[Senate Hearing 105-266]
[From the U.S. Government Publishing Office]
S. Hrg. 105-266
FRAUD IN THE MICRO-CAPITAL MARKETS INCLUDING PENNY STOCK FRAUD
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HEARING
before the
PERMANENT
SUBCOMMITTEE ON INVESTIGATIONS
of the
COMMITTEE ON
GOVERNMENTAL AFFAIRS
UNITED STATES SENATE
ONE HUNDRED FIFTH CONGRESS
FIRST SESSION
__________
SEPTEMBER 22, 1997
__________
Printed for the use of the Committee on Governmental Affairs
U.S. GOVERNMENT PRINTING OFFICE
44-227 cc WASHINGTON : 1997
_______________________________________________________________________
For sale by the Superintendent of Documents, Congressional Sales Office
U.S. Government Printing Office, Washington, DC 20402
COMMITTEE ON GOVERNMENTAL AFFAIRS
FRED THOMPSON, Tennessee, Chairman
SUSAN M. COLLINS, Maine JOHN GLENN, Ohio
SAM BROWNBACK, Kansas CARL LEVIN, Michigan
PETE V. DOMENICI, New Mexico JOSEPH I. LIEBERMAN, Connecticut
THAD COCHRAN, Mississippi DANIEL K. AKAKA, Hawaii
DON NICKLES, Oklahoma RICHARD J. DURBIN, Illinois
ARLEN SPECTER, Pennsylvania ROBERT G. TORRICELLI,
BOB SMITH, New Hampshire New Jersey
ROBERT F. BENNETT, Utah MAX CLELAND, Georgia
Hannah S. Sistare, Staff Director and Counsel
Leonard Weiss, Minority Staff Director
Michal Sue Prosser, Chief Clerk
------
PERMANENT SUBCOMMITTEE ON INVESTIGATIONS
SUSAN M. COLLINS, Maine, Chair
SAM BROWNBACK, Kansas JOHN GLENN, Ohio
PETE V. DOMENICI, New Mexico CARL LEVIN, Michigan
THAD COCHRAN, Mississippi JOSEPH I. LIEBERMAN, Connecticut
DON NICKLES, Oklahoma DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania RICHARD J. DURBIN, Illinois
BOB SMITH, New Hampshire ROBERT G. TORRICELLI, New Jersey
ROBERT F. BENNETT, Utah MAX CLELAND, Georgia
Timothy J. Shea, Chief Counsel and Staff Director
Jeffrey S. Robbins, Chief Counsel to the Minority
Mary D. Robertson, Chief Clerk
C O N T E N T S
------
Opening statements:
Page
Senator Collins.............................................. 1
Senator Cleland.............................................. 4
Prepared statement:
Senator Collins.............................................. 55
Senator Cleland with additional copy......................... 58
Senator Glenn................................................ 107
WITNESSES
Monday, September 22, 1997
Arthur Levitt, Jr., Chairman, U.S. Securities and Exchange
Commission..................................................... 9
Emile O. Murnan, St. Louis, Missouri............................. 21
Helen Sprecher, Philadelphia, Pennsylvania; accompanied by Henry
Ian Pass. Esq.................................................. 23
Louis Poggi, Pembroke, New Hampshire............................. 27
Joseph P. Borg, Director, Alabama Securities Commission, and
Member, North American Securities Administrators Association,
Inc. (NASAA)................................................... 39
Barry R. Goldsmith, Executive Vice President, NASD Regulation,
Inc............................................................ 43
Alphabetical List of Witnesses
Borg, Joseph P.:
Testimony.................................................... 39
Prepared Statement with attachments.......................... 158
Goldsmith, Barry R.:
Testimony.................................................... 43
Prepared Statement........................................... 252
Levitt, Arthur, Jr.:
Testimony.................................................... 9
Prepared Statement........................................... 112
Murnan, Emile O.:
Testimony.................................................... 21
Prepared Statement........................................... 145
Poggi, Louis:
Testimony.................................................... 27
Prepared Statement........................................... 154
Sprecher, Helen:
Testimony.................................................... 23
Prepared Statement........................................... 147
APPENDIX
Exhibit List
* May Be Found In The Files of the Subcommittee
Page
1. GCold Calling Alert, a brochure prepared by the North
American Securities Administrator Association, Inc. (NASAA) and
the Securities and Exchange Commission (SEC)................... 269
2. GMemorandum prepared by Ian Simmons, Counsel, Permanent
Subcommittee on Investigations, dated September 17, 1997, to
Permanent Subcommittee on Investigations' Membership Liaisons
regarding micro-cap fraud hearing.............................. 279
3. GGAO Report, Penny Stocks: Regulatory Actions to Reduce
Potential for Fraud and Abuse, February 1993, GAO/GGD-93-59.... *
4. GGAO Report, Securities Markets: Actions Needed to Better
Protect Investors Against Unscrupulous Brokers, September 1994,
GAO/GGD-93-208................................................. 297
5. GWall Street Journal, September 4, 1997, ``Despite Reforms,
Penny-Stock Fraud Is Roaring Back''............................ 345
6. GMaterials and news articles submitted to the Permanent
Subcommittee on Investigations by the North American Securities
Administrator Association, Inc. (NASAA) regarding May 1997
State enforcement actions to address the problem of fraudulent
sales practices in the micro-cap marketplace 347
7. GWall Street Journal, November 19, 1997, ``Departure of Many
Lawyers at SEC Stretches Its Resources, Delays Cases''......... *
8. GBond Buyer, November 10, 1997, ``Merrill Official Calls for
Securities Firms To Take Tough Stand on Compliance''........... *
9. GNew York Times, October 30, 1997, ``S.E.C. Schedules A
Meeting As Small-Stock Fraud Soars''........................... *
10. GWall Street Journal, September 26, 1997, ``Bear Stearns
Takes Stand on Clearing-Firm Says Regulation Could Hurt
Industry'' and additional news articles regarding Bear Stearns. *
11. GWall Street Journal, September 22, 1997, ``SEC Plan Assault
on Small-Stock Fraud'' and additional news articles on
Permanent Subcommittee on Investigations' September 22, 1997
hearing........................................................ *
12. GBarrons, September 15, 1997, and Kiplinger's Personal
Finance Magazine, July 1996, regarding the CRD System.......... 422
13. GWall Street Journal, September 8, 1997, ``Big Board Tightens
Clearing-Firm Rules''.......................................... *
14. GWall Street Journal, June 2, 1997, ``Securities Regulators
Cracking Down On Sales Fraud at Brokerage Firms''.............. *
15. GCorrespondence to Chairman Susan M. Collins, Permanent
Subcommittee on Investigations, September 24, 1997, from Barry
R. Goldsmith, Executive Vice President, NASD-Regulation, Inc.,
forwarding supplemental materials for the hearing record
regarding NASD-R's public disclosure program and NASD's
strengthening of examination requirements for registered
representatives. (Supplemental materials not reprinted--may be
found in the files of the Subcommittee)........................ 430
16. GSupplemental Questions and Answers for the Record of The
Honorable Arthur Levitt, Jr., Chairman, U.S. Securities and
Exchange Commission............................................ 432
17. GSupplemental Questions and Answers for the Record of Joseph
Borg, Director, Alabama Securities Commission, and Member,
North American Securities Administrator Association, Inc.
(NASAA)........................................................ 466
18. GSupplemental Questions and Answers for the Record of Barry
R. Goldsmith, Executive Vice President, NASD Regulation, Inc.
(Attachments to supplemental questions not reprinted--may be
found in the files of the Subcommittee)........................ 475
19. GWall Street Journal, December 9, 1997, ``Nasdaq, in Newest
Clean-Up Plan, Might Remove 3,400 OTC Stocks'' and Baltimore
Sun, December 10, 1997, ``Nasdaq looks to pull 3,400 small
stocks''....................................................... 553
FRAUD IN THE MICRO-CAPITAL MARKETS, INCLUDING PENNY STOCK FRAUD
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MONDAY, SEPTEMBER 22, 1997
U.S. Senate,
Permanent Subcommittee on Investigations,
of the Committee on Governmental Affairs,
Washington, DC.
The Committee met, pursuant to notice, at 1:35 p.m., in
room SD-342, Dirksen Senate Office Building, Hon. Susan M.
Collins, Chairman of the Subcommittee, presiding.
Present: Senators Collins and Cleland.
Staff Present: Timothy J. Shea, Chief Counsel/Staff
Director; Mary D. Robertson, Chief Clerk; Ian Simmons, Counsel;
Dennis McCarthy, Investigator; Kirk Walder, Investigator;
Lindsey Ledwin, Staff Assistant; Jeffrey S. Robbins, Minority
Chief Counsel; Bob Roach, Counsel to the Minority; Rachel
Sullivan (Senator Glenn); Jonathan Frenkel (Senator Glenn);
Barbara Olson (Senator Nickles); Steve Diamond (Senator
Collins), Bill Greenwalt (Senator Thompson), Ann Rehfuss
(Senator Cochran); Michael Loesch (Senator Cochran); Kevin
Franks (Senator Cleland); Wayne Howell (Senator Cleland); and
Barbara Perkins (Senator Levin).
OPENING STATEMENT OF SENATOR COLLINS \1\
Senator Collins. The Subcommittee will please come to
order. We expect Senator Cleland to be with us very shortly,
but in the interest of time, I am going to begin.
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\1\ The prepared statement of Senator Collins appears in the
Appendix on page 55.
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Today, the Subcommittee will launch an investigation of
securities fraud into what is known as the micro-capital
markets. For those unfamiliar with the arcane terminology of
Wall Street, the micro-cap segment of the market includes small
companies with relatively low market values. It includes but is
not limited to penny stocks.
These hearings are both the continuation of a tradition and
a look to the future. They are a continuation a tradition
because of our Subcommittee's long history of investigating
security scams aimed at small investors. They are a look to the
future because we will be examining new and growing abuses in
our capital markets.
These hearings are also timely. Last fall, Federal
prosecutors charged 46 individuals with stock fraud in New
York. In May of this year, a 20-State task force acted to shut
down some of the worst of the firms engaged in stock
manipulation. And less than 3 weeks ago, on September 4, the
Wall Street Journal published a lengthy story entitled,
``Despite Reforms, Penny Stock Fraud is Roaring Back.'' \1\
That story noted the very disturbing fact that investors may
lose as much as $6 billion annually due to penny stock fraud,
more than triple the 1980's peak.
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\1\ Exhibit 5 appears in the Appendix on page 345.
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We conduct these hearings against the backdrop of a booming
stock market and a new generation of unseasoned investors.
Hidden beneath the rising tide of the market, micro-cap fraud
represents a pernicious undercurrent that potentially affects
thousands of American families. Many of these families are, for
the first time, investing their hard-earned money to save for
skyrocketing tuition costs, unforseen medical expenses, and
lengthier retirements. While we have the safest and the most
successful capital markets in the world, the irony is that
public confidence in our markets actually creates opportunities
for con artists to exploit the unwary.
Micro-cap fraud not only harms the small investor, it also
has the potential to harm small companies. As this type of
fraud increases, the willingness to invest in emerging
enterprises decreases and legitimate companies are denied the
capital which is the life blood of our free market system.
How exactly do these scams work? Unscrupulous brokerage
firms, often operating through intermediaries, purchase large
amounts of stock in a small company. The stock is virtually
worthless or of very limited value, but the brokers act to
drive its price higher by aggressively cold-calling thousands
of unsuspecting individuals, many of whom have little or no
prior investment experience.
In repeated cold calls, the scam artists hammer away at the
investor on the telephone, promising glowing returns and
emphasizing the need for immediate action. The inevitable
result of these aggressive sales tactics is to push the stock
price higher, at which point the brokerage firms' insiders dump
their shares, leaving the public with worthless securities and
the brokers with millions in ill-gotten gains.
Scratch the surface of a stock manipulation scheme and you
will inevitably find false or exaggerated information. If you
doubt the potentially tremendous impact of false information,
consider the $6 billion Bre-X scam. In that instance, phony
reports about the gold content of the company's mines drove the
price of the stock from a few pennies to $240 per share, until
the fraud was exposed and the stock fell back down to earth. As
you can imagine, the so-called unsophisticated investors who
rode the stock down hit the ground with a thud.
Coercive cold-calling and spreading false information are
not the only tactics used by boiler rooms engaged in stock
manipulation. Other practices which I expect we will hear
testimony on today include making unauthorized purchases in
consumers' accounts, refusing to execute sell orders in order
to maintain a stock's upward momentum, using unlicensed persons
who are paid under the table for making sales, and bribing
brokers to recommend the stock being manipulated to their
unsuspecting consumers.
One particularly troubling problem that we will hear about
today is the difficulty that regulators have in driving
unethical brokers out of the industry. When a boiler room
operation is closed down, often after lengthy proceedings, it
is unfortunately common for the employees to show up in a host
of new firms. Not unlike a grade-B science fiction movie,
killing one of these monsters only seems to create a new army
of them. Our regulatory system must ensure that when a broker
participates in this type of fraud, he or she is not allowed to
remain in the industry and once again pick the pockets of
unwitting investors.
There are a number of other regulatory questions that we
must consider. For example, should the large Wall Street
clearing houses that process transactions for penny stock
brokerage firms have more of a role and responsibility in
stopping fraud and manipulation in the micro-cap markets? How
effective has the 1990 penny stock legislation been in limiting
abusive practices? More specifically, since that legislation
applies only to stocks selling for $5 or less, has the
fraudulent activity simply moved to somewhat higher price
stocks, also traded in the micro-cap market? What more should
be done to police the bulletin board markets?
While we are confronted with many complex issues, we are
indeed fortunate to have an outstanding set of witnesses who
are well-qualified to address those issues. We will first hear
today from the Hon. Arthur Levitt, Jr., the distinguished
Chairman of the United States Securities and Exchange
Commission.
We will then hear from three individual investors who were
victimized by fraudulent practices and who have kindly agreed
to share their experiences with us.
Finally, we will hear from two other regulators, Mr. Barry
Goldsmith, the Executive Vice President for Enforcement of NASD
Regulation, the regulatory arm of the Nasdaq market, and Mr.
Joseph Borg, the Director of the Alabama Securities Commission,
who will present the very important perspective of the States.
As we proceed with today's hearings, as well as with future
sessions on securities fraud, we should remember that this
Subcommittee has a dual role. Mindful of Justice Brandeis's
observation that sunlight is the best disinfectant, we have a
responsibility to expose abusive practices so that the American
people can be on guard against them.
We also have the obligation to determine whether our
current regulatory scheme affords adequate protection to an
ever-growing investing public. As I noted earlier, this
Subcommittee has a proud tradition of looking out for the
interests of small investors and I am determined, as the new
Chair of this Subcommittee, to continue that tradition.
In carrying out our responsibilities, we are indeed very
fortunate to have the participation of my colleague from
Georgia, Senator Cleland. As Secretary of State, Senator
Cleland oversaw securities regulation in Georgia, a State that
has been in the forefront of the battle against penny stock
fraud. His experience and his leadership and commitment in this
area will be an invaluable asset to the Subcommittee.
I would now like to turn to the Senator for any comments
that he might have.
OPENING STATEMENT OF SENATOR CLELAND \1\
Senator Cleland. Thank you very much, Madam Chairman. Mr.
Levitt, it is nice to see you.
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\1\ The prepared statement of Senator Cleland with attachments
appears in the Appendix on page 58.
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Ladies and gentlemen, one of the wonderful pleasures of
serving in the Senate is to serve with great talented people
like Senator Collins, who has a flair for quotes. I often find
myself quoting her. We are cosponsors of the McCain-Feingold
bill, which has found a new life based on the full Governmental
Affairs Committee. She had a great quote on the floor of the
Senate the other day about the $50 billion tax handout to the
tobacco companies, a quote from Harriet Beecher Stowe, that
``like Topsy, she was not born, she just was.'' I thought that
was pretty good. I love your Brandeis quote now about sunlight
is the best disinfectant. I think that is probably a great
prelude to these hearings.
Senator Glenn would like to be here. He has a strong
interest in the matters we will be discussing, but he asked me
to be the ranking member here on our side.\2\
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\2\ The prepared statement of Senator Glenn appears in the Appendix
on page 107.
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Madam Chairman and Members of the Subcommittee, it is a
pleasure for me to be here today seeking information and,
hopefully, some solutions to a major problem that has faced our
country for years. I did serve as Georgia's Secretary of State
and Commissioner of Securities for many years. I was
responsible for administering Georgia's security laws and
providing investor protection for our residents.
The securities markets are an integral part of our Nation's
economy and we have experienced tremendous growth, as has been
observed, in these markets. In fact, this year alone, the
markets have reached an all-time record. Unfortunately, these
successes have led to a tremendous increase in fraud and abuse.
In 1990, for example, only about 18 percent of all
Americans were investing in equities. Today, I understand that
some 31 percent of all Americans are now investing in equities
and that one in three households now own securities. Just as
recently as 1992, the daily share volume for the New York Stock
Exchange and Nasdaq was only about 200 million shares a day.
Today, the New York Stock Exchange and the Nasdaq market
consistently trade in excess of 500 million shares. At the end
of 1996, the market capitalization of Nasdaq was over $1.5
trillion, more than a three-fold increase from $508 billion at
the end of 1991.
The securities markets would not exist without public
confidence in the integrity of the professionals who work in
and manage these markets. I salute these professionals and
commend them for their efforts in promoting and encouraging a
strong securities market that provides the capital to make our
country grow and provide economic security for our citizens.
While there are justifiable criticisms of the markets, the
purpose of these hearings is to deal with a few bad apples, not
to force regulatory changes that would be burdensome and a
hindrance to legitimate capital formation.
The success of our markets is shown by the billions of
dollars that change hands each day, either from a telephone
call, a head nod, or a handshake, which clearly reflect the
trust and confidence we have placed in their integrity. Should
this integrity be replaced with mistrust, our confidence would
erode in the markets, as well as the American economy would
ultimately suffer.
We now have, beyond any doubt, the best securities markets
in the world and it is very important we strive to keep these
markets strong and the playing field level in order to give all
of our investors an opportunity to be successful in the market.
The confidence in our securities markets results, in part,
because of the excellent cooperation that has existed between
State and Federal Government regulators and self-regulatory
organizations. This regulatory partnership has proven to be one
of the most efficient and effective regulatory collaborations
in the country.
Substantive securities regulation in this country began at
the State level, as a matter of fact. It was in 1911, the State
of Kansas enacted the Nation's first blue sky law. Other States
quickly adopted their own version of such legislation. In 1929,
as a result of the stock market crash, Congress began a series
of legislative efforts that encompass the body of law known
today as the Federal securities laws.
In the 1970's, a major cooperative effort was initiated
between the States, the SEC, and the NASD and the stock
exchanges. The results of this effort include a uniform
competency exam that allow an individual to take one
examination accepted in all the States, uniform registration
forms that allow a firm or an individual to use the same forms
for the States, the SEC, and the self-regulatory organizations,
and a Central Registration Depository, CRD, that allows for an
automated one-stop registration filing system.
Georgia was one of the initial supporters of the CRD. This
registration and licensing process provides an efficient and
uniform process that compliments the fundamental purpose of
State and Federal securities laws to provide investor
protection and foster the confidence that will encourage the
investments necessary for capital formation, economic growth,
and job creation.
For a regulatory program to be successful, you must have
vigorous enforcement. When the securities laws were framed in
the 1930's and 1940's, Congress wisely realized that there
would never be enough ``cops on the beat'' in the form of
government-paid securities regulators but that it would be
necessary for the private bar to enforce the law on behalf of
defrauded citizens. It is these attorneys who, in the words of
SEC Chairman Levitt, ``serve a crucial role as a deterrent and
are a vital supplement to the Committee's enforcement
resources.''
In testimony before Congress and in court documents, the
SEC has repeatedly emphasized the critical role of the private
lawsuit. However, despite the best efforts of the SEC, the 50
State securities agencies, and the SROs, there continues to be
an unacceptably high level of fraud and abuse in today's
capital markets. Recently, top securities watchdogs in the
United States have warned investors that the explosion in the
stock market has brought a sharp rise in securities sales fraud
and stock price manipulation.
At a town meeting in Los Angeles, Mr. Levitt cautioned that
investors are ``more vulnerable than ever to fraud.'' This
concern has been echoed by others who point to a disturbing
rise in the level of securities fraud and allege that organized
crime is seeking a foothold in certain sectors of the
marketplace.
What is unusual about the increasing evidence of wrongdoing
in the stock market is that shady practices tend to go
unnoticed in the days of a strong bull market. Usually, the
misconduct is uncovered only after a sharp sustained market
drop similar to that of 1987. This has the regulatory community
wary about what it would face should the stock market collapse.
In the past 5 years, the number of stockbrokers doing
business in the United States has grown by 50 percent, to some
650,000. However, during the same time period, the regulatory
staffs of the Securities and Exchange Commission and the
National Association of Securities Dealers grew just 18
percent.
Let us all understand who suffers in cases of security
fraud. It is retirees living on fixed incomes, young families
struggling to make ends meet and save for their children's
education, teachers, factory workers, and bankers. Each day,
devastating cases are brought to the attention of securities
regulators, law enforcement officers, and the private bar.
Indeed, I am convinced that financial fraud is a serious and
growing problem.
Today's hearing will focus on micro-cap fraud, as Senator
Collins has mentioned. This is a new and modern term we are
famous for here in Washington for what we have known for years
as penny stock fraud. In Georgia talk, we call it cheating and
stealing.
In the late 1980's, as Secretary of State, I directed a
series of public hearings to focus on the penny stock fraud
taking place in Georgia. We heard substantial evidence about
serious securities violations involving misrepresentations,
omissions to State material . . . enough about illegalities.
What they were doing was lying, cheating, and stealing and
swilling our citizens out of their hard-earned money.
In the Governmental Affairs Committee, we have been looking
at the campaign finance fraud and the terms hard money and soft
money are used. Here, we are talking about hard money, the
hard-earned money of our citizens and investors. Of course,
this hard-earned money comes from them to provide capital for
economic growth, not only that, but unfortunately, a lot of
that money goes off to those who would line their own pockets
for ill-gotten gain.
This led me, when I was Secretary of State, to recommend a
series of changes to strengthen Georgia's securities laws.
These recommendations were unanimously enacted as amendments to
the Georgia Securities Act and gave my staff more tools to
effectively deal with penny stock fraud.
In 1990, the SEC recommended and Congress enacted penny
stock reform. The resulting reforms, both State and Federal,
were effective for a few years. However, these crooks are
clever. They accumulate their wealth by stealing, not with a
gun but with a telephone and a fast line and often through
threats and intimidations. It did not take long for them to
figure out how to avoid the reform requirements.
Now we see the micro-cap fraud being perpetrated by rogue
brokers making cold calls all over the country, promising
people that they can get rich quick in today's growing market.
They use the success of the legitimate market to demonstrate
the misrepresented potential for trade in their presentations.
They say whatever it takes to close the sale. They take
advantage of honest, hard-working people trying to live the
American dream who make honest money in the market.
I recognize the right of investors to seek legal remedies
against those persons selling fraudulent securities. I have
supported an investor's right to seek redress through
mediation, arbitration, and civil litigation. While I worked to
streamline the regulatory process in Georgia, I opposed
amendments to Federal regulations that would have impaired the
ability of a State to protect its investors. However, in 1995,
as Secretary of State and Commissioner of Securities in
Georgia, I opposed S. 240, the Private Securities Litigation
Reform Act.
It appears that we are now seeing a move to preempt
existing State securities laws by extending the Private
Securities Litigation Reform Act of 1995 to the States. It is
not yet clear whether this Act will provide sufficient
protection to defrauded investors. The main concern here is if
the courts ultimately interpret it in a way that makes
recoveries under the Federal law impossible, State remedies
will be the only means for defrauded investors to redress their
injuries.
In the 19 months since its passage, the new Act has barely
been tested, with no trials, no appellate decisions on
substantive provisions, no summary judgments, and few decisions
on any of its provisions. It will take more time to adequately
assess this law's impact as the courts struggle to interpret
its provisions.
The Congress did an excellent job of balancing competing
interests in the adoption of the National Securities Market
Reform Act of 1996. I have always favored improvements in the
regulatory system that do not curtail enforcement efforts to
protect investors. The current efforts by some industry
segments to preempt a State's role in the registration and
licensing of broker-dealers and sales representatives would
seriously impede the authority of the States to protect their
residents from unscrupulous firms and brokers.
I am confident that the SEC will find in its report that
the States are an integral part of the regulatory process and
that it would be a mistake to hamper our State regulators by
removing their jurisdictional authority over broker-dealers. I
have several suggestions as to where to go from here.
Investor education--I am interested in new and innovative
ways to educate the public about the securities markets and the
risks associated with investment opportunities. A program of
this type must be fully supported by the regulators and the
industry.
The CRD system--modernization of the Central Registration
Depository should be one of the highest priorities of the
regulators. Quality information made promptly available to
regulators is often the key to a successful investigation and
prosecution of violations. The CRD must be able to deliver both
data and analytical reports in order for it to be successful as
a regulatory tool. I encourage regulators to continue support
for a viable customer complaint database that will provide
information that could be useful in multi-State investigations.
Another point is the administrative process. The
administrative process provides regulators with the most
effective tools to investigate misconduct and to discipline
those firms and individuals who commit violations. However,
regulators must not misuse or abuse the administrative process
and the process must not be viewed as the ultimate weapon to
deter fraud in the securities business.
Civil actions--the filing of civil actions against firms
and individuals who commit violations appears to have been the
remedy of choice for the SEC. I think it is time to study the
effectiveness of the civil process in dealing with serious
fraudulent conduct by such firms and individuals.
Criminal prosecution--the filing of criminal complaints and
the seeking of indictments against rogue brokers and con
artists will be the most effective tool to deter this type of
criminal activity. I strongly encourage regulators to work with
local, State, and Federal prosecutors in developing coordinated
investigations and prosecutions. Also, State and Federal task
forces could also provide a opportunity in demonstrating to
criminals that justice will prevail.
The taping of sales presentations--I commend NASD for its
recent recommendation to require certain firms to tape sales
presentations by certain brokers. The taping of these potential
problem brokers is a positive step toward better investor
protection.
Cold call practices--this is not campaign finance here,
this is stock brokering here. I also commend the regulators for
their efforts to place some limitations and restrictions on
cold calls. I encourage further monitoring and study regarding
the control of cold calls.
Clearing firms--I question how many investors have been
improperly influenced to purchase high-risk and speculative
securities by using the name of a prominent firm that is merely
acting as a clearing agent.
Disclosure--disclosure has always been, as Senator Collins,
Madam Chairman, quoted Justice Brandeis, disclosure has always
been the foundation for investors in making investment
decisions. Regulators have done a good job requiring proper
disclosure of material facts in registered offerings. In fact,
some might say that the quantity of disclosure today may be a
deterrent to real meaningful disclosure. Disclosure in the
secondary markets, even by market makers, has not been
effective. I realize that the use of the telephone and market
volatility require prompt decisions. However, we must be sure
to find a way for regulators to require that investors in the
public markets be provided with sufficient information prior to
making their investment decision.
The Internet--it is imperative that our regulators have
access to modern technology and provide programs to monitor
investment activities on the Internet. Cyberspace fraud will be
the wave of the future.
The future of State regulation of securities--I support
strong enforcement of our securities laws and I am confident
the States must play a major role in these enforcement efforts.
I want to encourage the States to be more flexible in licensing
and registration procedures. I believe in using registration as
an enforcement tool, but I do not think that States should
place unreasonable burdens on firms and individuals attempting
in good faith to become registered in their jurisdictions. I
have been informed of many such unreasonable and inappropriate
tactics. In Georgia, I always insisted that my staff be fair
and reasonable in registration and licensing matters and tough
on fraud enforcement matters. In other words, reasonable
regulation and tough enforcement.
Madam Chairman, thank you for enduring my remarks. This is
the home of the filibuster. I am looking forward to hearing
from Mr. Levitt and others on the ways we can improve our
protection of our investors. Thank you very much.
Senator Collins. Thank you very much, Senator.
[The prepared statement of Senator Cleland follows:]
Senator Collins. Our first witness this afternoon will be
the Hon. Arthur Levitt, the distinguished Chairman of the
Securities and Exchange Commission. Prior to becoming Chairman
of the SEC in July of 1993, Mr. Levitt served as the Chairman
of the New York City Economic Development Corporation from 1989
to 1993 and the Chairman of the American Stock Exchange from
1978 to 1989. Prior to that, Chairman Levitt worked on Wall
Street for 18 years. I would also note that Chairman Levitt was
once the owner of a publication very well known here on Capitol
Hill, the newspaper Roll Call: so he is truly a man of diverse
talents.
We are truly fortunate that the Chairman could join us this
afternoon and I look forward to his testimony. Because of time
constraints, I am going to ask Mr. Levitt to limit his oral
testimony to no more than 15 minutes. We will have lights to
give you a sign of when you are getting low on time. In any
case, your prepared testimony will be made part of the record.
Pursuant to Rule 6 of the Subcommittee, all witnesses who
testify are required to be sworn, so at this time, I am going
to ask Mr. Levitt to please stand and raise your right hand.
Do you swear that the testimony that you will give before
the Subcommittee will be the truth, the whole truth, and
nothing but the truth, so help you, God?
Mr. Levitt. I do.
Senator Collins. Thank you. Mr. Levitt, you may proceed.
TESTIMONY OF ARTHUR LEVITT, JR.,\1\ CHAIRMAN, U.S. SECURITIES
AND EXCHANGE COMMISSION
Mr. Levitt. Chairman Collins, Senator Cleland, thank you
for this opportunity to appear on behalf of the Securities and
Exchange Commission before the Permanent Subcommittee on
Investigations. The foremost mission of the SEC is to protect
investors, and so we are especially grateful for the spotlight
you have brought to bear on this important issue.
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\1\ The prepared statement of Mr. Levitt appears in the Appendix on
page 112.
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It is an unfortunate irony of history that the best markets
bring out the worst elements. The higher the market, the
greater investor optimism, the more opportunities for outright
and outrageous fraud. The Chicago Tribune wrote that an aging
bull market always brings the sleazier elements out of Wall
Street's woodwork, and that was a year ago. As the market
continues to soar to new levels, each day brings us new
challenges in fighting fraud, especially in the micro-cap and
penny stock market.
These hearings are focusing on a matter of paramount
importance to the investing public, and they could not come at
a more opportune time. I commend you for bringing to these
hearings the defrauded investors who sit with us today, because
there is nothing worse for the integrity of our markets, there
is nothing worse for the process of capital formation, which
depends so extensively on trust and confidence in those
markets, than the dishonesty, the distortions created by greed.
I think that even in the days since the printed version of
my testimony was completed and submitted to the Subcommittee,
our Commission's law enforcement efforts have pursued some of
the most audacious frauds conceivable. I would like to give you
a few quick examples.
Just last Tuesday, September 16, the Commission obtained
emergency judicial relief from a Federal judge in California in
the form of a temporary restraining order and an asset freeze
against the Geneva Group and Nicholas Garcia. We charged the
defendants with a classic pattern of micro-cap fraud, where a
shell company with no apparent business operations was being
sold to investors through high-pressure sales practices,
pretending it was a legitimate company with wide-ranging
business operations.
The following day, September 17, the Commission filed a
securities fraud action in Federal court in California against
five defendants, charging them with involvement in a fraudulent
stock leasing scheme. The complaint alleges that the defendants
acquired large blocks of restricted stock of 18 public
companies, promising the companies that they would pay large
monthly rental fees. After holding the stock for 1 year, the
defendants promised to return the stock to the companies. The
defendants then tried to sell the stock for property, money, or
credit. The purchasers of the stock have suffered losses of at
least $9.5 million.
Finally, just last Thursday, in a tale frighteningly
similar to a Hollywood movie script, the U.S. Attorney for the
District of Nevada filed a detention motion against a penny
stock promoter who is the target of an ongoing securities and
bank fraud and money laundering investigation. This individual
was arrested after recorded telephone conversations revealed a
plot to arrange an accident for an accountant who was slated to
testify against him at an upcoming trial.
Allegations of this nature, once relegated to what we used
to call ``street crime,'' send a shiver through our markets.
This is not behavior that investors expect from market
professionals, from corporate executives. It is not behavior
that this Commission will tolerate.
I cite these recent cases because they are an indication of
some of the problems facing both civil and criminal law
enforcement agencies every single day, not to mention
investors. The remarkable efficiency, credibility, and success
of our capital markets today has attracted more and more con
men and criminals. Our securities markets are still the most
efficient and fairest markets in the world, and while we must
be careful not to be unduly alarmist, the actions that we have
already taken, coupled with the program I will outline today,
demonstrate the Commission's resolve to step up our regulatory
and enforcement efforts in this area.
As these cases suggest, fraud among low-capitalization
stocks frequently involves two different but related problems.
The first is aggressive and often fraudulent sales practices,
such as lying to customers or unauthorized trading in their
accounts.
The second problem involves manipulation of micro-cap
stocks by brokers, issuers, or promoters. These stocks are
often traded in markets where there are no listing standards;
and, in fact, often the issuer does not file financial reports
with the Commission because it is so small.
The Commission is responding to fraud in the micro-cap
market with a wide-ranging campaign focused on three
strategies: prevention, enforcement, and regulatory
initiatives. I will discuss each briefly in turn.
In terms of prevention, the Commission believes it is
better to prevent fraud before the life savings of investors
are destroyed than to simply punish the perpetrators after they
have done their damage. To achieve this, we have conducted
aggressive broker-dealer inspections as well as market and
Internet surveillance.
It is not enough, however, for regulators alone to protect
investors. We also have to give investors the tools to protect
themselves. The best tool, in my judgment, is investor
education, and that is why in recent years the Commission has
developed an incredibly aggressive investor education program.
We have created a Web site that offers SEC press releases,
investor alerts, litigation releases, tips on avoiding fraud,
and our huge EDGAR database of corporate information.
We have held 20 town meetings in cities all over America
where thousands of investors come out and for 2 hours sit there
and ask questions about their investments. We had nearly 6,000
investors in Los Angeles. We have had 2,000 investors near
Hamden, Connecticut. All over the country, to see investors
come and ask questions that they were embarrassed or ashamed to
ask their brokers, truly tells you what is going on out there.
We have created a toll-free SEC hotline. We have developed
a series of investor education brochures, and I am pleased to
announce to you today the release of the latest such brochure,
entitled ``Cold Calling:'' \1\ It is going to be distributed to
investors nationwide by the SEC and the North American
Securities Administrators Association. We also have brochures
on how to buy municipal bonds, how to buy a mutual fund, and
how to pick a broker.
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\1\ Exhibit 1 appears in the Appendix on page 269.
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One other vital defensive tool for investors is the broker
disciplinary database known as the CRD. We are going to do
everything we can to help NASDR head Mary Shapiro fulfill her
pledge to improve the CRD and make it available through the
Internet.
We have stepped up both our civil and our criminal
enforcement efforts. We are working with criminal authorities
as never before, not merely to kick brokers who steal from
innocent investors out of the business temporarily or
permanently but to put them behind bars where they belong. We
are sharing intelligence, pooling resources, and coordinating
cases with our fellow law enforcement agencies.
In the last year alone, for example, we charged or
prosecuted more than 80 individuals in a coordinated effort
with the Department of Justice. We have also worked closely
with the self-regulatory organizations, or SROs, State
regulators, local prosecutors, and our foreign counterparts to
maximize our resources and stop micro-cap fraud at its earliest
stages.
Finally, we have undertaken a series of regulatory
initiatives. Over the last several months, the Commission staff
has worked with the New York Stock Exchange and the NASD to
develop rules that address problems in this sector of the
market. For example, we think that clearing firms should be
more responsive to customer complaints and should provide more
information about the conduct of firms whose trades they
process. We are now considering a New York Stock Exchange rule
that will address these concerns.
We are going to ask market makers trading and broker-
dealers selling securities on the NASD's over-the-counter
bulletin board and the National Quotation Bureau's pink sheets
to obtain more up-to-date information about the issuer before
they are allowed to quote or recommend a stock. We will also be
asking the NASD to evaluate once again standards for securities
of companies quoted on the Bulletin Board.\1\
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\1\ See Exhibit 19 describing subsequent NASD action taken on the
Bulletin Board which appears in the Appendix on page 553.
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The SEC itself is taking a series of dramatic steps to
combat micro-cap fraud and rogue brokers. We are putting the
rules governing the micro-cap market under a magnifying glass
to examine how well they have worked, how to plug the
loopholes, and how to make them work even better. We are
focusing greater attention not only on rogue brokers but on
rogue firms, because boiler rooms belong in power plants, not
in professional brokerage firms.
The keystone of this initiative is the creation of a
special Commission-wide working group which will bring together
SEC divisions and offices to find better ways to attack these
frauds early on, before they have taken their toll on
investors. If our Office of Compliance Inspections and
Examinations finds a pattern of abuse of one of our small
business exemptions, for example, they will immediately work
with their counterpart from our Office of Small Business Policy
to determine whether we should change that rule.
The SEC can do a lot, but, especially in this market, we
cannot do it alone. That is why this morning I met with Dick
Grasso, the head of the New York Stock Exchange, Frank Zarb of
the NASD, and the head of the NASAA to ask for their support,
as well. In meeting with them today, they each pledged their
commitment to minimize abuses in the micro-cap market through
joint initiatives with the Commission, the industry, and the
States.
There is one other critical challenge presented by micro-
cap stock fraud. We need to control the fraud without damaging
the market for securities of legitimate small businesses. I
have always been a fierce advocate of the interests of small
business. I want to assure Senator Collins and the Subcommittee
that I am not about to stop now. We are going to weigh the
needs of small businesses very carefully as we attempt to close
some of the loopholes that have created these problems.
Madam Chairman, as I noted earlier, in a market like this,
parasites crowd in to feast on the bull's success. While we are
aware of the problem and actively addressing it, we are deeply,
deeply grateful for your interest in focusing public attention
on an issue so important. You have truly shown great
leadership.
I look forward to working with you, not just today but in
the future, and with your colleagues, to eliminate any of the
abuses that you and Senator Cleland have mentioned and others
that exist in the market today. Thank you for this opportunity.
Senator Collins. Thank you very much, Chairman Levitt.
In reading your written testimony and listening to your
comments, it struck me that many of the practices that you
describe, whether it is market manipulation or the high-
pressure cold calls or unauthorized transactions or no net
sales policies, sound very much like the practices of a decade
ago when I was a cabinet official in the State of Maine with
responsibility for a department that included securities
regulation. Indeed, to give my friend from Georgia yet another
quote, it does remind me of that old Yogi Berra line that it
sounds like deja vu all over again.
This leads me to wonder whether the remedies that we have
tried--whether it be greater disclosure requirements or
electronic monitoring of trades--can only take us so far, since
the business comes down essentially to how brokers treat their
customers. So is it almost impossible to get control of these
problems unless we raise the minimum competency levels and the
ethical standards of the brokerage community.
I want to emphasize that the vast majority of individuals
working in this field are ethical and are looking out for their
investors' best interests; but we have had a continuing problem
that does not seem to go away no matter how much we enact new
administrative or regulatory or legal reforms.
So starting first with the competency issue, we have no
minimum educational requirements and it has been suggested to
me that passing the entry-level NASD exams can largely be a
matter of just cramming and taking the test often enough.
Indeed, when I harken back to my regulatory days at the State
level, it truly was more difficult in the State of Maine to get
a license as a cosmetologist than as a broker, even though one
could argue that recovering from a bad hairdo is far easier
than recovering from bad investment advice.
But in all seriousness, with brokers engaged in the
business of advising people on what to do, in many cases with
their life savings, where mistakes can have just absolutely
devastating consequences, as we are going to hear from some of
our witnesses later today, do you believe that competency
requirements for brokers are sufficiently demanding?
Mr. Levitt. Senator, you know, I was a stockbroker for a
number of years, and I ran a branch office, and I managed
thousands of brokers, and I have enormous respect for the
profession. I think they have done remarkably well, and the
vast, vast majority of the brokers in America today are
extremely competent and the most professional in the world.
They account for the low cost structure in our process of
capital formation.
I would say that today's brokers are better trained and
better equipped than they have been at any other time in
history. They not only have to take the qualifying examination
to begin with, but through an initiative that was embarked upon
jointly among the Commission, the Securities Industry
Association, and the SROs, we imposed additional requirements
for training and retraining in products that brokers sell--
because today, it is not just stocks and bonds. It is options
and derivative instruments and real estate and insurance and a
host of other products, and those brokers have to be trained on
a regular basis in both products and regulations.
I do not believe that the problem is a lack of training. I
think there is some problem in terms of incentives that the
firms give to brokers, which have up to now been largely
quantitative, that is, the more the broker trades, the more he
gets paid. That issue, too, has been addressed by the industry
through the recommendations of the Tully Committee to create
other kinds of incentives and to do away with some of the clear
conflicts of interest, such as product-specific contests at
various firms where a broker gets sent to Honolulu by selling
more of a particular underwriting. They rarely exist any longer
today. Very few brokerage firms offer incentives to brokers to
sell the home-grown product any longer. But I think more work
has to be done in this area. The Commission does not intend to
legislate compensation, but we certainly intend to focus public
attention upon it.
I do not think that the competency levels have to be
raised. I think that the problem is not with the bulk of the
brokers. The problem is with the really bad actors, that no
matter what the competency levels were, these are dishonest,
crooked people. We have got to kick them out of the industry
and keep them out. We have to send them to jail. We have to
work with the Justice Department, and this Commission for the
first time has conducted joint efforts, and is presently
conducting a joint and public effort with the Justice
Department, to take brokers who have stolen vast amounts of
money from their customers, and not merely to push them out of
the industry but to have them wearing striped suits. That is
where the effort has to be made, in my judgment.
Senator Collins. I really applaud the efforts that you are
making to work with the Department of Justice and the State
Attorneys General to bring more criminal prosecutions. But let
me follow up on what you just said and ask your opinion on the
whole issue of ethical standards.
It seems to me that as long as we tolerate a sales as
opposed to a ``fiduciary'' mentality in segments of this
industry, we are going to have problems. In addition, high
ethical standards tend to result as much from tradition as from
rules and that is difficult to change overnight.
But I do have one specific approach that I want to get your
reaction to. Why not take a page out of the book of one of your
fellow New Yorkers and institute a zero tolerance policy,
making it known that one serious breach of the rules and you
are out of the industry? As the Chairman of the SEC, you could
send out the word that if you turn an account, you are out of
the industry. If you knowingly execute an unauthorized
transaction, you are gone for at least, say, 2 years.
If we are going to allow aggressive selling, the
consequences of exceeding the limits should be severe and known
to all in the industry. So why not announce a zero tolerance
policy and then follow through with it? It strikes me that what
has worked on the streets of New York might well work in its
offices.
Mr. Levitt. Well, I applaud the concern and interest that
underlies that thought. This particular Commission has included
among the foremost initiatives that we have pursued over the
last 4 years, our efforts to drive rogue brokers out of the
industry and to raise the standards of professionalism that are
part of the industry.
I believe that a broker's impact on a person's life is
every bit as great as a lawyer's, as his accountant's, and
maybe in some instances as his physician's, so that I regard
this with the same seriousness as you do.
The Commission has been approaching this in a number of new
ways. We have made a major issue of supervision. Every broker
who gets kicked out of the industry or gets suspended and who
then comes back into the industry, represents a responsibility
for a supervisor. If that broker becomes a recidivist and gets
kicked out again, this Commission wants to hold his supervisor
responsible. We have brought more supervisory actions than any
Commission in history.
Now, the way we get at this issue is through a cooperative
effort. Because of our limited resources, we can't do it by
ourselves. Nor should we. Because we are talking about a
culture, and that culture can be approached best, in my
judgment, with a consensus approach with State regulators, who
are the cops on the beat in the localities, which is terribly,
terribly important, and with the SROs in the form of the NASD
and the New York and the American Stock Exchanges. And they
know that this Commission cares enormously about their level of
tolerance of bad practices.
The committee that I have formed today is going to meet
within the next 2 weeks to talk about tightening up on the
practices. I do not know that it will decide to go to zero
tolerance because I am not certain as to which offense or
offenses should trigger that. While I think that churning is a
heinous offense, I think there are others that are even worse.
But I assure you that the industry, working collectively
and in the best fashion to change a culture, will bring about
stronger penalties, stronger methods for getting at this
problem. And the Commission will be absolutely relentless in
terms of pressuring the industry to raise the standards to see
to it that bad brokers do not enter, and no less can stay, in
the industry. And we will move in the direction of zero
tolerance. Whether we arrive there in one fell swoop is a
different question.
Senator Collins. I really believe that is key, because
every time we try to tighten up on the regulatory scheme
through increased information or more monitoring, we are not
really getting at the underlying problem. It seems to me that
the SEC more than anyone, perhaps, has the ability to force the
change in culture that you have just described, and I applaud
you for your willingness to send that message very clearly.
In a recent speech, or perhaps it was a newspaper, when you
were talking about the role of the SEC and State regulators,
you made what I thought was a very good point. You said that
investors would be better protected if our response were
triggered by complaints and not by job changes. Do we not need
a system that will trigger action at the time that a
disciplinary action is taken against a broker rather than when
the broker changes jobs? For example, you could have an
unethical broker stay with the same firm for a very long time.
Then he or she is unlikely to come to the attention of
regulators. The scrutiny comes when there is the job change and
the relicensing process takes place.
I know that the CRD improvements offer some hope in this
area, but could you elaborate on that?
Mr. Levitt. Sure. The CRD is the Central Registration
Depository. I am going to sound a little bit like a Ross Perot
imitation here because I think it is important to get this out
to investors. The telephone number for the CRD is 800-289-9999.
This is a crucial part of our investor education effort.
Mary Shapiro, the head of the NASDR and a former
Commissioner, made a courageous decision to discard the old
system and design a new one. We are going to have full Internet
access in 1998, and I want the entire project done by the end
of 1999. By that time, I want 100,000 calls that we now get
each year to increase to over a million. I want this to be one
of the best-known 800 numbers and Web sites in America, 1-800-
289-9999.
Senator Collins. Let me follow up on that point. When I was
meeting with the investors, the victimized investors who will
testify next, it occurred to me that one way we could help
people who believe they are being ripped off or encountering
problems is to require the account statements that are sent out
to have a telephone number such as the one you have just
described or perhaps the name, address, and phone number of one
of the regulators or the NASD so investors know where to turn
for help. Is that something that you would consider?
Mr. Levitt. Yes. I think that is a good idea, and that is
one of the notions that we talked about with the self-
regulating organizations. How can we get information out to the
public that tells them that you have got to be careful of this
firm, that you have got to watch this broker, or here is the
number that you should call, and please call it before you do
business with a new broker that you have never met.
Now, I urge in every way, in every forum I get, that an
investor who does business with a broker over the telephone
that he or she has never met before is just making a terrible
mistake. I encourage that linkage between a customer and a
broker. Know your broker. Call up and find out whether he or
she has had a regulatory problem, and do you really want to
entrust your life's savings to someone who has been kicked out
of the industry or disciplined or has been the object of
hundreds of investor complaints?
That is what we have got to get investors to begin to do.
The information is there. We are committed to making that
information more visible, more available, more usable, and the
form that you suggest, I think, is a good one; and we are going
to consider it. Whether the confirmation slip is already too
jumbled to be meaningful, whether we are talking about a
mailing that would go with the confirmation, I am not sure, but
it is that concept of revealing to investors brokers who have a
problem, is one that is high on our list of priorities.
Senator Collins. Let me ask you just one more question
before turning to my colleague, Senator Cleland. Your new
brochure is excellent. I was leafing through it as you were
describing it, and I think it would, in fact, help investors to
be very cautious. But I wonder how many investors are actually
going to see this brochure. Would there be merit in requiring a
broker or a brokerage firm which is doing a great deal of cold
calling to be required to send this information out to people
who are opening new accounts?
I am trying to think of a way to make sure that it gets to
the people who need to read it. It is very good. It would
certainly warn people of the dangers of responding to a cold
call pitch. But if investors do not get it, if it does not
reach them, then it is of little value. So what would you think
of actually requiring investor education materials to be
included with account statements or in some way distributed by
firms that do a great deal of cold calling?
Mr. Levitt. I think a phone in the hand of these cold
callers is as dangerous to the public as a car in the hands of
drunk drivers. Just the other day, a friend of mine told me of
a cold call that he got at 7:15 in the morning, and he said,
``How dare you wake me up at this hour.'' The broker said, ``It
is the early bird that gets the worm.'' It is that kind of
cavalier approach that, I think, bears on a culture that has
got to be discouraged.
We certainly are going to encourage wide distribution of
that cold calling brochure. We are going to encourage it
without forcing it. I think, again, the strategy of the
Commission has been to mobilize the best instincts of the
industry, which is mindful of these perceptual problems. The
bulk of the firms in America today would have nothing to do
with brokers who abuse the cold calling privilege, in effect,
and it is only firms that are really outlaw firms that cast a
reputational stigma upon the industry.
I think we have got to bring and encourage the NASD and the
New York Stock Exchange to bring cases against violators of the
cold calling culture. Cold calling is a function of American
business, and I would not dare say no calling should take
place. It should. It has an appropriate place.
Now, I think it is wrong, however, to have a battery of
cold callers who may be kids in high school or in college who
are not trained, who do not have to pass any of the tests that
a broker has to pass, out there cold calling and turning the
account over to a broker they work for or, indeed, illegally
making the sale themselves. That we are going to nip in the
bud. We are going to encourage cold callers to follow
standards. A cold caller must be experienced, must know what
kinds of clients qualify for a call and what kinds of
representations to make.
So my long-winded answer to your question is, you bet we
are going to encourage the broadest distribution by the firms
and others of this kind of information. We are not going to
regulate it, but we are going to encourage it in the strongest
way we possibly can. We are going to use our town meetings to
do it. We are going to use our Web site to do it.
We are going to talk about it continually, because the one
question that I ask in town meetings which gets the greatest
response is when I ask for a show of hands: ``How many of you
have been awakened in the morning or late at night by an
abusive caller who does not seem to know the word no?'' I would
say 75 percent of the hands shoot up. That tells us something.
So you are clearly onto something, and we intend to follow up
on it.
Senator Collins. Thank you, Chairman Levitt.
Senator Cleland.
Senator Cleland. Thank you, Madam Chairman.
Mr. Chairman, thank you for being with us today. When you
mentioned putting the con artists in the striped suits, you
meant broad stripes, right, not small stripes?
Mr. Levitt. Right.
Senator Cleland. I am wearing a striped suit today. I just
wanted to make sure. [Laughter.]
Senator Cleland. Thanks for being with us. I understand the
importance of injunctions and consent decrees and receivers and
trustees and other types of administrative and civil sanctions
that can be applied against violators. The media is full of
stories about the major frauds perpetrated on our citizens. It
is my opinion that the only sanction, quite frankly, as you
have indicated by your comment, that most of the serious
violators will understand as a successful deterrence is jail
time and the completion of a successful criminal prosecution.
Do you have any idea why more of the major fraud cases do not
end up in the criminal courts?
Mr. Levitt. Well, I think it is a question of calendars
that are so full and commitments that are so great, and these
are cases that are difficult cases to bring and to prove. It is
only in the most egregious instances that we get to criminal
actions. We find that there are very few districts of our
Federal courts that are experienced at bringing securities
cases. Some of them, such as New York and California and some
large areas, do have that experience and recognize it as a
major area for their involvement. Others simply would rather go
after bank robbers than they would going through the difficult
process of trying to prove what a securities fraud is.
Senator Cleland. Thank you. How about your enforcement
staff? Do you have enough people to do your job well?
Mr. Levitt. Probably not. With our markets exploding, with
many times more investors in the market today than ever before
in history, with mutual funds taking up more investors'
resources than all the combined deposits in our banks in
America today, our resources are severely strained,
particularly in the enforcement area. We, like every other
agency in government, are mindful of restrictions on
government; and, for the past 3 years, we have operated pretty
much on a flat budget.
I am under no illusion that we can ever wipe out totally
all fraud in America. And I would emphasize again that, while
the number of scamsters out there is probably greater today
than any time before, relative to the number of investors in
the market and the dollar volume of new issues coming on the
market, we are no worse than we have been for years.
Nevertheless, my answer to your question is we are
straining, and we have to leverage our resources by working
more closely with State regulators, by getting our self-
regulating organizations to assume more of the burden of
responsibility.
Senator Cleland. I would like to just follow up on that.
Where do you see the role of the States here, particularly in
terms of enforcement?
Mr. Levitt. I think it is critically important that the
States maintain their licensing abilities. States really need
to understand who is applying for a license and what is going
on. Senator Collins mentioned before the fact that, if a broker
stays at the same firm for a number of years, the focus of the
State tends to be on other things and does not come down until
a broker transfers from one State to another.
I think that has got to change. I think the State
regulators have to take cognizance of the fact that the States
are a vital linkage here, particularly since the passage of a
law last year which mandates the States to take on the
responsibilities for small investment advisers. That is a
critical problem.
I think it is essential that the SEC work closely with
State regulators. We may not see things exactly the same way,
because, from the standpoint of the firms and the standpoint of
the system, 50 different State regulators with different kinds
of regulation within the States can create redundancies and
costs that really make the system unworkable.
So we have tried very hard to persuade the States to try to
standardize their practices in a way which enables us to deal
with one system rather than 50 systems; and, until that
happens, we can never harmonize the role between the Federal
Government and the States. But I believe the States are moving
in that direction and they have taken recent actions. They
recognize the greatest danger that they face is moving into too
many different directions. They will earn the animus of the
brokerage firms, of the industry, of the self-regulators, and
the Commission by doing that, but, by harmonizing and working
together, I think we create a strong regulatory presence that
is the best way to get at fraud.
Senator Cleland. When I was Secretary of State in Georgia
and responsible for securities regulation, we worked closely
with the SEC just to do that very thing. One of the things that
has surprised me is the incredible dollar value now of the
whole penny stock market and its impact on illegal impact on
the economy, siphoning off legitimate investment to very, very
high-risk investment.
I notice that the Wall Street Journal recently estimated
that investor losses resulting from penny stock fraud has risen
from, say, $2 billion a year in the late 1980's to an
incredible some $6 billion today. Does that sound about right
to you?
Mr. Levitt. It is difficult to tell. I think that that
estimate was probably based upon a study done by the State
regulators some years ago and factored into that the growth of
the market, and assumed that the growth of fraud ran along
parallel lines. I am not sure whether that is so or not. I have
not seen a study which I would call reliable. But my anecdotal
experience tells me, as markets rise, as numbers of investors
proliferate, as numbers of brokers proliferate, as numbers of
new issues proliferate, there is no question but that fraud
will go right along with it.
Willie Sutton used to say that he robbed banks because that
is where the money is. Well, I think the scamsters and the
brokerage industry probably do the same thing. Again, the
percentage is small, but the scamsters that are out there do
incalculable harm to the system. To have these three investors
up here on national television testifying to how they were
violated does more to hurt our process of capital formation
than anything else I can imagine. I think it is an unfortunate
consequence which, I think, all of us have to resolve to give
the maximum exposure to and to try to make the penalties so
onerous that this will not be necessary in the future.
Senator Cleland. I appreciate that point of view. I am
concerned that Congress seems determined to continue on a
course of chipping away at investor protections and remedies as
a means of encouraging economic expansion. I am certainly
interested in a robust economy, but experience is our best
teacher here. We know that if we tip the scales too far in the
direction of promoting capital formation, fraud flourishes. Our
challenge, it seems to me, is in keeping the scales of capital
formation and investor protection in balance. Would you like to
comment on that?
Mr. Levitt. I think you are absolutely right, that while
the Commission has two initiatives: capital formation,
nurturing it, encouraging it, and investor protection--as far
as I am concerned, the primary initiative of this Commission or
any Commission must be protection of investors. There can be no
capital formation in a system that cannot be trusted.
The numbers that investors depend upon must be reliable.
You have read about a great deal of controversy involving the
FASB, the independent mechanism for establishing accounting
standards and their efforts to call for the accounting for
derivatives, which take up billions of dollars in our
marketplace today. We oversee the FASB, and I believe that the
business community and the regulatory community must support
efforts to see to it that the numbers that investors rely upon
are accurate. So I believe that public confidence comes first
in our scheme of things. There can be no markets, none, without
public confidence in the reliability of those markets and the
people who run them.
Senator Cleland. I could not agree more.
Madam Chairman, just to maybe wind up with a Yogi Berra
quote that I heard the other day for the first time, that 90
percent of baseball is mental and the other 50 percent is
physical---- [Laughter.]
Senator Cleland [continuing]. I think your point has been
well taken, Mr. Chairman, that 90 percent of this securities
investment game is confidence in those who play the game and
the other 50 percent is financial.
Thank you very much, Madam Chairman. Let me just recognize
Jeff Robbins, our Minority Chief Counsel who has done a lot of
work with our team today. Thank you very much.
Senator Collins. Thank you, Mr. Chairman. I know that all
of us have additional questions that we will submit for the
record.\1\
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\1\ Exhibit 16 appears in the Appendix on page 432.
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I would ask that you give careful consideration to my
suggestion for the zero tolerance policy and work with us to
see if we can come up with something that would assure due
process, if limited to serious breeches, but nonetheless sends
the message of zero tolerance.
Mr. Levitt. I promise you that I will. Thank you.
Senator Collins. Thank you.
The next panel of witnesses will please come forward. The
second panel includes Emile Murnan, Helen Sprecher, and Louis
Poggi. These are three investors who will tell the Subcommittee
about their recent experiences investing in the micro-capital
markets.
We are going to first hear from Mr. Murnan, who is a
resident of St. Louis, Missouri, who retired several years ago
as a salesman of industrial woodworking machinery.
We then will hear from Mrs. Helen Sprecher, a longtime
resident of Philadelphia. Mrs. Sprecher and her husband owned a
grocery store, I think for some 30 years----
Mrs. Sprecher. Thirty-seven years.
Senator Collins. Thirty-seven years. Mrs. Sprecher is
accompanied by her attorney, Mr. Henry Pass.
Finally, we are going to hear from Mr. Louis Poggi, a
resident of Pembroke, New Hampshire. He is a father of five
children and is employed by Federal Express.
We are looking forward to hearing from you and I want to
give each of you a special thank you for being willing to come
before the panel today and share your experience. What you are
doing is going to help others be better informed investors, and
I really thank you because I know this is difficult, to come
forward and talk about your own experiences.
I am going to ask each of you to limit your comments to 10
minutes. This green light will go on at the beginning. The
yellow will come on when you have 2 minutes left so that it
will allow you to wrap up. We will make any prepared testimony
that you have part of the record.
As I mentioned previously, pursuant to Subcommittee Rule 6,
all witnesses are required to be sworn in, so I am going to ask
you all to stand and raise your right hand.
Do you swear that the testimony that you are about to give
to the Subcommittee will be the truth, the whole truth, and
nothing but the truth, so help you, God?
Mr. Murnan. I do.
Mrs. Sprecher. I do.
Mr. Poggi. I do.
Senator Collins. Thank you very much.
Mr. Murnan, we are going to start with you, please.
TESTIMONY OF EMILE O. MURNAN,\2\ ST. LOUIS, MISSOURI
Mr. Murnan. Madam Chairman and Members of the Subcommittee,
my name is Emile Murnan and I am pleased to be here today to
testify before you about my recent experience as a victim of
fraud by a securities brokerage firm.
---------------------------------------------------------------------------
\2\ The prepared statement of Mr. Murnan appears in the Appendix on
page 145.
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I am 78 years old and retired several years ago from a
sales career. My home is in Ballwin, which is one of the many,
many suburbs of St. Louis, Missouri, famous for the Gateway
Arch and gullible people. [Laughter.]
Mr. Murnan. I do not receive a pension and, therefore, I
try to be careful in management of my funds. It is apparent to
me that control is needed to protect others from becoming
unwitting victims of fraud by an industry entrusted by so many
to conduct transactions which are critical to their financial
security.
My story begins on January 16, 1997, when I received a
telephone call from a Mr. Marlon Tropeano. He is with the L.T.
Lawrence and Company in New York City. I had never done any
business with him or his firm and I am not really sure how he
came about having information on me. It seems that when you
purchase a stock from a broker, especially in New York, they
must put your name on a list and sell it to all the other
brokers in town because I have had numerous telephone calls
from different brokerages, all in New York, and they are all
with this same type of thing, trying to get you to buy
something you never heard of.
However, in my case, he wanted me to buy shares in Callaway
Golf Company, and I was familiar with Callaway. I know it is a
good company on the New York Exchange and so forth, and at this
particular time, I had a few bucks to spend because a bond I
had had matured. So I bought 200 shares of the Callaway Golf
stock. I regarded this as a long-term investment, and on
January 18, I paid for it in the amount of $6,040.
The trouble began about 6 days later--exactly 6 days later,
after the date of purchase, when he sold Callaway Golf for a
total of $6,308. That is a slight gain, but I did not know he
had done it even. The same day that he sold that, he bought
1,000 shares of Medaphis Corporation stock for a total price of
$13,840. He has now established a margin account, without my
permission, of $7,530.
This thing gets worse. Six days after that, on January 28,
he purchased 4,700 shares of QPQ stock for a total of $12,940.
This means he had now established a margin account of $20,000.
One thing I might add that I had some thoughts on is how
ethical is it for a brokerage company to allow a firm to
establish a $20,000 margin account on an investment of $6,000?
It just does not seem to make any sense to me.
Anyway, on February 5, without my permission, he sold the
1,000 shares of Medaphis for $13,109. This is a small loss of
$730, but it gets worse. On the same day, he sold 1,600 shares
of QPQ, and on February 12, he sold 1,900 shares of QPQ, and
finally on April 10, the account was closed and I received a
check of $292, for a loss of $5,748 out of my original
investment of $6,040. It is only about a 94 percent loss.
On February 13, I returned from a trip to Florida and when
I opened my mail, here were all these confirmations of buys and
sells, which I just could not believe. I could not believe he
had sold the Callaway Golf stock and bought two other stocks
without my permission at a substantial loss, because now I have
the buys and the sells all in the same mail.
On February 21, I sent a letter to the Compliance
Department of L.T. Lawrence and Company disputing these
unauthorized trades and the loss of my money. On March 11, I
was contacted by telephone by Mr. Andrew Basile, who stated he
was Senior Vice President and head of the Compliance
Department. He assured me that he would investigate my
complaint, but nothing was ever done to resolve the issue of
this lost money. I talked to him several times, plus others
under him. Their attitude is, yes, so what? We lost your money.
We are not going to do anything about it and we do not
apologize. It is just tough luck.
So since I could not get anywhere with them, I took matters
into my own hands and I wrote the NASD in New York City, the
Securities and Exchange Commission in Chicago, and North
American Securities Administration Association in Washington,
D.C., as well as the Commissioner of Securities of the State of
Missouri in Jefferson City, plus I retained the services of an
attorney.
An examiner for the Missouri Securities Division later
determined that L.T. Lawrence and Company had 15 customer
complaints filed against Mr. Tropeano, 11 of these complaints
prior to his solicitation to me.
Finally, on July 12, a settlement was reached and the
losses were reimbursed through my attorney, minus his fee. This
whole affair has been an extremely troublesome experience for
me and has caused me considerable expense and made me very
unhappy. It seems that in this age of technology, these
renegade fraudulent activities should no longer be possible by
companies who are entrusted with the key elements of our
financial security.
This concludes my statement, Madam Chairman, and I would be
pleased to answer any questions.
Senator Collins. Thank you very much, Mr. Murnan. I
appreciate so much your sharing your experience with us. We are
going to hear from the other two witnesses first and then we
will be asking you questions.
Mrs. Sprecher.
TESTIMONY OF HELEN SPRECHER,\1\ PHILADELPHIA, PENNSYLVANIA;
ACCOMPANIED BY HENRY IAN PASS, ESQ.
Mrs. Sprecher. It is hardly necessary for me to say I
consider it a great honor to be here today. My name is Mrs.
Helen Sprecher and I reside in Philadelphia, Pennsylvania. My
husband, Harry Sprecher, is unable to attend this hearing due
to his declining health.
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\1\ The prepared statement of Mrs. Sprecher appears in the Appendix
on page 147.
---------------------------------------------------------------------------
My husband and I are both 85 years old. Before our
retirement in 1988, we owned a small neighborhood grocery
store. We worked very hard, 7 days a week for 31 years, and we
were able to save about $100,000 for our retirement. But as a
result of the devious and deceptive practices of unscrupulous
stockbrokers and their firms, nearly every penny was lost.
I am appearing before you today and making this statement
in the hope that what happened to my husband and me can be
prevented in the future. I am telling my story so that other
elderly and other vulnerable citizens might be spared the
suffering, the financial loss, and the emotional trauma that we
have had to endure.
Our problems with stock brokerage firms began in the fall
of 1990, when we were contacted by a stockbroker named John
Baratta. At that time, we were led to believe that Mr. Baratta
was affiliated with the prestigious Wall Street brokerage firm
of Morgan Stanley. Mr. Baratta persuaded us to open a brokerage
account with him and he started to purchase stock for us
shortly after the account was opened.
While Mr. Baratta was our stockbroker, we periodically
received account statements from Morgan Stanley showing the
status of our account. The account statements indicated that
Morgan Stanley had been introduced to us through a company
called Manchester Rhone Securities. However, I do not recall
Mr. Baratta ever telling us that he worked for Manchester Rhone
Securities. During this time, we always thought that we were
dealing with the firm of Morgan Stanley.
It was not until I recently consulted with attorney Henry
Pass that I found out that Mr. Baratta actually worked for
Manchester Rhone Securities, a very small brokerage firm that
has since gone out of business. Had we known Mr. Baratta was
not affiliated with Morgan Stanley, we would probably not have
done business with him.
During that time, Mr. Baratta said that Morgan Stanley was
looking at a company called Wave Tech, a waste disposal firm in
Canada. Morgan Stanley took Mr. Baratta and some other brokers
to look over the operation. He was so impressed, he purchased
20,500 shares at $1.25 a share for our account. Sometime during
the fall of 1991, Mr. Baratta informed me that he had switched
brokerage firms and was now working for S.D. Cohn, a company on
Wall Street in New York City. At that time, he also told me
that Morgan Stanley was no longer doing business with small
investors such as me and my husband. We then agreed to have the
stock in our Morgan Stanley account transferred to a new
account at S.D. Cohn by Mr. Baratta. When we switched brokerage
firms, our account was worth approximately $98,000.
Mr. Baratta continued to be our stockbroker until February
or March of 1993. Around that time, we learned that Mr. Baratta
was no longer affiliated with S.D. Cohn and that a stockbroker
named Donald Lou Spitzer had taken over our account. Although I
had never met Mr. Spitzer, he seemed nice on the telephone and
persuaded us to let him handle our account in the future. He
said his mother was 92 years old and he took care of her
accounts and he would be very careful with my portfolio.
Both my husband and I were having health problems. My
husband had three very serious operations, a double bypass, an
operation on the esophagus, and one on the colon. I was also
having health problems, so I was in no condition to make any
decisions. Mr. Spitzer was well aware of my condition. He
promised to make good on my losses.
He purchased 25,000 warrants in American Track System,
expecting the shares to come on the market at $5 or $6 a share.
Mr. Spitzer sent me a beautiful brochure of the company and its
prospects. I felt I could not leave Mr. Spitzer or the company
he was with because his promise of restitution, it would just
be dropped.
In August of 1994, Mr. Spitzer sold Wave Tech at 3/32,
which is a little more than a dime. The following week or so,
the company was taken over by someone else for a little over $1
a share, so that was a loss of over $20,000 right there.
Around September of 1994, Mr. Spitzer informed me by
telephone that he had left the S.D. Cohn brokerage firm and had
joined a new firm called Investors Associates. We allowed Mr.
Spitzer to transfer our account to Investors Associates. We
continued to deal with him until June of 1995.
Around that time, a gentleman named Keith Bleich telephoned
me and identified himself as a broker for Investors Associates.
He said that he was calling to inform me that Donald Spitzer
had been discharged from Investors Associates because of
unethical practices. Mr. Bleich then told me that our account
had been transferred to him and that he intended to give our
account his personal attention. He also assured me that because
of our age, he would make sure that we would never lose any
money. Unfortunately, I believed him. He said he was going to
be a father for the first time and was very considerate and
worried and sort of got me into that event, worrying about he
and his new baby coming on. He talked about that endlessly.
About a month later, Mr. Bleich called again and asked if I
had any other securities that were not in our account with
Investors Associates. At the time, I had in my personal
possession 440 shares of RJR Nabisco stock. Mr. Bleich said it
would be to our advantage to have everything in one place. I
suppose if I was deceased, my heirs, it would be nice for them
to have everything in one place. He told me he would send
Federal Express to pick up my stock certificates for delivery
to his office, which should have been some kind of a clue. He
was so glib and persuasive that I agreed to send him my stock.
Because the RJR Nabisco stock paid a nice dividend which
supplemented our Social Security benefits, I told Mr. Bleich
that the stock was not to be sold and he promised not to do so.
Over the next several days, he called me three or four times a
day, trying to convince me to buy stock in a company called
Electronics Communications. He told me that the company was new
and that the stock was about to skyrocket. I had never heard of
the company, so I would not commit myself. I told him it was a
very difficult time for me, since I was recuperating from
surgery for the aneurism of the aorta which had left me very
weak and unable to think straight and he was putting a lot of
pressure on me.
Sometime in August of 1995, a statement arrived from
Investors Associates. To my utter shock and surprise, most of
the stock in our portfolio had been sold without my permission,
including the RJR Nabisco stock from which we had been relying
on. The statement also indicated that we now owned 3,000 shares
of Electronic Communications and 1,500 shares of Air Methods,
Incorporated. Both of these stocks were purchased by Mr. Bleich
without my permission. I later learned that Investors
Associates was an active market maker in these securities.
Shortly thereafter, the value of both stocks started to
plummet and our margin obligation went from $950 to almost
$5,000. Margin calls were coming in two or three times a week,
so I frantically called Mr. Bleich. He insisted that the stocks
were going to make a lot of money. Margin calls continued to
come in two or three times a week, calls that I could not meet.
Although I continued to call Mr. Bleich, it became obvious
to me that my calls to him were seen as a nuisance. Whenever I
would call, I would always be told that he was in a meeting or
out of the office. Eventually, the 1,500 shares of Electronic
Communications had to be sold off to partially satisfy the
margin calls and we sent him $3,000 to satisfy some of the
calls.
In July of 1996, I informed NASD about my problems with
Investors Associates and Mr. Bleich. When Mr. Bleich heard
about this, he called to tell me that everything that had been
in our portfolio when he took over the account had been put
back and that we no longer owned any of the stock that he had
purchased without my permission. I later learned that this was
not true because the statements I continued to receive from
Investors Associates did not show the changes in our account
that Mr. Bleich had assured me had taken place.
In the meantime, margin calls against our account were
still coming in. When I phoned Mr. Bleich, he insisted the
changes had, in fact, been made and everything would be fine.
During one of my last telephone conversations with Mr. Bleich,
he brought another gentleman on the line who claimed to be an
attorney for Investors Associates, a David Sayed. David Sayed,
or whoever answered the telephone, verified that the changes in
our account had been made. However, I continued getting margin
calls and our account statements from Investors Associates
indicated that they were still charging me interest on stocks
that I was not supposed to own in the first place.
In February of this year, I consulted an attorney, Mr.
Henry Pass, to see what legal recourse we had as a result of
the unscrupulous handling of our stock brokerage account. After
Mr. Pass reviewed our records, I learned about the losses my
husband and I had incurred since the time we first opened our
account through Morgan Stanley in 1990 until the time that we
closed the account with Investors Associates in April of this
year.
Due to the declining health of my husband and myself, I had
not been able to keep track of all the activity in the account.
During this period, I had been recuperating from the surgery
related to the aortic aneurism. My husband had also undergone
surgery, as well as chemotherapy for cancer of the colon and
the esophagus and a lot of my time was spent caring for him. I,
therefore, was not aware of all the churning and other
improprieties that occurred during this time.
In December of 1990--I am sorry.
Senator Collins. You can conclude your statement. Take a
little bit longer.
Mrs. Sprecher. When we entrusted our retirement savings
with John Baratta through Manchester Rhone Securities and
Morgan Stanley, our account was worth approximately $96,000
[sic]. However, when we closed our account with Investors
Associates in March of this year, our account was worth $2,300.
The stress of the situation has greatly affected my health,
both physically and emotionally. I have been experiencing
anxiety attacks, nausea, loss of appetite, and inability to
sleep. The distress and anguish are sometimes unbearable and
have caused me to lose over 15 pounds.
Shall I stop?
Senator Collins. If you have more you want to say to us----
Mrs. Sprecher. There is another page.
Senator Collins. Please continue.
Mrs. Sprecher. Until I was referred to attorney Henry Pass,
I did not know that there are laws on both the State and
Federal levels that are supposed to protect my husband and me
from the unscrupulous and illegal practices that we
experienced. Unfortunately for us and for so many others, these
laws did not prevent the firms and stockbrokers with which we
dealt from engaging in the practices that caused us to lose so
much money and to experience so much grief and misery.
Mr. Pass has instituted lawsuits against the companies and
individuals involved and I am hopeful that my husband and I
will be able to recover at least some of the money that we have
lost over the years. I only hope that something can be done by
the government to prevent retirees, such as myself, from
becoming victims of the unsavory, unethical practices of
investment firms and stockbrokers that seek us out. Something
must be done to protect all of us from the kind of people who
preyed on my husband and me, caused me to lose most of our
retirement savings, inflicted on us such terrible anguish and
distress in our twilight years.
Thank you for inviting me to share my story with you.
Senator Collins. Thank you very much, Mrs. Sprecher. Your
story is the reason we are here today. What happened to you is
absolutely outrageous, and it is our commitment to try to
change the system in a way to prevent that.
Mrs. Sprecher. Yes, so I heard from Mr. Levitt.
Senator Collins. Exactly.
Mr. Poggi.
TESTIMONY OF LOUIS POGGI,\1\ PEMBROKE, NEW HAMPSHIRE
Mr. Poggi. Madam Chairman and Members of the Subcommittee,
my name is Louis Poggi and it is a pleasure for me to be here
today to tell you my personal story of being defrauded by a
stock brokerage firm.
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\1\ The prepared statement of Mr. Poggi appears in the Appendix on
page 154.
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I am employed as a truck driver by Federal Express. I live
in Pembroke, New Hampshire, and am the father of five children.
My life is hectic, to say the least, and the story I am about
to tell you was a devastating experience for me and my family.
I sincerely hope that this hearing will lead to new regulations
of the securities industry which will prevent others from such
unnecessary suffering.
My experience with this scam started in June 1995, when I
received a telephone call out of the blue from Pat Boyce. Mr.
Boyce identified himself as a broker for Investors Associates,
Inc., of Melville, New York. I am not sure how Mr. Boyce
obtained my telephone number or identified me as a potential
customer.
During this initial conversation, Pat Boyce solicited me to
purchase stock in Cheyenne Software, Inc. His sales pitch was
overwhelming and he tried very hard to convince me that the
price of this stock was going to rise very quickly, which would
result in a huge profit for me. I became tired of Mr. Boyce's
relentless solicitation and told him, sure, go ahead, buy the
stocks. It did not mean a thing to me. He was just a guy on the
phone from New York.
I told him, sure, go ahead and buy the stock, but I thought
it was a joke. I did not realize what I was doing because Mr.
Boyce told me at a later date that I had actually bought stock
in Cheyenne Software. As a result of this initial conversation,
I learned later that the trade date of this purchase was June
30, 1995, for 1,000 shares of Cheyenne Software at a total cost
of $18,216.75.
Mr. Boyce called me a few weeks after our initial phone
conversation. He informed me that the price of Cheyenne
Software stock was rising and that I had already made a profit
of $3,000. I was astounded to have gained such a profit on an
investment that I had not really made, or I thought I made. A
sudden profit of $3,000 was like a major windfall to me.
I told Mr. Boyce that I now wanted to sell my shares in
Cheyenne Software in order to receive my $3,000 profit. My
Boyce told me that I must send Investors Associates $18,216.75
to cover the purchase price of the stock. I replied that I was
not able to do that, but if I owned the stock, why could I not
just sell it and you send me the profit of $3,000. Please note
that at this point, I had not submitted any money to Investors
Associates.
Mr. Boyce stated that I must send him a check for the
initial purchase and then I would own the stock, so I could
then turn it in to sell it. I did not understand the stock
market business and this situation was confusing to me, but I
was intent upon getting my $3,000. That was quite a bit of
money to me. I was going to make that profit, even if it meant
coming up with the $18,216.75.
It happens that my father lives about 20 minutes from
Investors Associates office in New York. I routinely visit my
parents, so I decided to make a trip there to check out the
Investors Associates office. I wanted to see if it was a real
company or just some guy calling me from his kitchen. I went to
Investors Associates office and it appeared to be a legitimate
company in a normal office building, actually, a luxurious
office building.
This visit gave me confidence in Investors Associates, so I
told them I would purchase the Cheyenne Software stock with my
credit card. They told me that I could not do that. At this
point, I felt that all I had to do to get the $3,000 profit was
to obtain $1,216.75 which would be quickly returned to me
because I intended to sell the stock as soon as the purchase
was confirmed. In fact, I was led to believe that I could
quickly sell the stock to make back the $18,216.75 plus the
additional $3,000 gain.
That same day, on or about June 30, 1995, I obtained cash
advances from my credit cards and purchased the 1,000 shares of
Cheyenne Software. I told Investors Associates that I wanted to
sell my 1,000 shares of Cheyenne Software as soon as possible
in order to receive my $3,000 profit and get my initial
investment back to pay off the credit card debt, and they did
say ``fine''.
It was my understanding that the stock would be sold and my
money from the sale would be placed in an account with
Investors Associates. I waited approximately 10 days and still
did not receive the money or any confirmation of the trade. I
called Pat Boyce, who told me he had made money for me once and
that now he knew of another stock, Universal Self Care, and
that I should buy it. I told Pat Boyce that I wanted to close
out my account because I needed the money to pay back the cash
advances on my credit cards.
Pat Boyce gave me a strong sales pitch about Universal Self
Care stock. I told him that I did not want to purchase
Universal Self Care and he became very upset with me. Boyce
said that he had made money for me on the Cheyenne Software
stock and he could not understand why I would want to close out
my account.
Boyce told me the Universal Self Care stock was guaranteed
to rise in price because Investors Associates is on the board
of directors and they would be able to control the stock. I
told Boyce that the profit in Cheyenne Software was just a
fluke and that I really did not know anything about Universal
Self Care. I informed Boyce that I would not buy this stock
over the phone, that I needed time to research it. Boyce did
not seem to hear me, because he said, ``Mr. Poggi, do you want
me to put that order in now?''
The conversation ended with the agreement that we would
watch Universal Self Care stock until the end of the day but no
purchase would be made without my authorization. It seemed to
me that Pat Boyce was reading from some type of script during
this conversation because he would not take no for an answer.
I immediately called Waterhouse Securities, who I have done
business with previously, to determine the price of Universal
Self Care stock. The stock was quoted as selling at $.25 less a
share than the quote from Pat Boyce. I was outraged, so I
called Pat Boyce back and told him that he is charging me $.25
more per share than Waterhouse Securities, which is outrageous.
I would like to note here that that came out to an $800 profit
commission to him out of this transaction, which was very
generous on his part, to pay himself $800, I would say.
I informed him that I did not want anything to do with
Universal Self Care stock. Boyce told me it was too late
because he had already bought 5,000 shares of Universal Self
Care with the money in my account from the Cheyenne Software
trade. He said that the $.25 extra per share was his
commission. He told me that he had to make a living, too, and
that is why he did charge me an extra $.25 per share.
The first trade on Cheyenne Software was a $35 commission
charge, so I would say there was something unbalanced there, to
say the least.
I told Boyce that I did not authorize his purchase and just
wanted my money back. I was, to say the least, extremely upset.
I now owned a stock that I knew nothing about which was
purchased with money from my credit card cash advances. I
called Boyce again that day and told him to immediately sell
the stock in Universal Self Care. He told me that he was not in
a position to sell the stock.
I called Boyce back again a few days later, which he told
me that I have no worries because the price of Universal Self
Care is going to be pushed up and he will sell it. I continued
to insist that Boyce sell my shares in Universal Self Care,
even though he had almost convinced me that the stock was going
to be profitable. Boyce then transferred my call to Vince
Grecco, who told me that he was the owner of Investors
Associates. Grecco said that he would sell the stock in
Universal Self Care, but he snidely told me to enjoy retiring
on Social Security. He said that his company could have made me
a fortune. I told him just to sell the stock and send me the
money.
A few days later, I received a notice that I had bought
5,000 shares of Universal Self Care at a net cost of
$17,360.50. I thought this was just a mistake and that I would
be receiving my funds in the near future from Investors
Associates, basically taking him on his word that he was
sending me the money.
About 10 more days passed and I called Pat Boyce, who told
me that Universal Self Care stock was not sold from my account.
I told Boyce that Grecco had ensured me that the stock would be
sold. Boyce stated that my account had been closed and the
stock certificates were being forwarded to me. He said I should
receive the stock certificates in 6 to 10 weeks, at which point
I could then have the shares sold by a brokerage of my choice.
I broke down at this point in the conversation and became
very emotional. I was hysterical and Boyce hung up on me. I
composed myself and called Investors Associates a short time
later. This time, my call was transferred to Vince Grecco. He
told me that I had instructed him to close my account and that
it is standard procedure with this company to send investors
the stock certificates of their shares when they close an
account. I told Grecco that I wanted the shares in Universal
Self Care to be sold. I did not want the stock certificates.
Grecco told me that it was too late to sell because the account
had been closed and the stock certificates were in the system.
Shortly after this conversation with Grecco, I went on
vacation with my family, but I called Grecco every day trying
to resolve this matter. Grecco told me that there was nothing
he could do and that he was sorry I did not understand the
jargon of the industry. Grecco repeatedly told me that he just
was following my orders to close the account.
The clearinghouse for Investors Associates on my account
was Prudential Securities. I finally decided to call the local
office of Prudential Securities to try to determine the status
of my stock certificates. I do not remember the name of the
person I spoke with at Prudential, but he assured me that the
stock certificates would be forwarded to me as soon as
possible. The stock certificates for Universal Self Care were
subsequently received on or about August 22, 1995, in the mail
by my sister on Long Island. I instructed her to take the
certificates to the local Waterhouse Securities office and have
them sold. The 5,000 shares in Universal Self Care were sold on
or about August 25, 1995, for $14,437.50.
Subsequently, I filed a complaint with the National
Association of Securities Dealers, NASD, in New York. A couple
of months passed before the NASD conveyed to me that I should
pass on my complaint to New Hampshire authorities. I then filed
a complaint with the State of New Hampshire Bureau of
Securities Regulation. This complaint was finally settled on
April 23, 1997, with Pat Boyce being ordered to make
restitution to me in the amount of $2,925 and Investors
Associates assessed a penalty of $25,000.
This concludes my story, which obviously has been a
terrible experience that will affect me in many ways for the
rest of my life. I thank you for allowing me to share this
information with you and I would be pleased to answer any
questions.
Senator Collins. I want to thank you, Mr. Poggi, for
sharing your story with us.
I want to thank all three witnesses again before we go to
questions. What you have done today is put the human face on
what happens when an individual is ripped off by an
unscrupulous broker. We hear all the statistics and the amount
of money that is lost, but your testimony does more than
anything else to make people understand the human consequences
when this kind of unethical and illegal behavior occurs, and in
that sense, you have provided an invaluable service not only to
this Committee but to the public, as well. So I thank you for
coming forward.
I do want to ask you just a few questions. When each of you
ran into trouble, did you know to whom to turn for help? Was it
difficult to figure out where to go, whether to contact Federal
officials or State officials or the firm itself? Mr. Poggi, we
will start with you and go right across the panel.
Mr. Poggi. Well, to say the least, I was confused and I
immediately did not know where to turn. But just a little bit
of research, I figured out the NASD was based in New York City
and I called them and they told me to just handwrite something
and get the ball rolling. I did not realize about the
Securities and Exchange Department in New Hampshire or I
probably would have went right to them, because that is where I
got my best results. I just want to make a note----
Senator Collins. At the State level?
Mr. Poggi. Yes, at the State level, New Hampshire. As soon
as this happened, it probably was within days that I went on
vacation, and here I am spending quality time that I should be
enjoying my children, I am ready to have a nervous breakdown,
because as you know, all my money was tied up in cash advances
on my credit card, so it was not a fun vacation and how do you
put a dollar value on that? I should be enjoying my children.
As a matter of fact, I was vacationing in Maine.
Senator Collins. Good judgment. [Laughter.]
Mr. Poggi. Right, on the coast of Maine, which is a very
gorgeous place. I recommend everybody go there.
Senator Collins. I tell Senator Gregg that all the time.
Mr. Poggi. Oh, yes. It is beautiful. Here I am, instead of
enjoying the scenery and my children, I am writing letters and
talking to Vince Grecco on the phone. It was a nightmare.
Senator Collins. Mr. Murnan, was it obvious to you where
you could go for help or was that a difficult thing to figure
out?
Mr. Murnan. It was not obvious, but it was not really too
difficult. I know a couple brokers in St. Louis and I called
them and told them what had happened and they gave me names and
addresses. Then some of the agencies, when they sent me
information, they would also suggest that I contact this agency
or that agency, which I did. So eventually, I had, I think,
just about all the agencies alerted and on the case.
The first thing after I made my initial contact with the
NASD, I received a call from the L.T. Lawrence and Company
complaining that I had gone and alerted the authorities of
their actions. They put this broker on the phone and he started
screaming at me and he says, you are affecting my ability to
make a living by doing this, and I said, well, you have
affected mine, too, by losing all my money. I had conversation
after conversation with him and I saw it was never going to get
anywhere, so finally I enlisted the services of all the other
agencies that I mentioned plus my attorney. The NASAA and the
State agency were most helpful.
Senator Collins. Mrs. Sprecher, before you hired a private
attorney to help you sort through this maze that you were going
through, did you know where to turn for help?
Mrs. Sprecher. I did not know I had any other recourse. I
sent for a book that was advertised. It was called ``Legal
Problem Solver'' and I was thumbing through this book and I
came across stocks, and lo and behold, I read about the
Pennsylvania Security Commission and the NASAA, so I wrote to
the Pennsylvania Security Commission and they responded right
away. They also said I should contact the others, like the
NASAA, so I also wrote them.
Senator Collins. One of my suggestions which I am going to
be pursuing is it seems to me that the account statements
received by investors, should include the name, address and the
phone number of a regulator who could help an investor.
Investors would then not have to research, would not have to
wonder where to go. Do you think that would be helpful, if I
could just get pretty brief responses?
Mrs. Sprecher. If I was aware of what a regulator was. At
that time, I probably would have seen ``regulator'' and
thought, well, that is just something to do with the stock. I
would not have known to call that number or anything.
Senator Collins. So it is going to be----
Mrs. Sprecher. It has to be in plainer language than just
``regulator''.
Senator Collins. Right. What I am suggesting is, for
example, if it said on the bottom of the account statement, if
you are having difficulties----
Mrs. Sprecher. That would be better.
Senator Collins. OK. Mr. Murnan, would that kind of change
be helpful, if on the account statement it had the name,
address and the phone number of someone you could call if you
ran into the kind of trouble----
Mr. Murnan. That would be most helpful, and also, I believe
this would be a deterrent to these people doing it in the first
place, because now you easily know what to do. I think the way
they operate----
Mrs. Sprecher. Yes. I think that would be good.
Mr. Murnan [continuing]. They feel that the average
individual is not going to know what to do and a lawyer will
not take it because it is too small, perhaps, so they wind up,
a lot of them just do nothing and accept the loss. I was so
incensed when this happened to me, I was mad. I felt like I had
been robbed. He could not done it much worse with a gun. I just
was not going to put up with it. I was going to try to get some
results from it, which, finally, I did, but I was still out
half----
Senator Collins. Still at a loss, though. Mr. Poggi, would
that have been helpful in your case?
Mr. Poggi. Madam Chairman, I think that would have been
most helpful.
Senator Collins. Thank you. I have just a couple of
specific questions. Mr. Murnan, did Mr. Tropeano, is that how
you say it?
Mr. Murnan. Tropeano.
Senator Collins [continuing]. Tropeano ever discuss with
you Medaphis Corporation or QPQ Corporation prior to the
trading of the stock? Did you ever get a prospectus?
Mr. Murnan. He did not, and for months, I did not know what
they were, even. A broker in St. Louis, I told him about it and
he said he would do some research, which he did, and he sent me
information.
Senator Collins. What did you find out about QPQ?
Mr. Murnan. He sent me some data that they had. You know,
they have data on all companies. He sent me this data and it
showed that the all-time high for QPQ was $2.25 per share. He
charged me $2.75 a share, $4,700, which right away is a loss of
$2,350. It was not too much longer after that that he
apparently started selling it. This all happened within less
than 2 months, the buying and all the selling and all the loss.
Senator Collins. Was that the company that owns pizza
parlors in Poland?
Mr. Murnan. Yes. That is what I learned. The company had
two pizza parlors----
Senator Collins. And you found that out through your own
research?
Mr. Murnan. They are doing millions of dollars worth of
stock. This data I received also said that there was much, much
insider trading, buying and selling of this stock before they
hooked me with it.
Senator Collins. Thank you. Mr. Poggi, did your broker ever
discuss with you the risks of investing in Cheyenne Software or
ever provide you with a prospectus or other written information
about the company?
Mr. Poggi. No. There was no written information about any
company or any prospectus. The only thing he ever said was that
the stocks were going to go up and there was no discussion of
any risk whatsoever.
Senator Collins. My final question is for Mrs. Sprecher.
Mrs. Sprecher, it sounds like you were under the impression
that you were doing business with Morgan Stanley, a well-known,
reputable firm.
Mrs. Sprecher. That is right.
Senator Collins. Is that correct?
Mrs. Sprecher. That is correct.
Senator Collins. If you had known that----
Mrs. Sprecher. No, I would not have ever accepted a company
that was that weak. Before that, I had been dealing with Bache
and Company, another great big company.
Senator Collins. So if you had realized that you were not
doing business with Morgan Stanley but rather with Manchester
Rhone----
Mrs. Sprecher. This was taken over by Prudential, another
very well-known company. I would not have ever dealt with those
other companies.
Senator Collins. So you feel that you were misled not only
because of the unauthorized trades, but you were not even doing
business with whom you thought you were doing business, is that
correct?
Mrs. Sprecher. That is right. And when Mr. Baratta told me
that Morgan Stanley was actually taking them by helicopter to
look at something they were interested in in Canada, I was sure
I was dealing with Morgan Stanley.
Senator Collins. I want to again thank all three of you. I
feel bad for the experience you have. Senator Cleland has some
questions, but Mr. Poggi, did you have something you wanted to
add?
Mr. Poggi. I did not know if we were wrapping it up, but I
was thinking, when we have something this outrageous, I mean,
why cannot these young kids which a lot of these brokerage
houses hire to make these cold calls, to get swifter results in
investigating, why can they not be suspended upon investigation
and get them right out of that, get them away from that phone
and computer and let them sit home wondering if they are going
to collect unemployment or where their next move is going to
be, especially if they know they have ripped people like us
off?
Senator Collins. I think you raise a very good issue. I
know that the NASD is here and the State regulators are here,
but I am going to make sure that Chairman Levitt also gets a
copy of your testimony, all three statements. I know he will be
interested, because that is what I am pushing toward, is to
have quicker, firmer, more severe penalties for brokers who
engage in unethical behavior.
The problem we have now is it is relatively easy to get
into the brokerage business, to get into the industry. There
are no educational requirements, as we discussed earlier. There
is an exam, but if you study enough and cram and take it enough
times, you are probably going to pass. So really, the broker
does not have much of an investment in this case. He can just,
even if he gets out of the business, he has made the profit and
that is why I think we need a much more severe approach in the
zero-tolerance policy about which I talked with Chairman
Levitt.
Senator Cleland.
Senator Cleland. Thank you, Madam Chairman.
We are just all delighted that you had the courage to come
and visit with us today. Maybe it will do some good for
thousands of people out there like you who are, indeed, ripped
off, unfortunately, just like you, with these shameful,
dishonest people.
Let me just say, I would like to hear again how much each
of you lost, starting with Mr. Poggi.
Mr. Poggi. Well, I gained $3,000 and then I lost that
$3,000 on the unauthorized trade and probably about another
$3,500 of my money from my cash advances on the credit cards.
Senator Cleland. So you lost a total of, what, about
$3,500?
Mr. Poggi. Right, out of my own pocket, but that $3,000, as
far as I was concerned, I earned that and that was mine, too.
Senator Cleland. You certainly have gone through enough
pain. You sure have.
Mr. Murnan, how much money did you lose?
Mr. Murnan. My investment was $6,040 and I lost $5,748 of
that, so all but $292, I lost.
Senator Cleland. Not to count the suffering and the
emotional turmoil that you went through.
Mr. Murnan. Yes, that is for sure, the phone calls and
letter writing and so forth.
Senator Cleland. Mrs. Sprecher.
Mrs. Sprecher. About $96,000.
Senator Cleland. About $96,000?
Mrs. Sprecher. Yes. I would like to know if the broker
houses would not have to send--say if you were going to buy a
stock, they would have to send you like a buy permit that you
would have to sign and send back to them, especially for the
elderly people. Say they have to return it within 5 days. That
would give them 5 days to think about it, whatever somebody
wanted to sell them.
If a broker would ask a person's age and they were of
retirement age--I do not mean anybody as old as I am, anybody,
say, 70 or older, they want to buy a stock, unless they are
very influential and they have dealt and they have made money
with the company. If you are dealing with another company, a
small company, if they want to sell you a stock, they could get
someone on the telephone who would not even be aware of what
they were selling them and maybe buy it. If they had time to
send it to them and look at it, maybe a prospectus, maybe tell
them what the company did and what the earnings were in the
last few years, if the person still wanted to buy it, they
would have to sign a buy certificate and send it back. That
would give the person, say, 5 days' time to think about it and
also send them a check for it or whatever way they deal with
it.
Senator Cleland. Mr. Murnan, you had a comment?
Mr. Murnan. I had a question. It would be interesting to
know how these brokerage houses get your name, your phone
number, your address, and maybe a Social Security number before
they ever call you. This practice should be checked into, I
think.
Mrs. Sprecher. Everybody sells names.
Senator Cleland. One of the things that I have learned in
dealing with securities fraud is, first of all, just deal with
somebody you know.
Secondly, unfortunately, Mrs. Sprecher and Mr. Murnan, the
people who want to rip people off do focus on those most
vulnerable----
Mrs. Sprecher. I know. I found that out.
Senator Cleland [continuing]. And unfortunately, they are
the elderly and the retired who do have some small amount of
disposable income and then are able to, unfortunately, answer
the phone. Then many people are gullible to go ahead and send
people money that they do not know. That is part of the
problem.
What are some of the steps that you might suggest in terms
of, say, public education, maybe that the SEC ought to think
about or the State regulators ought to think about? Mr. Murnan.
Mrs. Sprecher. I did write it down. Now I do not know what
I did with it.
Mr. Murnan. I forgot what I was going to say.
Mrs. Sprecher. I think I just said what I thought they
should do.
Mr. Murnan. I have been asked, well, why would you buy a
stock from somebody that you do not know, and my answer was,
well, he was good enough to call me at the right time. He came
up with a good stock that I knew about, felt was a good
investment. I figured that this business is so well regulated--
in fact, I never had thought about it, getting ripped off. This
is so well regulated that it does not matter where you buy it.
Callaway Golf stock is Callaway Golf stock, if you buy it in
New York or Chicago, but that proved not to be the case.
Senator Cleland. Because, unfortunately, there are
unprincipled people out there----
Mr. Murnan. I know that.
Senator Cleland [continuing]. Who are determined to rip
people off.
Mr. Poggi, what do you think might have prevented your
experience in terms of, say, investor information or regulatory
authority that might have helped?
Mr. Murnan. Do not answer the phone.
Mr. Poggi. Well, I feel that I should have done a little
bit more investigating than just going down to their office.
They had a nice front, and I was going to get in and out real
fast and make my $3,000. But had I probably sent in or made a
phone call to the NASD and found out what kind of blemishes
they did have on their company, that might have been enough
right there, and really, that is all you have to do, is it is
all public knowledge, any broker or any company, and it really
is up to us to do our homework and find out who we are dealing
with. It is available. All we have to do is call the NASD.
So if we have the phone number on a bill or something, or
like they said before, maybe send them--I think you said
before, before they cold call, send you a piece of literature
with phone numbers and who you are and everything and that
ought to eliminate a lot of riff-raff. Then you have those
numbers. It is like, hey, here is a number. Check me out. Call
the NASD and find out who I am, or whatever. If they do not,
then that red flag goes up and watch out. But it is available.
Senator Cleland. In terms of my experience in Georgia, we
always advised people to just ask the first question, that was,
are you licensed by the Secretary of State in Georgia? That
usually ended the conversation on these kind of matters.
Secondly, Madam Chairman, did not the Chairman of the SEC
put forward a 1-800 number of some kind that he wanted to get
out?
Senator Collins. He did, indeed.
Senator Cleland. He wanted to receive more and more calls
there from investors that might have a problem or might want
some information about investing.
Correct me if I am wrong. Did I hear that all three of you
were positive, basically, in terms of your dealing with State
regulators? You got either a phone call returned or quick
response or some help or something? Is that right, Mr. Poggi?
Mr. Poggi. Yes, that is correct. When I contacted the NASD
right after Pat Boyce had purchased my stock, or the stock that
I did not authorize, I got right on the phone and I was
handwriting a letter. I mean, literally, you just have to
document something. But I figured, now my stock certificates
were going to be sent to me and Vince Grecco said that that was
going to be up to 10 weeks. It actually was about 4 to 5 weeks,
and NASD did not do anything. I think they are inundated with
all kinds of problems. I was pretty much on a list.
So it was not until after I had received my stock
certificates and sold them that I went to the New Hampshire
Securities and Exchange and then we really began the fight to
get my money back and try and get these guys thrown out of
business.
Senator Cleland. Mr. Murnan, what was your experience with
State regulators?
Mr. Murnan. Mine?
Senator Cleland. Yes, sir.
Mr. Murnan. They were most helpful. In fact, they were
instrumental in me going to New York, where the District
Attorney had a similar program to this and the news media was
there. In fact, they went into this L.T. Lawrence and Company
and went through the records and found they had had about 300
complaints, and on this particular Tropeano man, they had 15
complaints on him. Those were not all in Missouri, I guess, but
none of them were reported. They just all went unknown.
Senator Cleland. Mrs. Sprecher, what was your experience
with State regulators?
Mrs. Sprecher. With who?
Senator Cleland. State regulators, your State?
Mrs. Sprecher. Positive. I thought they had sent letters to
Investors Associates and really pushed them. They are out of
business now.
Senator Cleland. OK.
Mrs. Sprecher. But they just changed their name, as far as
I know, and they are back in business.
Senator Cleland. Madam Chairman, I will just wrap up my
part of the program here by just saying that when I was growing
up in Georgia as a young boy, I used to watch something called
the ``Ted Mack Original Amateur Hour'' and they used to say,
``The number in New York to call is . . . '' In this case, we
have the Chairman of the SEC giving us a 1-800 number for
investor protection, anybody interested in calling it, 1-800-
289-9999. We are not dealing with amateurs here. These are
professional rip-off people. Thank you very much.
Senator Collins. Thank you, Senator.
I want to echo the Senator's comments that I think it is
highly significant that each of these consumers found that when
they called State officials, that they got some help. You and I
both have experience in that area and know what important roles
State regulators play, as well.
I want to thank you so much for sharing your experiences
with us today. I know that they have been very painful
experiences and I really feel bad that you have had to go
through this. But through your bad experience, I believe we can
bring about some improvements in the system, so thank you very
much and good luck to all of you.
Mr. Murnan.
Mr. Murnan. Could I just tell you one more little thing?
Senator Collins. Sure.
Mr. Murnan. To add irony to the end of this, if he had not
sold my Callaway Golf stock, it would now be a paper profit of
$1,000.
Senator Collins. Is that not awful. Thank you very much.
Senator Cleland. Thank you all.
Senator Collins. Our final panel of witnesses this
afternoon includes Joseph Borg, the Director of the Alabama
Securities Commission and member of the North American
Securities Administrators Association, and Barry R. Goldsmith,
the Executive Vice President of NASD Regulation. We are very
fortunate to have this panel with us today. They represent the
States and, obviously, NASD and will be able to provide the
Subcommittee with an overview of their respective enforcement
missions.
As the witnesses are getting settled, I will continue the
introductions. The first witness is going to be Joseph Borg. He
is, as I mentioned, Director of the Alabama Securities
Commission. He is responsible for the direction and supervision
of the Statewide agency involving the registration of
securities dealers, agents, investment advisors, and investment
advisor representatives, as well as the enforcement of civil
and criminal statutes under the Alabama Securities Commission.
He has considerable investigative and litigation experience and
played a leading role in putting out of business one infamous
firm, Stratton Oakmont.
We will also be hearing today from Barry Goldsmith, the
Executive Vice President of NASD Regulation. In that capacity,
Mr. Goldsmith is responsible for formulating the enforcement
policy of the NASD and its over 500,000 individual registered
representatives. The creation of this new subsidiary was one of
the several major new recommendations made by the Select
Committee on Structure and Governance, headed by former New
Hampshire Senator Warren Rudman.
As I mentioned, all of our witnesses are sworn, pursuant to
Rule 6 of the Subcommittee, so if you would please stand as I
administer the oath.
Do you swear that the testimony you are about to give
before the Subcommittee will be the truth, the whole truth, and
nothing but the truth, so help you, God?
Mr. Borg. I do.
Mr. Goldsmith. I do.
Senator Collins. Thank you.
Mr. Borg, we will start with you, now that we have had all
these accolades to State regulation.
TESTIMONY OF JOSEPH P. BORG,\1\ DIRECTOR, ALABAMA SECURITIES
COMMISSION, AND MEMBER, NORTH AMERICAN SECURITIES
ADMINISTRATORS ASSOCIATION, INC. (NASAA)
Mr. Borg. Thank you, Madam Chairman and Senator Cleland. I
am Joe Borg, Director of the Alabama Securities Commission, and
I do, on behalf of NASAA, welcome the opportunity to
participate in your oversight hearings on the growing problem
of fraud in the sale of small company stocks.
---------------------------------------------------------------------------
\1\ The prepared statement of Mr. Borg appears in the Appendix on
page 158.
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I am representing NASAA, which has led numerous enforcement
efforts in this area, and I commend you for the timeliness in
holding a hearing on this important subject. As mentioned by
Chairman Levitt and Senator Cleland earlier, I believe, over
one in three households now are investing in the capital
markets, up from 1 in 17 in 1980. Securities fraud has a
profound impact on a great number of working families. That has
been demonstrated here just a few moments ago.
I have been involved in the securities markets for about 15
years as a partner in a law firm, as a State securities
regulator, and as an actual investor. I am here today to
discuss the very serious and growing problem of fraud in what
has been termed the micro-cap market. Daily, it threatens
investors across the United States with losses of millions of
dollars.
Moreover, in my opinion, this threat casts a shadow on
every financial institution in our markets today. One of the
unreported costs of this problem is the millions of dollars
intended to seed new businesses that end up in the pockets of
swindlers rather than creating new jobs, and its consequences
are also increased distrust of the markets by the grassroots
Americans that support the entire market.
I am actually speaking about the efforts of small
unscrupulous firms who use sophisticated scripts and an army of
cold calling solicitors and brokers to sell micro-cap stocks to
investors by any means, including false and fraudulent
misrepresentations, dishonest and unethical sales practices,
and I would agree with Senator Cleland, as the neighboring
State, we call it like you call it. It is lying, cheating, and
stealing.
On May 29, 1997, at a news conference with the New York and
New Jersey Attorneys General, NASAA announced that 20 State
securities agencies had filed 37 actions against 14 of these
firms. That announcement was phase one of what is going to be
and will continue to be the biggest nationwide crackdown ever
by the States aimed at brokers fraudulent selling stocks over
the phone.
That announcement resulted from a directive from the NASAA
office that created a strike force represented by 12 States. In
February, audit teams comprised of examiners from these States
struck five preselected firms in the New York metropolitan
area. Concurrently, other States conducted similar
investigations, and ultimately, 20 States participated in the
actions, with NASAA serving as the coordinating council for
this nationwide crackdown.
One of the targets, the brokerage firm of Investors
Associates, was subject to 15 State actions. To date, Alabama,
California, Indiana, Massachusetts, New Hampshire, Oklahoma,
South Carolina, and Texas have revoked the license of Investors
Associates and Ohio recently denied its application for a
license.
State securities examiners confirmed that employees of the
targeted firms pressure their victims into buying stock in
unknown companies by reading from scripts. The brokers and cold
callers know little or nothing about the companies they are
paid to hype. I would like to add at this point that these cold
callers are unregulated, unlicensed.
Here is an excerpt from one of the scripts taken from a
trash can at a brokerage house on Long Island. It is the sale
of micro-caps that is a planned and choreographed production.
In fact, the script begins with the stage instruction to
``speak slowly and nonchalantly''. Here is what they say.
``Two or three times a year, we at Investors Associates get
our preferred clients involved with a niche area of the market
where we can potentially turn a 6, 7-figure profit within the
course of a few trading hours, more specifically, what we call
initial public offerings.'' Now, after providing a little
detail about a particular stock, which is generally hype, the
script goes on to say, ``In other words, a return of 100
percent in 20 minutes perhaps sounds a bit unrealistic, but
that is exactly how our IPOs work. We did three deals last
year, yielding collectively 34 points within the first 10 days
of trading and that is a fact.'' That is out of the script.
Of course, once enough shares are sold and the price is
driven high enough, insiders sell the stock, creating a price
slide, making fortunes for themselves and wiping out the
savings of innocent investors. In the vernacular of the
industry, this is called the pump and dump. Although the
unknown companies being peddled are small, it is not their size
that is dangerous but the dishonest way that their stock is
represented and sold.
In the course of NASAA's sweep, State examiners discovered
four systemic abuses by the targeted firms. These include,
first, trading abuses, and you have heard this today. Our
examiners found an army of unlicensed solicitors who are
accused of falsifying records, conducting unauthorized trades,
and failing to complete trades. These are the tools of stock
manipulation and securities fraud.
Second, failure to report investor complaints. State
examiners found hundreds of unreported investor complaints.
Most of the offices audited failed to have centralized
procedures for handling and reporting customer complaints, as
required by regulation. The consumer complaints were just
gathering dust in some corner or on some shelf, totally
ignored.
Third, evasion of broker-dealer registration requirements
through the use of third-party franchise agreements. Rather
than acting as a legitimate branch of a broker-dealer, these
franchises operate independently with no central compliance, no
supervisory procedures, no oversight, as is generally the
industry practice. While they operate independently, they do
not have independent capital nor independent bonding upon which
the investing public can rely. When a broker-dealer or its
satellite offices are not properly registered, that is a sure
sign that something is terribly wrong.
Fourth, abusive cold calling practices. Most of the firms
and branches relied on high-pressure scripted telephone cold
calling techniques that include falsifying experience and
performance as well as other outright lies. This is the key to
the scheme. Without the high-pressure cold calling, the rest of
the illegal scheme would never succeed.
Again, we are talking about a small segment, a very small
segment, of the broker-dealer industry. However, the dollars
are phenomenal.
Unquestionably, as you heard from one of the witnesses
earlier, the use by unscrupulous broker-dealers and their
agents of a prestigious type New York, Wall Street-type name
and address still tends to create an air of legitimacy and the
promise of a golden opportunity, not only for the unwary or
inexperienced investor but, in my experience, in many cases
also for more well-educated and more sophisticated investors.
This is especially true when the lesser-known brokerage firm
markets a recognizable clearing firm name as a way to impress
investors and gain their confidence. This is a confidence game.
I am confident, Madam Chairman, that these hearings will
uncover numerous examples of high-pressure boiler room sales
practices, misrepresentations, unsuitable sales, failure to
execute trades, trading in accounts without authorization, and
in a number of cases, out and out threats.
But I do not want to focus on more problems of the victims
and what type of problems they incur, but I would like to take
a moment to go through a specific detailed study to show how
the manipulation occurs and also to present for your
consideration indications of generational networking among
these firms. We are going to talk a little about a history and
progression of networking that continues unchecked today.
Looking at the Steve Madden chart--now, Steve Madden is the
name of a shoe company that was brought public by IPO--there
was a big group of States, including a major player from
Senator Cleland's State of Georgia, that worked on this
project. Looking at this chart, you will notice, for example,
that the time line shows the creation of 10 million shares of
stock from 200. Now, this is all prior to public offering and
before the public gets involved, 10 million shares from 200. At
the same time, a $100,000 bridge loan was made by three
individuals who are the principals of Stratton Oakmont, or were
the principals.
As we go through the chart, a plan and scheme of bridge
loans and transitional shares, inside purchasers--the first
initial shares were sold to 16 purchasers, 12 of whom were
Stratton Oakmont insiders. The bottom line is, the stock went
from less than $.50 a share to an offering price over $5 to the
public, with the insiders making a profit. What is not shown at
the IPO level, when it goes out to the public, there was $5.1
million of promissory notes still owed to the principals of
Stratton Oakmont.
What came to my attention this morning is that those
principals are now trying to collect on that $5.1 million. I am
not sure what effect that will have. I did notice that last
Thursday, there was a filing with the SEC for Mr. Jordan
Belfort, the former principal of Stratton Oakmont who has now
been barred from the industry, to acquire almost 900,000 shares
more. The cost or source of funds was undisclosed. I do suspect
it is those promissory notes that are now showing up at this
late date.
If we could change the chart, I would like to point out
that of the Steve Madden initial public offering of
$12,500,000, 52.3 percent went to insiders and friends of the
insiders. I suspect that most investors, if they knew that
almost $.52 of their dollar was going to the pockets of
investors, would have a second thought about investing in that
company.
What that first chart does not indicate is the effect of
that $5.1 million, that if it gets collected, if it has to be
paid from Steve Madden assets, the proceeds to the company will
decrease from 52.3 to 11.3 percent. We are talking, out of $12
million, only $1.5 million getting to the company, supposedly
to increase the company's earning capacity and make a return
for the investors.
If we can go to the next chart, I would like to point out
this chart here is a generational networking analysis. Under
Stratton Oakmont, I have three individuals, the first of which
is Jordan Belfort. Mr. Belfort came from Investors Center. The
idea behind this chart is, if you track agents, starting at
First Jersey and working all the way down, First Jersey being
the Robert Brennan notorious penny stock promoter, and going
all the way down, agents become principals, get barred from the
industry after making, in Mr. Jordan Belfort's case, about $84
million, and move on to their agents, who become sales
professionals and then form their own companies, and it
continues on and on and on.
The conclusions are obvious and inescapable. You cannot
ignore them. The abuse in this area continues to grow. As
regulators pursue and shut down one firm, another or even
several emerge to take its place. The lying, cheating, and
stealing, as Senator Cleland stated earlier, continues
unabated.
Thankfully, Stratton is gone. Belfort is out of business,
and so is the other principal, Danny Porush. However, this does
not solve the problem, and it is said that those who do not
learn from history tend to repeat it. I think we have been
repeating history.
These losses are unacceptable, and unless regulators are
given necessary enforcement tools and resources to strike at
the individual agents with both civil and criminal sanctions,
the infestation in our markets will continue. We must
discourage rogue broker entrepreneurs by bringing criminal
cases. Prosecute the trainer. Let it be known that the cost of
business just went up.
Rogue brokers of firms will agree to pay a civil fine of
$100,000 or even $1 million as the cost of doing business as
long as they can continue to bilk the investors of tens of
millions of dollars. Again, this is just unacceptable.
We have heard that $6 billion is lost through these
fraudulent practices. Whether that is high or low is
immaterial. Those kind of losses of any type of amount is
unacceptable.
We would recommend three phases. Front-end protections, for
example, would be important. We recommend that the SEC consider
adopting the use of State enforcement actions to disqualify
persons based on those State orders by interpreting the
language in Section 3(a)(39), which States basically that the
Commission can utilize ``other appropriate regulatory agency
information''. That could mean State security agencies. If the
State has issued an order against a broker-dealer or a broker-
dealer-agent, I see no reason why that cannot be used by
Federal prosecutors or Federal agencies or the NASD as a
disqualifier.
The continuation of State licensing procedures is
absolutely important. It is the first barrier against entry of
fraudulent brokers and broker-dealer-agents into the market.
This is absolutely critical, I think, and I commend Chairman
Levitt for recognizing the importance of State licensing
authority.
Ongoing protections, we would recommend that the role of
the clearing firms be examined. It is important that clearing
firms have some responsibility to the industry and the
investors for whom they clear. Also, a disturbing trend has
been in the area of omnibus clearing arrangements, which are so
generalized as even the clearing arrangements do not know who
they are clearing for. We are very seriously concerned about
this trend.
Also, books and records. There is a proposed rule for books
and records requirements for broker-dealers under the
Securities Exchange Act of 1934, which was originally released
October 22, 1996. The SEC, in my opinion, has recognized the
importance of books and records for use by the States in
regulatory and enforcement actions. We believe the time is ripe
for SEC adoption of a meaningful and agreeable Federal books
and records rule that closely tracks the October 1996 release.
Lastly, after the fact. SIPC is 27 years old. It is time
for a review. This Act has not been amended since 1970 and the
question is, is the protection still sufficient coverage for
the investors? Should consideration be given to raising the
payment levels, and should actions other than a firm's
financial failure be the cause to trigger coverage?
Lastly, I am pleased by Chairman Levitt's comments
recognizing the value of State licensing powers, which
authority is on the forefront of protecting our markets and
investors, and I am ecstatic that the Chairman today announced
a new drive to combat this insidious problem. I can assure
Chairman Levitt and this Committee of my and my colleagues at
NASAA's commitment to assist in the war to protect the markets
and the investors because these markets and these investors
have served our great country so well. Thank you.
Senator Collins. Thank you, Mr. Borg.
Mr. Goldsmith.
TESTIMONY OF BARRY R. GOLDSMITH,\1\ EXECUTIVE VICE PRESIDENT,
NASD REGULATION, INC.
Mr. Goldsmith. Thank you, Chairman Collins. I am very
pleased to be here and thank you and the rest of the
Subcommittee and Senator Cleland for the opportunity to testify
about the micro-cap fraud problem in U.S. markets and our
efforts to address it.
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\1\ The prepared statement of Mr. Goldsmith appears in the Appendix
on page 252.
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Sitting here today listening to the three investor
witnesses who preceded me has done more to convince me than
anything I have heard at this hearing that we, as regulators,
need to do more. We have to look at fresh approaches at
addressing this problem.
I readily acknowledge that there are some dishonest
individuals and firms in the securities business today.
However, let me also say that the overwhelming majority of
securities professionals and individuals in the industry today
are honest and ethical and treat their obligation to comply
with the law seriously, and as they should, put the individual
investor's interest first.
The problem firms that we have heard about today represent
a tiny portion of the more than 5,500 securities firms in this
country and are, for the most part, firms that concentrate
their activities in the securities of thinly-capitalized micro-
cap companies. While many of these smaller companies offer good
invesment opportunities for public investors, sales of
securities of these companies are also susceptible to the
abusive practices that we have heard so much about today. We
see too much in the way of misrepresentation, manipulation,
phony guarantees, phony promises and unauthorized trades. It is
in this area, of micro-cap thinly-traded securities, that we
see the greatest growth in fraudulent activity today.
I would like to spend a moment talking about NASD
Regulation's enforcement record. As these hearings demonstrate,
we have to redouble everything we have been doing in the past.
NASD Regulation has already begun to do so, with major
investments and new staff and surveillance systems being made
now and budgeted for in the future. These enhancements have
increased both the numbers and impact of our enforcement
actions, as well as the effectiveness of the sanctions we have
obtained.
I have described some of our recent enforcement actions in
my written testimony. We have sanctions guidelines that are now
under review and are going to be totally revamped. Last year,
we brought 1,200 disciplinary actions, threw nearly 400 brokers
out of the business. This year, we are running about 18 percent
ahead of that in terms of barring individuals from the
business.
The priority in every case that we bring against offending
firms and individuals is to make restitution to injured
investors. In two recent micro-cap cases that we brought just
last month, D.H. Blair and GKN Securities, more than 4,300
investors in 48 States will receive more than $3.8 million in
restitution and interest.
Stratton Oakmont, a firm that we heard so much about today,
was thrown out of the business by NASD Regulation in December.
This is a prime example of how the States and the SROs and the
SEC can work together. The NASD decision expelling Stratton
Oakmont specifically made reference to securities actions
brought by 19 States, including the State of Alabama. I am
against regulatory duplication, but in certain cases, a little
duplication is not a bad thing.
The Subcommittee has expressed particular interest in how
we assure that past offenders do not repeat their violations.
We accomplish this by giving regulators and investors
information on past violations, punishing repeat violators more
heavily, closely monitoring the firms that hire past violators,
and requiring heightened supervision of any brokers with a
significant disciplinary history.
Our sanctions guidelines already provide for significant
escalating sanctions against recidivists. Where we see barred
brokers reappear on the fringes of our industry as unsavory
stock promoters and people who are beyond our jurisdiction, we
refer those cases to the SEC and to criminal law enforcement
authorities.
We cannot arrest people. We cannot put people behind bars.
But the NASD has the manpower and the technical expertise to
assist criminal prosecutors around the country to do their
jobs. Recently, we have noticed increased interest by State and
local criminal prosecutors in tackling these cases. With
appropriate training and help from the regulators, we believe
they can do just that and these cases are going to be brought.
We have made micro-cap a prime focus of our regulatory
program, but we have to do more. The NASD is actively studying
this market, particularly the over-the-counter bulletin board,
where many of the securities that we heard about today are
traded. We are going to make the changes that are necessary to
address the problems we see.
While the bulletin board provides a marketplace with real
time price and volume information, investors need to have
access to more accurate and current information about the
companies whose shares trade there. Too often, the only
information investors have is the misinformation and hype
posted on a stock promoter's Web page or the pie-in-the-sky
promises made by brash cold calling brokers.
We are going to propose a number of initiatives in that
area. First, we must take a hard look at whether there should
be higher threshold standards for including a stock in the
over-the-counter bulletin board. We will look closely at
whether a company that is either unwilling or unable to provide
full and timely disclosure of information to the public and to
regulators should be given quotation visibility on this
electronic medium. Such a proposal could limit quotation on the
OTC bulletin board to companies providing and filing periodic
reports with the SEC and other financial regulators.
Second, we are going to work with the SEC to strengthen the
tools that we have to keep the shares of bogus companies from
being traded in the over-the-counter market in the first place.
This can be accomplished by toughening and clarifying the rules
we have to prevent broker-dealers from initiating or continuing
to quote an OTC security when they do not have current,
reliable financial and other information about the issuer.
Third, we are also considering a rule to prohibit a broker
from recommending an OTC security unless he or she also has
first reviewed the issuer's current financial statements and
believes that they are accurate.
Fourth, we are considering rule changes that would place
tough new requirements on brokers, beyond the existing
suitability requirements, to confirm with their customers that
purchases of these types of speculative over-the-counter
securities are suitable, given the customer's age, experience,
and investment objectives. We are looking at requiring brokers
to disclose to their customers specific information about these
types of investments and explain to them the differences
between the over-the-counter market and the Nasdaq stock
market. We will determine if there is an increased need for
regulation on the operation of the bulletin board, such as to
give the NASD the authority to halt trading or halt quotes of
securities under certain circumstances.
Finally, we must be more proactive in educating investors
on the specific and unique characteristics of the OTC equities
market. We have already begun a program to educate investors
about the OTC bulletin board, the pink sheets, and other
quotation media.
I would like to talk about some of the new rules that we
have initiated and those that we are proposing and have under
consideration. We feel that these rules will have a very strong
impact on investor protection in this marketplace. First of
all, with respect to clearing firms, a focus of these hearings,
and we have heard testimony today about how one of these
brokers used Morgan Stanley's name in order to attract Mrs.
Sprecher to invest. The focus of these hearings has been the
increasing responsibility of clearing firms for notifying
regulators of problems with introducing firms.
We are working closely with the SEC and the New York Stock
Exchange, to impose new reporting responsibilities on brokers
that clear trades for these smaller firms. These proposals
would require clearing firms to provide information that will
allow self-regulators to better monitor the smaller firms for
which they clear trades--the introducing firms.
Our boards will soon be considering proposals to require
clearing firms to report to their designated examining
authority, either the NASD or the New York Stock Exchange, the
written complaints that they receive on introducing firms and
to forward these complaints to the introducing firms, as well.
This will help get at the problem that Mr. Borg identified of
complaints that are being deep-sixed and put on shelves that
nobody sees. This is a double check and additional information
that we need.
I would like to talk about taping. Taping has a salutary
effect. When we succeed in putting a recidivist firm out of
business, we think that our job is not over. We have heard
testimony today about principals of firms who we expel turning
around and forming new firms under a different name, or other
times the firms move en masse to a branch office of an existing
firm. When a large number of brokers like these become employed
at another broker-dealer, this raises a real risk that their
new firm will have significant sales staff who may not yet have
forgotten their old bad habits.
In addition to our other enforcement efforts against repeat
offenders, the NASD board this month sent to the SEC for its
review, and hopefully approval, a rule that would require
brokerage firms to tape all customer sales calls for 2 years if
a specified percentage of the firm's brokers worked for firms
that have been expelled for telemarketing fraud or sales
practice abuse.
Cold calls, telemarketing, we have heard stories today that
turn my spine cold about cold calling. These tactics are often
used to induce investors to purchase stock over the telephone
from a broker they do not know and probably would not want to
know if they met him or her. We have adopted telemarketing
rules, and in a related initiative, we now have out for comment
to our members a rule that for the first time would require all
persons who make cold calls to be registered security sales
representatives.
Right now, as I speak, there are firms who are using
unregistered staff, people who do not have to pass NASD
examinations or undergo the education that is required to make
calls to investors. The proposed rule will assure that those
making the cold calls are aware of our rules and subject to our
regulation and sanctions.
We are also developing a new Internet search engine that
will help combat Internet fraud, and obviously we are working
on new initiatives to give investors more information that they
want. One of the comments that Chairman Collins made about
putting phone numbers on brokerage statements is something that
I definitely want to consider. Right now, we are talking to a
number of major utilities on the East and West Coasts to use
envelope stuffers to put this kind of information in the hands
of the type of audience we must reach. We need to be marketers.
We need to be effective. Publishing an 800 number that nobody
remembers is not enough. We need to do more.
I would be happy to respond to any questions you might
have.
Senator Collins. Thank you very much, Mr. Goldsmith.
I commend you for the steps that the NASD is taking to
further regulate the bulletin board, to look at that issue,
since I think a lot of people, given the bulletin board's link
to Nasdaq, assume that it provides the same kind of stability
in terms of disclosure and listing requirements as the other
NASD markets. I also commend you for the other rule changes
that you have just described to us that are under consideration
involving among other clearing firms and cold calling.
But as I said to Chairman Levitt, in the end, I think this
comes down to an issue of the confidence and the ethics of the
people in the industry. As I said in my opening comments, the
vast majority of brokers, and you have underscored that, are
ethical. We do have, however, a persistent minority that no
matter what we seem to do from a regulatory or legislative
perspective just keep popping up and that is why I want to
pursue with you the questions that I asked Mr. Levitt.
I am not kidding when I say that in the State of Maine, it
is easier to get a license to be a stockbroker than it is to
become a cosmetologist. A cosmetologist has to have a high
school education, has to have undergone specialized training,
has to take both a written exam and a practical exam, has
continuing education requirements every 2 years, and yet,
obviously, the consequences of someone who is a licensed broker
for an unwitting, unsophisticated investor who is given bad
investment advice are so much more severe.
Do you think that the competency levels for brokers are
sufficient? Is entry into the industry too easy?
Mr. Goldsmith. I really do not think that the problem rests
with how difficult the exam is. In fact, we brought cases, I
believe, against 52 individuals who felt that it was too
difficult and they got somebody who they paid to take the exam
for them. That is something that, hopefully, will not happen
again.
But I think what we need to do, I agree with your comment
about increasing sanctions for the bad apples. We see too many
cases where firms, as a cost of doing business, will pay $1
million fines and go on to, in a sense, rob Peter to pay Paul.
Even in cases where arbitration systems are set up, we
sometimes find that these firms are paying old investors 10
cents on the dollar with new investors' money.
I do not think, though, that toughening the exams will
necessarily stop that problem. I think you hit it on the head,
that these are really ethics we are talking about and we have a
lot of very smart crooks in the business who would be able to
pass just about any reasonable exam that could be taken.
So I think we need to concentrate on getting the bad people
out, educating investors, and looking hard at cases and saying,
is this a firm or is this an individual that we want to, in a
sense, live another day with other investors, or are we going
to draw the line here and try to get them out of the business?
Sometimes with numbers of cases and burdens, it is something
you have to look back on and make the decision to bite the
bullet.
Senator Collins. I think that is a critical issue. I think
the NASAA issued a report that was quoted in the House report
accompanying the 1990 penny stock legislation that said in one
study, something like 83 percent of the people who were working
for firms with trouble had a previous history of violations of
securities laws. That again raises the concern to me of whether
we are tough enough and whether we should have a zero tolerance
policy. For example, if there is a serious breach of ethics,
you are out, or you are at least out of the industry for a
significant period of time. What is your reaction to that?
Mr. Goldsmith. I think, as I said, our sanctions guidelines
are being reviewed from top to bottom. We have a committee made
up of staff members, industry members, and committee members,
looking at our guidelines. I think there has been an
appreciation that we have ratcheted up our sanctions.
We have also, as part of the joint regulatory sales
practice sweep that the SEC, NASAA, and the NASD did last year,
issued a notice to members requiring heightened supervision of
brokers with disciplinary histories. And one thing we are doing
that I think has a very beneficial effect, particularly now as
CRD is going to become more investor-friendly and enable
investors to get information on brokers, is bringing cases and
drilling down to low levels in terms of brokers. We are not
just suing the top two or three people in the firm.
A.R. Baron is a case that we have heard a lot about. There
have been indictments by the Manhattan District Attorney's
office and we have sued 23 brokers there. GKN, a case I
mentioned, 29 brokers. H.J. Meyers, which I think is right
there on Mr. Borg's chart, more than 35 brokers. What we want
to do is tag these brokers, and these may not be brokers who
have committed capital offenses, but tag them with disciplinary
histories so when they go from firm to firm, that is known to
their new firms. When investors get a call and want to check
out the broker, they will see that this is a broker who has
been disciplined. That is something, I think, that is going to
have an effect.
Senator Collins. Let me follow up on that very point. You
just mentioned A.R. Baron, and in your testimony you mentioned
enforcement actions taken against Hibbard Brown. These are
firms that, it is my understanding, are no longer in business,
is that correct?
Mr. Goldsmith. Yes.
Senator Collins. With respect to each of those firms, do
you know how many brokers worked for the firm and how many of
those brokers are still in the industry? You mentioned that you
are suing further down, but are a lot of the people who worked
for those two firms still in the business and are they subject
to any sort of special ongoing scrutiny by either NASD or their
new firms, if they are still in business?
Mr. Goldsmith. A firm that we expel, our taping rule, if it
is approved, will come into effect. And one thing that we do,
we have an examination program and we had over 2,400 main
office exams last year and cause exams based on customer
complaints, 5,200. When our examiners go into firms, we are
aware of the brokers who are there and we are aware of their
past affiliations and those are red flags for us, as well.
So we do keep track of where brokers go. I think you will
find that in many of these firms, particularly some of the
younger brokers end up going into the used car business when
their firms go out of business. Also there are a fair number
that just scatter. But sometimes we hear that there is a
nucleus of brokers going to firm XYZ. We will go into that firm
and we will look around. It is a piece of regulatory
intelligence that I think is very important and one that we
use.
Senator Collins. Mr. Borg, earlier today, and I know you
were here for the testimony of our consumer witnesses, we heard
two of the witnesses, Mrs. Sprecher and Mr. Poggi, were the
victims allegedly of outrageous conduct by a firm called
Investors Associates. I wondered if you are familiar with the
firm, whether or not you know what its status is now and
whether there was a sufficient regulatory response, in your
judgment.
Mr. Borg. Investors Associates was suspended, their license
revoked in Alabama, I believe either December of 1996 or
January of 1997. It is my understanding that Investors
Associates still maintains its NASD license. Its license has
been revoked in at least 10, perhaps 12, States, and some of
the people of Investors Associates have moved on to other
firms, including some of the folks that were mentioned today.
I would point out, as I was listening to the testimony
today, I recognized a number of these names, these individuals,
such as Mr. Baratta, who came from Investors Center, which is
on the chart, and Mr. Bleich, who came from Duke Associates,
and Mr. Tropeano, who came from Continental Brokers, which is
on a subsequent chart in the submitted materials. Mr. Grecco is
well known. He is both from Investors Center and Stratton
Oakmont. So this, I think, proves the point. Mr. Spitzer was
also mentioned as one who took over the Sprecher account. He is
formerly with GKN. So I think this shows the pattern that goes
on.
Has there been sufficient response? That is a tough
question. I do not believe--I would prefer a stronger response,
and I think, as this program of working together on the micro-
cap attack, as Chairman Levitt mentioned today, including
joining with the NASD, perhaps the State concerns on the extent
of the regulatory attack can be increased, especially if there
are some other indications, such as cold callers who have to be
registered.
If they are not registered, they are not on the CRD. If
they are not on the CRD, I do not know about them and there is
nothing I can do except bring a criminal action. I cannot
revoke the registration or suspend it; they are not licensed.
So I am pleased to hear Mr. Goldsmith today talk about
enforcing a regulation or proposing a regulation to that
extent.
I do think that regulatory actions by the SEC, the NASD,
and the States--we fall into this category, as well--in the
past have concentrated on the principals and the firms. I do
not think that, historically, any of the regulatory agencies
really recognized the progression, as you will, or the
generational networking that existed until recently.
I do believe that there has to be greater response up front
prior to the time, for example, that Mr. Belfort and Mr.
Greene, who are on their yachts now, have taken several hundred
million dollars and are now out of the business. It is a little
late.
Senator Collins. It is incredible to me--and your tracing
the patterns of employment of these individuals just
underscores the point--it is incredible to me that these rogue
brokers can just keep popping up over and over again and that
we are not taking action to bar them from the industry. I am
just perplexed by that, because you know that they are going to
go on to victimize other people, similar to the people we have
heard from today.
Mr. Borg. And that is why I recommended that if the NASD
and the SEC could utilize a State order, to the extent that it
could utilize orders between NASD and SEC, to prevent these
brokers from continuing in the industry or at least suspend
their operations until such time as a full review could be
made, I think that would go a long way to preventing the
further transfer from place to place.
Unfortunately, the CRD system does not trigger our notice
at the State level until there is a firm transfer, and if it is
a mass transfer, then that means we have to go through one by
one, and we try to do that, but the States do have limited
resources.
That is why it is so important, and I heard Chairman Levitt
state today that they have all this information, but it is hard
to prosecute. Well, it is easier for the States to prosecute,
but I do not have the resources and information he does. It is
a combination of the SEC and the NASD, with their resources and
their information and their expertise and our ability to get
into State court in a quicker manner, perhaps, than the U.S.
Attorney's Office or the Department of Justice, but a
combination of all these factors is what it is going to take to
drive these people out of business.
Senator Collins. Thank you.
Senator Cleland.
Senator Cleland. Mr. Borg, it is good to see you.
Mr. Borg. Thank you, sir.
Senator Cleland. Mr. Goldsmith, thank you very much.
Let me just follow up on that point. I think you really hit
the nail on the head there. I mean, what we have here is a
troika with the SEC and then the NASD and then the States,
three levels, certainly two levels of government and one
involving the private sector there, all having to work hand-in-
glove to track down and nail and prosecute and put in striped
suits--broad stripes--bad guys or bad gals. They are pretty
elusive.
I can remember being Secretary of State in Georgia. We put
together a 6-State task force to crack down on some boiler
rooms out in Orange County, California. You just referred to a
20-State effort--was it not 20 States?
Mr. Borg. Yes, sir, the May sweep.
Senator Cleland. Yes. I think that is quite incredible.
I just want to come back to the role of the States.
Obviously, you have some defenders here who think the role of
the States ought to be a strong one, but you just mentioned
right there at the end your ability to get into State court
quickly if you had some help from others, NASD or the SEC in
terms of information. Is that correct?
Mr. Borg. Yes, sir, I believe so. My State brings a number
of actions every year. I think last year, we brought 30
criminal actions. I have something like 36 or 38 defendants
awaiting trial right now on charges, not necessarily micro-cap
but general securities fraud, whether they are non-existent
stock or investment advisors who have ripped off pension
accounts.
But the thing is, on this micro-cap, because of the time
and effort it takes--you may recall that time line on the Steve
Madden chart with the creation of the bridge units and the
selling of the private placements. This is information that is
the expertise of the NASD. If that could be combined with
getting the complaints to us quicker, because sometimes they do
end up at the NASD as opposed to the States, we would like to
facilitate a greater exchange of that information, and I think
we are doing it. It has started on a district level.
Then if the NASD would refer to us those complaints as soon
as they hit and if we can find sufficient basis in our State
law, I think the Attorney Generals or the District Attorneys,
or in our agency case, we prosecute our own cases most times
with the assistance of the DAs and the AGs, we could get into
court a lot quicker on a good criminal case.
In some cases, the determination may be there is not quite
enough to meet the burden of a criminal case, because as you
know, it is a much higher burden than revoking a license or
suspending them from business, and that is a decision that is
going to have to be made on a case-by-case basis.
But with the information from the SEC and the NASD,
combined with the cop on the beat, as Arthur Levitt has
referred to the States, abilities to get into court, I think
you would see an increase in criminal prosecution. I think you
would also see a speeding up of the process of revocations of
licenses and suspensions, and if the SEC and the NASD would
honor those suspensions of licenses, I think you would see a
quicker response.
Senator Cleland. Do you think criminal prosecution is the
ultimate deterrent?
Mr. Borg. Yes, sir. If I can give you a quick example of
what I think happens, and I was not a personal witness to this,
but one of the people we interviewed with regard to the
Stratton case indicated that at one point in time, one of the
principals in the boiler room, which is a big board room where
they had 250 to 300 people making cold calls, which, by the
way, Senator, they made a million calls a month. We took 18
months of their records----
Senator Cleland. That is more than I raised in soft money.
[Laughter.]
Senator Cleland. Strike that from the record. I am kidding.
Mr. Borg. But at one point in time, there was a fine levied
or there was an action brought and one of the principals got up
on the table to announce that one of the regulators had taken
this action or had fined them a certain amount and the report
goes that everyone, ``Awww.'' And then he announced, ``But, in
the same 30 days, we made $10 million,'' and everybody went,
``Yay.'' So, no, there is no sufficient response in a civil
proceeding if they can pay you $1 million and steal $5 million.
It is a cost of doing business. Therefore, I think the proper
response would be a criminal action, and you have to get past
the principals to the agents to deter new agents if they think
there is a possibility of going to jail.
Senator Cleland. What do you think about this concept of
zero tolerance the Chairman mentioned and Mr. Goldsmith is
interested in and made a comment to the New York Attorney
General in terms of zero tolerance? Should we be thinking about
that?
Mr. Borg. I am very interested in zero tolerance. I would
like to be able to work with NASD and the SEC on developing
guidelines toward zero tolerance. I think it is something that
can be discussed.
If I might digress just for a second, the idea of putting
the numbers on the account statements, I think, is an excellent
idea. However, I would recommend one change to that. In Mr.
Poggi's case, the number on the account statement would have
been too late because the account statement he got was after
the trades had been made, within that 30 days, and the
statement will not drop, chances are, until sometime at the end
of the month.
I would recommend that either at the initial application
stage, prior to any trade, that that information be delivered,
either as part of the client form to allow them to do business
or a separate mailing that gives that information up front,
because, as I said, in Mr. Poggi's case, I think had it been on
the account statement, he would not have seen it for 45 days
and it was too late in his case.
Senator Cleland. You mentioned about the effectiveness or
the ability to go into State court quickly. The Private
Securities Litigation Reform Act placed certain restrictions on
the ability of defrauded investors to seek redress in class
action lawsuits. Should the new Act be amended to preclude
investors from bringing actions in State courts?
Mr. Borg. I think the issue is different. I am not up on
the Private Litigation Reform Act, per se. I am sure my general
counsel at the Commission is. But what I am talking about here
is the enforcement of the anti-fraud authority and the criminal
violations under a criminal act. The State is not precluded, as
I understand it, from bringing any actions under private
litigation reform, and that is for class action type lawsuits,
and that would be a civil redress. Therefore, I am not
qualified to speak to that, Senator.
But I would say that on the criminal side, that that would
be a police power to the State and I think the State, if it has
a violation of its statute or a violation of a Federal statute
or Federal regulation that they are required to meet at the
State level, then I think the States can act on that.
Senator Cleland. Mr. Goldsmith, talk to us a little bit
about zero tolerance and how you see that in your line of work.
Mr. Goldsmith. Let me take an easier question first and
then I will answer that one. I think it is clear, I think we
all agree that we need to increase the sanctions, and I am not
talking about by $500 or $1,000. When we are dealing with
people who should not be dealing with investors, we ought to
get them out of the industry.
I think any kind of zero tolerance, just as I think in the
three strikes and you are out, in any court system, you have to
recognize that you are dealing with firms with limited
resources. If you have a zero tolerance that runs from a
technical violation all the way up, you are going to have
people litigating and prosecuting and appealing to the SEC and
the court of appeals.
Our disciplinary process moves quite quickly at the NASD,
but people have the right, as they should, to appeal that. It
then goes to the Commission. It could then go to the court of
appeals. If you are trying to throw people out of the business
for violations that may not warrant that, that could be a
problem and it is going to hurt your enforcement down the road.
But a carefully articulated policy with guidelines that,
with respect to certain types of violations of certain
magnitudes, would warrant expulsion, and we have that and we
are looking at toughening those, I think is something worth
looking at. Again, we are revamping our entire sanctions
guidelines to that end and we are toughening up. We have thrown
out more firms. We have expelled more individuals, and I think
we still need some further toughening.
Senator Cleland. Madam Chairman, that is the end of my
questioning. I would just like to thank some key people on my
staff. Wayne Howell, who is the former head of the North
American Association of Securities Administrators, now my
Administrative Assistant, has put a lot of work in on this
hearing and will be helping me on other hearings, as well as
Kevin Franks on my staff and Jeff Robbins, minority counsel.
Thank you, Madam Chairman.
Senator Collins. Thank you, Senator, and I want to thank
you for your personal leadership in this area. I know we are
going to continue to work together on it and I look forward to
that.
I want to thank our witnesses. The hearing record will
remain open for 30 days and it is possible that our counsels,
as well as other Senators on the panel, will have additional
questions to submit in writing and we hope that you will assist
us on our ongoing investigations.\1\
---------------------------------------------------------------------------
\1\ Exhibits 16, 17, and 18 appear in the Appendix on pages 432,
466, and 475 respectively.
---------------------------------------------------------------------------
I, too, want to thank my staff people who worked very hard
on this, Ian Simmons, Tim Shea, Dennis McCarthy, Mary
Robertson, Lindsey Ledwin. As you can see, when you are in the
majority, you get more people to thank. [Laughter.]
I want to acknowledge Jeff Robbins's assistance also as the
minority counsel, and I particularly want to have a special
thank you to my legislative counsel who is also a former State
securities administrator, Steve Diamond.
Thank you very much for helping us explore this issue and
the hearing is now adjourned.
[Whereupon, at 4:46 p.m., the Subcommittee was adjourned.]
A P P E N D I X
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