SPEAKERS CONTENTS INSERTS
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IT'S ONLY FAIR: RETURNING MONEY
TO DEFRAUDED INVESTORS
Wednesday, February 26, 2003
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance,
And Government Sponsored Enterprises
Committee on Financial Services,
The subcommittee met, pursuant to call, at 10:02 a.m., in Room 2128, Rayburn House Office Building, Hon. Richard Baker [chairman of the subcommittee] presiding.
Present: Representatives Baker, Gillmor, Kelly, Biggert, Green, Capito, Hart, Kennedy, Tiberi, Brown-Waite, Harris, Renzi, Kanjorski, Meeks, Inslee, Moore, Lucas, Clay, McCarthy, Baca, Matheson, Lynch and Scott.
Chairman BAKER. [Presiding.] I would like to call this meeting to order to discuss the Sarbanes-Oxley Act, specifically section 308(c) which requested the agency to study, evaluate and make appropriate recommendations with regard to what is known as the Fair Fund contained in that bill.
Before the passage of Sarbanes-Oxley, if the SEC was engaged in pursuit of wrongdoers and in fact assessed penalties for inappropriate conduct, those penalties would not directly benefit any wronged investor, but would return to the U.S. Treasury. With the passage of the Fair Fund, we have now created a mechanism where disgorgements, that is the return of ill-gotten gains, or penalties assessed now will be funneled into the Fair Fund for what is determined to be appropriate allocation to those who were victims of the wrongdoing.
Page 2 PREV PAGE TOP OF DOC I have been particularly stunned by the actions of some prominent enforcement authorities, not within the SEC, in their diligence in pursuit of those who have committed acts that are inappropriate. Specifically, taken from one web page, the statement, ''The money that was being abused, the money that was lost, the money of people like you who took their pension money, their 401(k)s, their IRAs, the money they had set aside for their kid's college education or a mortgage payment or their vacation, that was the money being used and violated by those on Wall Street who thought they were beyond the reach of the law.'' I am with him all the way to that point. It is just the next step that bothers me. When the award was finally settled, he kept the money. I likened it to the call to the sheriff's office when you report your car stolen, the sheriff calls you back two days later and says, ''Good news, we found the car; bad news is, I am keeping it.'' I find this vindication something less than whole.
So this is a new first step and effort to try to provide governmental assistance to individuals who have been defrauded that is meaningful. This is a first effort, and recognizing that, I have reviewed the report of the SEC and find it very constructive, and will after listening to further explanation this morning construct legislation, which I am hopeful other members of the committee will find of interest, for introduction soon, that will address those areas that the report identifies, as well as some other areas that I have found to be of importance, to move forward and make the Fair Fund more meaningful to more investors across the country. I think this is a very good start, and I am appreciative to the agency for their hard work and effectiveness in making the legislative concept an operating reality.
Mr. Kanjorski, do you have an opening statement?
Mr. KANJORSKI. Thank you, Mr. Chairman.
We meet today to examine the issue of investor restitution, an issue of great importance to me. Last month, the Federal Reserve determined that the United States stock ownership increased to 51.9 percent in 2001. Because more and more Americans continue to make investments in our securities markets, we have an obligation to ensure that these individuals are appropriately safeguarded in cases of wrongdoing.
Page 3 PREV PAGE TOP OF DOC Accordingly, I have made investor protection one of my priorities for work on our committee. Last year, in the wake of a tidal wave of cases of corporate wrongdoing, we worked to enact into law the Sarbanes-Oxley Act. This law advanced investor protection in a number of important ways, including the creation of the Fair Fund. The Fair Fund, as you know, allows the Securities and Exchange Commission to further help the victims of securities law violations by permitting the agency to add any civil penalties collected in enforcement cases to its disgorgement orders.
However, in order for the Fair Fund to work well, serving as a deterrent and as a means of returning funds to harmed investors, we must ensure that the SEC has an effective program that to the maximum extent possible collects the fines, penalties and disgorgements it orders. As you know, Mr. Chairman, I have been a leader in the congressional effort to examine these issues in recent years. In March, 2001, for example, I joined with a number of my Democratic colleagues in ordering an investigation by the General Accounting Office of the SEC's disgorgement policies. Last July, the GAO determined that the SEC's efforts to recover illegal gains from financial scam artists had fallen dramatically and required tougher oversight. Between 1995 and 2001, the SEC collected roughly $426 million or about 14 percent of the $3.1 billion owed in disgorgement cases. This finding represented a sharp drop from the 50 percent collection rate the GAO previously found in 1994. As a result, I call upon the SEC to tighten its disgorgement collection monitoring and to implement other oversight improvements.
In recent years, the GAO has also examined the success of securities regulators in collecting fines and penalties. In the next few months, I expect to receive a follow-up report from the GAO regarding this issue. A previous GAO report completed in July, 2001, determined that these collection rates have generally improved in recent years, but that more improvements can be made. The SEC, for example, now collects about 91 percent of assessed penalties and fines, an increase from the 83 percent in a similar GAO study in 1998. Despite this improvement, the GAO found that the SEC could take steps to enhance the collection of fines referred to the Treasury Department's Financial Management Service under the Debt Collection Improvement Act of 1996.
Page 4 PREV PAGE TOP OF DOC When we hear from our distinguished witness later today, I hope that he will address this important issue. The effective implementation of the Fair Fund in improving disgorgement and fine collection practices are important efforts to ensure that investors receive at least partial compensation for losses they incur as a result of securities fraud. However, the most meaningful route for investors to receive restitution for their losses is through private litigation. We need to ensure that investors harmed by corporate wrongdoers can seek legal redress in our nation's courts.
Accordingly, I was particularly pleased to read the SEC's report to Congress about the benefits of private litigation. As the SEC notes, investor lawsuits complement government enforcement action by providing a mechanism to compensate investors through the award of restitution or damages. While the SEC's enforcement actions often have several aims, the objective of private litigation is exclusively to compensate injured investors. In this report, the SEC also refers a number of recommendations for improving the effectiveness of the Fair Fund. For example, the SEC calls for legislation to exclude securities cases from state law property exemptions, such as homestead exemptions. The SEC additionally suggests that we amend the Fair Fund law to permit the agency to use penalty monies ordered in a particular matter for distribution to injured investors regardless of whether disgorgement was ordered. These ideas have merit and we should work to address them.
In closing, Mr. Chairman, I look forward to hearing from our witness on the issue of investor restitution. I also look forward to hopefully working with you to examine and adopt the legislative recommendations offered by the SEC in the weeks and months ahead.
Thank you, Mr. Chairman.
Chairman BAKER. I thank the gentleman for his comments.
Ms. Kelly, did you have a statement?
Mrs. KELLY. Thank you, Mr. Chairman, Mr. Kanjorski. I want to thank you for holding this hearing this morning.
Page 5 PREV PAGE TOP OF DOC It is a pretty simple principle we are talking about here. People who were damaged deserve to get some money back. If we can make them whole, so much the better. That is the whole principle that we put behind the Fair Fund last year. That was a significant step in the right direction. By establishing that fund, we said that wrongdoers are going to be punished and that every effort is to be made to make the people who have been victimized whole.
What is important now, I think, is that we understand how our direction is being implemented, and make sure that it is being implemented in a way that fully meets the expectations of Congress when we put the Fair Fund Act in place.
I think it is imperative that the Commission have the tools that it needs to protect investors, and it is my hope that this hearing will shed some light on whether or not the Fair Fund Act gives the Commission sufficient ability to collect payments and then disburse funds back to the harmed investors. If any modifications are needed, I hope that we can reach an agreement in a timely fashion and in a manner that maintains the strong focus we have in the Fair Act of directing funds back to the harmed investors. That is the top priority.
I expect through the testimony of you, Mr. Cutler, that we can all gain a better perspective and a better understanding of what the Commission's efforts and perspectives are in implementing the Fair Act. I think strengthening investor confidence through a strong protection in this way has got to be something that the investors understand, and it is clearly something that is needed in the markets today. The implementation of the Fair Fund Act is absolutely essential to that confidence.
I want to thank you, Mr. Cutler, for being here today. I very much look forward to your testimony, I hope it will help us get in the direction that we hoped to accomplish when we passed the Fair Act.
Thank you, Mr. Chairman. I yield back.
Chairman BAKER. Thank you, Ms. Kelly.
Page 6 PREV PAGE TOP OF DOC Mr. Scott, did you have a statement this morning?
Mr. SCOTT. No.
Chairman BAKER. Mr. Lynch?
Mr. LYNCH. No, thank you.
Chairman BAKER. Ms. McCarthy?
Mrs. MCCARTHY OF NEW YORK. No, sir.
Chairman BAKER. Does any member have a further statement? Mr. Renzi?
Mr. RENZI. Thank you, Mr. Chairman.
Mr. Cutler, I also want to thank you for coming today and for your testimony that we are about to hear. I am really specifically interested in the concept of debt collection focusing on the company itself, and not so much the individual. I realize in looking at the statistics and reading them last night that there has been very little success in going after individuals who defrauded investors. I would ask you to please look at the model that we see in our own military, where generals are called on the carpet after years and years of service. They are reprimanded and their pay and retirement is taken away from them. Now, it is easier because the government of the United States controls the flow of money, but it is also because we direct our focus to the DOD and to the agency.
So in your testimony and in your discussions today I hope you will talk about the possibility of our law stretching further than just the individual, but the possibility of it including the ability to go after the company itself who pays out the golden parachute to that individual, and the responsibility for the excessiveness in that golden parachute, so that we are going after two entities, not just one.
Thank you, sir.
Chairman BAKER. Thank you, Mr. Renzi.
Page 7 PREV PAGE TOP OF DOC Does any other member have an opening statement? If not, at this time I would like to call on our only witness today for this hearing, Mr. Stephen Cutler, who is the Director of the Division of Enforcement for the Securities and Exchange Commission. Welcome, Mr. Cutler.
STATEMENT OF STEPHEN M. CUTLER, DIRECTOR, DIVISION OF ENFORCEMENT, U.S. SECURITIES AND EXCHANGE Commission
Mr. CUTLER. Thank you, Mr. Chairman.
Chairman Baker, Ranking Member Kanjorski, and distinguished members of the subcommittee, good morning. I am pleased to be here today to testify on behalf of the Securities and Exchange Commission. I commend you for inviting me here and I commend the subcommittee for holding a hearing on the important and timely issue of returning funds to investors.
Clearly, this is a topic of mutual concern to the subcommittee and the SEC. Today you asked that I discuss the following matters: first, the principal findings and legislative recommendations in the Commission's report pursuant to section 308(c) of the Sarbanes-Oxley Act of 2002; second, the Fair Fund provision in the Sarbanes-Oxley Act; third, the difficulties the Commission encounters in collecting disgorgement; fourth, the Commission's efforts to improve the effectiveness of its collection program and return more money to defrauded investors.
I will touch on each of these subjects briefly, but I request that my more extensive written statement be included in the record.
Chairman BAKER. Without objection.
Mr. CUTLER. Thank you, sir.
Page 8 PREV PAGE TOP OF DOC On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002. A particularly novel provision of the act that should benefit investors significantly is the Fair Fund provision, section 308(a). The Commission receives payments from wrongdoers in the form of disgorgement and civil money penalties. While the Commission has always been empowered to distribute payments of disgorgement to harmed investors in appropriate circumstances, prior to Sarbanes-Oxley, the Commission was required by law to transmit penalty amounts to the Department of the Treasury. Penalty amounts could not be paid to harmed investors.
Now, as a result of the Fair Fund provision, in Commission actions where both disgorgement and penalties are obtained against a defendant or a respondent, the amount of the penalty may be added to the disgorgement fund for the benefit of victims of the violation. Within the first six months of the enactment of Sarbanes-Oxley, the Commission has authorized the Division of Enforcement at the SEC to seek approval of Fair Fund distributions on more than a dozen occasions.
Section 308(c) of Sarbanes-Oxley required the Commission to review its enforcement actions over the previous five years to determine how such proceedings may be best utilized to provide recompense to injured investors. The principal findings of the Commission study were set forth in a report submitted to Congress on January 24 of this year. The report found that significant payments or the failure to make such payments by a small number of defendants has a disproportionate impact on the Commission's overall collection success. Emergency actions, where appropriate, can limit investor losses and increase the chances of returning funds to investors in almost all types of cases, particularly when the Commission receives early notice of the misconduct.
The appointment of a receiver, where appropriate, can enhance the Commission's ability to maximize investor recovery. The Commission's historic practice of allocating defendants' payments first to disgorgement and then to penalties has produced results within prior statutory restrictions consistent with the principle on which the Fair Fund provision is based, that is that all monies recovered in Commission actions be made available to compensate the victims of securities fraud.
Page 9 PREV PAGE TOP OF DOC Now, I want to briefly describe the Commission's collection process and some of the difficulties the Commission encounters in collecting disgorgement and penalty amounts. When an SEC defendant or respondent fails to pay disgorgement or penalty amounts owed in a timely manner, there are two primary means by which the Commission staff collects judgments, through the efforts of Commission enforcement attorneys, which we call in-house collection, and through referrals to the Department of the Treasury.
In-house collection may involve litigation or non-litigation efforts, including contempt actions, asset foreclosures, and wage garnishments. Treasury administers two collection programs in which the Commission participates. The first, called the Treasury offset program or TOP, is a centralized process that matches and offsets certain federal payments such as tax rebates, against debts owed to the government. The other program is Treasury's collection services program. In this program, Treasury employs traditional collection agency services.
As described in the Commission's report, there are a number of factors that hinder our ability to collect money judgments owed by securities law violators, whether through in-house or outside means. First, substantial recovery of the fraudulent proceeds is often not possible because the violators have spent investors' money to bring in more investor money. Second, wrongdoers often hide assets, for instance in overseas accounts, to hinder collection efforts. Nevertheless, in appropriate circumstances, the Commission expends significant resources tracking down hidden assets and compelling defendants to satisfy monetary judgments.
Third, in many cases the Commission or criminal authorities may obtain remedies that contribute to defendants' inability to pay amounts owed. For example, the Commission can obtain an order barring a defendant from serving as an officer or director of a public company, or an order barring an respondent from associating with a broker or dealer. Criminal authorities may prosecute defendants and obtain jail sentences. These measures may limit or even eliminate an individual's employment opportunities and thus reduce defendants' ability to pay.
Page 10 PREV PAGE TOP OF DOC In the last year, the Commission has taken a number of steps to enhance its collection program. We have developed written guidelines for staff on how to pursue collections, established a collection tracking system, and designated collection monitors to oversee the collection program in each of our regional and district offices. Additionally, the Commission created and filled a position for an attorney dedicated solely to collections. We believe that these measures are improving the Commission's ability to collect on judgments, within the constraints I mentioned previously, and to monitor the effectiveness of our collection program.
Now, I want to briefly describe the legislative proposals recommended by the Commission to enhance our collection activities and strengthen the Commission's enforcement program. As I noted earlier, the Fair Fund provision changed the law to permit penalty amounts collected to be added to disgorgement funds in certain circumstances. However, there is a technical limitation in the wording of the Fair Fund provision that only permits the Commission to add penalty amounts to disgorgement funds when a penalty is collected from the same defendant who has been ordered to pay disgorgement. This limitation means that in certain cases, penalties collected from defendants may not be distributed for the benefit of harmed investors.
The Commission recommends making technical amendments to the Fair Fund provision to permit the Commission to use penalty monies for distribution funds in these additional circumstances.
Recommendation two relates to removing certain state law impediments to Commission collection efforts. All states have statutes that exempt certain property, such as a primary residence, from collection by creditors, including the SEC. Some defendants use these exemptions to buy lavish homes, and thus shelter their assets from collection. Currently when trying to collect disgorgement, the Commission staff faces the prospect of protracted litigation to overcome state law exemptions.
Page 11 PREV PAGE TOP OF DOC Accordingly, the Commission recommends that Congress enact legislation to remove state law impediments such as the homestead exemption to the Commission's debt collection efforts.
The Commission's third recommendation would enhance our ability to collect funds in litigation. Currently, the Commission can contract only for non-litigation collection services. If a private attorney does not have the direct and timely ability to invoke litigation during the collection process, however, it can dramatically lower the opportunity for success. The Commission recommends legislation to expressly authorize the Commission to hire private attorneys to conduct collection litigation, just as the Department of Justice is able to do.
The remaining recommendations I will discuss relate to strengthening the Commission's enforcement power generally, and thus can lead to greater success in returning funds to defrauded investors. First, in order to avoid duplication and increase efficiency, the Commission recommends authorizing the Department of Justice, subject to judicial approval in each case, to share grand jury information with the Commission staff in more circumstances and at an earlier stage than is currently permissible. This proposed modification of the grand jury secrecy rule would be modeled on the law that currently applies to bank and thrift regulators.
Second, also to help the Commission's enforcement staff gather information more efficiently, the Commission recommends that Congress amend the securities laws to allow persons or entities who produce privileged or otherwise protected material to the Commission to do so without fear that by virtue of such production alone, they would be deemed to have waived the privilege or protection as to anyone else.
Third, to increase the effectiveness and decrease the expense of SEC litigation, the Commission recommends legislation to make nationwide service of trial subpoenas available in the Commission's civil actions filed in federal district court. Under current law when witnesses are located outside of a district court's subpoena range and fail to volunteer to appear at trial, the staff must take the witness' depositions and then use those depositions at trial. Such deposition testimony is more expensive and less effective than live testimony.
Page 12 PREV PAGE TOP OF DOC The fourth and final Commission recommendation I will discuss was not previously included in the Commission's reports to Congress. The Commission recommends that Congress amend the federal securities laws to authorize the Commission to impose civil money penalties in additional cease and desist proceedings. Currently, the Commission has two primary means of seeking civil penalties, in administrative proceedings against entities and persons directly regulated by the Commission, or in federal court actions against any entity or person. The Commission also has the authority to seek remedies other than civil penalties against an entity or person in an administrative proceeding.
The result of this patchwork is that in some circumstances, the Commission must file two separate actions against the same entity or individual to obtain the appropriate array of relief. Moreover, under current law, if the Commission charges a respondent with causing another party's violation of the securities laws, a concept similar to aiding and abetting in a cease and desist proceeding, the Commission can impose a monetary penalty only in very limited circumstances. By granting the Commission additional authority to seek penalties in cease and desist proceedings, Congress would eliminate inefficiency, give the Commission added flexibility to proceed administratively, and strengthen the Commission's ability to hold those who assist in violating the securities laws financially accountable for their action.
In conclusion, the Commission is dedicated to improving its collections record and providing greater recovery to defrauded investors. We look forward to working with this subcommittee on additional measures to further these important goals. I would be pleased to answer any questions any of the members may have.
[The prepared statement of Stephen M. Cutler can be found on page 49 in the appendix.]
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Chairman BAKER. Thank you, Mr. Cutler. For the record, I will incorporate all of the recommendations of the SEC report into legislation, which we hope to have prepared for next week. I would just make the statement for members interested, if they have interest in being involved with that matter, please let our office know.
There are a couple of issues that are circling around the construction of the Fair Fund. One is with regard to, or at least alleged complexity of the distribution of assets to wronged investors. Isn't it the case that in prior years the SEC has on many occasions with the result of disgorgements identified a class of wronged investors and made distributions in previous reconciliations of events of this sort?
Mr. CUTLER. The short answer to that question is yes, on numerous occasions.
Chairman BAKER. So the short answer to the complexity issue is, you have done it, we know how to do it, and that should not stand in our way of moving forward with these collections.
Mr. CUTLER. I agree with you.
Chairman BAKER. Secondly, with regard to staffing allocations, my understanding is the SEC generally has about 3,000 employees, but I do not know how many are allocated to the Division of Enforcement.
Mr. CUTLER. It is approximately 1,000 people nationwide, that is spread out over 12 offices, with approximately 375 people in Washington and the balance in 11 offices located throughout the country.
Chairman BAKER. And primarily those would be seeking out wrongdoers, to differentiate that from the collection side, how many folks are actually in the business of pursuing return of assets?
Page 14 PREV PAGE TOP OF DOC Mr. CUTLER. The way we are structured currently, Mr. Chairman, is to have the members of the staff who are investigating and litigating our cases also pursuing the judgments in connection with those cases. Recently, we hired a collections expert, someone who is steeped in collections law, which is much different, as you know, from the federal securities laws and requires a different sort of expertise, to spearhead our collection efforts. Certainly, with increased staffing that I think the current budget contemplates, we are grappling with whether we ought to expand the group of people that we have who really devote all of their time exclusively to collection efforts.
Chairman BAKER. Let me help on that point. At the current time, if the award or penalty is small in relation to the number of investors and it is not practical to make a meaningful distribution, money still is returned to the treasury, as opposed to being used internally. It would be my recommendation in the bill we are to consider to have a structured requirement that first every effort be made for investor restitution; secondly, that funding for investor education be at its optimal level; and thirdly, that any residual funds remaining after penalties, disgorgement or other activities that net income to the agency, then be utilized for additional collection services within the agency.
I understand the professional concern about the outward appearance of incentivizing people to go after wrongdoers for their personal gain or the growth of the agency, but if we structure it in such a fashion where it first must go to the investor, secondly goes to education purposes, and then only if all those needs are met, would it wind up in the hands of the collection services, it seems to me to be appropriate, especially in light of the section of the report which identified the need to contract with outside services for litigation and/or collection purposes. One of the limiting factors to engage in that is resources to supervise it.
I will make it as hard as I can for you to answer this wrong. Would you object to inclusion of that approach in legislation the Congress might carefully consider?
Page 15 PREV PAGE TOP OF DOC Mr. CUTLER. Let me say first, Mr. Chairman, I so appreciate the support and the sentiment of that notion. I think we should be making every effort, and with your help and the subcommittee's help, we have been and will continue to make efforts to return money to investors. Certainly, we can use all of the budget help that we can get, and I think this Congress and this subcommittee have been instrumental in that regard.
Chairman BAKER. Well, you are a unique regulator. Every other one I have read about in recent weeks has not only collected, they have kept it all and not given any back to the investor. At least we are starting with the premise that we are going to give it back to the investor, then we are going to educate investors, and only then would we keep the money for the purposes of helping other wronged investors.
I find it especially troubling when I read the papers where a particular state government is going to use the proposed, not yet received settlement figures, to build a DMV office. Maybe that is because we want to catch the guys in the cars as they are leaving the state with your money. I do not know what the connection is to wronged investors, but we really have to get a handle on this.
Mr. KANJORSKI. Thank you, Mr. Chairman.
Mr. Cutler, in the report on page 19 and 20, it talks about the benefits of private litigation. Let me read a few sentences to you; ''Private litigation, however, offers the dual benefit of compensating Commission enforcement action and providing a mechanism to compensate investors through the award of restitution of damages. In contrast to Commission enforcement actions which have several aims, the aim of private litigation is solely to compensate injured investors. The ability of investors to fully recover their losses, indeed, may largely depend on the use of private actions.''
In other words, the Fair Fund and the disgorgement actions are well and good as far as they go, but the most meaningful route for investors to receive restitution for their losses is through private lawsuits. Is that correct?
Page 16 PREV PAGE TOP OF DOC Mr. CUTLER. Yes, sir. I think it is clearly the primary goal of law enforcement and civil law enforcement to deprive a wrongdoer of ill-gotten gains. I think the brilliance of the Fair Fund provision is that it takes that goal and does not do anything to diminish it, but at the same time I think satisfies another goal, which is to try to get as much money as possible back to the harmed investors, but it is certainly not the only means of doing that. Private litigation is an important part of the landscape in the federal securities law area.
Mr. KANJORSKI. As you know, in 1994 in the case of Central Bank of Denver, the Supreme Court ruled that private parties cannot recover damages from aiders and abettors of fraud, such as the accounting firms and investment banks that assist in perpetuating frauds. Soon after this ruling, the Congress restored aiding and abetting liability for the SEC, but not for private litigants. The report on aiding and abetting liability that the SEC submitted to our committee says that from a period of January 1, 1998 until December 31, 2001, the SEC concluded enforcement actions including against aiding and abetting actions over 1,700 securities professionals.
My question is, given your acknowledgement that private lawsuits are really the place that investors should look to recoup their losses, does it make sense not to allow those investors to sue aiders and abettors just like the SEC can? And wouldn't that help us achieve our goal of full recovery for victims of securities fraud?
Mr. CUTLER. I have not studied the issue of the impact of eliminating aiding and abetting liability in private actions. I will say that my sense of where our judicial system is going is to expand the concept of liability such that the division between aiding and abetting and primary liability has become less important. I think the primary example I can think of in that regard is Judge Harmon's decision in the Enron matter in Texas, where she refused to dismiss the case against a number of defendants who had argued that essentially the claim was another way of stating an aiding and abetting claim, as opposed to a primary claim. She rejected that motion on the part of those defendants.
Page 17 PREV PAGE TOP OF DOC Mr. KANJORSKI. Don't you think that Central Bank of Denver would have to be reversed by the court for that to stand up?
Mr. CUTLER. I think it would be imprudent of me to comment on what a court might do with respect to Judge Harmon's ruling. The Commission, if my recollection is correct, filed an amicus brief in support of the plaintiffs in that Enron matter and I believe that Judge Harmon could decide to refuse to dismiss that case, which is what she did.
Mr. KANJORSKI. Since the Congress has restored aiding and abetting to the SEC, why can't we in this legislation just restore across the board to investors, too, in private lawsuits?
Mr. CUTLER. You certainly could. I do not think the agency has taken a position, and I do not think it has done a study of the impact of the aiding and abetting provision.
Mr. KANJORSKI. Can you get us some information on that?
Mr. CUTLER. We can try to do that.
Mr. KANJORSKI. I appreciate that.
One other thing, Mr. Chairman, before I relinquish my time, if you do contract out, how are we going to be certain that there is not a good old boys club on the assignment of these cases? Are they going to be pursued in some way through, I know it is very difficult to bid out professional services. Are you going to use contingency fees or are you going to pay hourly rates?
Mr. CUTLER. Let me grapple with the second question first, the method of payment. I think most firms in this area do work on contingency, but the fact is since we have not gotten the authority yet, we have not really thought about whether it makes more sense to pursue one form of payment over another. In terms of making sure that there is not a good old boy network in connection with who is selected to pursue a judgment, we are subject to and we go through whenever we contract with outside parties, a very rigorous process to make sure that it is done fairly and equitably, and that the best party to do the job is selected to do the job. I know that we are committed to ensure that happens here if we get the authority to go ahead.
Page 18 PREV PAGE TOP OF DOC Mr. KANJORSKI. There is some feeling on the Hill about contingency fees. That is part of the problem and the need for tort reform, so you have to be very careful. This is going to be an issue that some of my friends on the other side of the aisle do not believe in contingency fees, that they are inherently bad. So you have to be very careful how you tread on that.
Mr. CUTLER. I am sure we will be careful, sir.
Chairman BAKER. Ms. Kelly?
Mrs. KELLY. Thank you, Mr. Chairman.
Mr. Cutler, there is a well known fact that civil lawsuits take forever, and this may not be the best way for us to return people's money. There is one other thing. A single agency working with the authority can freeze money before it goes offshore. Those are just a couple of things to think about as you address some of the concerns that Mr. Kanjorski has raised. I think that the points need to be thought through and certainly I know that this committee would work with you to try to speed the recovery and the redistribution of ill-gotten gains by some of the people. That is what the Fair Fund Act is all about.
I wanted to ask you another question as well. It seems to me that our governmental agencies do not work with each other very well. You have asked authority to have the Department of Justice share grand jury information. When you are thinking about contracting out, would it not be helpful to you to perhaps work with the DOJ, and if there is a suit that has to be run, run the civil and criminal suits together, your agency and the DOJ. It seems to me that would streamline the process and get to where we in Congress are interested, and that is get the money and get it back to the people. Do you want to comment on that?
Mr. CUTLER. Sure, Representative Kelly. We do try very hard to coordinate what it is that we are doing on the civil side with what our criminal law enforcement counterparts are doing on the criminal side. Yesterday, as you may know, we announced an action against eight executives and employees of Qwest Communications, at the same time that the Department of Justice announced criminal indictments against four of those employees. I do think it is critical that we do everything we can to leverage the government's resources to go after the wrongdoers as aggressively as we can.
Page 19 PREV PAGE TOP OF DOC I think the reason why we have proposed lifting some of the restrictions on grand jury information is I think it would help us to be able to coordinate those actions in a way that is much more efficient and makes much more sense. As of right now, if our criminal law enforcement authority counterparts proceed through a grand jury, we will not have access to that information. Just earlier this week, we held a two-day conference at the SEC in order to train some of our criminal law enforcement counterparts, including members of U.S. attorneys offices around the country, FBI agents and others, on securities law issues that come up in the criminal law context. It is an issue where we have tried to be very sensitive to the coordination.
Mrs. KELLY. I am specifically thinking right now about the Enron case, where there were members of the boards of directors there that also participated in enriching themselves at the price of costing their investors. I would hope that in a case like that, there would be a case to get after those people through not only civil, but also criminal suits. It would be I think important that we force those people to recognize their fiduciary responsibility as being board members. We have laws on the books that are bringing them to a criminal, there are criminal penalties attached there, I believe. If you need some support there, please let us know because we have got to try to get this money back to people, and that is the whole focus as I see it of the Fair Fund Act.
Thank you, Mr. Chairman. I yield back.
Chairman BAKER. Thank you, Ms. Kelly.
Mr. Scott, you are next on recognition.
Mr. SCOTT. Yes, Mr. Cutler, you had mentioned in your testimony that you would like for Congress to exempt from the security cases the states' homestead exemptions. Why is that, and what examples, or what has been the extent of debtors using or abusing the Homestead Exemption Act?
Mr. CUTLER. It has certainly been the case, particularly when it comes to disgorgement, we have been faced with protracted litigation, or the prospect of protracted litigation, in connection with homestead exemptions. I think we have all seen photographs of some very lavish homes that have been built by respondents and defendants in federal securities law civil enforcement actions. While I do not have any particular examples, we can provide those to you, Representative Scott, of instances where we have sought disgorgement, but we have been confronted with a homestead exemption. I know that it happens with some frequency. What we are trying to do is get as much money as we can back to investors. The homestead exemption can really stand in the way.
Page 20 PREV PAGE TOP OF DOC Mr. SCOTT. I yield back.
Chairman BAKER. Thank you, Mr. Scott.
Mr. RENZI. Thank you, Mr. Chairman.
Mr. Cutler, thank you for your report and your testimony, and for fielding our questions. I appreciate you coming over today with your staff.
I come out of Arizona, home to Charles Keating. I can remember selling insurance out there in Arizona during those days. We were trying to sell directors and officers insurance to the banking industry. There was an old saying that came out of the banking industry, which was that the fastest way to make a good businessman a bad businessman was to lend him too much money.
I recall trying to sell directors and officers insurance to the thrift savings industry. If you recall back, that whole debacle that we went through in those days, one of the solutions we found was that the board of directors of the thrifts and the savings could be held liable because of the excessive payouts that they would make, for the excessive loans, or the sweetheart deals that they would give to people who came and borrowed money. I cannot help but draw the correlation now between where we are in those days and where we are now.
Although I very much compliment you for your report, I notice we are focusing specifically on the defendants. I think I gave you fair warning in the introduction, to ask you now, shouldn't we look at the liability of the board of directors? Shouldn't we be able to say that their fiduciary obligation includes a personal responsibility to the investors that when they pay out these golden parachutes and they provide these excessive benefits at a time when the company's books or the stocks are in question, is that truly sound? And should corporate assets be also an area where we look for collection? Could you also, a second part of my question, answer unintended consequences by going after board members and corporation assets?
Page 21 PREV PAGE TOP OF DOC Thank you, sir.
Mr. CUTLER. That is an excellent question, Congressman. This is an issue that we are very sensitive to. First, I should say there is no financial reporting case that we investigate where we do not look at the conduct of the board of directors. Very recently the Commission sued Mr. Walsh, a Director of Tyco, in connection with his actions relating to that company. Again, I feel very strongly that we have to look at this whenever there is a financial reporting failure on the part of a public company.
In connection with efforts to ensure that companies do not pay out money, when they have done something wrong, pay out money to the wrongdoers; I think a good example of the Commission's sensitivity to that issue is the WorldCom matter, where the Commission went into court within 48 hours of WorldCom's announcement of its accounting misstatements and asked the court for an order freezing or prohibiting extraordinary payments of money absent court approval. That is something that the Sarbanes-Oxley Act also makes it much easier for us to do. I think you can expect that we will use opportunities in the future to take actions like that to ensure that monies are not paid out to the wrongdoers or to the alleged wrongdoers.
There have been other cases, I can tell you, where companies, because of Sarbanes-Oxley, and because of what they saw that we did in WorldCom, are much warier of paying out money, paying out golden parachutes to someone that they have severed ties with otherwise because of alleged wrongdoing.
Chairman BAKER. Thank you, Mr. Renzi.
Mr. LYNCH. Thank you, Mr. Chairman.
Mr. Cutler, I also want to thank you for coming here today with your staff, and your willingness to testify and help the committee with its work. I value the recommendations that you have offered the committee. I agree that restitution is a noble cause, and I think that given the history that we have heard here earlier about the Enron case and WorldCom and others, there has got to be a way that we can repair at least some of the losses to investors.
Page 22 PREV PAGE TOP OF DOC I do want to go back to Mrs. Kelly's remarks, though. I think that beyond restitution and beyond disgorgement, there is also an inherent value in relentless enforcement of the law. It goes beyond the ability to put all the money back into the investor's pocket. It goes beyond extracting as much of the ill-gotten gains from any of these individuals. It goes to the very enforcement of the law for the purpose of protecting values that we in this society have prioritized, if you will.
I noticed in your written testimony, although you necessarily abbreviated your remarks, that you talk about, for example, this Crazy Eddie case, the SEC versus Crazy Eddie. Crazy Eddie apparently was not that crazy. He hid his money in at least six different countries, and required us to try to get as much back as possible. I am sure that there are many of his creditors and investors who, even if presented with the reality that it is very difficult to get that money back because he has taken such time and lengths to conceal his assets, I think that those investors and creditors would be well-served in knowing that through your efforts and others, that Crazy Eddie would never have a moment of peace. I think that it is the power of example that we offer in the diligent and relentless pursuit of justice that is a big part of your role.
So while I certainly understand from one standpoint your concerns whether or not the efforts of prosecuting a disgorgement action would actually pay for itself or the costs of that disgorgement action would actually be justified with the resulting distribution, I do not think that is the end of the equation. I think that we can very much hope that future behavior might be impacted on the way we handle these scandals, and that it needs to go as far up the chain as possible. I know that the chairman has mentioned about the board of trustees, and others have mentioned about making sure we go to every corner of the corporate structure in order to extract restitution, disgorgement, or just plain justice. I just hope that we do not make this a profit and loss analysis in enforcing the law.
Page 23 PREV PAGE TOP OF DOC That is all I have, Mr. Cutler.
Mr. CUTLER. I could not agree with you more, Representative Lynch. I think it is critical that law enforcement work other than on a profit and loss basis. That is why we did pursue Eddie Antar to the corners of the globe. That is why we pursued Robert Brennan, and that is why we pursued Paul Bilzerian. We have a mission to protect investors, but also to achieve deterrence. A very important part of that is that we send the message loudly and clearly that we will pursue you; that we will go after you if you have broken the law. This is not just about how much money we can get back, and how much money we can return to investors.
Mr. LYNCH. Thank you.
Chairman BAKER. The gentleman yields back?
Mr. LYNCH. Yes, thank you.
Chairman BAKER. Thank you, Mr. Lynch.
Mrs. BIGGERT. Thank you, Mr. Chairman.
Mr. Cutler, it seems like there is an awful lot of process here that many parties are partaking in. My question involves the states. I know you cannot divulge some of the details concerning the enforcement actions, but some statements about the global statement have talked about that only the federal portion of the funds are potentially available to provide investors with restitution. Do you know whether any states intend to provide the restitution, or will the states simply place the money in their treasuries?
Mr. CUTLER. Representative, I am constrained about what I can say in connection with the global settlement of the research analyst matter. It has not yet been finalized or approved by our Commission. I think I can say that at this point I do not know whether any states intend to put any of the money that they receive as a result of the settlement in a distribution fund for investors.
Page 24 PREV PAGE TOP OF DOC Mrs. BIGGERT. Okay. Then you talk about how the Commission needs to have people that are well aware of many different jurisdictions; the State laws. And then later on, you talk about having them do away with so many of the State law impediments for the collection of judgments, and administrative orders. Will the states still be involved, then, in this type of litigation?
Mr. CUTLER. Well, there certainly will still be state law issues in connection with collection matters. Federal rule of civil procedure 69 provides that it is the state law method of collection that should be the basis for our efforts, even in Federal court.
Mrs. BIGGERT. So you are not recommending changing
Mr. CUTLER. Well, it is something I think we should give some thought to, Representative. I do not think we have done enough thinking about that issue to date. As the law currently stands, I know that state law expertise is something that is very helpful in the collections area.
Mrs. BIGGERT. Thank you.
Thank you, Mr. Chairman.
Chairman BAKER. Thank you, Ms. Biggert.
Mr. MEEKS. Thank you, Mr. Chairman.
I am sorry I missed your testimony, so I hope that I am not repeating anything that you might have said, but since there is only a few of us here, then maybe for my edification you can expound upon them.
The first, I was just wondering about the collections of penalties. How much money in addition to the disgorgements before penalties, how much additional money do you think that put in the pots so that people can be reimbursed or for restitution?
Page 25 PREV PAGE TOP OF DOC Mr. CUTLER. Mr. Representative, that is so variable. When I say that, I mean that it really depends on what kind of case that we are bringing. Just by way of example, in this past year we brought an action against Credit Suisse First Boston in connection with their IPO allocation practices. In that case, the penalty amount was $30 million. That is a significant amount, but that is unusual and we do not have those every day.
Certainly, recently we have had some very large penalty amounts. I think in that regard, it is very helpful that the Fair Fund provision allows the government to put that money toward investor recovery, as opposed to just paying it to the treasury.
Chairman BAKER. Would the gentleman yield on that point?
Mr. MEEKS. Yes.
Chairman BAKER. I would just like to point out, although not yet agreed to, the potential global settlement of about $1.4 billion, published reports indicate that about $900 million of that could be made available for investor restitution, by far the largest amount potentially agreed to. For what it is worth, of course I am very interested in seeing that agreement move in that direction, not wanting to influence anybody inappropriately, but I would hope that if we reach that kind of agreement, that the investors would see that significant assistance.
I thank the gentleman for yielding.
Mr. MEEKS. The other thing, I have noticed in the report it indicated that as far as collection is concerned, the lack of resources and staff and personnel have something to do with the hindrance of collections. I know that this committee has recently appropriated more money. I was wondering, will that be sufficient so that we can go and have better collections, with reference to disgorgement funds?
Mr. CUTLER. I think the recent budgetary measures will help considerably. You always have to do a balancing. What resources do you want to take away from pursuing ongoing securities fraud and devote to the collection process? You have got to do that balancing because it is important that we collect, because if we do not, that diminishes the effectiveness of the enforcement process overall. But I think given staffing levels that we can anticipate as a result of Congress' recent budget action, I am hoping that we can devote more resources to the collection effort.
Page 26 PREV PAGE TOP OF DOC Mr. MEEKS. Finally, my last question, and maybe you can answer this, because I am still unclear in my own head, just looking back at the entire root cause of the current issue, whether or not the breakdown in investor safeguards, whether that was initially a problem of sophisticated accounting techniques that were fooling the auditors, or whether it was collusion on the part of the auditing companies, just so we could try to develop and focus on what the root causes are so that we do not have to worry about going after the folks to help individuals who have been defrauded.
What do you think the root causes were? How did we get into this mess?
Mr. CUTLER. It is such a complicated question, Mr. Representative. There are so many causes, and I think academics and others smarter than I are going to spend a lot of time trying to figure out what all the causes are. Certainly there have been systemic issues that I think Sarbanes-Oxley and some of this subcommittee's efforts were designed to address problems with the integrity of the reporting process; incentives on management in connection with the financial reporting process. The role of auditors is one that has to be looked at very carefully. There are so many causes, and I am not sure that I am the person to turn to. I think of my role as going after the people who did it, and I think less about why it has happened, and more about doing our job and going after the people who caused the problem.
Mr. MEEKS. I yield back, Mr. Chairman.
Chairman BAKER. I thank the gentleman.
Mr. INSLEE. Thank you.
I want to make sure I understand your answer about contingency fees. I thought you said that you had not been given authority for that, or maybe you can tell me what your plan is on recoupment.
Mr. CUTLER. One of our proposals is that we be given the authority to outsource the collection efforts, the litigation collection efforts. What we have not grappled with is how those outside collection efforts would be paid for, that is, by contingency fee or by other methodology.
Page 27 PREV PAGE TOP OF DOC Mr. INSLEE. You do not need congressional approval to make that position, do you?
Mr. CUTLER. I do not believe so. What we do not have so far is congressional approval to actually outsource the litigation efforts.
Mr. INSLEE. I see. Well, as just one person, I hope you do consider contingency fees as an effective way to make sure you have people working on viable cases. Contingency fees separate viable from non-viable cases very effectively, because the pursuer makes a decision very quickly whether it makes sense economically or not. I think it makes sense for you to consider that. I hope you will do that.
A second issue, you made reference to potentially giving you the authority to get some grand jury information to you quicker. You made reference to other scenarios where that is done. Can we just graft those situations directly to your situation at the SEC? Is there any difference we would have to do in doing that? Do you have any guidance on that?
Mr. CUTLER. I believe that is right. Why don't I after this hearing is over confirm that, and we will get back to you Mr. Congressman. I think that what we are looking for is something comparable to what the banking regulators have in this regard.
Mr. INSLEE. Great. I am Jay Inslee from the State of Washington. If you can give me some of that information, I would be happy to work with you on it.
Mr. CUTLER. Thank you, sir.
Mr. INSLEE. Thank you.
Chairman BAKER. I have a follow-up question that I want to revisit; the observation about the outside collection issue. Quoting the report, setting aside for the moment whether it is contingency by the hour or what the reimbursement methodology might be, on page 32 of the report it says the Commission would need additional staffing and technology expenditures to oversee and audit such a program. So there is a resource limitation issue as well, which returns me back to the original question posed about funding at least, if we cannot feel comfortable with SEC staff growth, it would seem to me to be very defensible to have penalties that cannot be returned, penalties that are not needed for investor education, at least go to the program that is funded to oversee outside collection activities, because that purely benefits the individuals who have been wronged.
Page 28 PREV PAGE TOP OF DOC Given the committee members' comments, I think there is considerable support for granting whatever authority we need to grant. Maybe that is an approach we could pursue that would be more professionally acceptable to the agency, if you do not want to see the money come directly back to the agency for funding additional staff personnel. Is that a potential area to explore?
Mr. CUTLER. I think so. I appreciate any effort to separate out monies that would come to the agency or for the work of the agency from our enforcement activities. As you mentioned, and I think you are very sensitive to, Mr. Chairman, there is an appearance issue when our staff pursues actions and as a result of those actions can enhance our own coffers. I never want to be accused of pursuing an enforcement action, pursuing a collection action because it some way redounds to the agency's benefit. So if there is any way to insulate our enforcement activities from funding and fee issues, I think that is very useful.
Chairman BAKER. I do not want to diminish that attitude. It is so rare. I certainly feel that I want to compliment the agency for that obviously professional concern, because so many are pursuing wrongdoers and keeping the money. But at this juncture, there has got to be a way, given the repetitive statements in the report where actions are limited because of resource limitations to work this out. We will converse with you over the next few weeks to try to figure out if there is a methodology that makes professional conduct permissible.
I want to again express my appreciation to the agency, since we have no further members for questions, for the good work you have done, the timeliness of your report. I hope that in perhaps some formal if necessary, but at least informal way, we can get at least an annual report of dollars generated through disgorgements and penalties that have been distributed, not by individual name, but at least in categorical amounts, how much has been returned to investors as a result of this new activity, so we can assess our effectiveness and judge whether additional modifications to the statute may be warranted.
Page 29 PREV PAGE TOP OF DOC We will certainly have legislation drafted for the agency's review within the next few days and hope to be successful in seeing its consideration in a very timely manner.
Again, thank you for your courtesies. Our meeting stands adjourned.
[Whereupon, at 11:05 a.m., the subcommittee was adjourned.]