
me to tell you what I think about impersonation?
Mr. Sherman. Certainly, when it comes to enforcing our laws
against prostitution, police have a certain approach of
impersonation. The SEC will not impersonate an investor even
though local cops in my district will impersonate either side
of the oldest professional transaction.
Mr. Bachus. Is that a concern for you, Brad?
Mr. Sherman. I am more likely to lose in an investment
scam. But go on.
Mr. Metzger. That is a public policy decision. I am
troubled by the idea of impersonation. I understand what the
benefits are. It is a moral question. It is an ethical
question.
Mr. Sherman. Moral, so it is moral--
Mr. Metzger. On the one hand, you have potential
fraudsters, and you want to protect less sophisticated
investors from these people who are committing fraud.
Mr. Sherman. I believe my time has expired.
Mr. Kanjorski. Take the response, though.
Mr. Sherman. Thank you, Mr. Chairman.
Mr. Metzger. So, on the one hand, there is this idea of
just--I just feel uncomfortable sanctioning impersonation. It
just doesn't seem right. So you have to weigh the benefits. It
is costs and benefits. Standing on one leg, I can't give you an
answer right now about how I feel about it.
Mr. Sherman. Every law enforcement agency does it. The SEC
refuses to be a law enforcement agency. And I yield back once
again.
Mr. Kanjorski. Thank you, Mr. Sherman. We now have Mr.
Green of Texas.
Mr. Green. Thank you, Mr. Chairman. Mr. Goldstein, my heart
goes out to you. And I wish you and your wife the very best. My
suspicion is that you are not here today because you lost money
as a result of the stock market going down. You are here
because you lost your money by way of a fraud. If you had
invested the same amount of money and the stock market just
didn't serve you well, my suspicion is you would not be here
today. Is that a fair statement?
Mr. Goldstein. 100 percent correct.
Mr. Green. So I beg that you tell those who would say you
could have been a better watchdog, it is your responsibility to
protect yourself. We here on the committee have our opinions
about it, and we have expressed them. I think my colleague Mr.
Ackerman expressed himself quite well. And he made a great
case. But I think it is important for you to have a message for
those who say that you could have protected yourself and that
we leave it to you to investigate and to ascertain whether or
not you are being defrauded.
Mr. Goldstein. Is that a question?
Mr. Green. Yes, sir. Would you give--what would you say to
them?
Mr. Goldstein. I will say exactly what I said before. I
invested my money. The market goes up, the market goes down. I
understand that. But I also invested my money, knowing somehow
that the government, the SEC, whatever laws were involved, were
protecting me from fraud, not from market volatility. Market
volatility is my own problem. Fraud, on the scale that it was
perpetrated, I think the government has some complicity. There
were warning signs. There were letters. There were audits that
weren't made. There was an accountant who didn't fit into the
picture. There were so many things that happened and nobody did
a thing about it. So we were all victims.
Mr. Green. And as a victim, you made the statement that you
think that your government has failed you.
Mr. Goldstein. Yes, sir.
Mr. Green. And I truly understand the import of the
statement that your government has failed you. What by way of
restitution do you seek today as a result of this experience?
Mr. Goldstein. I don't expect to get $4.2 million back. I
don't. If I get the SIPC money, that would help me to survive
until I could sell my house. If there was some kind of
restitution from the assets of Madoff or even a little more
than that, that would be a miracle for me. That is what I am
looking for. I just want to continue my life. I am not going to
be driving a Mercedes-Benz. I am not going to Europe on
vacation. I just want to have a normal life being in my own
home, spending--I am not going to be around forever. I am 76
years old. Giving my wife some peace of mind every night so she
can go to sleep without a pill. That is all I want out of life.
Mr. Green. Let me thank you for having the courage to be
here today. And let me add this, that you were--as you were
perusing these monthly or quarterly statements--
Mr. Goldstein. Monthly.
Mr. Green. Monthly statements. I can easily see that you
were a person assuming that you were investing not only in
those corporations but in the country because all of the
businesses that were called to our attention, they do business
in this country. They make products that benefit the consumers.
They are engaged in discovery-type efforts such that we have a
better quality of life in this country. You were doing what
clearly can be considered American. It was an American thing to
do to invest in your country, though it was indirectly done
through Mr. Madoff, who made off with a lot of money. But you
were doing what was clearly an American thing to do. And I just
hope that people who are reviewing this will understand that
you are not some guy with deep pockets who just had millions of
dollars to throw away, that you inherited money and you have
had a silver spoon in your mouth all of your life. You earned
every penny of what you invested. And you invested it in
quality companies as perceived by you based upon what was
presented to you for your perusal. And I want to let you know
that I have great sympathy. And I want to make sure that we can
do whatever we can to help you.
Thank you.
Mr. Goldstein. Thank you very, very much, for myself and
all the other people who are in the same position I am, thank
you.
Mr. Green. You are welcome. Thank you, sir.
Mr. Kanjorski. The gentleman from Missouri, Mr. Cleaver.
Mr. Cleaver. Thank you, Mr. Chairman. I have no questions.
I appreciate you being here, Mr. Goldstein. There are no
answers you could give me that would cause my stomach to churn
less. Thank you.
Mr. Goldstein. Thank you.
Mr. Kanjorski. Thank you, Mr. Cleaver. The gentleman from
Illinois, Mr. Foster.
Mr. Foster. Thank you, Mr. Chairman.
Professor Metzger, my first question is relating to your
Recommendation VII, which has to do with transparency. For
instance, do you have a more detailed set of recommendations
for exactly what sort of disclosures you would recommend?
Mr. Metzger. Yes. It is in the written testimony.
Mr. Foster. Okay. All right. That is I think a very
interesting thing, interesting set of things to think about.
You also mentioned the possible danger of reverse engineering
of the trading strategies of the houses would be able to
reverse engineer that if you had too much disclosure of
positions and so on. And I was wondering, do you really think
that would result in a less effective, less efficient market if
that were, in fact, possible over time to do that? My question
is, what is wrong with that if over time--
Mr. Metzger. What is wrong with people reverse engineering?
Mr. Foster. Yes. And being able to understand what their
competitors were doing over a period of time.
Mr. Metzger. If someone has some sort of edge, some
investing edge that the adviser thinks that he or she can
exploit, the adviser doesn't want other people to copy what he
or she is doing.
Mr. Foster. I understand it might interfere with the
profitability of trading houses.
Mr. Metzger. Yes, in terms of society--
Mr. Foster. Would result in a less efficient capital
allocation for our country?
Mr. Metzger. Right. So society will benefit from that type
of disclosure.
Mr. Foster. Okay. Now the other thing has to do with the
compliance and regulatory costs for the different proposals. It
strikes me there is a big spread in how cost effective these
are in terms of the compliance costs and how effective they
would be at stopping this sort of scheme. For example, the
independent custodian thing strikes me as something that would
be fairly cheap and would be quite effective at eliminating the
possibility of this sort of Ponzi scheme. There are other
things like randomly assigning an independent auditor to all
financial entities that might be very effective but very
expensive to do. It might still be a good idea. I was
wondering, has anyone or do you intend to actually develop
estimates for the compliance costs for these different options?
Mr. Metzger. That I have suggested?
Mr. Foster. Yes.
Mr. Metzger. No, I haven't done that.
Mr. Foster. Do you think it might be feasible to do that?
Mr. Metzger. I don't think I have the data available to me,
but I don't think that it should necessarily be that costly.
Mr. Foster. Okay. Just when you go down the whole
smorgasbord of possibilities, having some estimate for what
they cost not only directly to the government but for everyone
that has to do with the regulations. You also had this mention
that confused me of managers generating an early fake alpha,
and how exactly does that work? Is there a quick way to explain
that?
Mr. Metzger. I will try to use an example. Take an XYZ
stock trading at $100. Assume that someone wants to sell an
uncovered call option where the call would be exercised at
$200, which means that the person who sells the call won't have
to pay up, if you will, until the stock exceeds $200. Let's say
the seller of the call receives $1 because it is very remote
that the stock will rise in 1 year from $100 to $200. So, let's
say this adviser does this trade 20 consecutive years; you make
a dollar a year. So, the investor will say, ``Wow, this person
is terrific, consistent results, $1 a year, no volatility
whatsoever.'' Then in year 21, the stock more than doubles.
There is a takeover, or for whatever reason the stock more than
doubles. You have lost your $20 and then some. So, that is what
I mean by a fake alpha. In other words, it looks good.
Mr. Foster. Just because you are not sampling the whole
distribution and getting the right average?
Mr. Metzger. Correct.
Mr. Foster. Okay. Got it.
And Professor Frankel, this is more a general question.
What do you think sets the scale for the amount of effort that
we should put into enforcement on this thing? If you look at
what we spend to prevent bank robberies compared to what our
society loses for bank robberies, shouldn't that roughly be in
the similar proportion to what we spend for security frauds
compared to what we lose for security frauds? Because if that
is the case, I think there is a big mismatch.
Ms. Frankel. Right now, our system is threatened. If it
were--I wanted to say just--but if it were just the individual
investors who were losing, that is one thing. But our whole
system is threatened and it is dragging our economy with it. So
what I am focusing on is the system. And as far as that is
concerned, I would pay--I think we should pay more. Then when
everything kind of balances again, then we can reduce. We don't
have to commit forever. But right now, I think there is a real
danger, and that--I don't know what it is.
Mr. Foster. It is in our straight-up self-interest to spend
more on enforcement is what your basic point is?
Ms. Frankel. That is correct. To spend more on not
enforcement, examination. I want verification. Transparency
doesn't mean verified transparency. So Madoff sent him a
transparency but it wasn't. I want to make sure that it is
true.
Mr. Foster. Last question. Do you think the Madoff affair
was really due in large extent to the increased complexity of
modern finance? Or would this whole thing be recognizable to
someone 100 years ago?
Ms. Frankel. No. I think we are inventive. Some of the
inventions are not lending themselves to transparency at all.
You have some instruments that can be understood only by those
who have the algorithms and so on, yes.
Mr. Foster. So you think Bernard Madoff's trading strategy
could not have been implemented 100 years ago?
Ms. Frankel. Oh, the Ponzi schemes?
Mr. Foster. Not the Ponzi schemes. Just his trading
strategy, the split strike thing.
Ms. Frankel. I think it couldn't. It couldn't. I know the
history of the 1920's and it was simple. It was
straightforward. Yes, there were pyramids. But that was the
most complicated thing.
Mr. Foster. Thank you. I yield back.
Mr. Goldstein. Could I add something, if I may? I am a
layman and you are talking in terms I probably don't
understand. But any industry where people make $50 million to
$100 million salaries and give out hundreds of millions of
dollars in bonuses can afford to pay for their own compliance.
Mr. Foster. Understood. I yield back.
Mr. Kanjorski. Thank you, Mr. Foster. I am just going to
take one or two things. Are you suggesting that we should be
looking at an insurance or government guarantee? I am not quite
sure that I understand from the panel what--
Ms. Frankel. No, no, no, no, no. Not an insurance and not a
government guarantee. But examinations that will--as a matter
of fact, our regulators have to find out what is really going
on in the financial system. It is complicated. And I don't
think they really know. There are people in the industry who
do. And now they are laid off so maybe this is a good time to
hire them to the government. And they will really find out what
is going on, how are things being done. That is what I
suggested. And then, then you know the examinations that are
being done within the SEC may not be enough and may not be the
right ones. We have to know what is happening in the market.
Mr. Kanjorski. I understand the problem. Earlier, when I
was examining the three of you, it sounded like I was harsh
because I have this struggle between caveat emptor and an
individual's duty to do their own due diligence.
Ms. Frankel. Goodness, no.
Mr. Kanjorski. To do their own due diligence. But quite
frankly, I don't want you to leave thinking that I am harsh
that way because quite frankly how you were taken in I can see
almost everybody in the world could be taken in that way. 21
years of successful dealing and a recommendation by an
accountant, potentially a lawyer. Just amazing. I don't know
where we come up with this. But I will say one thing, he is an
evil--who called him an evil genius? Did you call him that?
Mr. Bachus. He did, and I quoted him. I quoted Mr.
Ackerman.
Mr. Kanjorski. Mr. Ackerman is right. Where this comes
from. I am just going to throw out this one thing though and
this is the problem I have. The other night I watched a
druggist. They displayed the story of the druggist in Kansas
City who gave chemotherapy to thousands of his patients who had
cancer, and he watered down the prescription and hundreds of
them died. Now no one knows for certain that any of them
wouldn't have died if they had gotten the correct chemotherapy.
But obviously, they did die. I was thinking that as bad as Mr.
Madoff is, if all the allegations are correct, it doesn't quite
rise to the level of that pharmacist. And yet the FDA is not
being asked to guarantee that pharmacists give out proper
prescriptions. Whether it is we can't afford it, don't know how
to do it, I am not certain. But I guess what I am getting at is
there is a limit on just what we can guarantee or what we can
protect against. And when you get up to a fraud of this size,
with the number of people involved, I would be far more
understanding, quite frankly, if there were ill-informed
people. But man, what a clientele to take to the cleaners,
absolutely unbelievable. That is what astounds me. Bankers,
insurance companies, sophisticated investors, other hedge
funds. Unbelievable.
Mr. Metzger. Mr. Chairman?
Mr. Kanjorski. Yes.
Mr. Metzger. I didn't get an opportunity yet. I want to
express my sympathy for Mr. Goldstein. I really feel very badly
for you, and I just wish it had never happened to you. I wish
you happiness and good health.
Mr. Goldstein. Thank you.
Mr. Kanjorski. Yes. Thank you, Mr. Metzger. That is very
good. Mr. Goldstein, I am sure I speak for everybody who has
heard your story, and thousands of people or hundreds of
thousands who have seen it on television or will, you certainly
did put a human face on this and made it far more
understanding. Take care of your wife and make sure she doesn't
get extreme on the situation. Enough people have already lost
their lives or lost their futures. So we don't want anything
worse to happen. And as Mr. Cleaver indicated, I hope that
ultimately we come up with a solution to help serve--and
certainly, I am going to hold Mr. Ackerman responsible to
guarantee that $500,000 is at least there. Is that correct, Mr.
Ackerman?
Mr. Ackerman. We can work on that together, Mr. Chairman.
Mr. Goldstein. Thank you very much.
Mr. Kanjorski. Now, I will excuse the panel, and thank you
all for being as kind as you have been to remain as long as you
have.
The Chair notes that some members may have additional
questions for this panel which they may wish to submit in
writing. Without objection, the record will remain open for 30
days for members to submit written questions to today's
participants and to place their responses in the record.
Before we adjourn, the following written statements will be
made a part of the record of this meeting: a communication from
the Institute of International Banking Law and Practice and a
communication from the Investment Advisers Association. Without
objection, it is so ordered.
The panel is dismissed and this meeting is adjourned.
[Whereupon, at 6:57 p.m., the meeting was adjourned.]
A P P E N D I X
January 5, 2009