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H.R. 2179—THE SECURITIES FRAUD

DETERRENCE AND INVESTOR RESTITUTION

ACT OF 2003

HEARING

BEFORE THE

SUBCOMMITTEE ON 

CAPITAL MARKETS, INSURANCE, AND

GOVERNMENT SPONSORED ENTERPRISES

OF THE

COMMITTEE ON 

FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED EIGHTH CONGRESS

FIRST SESSION

JUNE 5, 2003

Printed for the use of the Committee on Financial Services

Serial No. 108–34

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa 

DOUG BEREUTER, Nebraska 

RICHARD H. BAKER, Louisiana 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

ROBERT W. NEY, Ohio 

SUE W. KELLY, New York, Vice Chairman 

RON PAUL, Texas 

PAUL E. GILLMOR, Ohio 

JIM RYUN, Kansas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

DOUG OSE, California 

JUDY BIGGERT, Illinois 

MARK GREEN, Wisconsin 

PATRICK J. TOOMEY, Pennsylvania 

CHRISTOPHER SHAYS, Connecticut 

JOHN B. SHADEGG, Arizona 

VITO FOSELLA, New York 

GARY G. MILLER, California 

MELISSA A. HART, Pennsylvania 

SHELLEY MOORE CAPITO, West Virginia 

PATRICK J. TIBERI, Ohio 

MARK R. KENNEDY, Minnesota 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

TIM MURPHY, Pennsylvania 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

KATHERINE HARRIS, Florida 

RICK RENZI, Arizona 

BARNEY FRANK, Massachusetts 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

JULIA CARSON, Indiana 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

BARBARA LEE, California 

JAY INSLEE, Washington 

DENNIS MOORE, Kansas 

CHARLES A. GONZALEZ, Texas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

KEN LUCAS, Kentucky 

JOSEPH CROWLEY, New York 

WM. LACY CLAY, Missouri 

STEVE ISRAEL, New York 

MIKE ROSS, Arkansas 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

RAHM EMANUEL, Illinois 

DAVID SCOTT, Georgia 

ARTUR DAVIS, Alabama 

BERNARD SANDERS, Vermont

Robert U. Foster, III, Staff Director 

(III)

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND

GOVERNMENT SPONSORED ENTERPRISES

RICHARD H. BAKER, Louisiana, Chairman

DOUG OSE, California, Vice Chairman 

CHRISTOPHER SHAYS, Connecticut 

PAUL E. GILLMOR, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

FRANK D. LUCAS, Oklahoma 

EDWARD R. ROYCE, California 

DONALD A. MANZULLO, Illinois 

SUE W. KELLY, New York 

ROBERT W. NEY, Ohio 

JOHN B. SHADEGG, Arizona 

JIM RYUN, Kansas 

VITO FOSSELLA, New York 

JUDY BIGGERT, Illinois 

MARK GREEN, Wisconsin 

GARY G. MILLER, California 

PATRICK J. TOOMEY, Pennsylvania 

SHELLEY MOORE CAPITO, West Virginia 

MELISSA A. HART, Pennsylvania 

MARK R. KENNEDY, Minnesota 

PATRICK J. TIBERI, Ohio 

GINNY BROWN-WAITE, Florida 

KATHERINE HARRIS, Florida 

RICK RENZI, Arizona 

PAUL E. KANJORSKI, Pennsylvania 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

JAY INSLEE, Washington 

DENNIS MOORE, Kansas 

CHARLES A. GONZALEZ, Texas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

KEN LUCAS, Kentucky 

JOSEPH CROWLEY, New York 

STEVE ISRAEL, New York 

MIKE ROSS, Arkansas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

RAHM EMANUEL, Illinois 

DAVID SCOTT, Georgia 

(V)

C O N T E N T S 

Page 

Hearing held on: 

June 5, 2003 ...................................................................................................... 1

Appendix: 

June 5, 2003 ...................................................................................................... 41

WITNESSES 

THURSDAY, JUNE 5, 2003

Bruenn, Christine A., President, North American Securities Administrators 

Association, Inc. ................................................................................................... 33

Cutler, Stephen M., Director, Division of Enforcement, U.S. Securities and 

Exchange Commission ......................................................................................... 7

Schapiro, Mary L., Vice Chairman an President, Regulatory Policy and Oversight, NASD .......................................................................................................... 10

APPENDIX 

Prepared Statements: 

Oxley, Hon. Michael G. .................................................................................... 42

Clay, Hon. Wm. Lacy ....................................................................................... 44

Gillmor, Hon. Paul E. ....................................................................................... 45

Israel, Hon. Steve ............................................................................................. 46

Kanjorski, Hon. Paul E. ................................................................................... 48

Kelly, Sue W. .................................................................................................... 50

Royce, Hon. Edward R. .................................................................................... 51

Bruenn, Christine A. ........................................................................................ 52

Cutler, Stephen M. ........................................................................................... 60

Schapiro, Mary L. ............................................................................................. 80

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Bruenn, Christine A.: 

Written response to questions from Hon. Paul E. Kanjorski ........................ 86

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H.R. 2179—THE SECURITIES FRAUD 

DETERRENCE AND INVESTOR RESTITUTION 

ACT OF 2003

Thursday, June 5, 2003

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE AND

GOVERNMENT SPONSORED ENTERPRISES

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to call, at 10:08 a.m., in Room 

2128, Rayburn House Office Building, Hon. Richard Baker [chairman of the subcommittee] presiding. 

Present: Representatives Baker, Ose, Castle, Manzullo, Kelly, 

Biggert, Capito, Kennedy, Tiberi, Brown-Waite, Harris, Renzi, Kanjorski, Meeks, Hinojosa, Lucas of Kentucky, Crowley, Israel, Clay, 

McCarthy, Baca, Lynch, Emanuel, and Scott. 

Chairman BAKER. [Presiding.] I would like to call this meeting 

of the Capital Markets Subcommittee to order. 

This morning, we are here to conduct a review of the provisions 

of H.R. 2179, the Securities Fraud Deterrence and Investor Restitution Act of 2003. We come to this point after an unfortunate period 

of corporate governance history in which it is apparent that certain 

managerial officers misused their privileged positions to enhance 

their personal well-being at the expense of investors and their own 

corporations. 

This is an unfortunate period of corporate performance and required the Congress to act in a forthright manner. To that end, the 

Congress adopted in rather record-setting time the Sarbanes-Oxley 

Act which set significant new standards for corporate performance. 

Contained within that Act was a proposal called the FAIR fund 

which established for the first time a formal mechanism by which 

fines and disgorgements proceedings would be returned to the people from whom the assets were taken. Although a new concept, it 

is not a new method of compensation to defrauded investors. Federal agencies over decades have pursued wrongdoers and utilized 

mechanisms to provide for investor restitution. This legislation 

would only provide for an enhanced ability to assist in this important task. 

To that end, I want to express appreciation to the NASD having 

read their testimony, not only for their comments in support of the 

bill, but in reviewing the performance history of the enterprise. 

Over history, there have been thousands of times and multi-millions of dollars returned to investors, even without the advent of 

2

the FAIR fund, demonstrating not only that it can be done, but 

that it has been done successfully. 

Even NASAA, who has expressed concerns about the legislation 

in their testimony, has indicated that investor restitution is a laudable goal, despite the attractiveness, I would suspect, of keeping investor dollars for the construction of executive parking lots and 

DMV offices. Investor restitution is at least a goal we should try 

to achieve if we can muster the will to accomplish it. 

Some have suggested that even if we are to enact appropriate authorities, there may be two significant resource limitations to enable Federal agencies to take on this task. I will propose and be 

interested to hear the response to the concept of providing that 

some portion of the fines, penalties and other assets that are acquired be set aside. After investor restitution, after investor education, after any other appropriate action that might be pursued, 

that the residual funds be placed into the hands of enforcement 

agencies for the support of these enforcement actions. I cannot understand why that would not be an attractive utilization of these 

resources. 

But as to the other provisions of the legislation which constitute 

the bulk of the proposal, it will enable the authorities to pursue in 

a much less fettered way, wrongdoers. If we were to take the cases 

of Scott Sullivan, Bernie Ebbers, and Tyco’s Kozlowski, with the 

passage of this act, authorities would have unfettered ability to 

pursue wrongdoers, to retrieve all ill-gotten gains. As to Mr. Sullivan’s $20 million-plus mansion, it will have a new for sale sign on 

it. It says ‘‘for sale by owner, the U.S. government.’’ As to Mr. 

Ebbers’s reported estate in Canada, equal in size to the State of 

Rhode Island, it is going to come back home. With regard to the 

Kozlowski art and yachts, all gone. Passage of this Act will make 

sure the art, the yacht, the mansions and even the State of Rhode 

Island will be returned to its rightful owner. 

Let me make it clear: This Act enhances, it does not inhibit, the 

authorities’s ability to act. It does not preclude any State or local 

regulator from pursuing wrongdoers wherever they may engage in 

inappropriate conduct. It does provide that the money that is recouped will be given back to the people from whom it was taken. 

I also want to express my appreciation this morning to the Consumer Federation. Over the past weeks, we have been in constant 

communication and negotiation with regard to the provisions of the 

Act. They have expressed their endorsement of the proposal and 

have suggested technical modifications on which we have not yet 

reached resolution, but I am confident that in the coming days we 

will. We can look forward to a wholesale endorsement without reservation of this important proposal. 

In summary, this legislation is essential to assist in the restoration of investor confidence. We give the United States government 

the authority necessary to pursue wrongdoers, and assure investors 

we will not stand idly by while fraudulent acts are perpetrated on 

innocent victims. When the government is successful in achieving 

conviction and recoupment, we will give it back to the people from 

whom it was taken. What is more fair than that? 

Mr. Kanjorski? 

Mr. KANJORSKI. Thank you, Mr. Chairman. 

3

We meet today to examine H.R. 2179, the Securities Fraud Deterrence and Investor Restitution Act which you recently introduced. As you know, I believe that we have an obligation to ensure 

the American investors are appropriately safeguarded against cases 

of securities fraud. I also share your concerns that to the extent 

possible we should prioritize efforts to compensate investors for 

losses resulting from securities wrongdoing. 

In testimony before our committee earlier this year, the Securities and Exchange Commission suggested a number of legislative 

reforms needed to enhance its ability to investigate wrongdoing, 

deter fraud and compensate deceived investors. H.R. 2179 would 

adopt these meritorious recommendations by permitting the commission to return more of the penalties that it collects to defrauded 

individuals. It would also increase the commission’s power to collect fines, penalties and disgorgements that it orders. Additionally, 

the bill’s provisions to increase access to information and raise fine 

levels would enhance the ability of the commission to conduct its 

investigations and deter fraud. 

While H.R. 2179 contains all the recommendations proposed by 

the commission earlier this year, it also contains other additions. 

I have serious reservations about one of these reforms, Section 8(b). 

This provision would require State security regulators to remit to 

the Federal government any penalties or disgorgements obtained 

from a broker-dealer under certain circumstances. As currently 

drafted, Section 8(b) poses a number of problems. 

Although it may be an unintended consequence, this provision 

would force a State that has already imposed and collected a restitution obligation to forward any additional penalty that it obtains 

to the Federal government. In effect, the commission would receive 

the State’s penalty, even though the State arranged for the wrongdoer to provide full restitution to the victims. State regulators have 

also raised concerns that this provision would significantly limit 

their ability to craft appropriate remedies like mandating corrective actions in securities enforcement cases. 

Moreover, by allowing the Securities and Exchange Commission 

to take funds from a State, Section 8(b) raises constitutional concerns. I am presently unaware of any other provision in Federal 

law that allows the Federal government to obtain the money collected by a State in an enforcement action without the State’s acquiescence. Because it takes money away, one could also construe 

this provision as an unfunded mandate on State governments. Historically, our dual securities regulatory system in which Federal 

and State agencies perform specific investor protection functions 

has served us well. In recent cases like the online and day-trading 

scams, penny stock fraud, and investment banking problems with 

Analyst Research, initial action by the States eventually led to a 

more comprehensive response by the Federal government. 

We should not upset this symbiotic relationship by undermining 

the incentives or placing fiscal constraints on the ability of States 

to vigorously pursue wrongdoing in the securities industry. It is 

therefore my hope that we will remove this provision or significantly revise it when considering this legislation in the future. 

While this bill will help to ensure that some investors will receive at least partial compensation for the losses that the incur as 

4

a result of securities fraud, I continue to believe that the most 

meaningful route for investors to receive full restitution for their 

losses is through private litigation. We therefore need to ensure 

that investors harmed by corporate wrongdoers can seek legal redress in our nation’s courts. As the commission notes in its recent 

report to Congress, investor lawsuits complement government enforcement action by providing for a mechanism to compensate investors through the award of damages. 

While the Securities and Exchange Commission’s enforcement actions often have several aims, the objective of private litigation is 

exclusively to compensate injured investors. Because the ability of 

investors to fully recover their losses often largely depends on the 

use of private actions, we need to work to restore the rights of individuals to bring actions against the perpetrators of securities fraud. 

Amending H.R. 2179 to provide investors with greater access to the 

courts in cases of securities wrongdoing would achieve this worthwhile objective. 

In closing, Mr. Chairman, I look forward to hearing from our distinguished witnesses on this important legislation. I also hope that 

we will not rush into a markup on H.R. 2179 before we can work 

together to address issues like improving the access of defrauded 

investors to the courts and protecting the ability of the States to 

robustly enforce their securities laws. 

[The prepared statement of Hon. Paul E. Kanjorski can be found 

on page 48 in the appendix.] 

Chairman BAKER. I thank the gentleman. 

Ms. Kelly? 

Mrs. KELLY. Thank you, Mr. Chairman. 

I appreciate your holding this hearing on this important legislation. I think it will send a clear message to all Americans that securities fraud offenders are going to be caught quickly, punished 

severely, and their ill-gotten gains will be taken away and returned 

to the injured investors. 

Over the past two years, our country has experienced monumental and extraordinary events that have changed the nature of 

our work here in Washington and shaped our agenda on this committee. No one could have predicted the terror attacks on September 11 or the collapse of several major corporations. With the 

passage of unprecedented legislation addressing terrorism, reinsurance, anti-money laundering and corporate responsibility, I am 

pleased to say that this committee stepped up to these challenges. 

But as the country faces a faltering economy and a war to rid the 

world of terror, it is even more important that Congress take action 

to rebuild our economy and address the eroding investor confidence. 

We have to continue to ensure that the U.S. investors, now over 

half of all American families, have the backing and Oversight they 

need to return the securities market to full-faith and hope for prosperous futures. That is why I feel very strongly about this Securities Fraud Deterrence and Investor Restitution Act, and I am very 

delighted that we are having this hearing and I look forward to 

hearing from our witnesses. 

Chairman BAKER. Thank you, Ms. Kelly. 

5

[The prepared statement of Hon. Sue W. Kelly can be found on 

page 50 in the appendix.] 

Chairman BAKER. Mr. Emanuel? 

Mr. EMANUEL. Thank you, Mr. Chairman. 

The only thing I can add is that obviously I look forward to hearing what they have to say on the priority we all put on the restitution in security fraud as it relates to what is going on. So I look 

forward to the testimony and the ability to ask questions afterwards. 

Thank you. 

Chairman BAKER. Thank you, sir. 

Mr. Kennedy? No statement? 

Mr. Ose? 

Ms. McCarthy? 

Mrs. MCCARTHY OF NEW YORK. Thank you, Mr. Chairman. 

Again, I will listen to the testimony and then follow through with 

questions. 

Chairman BAKER. Certainly. 

Mr. Hinojosa? 

Mr. HINOJOSA. Thank you, Mr. Chairman. 

I wish to welcome the panelists, and I commend you for calling 

this worthy hearing. I commend you and Ranking Member Kanjorski. 

Over the last two years, we have learned of the many dangers 

that can plague an unregulated marketplace. We have witnessed 

the disastrous effects of fraud, corruption and cooked books. Individually, American families lost college savings, retirement funds, 

and hopes for the future. Collectively, our markets lost the lifeblood 

of a thriving economy, and that is public trust. In response to these 

corporate injustices, Congress collectively and on a bipartisan basis 

passed aggressive legislative reforms to ensure that this devious 

behavior would not be duplicated. 

I believe that H.R. 2179 is a good addition to the Sarbanes-Oxley 

Act passed last year. I am confident that it will help fully restore 

our nation’s trust in the American marketplace. H.R. 2179 will 

greatly increase the Securities and Exchange Commission’s ability 

to investigate and deter fraud, levy and collect fines and 

disgorgement funds, and provide for injured investors. H.R. 2179 

will also give the SEC the authority to accept privileged information. This will enhance the commission’s ability to access significant and otherwise unobtainable information by allowing private 

parties to produce privileged or work product-protected documents 

to the commission without waiving the privilege or protection as 

against any other party. 

For this, I commend you, Chairman Baker and Chairman Oxley. 

However, I do want to point out a concern that I have. That is the 

impact with Section 8(b) of this legislation and what it will have 

on individual States and their ability to combat corporate fraud on 

a State level. I look forward to working with you on this issue. 

Again, thank you, Mr. Chairman. I look forward to hearing the 

panelists and I yield back my time. 

Chairman BAKER. I thank the gentleman. 

Mr. Scott? 

6

Mr. SCOTT. Yes, thank you very much, Chairman Baker and 

Ranking Member Kanjorski. I want to thank you for holding this 

very important hearing today regarding securities fraud deterrence 

and investor restitution. To you, Chairman Baker, I applaud you 

for your hard work on this legislation and on this very timely and 

important subject. 

I also want to thank the distinguished panel of witnesses that 

will appear before us today, for your testimony on this subject. 

Given that President Bush has just signed legislation that would 

cut taxes on dividends and capital gains, I think that it is very 

timely for this committee to consider additional investor protections. If the individual investor is not confident that anti-fraud actions have any teeth, they may still have some hesitation to reenter 

the market at a time when our economy desperately needs that 

boost. What good is a dividend tax cut if investors are being ripped 

off? 

I believe that H.R. 2179 has many good provisions that will help 

the SEC investigate and deter fraud and return money to wronged 

investors. I must admit I do join with some of my other colleagues 

in having some concerns about Section 8(b). I think that this committee will, after hearing and the questions, will certainly find an 

appropriate response to the Section 8(b) concerns that I have. 

I would also like to focus on one small component of H.R. 2179 

that would allow portions of the disgorgement funds established 

under Sarbanes-Oxley to be used for investor education. While I 

am a strong believer in preventive medicine and education, as I 

have worked very hard with this committee and with homebuyer 

education to prevent predatory lending, and I think the education 

component for investor education could likewise be beneficial, I 

would like to ensure that investor education programs are targeted 

in ways that reach intended audiences and have a maximum impact. 

Many Federal agencies, nonprofit groups and private sector firms 

have public investor education plans. However, I believe that we 

can improve the delivery vehicle for many of these worthy programs. I would like for the committee to continue to review the 

standards of investor education curriculum and discuss the ways to 

help match investors with these programs. 

Again, I look forward to hearing the testimony from today’s 

panel, and thank you, Mr. Chairman. 

Chairman BAKER. Thank you, Mr. Scott. 

Mr. Crowley? 

Mr. Lucas? 

With that, I would like to welcome our first panel to come forward please. This morning we will have joining us Mr. Stephen 

Cutler, the Director of the Division of Enforcement for the SEC, as 

well as Ms. Mary Schapiro, Vice Chairman and President, Regulatory Policy and Oversight, of the NASD. 

Your full testimony will certainly be made part of the record. 

Feel free to summarize your remarks in 5 minutes. 

Welcome, Mr. Cutler. 

7

STATEMENT OF STEPHEN M. CUTLER, DIRECTOR, DIVISION 

OF ENFORCEMENT, U.S. SECURITIES AND EXCHANGE COMMISSION 

Mr. CUTLER. Thank you, Mr. Chairman. 

Chairman Baker, Ranking Member Kanjorski and distinguished 

members of this subcommittee, good morning. 

I am pleased to be here today to testify on behalf of the Securities and Exchange Commission concerning the Securities Fraud 

Deterrence and Investor Restitution Act, H.R. 2179. I commend 

Chairmen Oxley and Baker and the other sponsors of this legislation for their initiative and commitment in introducing this very 

far-reaching, useful bill. I also thank the subcommittee for holding 

such a prompt hearing on this significant proposal. 

As you know, I testified before the subcommittee this past February concerning the findings and legislative recommendations contained in a number of reports the commission submitted to Congress pursuant to the Sarbanes-Oxley Act. H.R. 2179 incorporates 

a number of the proposals from the commission’s reports which, if 

adopted, would strengthen the commission’s enforcement capabilities and assist defrauded investors. 

These provisions would greatly enhance the effectiveness of the 

commission’s enforcement investigations and significantly improve 

the commission’s ability to prosecute securities law violations, collect money from wrongdoers, and return the money to injured investors. I can report that for these reasons, news of this bill has 

garnered a very enthusiastic response from the staff of the commission’s Enforcement Division, who will be eagerly watching its 

progress. 

Although all the provisions of H.R. 2179 are important, I would 

like to use the remainder of my time to touch briefly on just a few. 

Section 2 of the bill would improve the commission’s collection efforts by eliminating State laws that enable defendants to shield 

their assets from commission judgments or orders in their homesteads, the so-called homestead exemption. 

The exemption arises in commission litigation when a defendant 

fails to pay quarterly disgorgement and the commission asks the 

court to hold the defendant in contempt. In contempt actions, defendants often assert that they cannot pay some or all of the owed 

disgorgement because they lack sufficient assets. As a result, during the contempt proceeding the court must determine which of a 

defendant’s assets are available to pay disgorgement. The court has 

considerable discretion in determining whether or not exempted assets, such as a homestead, must be used to pay disgorgement. 

Currently when trying to collect disgorgement, the commission’s 

staff, at best, must engage in protracted litigation to overcome 

State law exemptions and, at worst, may be precluded from reaching assets that should be returned to the victims of securities 

fraud. By overriding State homestead laws, Section 2 of H.R. 2179 

would make more assets available for recovery by the commission 

and for return to defrauded investors, and increase the deterrent 

value of commission enforcement actions against wrongdoers by depriving them of more assets. 

Section 3 of the bill contains several important provisions to 

strengthen the commission’s enforcement program. Section 3(a) 

8

would enhance the effectiveness of the commission’s cease and desist proceeding by authorizing the commission to impose money 

penalties in these proceedings. Currently, we have two primary 

means of seeking civil penalties: administrative proceedings 

against entities and persons directly regulated by the commission, 

such as broker-dealers or investment advisers, and in Federal court 

actions against any entity or person. 

By granting the commission additional authority to seek penalties in cease and desist proceedings, Section 3(a) would eliminate 

inefficiency, give us added flexibility to proceed administratively, 

and strengthen our ability to hold those who assist in violating the 

securities laws financially accountable for their actions. The provision also would provide appropriate due process protections for subjects of these proceedings by making imposition of a civil penalty 

in an administrative cease and desist proceeding appealable to the 

Federal Court of Appeals. 

Section 3(b) would significantly increase the amount of penalties 

that the commission may seek for violations of the Federal securities laws in many types of actions. Increasing the size of penalties 

is an important step in achieving the desired deterrent effect under 

the securities laws. In addition, by using the FAIR fund provision 

in Section 308(a) of Sarbanes-Oxley, the commission may more 

fully compensate injured investors if larger penalties are paid. 

Section 4 would allow a person to provide privileged information 

to the commission without waiving that privilege as to other persons. If adopted, this provision would help the commission gather 

evidence in a more efficient manner by encouraging parties under 

investigation to voluntarily produce to the commission important 

information that otherwise could be withheld. Section 4 would help 

us conduct more expeditious investigations and contribute to 

quicker enforcement actions with a greater likelihood of recovery of 

assets for investors. 

Section 5 of the bill would enhance the commission’s access to 

grand jury information. Specifically, it would authorize the Department of Justice subject to judicial approval in each case to share 

grand jury information with the commission staff in more circumstances and at an earlier stage than is currently permissible. 

The judicial approval would be based on a finding of the commission’s ‘‘substantial need to be informed.’’ Federal and State financial institution regulators already have the kind of access to grand 

jury information that Section 5 would provide to the SEC. Enacting 

Section 5 would make it possible for us to efficiently and effectively 

receive timely information required to complete our investigations 

and prosecutions, and avoid unnecessary duplication of government 

efforts. 

Now let me skip to Section 8 of H.R. 2179. It contains substantive amendments to the FAIR fund provisions. Section 8(a) 

would amend the provision by allowing the commission to use any 

penalties paid as a result of commission actions to compensate investors injured by defendants in such actions. The FAIR fund provision was a groundbreaking measure to help the commission return more funds to defrauded investors. It did so by changing the 

law to permit penalty amounts collected to be added to 

disgorgement funds in certain circumstances. 

9

The commission has begun to make ample use of this new authority. To date, we have sought creation of 27 FAIR funds for investors and the disgorgement, and penalty amounts covered by 

these 27 actions total almost $990 million. I am confident that we 

will continue to regularly use this provision in the future for the 

benefit of investors. 

Section 8(a) would expand the application of the original FAIR 

fund provisions so that even more penalty dollars may be made 

available to harmed investors. As enacted, the provision only permits the commission to add penalty amounts to disgorgement funds 

when a penalty is collected from the same defendant that has been 

ordered to pay disgorgement. Section 8(a) eliminates this restriction so that all penalties may be used to create a FAIR fund, 

whether or not disgorgement also is ordered. 

Section 8(b) provides that if a State establishes by agreement or 

judgment a requirement for brokers or dealers that is different 

from the requirements of the Federal securities laws, then penalties or disgorgement paid as a result of the agreement or judgment shall be remitted to the commission for distribution to injured 

investors pursuant to the FAIR fund provision. 

Congress long ago created a dual securities regulatory system in 

which both Federal and State agencies serve specific valuable functions in protecting investors. At the same time, there is little question in my mind that the imperative to achieve consistent regulation of the U.S. securities markets dictates the need for a single 

dominant national regulator. This is not meant to suggest that the 

States should be relegated to the backseat of our regulatory system. State securities agencies have played and should continue to 

play a significant role in making our securities markets the most 

respected and trusted in the world. The more resources, both Federal and State, we can bring to the cause of maintaining this status, the better off investors are. 

During the past year, the overlapping responsibilities of Federal 

and State agencies have been vividly illustrated by the joint investigations of research analyst practices undertaken by the commission, the self-regulatory organizations, and the States. The commission believes it is important to return funds collected through enforcement actions to harmed investors whenever possible and at all 

levels of government, Federal, State and local. For this reason, the 

commission and other Federal regulators determined to use their 

portion of the monies obtained in the Global Research Analyst settlement to recompense investors. 

Moreover, we invited the States participating in the settlement 

to contribute their portions of the settlement payments to the Federal distribution fund as well. Thus far, one State, the State of Missouri, has responded affirmatively to our invitation and has expressed an interest in working with us to distribute disgorgement 

and penalty amounts to investors. The policy question of whether 

Section 8(b) strikes the appropriate balance between State and 

Federal securities enforcement power is appropriately Congress’s 

and not the SEC’s to resolve. Nevertheless, the commission strongly supports the concept of investor restitution and we are eager to 

work with the subcommittee to facilitate reimbursement of harmed 

investors from the broadest possible array of sources. 

10

In conclusion, the commission strongly supports congressional action to improve the commission’s enforcement capabilities. The proposed Securities Fraud Deterrence and Investor Restitution Act 

would greatly assist the commission in fulfilling its enforcement 

mission to prevent, detect and prosecute securities law violations 

and to provide recompense to injured investors. We look forward to 

working with this subcommittee in the future to further these important goals. 

I would be pleased to answer any questions the subcommittee 

has. 

[The prepared statement of Stephen M. Cutler can be found on 

page 60 in the appendix.] 

Chairman BAKER. Thank you, Mr. Cutler. We appreciate your 

appearance here today. 

Our next witness is Ms. Mary Schapiro, Vice Chairman and 

President, Regulatory Policy and Oversight from the NASD. Welcome. 

STATEMENT OF MARY SCHAPIRO, VICE CHAIRMAN AND 

PRESIDENT, REGULATORY POLICY AND OVERSIGHT, NASD 

Ms. SCHAPIRO. Thank you, Chairman Baker, Ranking Member 

Kanjorski and members of the committee. I appreciate having the 

opportunity to testify today on this very important legislation. 

NASD believes this bill will strengthen the enforcement hand of 

the Securities and Exchange Commission at a time when more 

than 85 million American investors are looking to regulators, legislators and industry leaders to meet our collective responsibilities to 

protect investors and strengthen market integrity. Toward that 

end, we endorse the bill’s twin goals, for we believe it will both 

maximize the amount of restitution that is returned to investors 

and strengthen our nation’s system of securities regulation. 

I believe this bill can have a third important affect on investor 

confidence and the culture of corporate America. That is to change 

significantly the calculus by some companies and executives who 

seem to believe that paying SEC penalties is not a sign that they 

have abused investor trust, but rather just another cost of doing 

business. 

As you know, NASD is the world’s largest securities self-regulatory organization. Virtually every brokerage firm in the country 

that does business with the U.S. public must, by law, be a member 

of NASD. With a staff of 2,100, more than a dozen district offices 

throughout our country, and an annual budget of $400 million, we 

touch nearly every aspect of the securities business. By providing 

a layer of private sector regulation between the SEC and the brokerage industry, NASD is not only a guardian for investors, but 

also a bargain for taxpayers. 

I am particularly pleased to be testifying with my colleagues 

from the SEC and NASAA. In the U.S. system of securities regulation, each of us plays a vital role. The SEC has overall responsibility for setting the national structure of securities markets and 

regulation. The SROs, including NASD, set and enforce rules for 

the day to day operations of the markets and the brokerage industry. The State Securities Regulators are our invaluable partners in 

11

licensing and enforcement, adding more cops on the beat at the 

local level. 

All three sets of actors, SEC, NASD and its sister SROs and the 

States, need the proper mandates and tools to do their work effectively. All three, for example, were critical to achieving the recent 

$1.4 billion Global settlement with the large Wall Street investment houses. In developing and finalizing that settlement, we 

sought to underscore four basic principles: one, to change the way 

Wall Street does business; two, to get maximum recovery to investors using the FAIR fund; three, to fund investor education in effective and innovative ways; and last but not least, to make certain 

that the evidence we uncovered would be made available to harmed 

investors so they would be able to seek recovery of their losses 

through meritorious arbitrations and court proceedings. 

At NASD, we believe that an important part of restoring investor 

trust is to ensure and demonstrate very publicly that where wrongdoing is uncovered and proven, significant fines will be collected 

and channeled to greater enforcement efforts, enhanced regulation 

and through restitution to investors. H.R. 2179 furthers the goals 

of maximizing restitution to investors and arming the SEC with 

additional tools to quickly and effectively combat securities fraud. 

In this same vein, NASD also welcomes the provisions of H.R. 

2179 that will strengthen the SEC’s ability to pursue violators and 

increase opportunities for investors to recoup losses due to fraud. 

In particular, I would note the elimination of the homestead exemption that will be helpful to investors as they attempt to collect 

from those who have defrauded them. This will stop illicit profits 

from winding up in the pockets of wrongdoers, while investors’ 

pockets remain empty. This is an important provision for solving 

the corrosive and perennial problem of crooks building massive 

homes to shelter ill-gotten gains from injured investors. 

Mr. Chairman, NASD is pleased to testify in support of this legislation. We remain committed to working with your committee and 

with our valued partners in securities regulation to bring integrity 

to the markets and confidence to investors. 

Thank you again for this opportunity and I would also be happy 

to answer any questions you or your colleagues have. 

[The prepared statement of Mary L. Schapiro can be found on 

page 80 in the appendix.] 

Chairman BAKER. Thank you very much. 

Mr. Cutler, the SEC prior to Sarbanes-Oxley obviously had been 

involved in investor restitution and recoupment of ill-gotten gains 

for decades. With the passage of Sarbanes-Oxley in the course of 

the year in which the FAIR fund has been created, you have indicated there are 27 funds now created, with the potential of $990 

million of restitution potentially made available. Is that correct? 

Mr. CUTLER. I believe that we have made motions in 27 different 

actions. I do not believe we have yet gotten court approval in all 

those actions. Indeed, I can tell you that one of the very significant 

actions where we are seeking court approval is in the WorldCom 

matter, which involves $500 million of the $990 million that I referred to before. But it is absolutely right that we are seeking to 

use this provision wherever we can to get money back to investors. 

12

We think it is very significant and a terrific thing that you and this 

subcommittee and Congress have done for investors. 

Chairman BAKER. Subject to court permission, then, you do not 

view mechanically a problem in providing for the distribution of 

those funds, subject to court approval to do so? 

Mr. CUTLER. Not at all. Again, you are absolutely right. It is 

what we have always done, always sought to get disgorgement payments back to investors. What this legislation allowed us to do was 

to try to enhance the amount of money that was returned to investors by allowing us to combine disgorgement payments with penalties. 

Chairman BAKER. With regard to the comments referencing 8(b), 

getting to the heart of the matter, if a State regulator were to pursue a wrongdoer and find that wrongdoer, and not as a consequence change market structure, that fine would be retained by 

the State. Would it not? 

Mr. CUTLER. Under the proposal as I understand it, yes, sir. 

Chairman BAKER. So that it would only be in a tandem action 

where the regulator would affect Federal securities law governance, 

and a fine being imposed, that the funds would be forwarded from 

the State regulator to the SEC to be disposed of through the FAIR 

fund. Is that correct? 

Mr. CUTLER. Yes, although as I understand the proposal, it is not 

always the case that actions that States bring are in tandem with 

those of the Federal regulators. 

Chairman BAKER. My point is not in tandem with the Federal 

regulator. It could be a unilateral action by a State regulator, but 

as long as the action does not affect Federal market structure, then 

the fine collected is retained by the State. It only is applicable with 

regard to Federal statutory market function and fine. A State regulator could enter into a voluntary agreement with a wrongdoer that 

does affect market structure, as long as they were not fined. What 

is it, then, that inhibits a State regulator from taking action if this 

bill were to become law? 

Mr. CUTLER. I don’t know, and it may be nothing. Probably Ms. 

Bruenn is in a better position to answer this than am I. I know 

that one of the technical concerns that the States have in connection with this proposal is whether the monies could be returned if 

some sort of FAIR fund were set up for investors of those States. 

Chairman BAKER. Correct, but my point being, let’s go to the 

Merrill settlement, for example; $50 million went to New York. 

There has never been anything represented to us that half of these 

defrauded investors resided in New York. If we are trying to get 

to a national policy that provides recompense in relation to the people who were wronged, the idea is that if you are going to change 

market structure and fine, then let’s distribute the resources where 

the people are, as opposed to an objection to having the compensation kept by the State that initiates the action, not with regard to 

where the investors are domiciled. 

If I had anybody explain to me how the $100 million distribution 

was made that was relative to some formula or study of participation by investors, it possibly might make sense. The NASSA, for example, received $2 million of that settlement. I would be interested 

13

to find out on what basis that allocation was made. It is not even 

a State, I don’t think. 

My point being that the current methodology for distribution of 

compensation does not have a rational nexus to the act itself. If we 

do not preclude States from pursuing wrongdoers; you can keep the 

money if you do not change market structure; you can change market structure and not levy a fine; you can do both and provide that 

the money go back to the people from whom it was taken. 

Ms. Schapiro, NASD has done this as well. Do you have observations of any technical inhibitions to your ability to provide compensation to wronged investors in actions of the NASD in prior 

years? 

Ms. SCHAPIRO. No. We have made returning funds to investors 

a high priority in our enforcement program. To date this year, 

there have been 33 cases in which restitution has been ordered by 

the NASD to firms to grant to investors. We share the goals, I believe, of this entire committee that we maximize on return to investors through restitution. 

Chairman BAKER. And NASD has done this for many years, I 

presume? 

Ms. SCHAPIRO. Yes, we have done it for many years and it will 

continue to be a priority whenever we do an enforcement action to 

look to identify victims of the wrongdoing and maximize return to 

those victims. It is not always possible, but that is our goal. Where 

it is not possible, fine money is devoted and dedicated to expanding 

enforcement capability and our regulatory abilities. 

Chairman BAKER. Thank you. I did not realize I had long exhausted my time. I want to come back. 

Mr. Kanjorski? 

Mr. KANJORSKI. Mr. Chairman, I am certainly willing to wait for 

any further questions you have. 

Chairman BAKER. Maybe I can get somebody to yield time. That 

is all right. 

Thank you, Mr. Kanjorski. 

Mr. KANJORSKI. Mr. Cutler, you obviously have not been the proposer of Section 8(b), but you seem to agree with the chairman’s 

and probably even my desire that there be some national standard 

and fairness in distribution. But have you considered some of the 

unintended consequences of 8(b)? For instance, suppose that the 

SEC at some future date is not aggressive. What is the incentive 

for States to proceed in the absence of an aggressive SEC when 

they would have to bear the expense of the pursuit of these fines 

and disgorgement and would not even be compensated for their expense? 

What I relate to is in the Federal government between the various departments we have this problem. I will give you an example 

I worked on several years ago that still happens to be constant 

today. Nothing has been done. In the Department of Energy there 

is about $50 billion worth of surplus equipment and property. 

Under existing law, if the department proceeds to sell or handle or 

dispose of that property, they have to spend it out of their departmental budget. 

On the other hand, when they sell that property or dispose of 

that property, it does not come to the Department of Energy, but 

14

goes into Treasury directly. As a result, there is a disincentive for 

them to get involved in disposing those surplus and excess properties. I am just analogizing that situation as a disincentive. 

Why would an Attorney General of a State or a securities exchange commission on a State level expend their budget and assets 

to pursue a wrongdoer when in fact they will receive none of the 

benefits from their success, but get all of the detriment and expense of pursuing it, not only the expense of that individual case 

where they are successful, but will be short-changed in pursuing 

other cases that they may not be successful in, and therefore further erode their budgetary considerations in the commission itself 

or in the Attorneys general office of the various States? How do we 

resolve that problem? 

Mr. CUTLER. First, I want to take issue with the predicate for 

your question. It is hard for me to imagine that we will not be aggressive, so let me start there because that is where you started. 

Mr. KANJORSKI. We have to assume that, not this SEC, but some 

future SEC just sits on its hands. It is always possible in government. 

Mr. CUTLER. I did not think you were talking about this SEC. 

Mr. KANJORSKI. Right. 

[LAUGHTER] 

Mr. CUTLER. So let me take the rest of your question. Why would 

a State continue to proceed, push forward to prosecute a violation 

if the money that they extracted was not coming into their coffers? 

Actually, the analogy that I thought of was actually the SEC. None 

of the money that we have ever collected in fines or disgorgement 

has been tied to our budget. Indeed, I think in some ways that has 

been very healthy because it means that we are pursuing wrongdoers not because somehow it would enhance our coffers, but because it is the right thing to do and that is our mission. 

In no way has the lack of any nexus between what we have collected and what we are budgeted at deterred us or precluded us or 

discouraged us from seeking to go after wrongdoers. It is hard for 

me to imagine that any State securities regulator or any State 

prosecutor would be deterred or precluded or discouraged from 

going after wrongdoing because the money was not going into that 

regulator’s back pocket. I think our State regulators are too professional to think that way. 

Mr. KANJORSKI. You just do not believe that there would be any 

budgetary considerations, and therefore the analogy I gave of the 

Department of Energy, they are unique, in fact, that they are not 

pursuing a good public policy to recoup $50 billion of property that 

they have no use for because it would take directly from their 

budget? That is a unique department of government, do you think? 

Mr. CUTLER. All I can speak to is the experience that we have 

had at the SEC as prosecutors, and that consideration does not 

enter into our calculations. 

Mr. KANJORSKI. I understand that, and of course you had a lenient Congress to be willing to appropriate and double the appropriations for the Securities and Exchange Commission, but that 

may not be true on a State level. I do not imagine that the budgets 

of State Securities Exchange Commissions are as robust as the 

Federal budget. Secondly, there very often may be a difference of 

15

political affiliation between the Chief Executive of a State and the 

Attorney General. 

What he expends his budget on may be very important in terms 

of not expending it on a situation where the recovery would not justify his expense to his own budget in continuing prosecution, and 

in fact would only be working for the benefit of the Federal government or the national Securities and Exchange Commission. He may 

have a very hard time justifying in a small State why he is spending one-third of his budget in the pursuit of securities actions and 

therefore having to ignore other prosecutions when none of that 

money will be recouped. 

Now, in the ideal world, I think you are probably right. All prosecutors do not consider budgetary considerations, but maybe I have 

had a terrible experience sometimes with district Attorneys and Attorneys general at the State level that that does become significant, 

as it is in the Department of Energy, I mean, with a huge problem. 

We have just not been able to force them to get rid of their excess 

property and allow the government to use it generally because we 

have not incentivised them; we have actually penalized them. You 

do not see that potential as an unintended consequence of Section 

8(b)? 

Mr. CUTLER. I understand the concern. I take the chairman’s 

point that we are only talking about in this proposal a very narrow 

slice of what it is that States do in securities enforcement actions. 

That is, you could probably count on a couple of hands actions that 

are brought where both restitution or penalties are sought, and relief is imposed that would require a broker-dealer firm to establish 

policies that go beyond the Federal securities laws. 

So I do not know if I have the concern as acutely as you do, Mr. 

Kanjorski, but I do understand the concern. I think there are complicated policy questions here, and it is probably not my purview 

to say what it is that would happen as a result of the State budgeting process. I can imagine that to the extent that States were returning money to investors in their States, that might actually put 

them in a position to achieve a greater budgetary allowance for the 

securities enforcement mission. 

Mr. KANJORSKI. Obviously, it is a concern of mine and I have 

heard it expressed in several of the opening statements, particularly Section 8(b). Could we extract from you an agreement to work 

with the State regulators to refine Section 8(b) in the immediate 

future so that if it is worthwhile, and it may be, it can be acceptable to some of us that have concerns, and particularly with the 

State regulators? Maybe something can be definitively worked out 

from the Federal SEC with the State regulators. 

Mr. CUTLER. I cannot speak for the commission, sitting here, but 

I think it is a terrific idea that we work with this subcommittee, 

as well as the SROs and the States, to figure out the parameters 

to the extent that there are technical issues with respect to this approach, that we figure out a way to work them out. I think that 

is a terrific idea. 

Mr. KANJORSKI. I appreciate that, Mr. Cutler. 

Chairman BAKER. Thank you, Mr. Kanjorski. 

Ms. Kelly? 

Mrs. KELLY. Thank you, Mr. Chairman. 

16

Mr. Cutler, I am a little confused about some of your comments. 

I have some prior testimony that was submitted, and then I have 

some testimony that I picked up this morning. This is in relation 

to Section 8(c). You say in both pieces of testimony, it is important 

to determine how it would affect incentives to and fiscal constraints 

on a State’s ability to pursue securities related misconduct aggressively and vigorously. And then you speak of technical drafting 

issues. I am interested in your prior testimony because you outlined a couple of technical drafting problems. 

I am also concerned, as Mr. Kanjorski is, about the effective regulation with regard to this, and the dialogue between the States 

and the SEC. Do you want to elaborate on that a little bit? Then 

I have one more question I would like to ask. 

Mr. CUTLER. Sure. I think we share the twin goals of Section 

8(b). We had referred to it as Section 8(c). The twin goals are getting as much money back to harmed investors as possible. I think 

that is probably a goal we share with the States. Also to the extent 

that the provision speaks to this, the need for a single dominant 

national regulator when it comes to issues of our national market 

system. 

Indeed, I was on a panel yesterday with Mr. Spitzer from New 

York, not a panel before Congress, but speaking session, and he 

agreed that when it comes to reforms that change how the national 

market system works, it is incumbent upon the States to work with 

the Federal government to ensure that we do not have balkanized 

markets. It seems to me and it seems to the commission that those 

are the twin goals of Section 8(b). To that extent, we are very supportive of Section 8(b). 

Yes, there are some technical issues; and yes, there are issues 

about what kinds of incentives this creates or disincentives it may 

create that Mr. Kanjorski pointed out. That is why I think it is important that we work with the States and with this subcommittee, 

and with the SROs, to come up with an appropriate and effective 

way to implement the twin goals of Section 8(b). 

Mrs. KELLY. In your testimony, you spoke of the commission inviting States to participate in the Global settlement, that they 

would contribute their portions of the settlement payments to the 

Federal distribution fund. And just now, speaking to Mr. Kanjorski, 

you gave a rather ringing endorsement of State regulators. Yet, you 

are also experiencing, I believe, some reluctance from the States to 

work with the SEC and with the Federal distribution fund, I believe. Is that not true? 

Mr. CUTLER. It is true. We extended an invitation to all of the 

States and we have to date heard from a single State that is prepared to work with us on distributing money back to investors. 

Mrs. KELLY. Why do you think that reluctance exists? 

Mr. CUTLER. In some cases, as I understand it, the State statutes 

themselves do not provide for State restitution when it comes to 

penalties. So one of the things that is very helpful in connection 

with Section 8(b) and the approach that Section 8(b) takes is a way 

to overcome those hurdles. 

Mrs. KELLY. Do you feel that because we have set up the Federal 

distribution fund, do you feel that the States are reluctant because 

17

they need the float currently? Do you think that situation might 

change? 

Mr. CUTLER. I just do not know. I have heard about the statutory 

hurdle. I know that one concern of States, and I appreciate this 

concern, is any money that they have collected be returned to citizens of their State. That is something we told the State of Missouri 

that we would work with them on, but I cannot speak to other potential concerns because I have not heard any. 

Mrs. KELLY. Do you feel the SEC is prepared to work with all 

50 States and would return that money to the individual States’s 

investors, because administratively, that could be quite a bit for 

you. 

Mr. CUTLER. Again, that is something that we are going to work 

on with the States. It is administratively difficult. But to the extent 

that it is practicable, we understand the issue and we respect the 

issue and would like to try to accommodate the States in connection with that concern. 

Mrs. KELLY. Certainly, my personal feeling is that any way that 

we can possibly rapidly get the money back to the investors that 

they are owed because of decisions, that needs to be done. We need 

to grease those skids. My concern with regard to what you are saying is that I would like to have the SEC take a look at which way 

is actually going to be the fastest, whether it is State redistribution 

of the funds or Federal. But I think that what we need to focus on 

is the speed with which those people can get their money back once 

these adjudications are made. I hope you will look at that. 

Mr. CUTLER. I share your concern, Representative Kelly. I think 

it is important to do this as quickly as possible. 

Mrs. KELLY. I do not think investor confidence is going to be improved until and unless we have some mechanism quickly in place 

to return the money. People need to have faith that if they are 

caught in a situation, as some of these people have been, with basically malfeasance on the part of some of these people, the investors 

need to know they can be made whole and swiftly. 

Thank you very much, Mr. Chairman. 

Chairman BAKER. The gentlelady’s time has expired. 

Mr. Scott? 

Mr. SCOTT. Thank you very much, Mr. Chairman. 

I wanted to ask about the role of the States. To what extent have 

States failed to return money to the investors, and have instead 

used the money for their general fund? I am a former State senator 

and rules chairman. I have worked with budget committees and I 

know that in the State when these funds are undedicated, they see 

that as free money. I was wondering to what extent have they 

failed to return the money to investors. That is the first part of the 

question. 

Mr. CUTLER. I do not want to overstate the problem, Representative Scott. Indeed, I believe the States typically are very concerned 

about getting restitution payments to investors. When it comes to 

the penalty portions of what they collect, I think the story may be 

slightly different. Again, I should let Ms. Bruenn speak to this 

when she follows with her testimony. 

I do know that in the Global Research Analyst settlement, again 

to repeat what I said earlier, we have only heard from one State 

18

that is interested in returning its portion of the penalty and 

disgorgement payments to investors. I just do not know if that is 

indicative of the approach that the States take in other matters. 

Chairman BAKER. Would the gentleman yield in response to his 

question? 

Mr. SCOTT. Sure. 

Chairman BAKER. I just happen to have a sheet relative to the 

Global settlement distribution. New York, Texas, Kansas, Massachusetts, Maine, Colorado, Arizona and New Hampshire did an unqualified allocation to the general fund. Utah did an education fund 

first, but any funds remaining over $100,000 at the end of the year 

went to the general fund. Washington State puts most of it in the 

State treasury, but a portion is going to go to the Securities Enforcement Division at the State level. Missouri is joined with the 

SEC in a restitution effort at the national level. Virginia is doing 

a DMV construction and loans for school construction. And Nebraska is going to endow a chair in its State university. So generally speaking, and I appreciate the gentleman yielding, it has not 

gone to restitution for any number of reasons. 

I thank the gentleman for yielding. 

Mr. SCOTT. Thank you. 

Chairman BAKER. Does the gentleman yield back, or do you wish 

to continue? I am sorry. Thank you, sir. 

Mr. Manzullo? 

Mr. MANZULLO. Thank you very much. 

I have some questions with regard to what could be some extraordinary remedies the SEC is seeking and perhaps you can help 

me on this. If the IRS obtains a judgment against an individual, 

does the law say the IRS lien will override a homestead exemption? 

Mr. CUTLER. I do not know the answer, Representative Manzullo. 

Mr. MANZULLO. Do you know of any laws that preempt the homestead exemption? 

Mr. CUTLER. With respect to other areas of the law, I just do not 

know, Mr. Representative. 

Mr. MANZULLO. I think this is extraordinary. I think that is 

something you ought to check on. The State of Illinois, when I practiced law, I have been here for 10 years, the homestead exemption 

was only $7,500 for an individual. Did somebody give you the answer on that on the IRS lien? 

Mr. CUTLER. I am sorry? 

Mr. MANZULLO. I am sorry. I thought somebody behind you whispered the answer on that. 

The remedies you are seeking only apply to a judgment that is 

obtained at a District Court. Is that correct? Or are you trying to 

give an order of the SEC the same efficacy as a court judgment? 

Mr. CUTLER. I would have to look back at the legislation. I know 

it applies to Federal court judgments. I just do not know whether 

it applies to administrative proceedings as well. 

Chairman BAKER. Would the gentleman yield on his question for 

a moment? 

Mr. MANZULLO. Yes. 

Chairman BAKER. The way in which Sarbanes-Oxley passed, it 

did in fact affect the homestead exemption at the State level, based 

on the presumption that securities fraud ill-gotten gains were 

19

dumped into houses pursuant to a State’s homestead exemption 

protection. However, there is an intervening step which may be 

taken by filing bankruptcy which precludes, then, your ability to go 

after the home once you are under the protection of the bankruptcy. What this provision would enable us to do is to go after the 

asset regardless of a homestead provision or a bankruptcy proceeding. 

So the gentleman is correct that this is an extraordinary remedy, 

but there has been a case in the past where the Congress has acted 

to lower the protections of the homestead exemption. 

Mr. MANZULLO. I think this needs to be taken a second look at, 

because number one, it is preempting all State laws. Traditionally, 

the common law exempted a horse, which has been interpreted by 

the State of Wisconsin to mean an automobile, a means of conveyance. It has exempted personal effects, wedding rings in the State 

of Illinois, and a homestead with a very modest amount. What you 

are saying is that your judgment is more important than judgments for back child support, for unpaid alimony, for families of 

people who are killed by drunk drivers, and places this ahead of 

every other judgment that is out there, and really does violence to 

the whole purpose of the homestead exemption. 

I think that is very roughshod. My suggestion would be maybe 

allowing a constructive trust to be placed on a homestead. In other 

words, if you can trace that the defrauded money was used to buy 

the residence or to pay down a mortgage, then to the extent that 

you could trace it, that would allow you to actually go after at least 

that portion of the homestead. 

One of the examples you used here also would wipe out an innocent spouse’s right to keep the homestead. If I am reading the example that you set forth on page five, citing this SEC v. Great 

White Marine case, where apparently you were upset with the fact 

that the innocent spouse was allowed to keep one-half of the equity 

in the homestead. This Congress about three years ago passed a 

provision insulating innocent spouses from the IRS lien whenever 

the spouse who had actually defaulted on his or her taxes ended 

up with a judgment. Do you recall that Chairman Baker? It was 

the Taxpayers Bill of Rights, I think, that we called it. 

Are you saying that the innocent spouse would lose his or her 

homestead right in the property? 

Mr. CUTLER. No. As I understand it, that is not the purpose of 

the legislation. Really, what we are talking about is the right of 

someone who has committed fraud to step in ahead of victims and 

keep the money, keep it sheltered in a mansion, as opposed to disgorging it and giving it back to harmed investors. 

Mr. MANZULLO. Okay. I can understand, but I would suggest 

there is a better way than simply saying SEC judgments will override homestead laws, and allow the court to set up a constructive 

trust. You know what that is, where you follow the trail of the 

money. Because at that point, you are still protecting the homestead right, while following the money, if somebody stole $1 million 

and took that $1 million and put it into a homestead. Do the 

courts, in your understanding, have the ability to set aside that 

homestead now to the extent that the defrauded money was put 

into the homestead? Or is that the remedy that you are seeking? 

20

Mr. CUTLER. That is the remedy that we are seeking. With respect to penalties, we do not have any ability to break through the 

homestead exemption, and with respect to disgorgement, it is very 

limited and requires substantial litigation. 

Mr. MANZULLO. But does the legislation specifically require the 

tracing of the defaulted money to the particular property? 

Mr. CUTLER. It does not, and I think for a very good reason. The 

very good reason is that money is fungible. Yes, would it be helpful 

to get the power to break through the homestead exemption when 

you can trace the money? Sure, that is more than we have now. 

But I would submit to you that it is not enough, Mr. Manzullo. The 

reason is because it is very easy for someone to put the money 

somewhere else and then go buy the big mansion. Because money 

is fungible, I do not think a provision that is limited to a tracing 

provision would be as effective as this subcommittee would like and 

we would like. 

Mr. MANZULLO. I do not know if the subcommittee is satisfied. 

I have very deep serious questions over simply coming in and saying the SEC order or final judgment is more important than an 

order for back child support, orders for victims of drunken driving 

cases, or orders for other common law or statutory frauds that are 

taking place. I mean, this is extremely serious when you are going 

to preempt those homestead laws. 

We went through that in the bankruptcy reform. If I recall, I am 

not sure if there was a provision allowed in there as to a monetary 

amount or as to the State, but what you are saying is that you 

would come ahead of all other classes of creditors involved, for example, in a bankruptcy in going after to try to find the homestead. 

I would think you might be better off working on the provision 

to allow that constructive trust. I do not think it is that difficult. 

If somebody stole millions of dollars and then after the fraud has 

taken place, they have gone out and bought a brand new home, 

what is so hard about that, to say that the home was purchased 

after the money was stolen? 

Chairman BAKER. I am sorry. I am just waiting for the gentleman to conclude. The gentleman’s time has expired. 

Mr. MANZULLO. Thank you. 

Chairman BAKER. Mr. Emanuel? 

Mr. EMANUEL. Let me ask you, on this homestead exemption, do 

you have a dollar figure? What is the revenue size here? What is 

the cost that we are looking at? 

Mr. CUTLER. I do not have that information available. 

Mr. EMANUEL. Is there any guesstimate out there besides from 

you that you could call, say a reputable organization? 

Mr. CUTLER. We can try to get that information. 

Mr. EMANUEL. One of the things that would be helpful here is 

to bring this down to some brass tacks, so that we understand 

what the size is that we are dealing with here. Not that this is not 

a relevant discussion; sometimes those irrelevant discussions are 

up in the air. But what in fact is the dollar figure that is at stake 

here? What is the cost here that we are dealing with? Nobody has 

ever put a guesstimate together, to your knowledge? 

Mr. CUTLER. Not to my knowledge, but why don’t we try to do 

that, Mr. Representative. 

21

Mr. EMANUEL. Okay. That would be helpful. 

Question whether requiring remission of penalties obtained by a 

State where remedial actions are ordered, will it weaken State security law enforcement efforts? Do you know that? 

Mr. CUTLER. Excuse me, I did not hear. 

Mr. EMANUEL. Whether requiring remission of penalties obtained 

by a State where remedial actions are ordered will weaken State 

securities law enforcement efforts. What is your view? 

Mr. CUTLER. Again, in my view, no responsible State prosecutor, 

no responsible prosecutor at any level would make decisions about 

whether to go after misconduct on the basis of whether the money 

was coming back to the coffers of the State or not. Having said 

that, I understand that there may be some complicated budgetary 

issues that I know Ms. Bruenn will speak to as well, and this subcommittee will consider. For the most part, they are beyond my 

area of expertise. 

Mr. EMANUEL. Thank you. No further questions. 

Chairman BAKER. Thank you, Mr. Emanuel. 

Ms. Harris? 

Ms. HARRIS. Thank you, Mr. Chairman. 

I don’t think anyone can argue with the concept of homestead 

preemption clause that has been included in this legislation to 

make sure that fraudulent funds are not harbored in multimillion 

dollar mansions. But I have grave concerns as you attack the 

homestead exemptions. In the State of Florida and many other 

southern States, these were originally conceived to protect mama 

at home with the children. I really want to associate myself with 

the gentleman from Illinois’s comments because it just strikes me 

as such a big government oppressive approach. 

Certainly, the tracing provision may not get you as close to it as 

you need, but to go in when there is an innocent spouse with children and home, and basically take that homestead, which is really 

considered sacred in the States of Florida and Texas and some 15 

other States. Many States do not have that provision and so it does 

not cause the angst, but this is something incredibly important. 

There has already been a crack in that homestead exemption, 

Mr. Chairman, in the bankruptcy bill where they have already attached a provision concerning homestead, cracking that initial 

issue. I am just extremely concerned that we move forward with 

this. I think it requires a lot more interest and effort, I can tell 

you, from the States that really consider homesteads that sacred 

issue. 

You do have vendors’s liens. You do have a mechanic’s lien. But 

just in terms of the mortgage laws, in order to get a mortgage, all 

of these kinds of things in some of these States, you are going to 

change the course of financing across-the-board when you are setting the SEC first in terms of being able to collect these funds in 

going after homesteads. So I have grave concerns about the homestead clause in this bill. 

Chairman BAKER. Does the gentlelady yield back? 

Ms. HARRIS. Yes, Mr. Chairman. 

Chairman BAKER. Ms. McCarthy? 

Mrs. MCCARTHY OF NEW YORK. Thank you, Mr. Chairman. 

22

I think with the questions that we are seeing, I mean, that is the 

whole idea of having a subcommittee hearing, so that we can hopefully work these things out. I think overall, the goal of the bill has 

its very good merits. Obviously, you have heard a number of us 

talking about our concern about the States. 

In your testimony, you indicated that with respect to Section 8(b) 

of the bill, that Congress created a dual securities regulatory system in which both State and Federal agencies serve specific valuable roles. You testified that the question of whether this section 

strikes the appropriate balance between the State and Federal securities enforcement power is Congress’s to resolve. 

You also recommend that this issue may require further study, 

given that the FAIR fund provision has been in effect for less than 

one year, and that distribution of funds under the Global settlement, as you testified, may yield important lessons. 

I guess my question is, and we talked about this earlier when 

you answered a question, how long would such a study last and 

who would conduct the study? Can you give me some specifics on 

the suggested study of what you would even be looking for? 

Mr. CUTLER. The only thing I think we were trying to suggest 

is that we have only had I think it is about 10 months worth of 

experience with the FAIR fund provision. You are probably in a 

better position to make the judgment as to how much experience 

we need with that provision. Again, I thought Mr. Kanjorski’s suggestion that we work together with the States and the subcommittee to see if we can come up with something workable was 

an excellent one. 

Mrs. MCCARTHY OF NEW YORK. The other thing, and again I 

know an awful lot of my State Attorneys or Attorneys general that 

certainly will continue to work, but obviously with the economic climate that is out there, my fear is would they back off on certain 

types of prosecutions through SEC if they do not have the money. 

I mean, their funds are going to be cut like everybody else’s because most States are mandatory. They have to meet their budget. 

It is not like here where we can just raise the budget ceiling. So 

I have a concern about that and I think that we have to, before this 

bill goes forward, try and work out something that we can guarantee that the States and the Federal government will work together. 

Thank you. 

Chairman BAKER. The gentlelady yields back. 

Mr. Tiberi? 

Mr. TIBERI. Mr. Chairman, I will yield my 5 minutes to the 

chairman. 

Chairman BAKER. I thank the gentleman for his insightful judgment. 

[LAUGHTER] 

I want to return to the issue just raised by the gentlelady and 

others with regard to the ability of a State Enforcement Authority 

to pursue wrongdoers and the disposition of the fines, penalties or 

disgorgements generated. As Section 8(b) is constructed, I am the 

Attorney General of Louisiana, and I am pursuing Corporation X 

and I get them. We collect $100 million. Those are the terms of the 

deal. We do not affect market structure at all. Give me the money; 

23

I get to keep it; the State gets to keep it; and I can go out and build 

all the parking lots I want. 

Is that your understanding of how the current Section 8(b) would 

function, Mr. Cutler? 

Mr. CUTLER. Yes. It is a very narrowly crafted provision. It only 

applies when the State both seeks money and a remedy that would 

require a broker-dealer firm to go beyond the current requirements. 

Chairman BAKER. The current Federal regulatory structure. 

Mr. CUTLER. That is right. 

Chairman BAKER. Now, the reason for that being constructed in 

that fashion is to retain the SEC’s primacy in Federal regulation 

of securities transactions. That means if the State regulator chooses to pursue someone and simply wants to change market structure, whatever that might be, however they choose to do, separating investment banking from something else that might be problematic, they can do that, but they cannot also levy a fine without 

distributing those proceeds back through the FAIR fund to the defrauded investor. Is that your understanding? 

Mr. CUTLER. It is, although I hope that if they do pursue market 

structure reforms, they will also come and talk to us. I think over 

the past year, we have developed a good enough relationship where 

I hope and am optimistic that that would happen. 

Chairman BAKER. Good luck. My point is that there is nothing 

that precludes a local Enforcement Authority from going after a 

wrongdoer and securing a fine and using it for whatever purpose 

they choose, even if Section 8(b) were operative law. 

Ms. Schapiro, do you have any different view? 

Ms. SCHAPIRO. No, I do not. 

Mr. MANZULLO. Will you yield, Mr. Chairman? 

Chairman BAKER. Sure. I would be happy to yield to the gentleman. 

Mr. MANZULLO. Let me construct something. 

Chairman BAKER. This is Mr. Tiberi’s time. He is yielding to you. 

Mr. MANZULLO. All right. The example the chairman gave, they 

go after Corporation X; they recover $100 million, but that $100 

million was ill-gotten gains by that particular broker or corporation 

as a result of setting up fraudulent operations against senior citizens. 

Rather than totally removing the brokering operation or the corporation from doing business in the future, the Attorney General 

secures as part of the settlement the agreement of on-spot monitoring of everyone dealing with that corporation or broker over the 

age of 65 because it is making the assumption is was some sort of 

fraud on senior citizens. That would change the structure. That 

would be outside the normal penalty that the Federal government 

SEC could lay in. That would trigger the funds under section 8(b) 

going to the Federal government, as opposed to coming to the 

State. 

So the question that comes to my mind, is the Attorney General 

that was pursuing that, would he probably study the structure of 

the settlement so as not to change the structure of security laws, 

so that the receipts would come back to the State, even though the 

proper methodology if you are handling that was perhaps setting 

24

up a monitoring device to protect 65-year-olds or older who were 

being particularly defrauded by this scheme? 

Chairman BAKER. Reclaiming Mr. Tiberi’s time, the structure the 

gentleman suggests would not change Federal market structure. It 

would have to be something inconsistent with current Federal regulatory oversight that would trigger this provision. So I appreciate 

the gentleman’s point, but it is a very narrow field of applicability 

that triggers this response. 

Mr. Cutler may want to respond or may not. Mr. Cutler? 

Mr. CUTLER. Again, to the extent that it does not change the national market regulations that we have in place, it obviously would 

not trigger the provision. 

Chairman BAKER. Define that. It would be helpful to us to define 

‘‘Federal market regulations in place.’’ What does that reference? 

Mr. CUTLER. As I understand it from the legislation, it is rules 

and requirements at the SEC level, as well as the SRO level, that 

are currently in effect. 

Chairman BAKER. So in effect, the State could not change SEC 

rules and regulations unilaterally, or if they did and fined, then the 

money would come to us. 

Mr. CUTLER. That is my understanding. 

Mr. KANJORSKI. May I add to that question, though? Under current SEC regulations, do you have the authority to establish monitoring of a particular category of brokers or corporations in dealing 

with 65-year-olds? Do you have that? I am not aware that you 

would have the ability to do that. 

Ms. SCHAPIRO. If I might jump in, I believe under SRO rules it 

would not be violating an SRO rule or an SEC rule or do any injustice here to say that as a result of a heightened supervision that 

is required under our rules with respect to particular conduct that 

takes place within a broker-dealer firm, that a firm must do anything necessary to guard against that conduct in the future, and 

could certainly, because the rules are written rather broadly, encompass something like maintaining separate records of how senior 

citizens are dealt with. 

Mr. KANJORSKI. Ms. Schapiro, using that argument, there is 

practically nothing that could be required in a settlement that 

would trigger the funds under Section 8(b) to come to the Federal 

government. 

Ms. SCHAPIRO. No, what I am suggesting is that in the example 

you posit, there is nothing that is contrary to self-regulatory organization rules that would in fact trigger this provision. 

Mr. KANJORSKI. Okay. That is for your rules. How about the 

SEC? 

Ms. SCHAPIRO. It is either rules, as I understand it. 

Mr. KANJORSKI. Well, is there anything in the settlement, then, 

that could trigger and would be in violation of those rules? I am 

not sure. I mean, you are seeming to say that a settlement could 

call for any structure and that would not be in violation of your 

rules or the SEC rules. If that is the case, then there will be no 

triggering mechanism for Section 8(b) to apply where the funds 

would come to the Federal government. 

Ms. SCHAPIRO. No, I do not believe that is the case. I think if you 

look at, for example, the Global settlement, which required fundaVerDate 0ct 09 2002 09:33 Oct 23, 2003 Jkt 000000 PO 00000 Frm 00030 Fmt 6633 Sfmt 6633 C:\DOCS\89810.TXT MICAH PsN: MICAHW
25

mental structural changes in an investment bank, that that is the 

kind of thing that would probably trigger this requirement. I do believe there will be some interpretive issues around exactly what 

falls under this provision and what does not, and what is contrary 

to an existing SEC or SRO rule. 

Mr. KANJORSKI. Who is the final determiner of whether they 

make a structural change like that? The Federal SEC? The Attorney General of the State? The Justice Department of the United 

States? Who makes that determination? 

Ms. SCHAPIRO. I think that is one of the issues that probably 

needs some further discussion. 

Chairman BAKER. Mr. Kanjorski, you have exhausted Mr. 

Tiberi’s time. 

Mr. TIBERI. Mr. Chairman, that is the most time I have ever had. 

[LAUGHTER] 

Chairman BAKER. And it is the most effective use you have ever 

made. 

[LAUGHTER] 

Mr. Hinojosa? 

Mr. HINOJOSA. Thank you, Mr. Chairman. 

I wish to address my first question to Ms. Schapiro. How do you 

think Section 8(b) of this legislation will affect a State’s ability to 

robustly combat corporate fraud? 

Ms. SCHAPIRO. Thank you. I really would associate myself with 

Mr. Cutler’s remarks. I think that there should not be any disincentive to rigorous State enforcement of the laws. My experience 

in working with State regulators over many, many years as an 

SEC commissioner, a chairman of another Federal agency, and at 

the NASD has been that they are as committed and dedicated to 

investor protection, regardless of where fine money or other remedy 

funds go. I think that they will maintain that commitment regardless. 

I also think that this really is a fairly circumscribed provision 

that does not hurt their ability to get fines so long as there is not 

prescriptive relief that changes either SRO or SEC rules. Of course, 

where they believe that that is the right remedy to change SRO or 

SEC rules in how a broker-dealer operates, then there would not 

be fine money, but one would hope that the Federal regulators 

would also step in there and more broadly look at that conduct. 

I think over time, we have to look at the impact of any legislation to see if any kinds of disincentives are created. But I think the 

combination of the professionalism of State Securities Administrators and their commitment to investor protection, and the narrowness of this bill, really should not create any disincentive. 

Mr. HINOJOSA. Mr. Cutler, some time ago SEC gave our committee some suggestions on how to improve investor protection in 

our marketplace. Why did you not see a need for these reforms 

back in February? 

Mr. CUTLER. Mr. Hinojosa, are you talking about Section 8(b) in 

particular? 

Mr. HINOJOSA. Well, the new amendments that are being proposed now to strengthen the law that we have is one that I think 

you should have brought to us back when you came and spoke in 

26

February, I believe, and that is specifically Section 8(b) that we are 

discussing today. 

Mr. CUTLER. Right. I think what has spotlighted, if you will, the 

Section 8(b) concern is the Global Research Analyst settlement 

which we had not yet consummated back in February. I think what 

has given rise to the concern about the use of penalty monies is the 

way that we are dealing with the Global Research Analyst settlement and the proposed distribution of monies in that settlement. 

That has only happened recently. 

Mr. HINOJOSA. With that, Mr. Chairman, I yield back my time. 

Excuse me, I would like to give my time, then, to Mr. Emanuel. 

Mr. EMANUEL. Could you expound? Earlier you had said something about monies being fungible as we were dealing with the 

homestead, to go back to that. I think you were onto something and 

then you kind of veered off or got cut off. So can you expound on 

what you were talking about as it related to money being fungible 

and its relationship to the homestead issue? 

Mr. CUTLER. Sure. The concern is that if illicit monies, monies 

wrongfully obtained are, let’s say, put in the bank, and then monies from the liquidation of stock were used to buy a house, under 

a provision which limited our ability to go after a homestead to 

where we could actually trace the money to the homestead, the 

homestead in that example might be protected because the monies 

were literally used for something other than the purchase of the 

house. 

Mr. EMANUEL. Do you have a particular example or cases where 

in fact exactly what you were trying to get at, because what I am 

trying to do is find a way to address some of the questions my colleagues have asked, both from Illinois and Florida, in the sense 

that one does not want to see the SEC stopped, but on the other 

hand where somebody is clearly using cracks within the law, fissures in the law to hide monies and dollars, that I want to address. 

So if there is a way that we can kind of lock these two together 

in some area. Do you have specific cases that come to mind or are 

there cases that exist where people clearly were buying a house for 

that purpose of sheltering dollars that would normally go back to 

those who have been defrauded? 

Mr. CUTLER. I cannot summon any right here. We will go back 

and look at it. The concern I would have, Mr. Emanuel, is that because of the way current law operates, there may be no need for 

a criminal or wrongdoer under the civil securities laws to go ahead 

and engage in that kind of mechanism. That is, that there would 

be no need to do anything other than plop the money right into the 

house. But we will go back and look, and I think your inclination 

is exactly right and you are a terrific diplomat. 

Mr. EMANUEL. That also has never been used to describe me. 

[LAUGHTER] 

Chairman BAKER. And the gentleman’s time has expired as well. 

Mr. EMANUEL. Thank you. I have made the most use of my time 

today. Thank you. 

Chairman BAKER. Very helpful, sir. 

I need to correct the record. In response to Mr. Manzullo’s question relative to homestead exemption in bankruptcy proceedings, I 

had indicated my recollection of Sarbanes-Oxley was that there 

27

was bankruptcy court protection against a securities fraud penalty 

being assessed. Section 803, staff has informed me, which was in 

the final adopted version of Sarbanes-Oxley, disallows, and this is 

significant, discharge under bankruptcy of any debt arising under 

a securities law claim, meaning if the person has engaged in 

wrongful conduct and has been fined by the SEC, that is not protected in bankruptcy proceedings. So the concerns raised by Mr. 

Manzullo should have been raised with regard to Sarbanes-Oxley 

as well, because you now have a privileged position as a result of 

the passage of that Act. So we may talk about both issues in the 

same context. 

Ms. Biggert? 

Mr. Crowley? 

Mr. CROWLEY. Thank you, Mr. Chairman. 

I find myself as a member from the New York delegation in an 

interesting position here, because I do not necessarily disagree with 

where you are going, but I am at the same time somewhat defending my Attorney General for what was really some outstanding 

work in the settlement in my State. Let me first say that in New 

York, we know that the industry in which Mr. Spitzer was engaged 

in investigating is an important one for New York State and for 

New York City. It is critical. It is crucial. I do know it goes beyond 

New York. The market and the marketplace is something that this 

nation and the world is concerned about. 

But I think besides our Federal banking laws, there are probably 

only two other banking laws in the world that really matter. One 

is Switzerland’s and the other is New York State’s banking laws. 

The Martin Act is the State law which Attorney General Spitzer 

used to conduct his investigation. 

Also, I consider all the money from the people who pay taxes in 

New York were spent on the investigation. So it is not really unreasonable for me to see at the end when there is a settlement that 

New York State would look to recoup some of the monies that were 

spent in that investigation, and one that was brought to a conclusion that amounts to some $1.5 billion. So just for the record, I 

want to state that. 

One side says yes, well, there should be uniformity, and I think 

you are saying that Mr. Spitzer agrees with you, Mr. Cutler, that 

there should be some form of uniformity. I am one who generally 

supports preemption on many of these issues from the Federal end. 

But here is an example where New York State took the bull by the 

horns, that may not be the right animal to describe here, but he 

certainly did in this case, and I think deserves a great deal of credit for the settlement that took place. 

I also think it is hard to separate whether or not that would not 

have an impact upon Mr. Spitzer or whoever he or she may be, the 

Attorney General of New York State or any State. It is really difficult for me to believe that that is not going to have an impact on 

their ability to conduct those investigations. I do not know what 

the cost of the investigation was. It probably was not $50 million. 

I do not know what it was, but it was a considerable amount of 

money. I just wanted to lay that out there. 

I have a question, though, in regards to some of the discussion 

that I have heard trickle down to my office from Wall Street and 

28

their lawyers is that it is believed by many that a considerable portion of the penalties that some of these firms have been hit with, 

they believe can be paid by insurance companies that they have 

contracted out with. What is your feeling on that? Do you think 

that that is fair if that is the case? And is that true and is that 

fair? It is almost like the analogy of if I got a ticket for speeding 

on the New York State Thruway, I would ask my insurance company to pay for it. Innately, that does not seem very fair to me. 

Can you comment on that? 

Mr. CUTLER. Sure. I agree with you. What we did in the Research Analyst settlement is something we had never done before, 

which was to include a provision which expressly prohibits any of 

the firms from seeking insurance coverage or indemnification for 

the penalty portion of their payments. 

Mr. CROWLEY. So it is covered in that? You have come to an 

agreement that is solid on this, right? 

Mr. CUTLER. Yes. 

Mr. CROWLEY. Okay. I appreciate it, and thank you very much. 

I yield back the balance of my time. 

Chairman BAKER. Thank you, Mr. Crowley. 

Mr. Baca? 

Mr. BACA. Thank you very much, Mr. Chairman. 

Mr. Cutler and Ms. Schapiro, thank you very much for appearing 

here today. I believe that the legislation does have merits and I 

have a couple of questions that I would like to ask. 

My first question deals with Section 8(d) of the bill. This section 

provides that SEC may use undistributed amounts of fund from 

disgorgement funds or FAIR funds to educate investors. Such educational programs would be administered by an established not-forprofit or governmental organization. I commend these efforts. I 

agree that financial literacy is crucial for participation in capital 

markets. Financial literacy is the first line of defense against fraud. 

Could you tell me what kind of programs you have in mind? That 

is question number one. Number two: What kind of organizations 

would administer these programs? That is question number two. 

And are you making efforts to target Hispanics and other minorities? 

Ms. SCHAPIRO. Under the legislation, any undistributed funds 

could be used for investor education. That would include funds 

where it was just infeasible to distribute the money or where there 

was more money than was appropriate to distribute. The money 

could be administered for investor education purposes by a not-forprofit foundation and so forth, or a governmental entity. It will obviously be the SEC’s choice ultimately about what to do in that regard. 

I will say that there is an enormous amount of money as well 

available under the Global settlement for investor education purposes that will be administered through a court-approved plan to 

broadly educate investors about how to make better decisions with 

respect to the stock market and other investing. As part of that, 

I would hope and we have encouraged the SEC to do a survey of 

what works and what doesn’t work in the investor education arena. 

There are hundreds of organizations engaged in investor education. There are wonderful programs that develop high school curVerDate 0ct 09 2002 09:33 Oct 23, 2003 Jkt 000000 PO 00000 Frm 00034 Fmt 6633 Sfmt 6633 C:\DOCS\89810.TXT MICAH PsN: MICAHW
29

ricula, that target the Hispanic community, senior citizens, the African American community. All of those are areas where we need 

to put a renewed emphasis on investor education. It is part of what 

NASD is doing. 

Now, I would turn it over to Steve for the specifics. 

Mr. CUTLER. Mr. Baca, I think it is critical that any investor outreach and education efforts embrace all sectors of society. We ought 

to, and I think it is incumbent upon the government to embrace the 

concept of diversity when it comes to investor education dollars. I 

agree with my colleague in that regard. 

Mr. BACA. Thank you very much. That is why I hope that we 

look at the kind of programs that we develop to target not only the 

Hispanic population, but other minorities as well. But what kind 

of programs would administer these? I don’t know. Do you have a 

list or something that would be available for us that would administer these kinds of programs? 

Mr. CUTLER. We can certainly get to you a list of current investor 

education programs and entities. I know that in connection with 

the Global Research Analyst settlement, it is something that we 

are looking at very hard because we have available in connection 

with that settlement on the Federal side on the order of $50 million 

over a five-year period to expend on investor education efforts. Our 

investor education office is gathering a list, I assume they actually 

already have it, and we will provide it to you, of investor education 

programs that currently exist. 

Mr. BACA. Okay. Thank you. 

My second question is in regard to Section 7 of the bill. Section 

7 authorizes SEC to retain private legal counsel to collect debt 

owed as a result of SEC judgments or orders and to negotiate appropriate fees to pay for such private legal counsel. As I understand it, this provision would enhance the SEC’s ability to recover 

more of the money owed by securities law violators. 

How does this program compare to efforts by other agencies to 

hire private sector debt collection contractors? That is question 

number one. And then question number two, is this different than 

the program run by the IRS in which contractors violate the Fair 

Debt Collection Practice Act, which is question two. And three is, 

are these just apples and oranges, is there some level of commonality that should concern me? 

Mr. CUTLER. We do think this provision would be very helpful. 

It is a power that I believe the Department of Justice already has 

available to it, to contract directly with private Attorneys. We have 

not had that power. It has created a number of inefficiencies in 

how we go about collecting on judgments. 

We also think it would allow us to leverage our resources much 

more effectively because the collection of judgments invariably 

turns on interpretations of State law. It is a lot more efficient to 

be able to rely on local counsel in the relevant jurisdiction than to 

have a Federal regulator learn the collection procedures and laws 

of each jurisdiction around the country. 

What makes some of our judgments different than other judgments is that they tend to be big, and they also tend to have been 

collected from scofflaws or entered against scofflaws, and that difVerDate 0ct 09 2002 09:33 Oct 23, 2003 Jkt 000000 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 C:\DOCS\89810.TXT MICAH PsN: MICAHW
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fers from other sorts of judgments that other government agencies 

would ordinarily try to collect. 

I understand your concern about violations of the Federal Debt 

Collection Act, and I think it would be incumbent upon us in the 

contracting process with private law firms to ensure that we have 

protections in place so that those violations do not occur. 

Mr. BACA. Could there be a possibility of double-dipping in collecting by one agency versus another? 

Chairman BAKER. That will be the gentleman’s last question. 

Your time has expired, but please respond. 

Mr. CUTLER. That does not strike me as a particular problem, 

and I think we could work that out. 

Chairman BAKER. Thank you, Mr. Baca. 

Mr. Meeks? 

Mr. MEEKS. Thank you, Mr. Chairman. 

I think I caught the tail end of Joe Crowley, the gentleman from 

New York’s statement. I am also from New York and have a background somewhat. I used to be an investigator for the New York 

State Investigation Commission. On the whole question about restitution, no one wants to say they are against restitution to individuals who have been defrauded. 

However, on the question of how much money we are talking 

about and how many people are in the class, so how much really 

do they get back, I think that is a real question, as opposed to the 

costs to undergo the investigation, et cetera, as the States have 

done. That is a real consideration and something that I think we 

have to look at and make a determination on because we do not 

want to dissuade the States’s Attorneys general, whether it is New 

York’s or anyone else, from engaging in investigations because they 

know the cost of it and they cannot recoup any of those costs. So 

that is a real concern. 

Let me ask this to you, Mr. Cutler. I really want to ask you a 

question that is more related to a hearing that we conducted Tuesday regarding employee stock options. I understand that the offer 

of employee stock options helps small cash-strapped companies attract top-rate employees in place of a salary. Actually, I support 

that. 

On the other hand, I am tremendously concerned when I look at 

companies like WorldCom, whose executives manipulated their own 

stocks and statements to boost the stock price, and turned the benefit of their own stock to their benefit. And then I know that we 

go after individuals, and I am not talking about anything but the 

merit of the case, et cetera, when you are talking about what is 

happening with Martha Stewart, but when we look at what is 

being done with the settlement now of $1.5 billion, which 

WorldCom was going to have to pay, I guess the agreement is now 

$500 million. 

The question that I have is, with all of this, and I do not see anybody from any of the executives being indicted right now from 

WorldCom. Let me ask you the question I asked on Tuesday. How 

do we maintain stock options as an incentive for hard work, while 

not providing an incentive for executive management to manipulate 

their own compensation? Do you have any opinion on that? 

31

Mr. CUTLER. Discretion suggests to me that I do not. I am just 

the enforcement thug who when they tell me what the law is, I go 

out and prosecute violations of it. I think probably the policy questions here are better left to others. I know certainly it has been a 

problem in the past, executive compensation and whether that creates the right incentives. But I cannot give you advice on how to 

get out of that box. I know that the expensing of options is now 

an issue before FASB. 

Mr. MEEKS. Ms. Schapiro? 

Ms. SCHAPIRO. I guess I should exercise the same discretion as 

Mr. Cutler and not answer. But I will say that I think options have 

served an important purpose for many companies over the past 10 

or so years in this country. I think the problem is abuses, grants 

of stock options. 

I think much has happened under Sarbanes-Oxley and other 

events in the last year that really have given management compensation committees of boards of directors a higher sense of what 

their obligation is to shareholders when they are granting stock options. I believe that we are starting to see a chilling effect of some 

of the events in the last year on abuse of grants of stock options. 

The other terribly important thing here is the appropriate accounting treatment for stock options. That will do more, I think, 

than any other thing to cut down on abuse of grants of stock options, if they are accounted for correctly. 

Mr. MEEKS. Thank you. 

Mr. CROWLEY. Will the gentleman yield? 

Mr. MEEKS. I yield. 

Mr. CROWLEY. Thank you. I thank my colleague for yielding. 

I just wanted to go back real quickly. I had my staff just check 

something out before I brought it up. I understand that in the settlement that took place, that all the companies involved admitted 

to no wrongdoing and that was part of the settlement. I am not 

suggesting anything beyond that. 

I just wanted to go to another set of laws and rules, the RICO 

laws. I am not suggesting, again, that these companies were involved in any type of action that could be undertaken by RICO. But 

under those set of laws, isn’t it true that local law enforcement is 

able to retain a portion of the ill-gotten gains and possibly sell 

them off and use the proceeds to fight crime in their jurisdictions? 

If that is the case, aren’t we setting up a separate protocol in the 

future for illegal-gotten gains within the financial services and the 

capital markets sector specifically? 

Mr. CUTLER. I cannot tell you because I am not an expert on 

RICO. I can tell you, Mr. Crowley, that I do not think the issue 

of recouping expenses was the turning point, if you will, for the fulcrum of the decision by the New York Attorney General and others 

about where the money should go. Indeed, back in December when 

we announced the settlement in principle, I know that Mr. Spitzer 

said at that time that to the extent practicable, any monies that 

the State of New York collected would be returned to investors. 

Now, at the end of the day for statutory and other reasons, the 

New York Attorney General determined that it was not practicable, 

but it was not an issue, and he can speak to this, and I think Ms. 

32

Bruenn can speak to this as well, it was not an issue about whether to recoup expenses or not. 

Mr. CROWLEY. I agree with you. I don’t mean to say that that 

was the sole purpose. That wasn’t. At the same time, New York is 

not asking for one-third of the money that was recouped either, and 

putting that into the New York State coffers as well. So I mean, 

all things said and done, $50 million is a very small amount in the 

overall picture of the $1.5 billion. 

I thank you for your time and I thank the chairman for the time. 

Chairman BAKER. Thank you, Mr. Crowley. 

I would just observe that much of what is contained in Section 

8(b) is responsive to comments by many States’s Attorneys general 

who said, one, we may not have the authority, but two, we clearly 

do not have the resources, although we agree that restitution 

should be a principal goal. I think we are very close to having resolution to the matter that the committee would find favorable. 

Certainly, we can address expenses of litigation as an appropriate cost item to be shared by the State, but one overriding element that we cannot take our eye off of, the money came from 

somebody’s pocket. It is no different from walking down the street 

and seeing someone drop a $20 bill and making the effort to pick 

it up and give it back to them. I think that is an extremely important role for the government to pursue, and I think we can achieve 

that goal ultimately. 

I am going to suggest a recess, given the pending vote on the 

floor, unless any member has any further statement or question of 

this panel. 

Mr. CROWLEY. If the gentleman could just yield for a moment. 

I don’t disagree with your premise either. I think it is difficult 

for those people who have been wronged to have the advocacy outside the SEC, and the SEC does a wonderful job and are not paid 

enough to do the job that they do. Having said that, in New York 

State, for instance, the Attorney General’s office, he is acting on behalf of his constituency, which is within New York State, many of 

whom have been wronged. So I do understand that. I do not necessarily disagree with the premise of our panelists either, that 

there should be some uniformity and conformity, and I am happy 

to hear that you are open to discussing how that can be divided in 

the future. 

Chairman BAKER. Sure. No, I laud him for grabbing the horns 

of the bull. The only question I have is where he sent the filets. 

That is all I am talking about. 

[LAUGHTER] 

Let me express my appreciation to the panel for their helpful testimony this morning. We are going to stand in recess for a few minutes. We have more than one vote. We will return as soon as possible to reconvene for our second panel. 

Thank you. 

Mr. CUTLER. Thank you. 

[RECESS] 

Chairman BAKER. We are going to go ahead and proceed. It 

would be inappropriate to keep you waiting without presenting 

your testimony. In fairness to the hearing record, what I would 

then do is probably submit my questions in writing, since there is 

33

no member from the other side to have equal time. That is acceptable to me, and I think to the folks representing both interests. 

So at this time, Ms. Christine Bruenn, President, North American Securities Administrators Association. Welcome. Your full testimony will certainly be made part of the record. In the meantime 

if we get a second member, we will stay around for a bit. 

Please proceed. 

STATEMENT OF CHRISTINE A. BRUENN, PRESIDENT, NORTH 

AMERICAN SECURITIES ADMINISTRATORS ASSOCIATION, INC. 

Ms. BRUENN. Thank you, Chairman Baker. 

I am Christine Bruenn, Maine Securities Administrator and 

President of the North American Securities Administrators Association. I commend you for holding this hearing and thank you for 

the opportunity to appear before your committee to present the 

States’ views on the Securities Fraud Deterrence and Investor Restitution Act of 2003. 

The Securities Administrators in your States are responsible for 

the licensing of firms and investment professionals, the registration 

of some securities offerings, branch officer, sales practice audits, investor education, and most importantly the enforcement of State 

securities laws. 

Some securities commissioners are appointed by their Governors 

or Secretaries of State. Others are career State government employees. Notably, only five report to or are under the jurisdiction 

of their Attorneys general. We have been called the local cops on 

the securities beat, and I believe that is an accurate characterization. Because of our proximity to the local investor, the States are 

an indispensable early warning system for fraud. The State Securities Regulators work with national regulators on market-wide solutions. 

That was the pattern followed with penny stock fraud, micro-cap 

fraud, day trading, and other areas. It bears repeating: The States 

investigate and bring enforcement actions; they do not engage in 

rulemaking for the national markets. That is rightly the purview 

of the SEC and the SROs. 

We appreciate the subcommittee’s leadership in identifying some 

of the practices that resulted in the analyst conflicts of interest inquiry, as well as the continuation of the work you started during 

the last Congress that culminated in the Sarbanes-Oxley Act. 

NASAA applauds the subcommittee for many of the provisions in 

H.R. 2179. We appreciate your commitment to strengthening securities regulation and we want to work with you to reach our shared 

goals of enhanced investor protection and stiffer penalties for those 

who commit securities fraud. Given what has happened in the past 

few years on Wall Street and in boardrooms across the country, 

now is the time to strengthen, not weaken, investor protection. 

Although NASAA supports the vast majority of the provisions in 

H.R. 2179, I must express our deep concerns regarding Section 

8(b). First let me say that we share your goal of returning more 

funds to defrauded investors. We agree that restitution should be 

a priority for all regulators. In fact, a primary and routine objective 

of State Securities Regulators is to obtain restitution for investors 

as part of enforcement actions. For example, in the 2002 reporting 

34

period, State Securities Regulators collectively obtained orders of 

over $309 million in restitution. During the same period, roughly 

only $71 million was ordered in fines and penalties. 

To make the point that restitution is a priority, let me illustrate 

with some statistics. In my home State of Maine for fiscal year 

2003 to date, my agency participated in the return of over $2.8 million to investor victims, while collecting, apart from the Merrill 

Lynch settlement, only $16,000 in penalties to the general fund. 

Data for Pennsylvania reflects the same priorities. For fiscal year 

2003 to date, the Pennsylvania Securities Commission oversaw the 

payment of $8.2 million in restitution and disgorgement and the 

collection of just $130,057 in civil penalties. 

While we agree on the priority of restitution, there are provisions 

of H.R. 2179 that raise practical and public policy issues, as well 

as the specter of unintended consequences that could actually harm 

investors. We believe it would be bad public policy to attempt to 

direct a State authority to remit a civil penalty or disgorgement ordered in a State case to a Federal governmental body for distribution. These funds rightfully belong to the citizens or investors in 

the State. Decisions regarding the use of penalties are best made 

by the State legislatures and regulators so they can be tailored to 

the unique circumstances of each jurisdiction. 

State Securities Regulators apply a variety of sanctions when 

taking enforcement actions against broker-dealers, depending upon 

the specific facts of each case. Remedial sanctions are very important enforcement tools in addition to restitution and monetary penalties. Where State Securities Regulators investigate and resolve 

enforcement cases using these remedies, their judgment regarding 

appropriate outcomes should be respected and supported. We impose remedies to suit the particular enforcement case and use our 

discretion to address unique situations. 

There are a wide variety of remedies we may choose to impose. 

In the case of selling unsuitable investments, for instance, we may 

have the branch manager review trades and compare them with a 

customer’s investment objectives, or ask a broker-dealer, for a fixed 

period of time, to keep a separate file on transactions with senior 

citizens. In other cases, closer supervision of a broker, expansion of 

the compliance department, or enhancement of internal controls 

might be necessary. 

Finally, the legislation leaves open some questions. It is unclear 

if it would apply if a State imposed the same remedial sanctions 

that were imposed in a parallel Federal proceeding, where both the 

State and Federal orders went beyond the requirements of Federal 

law. The uncertainty in the mechanics of the bill points to another 

problem. When the State, the SEC and the industry respondent in 

a given case disagree on whether the provisions of Section 8(b) are 

triggered, how is that impasse to be resolved? This question suggests increased conflict between all three players and resources 

being wasted in resolving such disputes. 

In contrast with this scenario is the very positive experience in 

the recent Global settlement with the leading Wall Street firms. In 

my view, the Global investigation and agreement was a model for 

State-Federal cooperation that will serve the best interests of investors nationwide. We must be able to leverage our resources and 

35

continue to work together on these cases. With 85 million investors 

relying on our securities markets to meet their financial goals, and 

on regulators to keep their markets well-policed, we cannot afford 

to undermine our complementary regulatory system. 

To sum up our concerns, while we wholeheartedly support the 

provisions in H.R. 2179 to strengthen the SEC’s Enforcement Authority, it appears to be inconsistent to enhance the SEC’s enforcement power while at the same time inhibiting the States’s options 

in enforcement actions. 

Mr. Chairman and members of the subcommittee, in closing I 

want to repeat our support of the goals of this legislation. The SEC 

needs more authority and resources, and those who break our securities laws should pay a higher price than they do today. But we 

are deeply troubled that this legislation, while strengthening the 

SEC, could weaken and limit the efforts of State Securities Regulators to protect investors in your States. Eighty-five million investors, many of them wary and cynical, expect us to remain vigilant, 

to work together, to stay the course, and to make sure that Wall 

Street puts investors first. 

I pledge the support of the NASAA membership to work with you 

and your subcommittee. We would be willing to work with the SEC 

and others to come to an agreement on Section 8(b) and to provide 

you with any additional information and any assistance you may 

need. 

Thank you for this opportunity to testify. 

[The prepared statement of Christine A. Bruenn can be found on 

page 52 in the appendix.] 

Chairman BAKER. Thank you, Ms. Bruenn. 

I noted on page four of your testimony when you were referencing the actions in Maine, Pennsylvania and Arizona, and the 

collections made in reference to the penalties assessed. To your 

knowledge, particularly in the State of Maine where I am certain 

you do know, were those penalties or recoupments in relation to 

events or activities that were within your State and affected principally residents of the State of Maine? 

Ms. BRUENN. The way I would respond to that is to say that 

those investigations primarily affected Maine investors. There are 

occasions when our cases go into New Hampshire or Massachusetts, or we collectively join with other regulators in either New 

England or nationwide on a particular broker-dealer or a particular 

issue. 

I think the important point here is that I have made it a priority 

to take penalties generally unless I have made restitution first. I 

absolutely agree that restitution should be the priority in every example. I think we have had a difference on one case, the Analyst 

case, about what the right answer is, but I totally agree with you 

that restitution should always be a priority. 

Chairman BAKER. Thank you for that. The point of my question 

was that generally speaking the actions taken in the three States 

that generated the restitution cited in relation to the small amount 

of penalty were more often than not local aberrations within the 

State over which you have jurisdiction. You would not, for example, 

tell the people of Pennsylvania with your actions what remedy they 

should seek with regard to misconduct in securities markets. 

36

Ms. BRUENN. I can speak for Maine. Our penalties are generally 

for brokerage firms who have violated a specific statute in Maine, 

with Maine investors. 

Chairman BAKER. That being the point, there are a couple of observations. One, generally speaking these were local in nature in 

violation of a particular statute or regulation of the agency. Secondly, it is responsive to the point made earlier, if you do not get 

to keep the money, would you take the action? 

You have three States where you have had significant 

recoupment and very small penalties in relation to that action, only 

$16,000 in monies to the general fund, and giving $2.8 million in 

compensation to Maine residents. That is a pretty good deal. I 

think it supports the view by Mr. Cutler earlier in the day that 

professional regulatory agents are going to act in the best interest 

of their constituents, money notwithstanding. 

Secondly, under Section 8(b) as constructed, if you took the actions cited in these three States and laid them aside the requirements of Section 8(b), and it may not be appropriate to do it today, 

but I would like to get back from you the case, just take Maine, 

we will keep it narrow, and present to us the prohibitions that the 

resolutions reached would not have been permissible under Section 

8(b). That would be very helpful to us. 

It is not the intent to preclude State regulators from acting, but 

it is the intent to make sure that where your actions go beyond 

State boundaries, where there are people who have been wronged, 

and where you take the money and bring it into your State general 

fund, and it is not distributed to those non-resident victims, there 

ought to be a way to work this out. 

If you can give us case-specific points that show how the proposed rule is not consistent with the remedy you have sought in 

those $2.8 million worth of recoupment in Maine, that would be 

very instructive, because we have limited the taking of the dollars 

to a twofold step. You have got to change market structure and you 

have got to seek a penalty. 

Now, I would be happy to look at even stipulating further, as we 

have had these discussions with the Consumer Federation, where 

it clearly is an action relating, for example, to a broker-dealer in 

a city who has run false advertisements and you find him, there 

is no question about that. That stays with a State. There ought to 

be a way to have an illustrative list and then figure out how we 

describe it. 

Let me put it this way. Do you have a theoretical problem, forgetting Section 8(b), with giving money back to people who have 

been defrauded, when your actions within your State make resources available, and the preponderance of investors who would 

benefit from your action are not within your State? 

Ms. BRUENN. Mr. Chairman, I think you have identified the key 

issue here, which is the triggering mechanism. I think the way we 

were reading Section 8(b), the trigger seemed much broader than 

the way it has been described here today. I believe that we could 

probably work together on coming up with something that made us 

all comfortable. I need to be free to do my routine investigations 

that affect one broker or eight brokers and 25 or 50 or 150 invesVerDate 0ct 09 2002 09:33 Oct 23, 2003 Jkt 000000 PO 00000 Frm 00042 Fmt 6633 Sfmt 6633 C:\DOCS\89810.TXT MICAH PsN: MICAHW
37

tors in Maine, where I can impose a remedy that seems to address 

a particular broker-dealer or branch office’s problem in that case. 

My jurisdiction is very narrow. It is for offers and sales of securities in Maine. I do not have the authority to tell any broker-dealer 

how to do their business outside my boundaries. So I feel very comfortable saying to you that I think that there is an answer here. 

Chairman BAKER. Let me return to the question, because I want 

to make sure we get on the record a specific answer, and we can 

take the Global settlement as the nexus to come together here. 

There is no evidence that 50 percent of the harmed investors as a 

result of the Merrill Lynch settlement resided in New York, yet 

half the money went to New York. That was the problematic aspect 

of the settlement from my perspective. 

Secondly, only a very small portion of the Global settlement, 

again from my perspective, went to investor restitution. From 

Maine looking into the Global settlement, if 20 percent of the investors lived in Maine, I would have no difficulty in supporting an effort to give Maine 20 percent of the settlement. Would you object 

to that? 

Ms. BRUENN. No, sir. And we tried to address exactly the concern 

you raise. I think, one, the Merrill Lynch settlement was a unique 

circumstance where the State of New York’s Attorney General had 

already done most of the work, and was trying to make sure that 

the procedure ended with all of the States coming together. I think 

it was a very unique situation, and I would hate for all of State 

securities regulation and our approach to restitution to be judged 

by that one case. 

Chairman BAKER. No, we are together. All I am suggesting is if 

you take an action that results in harmed investors outside your 

State not having the opportunity for restitution, but it is your 

prompt corrective action that brought this person to justice, you 

would not object to a mechanism to provide for distribution of compensation to people outside the State, as long as you do not have 

to do it yourself. You do not have to pay for it and you do not have 

to sort out who gets what. 

That is the reason for the SEC distribution mechanism, because 

every State Attorney General who has come to us expressing concern said, ‘‘We don’t have the ability to do this.’’ I said, well, would 

you object to the SEC doing it? ‘‘Well, no, as long as we got fair 

treatment.’’ 

Ms. BRUENN. I guess the problem I have is that with that particular Merrill Lynch settlement, for instance, Maine got 1 percent 

of the penalty money. So putting aside what New York got and 

whether that was the right way to do it or not, the rest of the 

States divided up the money based on population, trying to address 

the fact that in a small State I am going to have fewer victims than 

they are going to have in a much larger State. I think we tried to 

do that. I think my problem with the legislation is it takes away 

my discretion. 

Chairman BAKER. Let me jump on that small State issue. 

Ms. BRUENN. Okay. 

Chairman BAKER. If Connecticut, a high-income State, sophisticated people, contrast that with Louisiana. I will guarantee you, 

there are five times as many investors harmed by the Merrill 

38

Lynch action as there were in Louisiana. Now, why should we get 

more money than Connecticut because we have a bigger population? 

The equity of it is what I am driving at. That is the whole issue 

behind the proposal, is if we are going to collect vast sums of 

money, we ought to make sure we make our best effort, and if 

there are legitimate reasons why we cannot, let’s explain it. But 

let’s make our best effort to give the money back to the people from 

whom it was taken. 

I am going to yield to Mr. Kanjorski. 

Mr. KANJORSKI. Mr. Cutler does not believe that there would be 

any budgetary considerations by State regulators or Attorneys general in expending money for lawsuits where there would be a small 

recovery. Do you feel that, at least in some way, the States that 

get heavily involved in these transactions and expend a larger portion of their budget or allocation for that particular litigation, 

should be compensated for that, as opposed to just splitting it in 

some formula without taking that into consideration? If you don’t 

take that into consideration, will that tend to cause the justice departments of the various States or the SECs of the various States 

not to be as aggressive? 

Ms. BRUENN. Representative Kanjorski, I believe we are all committed public servants and we are going to go do the right thing 

whether the funding comes our way or not. However, we are also 

human, and we run agencies where we are expected to produce results. If the results are that money gets sent to Washington, with 

all due respect, I have to say that that will undermine my ability 

to get funding for my agency. 

Mr. KANJORSKI. Do any of these actions constitute something 

similar, or are they constructed in the class action type of situation 

where the decision process would eliminate any further liability if 

other actions are brought by other individuals? 

Ms. BRUENN. Under the State laws, investors in our States are 

not only served by the actions that I bring as a regulator and my 

colleagues bring as regulators, but they have their own private 

cause of action that can be pursued either in a class action lawsuit 

or in arbitration. We had three goals in the Analyst conflicts of interest settlement. One of them was to make sure that we provided 

information for investors. We intend to help them with that arbitration process. 

Mr. KANJORSKI. So the courts do not consolidate the actions into 

one class action? They preserve the rights of private class actions 

or private investor lawsuits? Is that correct? 

Ms. BRUENN. I am not an expert on class action law, but I would 

point out that most of these actions will be brought in arbitrations 

which are not consolidated. Each investor gets the opportunity to 

have a hearing based on their own personal situation. 

Mr. KANJORSKI. That is in making restitution claims from the 

State of Maine. I am talking about in the recovery from the party 

who has wronged them. What I am trying to get at, is there any 

time, as in class actions, that a settlement constitutes a universal 

global settlement, and that forestalls any other State or any other 

class from bringing any action against that particular defendant, 

and the potentiality of that being abused? 

39

I do not want to suggest it, but in corporation law, we have seen 

that Delaware has created a mechanism to become the land of corporations. You theoretically could have another State, Louisiana, 

become the land of securities transactions in order to allow a final 

settlement to be arrived at to bar any further recovery from other 

States that probably suffered a great deal more. I don’t want to 

suggest that they would act as a straw man or a shill for the defendants, but in fact they could do that. 

Ms. BRUENN. To the best of my knowledge, there is no State jurisdiction that would preclude any other regulator from also bringing an action, or any individual from pursuing their private right 

of action. No settlement would preclude another action. 

Mr. KANJORSKI. So what happens is they insist before they arrive 

at a settlement that all 50 States’s Securities Regulators enter into 

the agreement and are satisfied with the disposition of the funds? 

Ms. BRUENN. That happens in these very large cases with national impact. The defendants want to make sure that the States 

will have buy-in, and that is where we have used the mechanism 

of NASAA, the membership organization that I am serving as 

President, to bring the States together and to try and speak with 

one voice and come up with one resolution. 

Mr. KANJORSKI. Do you think the bill as presently structured 

fails to put in place a mechanism to decide how the disposition 

should be made or whether there is a change in the structural laws 

or regulations of securities so that it would trigger the mechanism 

to go to the Federal government? Do we have to find some arbiter, 

rather than retreating to a full class and Supreme Court decision 

between the SEC and the various States, which could be very expensive and probably smaller States would not be able to be parties 

to it just because of the expense involved? 

Do you see a need for some final decision making body that is 

representative of the interests of both the States and the Federal 

government, a board of arbitration or something that would be set 

up and properly appointed to have a balanced representation to 

make some of these jurisdictional decisions as to whether or not 

the fines and disgorgements or other restitution would flow to the 

Federal government or the individual States? 

Ms. BRUENN. I think we need a bill that is clear about the triggering mechanism. I would hope that we would have something 

that would be clear enough. I do not think it would be a good use 

of resources for me to be litigating with the SEC or with an industry member about what this bill means and whether I have overstepped my jurisdiction. I would like it to be as clear as possible. 

We have had a very good relationship with the SEC. I think of 

us as being partners in working on the same issues, just from different perspectives. I think our relationship with them would be 

undermined if they became the big brother who got to go behind 

our cases. 

I think the trigger here was the analyst cases. The New York Attorney General got out in front. I do not think you want to really 

preclude States from playing that role of being the early warning 

system on issues. I think what you want is a mechanism that says 

once that happens, let’s all get together and resolve this together, 

with the SEC providing the national leadership. 

40

Mr. KANJORSKI. From your statements just now, I suppose you 

don’t mean to make the SEC, then, the final arbiter. We should 

have some independent entity to make that decision because there 

may be a time in the future that an SEC just asserts its jurisdiction all the time and makes the decision in favor of itself all the 

time. That would basically either give you the choice of going toward regular litigation or surrendering your rights eventually, and 

becoming cowed to the Federal SEC. 

Ms. BRUENN. I would suggest that you are right; that if the SEC 

becomes the arbiter, our ability to be unique or initiate things that 

the SEC has not blessed would be hobbled. 

Mr. KANJORSKI. Okay. You offered to participate with trying to 

work with the SEC and with the committee, to see if this can be 

crafted. Do you feel that Section 8(b) is something, and we know 

it all has merit, I mean, what the intentions are. I don’t think anybody argues with the merit of the final result that we are trying 

to get at. But do you think we can craft something that is agreeable both to state regulators, to the SEC, and basically to the Congress to get the ideal accomplished? 

Ms. BRUENN. I would hope so, and I am committed to trying. 

Mr. KANJORSKI. Very good. 

Thank you very much, Mr. Chairman. 

Chairman BAKER. Thank you, Mr. Kanjorski. 

I have a series of questions, and at this point I don’t want to 

enter into and start a whole new series of questions. What I will 

do, just to give you notice, we will get a letter out to you probably 

tomorrow that will have a series of issues, for example, for illustrative purposes. I would like to see from your perspective what 

each State did allocate their settlement proceeds from the Global 

settlement to have on the record. So members who ask what happened to the money, and whether it is used for enforcement, for 

education, or for general fund purposes, can make that judgment. 

I know they will rely on your representations of what did take 

place as being the accurate indicator of how those funds were used. 

I have other questions even with regard to NASAA’s receipt of 

the $2 million allocation of the settlement and how that is utilized. 

So I will get that out. 

I do appreciate the time you spent here today to testify before 

the committee, and I appreciate your good-faith representations to 

work with the committee to come to resolution. At least I think we 

are generally in accord, that getting money back to the people from 

whom it was taken is a good thing. 

Mr. KANJORSKI. Mr. Chairman, may I call your attention to the 

fact that this administrator works for a great Governor, that was 

a former colleague of ours? 

Chairman BAKER. Absolutely. I look forward to having further 

continued excellent cooperation as we move forward toward a legislative remedy to what we all agree is an appropriate step, and that 

is to give the money back to the people from whose pocket it was 

taken. 

I thank you for your appearance here today. 

Ms. BRUENN. Thank you for inviting me. 

[Whereupon, at 12:42 p.m., the subcommittee was adjourned.] 

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