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BANK OF AMERICA AND MERRILL LYNCH: HOW

DID A PRIVATE DEAL TURN INTO A FEDERAL

BAILOUT? PART V

JOINT HEARING

BEFORE THE

COMMITTEE ON OVERSIGHT

AND GOVERNMENT REFORM

AND THE

SUBCOMMITTEE ON DOMESTIC POLICY

OF THE

COMMITTEE ON OVERSIGHT

AND GOVERNMENT REFORM

HOUSE OF REPRESENTATIVES

ONE HUNDRED ELEVENTH CONGRESS

FIRST SESSION

DECEMBER 11, 2009

Serial No. 111–102

Printed for the use of the Committee on Oversight and Government Reform

(

Available via the World Wide Web: http://www.gpoaccess.gov/congress/index.html

http://www.house.gov/reform

(II)

COMMITTEE ON OVERSIGHT AND GOVERNMENT REFORM

EDOLPHUS TOWNS, New York, Chairman

PAUL E. KANJORSKI, Pennsylvania

CAROLYN B. MALONEY, New York

ELIJAH E. CUMMINGS, Maryland

DENNIS J. KUCINICH, Ohio

JOHN F. TIERNEY, Massachusetts

WM. LACY CLAY, Missouri

DIANE E. WATSON, California

STEPHEN F. LYNCH, Massachusetts

JIM COOPER, Tennessee

GERALD E. CONNOLLY, Virginia

MIKE QUIGLEY, Illinois

MARCY KAPTUR, Ohio

ELEANOR HOLMES NORTON, District of

Columbia

PATRICK J. KENNEDY, Rhode Island

DANNY K. DAVIS, Illinois

CHRIS VAN HOLLEN, Maryland

HENRY CUELLAR, Texas

PAUL W. HODES, New Hampshire

CHRISTOPHER S. MURPHY, Connecticut

PETER WELCH, Vermont

BILL FOSTER, Illinois

JACKIE SPEIER, California

STEVE DRIEHAUS, Ohio

JUDY CHU, California

DARRELL E. ISSA, California

DAN BURTON, Indiana

JOHN L. MICA, Florida

MARK E. SOUDER, Indiana

JOHN J. DUNCAN, JR., Tennessee

MICHAEL R. TURNER, Ohio

LYNN A. WESTMORELAND, Georgia

PATRICK T. MCHENRY, North Carolina

BRIAN P. BILBRAY, California

JIM JORDAN, Ohio

JEFF FLAKE, Arizona

JEFF FORTENBERRY, Nebraska

JASON CHAFFETZ, Utah

AARON SCHOCK, Illinois

BLAINE LUETKEMEYER, Missouri

ANH ‘‘JOSEPH’’ CAO, Louisiana

RON STROMAN, Staff Director

MICHAEL MCCARTHY, Deputy Staff Director

CARLA HULTBERG, Chief Clerk

LARRY BRADY, Minority Staff Director

SUBCOMMITTEE ON DOMESTIC POLICY

DENNIS J. KUCINICH, Ohio, Chairman

ELIJAH E. CUMMINGS, Maryland

JOHN F. TIERNEY, Massachusetts

DIANE E. WATSON, California

JIM COOPER, Tennessee

PATRICK J. KENNEDY, Rhode Island

PETER WELCH, Vermont

BILL FOSTER, Illinois

MARCY KAPTUR, Ohio

JIM JORDAN, Ohio

MARK E. SOUDER, Indiana

DAN BURTON, Indiana

MICHAEL R. TURNER, Ohio

JEFF FORTENBERRY, Nebraska

AARON SCHOCK, Illinois

JARON R. BOURKE, Staff Director

(III)

C O N T E N T S

Page

Hearing held on December 11, 2009 ...................................................................... 1

Statement of:

Bair, Sheila C., chairman, Federal Deposit Insurance Corporation ............. 39

Khuzami, Robert, Director, Division of Enforcement, U.S. Securities and

Exchange Commission .................................................................................. 60

Letters, statements, etc., submitted for the record by:

Bair, Sheila C., chairman, Federal Deposit Insurance Corporation, prepared statement of ........................................................................................ 41

Connolly, Hon. Gerald E., a Representative in Congress from the State

of Virginia, prepared statement of .............................................................. 100

Issa, Hon. Darrell E., a Representative in Congress from the State of

California, information concerning daily pacing ........................................ 69

Khuzami, Robert, Director, Division of Enforcement, U.S. Securities and

Exchange Commission, prepared statement of .......................................... 63

Kucinich, Hon. Dennis J., a Representative in Congress from the State

of Ohio, prepared statement of .................................................................... 35

Towns, Hon. Edolphus, a Representative in Congress from the State

of New York:

Letter dated December 10, 2009 .............................................................. 84

Prepared statement of ............................................................................... 3

(1)

BANK OF AMERICA AND MERRILL LYNCH:

HOW DID A PRIVATE DEAL TURN INTO A

FEDERAL BAILOUT? PART V

FRIDAY, DECEMBER 11, 2009

HOUSE OF REPRESENTATIVES, COMMITTEE ON OVERSIGHT

AND GOVERNMENT REFORM, JOINT WITH THE SUBCOMMITTEE ON DOMESTIC POLICY,

Washington, DC.

The committee and subcommittee met, pursuant to notice, at 10

a.m., in room 2154, Rayburn House Office Building, Hon. Edolphus

Towns (chairman of the Committee on Oversight and Government

Reform) presiding.

Present: Representatives Towns, Cummings, Kucinich, Tierney,

Clay, Watson, Connolly, Quigley, Cuellar, Speier, Issa, Duncan,

Bilbray, Jordan, Flake, Luetkemeyer, and Cao.

Staff present: John Arlington, chief counsel—investigations; Jean

Gosa, clerk; Adam Hodge, deputy press secretary; Carla Hultberg,

chief clerk; Marc Johnson and Ophelia Rivas, assistant clerks;

Mike McCarthy, deputy staff director; Jenny Rosenberg, director of

communications; Joanne Royce, senior investigative counsel; Leneal

Scott, IT specialist; Christopher Staszak, senior investigative counsel; Ron Stroman, staff director; Gerri Willis, special assistant; Alex

Wolf, professional staff member; Jaron Bourke, staff director, Subcommittee on Domestic Policy; Lawrence Brady, minority staff director; John Cuaderes, minority deputy staff director; Rob Borden,

minority general counsel; Jennifer Safavian, minority chief counsel

for oversight and investigations; Frederick Hill, minority director of

communications; Adam Fromm, minority chief clerk and Member

liaison; Kurt Bardella, minority press secretary; Seamus Kraft, minority deputy press secretary; Christopher Hixon, minority senior

counsel; Hudson Hollister, minority counsel; and Brien Beattie and

Mark Marin, minority professional staff member.

Chairman TOWNS. The committee and subcommittee will come to

order. Good morning and thank you for being here.

The committee’s investigation into Bank of America’s acquisition

of Merrill Lynch has resulted in an unprecedented look behind the

scenes of one of the biggest bailouts in American history. Did the

Federal Government force Bank of America to go through with the

merger? Every Bank of America senior executive involved has told

the committee that the government did not force them to go

through with it. In fact, they told us they decided to go through

with the deal because they thought it was in the best interests of

Bank of America and its shareholders. Ken Lewis also testified

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that no one in the Government did anything improper during this

transaction.

If there are still people who want to say the Government forced

Bank of America to go through with the deal, they are turning a

blind eye to the facts we now have before us. Over the course of

this 8-month investigation, the committee has held five hearings,

received extensive testimony from top executives at Bank of America and senior Government officials, conducted numerous interviews, issued two unprecedented subpoenas to the Federal Reserve

for internal records, and reviewed nearly half a million documents.

Most importantly, public scrutiny and oversight by this committee has produced tangible results. Two days ago, Bank of America

paid back its entire $45 billion Federal loan plus interest. In addition, under pressure from the committee, Bank of America agreed

in September to pay $425 million to the Treasury Department in

compensation for toxic asset insurance the bank received but never

paid for.

In sum, our bipartisan investigation has resulted in the Amer- ican taxpayers receiving approximately $471⁄2 billion. Even in today’s world, that is real money.

Every member of this committee should be proud of our efforts,

and I take the time to salute you for your involvement and your

hard work that has been great to get to this point.

While we have thoroughly examined all these issues involved in

this case, I agreed to grant the ranking member’s request for one

more hearing to tie up some loose ends that he is concerned about.

This will close the committee’s full, fair, and successful investigation of the Bank of America-Merrill Lynch merger.

On that note, I thank you; and I yield to the ranking member

of the committee, the gentleman from California, Congressman

Darrell Issa.

[The prepared statement of Hon. Edolphus Towns attached:]

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Mr. ISSA. Thank you, Mr. Chairman, and thank you for holding

this hearing.

I have already told the chairwoman that, quite frankly, I do believe she is the bookend of this investigation. She is the bookend

because Tim Geithner has never appeared before us. She is the

bookend because, in fact, there never really was much there. Bank

of America is a regulated bank. Moneys were made available on an

extraordinary basis and have now been paid back.

Today, in the short time that we will take of the chairwoman, we

in the minority will ask, where do we go from here? The security

of our banks, FDIC-insured banks, the future of banks conveniently

becoming banks in times of trouble and perhaps not being banks

in other times, these are important questions that this committee

should ask not because we are the Financial Services Committee

but because we are the watchdog of the American dollar and the

American process and the laws that are passed that the executive

branch and its affiliates must adhere to.

Mr. Chairman, I am deeply concerned that in your opening statement you, quite understandably, said that the American people

were paid back $45 billion with interest, over $47 billion. I must

caution you, the American people didn’t get a penny back. That

money has not come back to the American people. In fact, it has

simply been put back into the slush fund that was created under

a Republican President with Tim Geithner and Hank Paulson’s assistance; and today, in fact, not a penny has been paid back to the

American people. That money is being recycled into do-good causes

or whatever the President and this administration would like to do.

Mr. Chairman, I look forward to us getting the American people’s

money back as it was promised. We were told that, in fact, we

would be paid back all of our money, and probably with interest.

Mr. Chairman, unless that money comes back immediately, when

you look at Chrysler, General Motors, and, of course, $31-plus billion to AIG that Tim Geithner himself has now said we will not get

back, it is clear that even if all the other moneys given to various

organizations through a process of buying mostly preferred debt, if

in fact all of that is paid back with interest, the offset of the money

that we now know we are going to lose would barely make us

whole without considering interest as anything other than principal payback.

So Mr. Chairman, this is the bookend. We have only a few questions for our esteemed witness, and we appreciate your bringing

her here today. But this is not the end of protecting the American

people’s money, not the end of this committee’s jurisdiction of ensuring that the intent of law becomes the fact in law.

With that, I thank the chairman and yield back.

Chairman TOWNS. I thank the gentleman for his statement. And

maybe what we can do with some of this $471⁄2 billion is use it to

create jobs and job opportunities. So maybe that is a good way to

use it.

Mr. ISSA. Mr. Chairman, I would certainly appreciate a bill authorizing that and appropriating that through the Congress. And I

look forward to working with you on such a piece of legislation,

which is our constitutional responsibility.

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Chairman TOWNS. Thank you very much. I appreciate the gentleman’s offer and look forward to working with you.

Mr. CONNOLLY. Mr. Chairman? Would the ranking member

yield?

Chairman TOWNS. Actually——

Mr. ISSA. The Chair certainly could.

Mr. CONNOLLY. Would the chairman allow me to just respond to

something the ranking member said?

Chairman TOWNS. Very quickly.

Mr. CONNOLLY. Very quickly. I just want the ranking member to

know there are Members on this side of the aisle who share his

view about the need to address the deficit and that the first obligation of the repayment of TARP money or the use of unused TARP

money ought to be that.

Mr. ISSA. Thank you.

Chairman TOWNS. Thank you very much.

As this hearing is being conducted by the Domestic Policy Subcommittee, of course, and they have done a superb job in working

with us on this issue, I now would like to yield 5 minutes to the

gentleman from Cleveland, OH, Mr. Kucinich, the Chair of that

subcommittee.

Mr. KUCINICH. Thank you very much, Mr. Chairman, Mr. Issa,

members of the committee.

On December 5, 2008, the shareholders of Bank of America voted

to approve a merger with Merrill Lynch. Only 12 days later, Ken

Lewis, CEO of Bank of America, made a call to then-Secretary of

Treasury Hank Paulson, initiating a process that led to a $20 billion bailout of the merger and a promise of government insurance

for losses of up to $118 billion.

The chronology of events strained belief. Was it true that the financial situation at Merrill Lynch shifted so dramatically in that

short amount of time, as Ken Lewis said? Or did top management

know, or should they have known, about the deteriorating situation

at Merrill Lynch much earlier? Did they fail to make necessary disclosures to the shareholders? Bank of America would be in legal

jeopardy if it failed to disclose to shareholders information about

large accelerating losses at Merrill Lynch known or knowable before the shareholder vote.

The Domestic Policy Subcommittee investigation has found evidence of possible security law violations at Bank of America. Bank

of America unreasonably and negligently relied on internal fourth

quarter 2008 forecasts created by Merrill Lynch that omitted any

forecast of how the CDOs, CDS, and other toxic assets would perform during the quarter. The former Merrill CFO admitted that

this forecast was not, in fact, a valid forecast.

Bank of America knew at the time that the forecast was of questionable validity. However, Bank of America did not do any actual

financial analysis to make up for the Merrill omissions. Instead,

Bank of America merely pulled a number out of thin air, which was

recorded on a forecast as the gut feeling of Neil Cotty, Bank of

America’s chief accounting officer. Bank of America simply created

an assumption that Merrill Lynch’s illiquid assets would almost

break even for November, thereby spreading October’s bad results

over 2 months.

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The attorneys at Bank of America and at Wachtell, Lipton recklessly did not question this financial information. They advised

Bank of America not to make further disclosures to its shareholders based on the deficient forecast and the gut feeling.

Within only weeks, however, reality crowded out wishful thinking. Merrill Lynch’s exotic investments continued to lose large

amounts of money, causing Merrill to lose over $21 billion in just

the fourth quarter. Bank of America went running to the U.S. Government for rescue.

When I asked Ken Lewis about this at our first hearing, he told

us that he relied on advice of counsel. Protecting shareholders is

often, in the final instance, the responsibility of corporate general

counsels and their outside counsel. The subcommittee’s investigative findings demand the question, where were the lawyers? Where

were the lawyers?

The glaring omissions and inaccurate financial data in the critical November 12th forecasts were so obvious that they should have

alerted the attorneys to the necessity of reasonable investigation

before making a key decision on Bank of America’s legal duties to

disclose. The apparent fact that they did not mount such an investigation makes the decision not to disclose Merrill’s losses to shareholders an egregious violation of securities laws.

The stage for these possible violations was set by former SEC

Chairman Christopher Cox. At exactly the time that CDOs, CDSs,

and other exotic instruments proliferated in financial markets,

Chairman Cox discouraged formal investigations of, and large corporate penalties against, securities fraudsters. Bank of America’s

conduct was the corporate reaction to years of weakening enforcement at the SEC under Chairman Cox. Chairman Schapiro has

made efforts to turn enforcement policy around.

While I applaud the SEC for enforcing the law, in the case of the

nondisclosure of the Merrill bonuses, Bank of America’s failure to

disclose accelerating losses at Merrill Lynch before the shareholder

vote is more significant. Indeed, those undisclosed losses dwarf the

amount of undisclosed bonuses. The reliance on counsel defense asserted by Ken Lewis raises the broader question will the Securities

and Exchange Commission allow corporate management to rely on

the advice of counsel defense and then allow the counsel to avoid

liability for their advice? The investing public and now this Congressman wants to know, where is the SEC? As of yet, we don’t

know.

Thank you.

[The prepared statement of Hon. Dennis J. Kucinich follows:]

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Chairman TOWNS. Thank the gentleman for his statement.

I now yield 5 minutes to the ranking member of the Domestic

Policy Subcommittee, Mr. Jordan, from the State of Ohio.

Mr. JORDAN. Thank you, Mr. Chairman, and I want to thank you

for holding today’s hearing. I look forward to exploring the role of

the SEC and FDIC in the merger between Bank of America and

Merrill Lynch.

This committee’s investigation has revealed important evidence

of the abuse of power by the Federal Government in response to

the financial crisis. As I have said before, Mr. Chairman, while the

actions of the government officials took place in a time of significant economic challenges and uncertainty, there must be limits to

government action even in a time of crisis, and those limits must

be respected.

We must also keep in mind that the actions of government officials in this merger occurred after many of the Nation’s banks were

forced to accept taxpayer money through the TARP program. We

know that in October 2008—this is from testimony Ken Lewis gave

us at the very first hearing we had on this issue. We know at that

October 2008, meeting, Mr. Paulson, Mr. Bernanke, Mr. Geithner,

and Ms. Bair brought the CEOs of the largest private banks in

America to the Treasury Department, demanded that they accept

the partial nationalization of their banks in exchange for an

amount of money of the government’s choosing. I look forward to

learning more about Mrs. Bair’s role in that meeting and this entire affair.

This investigation has continued to reveal the unintended consequences and negative implications of the government’s unprecedented intervention in the private sector. I hope the Congress will

apply these lessons as we continue to debate the appropriate regulatory framework for our financial system as we move forward.

And with that, Mr. Chairman, I thank you and yield back.

Chairman TOWNS. Thank you very much.

We now move to our witness. We have with us today the Chair

of the Federal Deposit Insurance Corporation.

Madam Chair, it is the longstanding tradition that we swear all

of our witnesses in. If you would stand and raise your right hand.

[Witness sworn.]

Chairman TOWNS. Let the record reflect that the witness answered in the affirmative. You may begin with your testimony.

STATEMENT OF SHEILA C. BAIR, CHAIRMAN, FEDERAL

DEPOSIT INSURANCE CORPORATION

Ms. BAIR. Thank you, Chairman Towns, Chairman Kucinich,

Ranking Members Issa and Jordan, and members of the committee.

As requested by the committee, my testimony today will focus on

the FDIC’s role and the decision——

Chairman TOWNS. Madam Chair, you want to pull that mic down

just a little bit there?

Ms. BAIR. Sure. As requested by the committee——

Chairman TOWNS. And closer, too, I think.

Ms. BAIR. As requested by the committee, my testimony today

will focus on the FDIC’s role and the decision to provide assistance

to Bank of America.

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Let me note at the outset that Bank of America is an open institution, and the FDIC is very sensitive about any discussion of the

condition of open and operating insured depository institutions.

In mid-September 2008, in the wake of Lehman’s failure, BofA

announced that it would acquire Merrill Lynch. BofA’s acquisition

of Merrill Lynch was approved by the Federal Reserve on November 26, 2008, and was to be finalized in early 2009. However, on

or very shortly before December 21, 2008, the FDIC was told by the

Federal Reserve and Treasury that BofA had expressed reservations about completing the acquisition of Merrill Lynch. Over the

course of time, it was clear that officials from the Federal Reserve

and Treasury believed that systemic risk would exist absent an

agreement by the government to provide assistance to BofA.

On January 14, 2009, the FDIC received from the Federal Reserve a draft terms sheet describing an assistance package, the

principal elements of which were capital infusion in a transaction

where the FDIC, Treasury, and Federal Reserve would share in a

guarantee against certain losses, otherwise known as a, ‘‘ring

fence,’’ transaction.

The FDIC continued to analyze where and how much the exposures were and how that specifically impacted the FDIC. The

FDIC’s board ultimately was persuaded that BofA’s condition presented a systemic risk and that the ring fence transaction would

mitigate that risk and the risks to the deposit insurance fund in

a cost-effective manner.

The transaction also limited the FDIC’s risk to a small portion

of the covered exposures, recognizing the fact that most of the exposures resided within the investment bank and not the insured

depository institution.

On January 16, 2009, the planned Treasury capital infusion and

the Treasury-Fed-FDIC ring fence transaction were announced. In

early May 2009, BofA asked that the ring fence transaction not be

completed.

Moving forward, we have worked continuously with Congress,

the Treasury, and the financial regulators toward creating a more

resilient, transparent, and better-regulated financial system, one

that combines stronger and more effective regulation with market

discipline. One of the lessons we have learned over the past few

years is that regulation alone is not enough. We need to establish

an effective and credible resolution mechanism to ensure that market players will actively monitor and keep a firm handle on risk

taking.

We commend you and your colleagues on the progress you have

made in moving toward providing the regulators with the tools to

effectively deal with any future crisis.

Thank you, and I will be pleased to take any of your questions.

[The prepared statement of Ms. Bair follows:]

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Chairman TOWNS. Thank you very much for your statement.

Let me just state to the Members we are going to be really tight

on the 5 minutes today. Because 5 minutes really means 5 minutes, which means 5 minutes to ask the questions and for the person to answer the questions. Because I promised the chairperson

that I would have her out by no later than 11:15, 11:20. So we

want to respect that and try to move forward.

Let me just sort of ask one quick question. Are there steps you

think the Congress can take to avoid future bailouts of the banking

industry?

Ms. BAIR. Yes. I think we have put a very high priority on a robust resolution mechanism. We have that for insured depository institutions. And when smaller institutions start to fail, they are put

into a very severe resolution mechanism that requires shareholders

and unsecured creditors to take a loss, generally a complete loss.

For nonbank entities or activities outside of banks, this resolution authority does not apply and, we think, something very similar

to the FDIC process, which is shareholders and creditors take

losses, not the government, is very important. And we think that

the House bill that is being on the floor now moves very well in

that direction, and we think they should be very clear and that the

resolution authority should specifically ban assistance to individual

institutions going forward. And I believe that is also in the House

bill.

Chairman TOWNS. Thank you very much.

I now yield to the gentleman from California, ranking member,

Congressman Issa. Thank you very much, Madam Chair.

Mr. ISSA. Actually, Mr. Flake wanted to be recognized first.

Chairman TOWNS. The gentleman from Arizona. He yields to the

gentleman from Arizona. Congressman Flake.

Mr. FLAKE. I yield to the gentleman from California.

Mr. ISSA. The gentleman is yielding me his time in order to be

expeditious.

Madam Chair, I want to be brief, also; and I have just a series

of short questions.

First of all, from the standpoint of the FDIC looking back now,

wasn’t—forgetting about whether the merger was a good merger,

the MAC, all the other things that this committee has worked on,

wasn’t the underpinning of the additional money, preferred stock

as a form of loan, wasn’t that in fact the most appropriate thing

for the FDIC to approve of so that the capital worth of Bank of

America would be undeniable?

Ms. BAIR. Well, I think it is always hard in hindsight to answer

questions like that.

Mr. ISSA. Actually, I normally find it easier in hindsight.

Ms. BAIR. It may be easier in hindsight. I guess it is easier to

reevaluate decisions that were made.

I think the distinction needs to be made between the insured depository institution that had a strong capital position with other activities that were going on in the bank holding company. And so

I think if you are looking just to the insured depository institution

where we had the exposure, there is a question about whether additional capital was needed. I do think——

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Mr. ISSA. I am not saying whether it was needed. It is clear

that—in hindsight, it is clear they didn’t need it, because they paid

it back to you essentially without it being from actual new money

in any large amount. They passed the stress test. And they passed

the stress test and said they could pay it back. So I know that part

of hindsight is clear.

Ms. BAIR. Right, right.

Mr. ISSA. But the real benefit of the $45 billion of loan, and I repeat it was not—it is not—you know, we didn’t bail them out. We

didn’t give them anything. We bought stock. We bought the worth

of the company, and we got interest guarantee and the ability to

get our money out ahead of everyone else. Preferred stock is not

all bad.

But the effectiveness of it was to, if you will, overcapitalize the

company in hindsight. But wasn’t that essentially a good thing in

that, if there was no other benefit to TARP, the confidence of knowing that these companies, particular banks, were extremely well

capitalized, not as to the stockholders but as to the depositors,

wasn’t that effectively the good thing that came out of this arrangement?

Ms. BAIR. Well, I think, yes, the capital investment certainly created a fortress balance sheet. I think that was the original intention of all these capital investments under TARP.

Again, we were not—the only role that we had was on the ring

fence, not on the TARP investment. That was a Treasury program

and Treasury decision.

But yes, certainly——

Mr. ISSA. But you were the beneficiary of it in a sense.

Ms. BAIR [continuing]. Is absolutely going to have a stabilizing

impact, yes.

Mr. ISSA. The next question is a harder one.

Ms. BAIR. Uh-huh.

Mr. ISSA. Many nonbanks decided to become banks conveniently

in this crisis.

Ms. BAIR. Right, right.

Mr. ISSA. Many entities in fact fled to the FDIC. And the FDIC

finds itself with its funds, funds which are designed to ensure that

we never have to actually put in taxpayer dollars, those funds are

stressed right now. Going forward, do you believe that in fact in

the future people should be able to run to the FDIC, run to being

a bank when it suits them, even if they hadn’t been when it didn’t

suit them?

Ms. BAIR. No, I don’t think they should be able to do that.

Mr. ISSA. Is that a reform that you presently see on the horizon

that would give you that ability next time to say you better be

there early or not come at all?

Ms. BAIR. Well, I think—two things. I think we need a robust

resolution mechanism so when entities get themselves in trouble

they don’t get government assistance. They get put into receivership. And I think entities asking for assistance maybe won’t ask for

assistance so much if they know that is the repercussion.

In terms of entities becoming bank holding companies and having insured depository institutions not just for deposit insurance

but for the Fed lending facilities, we have suggested that there

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needs to be a systemic risk council that would decide and have the

power to say to an entity that became a bank holding company but

perhaps later doesn’t want all the regulation that entails that they

still need to subject themselves and be subject to prudential supervision, that they can’t arbitrage just becoming a bank holding company when it suits them and then not and escaping the regulation

when that suits them.

Mr. ISSA. Thank you. I yield back to the gentleman from Arizona,

and he yields back.

Mr. FLAKE. I yield back.

Chairman TOWNS. Thank you very much.

I now recognize the ranking member—I am sorry—the chairman

of the Domestic Policy Subcommittee, yes, Mr. Kucinich from Ohio.

Mr. KUCINICH. Chairman Bair, do you have any concerns that

America may face yet another bank collapse?

Ms. BAIR. No, I don’t, but I think there is a lot of work that

needs to be done to continue the stabilization and the cleanup, and

I think the regulatory reform efforts going on right now in Congress are absolutely crucial to that.

Mr. KUCINICH. Do you think banks that are too big to fail are too

big to exist and ought to be broken up?

Ms. BAIR. Well, I think there needs—the problem with too big to

fail is the same problem that you had with Fannie and Freddie.

There is an implied government backstop, which feeds into risk

taking. If shareholders and creditors think they have the upside

and the government has the downside, that is going to encourage

risk taking. We think that is a major factor that drove the crisis.

And again, this is why—I hate to sound like a Johnny One Note,

but we really need—Congress needs to establish a very robust, very

severe resolution mechanism that tells shareholders and creditors

they will take losses if these institutions go down. Right now, they

are just happily, you know, feeding, extending credit, and making

equity investments, and I fear that they are not really doing their

own due diligence in terms of looking at what is going on in these

very large institutions. Do they understand the risks? Do they understand—is the management on top of those risks? I don’t think

we have market discipline right now, and we need that.

Mr. KUCINICH. Do you have any concern that banks may still be

overleveraging derivative markets?

Ms. BAIR. Absolutely. Yes. I would say financial institutions,

not——

Mr. KUCINICH. Pardon.

Ms. BAIR. I think banks as loosely used. I would say financial institutions, I absolutely have that concern, yes.

Mr. KUCINICH. And what can you tell the American people about

the security of their bank deposits?

Ms. BAIR. Their bank deposits are very secure. That is one thing

we have been very early on with a public information campaign.

The resolutions have been smooth. Everyone’s deposits have been

completely protected, as they always have been. So there is no

question that the FDIC has resources to deal with whatever may

come.

Mr. KUCINICH. Would you tell us what those immediate resources

are to assure security of deposits?

49

Ms. BAIR. Right. Well, we are full faith and credit, and we have

a Treasury line and a congressional commitment to back insured

deposits. And, again, that has been in effect for 75 years. Right

now, we have required prepayment of assessments that is going to

bring in another $45 billion at the end of the year, which will bring

our cash position probably in the first quarter to around $60 billion, given what we already have and additional moneys that we

are going to be bringing in. So I think it is a very strong cash position. We can borrow up to $500 billion from the Treasury Department if we would need to do that. I don’t foresee any circumstance

where that would become necessary.

Mr. KUCINICH. Thank you, Madam Chair.

Thank you, Mr. Chairman. Yield back.

Chairman TOWNS. Thank you very much.

I now yield to the ranking member of the full committee, Congressman Issa.

Mr. ISSA. Thank you, and I will be equally brief this time.

Madam Chair, you on January 9th determined it was clear ‘‘It

was clear that officials from the Federal Reserve and Treasury believed the systemic risk would exist absent an agreement by the

government to provide assistance to BofA.’’

That is really the point at which you came in. But isn’t it true

that the deal was already done prior to that time to give them the

money? Isn’t that what we have essentially discovered?

Ms. BAIR. Right. Well, I will tell you I know conversations already occurred between the Treasury and the Fed and Mr. Lewis

prior to the time we were contacted. I wasn’t privy to those conversations, so I don’t know.

Mr. ISSA. Sure. I realize we have been very unfair to you in that

you came in on the tail end of everything.

Ms. BAIR. Yes, I did.

Mr. ISSA. And only if something was a bank or about to become

a bank holding company.

Ms. BAIR. Right.

Mr. ISSA. Let me followup with this question.

Specifically in your role as FDIC Chair, if you had a choice and

you were told, what would you like to do when BofA said we are

going to invoke the MAC or give us more money? It doesn’t matter

who said it, but that occurred. Wouldn’t the FDIC’s position in the

future be go to Congress or go to the TARP and bail out Merrill

Lynch directly? If they don’t want it and there is money needed,

and obviously there wasn’t new management or consolidation in

the merger at all, wasn’t it really go bail out Merrill Lynch, do

whatever you are going to do with Merrill Lynch, they are not a

bank, and why should it be clouded with me? Isn’t that essentially

the—you and future Chairs’ position that you would prefer?

Ms. BAIR. Well, we think it is important to act as one government, yes. But my first job and foremost job is to protect insured

depositors. And I can’t, with at that time about a $50 billion deposit insurance fund, bail out the entire economy and everybody

else with the resources that we have. And I have to make sure that

we have credibility to protect insured depositors, first and foremost.

50

So, yes, investment banks are not insured depository institutions,

and it would have been nice to have other mechanisms available.

Absolutely.

Mr. ISSA. So as we are Monday morning quarterbacking up here,

if there is anything—and since we have determined that Chrysler

and General Motors qualified for TARP money, if there was any

mistake made, it was this very lucrative merger that BofA is now

happy about and touting, to be honest, when faced with the dilemma, it was a Merrill Lynch decision. Treasury, Paulson,

Geithner, they should have made a Merrill Lynch decision relative

to. Instead, what they do is they pushed it onto a bank holding

company, and a bank holding company then had a systemic risk

problem which fell to your doorstep, and $45 billion of taxpayer

money, albeit paid back, in fact was put in play.

Ms. BAIR. Well, yes, BofA was already a bank holding company,

obviously. This is a situation where Merrill Lynch was not. So

through the acquisition it got folded into the bank holding company

structure. And, yes, there were significant benefits that accrued because of that, yes.

Mr. ISSA. Now on a lighter note——

Ms. BAIR. OK.

Mr. ISSA [continuing]. Yesterday this committee on a bipartisanship basis moved for a common searchable platform, although not

XBRL, which of course you use. We mandated a common uniform

platform with rigorous structures so that there could be transparency either to those cleared or, in the case of assets, information

available normally to the public, directly to the public. What is

your experience and what would you guide us with, in your case,

XBRL and that kind of capability that it gives you to look down

and, if possible, even allow others to look down?

Ms. BAIR. Right. Well, IT is not my forte. We have been leaders

in this area. I think we have had a very good experience, and I

would certainly offer our IT people to give you a more detailed

briefing on that, if you would like.

Mr. ISSA. Let me—last followup question, and I will yield back.

Do you believe that this committee is on the right track when we

insist that data bases be common, robust, searchable, and interactive so that in fact, when appropriate, the American people can

have transparency?

Ms. BAIR. Right. You may get me in trouble with other agencies,

but if I could just follow that, we have had a very positive experience, and I would encourage others and this committee to facilitate

broader use.

Mr. ISSA. Thank you, Madam Chair. I yield back.

Chairman TOWNS. Thank the gentleman from California.

I now yield to the gentleman from Maryland, Congressman

Cummings.

Mr. CUMMINGS. Thank you very much, Mr. Chairman; and, Ms.

Bair, welcome, and thank you doing such a superb job.

I recognize that the FDIC’s job in the Bank of America bailout

was different from that of your fellow regulators at Treasury and

the Federal Reserve. But, nonetheless, we have a responsibility to

explore all aspects of this tainted transaction.

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In your written testimony, you note that the FDIC was notified

of potential government assistance in the Bank of America-Merrill

Lynch merger around December 21, 2008. You go on to say that

over the next 3 weeks the discussion continued about Bank of

America’s financial condition and the nature of the assistance to be

provided. You discussed the case with Secretary Paulson, Chairman Bernanke, and others on January 9, 2009, and were provided

a draft terms sheet on January 14th. This is all correct, I hope, and

I am working from your own written testimony. Is that right?

Ms. BAIR. That is right.

Mr. CUMMINGS. My concern is the fact that in past hearings in

this committee we have heard about how Ken Lewis briefed his

board of directors on December 22, 2008, and again on December

29, 2008, indicating that at least $12 billion in fourth quarter Merrill Lynch losses would be covered by the Federal Government.

I am not asking you what happened at those meetings. I know

you weren’t there. But what I would like to address is this. Do you

have any reason to believe that Ken Lewis had sufficient basis on

the structure of any potential deal to brief his board with such certainty?

Ms. BAIR. No. Again, we weren’t privy to any of those discussions, and certainly the FDIC had made no decision at that time

about whether we would participate and to what extent we would

and how that would take place or whether it was necessary.

Mr. CUMMINGS. Based on your testimony, the government regulators were still reviewing the Bank of America positions and working on whether a deal would occur well into the new year. It certainly doesn’t sound like it was a done deal, does it?

Ms. BAIR. No. And, again, I can’t—we were only one small piece

of this. But certainly from the FDIC’s perspective we had committed to continue talking with the Fed and Treasury and examine the

facts and analyze to what extent assistance would be appropriate.

We had not made any decisions during that time period, no.

Mr. CUMMINGS. This is not you saying this. This is me saying

this. One could certainly read this as Mr. Lewis pulling a fast one

on his board to get them to approve the deal. Unless you want to

comment.

Ms. BAIR. I think I will stay away from that.

Mr. CUMMINGS. I am sorry?

Ms. BAIR. I think I will stay away from that. Thank you.

Mr. CUMMINGS. Thank you very much.

Thank you, Mr. Chairman. I yield back.

Chairman TOWNS. Thank you very much. I thank the gentleman

from Maryland for his questions.

Now yield to the ranking member of the committee, Mr. Jordan

of Ohio.

Mr. JORDAN. Thank you, Mr. Chairman.

Chairwoman Bair, let me—I have looked at your record, and you

were a professor of regulatory policy, and—very impressive—and I

am just curious, on a broad context are you, like I am, a bit troubled—frankly, for me, it is more than a bit—troubled by this what

I have called unprecedented involvement by the government in the

private sector?

52

Whether we are talking President of the United States deciding

who gets to be CEO of General Motors, whether we are talking

about the fact that we now have in the United States of America

something I thought I would never see but a Federal Government

pay czar telling private American citizens how much money they

can make, and bailouts, and TARP, and second stimulus coming in,

on and on it goes. So just as an accomplished professional individual, are you nervous about this general direction and, again, this

unprecedented involvement of the government in the private marketplace?

Ms. BAIR. Absolutely. And we think better tools are needed for

the government to deal with this in different ways going forward.

We are very much opposed to—and I believe the House bill does

this, prohibits capital investments in banks and financial institutions going forward. I think government ownership of financial institutions has created not only a lot of public outcry and cynicism

but also very difficult issues about what should be private entities

and private sector decisions, based, obviously, on some prudential

regulatory standards. But government ownership has created a

whole list of problems, and we would like to end that going forward.

Mr. JORDAN. OK. With that being said, let me take you back—

and this, again, as I pointed out in my opening statement, was

brought out when we first had Ken Lewis in front of this committee several months ago. The meeting that took place here in D.C.

with the nine largest banks 10 days after the TARP legislation was

passed—and, again, the TARP legislation was passed designed to

go in and get these troubled assets off the books, free up credit,

straighten up these balance sheets, et cetera.

Ten days later, the nine biggest banks were brought to the Nation’s Capital. According to Mr. Lewis’ testimony, Mr. Paulson and

Mr. Bernanke and you were in that meeting; and Mr. Lewis indicated he had no idea what the meeting was about. That the meeting went with a piece of paper slid across the table to the banks

telling them how much money they were now going to take from

the TARP program, whether they asked for it or not, and that they

had to sign a statement saying they were in agreement to that.

Is his recollection of that meeting accurate? Is that in fact what

took place?

Again, not 10 days after we were told—the Congress of the

United States was told that the TARP program, the money that

was made available be used for something entirely different.

Ms. BAIR. Right. I was invited to attend that meeting. I was not

involved in decisions about who should come to that meeting and

who was going to get what. My role was confined to explaining the

temporary liquidity guarantee program, the debt guarantee program. The only remarks I made were to explain that program, and

I did not opine or comment at all on the capital investments piece.

We were not involved in decisionmaking, and we remained silent

during that discussion. But, yes, these banks were strongly encouraged to take this money.

Mr. JORDAN. Going back to your answer to my first question,

though, were you troubled that day about what you saw taking

place in that meeting in light of the fact you just said—you made

53

two statements already today. You said you were troubled by this

unprecedented involvement of the government in the private sector;

and you also said, in an answer to Mr. Issa’s question earlier, that

the government should act as one. So were you sitting in that

meeting troubled by what you saw taking place in that meeting,

again 10 days after the legislation had been passed for an entirely

different purpose?

Ms. BAIR. Yes. I think—two things. I think these decisions were

made in the fog of war. These decisions had to be made very quickly, and the situation was becoming more and more destabilizing.

And, also, there had been an international agreement to use a combination of liquidity guarantees. We were involved in liquidity

guarantees and capital investments to stabilize the system.

Frankly, the idea of it took my breath away, and it was quite unprecedented in terms of the private sector system that we have.

And so I was concerned, and I have——

Mr. JORDAN. Was that the first time—did you know what was

going to take place in that meeting, or did you come into that meeting much like Ken Lewis and the rest of the other——

Ms. BAIR. We were told in advance who was going to come and

that they were going to be asked to take—or encouraged to take

capital investments. We were absolutely told that in advance.

I did not weigh in one way or the other. I confined my role to

explaining the debt guarantee program. I have said in retrospect

I wish we had weighed in, because I think, again, government ownership in banks has created a whole host of problems.

And, by the way, on troubled asset relief, I think we still need

a program, and we would like to see maybe perhaps Congress authorize that going forward. That still needs to be done and has to

be done.

Mr. JORDAN. Mr. Chairman, real quick—I appreciate what you

said, Ms. Chairwoman. I think this has been very helpful. If I could

just ask one other question, Mr. Chairman.

Chairman TOWNS. Go ahead.

Mr. JORDAN. The talk this week is about using TARP dollars for

stimulus, for something outside of the scope.

Ms. BAIR. Right.

Mr. JORDAN. Again, I think it was done already. But I totally disagree with this. Your thoughts, if you would, on the idea of using

TARP money for a second stimulus.

Ms. BAIR. Well, I think you are asking me something beyond my

pay grade, because I like to confine my public comments to areas

where I think appropriately fall within my sphere as chairman of

the FDIC.

I do think that there needs to be more focus in terms of troubled

asset relief. We still have toxic assets on the books of banks. Particularly the smaller banks really did not benefit from the capital

investments. The smaller banks are a large share of small business

lending, but their need to continue to work out and reserve against

these legacy loans that they have is inhibiting their ability to engage in new lending. So we do think it would be appropriate and

consistent with the Troubled Asset Relief Program to try to deal

with that problem.

54

But, beyond that, I would not want to opine about other uses

that others might want to make of the TARP money.

Chairman TOWNS. The gentleman’s time has expired.

Mr. JORDAN. Thank you, Mr. Chairman.

Chairman TOWNS. I now yield to the gentleman from Virginia,

Congressman Connolly.

Mr. CONNOLLY. I thank the chairman.

Welcome, Chairwoman Bair. And I am going to ask you to move

your mic closer. I cannot hear you sitting here because of the

acoustics in this room.

I am listening to my friend from Ohio, and he loves to use the

phrase ‘‘this unprecedented Federal intervention in the financial

sector’’, as if we didn’t have the worst meltdown in 70 years a year

ago September.

Let me ask you, wearing your FDIC hat, as somebody who has

an interest in insuring deposits in depository institutions regulated

by the Federal Government, so what if we hadn’t had that unprecedented Federal intervention by a Republican administration, by the

way? What would have happened to the banking sector in America,

wearing your FDIC hat.

Ms. BAIR. I think it wasn’t pretty. It wasn’t perfect. I think retrospect and hindsight always has additional wisdom.

Mr. CONNOLLY. So should we not have done anything?

Ms. BAIR. No, we had to do something, and it did stabilize the

system. I absolutely agree with that. Something needed to be done,

and that was the decision that was made, and it did stabilize the

system.

Mr. CONNOLLY. So intervention was necessary, in your view?

Ms. BAIR. Intervention was absolutely necessary.

Mr. CONNOLLY. Now, the intervention that was designed, this

came from some pointy-headed liberal academic from some Ivy

League College, right? It didn’t come from a Republican Secretary

of State and a Republican administration, did it?

Ms. BAIR. I am sorry, what are you referring to?

Mr. CONNOLLY. Who proposed the idea of the TARP?

Ms. BAIR. Oh, the TARP. The TARP was proposed by, yes, the

Treasury and the Fed.

Mr. CONNOLLY. Oh. Not a pointy-headed liberal academic from

an Ivy League college? By a Republican businessman who was the

Republican-appointed Secretary of the Treasury in a Republican

administration. Is that correct?

Ms. BAIR. Yes, that is my recollection of how——

Mr. ISSA. If the gentleman would yield?

Mr. CONNOLLY. No, I am not going to yield.

Let me ask you a question. In your testimony you say that you

have, wearing your FDIC hat, a direct interest in both Bank of

America and Merrill Lynch because they are depository institutions. Is that correct?

Ms. BAIR. That is right. Well, Merrill Lynch is not.

Mr. CONNOLLY. I am sorry?

Ms. BAIR. Bank of America, the bank is an insured depository institution. Merrill Lynch was an investment bank.

Mr. CONNOLLY. I know, but I am reading from your testimony.

Ms. BAIR. Right.

55

Mr. CONNOLLY. OK. And you assert that FDIC has a continuing

stake in the financial well-being of those insured depository institutions.

Ms. BAIR. Right.

Mr. CONNOLLY. OK. So what was the view of the FDIC at the

time the Bank of America proposed to acquire Merrill Lynch? Was

that a good business decision? Was that a risky business decision?

Were you aware of the fact that they had unprecedented losses, by

the way, without unprecedented Federal regulatory intervention?

Ms. BAIR. Well, a couple of things. We are not the holding company regulator. The Fed is. And we do not approve mergers and

acquisitions. The Fed does. We are also not the primary regulator

for Bank of America.

Mr. CONNOLLY. I understand.

Ms. BAIR. We insure them. We have backup supervisory authority. So I think in terms of the more intimate knowledge of that situation would come from the Fed and the OCC.

As backup supervisor, frankly, we must rely on the primary regulator. If there starts to be troubles, then we move in. But without

red flags, no. With those caveats, I was not aware until we got

these phone calls and started looking into it that Merrill Lynch had

such significant losses in the fourth quarter. They were quite profound.

Mr. CONNOLLY. Let me ask you, we have a bill that is pending

before the floor of the House of Representatives today that would

constitute a major overhaul of regulation and for the first time finally allow some oversight of the risky derivatives market, for example, and would, in effect, extend some Federal oversight and regulation of investment banking by any other name, not many are

left, none of which existed previously.

In retrospect, just given your financial expertise, do you think we

made a mistake to explicitly exempt derivatives, a multi-trillion

dollar market, from any Federal regulation?

Ms. BAIR. Oh, absolutely. That was a mistake. Absolutely.

Mr. CONNOLLY. So, again, this unprecedented Federal intervention in the financial markets, in the case of derivatives, since there

is no such unprecedented Federal intervention at the moment,

maybe in retrospect we should have had some?

Ms. BAIR. I think we absolutely should have had more regulation

in a lot of areas and particularly in OTC derivatives. There is no

question in my mind about that.

Mr. CONNOLLY. Thank you.

And my final question, does the FDIC have a point of view with

respect to the extension of FDIC that is contained in the bill that

is pending before the House today? Is that a good idea to extend

the FDIC and finance that extension by having the big banks have

an extra fee rather than taxpayers do it?

Ms. BAIR. Right. Yes, we do support. We have said that for banks

and bank holding companies that have insured depository institutions we would like to be the resolution authority. For nonbanks,

we will let Congress decide that. And I think they have decided

they would like one entity doing it all.

And, yes, we think that this should be a very robust resolution

mechanism that provides no open bank assistance, no conservatorVerDate 11-MAY-2000 14:33 Feb 15, 2011 Jkt 000000 PO 00000 Frm 00059 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\63135.TXT KATIE PsN: KATIE
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ship, everyone goes into receivership, their shareholders and creditors take losses. That is the process that we use for banks, and

that is the process that works.

And so, yes, and we think the working capital needs for this fund

should be provided through a risk-based assessment on the larger

financial entities. And, again, this could be another lever, another

tool to discourage excessive risk taking. So we do support that part

of it.

Mr. CONNOLLY. Thank you.

My time is up. Thank you, Mr. Chairman.

Chairman TOWNS. The gentleman’s time has expired.

I now yield to the gentleman from Missouri, Mr. Luetkemeyer.

Mr. LUETKEMEYER. Thank you, Mr. Chairman.

Madam Chairwoman, thank you for being here this morning.

I am just kind of curious, now that we have some nonbanks that

are banks and Lehman Brothers has been absorbed by BofA, have

you been in to examine that portion of BofA? Have you been in to

examine the bank itself? Have you been in to examine like Goldman Sachs and those folks at all since this all took place?

Ms. BAIR. I cannot comment on specific institutions. Let me tell

you generally what we are doing, which is, right now, we have

backup authority only for insured depository institutions. So activities outside of insured depository institutions like investment banking, even though they might be part of a broader holding company

structure, we have no authority there. That is the exclusive domain

of the——

Mr. LUETKEMEYER. Goldman Sachs is now a bank, is it not?

Ms. BAIR. No, because the insured depository institution is only

a subsidiary of a larger bank holding company structure. This has

been a problem for us.

And another positive thing that we think the House bill does is

give us backup authority over everything in the holding company.

Right now, it is only over the piece that has the deposit insurance,

which is not the whole thing.

Mr. LUETKEMEYER. Do you think that there needs to be some

ability to regulate and have some oversight over some of these off

balance sheet liabilities that a lot of these folks are involved with?

Ms. BAIR. Absolutely. Yes.

Mr. LUETKEMEYER. What are your plans do that?

Ms. BAIR. Well, fortunately, the accountants have done a lot of

it already. We are implementing FAS 166 and 167, which basically

requires that these off balance sheet exposures now be counted on

balance sheet. So you have to hold capital and reserves against

them. So we will be finalizing rules next week to make clear that

you need to hold capital and reserves from the regulatory capital,

that we will treat those as on balance sheet assets.

On the derivatives area, the OTC derivatives area, I think Congress needs to act on that. Because of the Commodity Futures Modernization Act, there is very little authority to provide product regulation or market regulation; and we have been working with the

SEC and the CFTC to strengthen that. And we are generally supportive of that.

Mr. LUETKEMEYER. OK. You mentioned a while ago that all our

banks are in great shape, yet this last year or two we have had

57

almost a record number of bank failures within a short period of

time.

Ms. BAIR. I don’t know that I said——

Mr. LUETKEMEYER. How many more failures do you anticipate

over the next year or 2 years?

Ms. BAIR. I would not say—I think most banks continue to be

profitable and—but there are clearly some under distress. And we

do not publicly release our failed bank projections, but it will continue to go up. We think it will peak next year.

Mr. LUETKEMEYER. I understand. OK.

But your comment earlier was also with regards to a lot of small

banks are having to absorb some of these—they are part of the ripple effect of some of the big guys here and are certainly under

stress at this point. Do you have any plans for some forbearance

for those folks to allow them to be able to withstand this and to

outlive some of these problems so that they are not going to be

closed as a result of some of the actions of some of the big guys?

And while we had forbearance with the big folks and helped

them get over this, we don’t have TARP funds available for the

small guys. And if we don’t have forbearance for those folks, they

are the ones who are going to suffer disproportionately compared

to what the other folks have. And while it may not be a big deal

to the folks who are concerned with BofA, it certainly is going to

impact a lot of community banks in my district and a lot of small

districts around this country.

Ms. BAIR. Well, Congressman, by statute, if a bank becomes insolvent or can no longer meet its liquidity demands, it needs to be

closed. There is a very well-defined, prompt corrective action procedure in the statute. We cannot provide open bank assistance unless

there is a systemic risk and then only if the Fed and the Treasury

and the President agrees. By statute, we cannot provide——

Mr. LUETKEMEYER. With all due respect, Madam Chair, my question, though, is are you going to have some forbearance on those

folks because of the unusual circumstances that they find themselves in through no fault of their own, only being a participant in

investing in some things that wound up getting them into trouble?

And they don’t have the opportunity, like you just said, for some

of the TARP funds and things like this.

Is there willingness on your part to look at these situations on

a case-by-case basis and say, hey, the rest of the bank has been

profitable; it has been under good management; just this one area

is a problem; and, therefore, we are going to deal with this and

work with them on this and not close them down as a result of

that? Is there a willingness to look at that situation?

Ms. BAIR. We have done that already, I think. We released and

were able to get interagency agreement on some guidelines recently

that explicitly allow banks to do loan restructurings with the commercial real estate loans. It needs to be disclosed and well documented and only if you have a creditworthy borrower that continues to make repayments on a restructured loan. We tried do that

already.

I guess my only point is, though, Congressman, once the institution no longer becomes viable under the statutory criteria, there is

no flexibility to provide forbearance. And I think these rules were

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put in place after the S&L crisis, where there is forbearance and

there is forbearance. And sometimes if forbearance just denies the

problem that exists and delays the closing, it will end up costing

the government more money, which is what happened during the

S&L days. So we do need to be careful.

But, absolutely, for the healthier institutions that can make it,

we are trying to give them flexibility to work these loans out.

Mr. LUETKEMEYER. OK. Thank you, Madam Chair. Thank you.

Chairman TOWNS. The gentleman’s time has expired.

I now yield 5 minutes to the gentleman from Louisiana, Mr. Cao.

Mr. CAO. Thank you very much, Mr. Chairman; and I would like

to continue questioning concerning community banks similar to Mr.

Luetkemeyer. Because, in Louisiana, many of the banking systems

are community based banks, and they are impacted tremendously

by the financial overhaul that we are looking at in the Congress.

Madam Chair, can you provide me with the number of banks that

have failed in Louisiana?

Ms. BAIR. I do not know that off the top of my head, but I will

certainly get it to you this afternoon when I get back to my office.

Mr. CAO. OK. But probably it is either none or extremely few.

Ms. BAIR. I would really need to check. I am sorry, Congressman,

but we have had about—I think we will have about 140 failures,

and it is very difficult to know State by State. I will get that information back to you very quickly.

Mr. CAO. That is fine.

The community banks in Louisiana, they did not involve themselves in the subprime mortgage mess; and, as such, many of them

were profitable in the past years, while some of the big banks have

failed. My question to you here is, why are we making these small

community banks, who were successful, who operated within the

boundaries of the traditional loaning criteria, they followed the

rules, why are we making them pay for the faults of the big banks

through this tremendous overhaul process?

Ms. BAIR. Well, I think—two things. I think you are right. Community banks generally did not make subprime, they didn’t make

these high risk mortgages, they did engage in commercial real estate lending. Some of that was not prudent. A lot of it was. They

were good loans when they were made, but because of the economy

they are going bad now. And as the economic problems continue,

more and more of the failures are driven by that.

But, again, banks must hold certain levels of capital and loan

loss reserves against their loans. And if their loans are going to

have losses that exceed their capital capabilities, they become insolvent. Or if they can’t meet their liquidity demands, if depositors

want to withdraw money and they can’t have enough cash to do

that, then they need to be resolved. And that is—again, there is a

fairly well-defined procedure in our statutes to do that.

I think this Congress, you know, again back to the conversation

about the appropriate use of TARP going forward and troubled

asset relief, I think this is a ripe area, especially for smaller banks,

to provide some assistance, continued need for troubled asset relief

for the smaller institutions. And we would be very strongly supportive. But our statute does not allow us to provide open bank asVerDate 11-MAY-2000 14:33 Feb 15, 2011 Jkt 000000 PO 00000 Frm 00062 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\63135.TXT KATIE PsN: KATIE
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sistance to large or small institutions, again, unless it is under this

very narrow systemic risk exception.

Mr. CAO. It seems to me that the small banks are being penalized for the actions of bigger banks.

Ms. BAIR. I am greatly troubled, and I have spoken out about

this for a long time, of the different treatment between large and

small. And the very large get the TARP money and get the support

and the small ones get closed. I don’t like that.

Going forward, I would like to close the big ones, too. I mean, I

think that is really—if we are going to have a free market system,

not a free-for-all system but a free market system, I think going

forward the resolution regime needs to be able to work for small

and large institutions, and right now it can only work for the

smaller ones.

But the immediate problem, you are right. It is not fair, and we

have said that TARP needs—we need to figure out a way to make

TARP work better for the smaller institutions. And, again, with

troubled asset relief, not so much capital investments, I think that

is a problem. But troubled asset relief, providing support there to

help them get rid of these bad loans so they can make new loans,

we are very supportive of that and work with Treasury, work with

Congress on trying to make those programs more effective.

Mr. CAO. Can you explain to me—I agree with you that the big

bank institutions that were involved in these subprime mortgage

loans, we need to have a better mechanism of overseeing their operations. But can you explain to me how regulating these smaller

community banks that are already regulated by State law, how

would that improve our country’s financial health when they have

been profitable, when they have been following the traditional

methods of loaning? They were not involved or did not contribute

to this financial mess? How would regulating them improve our financial health?

Ms. BAIR. First of all, no Louisiana failures. My staff just handed

me a note. So no failures in your State.

I think we provide supervision, obviously, of small and large

banks because they have deposit insurance. There is a government

exposure there. If they get in trouble, we always protect the insured depositors. So with that comes prudential supervision, and

that has been the cover for over 75 years.

I think, moving forward, my concern from a supervisory perspective with the smaller banks is helping them diversify their balance

sheet. Because of unlevel playing fields between large and small institutions, as well as between insured depositor institutions and

the shadow sector, the nonbank sector, community banks have

been relegated primarily to commercial real estate lending and

small business lending; and they provide good support for their

communities in those two areas, but they don’t have much diversification. They got the mortgages taken away from them, a lot of

the consumer credit taken away from them, and I think a lot of

that has been driven through an unlevel regulatory requirement.

So, going forward, I would change that to help them further diversify their balance sheet and get back to where we used to be

with community banking, where they were in a position to offer a

more full range of services to their communities.

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Chairman TOWNS. The gentleman’s time has expired.

Let me announce that we have 3 minutes left on the vote, and

of course we will return 10 minutes after the last vote. I understand there are three votes.

Madam Chair, let me thank you very much for coming this morning. We will now recess until 10 minutes after the last vote.

The committee is in recess.

[Recess.]

Chairman TOWNS. The committee will reconvene.

Our second witness today is Mr. Robert Khuzami, Director of the

Division of Enforcement at the Securities and Exchange Commission. It is committee policy that all witnesses are sworn in. So if

you would stand and raise your right hand.

[Witness sworn.]

Chairman TOWNS. You may be seated. Let the record reflect that

the witness answered in the affirmative.

Mr. Khuzami, you may begin.

STATEMENT OF ROBERT KHUZAMI, DIRECTOR, DIVISION OF

ENFORCEMENT, U.S. SECURITIES AND EXCHANGE COMMISSION

Mr. KHUZAMI. Thank you, Chairman Towns, Ranking Member

Issa, Congressman Kucinich. My name is Robert Khuzami, and I

am the Director of Division of Enforcement at the Securities and

Exchange Commission. I became director on March 29th of this

year. Thank you for the opportunity to testify on behalf of the SEC

regarding Bank of America’s acquisition of Merrill Lynch.

The committee’s invitation asks about the SEC’s litigation

against Bank of America. Because the enforcement action is ongoing, discussion of certain aspects of this litigation pose a risk of

negatively affecting our case. I am happy, however, to discuss elements of our publicly filed court papers.

The complaint in our case concerns a November 2008, joint proxy

statement that Bank of America and Merrill sent to their shareholders soliciting shareholder approval for Bank of America’s acquisition of Merrill. The complaint alleges that the proxy statement

violated proxy solicitation provisions because it contained material

faults and misleading statements.

Specifically, we allege that Bank of America represented in the

proxy statement that Merrill had agreed not to pay year-end performance bonuses to its executives prior to the closing of the merger without Bank of America’s consent. Bank of America, however,

failed to disclose that it already had consented to Merrill’s payment

of up to $5.8 billion in discretionary year-end and other bonuses to

Merrill executives. That complaint alleges Bank of America’s omission of the information rendering the proxy statement misleading

and false.

At the time we filed our complaint, the Commission submitted a

consent judgment for the court’s consideration under which Bank

of America agreed to settle on terms that included payment of $33

million and the entry of an injunction prohibiting it from further

proxy solicitation violations. As you know, the judge declined to approve the settlement, and the litigation is thus ongoing.

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The judge’s decision has not affected our underlying case, which

is set for trial in March of next year. We stand by our charges, and

have used the additional discovery available in the litigation to further pursue the facts and to determine whether or not additional

claims are appropriate. In determining how to proceed, we will, as

always, be guided by what the facts warrant and the law provides.

With regard to the proposed settlement, we believe it was reasonable, appropriate, and in the public interest, and also properly balanced to relevant factors that must be considered when assessing

any settlement. Where a corporate issuer fails to meet its statutory

obligations, the need for deterrence is paramount. The proposed

penalty, which would have been the second largest ever imposed in

a proxy statement case, would have sent a clear message that

proxy solicitations must include the substance of separate nonpublic documents when the failure to do so results in material misrepresentations or omissions.

It also clearly communicated to shareholders and the public that

management had failed to keep the company in compliance with securities laws and undercut the position now asserted by Bank of

America that there was no legal requirement to disclose such information.

Importantly, these objectives would have been achieved in a way

that did not place an undue burden on shareholders. Although a

$33 million penalty is a significant amount, it is not likely to have

had a material adverse financial impact on individual innocent

shareholders, given the billions of shares of Bank of America stock

then outstanding.

You have also asked why our complaint did not charge individuals. The SEC pursued the charges we believe were appropriate

based on the investigative record and applicable law. The securities

provisions that govern proxy statements are directed to those who

solicit proxies or in whose name proxies are solicited. Here, the corporations solicited the proxies. As such, the Bank of America had

a legal obligation that we alleged it failed to meet.

To establish that individuals aided and abetted a proxy solicitation violation or committed frauds under the security laws, it is

necessary to prove scienter, or knowing or reckless misconduct.

Based on the record that existed at that time, we did not believe

that we could fairly and properly assert scienter-based charges

against individuals under the applicable legal standards. We have

followed and will continue to follow any additional evidence developed wherever it leads.

I want to be clear that the proposed settlement in no way reflects

a change in the Commission’s approach to pursuing charges

against individuals who violate the Federal securities laws. The

Commission has been and will continue to be aggressive in bringing actions against individuals who violate the securities laws and

also will continue to vigorously pursue penalties from culpable individuals, including corporate executives. In fact, as outlined in my

written testimony, the Commission recently has filed a number of

enforcement actions against corporate executives charging violations of the Federal securities laws and seeking extensive remedies.

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Thank you for the opportunity to address these important issues,

and I look forward to answering your questions.

[The prepared statement of Mr. Khuzami follows:]

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Chairman TOWNS. Thank you very much.

Again, we apologize for the break, but we have to vote around

here.

Mr. Khuzami, I know you are currently preparing the case

against Bank of America. I don’t want to do anything or say anything that is going to jeopardize your case, but in general what is

the SEC—what do they believe Bank of America did wrong? What

do you think happened here that was wrong?

Mr. KHUZAMI. Mr. Chairman, in our complaint we allege that the

proxy materials that were sent to shareholders, which was the

basis upon which they would decide as to whether or not to vote

to approve the merger, stated that Merrill Lynch could not pay discretionary bonuses without the consent of Bank of America.

In fact, what the proxy solicitation did not disclose, that there already had been an agreement that Bank of America would allow

Merrill to pay up to $5.8 billion in exactly those kinds of bonuses.

So the proxy was misleading because it suggested that no consent

had been given and no such bonuses would be paid without such

consent when in fact the consent had already been given.

Chairman TOWNS. I know you are a very serious prosecutor, and

that is what we need in this day and age.

What can we expect from the SEC going forward in terms of aggressive enforcement against corporate wrongdoers? What can we

expect from this point on? We are talking about a lot of money

here.

Mr. KHUZAMI. I understand.

Look, first, I would point to the recent cases that we have

brought against corporate executives. In the mortgage fraud area

alone we have charged the CEOs, the CFOs, or other senior executives in New Century, Countrywide, American Home Mortgage,

Brookstreet Securities. We charged Hank Greenberg and another

official at AIG. Just in the recent past we have gone vigorously

after those individuals who we believe were heading companies

that engaged in one form or another of fraud or wrongdoing, particularly with respect to mortgage and mortgage-related products.

So I think past is prologue, and you will continue to see that

kind of approach. Under Chairman Mary Shapiro, we are embarking on a number of internal efforts to streamline our processes and

make ourselves more responsive, but we are reinvigorated and rededicated to that effort.

Chairman TOWNS. But you do feel that you have the tools to be

able to do the job that needs to be done, that no legislation or anything is required in order to be able to move forward with this aggressive approach? The word around here now is robust approach.

Mr. KHUZAMI. Robust, yes. Yes. We have a number of legislative

proposals that we have presented, particularly involving hedge

fund registration; the creation of a central clearing party for derivative transactions; more and better information on exactly the kind

of trading and activity that goes on in some of these over-thecounter and opaque markets.

In addition, we have sought legislation regarding nationwide

service of process and some other things to help make our job easier.

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And last, of course, funding is a significant issue. We have—I

think the last statistics I saw—over 35,000 regulated entities that

the SEC is responsible for between issuers, broker-dealers, investment advisors, transfer agents, credit rating agencies; and that is

before we get to hedge fund registration.

Despite those numbers, the enforcement staff is 1,100, total. I

think that additional funding would also go a long way toward

helping us complete our mission.

Chairman TOWNS. Thank you very much. Thank you for your testimony.

I now yield to the gentleman from California, the ranking member, Mr. Issa.

Mr. ISSA. Thank you, Mr. Chairman.

Mr. Khuzami, I know you were not on board on December 18th

of last year, but are you familiar with the document dated December 10th, which was delivered to the Fed on that date, which is

called the ‘‘fourth quarter 2008 walk-down,’’ the so-called ‘‘walkdown document?’’

Mr. KHUZAMI. I do not believe that I have seen that, Congressman.

Mr. ISSA. Mr. Chairman, I ask unanimous consent this be placed

in the record at this time.

Chairman TOWNS. Without objection.

Mr. ISSA. It is already in our information, but I want to make

sure it is in the record at this point.

Chairman TOWNS. Without objection, so ordered.

[The information referred to follows:]

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Mr. ISSA. I apologize; December 17th I believe it was delivered.

It probably would not surprise you to know that it actually—on

page 6 it lays out those bonuses. Mr. Bernanke, Mr. Paulson had

that on those days in December.

Had you been in the room when this was delivered—in other

words you, the SEC—would you have then been aware of the failure of the proxy in time to at least begin action at that point in

December?

Mr. KHUZAMI. Well, I guess you would have to know exactly what

was said in the proxy and compare that to the information that

was then available.

Mr. ISSA. But you knew that. You have compliance people. You

were hand-in-hand, and you get paid to make sure that the public

is protected throughout the process of a merger.

So let me ask you the real question. We are the Government

Oversight Committee, and it is a double entendre because we oversee the government.

We are also the government entity that oversees a number of

things that are outside the government; but in this case, the Federal Reserve, the Treasury, and the SEC—as I understand it

through testimony again and again, the SEC was locked out of this

process during that time and did not get into the process until January.

Isn’t that correct? Your agency was not informed of what the Fed

was doing or the Treasury was doing, and you were not at these

meetings? You were conspicuous in your absence, right?

Mr. KHUZAMI. I understand that is correct, yes.

Mr. ISSA. So from a standpoint of the Securities and Exchange

Commission, the respect the Treasury and the Fed should show in

the future, shouldn’t you be at the table if tens of billions of dollars

of taxpayers’ money are being thrown in to complete a merger; and

at the moment that an executive, a party says, I’m looking at the

MAC clause, I’m looking at breaking up this because things have

changed, or things were not disclosed, or we have learned something, wouldn’t that, in your opinion, be an absolute mandate for

the Securities and Exchange Commission to be in the room from

that time forward?

Mr. KHUZAMI. Congressman, I think if it was a matter that impacted on the SEC’s jurisdiction or responsibilities with respect to

shareholder disclosure, regulation of the securities markets, the answer would be ‘‘yes.’’

Mr. ISSA. Now I’m going to ask you a hypothetical, but it is not

much of a hypothetical. If you’d been in the room on September

17th, 18th, 19th, if you’d been in the room when they said, this is

not going to go forward because there have been material adverse

effects, and on top of that, you were aware of misstatements in the

proxy, would you have interjected at least your oversight, your

opinion, and your demand that compliance to law be adhered to,

which it wasn’t?

Mr. KHUZAMI. Well, I’m not sure that I would have commented

on whether or not a MAC clause was properly invoked or not.

Mr. ISSA. But we have already had testimony that if they invoked the MAC, they have to go back to the stockholders.

Mr. KHUZAMI. Correct.

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Mr. ISSA. The Federal Government came in with $20 billion—and

there’s some debate about whether it was forced on B of A or B of

A demanded it. Regardless of which one that is, at that point when

there’s new money, a MAC clause, or money in lieu of you, and on

top of that, material misinformation in the proxy, shouldn’t you be

in the room; and more importantly, if you are in the room, wouldn’t

you have acted to at least advise—and let’s assume you’re willing

to take on the Fed chairman and the Secretary of the Treasury—

that, in fact, they’re crossing lines at that point that should not be

crossed, they are failing to disclose to the very stockholders, the

public that you protect?

Mr. KHUZAMI. If those events triggered disclosure obligations, we

would certainly communicate that.

Mr. ISSA. For Christ’s sake, we have had five, six hearings. Mr.

Kucinich has dedicated probably a whole wall of his library to this

very question. And you’re saying ‘‘if.’’

Let’s go back again. They failed to disclose these bonuses. The

Fed and the Treasury became aware of that. They also became

aware that these losses were mounting, and through a negotiation

behind closed doors in which you were locked out, they negotiated

additional money, now repaid, but additional money to make BofA

go through with this deal or to encourage or, in fact on their demand, to have them go through.

So all of that occurred with your agency locked out of the room.

Are you going to tell me today—if there was something to be reported, are you going to say, like Sheila Bair that was here earlier,

Yes, I would like to have been in the room, and if I had been in

the room, or when I was in the room, I wish I had said or done

more.

Which is it? Are you going to say the SEC should darn well be

in the room and be protecting stockholders, or are you going to say

‘‘if,’’ ‘‘if,’’ ‘‘if’’ today? Which one is it?

Mr. KHUZAMI. Perhaps I didn’t make myself clear.

Mr. ISSA. I think I did.

Mr. KHUZAMI. Yes, you did. Very clear.

My only point was that we would certainly like to be in the room

any time there are discussions that go on that affect shareholders

and the entities and individuals that we regulate and protect. My

only point was a more modest one—whether or not discussions

about invoking a MAC clause necessarily triggered disclosure obligations under the Federal securities laws.

Mr. ISSA. Thank you.

Thank you, Mr. Chairman, for your indulgence. I think we made

the point that Mr. Kucinich and I have both been wanting to make,

and I look forward to continuing to followup on it.

I yield back.

Chairman TOWNS. Right. At this time I would yield to the Chair

of the Domestic Policy Subcommittee, the gentleman from Ohio,

Mr. Kucinich.

Mr. KUCINICH. Mr. Chairman, I just want to say at the outset

to my friend from California that there’s a distinction between

what you’re discussing and what our subcommittee has been doing;

and that is that you’re talking about disclosure events that ocVerDate 11-MAY-2000 14:33 Feb 15, 2011 Jkt 000000 PO 00000 Frm 00075 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\63135.TXT KATIE PsN: KATIE
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curred after the shareholder vote. Our focus in this subcommittee

has been about disclosure events before the shareholder vote.

Now, Mr. Khuzami, my subcommittee investigation has found

that Bank of America relied on the November 12th forecast for

fourth quarter 2008, created by Merrill Lynch, that omitted any

forecast of how collateralized debt obligations, subprime mortgagebacked securities, credit default swaps, would perform in the quarter.

The former Merrill CFO admitted to staff that the November

12th forecast was not in fact a valid forecast. Bank of America

knew at the time that the November 12th forecast was of questionable validity; it’s in quotes. However, Bank of America did not do

any actual financial analysis to make up for the Merrill omissions.

Instead, Bank of America merely pulled out of thin air a number

on November 13th, which was recorded on the forecast document

as the ‘‘gut’’ feeling of Neil Cotty, Bank of America’s chief accounting officer.

The attorneys at Bank of America and at Wachtell Lipton did not

question; in spite of the omission and the explicit reference to a

‘‘gut’’ feeling, they advised Bank of America not to make further

disclosures to its shareholders in advance of the merger vote based

on the information in the deficient forecast and a ‘‘gut’’ feeling.

The November 12th forecast omission of any projection for losses

and the CDOs and other liquid investments and the implication

that Merrill Lynch would break even in those investments for the

remainder of the quarter was material to the advice attorneys gave

Bank of America.

Now when I asked Ken Lewis about this at our first hearing, he

told us he relied on advice of counsel. Protecting shareholders is

often, in the final instance, the responsibility of corporate general

counsels and/or outside counsel. This subcommittee’s investigative

findings demand the question: Where were the lawyers, the glaring

omissions, inaccurate financial data, and the critical November

12th forecast so obvious that they should have alerted the attorneys to a necessity of a reasonable investigation before making a

decision on Bank of America’s legal duties to disclose. The apparent

fact they did not mount such an investigation makes the decision

not to disclose Merrill’s loss to the shareholders an egregious violation of security laws.

Mr. Khuzami, in March, GAO issued a scathing report on the effect of Christopher Cox’s leadership of the SEC in reducing corporate penalties and formal investigations at exactly the time that

the CDOs and CDSs were proliferating. To Chairman Shapiro’s

credit, she rescinded the Cox policy and appointed you to reinvigorate the Enforcement Division.

Now I am concerned that one pernicious aspect of the Cox legacy

may have survived: the unwillingness to pursue, as GAO wrote,

‘‘more complicated cases, those with industrywide implications, in

favor of those seen as more routine.’’

Mr. Khuzami, this is the test case. This is the case with industrywide implications, where what is at issue is the performance of

the attorneys in interpreting the Nation’s security laws strictly or

permissively. Here’s the case where the SEC’s Shapiro breaks with

the SEC’s Christopher Cox.

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Mr. Khuzami, is the SEC widening its investigation to include

the issue of Bank of America’s failure to disclose to its shareholders

the mounting losses at Merrill Lynch, known or knowable by midNovember 2008, weeks before—weeks before the shareholder vote

on the merger?

Mr. KHUZAMI. Congressman, we have been and are looking at all

aspects of the activity with respect to the proxy statements, including the fourth quarter losses at Merrill Lynch.

Mr. KUCINICH. Is that a ‘‘yes’’ or a ‘‘no?’’

Mr. KHUZAMI. That’s a yes.

Mr. KUCINICH. If it’s a ‘‘yes,’’ then the work of this committee has

been worthwhile, because you now have a chance to do your job.

Because we have done ours, and the information that we have uncovered should facilitate your investigation.

I thank the gentleman.

I thank the Chair. I yield back.

Chairman TOWNS. Thank you very much.

I now yield to the gentleman from Missouri, Mr. Luetkemeyer.

Mr. LUETKEMEYER. Thank you, Mr. Chairman.

Mr. Khuzami, Messrs. Bernanke and Paulson were negotiating

with Merrill Lynch and Bank of America and sort of came to an

agreement, yet they didn’t disclose this. They didn’t want to put in

writing the transaction that they were about to embark on here

and about to approve and had been working with. My understanding is that once they did that, that would have been a disclosable

event that the SEC would have been able to come into and be a

part of and have some oversight over.

What is your opinion of this transaction and how it all happened,

and this unwillingness to put this in writing?

Mr. KHUZAMI. Congressman, what the securities laws require is

that if that understanding had solidified to a material contract,

then it would have been required to have been disclosed under

what is known as Form 8-K. So Bank of America would have had

to make a disclosure if it rose to the level of an enforceable contract.

Mr. LUETKEMEYER. But isn’t this skirting the law by them saying, We are going to have a little wink-and-nod agreement here

and let’s just have a gentleman’s handshake on it? I mean, aren’t

they trying to subvert what really is a necessary part of a transaction, the disclosure to all parties involved?

Mr. KHUZAMI. Congressman, it wouldn’t be appropriate to comment on my views of that in light of the ongoing nature of the investigation, but certainly there can be circumstances where there’s

an enforceable contract, even though it’s not formally written down,

in which case it may trigger the disclosure obligations.

Mr. LUETKEMEYER. Following along that process, do you see

something that’s happened here that you think needs to be

changed in existing law? Do we need to have something more clarified by the way we have these transactions take place, so that

there’s more disclosure?

Mr. KHUZAMI. Congressman, we sort of constantly review our disclosure rules and regulations to determine whether or not more disclosure or different disclosure is appropriate. That process is ongoing now. The Sarbanes-Oxley Act required us to consider more

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real-time or robust disclosure, and that is a process that continues.

We would certainly take the experience here and determine whether or not we should change our rules and regulations appropriately.

Mr. LUETKEMEYER. You still haven’t said, yes, there are some

things we need to do, and they are—can you fill in the blank?

Mr. KHUZAMI. The question whether or not events such as these

should require more affirmative disclosure obligation is something

that we are considering. So, for example, contracts or discussions

short of a formal, legally enforceable obligation, should that be disclosed even though all the terms are unfinalized or interim results

that may not rise to the level of a material impairment of an asset,

which is the current standard, whether or not that should be disclosed.

Mr. LUETKEMEYER. Are you currently looking at that with your

rules and regulations, or do we need to have some congressional action? What do you think we need to do?

Mr. KHUZAMI. Congressman, that is something that we look at

on a regular basis and we are looking at now.

Mr. LUETKEMEYER. As someone who has gone through this and

been in the middle of it—and we are in the process now congressionally to try and do something with this too-big-to-fail situation—

what do you see that we are not doing with the legislation that’s

proposed that you think would be advantageous or a big aid to you,

or would be something that we could do in the future to mitigate

or minimize some of the things that have gone on?

Mr. KHUZAMI. Congressman, from an enforcement perspective,

which is my perspective, transparency and information are critical.

We cannot determine if misconduct is going on in markets if we

don’t have complete and accurate and standardized information

about what is going on. So, for example, registration of hedge

funds, which would require better reporting and stronger client and

inspection authority, would be highly beneficial.

Mr. LUETKEMEYER. Transparency and registration is in the bill

right now. Does it go far enough? Does it go too far? What is your

opinion?

Mr. KHUZAMI. I’m not sure I understand the full and complete

details of what is in the current version of the bill, so if I could

have an opportunity to respond to you, I would appreciate that.

But the same is true in the derivatives markets. We would like

that kind of information.

One case we brought, for example, recently, involved insider

trader, which typically takes place in the equity world, in stocks,

was actually going on in the credit default swap market. Yet we

don’t have nearly the same kind of information in that market as

we do in the equities.

Mr. LUETKEMEYER. Interesting. Thank you, Mr. Khuzami.

Thank you, Mr. Chairman.

Chairman TOWNS. The gentleman’s time has expired.

I now call on the gentleman from Baltimore, Mr. Cummings, who

is a very active member of this committee.

Mr. CUMMINGS. Thank you very much, Mr. Chairman.

Mr. Khuzami, I’ve got to tell you, as I listened to my good friend

and colleague, Congressman Kucinich, he said, ‘‘Our work is done.’’

And I don’t think our work is done. Let me tell you why.

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As you know, the SEC, in the case of the SEC v. Bank of America, there was a settlement that was submitted to the Federal court

in New York on August 3, 2009. The settlement agreement provided for the Bank of America to pay $33 million in fines for making false and misleading statements in proxy statements to shareholders. Bank of America, of course, told shareholders that no yearend bonuses would be paid to Merrill Lynch executives, when in

fact it had been agreed that Bank of America would pay up to $5.8

billion in bonuses to Merrill executives.

Putting aside the fact that $5.8 billion was to be paid to the executives of a company that was hemorrhaging money at the time,

the decision to settle the matter for $33 million struck many of us

as being a perverse outcome. Here was a company with $45 billion

in government assistance, $20 billion of which was from this exact

deal; and the Securities and Exchange Commission let them pay a

fine. And this is the piece that got me: Pay a fine with our money,

with taxpayers’ dollars.

Does this strike you as fair to the taxpayer shareholders? Does

it fit your mission of protecting American investors?

To me, it’s like you fine somebody and then take somebody else’s

money to pay the fine. And I’m trying to figure out, where is the

punishment in that, where is the enforcement in that? If I’m sitting

back, I say, ‘‘Oh, boy, a great day here; got the public’s money to

pay the fine. Everything is fine. I don’t have to pay a dime.’’

And then one of the things that I read about the settlement—

once I read about it, I fired off a letter to your inspector general,

David Coates, asking him to look into the settlement. I just read

in Mr. Coates’ recent semiannual report to Congress that he is in

the midst of this investigation, and I look forward to his conclusions.

One of the main reasons I requested the investigation was because I would not be the least bit surprised that in the aftermath

of this crisis that further securities laws violations are uncovered

and the violations may have occurred at a firm that has received

government assistance.

In that case, what is the calculus that is used to determine how

to punish a company without penalizing the involuntary investors

in the firm, the taxpayers? I want you to understand I’m concerned

about, when we catch folks, what is the thinking that goes into the

process of how to punish them? Because, to me, this was not punishment, and I’m glad the judge did reject it.

I know you may not be able to talk about the case, but I assume

you can talk about what goes into your thinking as the No. 1 guy

who addresses these issues.

And the only person that you answer to is Ms. Shapiro, Mary

Shapiro; is that right? It’s you and straight up to her; is that right?

Mr. KHUZAMI. That’s correct.

Mr. CUMMINGS. So help me with this. As a lawyer, when I read

this, I got so upset because, I said, it makes absolutely no sense.

And I know you’ve got a great answer for me, and I’m waiting to

hear it.

Mr. KHUZAMI. Congressman, let me take each of those.

First, with respect to the amount of the fine. The penalties that

we assess have to be proportionate to the actual wrongdoing that

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occurred. And here the wrongdoing was not the payment of the bonuses. That may be excessive and wrong as a policy matter, as a

corporate governance matter, as a number of other matters; but

from a pure enforcement point of view, the wrong was to fail to disclose to shareholders that they said that they would not pay bonuses without Bank of America’s approval when they had already

agreed to pay the money.

And so the wrong was the depravation of information to the

shareholders in deciding how to vote, not the fact that the amount

of money that was paid was illegal or improper in and of itself. So

we look at the wrongdoing.

Mr. CUMMINGS. They had a duty to disclose; is that right?

Mr. KHUZAMI. Yes, they have a duty to make sure the statements

in the proxy are not misleading. So the number of $5.8 billion, although it was $3.6 billion that was ultimately paid, is not, I don’t

think, the measure of the wrong. The wrong was that they did not

tell shareholders who needed all the information they could to decide whether or not to vote. So that was the starting point.

Then we look at the amount. We looked at our precedent. In the

proxy violation area, the largest fine that we had imposed was $38

million, give or take or so, in a case involving, frankly, more egregious conduct than this because it involved manipulation of their

stock and obstruction and other things, in addition to the proxy violation.

Next, we try and balance the benefit of the penalty versus the

burden on the shareholders. So we recognize the penalties that we

assess may come out of the pockets of shareholders who may themselves have been wronged by the conduct. So we try and balance.

But we have to still impose the penalties because it sends a strong

deterrent message to other corporations and other issuers that this

kind of conduct will not be tolerated.

The deterrence message is critical. It tells others they shouldn’t

do it. It says that if you do it, you’re going to pay a cost. It

incentivizes them to fix their own problems before we come knocking. It allows us to leverage our limited resources so that companies voluntarily engage in corrective measures rather than us having to go to each one of them. The lawyers read these things, the

corporate executives read these decisions; they implement changes.

So there’s many good reasons to have the penalty, but we don’t

want to burden the shareholders more than necessary. That’s a balancing that we look at under our penalty guidelines, and we come

to the best determination that we can.

Mr. CUMMINGS. I see my time is up. Thank you, Mr. Chairman.

Chairman TOWNS. The gentleman’s time has expired. The gentlewoman from California, Ms. Speier.

Ms. SPEIER. Thank you, Mr. Chairman.

Mr. Khuzami, I am deeply troubled by your description of what

took place. You said that the bank misled the shareholders. The

bank didn’t mislead the shareholders. It lied to the shareholders.

It was a bald-faced lie.

Now, on a proxy statement, if you make a bald-faced lie, I think

that you should have a penalty that is so strong that you won’t

ever do it again.

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Now the courts seem to believe that $33 million was insufficient.

Who initiated the settlement?

Mr. KHUZAMI. Congresswoman, this was a settlement that

was——

Ms. SPEIER. Who initiated it? Did SEC go to the Bank of America

and say, let’s settle this; or did the Bank of America come to the

SEC and say, let’s settle this?

Mr. KHUZAMI. I don’t know the answer to that, Congresswoman.

Typically, settlements result from both parties coming together and

discussing the possibility of settlement.

Ms. SPEIER. Someone initiates it. If you don’t have the answer

today, I’d appreciate it if you would make that available to the

committee.

Mr. KHUZAMI. Certainly.

Ms. SPEIER. You based your decision on the fact that there was a precedent where $38 million was fined in another setting.

Now, you know that the SEC, historically, when you were not a

member of the staff, was reducing its enforcement actions dramatically. In fact, the recent GAO study indicated that the enforcement

actions had been reduced by some 80 percent and the disgorgement

actions I believe by some 60 percent. Presuming those figures are

indeed accurate—I may be off a little bit—you’re basing a decision

on whether or not to impose a fine on a very anemic SEC that was

not doing a good job of enforcing the law.

So I guess my real question to you is, if something is substantive,

if something is significant, if it is a lie, shouldn’t the penalty reflect

that? I’m not accepting the fact that somehow, because there was

another fine issued before, that somehow should be a measurement, when we know that the SEC wasn’t doing its job.

Finally, your argument that somehow you’ve got to balance what

happens to the shareholders, if that’s the deliberative process

you’re going to use, then the appropriate fine is never going to be

imposed on companies that do, in fact, lie.

Mr. KHUZAMI. As to your latter point, the harm to shareholders

who may have been victimized by the wrongful conduct is only one

factor amongst eight or nine that we take into account, one of

which is the importance of the deterrence impact of the penalty. So

I don’t want to mislead you to suggest that we only look at whether

or not there’s harm to shareholders. We look at a variety of factors,

including, most importantly, the deterrent effect of the fine.

Ms. SPEIER. Let me ask you this. Based on what the judge has

said in this case, if you were to start over again, what would be

the fine that you believe would be appropriate for a proxy statement that had a bald-faced lie in it, that shareholders relied on—

or prospective shareholders relied on in terms of purchasing the

stock?

Mr. KHUZAMI. Congressman, I think the judge’s concern in his

opinion had to do more with whether or not the fine was too high,

because he felt that it was falling—the burden was falling on

shareholders who had been victimized by the wrongful conduct, not

that it was too low.

But reasonable minds can have different opinions on that issue.

My belief is the settlement that we struck was fair and appropriate.

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Ms. SPEIER. So in terms of further negotiations, will there be another settlement offered up to the judge, or will this go to trial?

Mr. KHUZAMI. The matter is scheduled for trial in early March

and the case is proceeding.

Ms. SPEIER. So there will not be any further settlement on this

case?

Mr. KHUZAMI. I couldn’t predict the future as to whether or not

the case will settle or not. As of now, the case is proceeding in the

discovery phase and it’s scheduled for a March trial.

Ms. SPEIER. I just want to understand. Could you then go back

and negotiate a smaller—is what you’re saying, that the judge

wants a smaller fine imposed? I find that absolutely unbelievable.

Mr. KHUZAMI. No. My only point was that, in the judge’s opinion,

he indicated that he was concerned about the penalty because he

thought that it was being imposed on shareholders who were victimized by the wrongful conduct.

Ms. SPEIER. His opinion was not based on the fact that the fine

was too low?

Mr. KHUZAMI. I don’t remember whether or not he used exactly

those terms, but his point was more that the fine was—sorry to repeat myself—but the fine was falling on the shareholders victimized by the wrongful conduct.

Ms. SPEIER. Or maybe his focus was that the fine should be imposed on the executives who misled the shareholders and maybe

have it taken out of their salaries.

Mr. KHUZAMI. He did question why no individuals were charged,

you’re absolutely right; but he didn’t suggest that the fine should

be paid out of the pockets of individuals or particular corporate executives.

Chairman TOWNS. The gentlewoman’s time has expired.

I now yield 5 minutes to the gentleman from Ohio, the ranking

member on the subcommittee.

Mr. JORDAN. Thank you.

Mr. Khuzami, were you here for Ms. Bair’s testimony and questioning earlier this morning?

Mr. KHUZAMI. Yes, I was.

Mr. JORDAN. So you’re aware of what she said in confirming

what Mr. Lewis had told this committee about the meeting that

took place in October, 10 days after TARP had passed, where the

nine biggest financial institutions were brought to this town, including Bank of America, and told they were going to have their

bank partially nationalized, they were going to have to accept

TARP money, they had to sign a form. You heard all that testimony that she gave?

Mr. KHUZAMI. Yes.

Mr. JORDAN. I guess my point is or my question is—well, let me

go back to this.

Her testimony to this committee a few hours ago was that action

by the Fed, by Mr. Paulson—Treasury Secretary Paulson and Federal Reserve Chairman Bernanke took her breath away when she

saw what took place at that meeting.

So now, as we move forward, it seems to me that—I guess your

testimony—and I apologize for not being here, I was at another

commitment. You talked about shareholders being misled. But it

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seems to me that this unbelievable involvement by the government,

the e-mail we have that’s been part of the record in earlier hearings from Mr. Lacker, Federal Reserve Bank of Richmond, where

he talked about the fact they didn’t want a disclosable event so Mr.

Paulson, Mr. Bernanke were not willing to put anything in writing

about the willingness to help Bank of America with additional

TARP dollars.

I mean, it seems to me that someone looking at this can say, you

know, Bank of America—what was the government’s culpability

here in running the show and pushing for this deal, particularly

Mr. Paulson and Mr. Bernanke?

I assume you at the SEC are looking at—I mean, that has to, in

my mind, factor into this whole picture, this whole scenario that

we have been looking at now for several months. Any response you

would have to all that?

Mr. KHUZAMI. Congressman, as we look at these events, we look

at the roles of all the participants that are relevant and all of the

facts. I guess that would be my response.

Mr. JORDAN. Yes or no, would potential arguments by Bank of

America that the bank and its management were not necessarily

completely liable because they were acting at the government’s directions?

Mr. KHUZAMI. Well, events that you’re talking about I believe occurred after the proxy, and so after the merger had been approved.

And so the question is whether or not—with respect to the TARP

money, whether or not that understanding had become a material

contract that had to be disclosed under the 8-K rules and regulations. So that is certainly an issue.

Mr. JORDAN. When did you guys first become aware of what was

taking place or the mounting losses at Merrill Lynch? When did

you first become aware of that?

Mr. KHUZAMI. Unfortunately, I wasn’t there until March, so I

can’t—I don’t know the answer to that question.

Mr. JORDAN. Why do you think—when we have the e-mail saying

we don’t want disclosable, why do you think there was a reluctance

by the Federal Reserve not to have information be made known to

the SEC?

Mr. KHUZAMI. It probably wouldn’t be appropriate for me to speculate about that.

Mr. JORDAN. Mr. Chairman, I yield back.

Chairman TOWNS. Thank you very much.

I now yield to the gentlewoman from California, Congresswoman

Watson.

Ms. WATSON. Thank you, Mr. Chairman, and thank you for this

followup hearing. We have had several in the past, and after listening to the testimony from the Bank of America CEO Kenneth

Lewis; the Federal Reserve chairman, Ben Bernanke; former Treasury Secretary Hank Paulson; and officials at the Bank of America,

there’s still strong questions. And I know the intent of this committee, through its Chair, is to get some of these questions answered

so we will know really what took place.

We want to hear from you the role of the government and what

was played in the negotiations; the quality of the Bank of America’s due diligence process; and the motivation behind BofA’s atVerDate 11-MAY-2000 14:33 Feb 15, 2011 Jkt 000000 PO 00000 Frm 00083 Fmt 6633 Sfmt 6633 C:\KATIES\DOCS\63135.TXT KATIE PsN: KATIE
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tempt to claim a material adverse change [MAC], and the adequacy

of their disclosure to shareholders.

Can you package all that and clarify it for us? I think this is

what, the third or the fourth hearing, Mr. Chairman?

Chairman TOWNS. Fifth.

Ms. WATSON. Fifth.

Let us hear how you would describe the roles that each one of

these sectors played.

Mr. KHUZAMI. Well, Congresswoman, involving some or all of the

matters that are currently under investigation, I have to be careful

about my comments.

With respect to the proxy that was sent out in connection with

the merger, as we have charged in our complaints, we believe that

the disclosure was misleading because Bank of American did not

disclose that they already had an agreement to pay bonuses, when

they told shareholders that Merrill Lynch would not be paying such

bonuses without their consent; but, in fact, consent had already

been given. That is the case we charged and that is the case that

is proceeding.

Ms. WATSON. Let me stop you and I want to query these bonuses.

Ethically, I don’t see how the bonuses could even be in contention

when we are bailing out too-big-to-fail institutions with taxpayers’

moneys to try to capitalize these big institutions so they can save

people’s homes, etc.

Is a bonus appropriate under the crisis conditions that exist? I

just want you to talk about bonuses, and then continue.

Mr. KHUZAMI. Well, Congresswoman, again, from an enforcement

perspective, my focus is on what the law requires and whether or

not the law has been violated.

Ms. WATSON. Do bonuses fall under that provision in the law?

Mr. KHUZAMI. Generally not, except in this situation, where they

made a representation about what they were going to do about bonuses, and that representation, in our view, was false.

Ms. WATSON. But that was prior to the collapse, wasn’t it? When

people signed their contracts, as I understand, they had bonuses

attached in there. But the whole condition has changed now, where

they have to comply with the provisions that were in the original

agreement.

Mr. KHUZAMI. Well, that is correct. The bonuses that were paid

in this case were paid, frankly, shortly after the merger was approved. That’s correct.

Ms. WATSON. Would you continue on, please.

Mr. KHUZAMI. There’s probably not much more. I don’t mean to

disappoint you, but probably not much more I would say on that

topic. Whether or not bonuses are appropriate and the appropriate

level, and the balance between incentivizing talent and retaining

talent versus what is an appropriate compensation is probably

something that is above my pay grade.

Ms. WATSON. I’ve heard that said, to retain talent. That really

goes beyond—I feel it’s so absurd. I don’t think at this point that

you couldn’t find 1,000—or you could find 1,000 people out there

with tremendous talent. If that talent goes, there are people lined

up.

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I mean, we are really being hit hard, and I’m talking about my

district now, which is Los Angeles, Culver City, Hollywood. And

people have lost their jobs in droves, lost their investments.

Talent is available, believe me. And so it’s a phony, phony excuse. But in putting this all together, I feel there were tremendous

failures on all sides. Would you agree to that?

Mr. KHUZAMI. I think there’s a lot of blame to go around.

Ms. WATSON. Yes.

My colleague, Ms. Speier, said it was just downright lies that

were given and possibly it was done so that government could support BofA and give them more support in the merger. So I’m just

really thoroughly, thoroughly disappointed that the people that

were in place, particularly at the SEC, looked the other way.

Thank you. I yield back.

Chairman TOWNS. The gentlewoman’s time has expired.

I now yield 5 minutes to the gentleman from Missouri, Congressman Clay.

Mr. CLAY. Thank you very much, Mr. Chairman.

Thank you, Mr. Khuzami, for being here. Just a couple of questions. At what point should action have been taken to curb some

of the activities of the big banks’ involvement in the security market? There had to be some indication to the SEC that some investment houses were stretched too thin without the proper reserves

to cover their risk in this market.

Did red flags or alarms ever go off? What did you know and

when did you know it?

Mr. KHUZAMI. Congressman, I didn’t arrive at the SEC until

March of this year, so I’m probably not the right person to ask that

question of.

Mr. CLAY. How about the people that you work with now that

have been there for years? Did red flags go off for them?

Mr. KHUZAMI. Well, there were certainly systemic risks and a

bubble that had occurred in the housing market and elsewhere that

resulted in the collapse and the excessive leverage and risk-taking

that we saw.

What the Commission saw at various points along the way, it’s

difficult for me to answer that question. We didn’t have regulatory

authority over certain areas. It might be better if I have an opportunity to respond to you after today’s hearing, so I can give you a

more fulsome answer.

Mr. CLAY. I’d love to hear from your colleagues in writing just

what alarms went off or whether the relationship was too cozy with

the big banks, that they never wanted to cite them for risky practices.

Let me ask you in particular, why did Bank of America get only

a slap on the hand when it was cited in 2006 for improperly marketing auction rate securities? Why were they allowed to continue

these practices of using false and misleading information in selling

these instruments, in hindsight? Do you think the BofA was given

too much leeway?

Mr. KHUZAMI. Congressman, I would have to familiarize myself

with that case. I’m aware generally of the auction rate securities

matter, but as I sit here, not with the particulars of whatever action may have been brought in 2006.

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I’d be happy to respond.

Mr. CLAY. Would you respond to us and to the committee in writing on that issue also?

Mr. KHUZAMI. Certainly.

Mr. CLAY. Mr. Chairman, I have no further questions. I yield

back.

Chairman TOWNS. Thank you very much.

Before we close out, let me just say, Mr. Khuzami, I’m troubled

by the question the gentleman from Maryland raised, Mr.

Cummings. It seems to me that individual executives, the ones who

sign off on the proxy filings, should be the ones that are responsible. So, therefore, why wouldn’t they be the ones that you go

after, you know, fine them from the personal standpoint? Like he

said, taking our money and then paying the fine. I’m not sure we

get to where we need to go with that.

The other thing, the general feeling, in terms of the community

at large, they feel that the reason the judge sent it back to you is

that you were not aggressive enough, that you did not pursue it in

the fashion that he felt it should have been. And, of course, that’s

the general feeling among people, as they say, ‘‘in the street,’’ as

to what’s going on.

I don’t know whether that’s the case or not, but I do believe that

you really need to look at that because when I listen to the fact

that they are paying with our money, that doesn’t encourage people

to do what’s right.

Mr. KHUZAMI. A couple of responses: First, with respect to the

payment of the fine, obviously, any entity that receives TARP funding or other money still has to pay that full amount back, with interest. So whether or not a fine was paid with government money,

which can tend to be fungible in an institution, but ultimately they

had pay back all the money they got from the government with interest. I would just make that point.

Second of all, you’re right, the judge expressed concern about not

charging individuals. We have shown a very aggressive posture of

charging individuals. If you look historically at our cases, the overwhelming number of cases result in charges against individuals

and not corporations alone. I just mentioned some earlier today.

But the particular issue in the proxy area is that the proxy laws

impose the obligation on the entity whose proxy is being solicited

or on whose behalf it’s being solicited, and those are the corporations.

To charge individuals, you need a higher level of proof. You need

to show what is called scienter, or either knowledge or reckless conduct, meaning a significant and substantial deviation from normal

standards of care. It is that difference in the legal standard that

makes a difference in how we can proceed. There’s a higher burden

of proof with respect to the individuals; and our determination,

based on the record we had, is that we did not have the basis to

charge them as individuals.

Now as we get into the discovery process, we may get additional

information, and we will take that into account. But I don’t want

to leave the impression that we do not aggressively pursue individuals. We recognize the deterrent impacts of charging individuals as

much as corporate penalties deter people. Nothing substitutes for

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charging individuals. And we do that across the board in many,

many, many of our cases.

Chairman TOWNS. Because the shareholders are really the ones

who suffer in a case like this.

Let me thank you very, very much for your testimony. Of course,

we really appreciate the fact that you’re here and that you shared

with us.

This is the end of many, many hearings that we have had on

this. And of course we hope that we will now be able to move and

to give the kind of confidence that people really need in order to

turn the situation we now find ourselves in around. So I want to

thank you again.

This hearing is now adjourned.

[The information referred to follows:]

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[Whereupon, at 12:37 p.m., the committee and subcommittee

were adjourned.]

[The prepared statement of Hon. Gerald E. Connolly follows:]

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