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S. HRG. 111–1115 

INVESTIGATING AND PROSECUTING FINANCIAL 

FRAUD AFTER THE FRAUD ENFORCEMENT AND 

RECOVERY ACT 

HEARING 

BEFORE THE

COMMITTEE ON THE JUDICIARY 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

SECOND SESSION 

SEPTEMBER 22, 2010 

Serial No. J–111–110 

Printed for the use of the Committee on the Judiciary 

( 

(II) 

COMMITTEE ON THE JUDICIARY 

PATRICK J. LEAHY, Vermont, Chairman 

HERB KOHL, Wisconsin 

DIANNE FEINSTEIN, California 

RUSSELL D. FEINGOLD, Wisconsin 

CHARLES E. SCHUMER, New York 

RICHARD J. DURBIN, Illinois 

BENJAMIN L. CARDIN, Maryland 

SHELDON WHITEHOUSE, Rhode Island 

AMY KLOBUCHAR, Minnesota 

EDWARD E. KAUFMAN, Delaware 

ARLEN SPECTER, Pennsylvania 

AL FRANKEN, Minnesota 

JEFF SESSIONS, Alabama 

ORRIN G. HATCH, Utah 

CHARLES E. GRASSLEY, Iowa 

JON KYL, Arizona 

LINDSEY GRAHAM, South Carolina 

JOHN CORNYN, Texas 

TOM COBURN, Oklahoma 

BRUCE A. COHEN, Chief Counsel and Staff Director 

MATTHEW S. MINER, Republican Chief Counsel 

(III) 

C O N T E N T S 

STATEMENTS OF COMMITTEE MEMBERS 

Page 

Grassley, Hon. Charles E., a U.S. Senator from the State of Iowa ..................... 4 

prepared statement .......................................................................................... 82 

Kaufman, Hon. Edward E., a U.S. Senator from the State of Delaware ............ 1 

prepared statement .......................................................................................... 85 

Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont, prepared 

statement .............................................................................................................. 89 

WITNESSES 

Breuer, Lanny A., Assistant Attorney General, U.S. Department of Justice, 

Washington, DC ................................................................................................... 5 

Khuzami, Robert S., Director, Division of Enforcement, Securities and Exchange Commission, Washington, DC ................................................................ 7 

Perkins, Kevin L., Assistant Director, Federal Bureau of Investigation, Washington, DC ............................................................................................................. 9 

QUESTIONS AND ANSWERS 

Responses of Lanny A. Breuer to questions submitted by Senator Specter ....... 36 

Responses of Robert S. Khuzami to questions submitted by Senator Specter ... 40 

SUBMISSIONS FOR THE RECORD 

Breuer, Lanny A., Assistant Attorney General, U.S. Department of Justice, 

Washington, DC ................................................................................................... 43 

Khuzami, Robert S., Director, Division of Enforcement, Securities and Exchange Commission, Washington, DC ................................................................ 54 

Perkins, Kevin L., Assistant Director, Federal Bureau of Investigation, Washington, DC ............................................................................................................. 91 

(1) 

INVESTIGATING AND PROSECUTING FINANCIAL FRAUD AFTER THE FRAUD ENFORCEMENT AND RECOVERY ACT 

WEDNESDAY, SEPTEMBER 22, 2010 

U.S. SENATE, 

COMMITTEE ON THE JUDICIARY, 

Washington, D.C. 

The Committee met, pursuant to notice, at 2:06 p.m., in room 

SD–226, Dirksen Senate Office Building, Hon. Edward E. Kaufman, presiding. 

Present: Senators Kaufman, Klobuchar, Franken, and Grassley. 

OPENING STATEMENT OF HON. EDWARD E. KAUFMAN, A U.S. 

SENATOR FROM THE STATE OF DELAWARE 

Senator KAUFMAN. I am honored to call to order this hearing of 

the Senate Committee on the Judiciary. I want to thank Chairman 

Leahy for permitting me to chair this hearing. 

Today we are going to examine the efforts of Federal law enforcement to investigate and prosecute the financial fraud that contributed to our current economic crisis in light of the Fraud Enforcement and Recovery Act, FERA, signed into law by President 

Obama in May 2009. This is the second post-FERA oversight hearing that we have held. The first was December 9th of last year. 

Today the same distinguished witnesses—and I truly mean distinguished witnesses—who testified at that hearing join us to discuss 

these issues: Assistant Attorney General Lanny Breuer, SEC Director of Enforcement Robert Khuzami, and FBI Assistant Director 

Kevin Perkins. Welcome back, gentlemen. 

My objective for this hearing is several. The first comes under 

the heading of FERA oversight. In the time since the December 

2009 hearing, what have the Department of Justice, the FBI, and 

the SEC done in terms of investigating and prosecuting fraud at 

the heart of the financial crisis? Do they have the infrastructure, 

personnel, and strategies in place they need to be successful? 

All three entities have received significant additional resources 

in part as a result of FERA, and I want to explore whether those 

resources are being deployed effectively. I will say right now I am 

frustrated. I know the Justice Department, the SEC, and the FBI 

have all been working incredibly hard—and I mean incredibly 

hard—reviewing countless transactions, interviewing myriad witnesses, poring over literally millions of pages of documents. 

And yet we have seen very little in the way of senior officer or 

board room-level prosecutions of the people on Wall Street who 

2 

brought this country to the brink of financial ruin. Why is that? Is 

it because none of the behavior in question was criminal? Is it because too much time passed before the investigators got serious? 

Has the trail gone cold? Is it because the law favors the wealthy 

and powerful? Or is the explanation much more complex? 

Are there systemic challenges that the agencies are finding difficult to overcome? Is there a foundational, targeted strategy in uncovering those instances of actual misrepresentation of material 

facts which exist, which is a mountain, a veritable mountain of ‘‘everybody was doing it’’ mentality on Wall Street? Is the fine print 

exculpatory or only chilling prosecutorial efforts that still deserve 

to move forward? 

My second objective is legislative. Are there changes in the law 

that would make it harder for people to construct and sell incredibly complex financial instruments without disclosing their own belief that the value of these products will soon plummet? While I 

will be leaving the Senate before long, I would like to help my colleagues get started on making those changes in the law, if they are 

required, and if there are useful changes to be made. 

In the last year or so, through the work of people both in and 

out of Government, we have been learning more and more about 

the wide range of conduct that contributed to the financial collapse. 

I have said from the beginning that much of that behavior, though 

terribly misguided, inexcusable, or morally bankrupt, was not 

criminal. But I do remain convinced by what we have learned 

through a host of sources, including hearings by Senator Levin on 

the Permanent Subcommittee on Investigations, that appears from 

evidence that there was also serious criminal behavior on all of 

this. 

Let me start a discussion about the difference between criminal 

behavior and behavior that was merely misguided with a hypothetical example. Assume that there is a bank in the mortgage orientation business. During the early and mid-2000s, as home prices 

increased nationwide, the bank is able to make huge profits both 

by packaging these mortgages into bonds for sale to others and by 

holding onto them as investments. In the race to maximize market 

share and raise profits, the bank decides to relax its official underwriting standards to a greater and greater degree until a large majority of even some of its riskiest loans to the least qualified borrower, or so-called liar’s loans, issued without even bothering to 

verify that the income stated by the borrower is accurate. They literally go into a bank, ‘‘My name is Ted Kaufman.’’ ‘‘How much are 

you making?’’ ‘‘Five hundred thousands dollars a year.’’ And that 

goes on the form, and there is no further checking done on whether 

that is true or not true. It obviously plays a big part in what kind 

of a mortgage you can get. 

This behavior was unwise and dangerous, creating tremendous 

risk on many levels—to the bank extending the credit, to the borrowers without the means to pay, to those who bought the loans 

from the bank. More important, it also created a grave risk to the 

broader economy. As we now know all too well, extending credit 

without regard to creditworthiness can help fuel a speculative 

boom that ends only with a painful market correction involving 

crashing prices and foreclosed-upon homeowners. 

3 

But without more, making loans that should never be made, even 

on a tremendous scale is not a crime, particularly if the quality of 

those loans were disclosed. Was there more? In the lead-up to this 

country’s recent national housing market crash, did some banks 

and board room executives step over the line and commit actionable fraud? For example, what if this hypothetical banks knowingly 

issues widespread exceptions to its published underwriting standards while at the same time claiming to would-be purchasers of 

mortgage securities that the underwriting standards had been substantial complied with? 

Let me repeat that. What if a hypothetical banks knowingly 

issues widespread exceptions to its published underwriting standards while at the same time claiming to would-be purchasers of 

mortgage securities that the underwriting standards had been substantial complied with? Or suppose it determines that a class of 

mortgages that it has held for its own investment—held for its own 

investment—are likely to default in the near future onto third parties. That might not be a crime. But what if the bank has claimed 

to purchasers that it has not selected mortgages for sale based on 

a belief that they are likely to default? If criminal conduct contributed to the financial meltdown, then the people responsible should 

be investigated, prosecuted, and sent to prison. And I know that 

our three witnesses agree with that. If we fail to do so, we will lose 

our chance to restore the public’s faith in our financial markets and 

the rule of law. 

Criminals on Wall Street must be held to account; otherwise, one 

of the great foundations of this country—our capital markets—will 

simply fade away. This is why very early in the Congress I joined 

with Chairman Leahy and Senator Grassley and others to help 

pass the Fraud Enforcement and Recovery Act. FERA was designed 

to ensure that additional tools and resources were provided to 

those charged with enforcement of our Nation’s laws against financial fraud. 

In the year-plus since the passage of FERA, we have seen some 

important progress. The FBI, the Department of Justice, and the 

SEC have all ramped up their efforts. Last November, President 

Obama created an Interagency Financial Fraud Enforcement Task 

Force. Its mission is not only to pursue crimes already committed, 

but also to deter criminal behavior that might lead to another financial crisis. But despite the new resources and the renewed emphasis, despite the presidentially created task force, we are now 

nearing the final quarter of 2010 without the sort of prosecutions 

that I had fully expected we would hope to see by this time. Without successful investigation, prosecution, and meaningful punishment, deterrence is an illusion. 

So where does that leave us? That is what I want to explore in 

today’s hearing. Where is the line between conduct that is actionable and conduct that is not? What are the disclosure obligations 

of individuals and entities that select, bundle, securitize, and market groups of mortgages with characteristics that at some point 

along the way foretold their failure? These obligations need to be 

strengthened in terms of either what must be included or in terms 

of how prominent the disclosure must be made. 

4 

Last spring, Senator Specter and I offered an amendment to the 

Dodd-Frank bill that would have imposed on broker-dealers and 

banks the same sort of duty to customers that financial advisers 

already have. Had that amendment become law, those broker-dealers and banks would have been obligated to disclose not only their 

own conflict of interest, but also their knowledge that a particular 

security is likely to underperform. 

I want to get a sense from you, from the witnesses, in the enforcement community whether that sort of change in the law would 

make a difference in your world. Many on Wall Street have argued 

that there is no criminality in this financial crisis, merely a collective delirium brought about by soaring profits and mistaken assumptions about risks. I and others have disagreed. But so far I 

have waited in vain for the sort of prosecutions that we predicted 

would come. I hope this hearing will help us understand why that 

is so and also give us a better sense of what to expect in the future. 

I also want to emphasize that the existence of criminality, or the 

lack thereof, should not be our only guiding star. Our job is to focus 

on what is right and wrong, fairness and unfairness, and legislate 

accordingly. What laws do we need to make sure that we focus on 

right to wrong, fairness to unfairness? Law enforcement officials 

represented by these witnesses today have to ask whether the conduct they are investigating violated the law? If not, they move on 

to the next case. As Members of Congress, we have a different obligation. We have to ask whether the laws that exist reflect sound 

public policy. If not, if the law permits conduct that should be prohibited, then we need to change the law. 

Ours is a Government of laws rather than men, and as Justice 

Brandeis reminded us, ‘‘If we desire respect for the law, we must 

first make the law respectable.’’ Our laws are not a static code of 

received wisdom from on high. They are an evolving reflection of 

public debate and national need. Where laws let America down, 

Congress must remedy those laws so that they may not do so 

again. 

Senator Grassley, do you have something you would like to say 

at this point? 

STATEMENT OF HON. CHARLES E. GRASSLEY, A U.S. SENATOR 

FROM THE STATE OF IOWA 

Senator GRASSLEY. Well, first of all, I associate myself with the 

remarks you just made, and it is very important to have these 

oversight hearings, particularly within 1 year after FERA has been 

passed, to make sure it is working right; and, second, if it is not, 

as you suggested, the extent to which we need additional tools, because the goals of FERA are very important for the benefit of the 

taxpayers and for discouraging fraud. 

I have a long statement I want to put in the record. I want to 

take a couple minutes to give a view of my interest in this hearing. 

First of all, as a lead cosponsor for the Republicans of FERA, I 

am pleased that we are here today to hear testimony from the various agencies that can use it as a tool to see how the implementation of FERA is going. Our legislation is a very important key to 

investigating and prosecuting complex financial fraud that were a 

part of the root cause of the financial crisis. I am interested to hear 

5 

from the witnesses before us how FERA has helped them hunt 

down criminals and the extent to which it will be used as a tool 

to bring people to justice. While I will not be able to stay for the 

entire hearing, I will have a number of follow-up questions for the 

witnesses. 

Specifically, I have a number of questions about how the Securities and Exchange Commission is implementing recommendations 

made by the SEC Inspector General following the failures of followup on investigative leads regarding the Madoff and Stanford Ponzi 

schemes. The Inspector General found serious deficiencies at the 

SEC, and I want to know whether the SEC is serious about fixing 

the problems. 

Additionally, I would like to take a moment to alert people from 

the Justice Department about this letter that I sent to the Attorney 

General this very day, so you would not have it yet, regarding the 

Department’s failure to respond to serious allegations raised by the 

retiring Inspector General of the Department of Housing and 

Urban Development. The Inspector General is the chair of the 

Mortgage Fraud Committee at the Justice Department, and he 

raised concerns to the Department about the systematic fraud 

against the Federal Housing Administration, FHA, and whether 

the Department obtained the best settlement possible. Given the 

seriousness of the allegations, I expect an answer as soon as possible from the Attorney General. 

I thank you very much. 

[The prepared statement of Senator Grassley appears as a submission for the record.] 

Senator KAUFMAN. Thank you, Senator Grassley. 

Before we turn to the opening statements of Mr. Breuer, Mr. 

Khuzami, and Mr. Perkins, I ask the three witnesses to stand and 

be sworn. Do you affirm that the testimony you are about to give 

before the Committee will be the truth, the whole truth, and nothing but the truth, so help you God? 

Mr. BREUER. I do. 

Mr. KHUZAMI. I do. 

Mr. PERKINS. I do. 

Senator KAUFMAN. Let us begin with Mr. Breuer. 

STATEMENT OF HON. LANNY A. BREUER, ASSISTANT ATTORNEY GENERAL, U.S. DEPARTMENT OF JUSTICE, WASHINGTON, DC 

Mr. BREUER. Good afternoon, Senator Kaufman, Senator Grassley. Thank you for inviting me to speak with you today about the 

Department of Justice’s efforts combatting financial fraud. 

Before I begin, I would like to take this opportunity just for a 

moment to thank this Committee, and particularly you, Senator 

Kaufman, for your leadership in this area of financial fraud enforcement. 

As you know, and as you both have said, the Fraud Enforcement 

and Recovery Act, FERA, and most recently, the Dodd-Frank Wall 

Street Reform and Consumer Protection Act, were signed into law. 

Both of those laws have provided our investigators and prosecutors 

with more robust tools and resources in our fight against financial 

fraud. We thank you for your support, and we intend to continue 

6 

to aggressively use those tools and resources in the coming months 

and years. 

I am pleased today to be able to speak with you about the Justice 

Department’s efforts in combatting financial fraud, and I am particularly gratified to be here today with Robert Khuzami of the Securities and Exchange Commission and Kevin Perkins of the Federal Bureau of Investigation, two of our most critical partners in 

this fight. Together with them, and our many other partners on the 

Financial Fraud Enforcement Task Force, the Department of Justice is committed to investigating and prosecuting those who defraud our citizens of their hard-earned savings. 

Since the passage of FERA in May of 2009, the Department has 

re-evaluated the manner in which it investigates financial fraud, 

and as a result, we have significantly heightened our enforcement 

efforts. We have forged even closer partnerships with the many law 

enforcement and regulatory agencies that are focused on fighting 

fraud, and we have redoubled our efforts to send a strong deterrent 

message to would-be fraudsters by vigorously prosecuting these 

criminals and sending them to jail. 

Indeed, since the passage of FERA, the Department has prosecuted and incarcerated thousands of financial criminals, and we 

have sought stiff sentences for their crimes. Let me highlight for 

the Committee just a few of the areas in which we have focused 

our efforts. 

Fraud, of course, takes many forms, but perhaps the most pervasive and pernicious of these are investment fraud schemes, which 

include what we commonly refer to as ‘‘Ponzi schemes.’’ Those who 

commit investment fraud schemes often prey upon the vulnerable 

individual investors, and the resulting losses can be devastating to 

families around our country. For this reason, the Justice Department has dedicated significant resources to unearthing and vigorously prosecuting these crimes. Indeed, our agents and prosecutors 

around the country uncover and investigate investment fraud nearly every week. Let me describe for you just three examples of such 

prosecutions, all from last week alone. 

On September 15, 2010, Nevin Shapiro, the former CEO of Capital Investments USA, Inc., pleaded guilty in Newark, New Jersey, 

to fraudulently soliciting funds for a non-existent grocery distribution business. Mr. Shapiro’s $880 million investment fraud resulted 

in losses of somewhere between $50 million and $100 million to investors. Mr. Shapiro will be sentenced on January 4, 2011. 

On that same day that Mr. Shapiro pleaded guilty, Frank 

Castaldi, an accountant and businessman, was sentenced in Chicago to 23 years in prison for bilking hundreds of investors—many 

of them elderly Italian immigrants—out of more than $30 million. 

And just 2 days earlier, on September 13th, Michael Goldberg 

pleaded guilty in Bridgeport, Connecticut, to three counts of wire 

fraud relating to his operation of a $100 million fraud scheme that 

cheated investors out of more than $30 million over an approximately 12-year period. Mr. Goldberg will be sentenced on December 

2nd. 

As I mentioned, these three prosecutions, which taken together 

targeted fraud relating to over $1 billion, were from last week 

alone. The list of investment frauds, however, goes on and on. We 

7 

stand ready to continue to prosecute the perpetrators of these 

frauds and to send them to jail. 

Our efforts to combat financial fraud, including mortgage fraud, 

have also targeted high-level executives in the most sophisticated 

of frauds. As just one example, in June of this year, the Department obtained an indictment in the Eastern District of Virginia 

against Lee Bentley Farkas, the former Chairman of Taylor, Bean 

& Whitaker Mortgage Corporation. TBW was once one of the largest private mortgage companies in the United States. Mr. Farkas 

was charged with perpetrating a massive fraud scheme that resulted in losses exceeding $1.9 billion and that contributed to the 

failure not just of TBW, but also of Colonial Bank, one of the 50 

largest banks in the United States before its collapse in 2009. This 

prosecution is just one example of our sustained efforts to reach 

and uncover fraud at every level. 

Financial fraud in its various forms has devastating effects on 

our citizens, and it deserves the full attention of law enforcement 

and regulatory communities. With the increased resources afforded 

to the Justice Department under FERA and other legislation, and 

through our close collaboration with our partners on the Financial 

Fraud Enforcement Task Force, we have made this fight a priority, 

and we will continue to do so. 

Thank you for the opportunity to provide the Committee with 

this brief overview of the Department’s efforts to address financial 

fraud, and, of course, I would be happy to answer any questions. 

[The prepared statement of Mr. Breuer appears as a submission 

for the record.] 

Senator KAUFMAN. Thank you. 

Mr. Khuzami. 

STATEMENT OF ROBERT S. KHUZAMI, DIRECTOR, DIVISION OF 

ENFORCEMENT, SECURITIES AND EXCHANGE COMMISSION, 

WASHINGTON, DC 

Mr. KHUZAMI. Thank you, Senator Kaufman, Senator Grassley. 

Thank you for the opportunity to testify here today on behalf of the 

Securities and Exchange Commission alongside my valuable colleagues from the Department of Justice and the FBI. 

When I first testified before this Committee in December of last 

year, we were emerging from an economic crisis that threatened 

our financial system and tested the public’s confidence in the institutions charged with enforcing the laws that govern that system. 

Although there is much work to be done, during that 9 months we 

have achieved significant results at the SEC in our efforts to enforce the securities laws, particularly in areas relating to the financial crisis. 

Our statistical accomplishments for year-to-date fiscal year 2010 

are compelling, include 634 actions filed, over $1.5 billion in 

disgorgement of ill-gotten gains that have been returned to investors, $968 million in penalties imposed, and nearly $2 billion in 

funds distributed to injured investors. 

But statistics alone do not capture the breadth and the complexity of the high-impact cases that we have filed since I last testified, and let me just give you a couple of brief examples. 

8 

Boston-based State Street Bank and Trust Company agreed to pay over $300 million into a Fair Fund for the benefit of injured 

investors to settle our charges that it misled investors about their 

exposure to subprime investments and selectively disclosing more 

complete information to certain favored investors so that they could 

get out of those funds sooner during the 2007 mortgage crisis. 

We charged investor adviser ICP Asset Management and its 

founder, owner, and principal, alleging conflicts of interest and 

fraud related to its simultaneous management of multiple CDOs, 

managed accounts, and affiliated hedge funds that came under 

pricing and liquidity pressures in 2007. Mr. Priore and ICP collected millions of dollars in advisory fees on investments that were 

inflated as a result of that crisis and otherwise interposed themselves in certain trades in order to benefit themselves and to the 

detriment of their fiduciary clients. 

As Mr. Breuer testified, we, along with the FBI, Department of 

Justice, SIGTARP, and many others, charged Lee Farkas, the 

former Chairman of Taylor, Bean & Whitaker, in the large-scale securities fraud that Mr. Breuer mentioned. I mention that because 

it reflects the coordination of all of our agencies, both before but 

only enhanced by the formation of the Federal Financial Enforcement Task Force. 

In addition, Goldman Sachs agreed to pay $550 million to settle 

SEC charges alleging fraud in connection with the marketing of a 

synthetic CDO in which Goldman represented that the portfolio of 

securities underlying the CDO had been selected by a neutral, objective third party, when, in fact, the hedge fund investor at whose 

request the CDO had been structured and whose interests were directly adverse to CDO investors had heavily influenced the selection of that portfolio. 

We charged the former CEO, CFO, and comptroller of New Century Financial Corporation, once the third largest subprime lender 

in the United States, and they all agreed to pay disgorgement penalties and be barred from serving as an officer or director of public 

companies to settle charges stemming from their respective roles in 

the misleading New Century financial statements. 

And while doing these cases, we have pursued other traditional 

areas of SEC focus, including accounting fraud, insider trading, 

municipal securities, Ponzi schemes, offering fraud, pension fund 

fraud, and violations of the FCPA statute. 

We also brought charges against Dell, who paid a $100 million 

penalty to settle charges that it failed to disclose material information to investors and used fraudulent accounting to make it falsely 

appear that the company consistently met Wall Street earning targets while reducing operating expenses from 2002 through 2006, 

and certain Dell executives, including the chairman, the CEO, the 

former CEO, and a former CFO, all agreed to pay penalties to settle our charges. 

But we are not just focused on wrongdoing in connection with the 

financial crisis. We are equally focused on the future, embracing a 

range of initiatives designed to increase our ability to identify hidden or emerging threats to our markets. 

Stopping misconduct as soon as possible and minimizing investor 

loss and erosion of the public’s confidence in our markets is one of 

9 

our top goals. As I detail in my written testimony, to accomplish 

this goal we have, among other things, established national specialized units focused on key areas of activity, and we are using riskbased metrics and other proactive measures in order to identify, for 

example, investment advisers who misrepresent credentials or performance returns, mutual funds who charge excessively high fees, 

suspicious pattern and relational trading in market-moving securities, and troubling marketing practices, improperly minimizing the 

risk to investors of complex securities. These efforts all involve the 

integration of market data, event analysis, and red flags to flush 

out those firms, individuals, practices, and transactions that are 

most likely to be engaged in questionable conduct. This will help 

our staff to shine a bright light on the dark corners of the financial 

industry. 

We are also engaged in other reforms, streamlining our management structure, swiftly obtaining formal orders so that our staff 

can focus on what they do best. And we are also integrating the 

new authority and responsibility granted to us under Dodd-Frank. 

There is much to be done, but I am confident the Commission is 

up to the task. I thank you for the opportunity to appear here 

today, and I am happy to answer any questions. 

[The prepared statement of Mr. Khuzami appears as a submission for the record.] 

Senator KAUFMAN. Thank you. 

Mr. Perkins. 

STATEMENT OF KEVIN L. PERKINS, ASSISTANT DIRECTOR, 

FEDERAL BUREAU OF INVESTIGATION, WASHINGTON, DC 

Mr. PERKINS. Good afternoon, Senator Kaufman and Senator 

Grassley. I want to thank you for the opportunity to testify before 

you today about the FBI’s continued efforts to combat significant 

financial crimes. 

Since my last appearance before you, the FBI has continued to 

uncover massive financial frauds, and there are several notable 

cases that I will discuss which clearly highlight our commitment to 

combatting financial crimes at every level. 

In June, for example, and as Mr. Breuer and Mr. Khuzami have 

mentioned in their testimony, Lee Farkas, the former Chairman of 

Taylor, Bean & Whitaker, was charged and arrested in coordination with the SEC and with other—SIGTARP and the Justice Department. I mention this case specifically because of the role that 

leveraging resources between the various investigative agencies 

plays in the fight against financial frauds. 

Other cases I will mention include: In June, Scott Rothstein, a 

Miami attorney, was sentenced to 50 years in prison and ordered 

to pay $363 million in restitution for operating a $1.2 billion Ponzi 

scheme, which took money from over 300 victims. 

In August of this year, former chief accounting officer Michael 

Rand of Beezer Homes, a former Fortune 500 company, was 

charged and arrested for his role in an alleged accounting fraud 

that manipulated the company’s reported earnings. Beezer Homes 

previously agreed to a deferred prosecution agreement and paid a 

$50 million fine in relation to this fraud scheme. 

10 

Over the past 6 months, the prosecutions of the Galleon insider trading case in New York and the Petters $3.7 billion Ponzi scheme 

in Minnesota continued, with guilty pleas and with significant sentences of top corporate executives. 

These cases are just a few examples of the thousands of financial 

fraud cases investigated by the FBI and its partners and conducted 

in conjunction with the administration’s Financial Fraud Enforcement Task Force. 

Our message is clear: Together, the FBI, the Department of Justice, and our partners throughout law enforcement and regulatory 

communities will investigate and, where appropriate, bring charges 

of criminal misconduct on the part of businesses and business executives. 

Mr. Chairman, the wave of mortgage fraud we have experienced 

shows no sign of slowing at this point. In the last 3 years alone, 

the FBI has seen the number of mortgage fraud cases steadily 

climb from 1,200 cases in 2007 to over 3,000 cases today. Seventy 

percent of those investigations of pending cases represent losses to 

victims exceeding $1 million. In many of these cases, the losses far 

exceed $1 million. 

Just today, seven individuals, seven mortgage industry insiders, 

were indicted in San Juan, Puerto Rico, for their role in a scheme 

which cost victims over $21 million. 

Recently completed Operation Stolen Dreams demonstrated just 

how rampant mortgage fraud is in this country. This operation resulted in charges against 863 subjects who were allegedly responsible for more than $3 billion in losses. 

Since my last appearance before you, the FBI has also observed 

a continued rise in corporate and securities fraud schemes, such as 

the falsification of accounting records and the continued increase in 

complex investment frauds. In addition to the number of corrupt 

high-level executives that have been exposed during this time, we 

have also experienced an increase in the number of financial crime 

cases involving loan offenders who have defrauded unsuspecting 

victims of millions of dollars. 

For example, earlier this month, a Federal grand jury charged an 

Ohio couple, Michael and Melissa Spillan, in a 47-count indictment, 

alleging that they defrauded over 50 victims of more than $25 million through a series of fraudulent stock-based loan schemes. 

By using the additional resources appropriated by Congress with 

your assistance, we have continued to implement innovative and 

proactive methods to detect and combat significant financial frauds. 

Foremost is the FBI’s continued development of the Financial Intelligence Center, established 1 year ago. The Center is an amalgamation of intelligence analysts and professional staff and provides tactical analysis of financial intelligence data sets to identify ongoing 

financial fraud schemes. Their work includes not only traditional financial fraud schemes but also those employed within health care 

frauds, contracting frauds against the Government, and money 

laundering, among others. 

Mr. Chairman, I would also be remiss if I did not emphasize the 

vital role that partnerships play in our efforts. Most recently, the 

FBI and the SEC reached an agreement to place an FBI agent on 

a full-time basis within the SEC’s Office of Market Intelligence. 

11 

This cooperative effort on the part of both organizations will allow 

for a much better coordination with regard to the referral of potential criminal activity within the securities markets. 

The FBI works closely with its Federal, State, and local investigative partners in efforts to combat mortgage fraud. Right now 

we have over 25 mortgage fraud task forces located across the 

country. 

Mr. Chairman, I appreciate the opportunity to come before you 

and the Committee today and share the work the FBI is doing to 

combat significant financial fraud. I look forward to working with 

you, and I am happy to answer any questions you may have. 

[The prepared statement of Mr. Perkins appears as a submission 

for the record.] 

Senator KAUFMAN. Thank you very much. We will be doing 7- 

minute questions, and I will start. 

Mr. Breuer, I think it is fair to say that, maybe because of popular press or whatever, we thought that on Wall Street there would 

be more criminal prosecutions on Wall Street, and since Bear 

Stearns there have not been. What is your thinking about that? Is 

that something that we just misjudged it, or there are problems 

that nobody anticipated, or we are moving ahead but it is just taking longer to get the cases started? 

Mr. BREUER. Well, Senator, just to take a step back for a moment, it is always hard to know what people define and what their 

expectations are. But there really has been, as my colleagues have 

said and as I have said, a very rigorous enforcement effort. And so 

even if you look at FERA, you look over the last months, we have 

indicted, prosecuted, and sentenced numerous officials of public 

companies. Mr. Perkins talked about Beezer Homes, which is a 

publicly traded company. There we went after the chief accounting 

officer, and he was indicted for false revenue recognition. For the 

average person or investor of Beezer Homes, that is a very meaningful prosecution. 

We went after the executive vice president and the former risk 

vice president of Integrity Bank. That is a financial institution, and 

those gentlemen pled guilty for both accepting bribes and for insider trading. 

Aeropostale, that is another public company, Senator. There just 

a couple of months ago, the executive vice president was indicted 

for a kickback scheme. 

And so we can go on and on with publicly traded companies and 

private companies and senior executives who, in fact, have been 

prosecuted vigorously. 

With respect to the Wall Street institutions that you are specifically referring to, as I said last time and as I continue to and as 

the public press has talked about, there has been no lack of effort 

in pursuing fraudulent activity—and I know you know it—wherever it is. But there is a big difference between pursuing it and 

then concluding an investigation. If there is criminal activity, we 

will prosecute it. And if we cannot prove criminal activity, then we 

will not prosecute it. And, of course, we have the SEC, which, of 

course, has been extremely vigorous as our partner here. 

So my view is that, in fact, it has been a very robust response 

by the Department of Justice and by the SEC and others. I think 

12 

we have a lot to be proud of, frankly. But these are, of course— 

the cases you are referring to, of course—extremely complicated 

cases. 

Senator KAUFMAN. Right. And the point I want to make, because 

I am going to have a series of questions on this, but really the 

point that we made, that I made and that Senator Grassley made, 

this is an oversight hearing, and we are trying to see how the 

funds were spent and the rest of it. But it is also a legislative hearing. If there are some problems that you are running into in prosecuting these cases because the law—I mean, the law, as I said in 

my statement, it did not come from on high. 

Mr. BREUER. Right. 

Senator KAUFMAN. We write the laws. And so we can change the 

laws. I do not want a single innocent person to go to jail or be 

criminally indicted for any reason. But are there things going on 

that really give you concern, as I said in my opening statement, 

where there are really things going on that are clearly wrong, but 

just because of the way that the law is being formed or the way 

the law is being implemented or the way the regulations are written, we can see that people are doing bad things and not being 

prosecuted for them. 

Mr. Khuzami, what has changed about how you identify higherlevel targets and how you conduct resulting investigations? Has 

anything changed on that? 

Mr. KHUZAMI. No, I think the fundamental tools that have always been in place are still the ones that we use—you know, thorough and vigorous investigation, partnering with our colleagues. 

The Galleon case was mentioned. Of course, there is no substitute 

for the kind of wiretap work that was done in that case, and, you 

know, one of the asks I would suppose I would have on my list 

would not necessarily be for me, but it would be more resources for 

the Justice Department and the FBI to be engaged in those kind 

of undercover activities for which there is no substitute. 

We have developed a cooperation program at the SEC where we 

can now offer reduced sanctions in exchange for insiders who come 

forward and provide us with information. And the same is true 

with the whistleblower legislation that was part of Dodd-Frank 

where we will be able to award financial incentives. 

Those last two efforts should do a lot to get us earlier information on the inside while a scheme is unfolding. That is the best way 

to get as high up in the organization as you can. 

Senator KAUFMAN. Thank you. 

Mr. Perkins, can you think of anything? 

Mr. PERKINS. Sir, just as far as use of resources, Senator, I wanted to make note of the fact that just looking at our resource levels 

from 2007 to 2010, a notable increase in each of our four priorities. 

Right now, we utilize just over 2,000 agents to work white-collar 

crime matters. That is all of white-collar crime. Ninety-three percent of those 2,000 agents work our top four priorities: complex financial frauds, securities and commodities frauds, public corruption, and health care fraud. 

Now, when you look back to 2001, it is known that, following 

9/11, there was a shift of resources within the Bureau away from 

criminal activities in the early days because of the crisis the counVerDate Nov 24 2008 11:18 Jan 17, 2012 Jkt 071990 PO 00000 Frm 00016 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\71990.TXT SJUD1 PsN: CMORC
13 

try was in. Over the ensuing 9 years and through the help of the 

Congress and through prioritization within the Bureau, many of 

those resources have come back. I am still about 200 agents below 

where I was on the white-collar side at 9/11. The difference between then and now, however, at that point in time—well, at this 

point in time, 93 percent of our resources are focused on priorities. 

It was much less than that at 9/11. 

So what has happened is we have had to prioritize and shift our 

resources away from the lower-priority matters. One particular 

case in point, on 9/11 we had nearly 1,800 financial fraud cases 

where the loss suffered by the financial institution was less than 

$25,000. Today we have one. And I believe that is a fugitive case 

that is still just pending. 

So we have shifted our priorities away, and we are focusing the 

resources that have been given to us by the Congress where they 

need to be. 

Senator KAUFMAN. Very good. Thank you. 

Mr. Breuer. 

Mr. BREUER. Well, Senator, with respect to the resources, we feel 

we have good resources. To make a point, Mr. Khuzami a moment 

ago spoke about the fact—and I could not agree more—that, for instance, one of the strategies that we are employing in these whitecollar cases and insider cases is to use wiretaps. Well, at the Department of Justice, we have tripled—tripled—the number of people who review wiretaps. Now, many of those are for violent 

crimes, but many of those are for white-collar offenses. That is a 

very real direct result. We have cut down in half the time that it 

takes to review these. We move as nimbly as we can. And that is 

just one small example. Everybody knows about the prosecutors 

both in Main Justice and in the field. But that shows how deeply 

we are dealing with the situation and how nimbly we are trying 

to react and be as forceful as we can. 

Senator KAUFMAN. Thank you very much. 

Senator Grassley. 

Senator GRASSLEY. Thank you, Mr. Chairman. 

Mr. Khuzami, the Ponzi scheme perpetrated by the Madoffs and 

Stanford were serious breaches of our financial regulatory system. 

Most shocking is how these frauds went undetected for years by 

SEC, despite repeated warnings and tips from various sources. So 

the SEC Inspector General issued some scathing reports following 

these frauds, finding that the SEC made a number of failures along 

the way that allowed these schemes to go on for so long. 

Leadership there at the Commission has said that the Madoff 

scheme happened to be a perfect storm of fraud that allowed it to 

go undetected for years. I understand that the SEC has agreed 

with a number of recommendations that the SEC Inspector General 

made and that the SEC is currently implementing these recommendations. However, the Inspector General’s report also recommended that the SEC take appropriate action against employees 

that are still employed at the agency to ensure that failures do not 

happen again. It has been over a year since the SEC Inspector 

General issued the Madoff report and 6 months since the Stanford 

report came out. 

14 

So the question: To date, has the SEC taken any personnel action against the SEC employees that were highlighted in the reports for failing to perform on the jobs? And if so, what sort of action was taken? And if not, why hasn’t action been taken? 

Mr. KHUZAMI. Senator, in both cases you mentioned, large numbers of the individuals involved are no longer with the Commission, 

and, of course, we cannot discipline ex-employees. But for those 

that remain, with respect to Madoff, the internal review is completed, and it is my understanding that those decisions will be 

made in the very near future. 

With respect to Stanford, the same recommendations by the IG, 

that process is underway. We have a variety of rules and regulations we follow in these circumstances, and that is what we are 

doing. 

Senator GRASSLEY. And that sort of punishment will be known 

to the public? Or will there be an attempt to keep it secret? 

Mr. KHUZAMI. Senator, I actually do not know the—I will get 

back to you. I do not know whether or not there are restrictions 

on to what extent we can disseminate that information. 

Senator GRASSLEY. Well, it is along the line of what the Chairman said. If heads do not roll, nobody makes any changes. I will 

go on with you also on another point. 

The SEC Inspector General issued an audit report in March regarding the SEC’s use of the whistleblower provisions that authorize the SEC to pay a bounty to individuals who provide information 

leading to the recovery of funds from securities fraud, particularly 

insider trading. That report found that, despite having the authority for more than 20 years, there has been very few payments to 

whistleblowers under the program. The IG noted that the number 

of applications for the county was also low and that the program 

was not well known either inside or outside of the agency. The Inspector General ultimately concluded that the program was not 

well designed and was not successful because of poor design. 

During the debate on the Wall Street reform bill, enhanced whistleblower provisions were discussed as a means to bring more tips 

to the SEC and to make the agency more accountable. The SEC 

was ultimately provided a new whistleblower program under the 

law. 

Question number one—and I have three questions. Now that you 

have the whistleblower authority that the SEC requested, do you 

believe it will fundamentally increase the productivity of the agencies in hunting down financial fraud? 

Mr. KHUZAMI. Senator, I think it is potentially extremely valuable. There is no substitute for insiders, and if we incentivize them 

properly to come forward, that is all to the benefit. The challenge, 

of course, is separating the wheat from the chaff to make sure that 

we cast a wide enough net so we get as many people as possible, 

but not so wide that we inundate ourselves with complaints. 

So we are working through it in a way to strike the right balance, but we are very optimistic. It was our highest priority under 

the Dodd-Frank legislation, and we are eagerly writing rules and 

moving forward. 

Senator GRASSLEY. OK. Then a follow-up to that, but I think you 

partly answered this. Since the authority has been previously little 

15 

used based upon what the Inspector General said, and the agency 

did little to promote or facilitate the program as a useful tool, why 

should we have faith that the SEC will implement this new authority in a meaningful manner? 

Mr. KHUZAMI. Senator, the plans are to distribute word of this 

new program far and wide—on the Internet and various other forums—to let people know that this exists and they should come forward if they have information. 

Senator GRASSLEY. OK. I think you answered my last question 

at the same time. 

Thank you, Mr. Chairman. 

Senator KAUFMAN. Senator Klobuchar. 

Senator KLOBUCHAR. Thank you very much, Mr. Chairman. 

Thank you for your work on this. We are going to miss you, I can 

say. 

I thank all of you for being here today. I have always been a big 

supporter of this legislation. I was proud when the President 

signed it into law, and I am mostly here today just to get more updates on what has been happening. I think from what I understand, you have had nearly 3,000 defendants sentenced to prison 

for financial fraud between October 2009 and June 2010, and that 

so far the SEC has obtained orders requiring the repayment of 

$1.53 billion this year. 

So I guess one of my questions—maybe it is of you, Mr. Breuer— 

is how this compares to other years. Do you have any historical 

data of the number of convictions and the number of the amount 

of money that has been brought in? 

Mr. BREUER. Senator, I do not have at my fingertips the numbers 

of prior years—— 

Senator KLOBUCHAR. Oh, come on. 

Mr. BREUER. I know. It is shocking. But I will not lose the opportunity to echo what you said. I think under any objective criteria 

the results since October of 2009 really are quite positive. As you 

said, 4,300 defendants have been charged; 3,200 defendants have 

pled guilty; 2,800 have received prison terms; and 1,600 have received prison terms of over a year. I think by any measure those 

are very, very ample and high numbers. Those, of course, do not 

include what we are doing in the health care area, another enormous area that I know this Committee cares about. They do not 

deal with the FCPA, so this is just one level of criteria. 

I will get you the old numbers, but this is, I think, a very robust 

response. 

Senator KLOBUCHAR. OK. Very good. And then if you could get 

these numbers, that would be great. 

[The information appears as a submission for the record.] 

Senator KLOBUCHAR. What are some of the lessons you learned 

as you took over this area in terms of what works and what does 

not work? 

Mr. BREUER. Well, clearly one of the things that works is that 

we need to employ aggressive techniques in the area of white-collar 

and financial fraud. We have to use undercovers. We have to use 

Title III wiretaps. We have to seek very stringent prison terms. We 

have to hold companies accountable and ensure that they have very 

16 

robust compliance programs. And we have to get the word out. All 

of that really does work. 

The other thing that I think works very closely is the gentlemen 

at this table next to me are not just my colleagues. They have become my friends, as have their most senior people, and that works, 

because frankly what really matters in cases that we can pick up 

the phone and in a very nimble way address issues. And so that 

has worked, and the Financial Fraud Enforcement Task Force has, 

at an unprecedented level, allowed Federal prosecutors and investigators throughout the agencies to work together and, frankly, to 

partner with State district attorneys and State AGs. That really 

matters a lot, because what we need are comprehensive responses. 

The Federal Government cannot, and Federal prosecutors and investigators cannot, be always the answer. 

Senator KLOBUCHAR. And I have found in this area, just from my 

past job, that those prison sentences are very important. Maybe I 

have mentioned before when we prosecuted eight airline pilots who 

were not paying their taxes in the State where they should have 

paid it, as in my State, it created a huge amount of money coming 

into our State revenue department because the prosecutions got a 

lot of attention. And I think in this area more than any other, 

going after these cases actually sets a precedent that people tend 

to follow. So I commend you for that. 

I also wanted to mention not only the Petters case, which was, 

I think, the second biggest case in terms of money that was prosecuted by the Justice Department next to Madoff in the last year, 

but also the two others that I think were in your testimony out of 

our jurisdiction. I do not know if I am supposed to be proud of that, 

but Corey Johnston pled guilty. It was 17 lenders, $80 million, and 

then you also in August of this year, a Federal judge sentenced 

Trevor Cook, who orchestrated a Ponzi scheme by selling $158 million in bogus foreign currency trading investments, to 25 years in 

prison. So I wanted to thank you for that. 

What has not worked, have you learned? Or maybe things that 

were going on before that you do not think were very helpful? 

Mr. BREUER. Well, I think the real challenge is, candidly, the 

public perception and the fact that for very complicated cases there 

are lots of different issues. So that we will continue to do it, and 

we will call it the way we see it. But, obviously, we have to put 

enormous resources in some of the most complicated cases. They 

take time. They take the review of, you know, sometimes thousands, tens of thousands or more of documents. And, of course, at 

the end of the day, it does work in the sense that if we do not think 

we can prove beyond a reasonable doubt a crime, we move away. 

That is the system working. But I understand that that also on the 

public frame can cause some level of frustration. 

So there is really no alternative to hard work and, frankly, as 

prosecutors, we could not be more delighted with what our friends 

at the SEC, and the other regulators, are doing because, of course, 

what we need as the prosecutors are people with deep, substantive 

knowledge who really understand these very complicated transactions, and who along with the FBI, which has done a stellar job, 

are able to bring the cases to us. And so that partnership has 

17 

worked. But, clearly, it will be over a period of time that we’ll really be able to assess the fruits of our efforts. 

Senator KLOBUCHAR. Thank you. 

Mr. Khuzami—I am sorry. Every time I see your name, my staff 

wrote, ‘‘Pronounce it like ‘tsunami.’ ’’ And so I keep wanting to say 

that. 

Did you have those numbers on the SEC and the money brought 

in at all? Or maybe you are the best person to ask for that? 

Mr. KHUZAMI. I do not have them specifically. We will get them 

for you. I can tell you that certain categories have certainly increased. The number of TROs and asset freezes we have done in 

the last few years has increased dramatically. That is an intentional decision because that is the best way to make sure we get 

as much money back to investors as possible. 

Our penalty numbers are up considerably, and our Fair Fund 

numbers—that is the amount of money that actually gets distributed back to harmed investors—are up in the last 2 years. 

So all in all, I think those statistics reflect significantly enhanced 

performance, but even more so, I think, is the nature of the cases. 

The list of credit crisis and financial crisis cases from Countrywide, 

to American Home Mortgage, to New Century, to Goldman, to the 

Colonial Bank-TBW case mentioned today, to Dell, to Ernst & 

Young, all of those cases, a great deal of time and effort goes into 

those. They are challenging cases to make. So what I am most 

proud of is that while we have been able to increase the statistics, 

at the same time or perhaps more importantly, we have taken on 

the challenging cases. 

Senator KLOBUCHAR. OK. One last question. Mr. Perkins, maybe 

you are the right one for this. I just remember after Katrina there 

were a number of sort of disaster fraud cases. I wonder if you are 

seeing the same thing with the BP oil spill in the gulf. 

Mr. PERKINS. We are taking some significant proactive steps to 

address those issues. We met, in fact, just last week with nearly 

all of the U.S. Attorneys from the gulf region. We went to the campus of LSU—— 

Senator KLOBUCHAR. You are the right person to ask. 

Mr. PERKINS. Yes, ma’am. 

Senator KLOBUCHAR. That is good. 

Mr. PERKINS. Mr. Breuer and myself attended the conference, 

spoke at the conference. Mr. Feinberg was there and spoke as to 

his efforts with the trust fund. We have the National Disaster 

Fraud Center on the campus of LSU where we are operating the 

call centers. We are seeing some signs of fraud, but what we are 

trying to do is be ahead of it, and—— 

Senator KLOBUCHAR. Yes, to try to prevent it by the rules you 

have put in place? 

Mr. PERKINS. It is a combination of prevention, public awareness. 

Our colleagues, for instance, from the Postal Inspection Service 

have done a great deal of media within their organization, pushing 

out to individuals in the gulf region that there is going to be very 

little tolerance to any type of fraud, that prosecution is going to 

take place. And so we are closely monitoring that. We will have the 

resources to address it. 

18 

The prosecutors and the agents met at this meeting just 2 weeks 

ago and spoke about what worked during Katrina, what did not 

work, and what we are going to try to do going forward. 

Senator KLOBUCHAR. Well, that is very helpful, because as we 

know, this was a public trust issue to begin with, and I think now 

that the spill is plugged and the work is getting done to help people 

that were victims, we just want to make sure the money goes to 

the right people. So thank you very much. Thank you, all of you. 

Senator KAUFMAN. Senator Franken. 

Senator FRANKEN. Thank you, Mr. Chairman. 

Gentlemen, I am sorry I was not here for your testimony, but I 

did read it last night. Mr. Khuzami, back in December I asked you 

a question about prosecuting credit rating agencies that had a clear 

conflict of interest when valuating securities. And I notice in your 

testimony you talked about a credit rating agency, LACE Financial, 

that you settled some charges against. 

Mr. KHUZAMI. Correct, Senator. 

Senator FRANKEN. And that was about its conflict of interest? 

Mr. KHUZAMI. That arises out of—there were a number of theories there, the primary one of which is that the laws provided that 

you could not rate instruments for, I believe, an entity that accounted for more than 10 percent of your revenue in a given year. 

And there were some accounting shenanigans to make sure they 

did not go over that 10-percent threshold to allow—— 

Senator FRANKEN. Right, so for the accounting shenanigans. 

Mr. KHUZAMI. Correct. 

Senator FRANKEN. Right. But it was addressing this conflict of 

interest. 

Mr. KHUZAMI. That is correct. 

Senator FRANKEN. So this conflict of interest is kind of a big 

problem. 

Mr. KHUZAMI. Senator, we are looking—we have looked at the 

area closely, and I agree with you. And Dodd-Frank, obviously, as 

I am sure you know, addressed a number of those issues. 

Senator FRANKEN. Well, actually, not quite as strongly as I 

would have liked. In fact, I presented an amendment that passed 

the Senate 64–35 that would eliminate this conflict of interest by 

creating a third party that would assign a credit rating agency to 

the instrument and take the conflict of interest out. And that has 

been now—that became a study, after 2 years under the SEC, and 

that is kind of what I wanted to ask you about. 

This conflict of interest is pretty serious, right? 

Mr. KHUZAMI. Correct, Senator. We see conflicts not just in the 

credit rating agency but in a number of areas, and each time it is 

typically a source of concern of ours. 

Senator FRANKEN. But let us talk about it specifically in the 

credit rating agencies. I think basically what would happen is they 

would get paid to rate an instrument, and they would give it a 

AAA rating, whether it deserved it or not often. In fact, in your testimony you have a thing about Moody’s doing that, right? 

Mr. KHUZAMI. Correct. 

Senator FRANKEN. OK. And you say here that the Commission’s 

report warned that, ‘‘. . .the conduct of Moody’s European credit 

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scribed in Moody’s NRSRO application submitted to, and later approved by, the Commission.’’ It sounds like they are in breach of 

the law. 

Mr. KHUZAMI. Well, in the Moody’s case, the problem was one of 

jurisdiction. 

Senator FRANKEN. Well, I know, and that speaks to this exactly, 

that it is ‘‘contrary to the methodologies described in Moody’s 

NRSRO application submitted to, and approved by, the Commission.’’ You wrote that to say, however, it may very well be—you 

said, ‘‘The report cautioned Moody’s and other NRSROs that deceptive conduct in connection with the issuance of credit ratings may 

violate the antifraud provisions of the Federal securities laws. .

.’’ 

So my question is why—now, didn’t you at one point give them 

a Wells notice? 

Mr. KHUZAMI. We did, Senator. 

Senator FRANKEN. And why did you decide not to go further with 

that? 

Mr. KHUZAMI. Because of the jurisdictional hurdles. As I am sure 

you know, the transactions at issue were European—— 

Senator FRANKEN. Right, OK. 

Mr. KHUZAMI. The ratings were done by the European entity. 

There was really no connection to the United States. 

Senator FRANKEN. OK, even though in your own testimony here 

you write this caveat that it is in violation—it is possibly in violation of our laws. 

Mr. KHUZAMI. Correct. If we had jurisdiction over the conduct, 

absolutely. 

Senator FRANKEN. OK. Well, maybe I do not totally understand 

your testimony, then. I am sorry. I apologize if I do not. 

I guess my point is that there was also testimony in Chairman 

Levin’s Committee of a number of credit rating agencies that their 

e-mails basically said we better give this a good rating because we 

want their business, right? 

Mr. KHUZAMI. Yes, I am aware of that testimony, Senator. 

Senator FRANKEN. OK. And it is more evidence than testimony. 

It is e-mails. 

I guess my point is that I want the SEC, after examining this— 

I would like to find some solution to this conflict of interest, and 

I do not see any other solution other than having some kind of 

third party—and it does not have to fit my prescription, but I 

would like to see some kind of way of eliminating this conflict of 

interest where the credit rating agency is chosen by the bank that 

is issuing the product and paid by the bank that is issuing the 

product. 

Mr. KHUZAMI. I completely agree with you, Senator. 

Senator FRANKEN. Oh, good. I am glad you do. Thank you very 

much. 

Let us see. Mr. Breuer, thank you for being here. In a speech 

given to the American Bar Association, National Institute of WhiteCollar Crime—a terrific group, by the way—in March 2010, you 

discussed that the Department of Justice needed to ‘‘be more targeted, more creative, and more strategic in where and how we look 

for criminal conduct when investigating financial fraud.’’ 

20 

What specifically has the Department of Justice done with FERA 

funds to be more creative and strategic when prosecuting crimes so 

that we are ahead of the curve? And maybe this was asked before, 

and I am sorry if it has been before I got here. 

Mr. BREUER. Senator, both at Main Justice and at the U.S. Attorney’s Offices, numerous U.S. Attorneys have created securities 

sub-groups, or even if they have not denominated them specifically 

as that, have either selected lawyers or recruited lawyers to work 

specifically on what we will call securities-related kinds of cases. 

That is what we are doing. We have beefed up in our Fraud Section 

the number of lawyers who work in this area. We have recruited 

lawyers with very deep experience in the specific areas. We have 

recruited alums of the SEC who have then decided to become prosecutors. We have recruited lawyers from other U.S. Attorney’s Offices and given them supervisory positions. So that is one thing we 

have done. 

As I said earlier, it is always hard for me to know exactly where 

the monies go, but we think very much that, given the kinds of 

cases that we need to bring, we have to be very aggressive in doing 

it. We have to have wiretaps, we have to have undercovers. In 

doing that, we have allocated more positions for people who review 

wiretap applications, because the ones that take the longest are the 

ones, frankly, in the very complicated white-collar cases. And I 

think, Senator, you will see in the coming period of time announcements of perhaps insider trading cases or others that will have 

been brought about, as had the Galleon case, from things such as 

wiretaps. We have been taking more and more aggressive steps. 

Then, frankly, we have taken these lawyers, and we have put 

them on some of the most complicated cases. In January, we will 

go to trial in the Stanford case. We, of course, brought the Farkas 

case dealing with TBW, one of the largest mortgage lending institutions, which led to the failure of both that and Colonial Bank. 

So we are taking the funds. We are hiring lawyers. I think probably, Senator—I do not know exactly -probably nationally at this 

point maybe, ball park, 75, 80 new prosecutors in this area have 

been hired, and probably another 70 are in the process of being 

hired. 

Senator FRANKEN. Thank you, and I want to thank all three gentlemen for your service. Thank you, Mr. Perkins. I did not get a 

chance to question you, but my time is up. 

Thank you, Mr. Chairman. 

Senator KAUFMAN. Thank you. 

Mr. Breuer, during the savings and loan crisis, bank regulators 

played an important role in cases. Now, you used the term ‘‘deep, 

substantive knowledge,’’ and I think that is the real driving force. 

They can deliver cases that are ready to go to prosecution. 

Can you talk a little bit about how you are working with bank 

regulators in order to find fraud? 

Mr. BREUER. Yes, it is going very well, and, Senator, it is, candidly, going particularly well after FERA, and to be very open, 

after speaking with members of the Committee and specifically 

you. We in the Criminal Division and our colleagues have been 

meeting regularly with the bank regulators. We have been reviewing with them, after they have selected some, the Suspicious ActivVerDate Nov 24 2008 11:18 Jan 17, 2012 Jkt 071990 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\71990.TXT SJUD1 PsN: CMORC
21 

ity Reports, which are in this day and age the equivalent of referrals. And, frankly, those kinds of reviews are leading to very active 

investigations. 

The task force in particular has been a terrific forum to get the 

regulators together. Just earlier this week in New York, for instance, the Securities and Commodities Working Group of the task 

force met. We met at the CFTC. Mr. Khuzami and I, and the U.S. 

Attorney in New York, are the co-chairs of that committee. And at 

that meeting, there were many of the bank regulators and others, 

and we spoke about these very issues. 

So we will continue to work. We have more to do, but overall I 

think it is a good report. 

Senator KAUFMAN. Great. Thank you. 

Mr. Khuzami, as you justifiably said, the SEC settles its highestprofile cases, such as Bank of America, Goldman Sachs, Barclay’s, 

and Citi. Can you kind of go through the decisions you make when 

settling versus taking a case to court? 

Mr. KHUZAMI. Sure, Senator. Look, when we consider settlement, 

we consider whether or not we can achieve the objectives we started out in bringing the case through settlement. And if we can do 

that and avoid the litigation risk of an unfavorable outcome as well 

as the resource considerations—not that the resource considerations are paramount, but there are opportunity costs in everything we do. If you are working on Case A, you are not working 

on Case B. And so we look at all of that, and it is a complicated 

analysis just because you need to analyze the strength of your 

proof and what you think the remedies will be even if you prevail. 

And that is the general formula, and we do it in all of our cases. 

Senator KAUFMAN. Do you ever take into account what the message will be if somehow you go into court and you lose in terms 

of just the impact people have about whether they can break the 

law? 

Mr. KHUZAMI. If we lose? 

Senator KAUFMAN. Yes. 

Mr. KHUZAMI. We do worry about—I think about that in some 

context. If you are bringing a case, for example, a TRO or an asset 

freeze against a suspected Ponzi scheme, and you are uncertain if 

you have got the evidence to stop it, but you very much want to 

be able to because it may be an ongoing fraud, if you bring that 

case and lose, all of a sudden it becomes potentially -you know, the 

Good Housekeeping Seal of Approval that the perpetrators then 

say, ‘‘The SEC tried to stop us and nothing was found wrong.’’ And 

so sometimes you have to take that into account. 

But as a general matter, I think that you cannot be cowed by the 

possibility of losing, and we do enough good things and bring 

enough good cases that we can take a few losses if the cause is 

right. 

Senator KAUFMAN. Mr. Breuer, the behavior of the borrowers, 

lenders, banks during the housing boom, which ultimately led to 

the financial catastrophe, represented a continuum from innocent 

to the unwise to the criminal. What are the hallmarks of criminal 

or fraudulent behavior that you look for when deciding whether to 

initiate an investigation? 

22 

Mr. BREUER. Well, we look, Senator, to see if we believe that 

fraudulent conduct occurred and whether or not it is the kind of 

conduct that we believe we can prove beyond a reasonable doubt. 

So if someone made a material false misrepresentation and we believe that that is something that is colorable, then that is exactly 

what we would investigate. 

And so working with my colleagues to my left, whether it is the 

most sophisticated or the simplest, that is the kind of benchmark 

that we follow. 

Senator KAUFMAN. Mr. Khuzami, how about you? 

Mr. KHUZAMI. In terms of what we look at? 

Senator KAUFMAN. Yes, look for in terms of deciding whether to 

initiate an investigation. What kind of behavior kind of sends a signal that it is time to start looking and investigate this? Not prosecute, but earlier on in the investigation phase. 

Mr. KHUZAMI. Well, you know, some cases come to you with pretty good evidence of wrongdoing, and that is an easy call. You look 

at that—— 

Senator KAUFMAN. And the whistleblower thing is really very 

helpful in that, right? 

Mr. KHUZAMI. That is the—— 

Senator KAUFMAN. And everybody agrees to that? I mean, you 

know, there is nothing like having somebody come forward who can 

tell you actually what is going on. 

Mr. KHUZAMI. That is correct. Potentially extremely valuable, 

both in terms of getting at the conduct earlier, getting at those who 

organize and supervise and lead an organization, because if you 

have an active scheme really of any kind, odds are there is just a 

handful of people who are in on it. And in order to gain access and 

a window into that and the evidence that you need to bring that 

case, you need somebody similarly trusted. And so whistleblowers 

and cooperators are the kind of people that can do that for you. 

Senator KAUFMAN. Yes, and we have talked about it before. I 

mean, this is not—at one time I said it is not like drug dealers. 

These folks that are involved in this kind of fraud have very good 

lawyers and accountants, and they cover up behind themselves 

very, very well. Do you want to comment on that? 

Mr. KHUZAMI. It is absolutely right. The simplest example is the 

person who is engaged in insider trading who at the same time 

they are receiving the information and executing the trades are 

searching the Internet for a few research reports on the particular 

company and stick it in their file, so when the cops come knocking, 

they point to the file and say, ‘‘This is why I bought.’’ And in order 

to be able to rebut that defense, you need a pretty tight case. 

Senator KAUFMAN. Mr. Perkins. 

Mr. PERKINS. Senator, I can give you a couple specific examples 

of what we are trying to do, especially involving resources that we 

receive based upon FERA and through Congress over the last year. 

I mentioned in my opening statement in my testimony the Financial Intelligence Center. I also want to mention the usage now of 

forensic accountants, something we did not have in the past. 

We found in the past walk-ins, people that are motivated 

through whistleblower and the like, yes, those can deliver a lot of 

cases. But the best cases are the ones you can get on the front end 

23 

where you can utilize the Title III, the undercover technique, and 

whatever the case, whether it is a financial fraud or any other type 

of criminal activity. 

What we are trying to do with the Financial Intelligence Center, 

we have intelligence analysts there who look at SARs, which you 

mentioned. When I came into the Bureau in the mid–1980’s, it was 

the RTC, Resolution Trust. I worked those cases. Today we have 

SARs not only from the financial institutions but from the securities industry. We are able with our analysts there to look at those, 

determine patterns of activity, and actually have identified investigations based out of that that no one came in the door, that we 

have actually referred out to our field offices, to follow up on that 

with the forensic accountants, again, something that 1 year ago we 

did not have. We have a position now—— 

Senator KAUFMAN. I am smiling because I can remember that little accountant in ‘‘The Untouchables.’’ 

Mr. PERKINS. Yes. 

Senator KAUFMAN. The FBI accountant that found out about Al 

Capone. 

Mr. PERKINS. Exactly. 

Senator KAUFMAN. He was gone by this time. 

Mr. PERKINS. Being the one accountant sitting at this table, I can 

appreciate that, sir. But with the forensic accountants, we have 

been able to hire nearly 100. We send them to a 6-week class at 

Quantico. Our first class graduated with 35 students just a few 

weeks ago. 

I will give you an idea of the quality of the people we have in 

these classes, and these are all newly hired employees—I am sorry, 

38 students. Of the 38 students, 28 of them are certified public accountants; 10 of them are certified fraud examiners. So that is just 

the beginning. Multiple MBAs. These people are now in the field. 

Over half of that original class went to our top five field offices 

where these cases exist. 

We have another class of 40 about to start in a month, and we 

are going to keep that continuum going. So we are using these individuals to identify those types of cases and then to work those 

cases. 

Senator KAUFMAN. I think that is really what we all talked 

about. That is what FERA was all about, to try to get the capability to move up the chain to get to the more complex cases. That 

is why the whistleblower provisions are in Dodd-Frank. I think this 

is all the ability to know you just cannot have two different sets 

of rules for people, and if you are powerful and you have got money 

and you have got good accountants and good lawyers, you can get 

away with something that normal people cannot. 

I would like to turn back to the hypothetical I discussed in my 

opening statement to try to define the distinction between actionable fraud and legally permissible behavior. Mr. Breuer, I described 

a bank that sought to increase market share by lending a larger 

and larger percentage of its loans on a stated-income basis, or liar 

loans. Over time, almost three-quarters of the Option ARM loans 

and about half of the subprime loans were offered on a stated-income basis. Does that in itself give rise to actionable fraud? 

24 

Mr. BREUER. Senator, from my perspective, it really depends—I 

hate to say it but—on what the disclosure says. 

Senator KAUFMAN. Sure. 

Mr. BREUER. At the end of the day, that is the difference. If the 

institution materially misrepresented what it was doing, if it purported to the public one thing and was doing something very different, materially different, then, yes, that could very well be criminal. But, frankly, if within the large disclosure of the kind of activity that they were engaged in is covered in some way, then that 

could very well pose an enormous burden for us and could preclude 

us from proceeding criminally. 

So until we read those dense disclosure materials or unless we 

have somebody from the inside telling us what was going on, those 

are the kinds of challenges that we will continue to face. 

Senator KAUFMAN. Now, if the bank takes loans itself, it is free 

to sell the loans; it is free to hold them on its balance sheet, right? 

It can do anything with these loans it wants to do. 

Mr. BREUER. There are others, such as Mr. Khuzami, who are 

more expert in this than I, but so far it seems as if, yes, they would 

be able to do that in your hypothetical. 

Senator KAUFMAN. Now, if the bank at some point decides that 

loans on its own balance sheet are likely to default and plummet 

in value, may the bank sell these loans to third parties without disclosing its belief that they are a bad investment? 

Mr. BREUER. Well, again, Senator, I mean, there are cases—and 

the SEC I think is litigating some of these right now. But I think 

that there would be a question of what is being disclosed and what 

is being withheld and whether it is just an opinion being withheld 

or whether the underlying facts are being withheld. And, again, 

those are difficult issues. 

Senator KAUFMAN. Mr. Khuzami. 

Mr. KHUZAMI. Well, look, under the scenario you describe of a 

securitization, a company in the securitization business, a couple 

points. 

One, there are various theories: disclosure; the accounting could 

be bad; they could be not setting aside proper reserves given the 

deteriorating quality of the loan portfolio. That is a separate and 

independent potential violation. And there is the MDNA provisions 

of the disclosure laws which require them to disclose trends and 

uncertainties and kind of management’s perspective of the business 

model. So you might look at all those three. In fact, in Countrywide, we brought the case based on an MDNA theory, not so much 

on the accounting or other aspects but the fact that they knew that 

the business model was deteriorating because the quality of the 

loan portfolio was going down, and they did not disclose that. So 

we try and be creative with the theories. 

One of the hurdles in the securitization world is that typically 

these securitization vehicles, the offering materials attached to 

them, in addition to the disclosure, every loan in the portfolio 

where you get the loan identity and geographic location, the average FICO score, and all the information. So a lot of granular level 

is disclosed in connection with the securitization that can make it 

difficult to make the case. 

25 

But, on the other hand, in your hypothetical, if a company were 

to say, you know, our portfolio may consist of a certain percentage 

of liar loans and, in fact, they already do consist of that, you might 

even try to be aggressive and seize upon the difference between 

‘‘may’’ and, in fact, ‘‘does’’ as a theory to proceed. And we consider 

those kind of theories as well. 

Senator KAUFMAN. And this disclosure thing, because I think disclosure is really the root of a lot of these problems. Is that fair to 

say? You know, one of the things I was thinking about—because 

I have been thinking about this a lot—is, you know, we had the 

truth-in-lending law which took—you know, everybody in America 

was borrowing things, and somewhere deep down—and it was not 

100 pages like some of these prospectuses are, but, you know, it 

would be three or four pages, little print—would be what the interest rate was. Then we took the interest rate and put it right out 

on the front of the page so you cannot miss the interest rate. 

Is there something in disclosure—I mean, it just seems to me 

this is not right. This falls into the ‘‘not right’’ category. It may be 

legal that you can hide these things down in the body of the thing, 

you can put in there what the statements are, when all along you 

know what it is that you are selling is not a good thing. 

What can we do in terms of changing the disclosure rules so that 

it makes it easier for people who are buying, even supposedly, you 

know, the big boys, so that people know what it is that they are 

getting and how really risky it is? 

Mr. KHUZAMI. Well, I guess I would like to give that a little 

thought and perhaps get back to you. 

Senator KAUFMAN. That would be fine. 

Mr. KHUZAMI. A lot of the risks that are disclosed are typically 

disclosed up front in the offering materials, then followed on in the 

offering materials by more detailed and less important ones. So if 

you open up securitization offering material, the risks can start 

out, you know, the housing market, if that falls, these things are 

going to be badly worth; and if, you know, originators cannot make 

loans anymore, then this will be this, this, or this; or if there is an 

earthquake in Fresno, that could hurt. 

And so a lot of the stuff is identified up front, but you are also 

right that it is a big book of information and not always fully transparent to all buyers. 

Senator KAUFMAN. Mr. Breuer. 

Mr. BREUER. Well, I would say the same. I mean, obviously at 

the Department we are less the regulators, of course. We are the 

prosecutors. And so whatever the regulations and the laws are, we 

will look to see whether people violated them. 

I, too, would want to look at it. I think at its most basic level 

disclosure is a good thing, and making it simpler and understandable is a good thing. But, of course, in the very kinds of transactions that you are discussing and that Mr. Khuzami was referring to, many times you have very sophisticated parties on both 

sides of these very, very difficult and complicated transactions. And 

so, you know, where the right balance is I think is for others to 

probably figure out. 

Senator KAUFMAN. But I think in the end, I think you would all 

admit that these ended up being sold to very unsophisticated invesVerDate Nov 24 2008 11:18 Jan 17, 2012 Jkt 071990 PO 00000 Frm 00029 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\71990.TXT SJUD1 PsN: CMORC
26 

tors. I mean, a lot of people ended up—when you go around and 

look at the people who—I mean, major institutions maybe, but not 

at all familiar with what it is that we were doing and what was 

going on. This was not just—so, you know, the big boy thing, just 

as long as everybody is a big boy. But I think if you go back and 

look at most of these things, they were not big boys. 

OK. So they have the disclosure, and they said they had toxic securities and they sold them. But at the same time, they bet huge 

amounts of money against them in the credit default swap market. 

Mr. Khuzami, is that OK? 

Mr. KHUZAMI. Well, I mean, if an institution is engaged in legitimate hedging activities, if it looks at its overall risk and decides 

I am more long in the mortgage market than I really want to be 

and I offset some of that risk through derivatives or other instruments, there generally is—that is not improper. And, in fact, you 

want companies to hedge their activities. 

Senator KAUFMAN. But they can always hedge their activities by 

selling the securities. 

Mr. KHUZAMI. They can sell them, or they can—there is a variety 

of hedging tools. 

Senator KAUFMAN. I mean, most people, when they have something they do not like, they do not sell something, you know, as an 

offset, which is what the argument is. They sell the basic securities. But the basic securities are such that they know how bad they 

are at this point so they cannot sell them. So they can say that, 

you know, it is a hedging move. But if, in fact—I guess the key 

thing is if they know these securities are going south, they know 

that the housing market—at some point in there, if you know the 

housing market is going south, and you cannot sell the securities 

because you will not be able to disclose—you cannot say, ‘‘I know 

these are bad.’’ You have reached that point. Is it OK to go out at 

that point and then begin to sell swaps, to buy swaps to cover that? 

Mr. KHUZAMI. If I understand it right, a portfolio of bad loans, 

a company decides they are in bad shape and I don’t want them 

anymore, and I put them in some sort of vehicle to sell them to 

third parties. 

Senator KAUFMAN. Right. 

Mr. KHUZAMI. First off, they have to accurately describe what is 

in that portfolio, which means all the information that they are required to provide. If they provide any misleading information in 

connection with that, then that is clearly improper. 

Senator KAUFMAN. But if they do not sell them, they do not want 

to sell them because they cannot sell them because they disclosed, 

and what they do is they do exactly what you said. They leverage 

it by going out into the swap market and bet huge sums that the 

securities are going to fail. 

Mr. KHUZAMI. So that they basically go short. 

Senator KAUFMAN. Yes. 

Mr. KHUZAMI. The loans that are in their portfolio. I mean, the 

problem is that may be a legitimate hedging activity. They may 

have this risk on their books that they cannot get rid of, they cannot sell, they do not want the exposure. So they take other steps 

in order to protect themselves. That may not be improper if the 

27 

counterparty to the swap sort of understands what it is that the 

underlying reference obligations are in the swap. 

Senator KAUFMAN. Got it. But to the extent that they know they 

have got a problem, at least it poses a conflict of interest. If they 

are selling some of these securities—if they are holding them all, 

no problem. But if they are selling some of these securities at the 

same time they are selling—betting against them, that is at the 

very least a conflict of interest, right? 

Mr. KHUZAMI. It could be, yes, Senator. 

Senator KAUFMAN. Is it legal for a firm to manufacture and sell 

securities which it knows or is virtually certain are going to default? 

Mr. KHUZAMI. Well, again, if page 1 of the disclosure material 

said here is X security, but I am virtually certain that these are 

going to default, the answer would be no. Of course, no one would 

buy them. 

Senator KAUFMAN. So the same thing, to the extent that you 

reach a point in a market and you have got these secured investments that you are selling, you are selling them to customers, you 

put the disclosure in them. But you sit down and have a meeting. 

In the meeting you say, you know, this business has gone south, 

so what I am going to do, I am going to continue to sell as much 

of these as I can, but I cannot sell very many, and I’ve got to be 

protected if I do not. So then I go out and I sell the swaps in order 

to offset any potential loss. Is that criminal behavior? 

Mr. KHUZAMI. Well, is it the subject of a civil enforcement action? 

Senator KAUFMAN. Excuse me. Civil action. 

Mr. KHUZAMI. Well, I think the point is that at some point the 

securities are in such bad shape that it is virtually impossible to 

make adequate disclosure. And so I think if you really had a portfolio of securities that were that bad, you would—you know, odds 

are the disclosure, if they tried to sell them and nobody bought 

them, it just would not be adequate. 

Senator KAUFMAN. So the key to this really is finding out—you 

know, if you assume—and I think we can assume based on the hypothetical—that they did not actually say the housing market is 

going to fail and we are all going to fail. They said what they were 

saying before, which is if the housing market—exactly what you 

said, if the housing market fails, dah, dah, dah, dah, dah, then you 

are going to lose. 

Mr. KHUZAMI. Yes, or if—— 

Senator KAUFMAN. Isn’t it relevant—because it is very difficult— 

for instance, in this hypothetical it would be very difficult if the 

bank never will admit that they thought the housing market has 

gone south. Once they admit the housing market was going to go 

south, they should have disclosed that, right? I mean, there is a 

difference between saying the housing market might go south. It is 

different when you know the housing market—you have decided as 

a group the housing market is probably going to go south. I do not 

think anybody disclosed in their disclosure, well, the housing market is probably going to go south, and you are going to buy this security anyway. I think what they said was—and correct me if I am 

wrong. That is why we are having a hearing. They said what they 

were saying all along, which was, you know, if you invest in the 

28 

housing market, the housing market could fail. But isn’t it key at 

what point they think the housing market is actually going to fail? 

And isn’t that disclosure key to whether what they are doing is 

criminal? 

Mr. KHUZAMI. That could, although, you know, when the housing 

market is going to fail is a little more amorphous than more specific information about the particular security. So if they knew 

that, you know, the mortgages in Fresno were defaulting at a 45- 

percent rate and made misleading disclosures suggesting that they 

were performing adequately, that is more likely, were you to find 

the hook that you would need to bring an action. 

Senator KAUFMAN. But, remember, in this hypothetical they are 

selling—90 percent of their prime loans are liar loans. I mean, you 

cannot sit there—if this housing market is going south, it is hard 

to figure out how instruments being sold where over 50 percent of 

all their loans are liar loans, that you can—you know, that this is 

going to work. Once you reach—that is all based—that whole philosophy of liar loans rests with if you believe it—although I must 

say the head of the Office of Thrift Supervision said that liar loans 

are anathema to the banking industry. Of course, the problem was 

he was overseeing a bank that was using them and did not even 

know it. 

Mr. KHUZAMI. Right. The other hook you could use here is to 

show that if you had these loans on your own books, then typically 

you would be required to disclose that the source of these loans 

were your own balance sheet, because it is one thing—— 

Senator KAUFMAN. Yes. 

Mr. KHUZAMI. You know, it is one thing if you went out into the 

street and collected loans from everybody and then packaged them 

and sold them. If you are offloading your own risk from your own 

balance sheet, that is typically something that needs to be disclosed 

because that speaks to your—— 

Senator KAUFMAN. But it would not—but the equivalent thing is 

selling these swaps, right? Wouldn’t you have to disclose that, too? 

I mean, what is the difference between—essentially in the hedge 

case you gave, what is the difference between unloading stocks off 

your own account and going out and selling swaps? 

Mr. KHUZAMI. Buying protection. No, that is certainly true, and 

that could be a hook. I will say that certain of many structured 

products, including CDOs, often disclose that the underwriter or 

the arranger may take a short position or may be otherwise engaged in transactions, you know, long or short of the portfolio in 

question. So this sort of goes to your earlier question of whether 

or not that kind of disclosure is sufficiently prominent that people 

can make a decision. 

Senator KAUFMAN. But it goes back to what we are trying to say. 

One of the things we are talking about in the hearing, I mean, that 

kind of behavior should not be allowed—I mean, I know what the 

law is now. But isn’t there something we should do about that kind 

of behavior, especially when you look back on what happened to so 

many folks after it was clear that the banks continued to sell these, 

continued to turn them out, continued to securitize them, mortgage 

brokers, appraisers knew, everybody knew what was going on, and 

they had this incredible conflict of interest, as you admit. I mean, 

29 

there should be some way legally we can turn that conflict of interest, if you abuse it, into a crime. Anybody? 

Mr. KHUZAMI. Well, I mean, I think the answer is yes. Again, because we have a disclosure-based system, that is where the focus 

is on. If the question is we should just out and out prohibit that 

kind of activity, I think, you know, there are certainly some instances where we have seen where that would have been a better 

result. I would want to look at the overall impact that that might 

have before planting my feet. 

Mr. BREUER. Senator, I just want to be clear. At its most core 

principle I know, of course, you are talking about the CDOs and 

the swaps and really the kinds of very sophisticated transactions 

that the SEC in particular is focusing on and doing such a great 

job. But if we look at the kinds of cases that we have been bringing—and there have been many, many investment fraud cases, indeed many over the last months, the one common theme is that 

every one of the people we have prosecuted made false statements. 

Senator KAUFMAN. Right. 

Mr. BREUER. They made materially false statements. They told 

investors one thing, whoever they were, and they did something 

different. And they could not point to something to show that they, 

in fact, had revealed whatever it was. There was falsehood and 

there was criminality. 

And so at the end of the day—at the Department of Justice we 

are pretty simple—whether it is the simplest case or the most sophisticated case, that is what we are looking for, and that is what 

we need. That is what we need the regulators to show us. That is 

what we need the FBI to bring us. Those are the kinds of cases we 

look for, and at its core that is what we want. 

So if disclosure, for instance, as you suggest, is simpler and that 

would be appropriate for whatever the transaction is, then we can 

see what the disclosure is, and we can match it up to what the conduct was. And, really, that is what we look for. 

Senator KAUFMAN. Good. And, by the way, the only reason I— 

this probably is not going to happen again. It is going to be some 

new thing that is going to happen that we have not even thought 

about. But it is the basic premise. The basic premise is that, you 

know, I do not think anybody in America can sell something and 

at the same time sell insurance, buy insurance it is going to fail, 

a product. I think in a product liability case, this would be a real 

problem, right? If you made a car that you knew was going to crash 

and then sold insurance so that every time everyone crashed you 

made money, that would be a conflict of interest and be criminal 

behavior, correct? 

Mr. KHUZAMI. Yes. 

Senator KAUFMAN. So that is the thing we are trying to get at. 

In the securities industry, where in the securities industry do they 

have a special situation that does it? 

To follow up on this, Mr. Khuzami, if the bank relies on the credit rating to market the security, which it knows to have been 

awarded based on faulty methodology, is that a problem? 

Mr. KHUZAMI. If the bank is aware of that and they did not disclose that, that could well be a problem. 

30 

Senator KAUFMAN. If the bank relies on a credit rating that it 

knows to have been awarded due to a clerical error, is that a problem? 

Mr. KHUZAMI. Same thing. Again, if they know that and they intentionally do not disclose it or make misrepresentations that mislead the buyer, that is, in fact, a violation of the law. 

Senator KAUFMAN. And, Mr. Breuer, what if the bank relies on 

third-party representations such as claims by the originator regarding the quality of loans which it knows to be false? 

Mr. BREUER. Well, if it knows something is false, Senator, and 

it acts as if it is not false, and it represents as a result to third 

parties that that which it knows to be false is not, then that certainly would have the potential of being a criminal case. 

Senator KAUFMAN. And are there any cases like that? I mean, 

are you investigating cases like that? Is that a problem out there, 

or is it just hypothetical? 

Mr. BREUER. Well, no, we are looking at a whole host of conduct, 

and some of the conduct we are looking at would be related to the 

scenarios you are discussing. 

Senator KAUFMAN. Mr. Khuzami. 

Mr. KHUZAMI. Same thing. I mean, typically we focus on the 

issuers, the underwriters, and the public companies. But it is no 

defense if they know that a third party is doing something improper, they know that and they do not disclose it, that is improper. Even if they tried to disclaim complete responsibility—you 

know, no responsibility for the conduct of the third party, I am not 

sure that would cure the problem. 

Senator KAUFMAN. Now let us talk about some legislative 

changes to continue what I was just talking about because I think 

that is not the oversight now. What do we do going forward? And 

going back to this basic question, which is they are not—it is not 

illegal to do a number of things that I asked you about. 

Where the bank manufactures assets for sale to unwitting customers while at the same time shorting those securities, Congress 

should pass laws to fix that, I think. How would a law imposing 

a fiduciary duty on broker-dealers affect your ability to do your job 

and to catch people that are doing bad things? 

Mr. KHUZAMI. Well, Senator, as you know, that is a matter under 

study by the Commission now as a result of Dodd-Frank and 

whether or not to move to a uniform standard. For that reason, it 

probably would not be appropriate for me to—— 

Senator KAUFMAN. I am just talking about it from a legislative 

standpoint. I am saying, you know, it is in there as one of the 

things to consider. But we had offered a proposal—and I am not 

going to be here so I am not doing this to kind of pump my—— 

[Laughter.] 

Senator KAUFMAN. I am really trying to figure out, genuinely trying to figure out how we help get at some of this. And I am just 

saying I think that—let me put it this way: What separates what 

went on with that hypothetical bank and what most Americans 

view and most—is that there is this fiduciary—there is not a fiduciary duty. In other words, the key to this thing is I can do anything I want, you know, as long as I disclose it, and I can hedge 

my—I can use it as a hedge, but basically the ‘‘get out of jail free’’ 

31 

card in this, which I think exists only in this business, is I do not 

have a fiduciary responsibility to tell you what is actually going on 

here or to warn you about what is happening. Is that fair to say? 

Mr. KHUZAMI. Well, look, certainly a fiduciary standard is a 

heightened standard, and it would sweep into it more conduct that 

would be deemed improper. No doubt about that. 

Senator KAUFMAN. Mr. Breuer. 

Mr. BREUER. Senator, obviously, we really would at DOJ, I think, 

be very affected by what our friends at the SEC thought. So if they 

determined that broker-dealers should have an equivalent fiduciary 

duty, let us say as investment advisers, we would want to have 

long discussions with them. But, really, in the first instance, they 

really do have more expertise in that area than we, and so we 

would study it. But at the end of the day, we would probably be 

guided by that, and if there was a determination that that was appropriate, then to make it as simple as we can, then we would start 

prosecuting those cases when broker-dealers acted contrary to their 

duty. 

Senator KAUFMAN. Great. What about a law requiring brokerdealers—Mr. Khuzami, what about a law requiring broker-dealers 

to disclose internal company analysis regarding securities that it 

offers for sale? 

Mr. KHUZAMI. I am sorry. As a proposal? 

Senator KAUFMAN. Yes, as a proposal. Just a thought in terms 

of how do we get at this problem. 

Mr. KHUZAMI. Well, I suspect one result of that is there would 

be much less internal analysis of securities that would be issued. 

Senator KAUFMAN. Yes. 

Mr. KHUZAMI. So, you know, I think you would want to think 

about whether or not—whatever value that has—and obviously 

firms have research departments and they issue research across 

wide ranges of topics. So I guess I would want to think about that. 

Senator KAUFMAN. Got it. I understand that the toxic CDOs 

which undermined the financial system leading up to 2008 were, 

by and large, accompanied by extensive disclosure. We have talked 

about that. The problem was that few investors bothered to read 

and study them. The economic crisis actually underscores one potential problem in the disclosure regime. Mr. Khuzami, is there a 

better way to regulate disclosure so that investors are able to more 

readily determine what it is they need to know about a security? 

Mr. KHUZAMI. Well, I think this goes back to your point earlier 

about perhaps you need a Truth in Lending Act for securities disclosure. But, again, I think some of these are under consideration 

now, including revisions with respect to disclosure in connection 

with securitization and other similar products. So, again, that is 

something I think we would probably have to give some thought to. 

Senator KAUFMAN. OK. Mr. Breuer, you testified during the December 2009 fraud hearing that one type of fraud that contributed 

most to the financial mortgage crisis was when banks lied about 

the mortgage underwriting standards they used in issuing loans. 

Can you tell me what progress in pursuing those cases since last 

December? 

Mr. BREUER. Senator, I think I probably said something like we 

were looking at sort of a whole host of conduct from the very beginVerDate Nov 24 2008 11:18 Jan 17, 2012 Jkt 071990 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\71990.TXT SJUD1 PsN: CMORC
32 

ning to the end without probably making a statement that, you 

know, I had come to a conclusion that they had, in fact, lied. 

Senator KAUFMAN. Right. 

Mr. BREUER. We are looking at all the codes of conduct. We continue to look at them. And obviously the cases that we have already brought suggest that. The Farkas case that we have talked 

about is a very good example of that where we look at an originator 

and we look at his misrepresentations to a financial institution and 

proceeded. And we continue to look, as do our colleagues throughout the country. 

Senator KAUFMAN. Mr. Khuzami, when the SEC conducts an investigation and determines that the conduct was harmful though 

not actionable, the Commission can issue a so-called 21(a) report 

to publish its conclusions. Can you talk a little bit about a 21(a) 

report? 

Mr. KHUZAMI. Sure. The 21(a) reports can be issued in a variety 

of circumstances, including where there is a lack of clarity in the 

law and, you know, the investing public is well served by hearing, 

you know, a description or an explanation of what kind of conduct 

is improper. It gives proper notice and warning to institutions involved in that business to make sure they conform their conduct to 

the law. So it is a good way of getting the word out even if you 

do not have an enforcement action to file, so you correct behavior 

going forward. 

Senator KAUFMAN. In the case of the Moody’s European credit 

rating committee, can you explain the facts of that case and why 

the SEC issued the 21(a)? 

Mr. KHUZAMI. Quite simple. The structures at issue were European. The decisions—the error with respect to the rating of those 

instruments was European. The decisions by the individuals not to 

correct the error was made in Europe. There was really no connection to the United States, and, frankly, in addition, under the previous law, there was some question as to whether or not we even 

had the ability to bring actions against credit rating agencies with 

respect to either their methodologies or their ratings, which has 

now been cured under Dodd-Frank. 

Senator KAUFMAN. Yes. You know, the 21(a)’s sound like a pretty 

good thing to me, I mean, in terms of what we are talking about, 

sending a message to the industry that, you know, this is bad behavior, we know what you are doing, we cannot bring a case. Do 

you ever think about issuing more 21(a)’s? Or is there a real problem with doing that? 

Mr. KHUZAMI. No, I mean, we consider it on occasion. I cannot 

say I know the complete history of how many we have brought over 

the years, but it certainly is something that is always viewed as 

an alternative to an enforcement action. 

Senator KAUFMAN. And, again, this is not for publicity or anything. This is to actually turn to behavior. One of my major concerns is—and I have spoken of this extensively. The vast majority 

of people on Wall Street are really good people, and I went to 

school with them, you know, I really think the best of them. But 

there is a small group up there that continues to behave in what 

I would call—I mean, just totally opposed to what Senator—the 

former hear of the Fed Greenspan said, which was, you know, peoVerDate Nov 24 2008 11:18 Jan 17, 2012 Jkt 071990 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 S:\GPO\HEARINGS\71990.TXT SJUD1 PsN: CMORC
33 

ple will look out for the corporation, you know, they are not going 

to do anything really bad because they do not want to hurt corporation, they do not want to hurt other people. It seems to me coming 

out of this it continues to be a group of people who do not care 

about the corporation, who do not care about the taxpayer, who do 

not care about anything, except just maximizing—I think, again, a 

small percentage of people. 

And I think that what worries me about the difficulty of bringing 

these cases because they are so complex and because of the fact 

that we have—they are able to gain the services of extremely competent lawyers and accountants, that it is hard to bring these 

cases. But I do not want people sitting around in their office on 

Wall Street saying, Well, you know, we have kind of been doing 

this, and it has kind of worked for us, so we are going to keep 

doing it. 

So I think the deterrent piece of this is not to see someone go 

to jail, but a deterrent so that the next time something comes 

along—because it is going to be something different. It is not going 

to be the same thing. It is going to be something different. Could 

each one of you comment on that kind of thought? 

Mr. BREUER. Well, Senator, I could not agree more, and there, 

of course, will be some group of people—small, as you suggest— 

that will be willing to break the law and act in a criminal manner 

in order to benefit themselves. And what we have to do and what 

we are doing and what we will continue to do is have a robust and 

comprehensive response. 

Just last week, Senator, in New York, we completed an 8-month 

trial, 8 months, where we convicted a CEO and a COO of insider 

trading and a whole host of conduct, accounting fraud, where they 

took a public company and engaged in activities for their personal 

benefit. 

We are going to continue to bring those cases, whether they are 

hard or not. We hope that that creates deterrence. We will continue 

to be as aggressive as we can be, and we will continue to seek very, 

very stern and long sentences for those who cannot be deterred and 

for those who decide that their own selfishness and need for material wealth is more important than abiding by the law. And so we 

will continue to do that. 

Senator KAUFMAN. Mr. Khuzami. 

Mr. KHUZAMI. Yes, I agree. You know, you want to take on a 

comprehensive effort to make sure that people do not cross the line 

into illegal behavior, and in any particular company or bank, there 

is a large number of people who work in the legal departments, the 

compliance departments, the risk departments, the audit departments, the control functions, the management, whose function it is 

to make sure the company operates properly. And you want to empower those people—they are your deputies—because they are the 

ones that are in the offices every day. You want to empower them 

in order to make sure they get the message out that improper activity will not be tolerated. So they are your allies in this fight, and 

to give them the tools they need, you do a whole host of things. You 

know, you have better quality directors and more active management and compensation reform and just a whole host of activity 

34 

that collectively sends the message to the corporation that, in 

short, crime does not pay. 

Senator KAUFMAN. Let me ask you—Mr. Perkins, I will get to 

you in a minute—because that compensation thing—in the Permanent Subcommittee on Investigations, it was clear in a number of 

these places where bad things happened the compensation, the incentives were to behave in a very bad way. In other words, you got 

much more money to go out and find a subprime loan than you did, 

you know, a conventional loan. 

Is there any—does that play any role, is there any criminal—not 

criminal. Is there any civil or any other thing to deal with a company that continues to offer incentives that lead to bad behavior? 

Mr. KHUZAMI. Well, we have certain remedies, particularly in 

304 of S-Ox, which allow us to claw back executive compensation 

for at least CEOs and CFOs under circumstances where there was 

misconduct that occurred on their watch, frankly even if they were 

not personally involved in it. And we have used that authority on 

some occasions. 

There is more compensation structures—this is not really a matter of regulatory action, but more compensation structures particularly in banks that provide for claw-backs so that if a trade takes 

home a $10 million payday but his book blows up 6 months after 

he got that bonus, some of that is going to be clawed back, so you 

reduce the incentives for sort of the short-term gain. And I think 

that is a good development. 

Senator KAUFMAN. Good. And that is good for legislation. 

Yes, Mr. Breuer. 

Mr. BREUER. And, Senator, with respect to the Department, we, 

of course, were investigating, looking, for instance, at the conduct 

of a corporation or a large entity, there is a fair bit of discretion 

in how we are going to use our—how we are going to resolve the 

matter. Often a company is going to argue vociferously that they 

are a good company, that they have robust compliance programs, 

and that in this context they should not be prosecuted, or perhaps 

that they should have a deferred prosecution agreement or the like. 

Perverse incentives are certainly a factor and one of the issues we 

are going to look at, and we will look at it hard. 

Similarly related to it, Mr. Khuzami said before, we want to empower and encourage lawyers, accountants, and all to do as good 

a job as they can, to be as robust as they can. And on the other 

side, when they do not do that, when they act criminally, we think 

we have to prosecute those gatekeepers and prosecute them aggressively. And I think that also sends a powerful message. 

Senator KAUFMAN. Yes, it does. 

Mr. Perkins. 

Mr. PERKINS. Yes, thank you, Senator. I think you are exactly 

right when you described the threat tomorrow is going to be different. There is going to be something coming down the track next 

week that will not be anything like what we are looking at now. 

With my colleagues here at the table, as we have described, a great 

deal of effort and work is going to address the issue at hand right 

now, and example after example has been given. 

I think the success in FERA and what it has done for the FBI 

in particular is that it has allowed us to begin to build our capacity 

35 

to look over that horizon. One of the issues, the mantra we push 

is we want to chase the threat, not the case. We want to see what 

is coming over the horizon. And until we have been able to establish the Intelligence Center, the Forensic Accounting Program, 

bringing on additional agents, we did not have that capacity to do 

that. We are gaining that capacity now. We are building that so 

that we can identify that threat, much as we are doing in a much 

simpler matter on the gulf coast. We are trying to be ahead of what 

the threat is. We are trying to be proactive and address those 

things before they come up. 

Senator KAUFMAN. Thank you. And, listen, I want to thank the 

three of you for what you do, and the folks sitting in the row behind you and behind them and behind them and behind them. I 

mean, the people that we have, you know, fighting this fight is 

really quite impressive, and I think we are in a difficult war. But 

I am very pleased with the people we have on our side in the battle 

against people who are doing bad things. 

The thing that bothers me, I have said repeatedly in the Congress that the two most important things we have as a country is 

democracy and free markets. They are just key to maintain the 

credibility of our free markets. If we lose that, talk about not passing on to our grandchildren being responsible. And one of the 

things of our free market is making sure that if people use the 

market in a bad way or something like that, they pay a penalty for 

it. 

So it is really important. I mean, you are the police who make 

sure, you are the referees on the football field that make sure everybody is playing according to the rules. And that is really what 

we need. We had a period where I think we were not as concerned 

about that. We thought—I said a number of good people, smart 

people, said we do not need that anymore. But I think we have to 

have the confidence that our capital markets are fair, transparent. 

We have to make sure that capital formation—without capital formation, they will slow our growth. Widespread cheating and fraud 

of the sort that drove the speculative housing and derivatives securities bubbles are anathema—an anathema—to public confidence in 

the markets. In order to assure investors and the public that we 

have learned our lessons from the last disaster, we must have a 

full account of the criminality that has led us there. 

This November, I will leave the Senate, and the task of oversight 

will fall to my colleagues. I encourage each of you—I do not think 

you really need my encouragement, but I am going to encourage 

you anyway—to keep up the hard work, keep digging in the offerings documents, e-mails, board minutes, to keep developing leads 

through whistleblowers, plea deals, and tip hotlines. I am confident 

you will, and I want to thank you and thank you for your service. 

The record will stay open for additional information for a week. 

This hearing is adjourned. 

[Whereupon, at 3:54 p.m., the Committee was adjourned.] 

[Questions and answers and submissions follow:] 

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