U.S. SEC CHARGES J.P. MORGAN SECURITIES LLC AND CREDIT SUISSE SECURITIES WITH MISLEADING INVESTORS IN OFFERINGS OF RMBS

FROM: U.S. SECURITES AND EXCHANGE COMMISSION

Washington, D.C., Nov. 16, 2012 — In coordination with the federal-state Residential Mortgage-Backed Securities Working Group, the Securities and Exchange Commission today charged J.P. Morgan Securities LLC and Credit Suisse Securities (USA) with misleading investors in offerings of residential mortgage-backed securities (RMBS). The firms agreed to settlements in which they will pay more than $400 million combined, and the SEC plans to distribute the money to harmed investors.

The SEC alleges that J.P. Morgan misstated information about the delinquency status of mortgage loans that provided collateral for an RMBS offering in which it was the underwriter. J.P. Morgan received fees of more than $2.7 million, and investors sustained losses of at least $37 million on undisclosed delinquent loans. J.P. Morgan also is charged for Bear Stearns' failure to disclose its practice of obtaining and keeping cash settlements from mortgage loan originators on problem loans that Bear Stearns had sold into RMBS trusts. The proceeds from this bulk settlement practice were at least $137.8 million.

J.P. Morgan has agreed to pay $296.9 million to settle the SEC's charges.

According to the SEC's order against Credit Suisse, the firm similarly failed to accurately disclose its practice of retaining cash for itself from the settlement of claims against mortgage loan originators for problems with loans that Credit Suisse had sold into RMBS trusts and no longer owned. Credit Suisse also made misstatements in SEC filings about when it would repurchase mortgage loans from trusts if borrowers missed the first payment due. The firm made $55.7 million in profits and losses avoided from its bulk settlement practice, and its investors lost more than $10 million due to Credit Suisse's practices concerning first payment defaults.

Credit Suisse has agreed to pay $120 million to settle the SEC's charges.

"In many ways, mortgage products such as RMBS were ground zero in the financial crisis," said Robert Khuzami, Director of the SEC's Division of Enforcement. "Misrepresentations in connection with the creation and sale of mortgage securities contributed greatly to the tremendous losses suffered by investors once the U.S. housing market collapsed. Today's actions involving RMBS securities are a continuation of the SEC's strong efforts to pursue wrongdoing committed in connection with the financial crisis."

Mr. Khuzami is a co-chair of the RMBS Working Group, which brings together federal and state agencies to investigate those responsible for misconduct that contributed to the financial crisis through the pooling and sale of RMBS.

RMBS Working Group Co-Chair and U.S. Attorney for the District of Colorado John Walsh said, "Today's filings represent significant steps towards the accomplishment of the Working Group's mission - to investigate and confront the abuses in the residential mortgage-backed securities market that significantly contributed to the Financial Crisis. The Working Group model allows the Department of Justice to lend a hand to other enforcement partners around the country who, in turn, have their own unique resources, talents, and legal tools to contribute to the effort. And the Justice Department's efforts in this area have benefited from SEC's work on its own cases."

RMBS Working Group Co-Chair and New York State Attorney General Eric Schneiderman said, "Today's actions are another step forward in the process of bringing accountability for the misconduct that led to the collapse of the housing market. We will continue to work together on behalf of consumers and investors to ensure that it never happens again."

According to the SEC's complaint against J.P. Morgan filed in federal court in Washington D.C., federal regulations under the securities laws require the disclosure of delinquency information related to assets that provide collateral for an asset-backed securities offering. Information about the delinquency status of mortgage loans in an RMBS transaction is important to investors because those loans are the primary source of funds by which investors can earn interest and obtain repayment of their principal.

The SEC alleges that in the prospectus supplement for the $1.8 billion RMBS offering that occurred in December 2006, J.P. Morgan made materially false and misleading statements about the loans that provided collateral for the transaction. The firm represented that only four loans (.04 percent of the total loans collateralizing the transaction) were delinquent by 30 to 59 days, and that those four were the only loans that had had an instance of delinquency of 30 or more days in the 12 months prior to the "cut-off date" for the transaction. However, at the time J.P. Morgan made these representations, the firm actually had information showing that more than 620 loans (above 7 percent of the total loans collateralizing the transaction) were, and had been, 30 to 59 days delinquent, and the four loans represented as being 30 to 59 days delinquent were in fact 60 to 89 days delinquent.

The SEC's complaint also alleges that Bear Stearns' bulk settlements covered loans collateralizing 156 different RMBS transactions issued from 2005 to 2007. Loan originators were usually required by contract to buy back loans that suffered early payment defaults or had other defects. However, Bear Stearns frequently negotiated discounted cash settlements with these loan originators in lieu of a buy-back on loans that were owned by the RMBS trusts. The firm - both before and after the merger with J.P. Morgan - then kept most of the bulk settlement proceeds. The firm failed to disclose the practice to investors who owned the loans. Bear Stearns repurchased only about 13 percent of these defective bulk settlement loans from the trusts, compared to a nearly 100 percent repurchase rate when loan originators agreed to buy back the defective loans. For most loans covered by bulk settlements, the firm collected money from originators without paying anything to the trusts.

J.P. Morgan settled the SEC's charges by consenting to pay $50.5 million in disgorgement and prejudgment interest and a $24 million penalty for the delinquency misstatements, which the SEC will seek to distribute to harmed investors in the transaction through a Fair Fund. J.P. Morgan agreed to pay $162,065,536 in disgorgement and prejudgment interest and a $60.35 million penalty for the bulk settlement practice misconduct, and the SEC will seek to distribute these funds to harmed investors through a separate Fair Fund. J.P. Morgan consented, without admitting or denying the allegations, to the entry of a final judgment permanently enjoining them from violating Section 17(a)(2) and (3) of the Securities Act of 1933. The settlement is subject to court approval.

According to the SEC's order instituting a settled administrative proceeding against Credit Suisse, the firm and its affiliated entities misled investors in 75 different RMBS transactions through the bulk settlement practice. From 2005 to 2010, Credit Suisse frequently negotiated bulk settlements with loan originators in lieu of a buy-back of loans that were owned by the RMBS trusts. Credit Suisse kept the bulk settlement proceeds for itself and failed to disclose the practice to investors who owned the loans. In nine of the 75 RMBS trusts, Credit Suisse failed to comply with offering document provisions that required it to repurchase certain early defaulting loans. Credit Suisse also applied different quality review procedures for loans that it sought to put back to originators, instituted a practice of not repurchasing such loans from trusts unless the originators had agreed to repurchase them, and failed to disclose the bulk settlement practice when answering investor questions about early payment defaults.

The SEC's order also found that Credit Suisse made misleading statements about a key investor protection known as the First Payment Default (FPD) provision in two RMBS offerings. The FPD provision required the mortgage loan originator to repurchase or substitute loans that missed payments shortly before or after they were securitized. Credit Suisse misled investors by falsely claiming that "all First Payment Default Risk" was removed from its RMBS, and at the same time limiting the number of FPD loans that were put back to the originator.

Credit Suisse settled the SEC's charges by consenting to pay $68,747,769 in disgorgement and prejudgment interest and a $33 million penalty, which the SEC will seek to distribute through a Fair Fund to harmed investors in the 75 RMBS transactions affected by the bulk settlement practice. Credit Suisse agreed to pay $12,256,651 in disgorgement and prejudgment interest and a $6 million penalty, which the SEC will seek to distribute through a separate Fair Fund to harmed investors in the two transactions affected by the FPD misstatements. Credit Suisse agreed to an order, without admitting or denying the allegations, requiring them to cease and desist from violations of Section 17(a)(2) and (3) of the Securities Act and Section 15(d) of the Securities Exchange Act of 1934.

These investigations were conducted by members of the SEC Enforcement Division's Structured and New Products Unit in both the Denver and Washington, D.C. offices, including Zachary Carlyle, Mark Cave, Sarra Cho, Allison Herren Lee, Laura Metcalfe, Colin Rand, Thomas Silverstein, John Smith, Andrew Sporkin, Amy Sumner, and Jeffrey Weiss. The trial unit members assigned to this matter were Dugan Bliss, Kyle DeYoung, Jan Folena, and Christian Schultz. The Enforcement Division was assisted by Eugene Canjels and Vance Anthony in the Division of Risk, Strategy and Financial Innovation. The SEC thanks the other agencies who are members of the RMBS Working Group for their assistance and cooperation regarding these enforcement actions.

"These actions demonstrate that we intend to hold accountable those who misled investors through poor disclosures in the sale of RMBS and other financial products commonly marketed and sold during the financial crisis. Our efforts in that regard continue," said Kenneth Lench, Chief of the SEC Enforcement Division's Structured and New Products Unit.

SEC Issues Staff Summary Report of Examinations of Nationally Recognized Statistical Rating Organizations

SEC Issues Staff Summary Report of Examinations of Nationally Recognized Statistical Rating Organizations

SEC'S LARGEST INSIDER TRADING CASE

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

November 20, 2012

The Securities and Exchange Commission today charged Stamford, Conn.-based hedge fund advisory firm CR Intrinsic Investors LLC and its former portfolio manager along with a medical consultant for an expert network firm for their roles in a $276 million insider trading scheme involving a clinical trial for an Alzheimer's drug being jointly developed by two pharmaceutical companies. The illicit gains generated in this scheme make it the largest insider trading case ever charged by the SEC.

The SEC alleges that Mathew Martoma illegally obtained confidential details about the clinical trial from Dr. Sidney Gilman, who served as chairman of the safety monitoring committee overseeing the trial. Dr. Gilman was selected by Elan Corporation and Wyeth to present the final drug trial results to the public. In phone calls that were arranged by a New York-based expert network firm for which he moonlighted as a medical consultant, Dr. Gilman tipped Martoma with safety data and eventually details about negative results in the trial about two weeks before they were made public in July 2008. Martoma then caused several hedge funds to sell more than $960 million in Elan and Wyeth securities in just over a week.

Dr. Gilman, who lives in Ann Arbor, Mich., where he works as a medical school professor, has agreed to settle the SEC's charges and cooperate in this action and related SEC investigations. In a parallel action, the U.S. Attorney's Office for the Southern District of New York today announced criminal charges against Martoma and a non-prosecution agreement with Dr. Gilman. Martoma lives in Boca Raton, Fla.

According to the SEC's complaint filed in federal court in Manhattan, Martoma first met Dr. Gilman through paid consultations arranged by the expert network firm. Dr. Gilman provided Martoma with material nonpublic information concerning the Phase II trial of the potential Alzheimer's drug called bapineuzumab (bapi). They coordinated their expert network consultations around scheduled safety monitoring committee meetings, and during their phone calls they discussed PowerPoint presentations made during the meetings and Dr. Gilman provided Martoma with his perspective on the results. Dr. Gilman developed a personal relationship with Martoma, eventually coming to view Martoma as a friend and pupil.

The SEC alleges that Martoma caused hedge funds managed by CR Intrinsic as well as hedge funds managed by an affiliated investment adviser to trade on the negative inside information he received from Dr. Gilman. Although Elan and Wyeth's shares rose on June 17, 2008, on the public release of top-line results of the Phase II trial, market participants were disappointed by the detailed final results issued on July 29, 2008. Double-digit declines in Elan and Wyeth shares ensued. After Martoma was tipped, the hedge funds not only liquidated their combined long position in Elan and Wyeth of more than $700 million, but went on to hold substantial short positions in both securities. This massive repositioning allowed CR Intrinsic and the affiliated advisory firm to reap approximately $82 million in profits and $194 million in avoided losses for a total of more than $276 million in illicit gains.

According to the SEC's complaint, Martoma received a $9.3 million bonus at the end of 2008 - a significant portion of which was attributable to the illegal profits that the hedge funds managed by CR Intrinsic and the other investment advisory firm had generated in this scheme. Dr. Gilman, who was generally paid $1,000 per hour as a consultant for the expert network firm, received more than $100,000 for his consultations with Martoma and others at the hedge fund advisory firms. Dr. Gilman also received approximately $79,000 from Elan for his consultations concerning bapi in 2007 and 2008.

The SEC's complaint charges each of the defendants with violating Section 17(a) of the Securities Act of 1933, and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, and seeks a final judgment ordering them to disgorge their ill-gotten gains plus prejudgment interest, ordering them to pay financial penalties, and permanently enjoining them from future violations of these provisions of the federal securities laws.

Dr. Gilman has agreed to pay more than $234,000 in disgorgement and prejudgment interest. He also agreed to a permanent injunction against further violations of the federal securities laws. The proposed settlement is subject to approval by the court, which also will determine at a later date whether any additional financial penalty is appropriate.

"SKY-HIGH" YIELDS, SECRET EUROPEAN TRUST AND, SEC CHARGES OF INVESTOR FRAUD

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

Washington, D.C., Nov. 19, 2012 — The Securities and Exchange Commission today charged the operators of a long-running prime bank scheme with defrauding investors who were promised sky-high returns on loans to a secret European trust. It also is seeking an emergency court order to freeze the operators’ assets for the benefit of investors.

The SEC alleges that Billy W. McClintock, who lives in Florida, and Dianne Alexander, a former Georgia resident who now lives in California and also is known as Linda Dianne Alexander, raised $15 million from at least 220 investors in more than 20 states, primarily Georgia. McClintock portrayed himself as the "U.S. Director" of a secret European trust that had the power to create money and claimed to have appointed Alexander as a "U.S. Regional Director" for the trust. McClintock and Alexander led investors to believe that they could receive 38 percent annual interest on loans to the trust, provided they abide by the trust’s strict rules requiring secrecy. However, investor money was instead used to merely pay other investors, the hallmark of a Ponzi scheme.

"McClintock and Alexander pitched an investment opportunity that simply did not exist. They merely reshuffled funds between investors in a modern take on a classic prime bank scheme," said William P. Hicks, Associate Director of Enforcement in the SEC’s Atlanta Regional Office.

According to the SEC’s complaint filed in U.S. District Court for the Northern District of Georgia, McClintock and Alexander began conducting the scheme by at least 2004 and misrepresented or omitted facts about investment risks, expected returns, and how investor funds would be used. The complaint charges McClintock and Alexander with violating the securities registration, broker-dealer registration, and antifraud provisions of the U.S. securities laws and a related SEC anti-fraud rule.

The SEC’s complaint also names as relief defendants two entities that McClintock controls — MSC Holdings USA LLC, and MSC Holdings Inc. — and another entity controlled by Alexander — MSC GA Holdings LLC. The SEC believes the three firms may have received ill-gotten assets from the fraud that should be returned to investors.

Information on how to avoid prime bank frauds is available at: http://www.sec.gov/divisions/enforce/primebank.shtml and


http://investor.gov/investing-basics/avoiding-fraud/types-fraud/prime-bank-investments

The SEC’s investigation, which is continuing, has been conducted by Natalie M. Brunson and Lucy T. Graetz of the SEC's Atlanta Regional Office under the supervision of Aaron W. Lipson. Senior Trial Counsel Pat Huddleston II will lead the litigation. The SEC acknowledges the assistance of the U. S. Attorney's Office for the Northern District of Georgia and the Federal Bureau of Investigation’s Atlanta Division in this matter.

SEC CHARGES MAN WITH ALLEGEDLY SPENDING INVESTOR FUNDS ON DRUGS AND GAMBLING

FROM: U.S. SECURITIES AND EXCHANGE COMMISSION

The Securities and Exchange Commission today charged a purported investment adviser in New York with defrauding investors who he convinced to invest in his start-up businesses while in reality he was spending their money on illegal drugs and gambling.

The SEC alleges that Stephen A. Colangelo, Jr. repeatedly misled investors while raising $3 million in investments for four start-up companies that he created. He also persuaded three other investors to let him act as their investment adviser, and they gave him more than $1 million to invest in the markets on their behalf. Colangelo boasted a phony professional and educational background and hid his past criminal activities from potential investors, and he falsely claimed to have historically achieved extremely high returns buying and selling securities. Meanwhile, Colangelo siphoned off at least $1 million in investor funds to pay such unauthorized personal expenses as his federal income taxes, illegal narcotics, gambling, cigars, and travel for him and his family.

In a parallel action, the U.S. Attorney’s Office for the Southern District of New York today announced criminal charges against Colangelo.

According to the SEC’s complaint filed in the U.S. District Court for the Southern District of New York, Colangelo’s fraudulent scheme began in 2009 when he induced investors to invest more than $750,000 in the Brickell Fund LLC, a pooled investment vehicle that he created, advised, and controlled. In March 2009 when the Brickell Fund did not have any investors and Colangelo was not buying and selling securities on behalf of the fund, he sent numerous e-mails to potential investors boasting phony information. For instance, one e-mail claimed, "BEST TRADING DAY OF MY LIFE!!!!!!!. . . . Up over 400% and documented. Mind boggling to say the least." In reality, Colangelo did not make any trades that day.

The SEC alleges that after spending or losing all of the money invested in the Brickell Fund, Colangelo continued to fraudulently raise funds from investors for three other startup businesses he created — Hedge Community LLC, Start a Hedge Fund LLC, and Under the Radar SEO LLC. Some individuals provided Colangelo with funds directly to invest on their behalf. Colangelo continued to use investor funds for a variety of purposes that weren’t disclosed to investors, namely personal expenses and unrelated business expenses.

According to the SEC’s complaint, Colangelo created a profile on the LinkedIn website used for professional networking and misrepresented that he had studied finance at Nyack College from 1986 to 1989. Colangelo provided a link to his profile to potential and existing investors in one of his start-up companies. His representations to investors were false because he never attended Nyack College and has not graduated from high school.

The SEC’s complaint charges Colangelo with violations of Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Sections 206(1), 206(2), and 206(4) of the Advisers Act and Rule 206(4)-8 thereunder.

The SEC’s investigation was conducted in the New York Regional Office by Senior Attorney Christina McGill and Assistant Regional Director Wendy B. Tepperman. The SEC’s litigation will be led by Senior Trial Counsel Kevin McGrath. The SEC thanks the U.S. Attorney’s Office for the Southern District of New York and the Federal Bureau of Investigation for their assistance in this matter.

CFTC COMMISSIONER CHILTON SPEECH TITLED "THE OBSERVER EFFECT"

FROM: U.S. COMMODITY FUTURES TRADING COMMISSION

"The Observer Effect"

Commissioner Bart Chilton’s Speech to Risk USA 2012, New York, NY
November 14, 2012
Introduction

Good morning! It’s good to be with you today. Thank you for the kind invitation. Let’s do something a little unconventional this morning. Let’s talk about science as our guidepost for what’s going on with financial regulatory reform under Dodd-Frank—that is: the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. As part of that, we will of course want to talk risk—a reason you’re here at Risk USA.

As we get started, I’ll remember Albert Einstein’s quote: "You do not really understand something unless you can explain it to your grandmother." So, I’ll try to keep the science and the financial markets stuff pretty straightforward.

The Catalyst

Maybe a little review will help set the stage for where we are. We all know that in 2008, we began experiencing the most disastrous economic meltdown since the Great Depression—a colossal collapse. The catalyst for all that was two-fold, according to the congressionally established Financial Crisis Inquiry Commission, or FCIC: Regulators and regulation, or lack thereof; and the captains of Wall Street who took advantage of the lax rules and regulations. Those two things together caused a reaction that created the economic chaos, our Great Recession. Institutions that were thought to be too big to fail—failed. Taxpayers were stuck with a hideous bailout. Nine million people lost their jobs and millions more their homes. It was an economic force that created havoc of which we’re still trying to pull our way out.

Fundamental Forces

That fundamental economic force led to the creation of something novel: Dodd-Frank. Now scientists, I mean regulators, are in the process of implementing that financial reform. I will be the first to admit to you that it’s been a slow process. But there were 398 rules that needed to be put into test tubes and experimented with before they were deemed appropriate. Of those 398 Dodd-Frank rules to be promulgated under the Act, only about 33 percent are complete. We at CFTC have done a little better with our experiments, having completed about two-thirds of our 60 rules. One thing is for sure, all of these rules, these different experiments, are in one way or another, inter-connected, regardless of which agency is writing them. They are not done in isolation.

The Observer Effect

Now then, maybe a little physics review is in order. No need to take notes. You won’t be tested. There’s a term in physics called the "Observer Effect." Anybody heard of it? It refers to changes that the very act of observation causes when any phenomenon is being observed. It makes sense, really. Sometimes the very instruments used to observe something create the change. Think of a really simple example. If you go to check the air pressure in your tires—at least if you’re like me—it’s almost impossible not to let a little air out first when you put the gauge on the valve stem. So do you get a perfect reading? It’s probably a very close reading but the observer effect prevents it from being perfect. The same is true when you take your temperature. The mercury in the thermometer changes ever so slightly throwing off the result in a minuscule way. It’s so small that it’s not even observable to us.

Bear with me. In financial reform too, there is an observer effect. While it may not look like it, the Dodd-Frank implementation experiment is coming together a piece at a time. And what’s going on is influenced to a large extent by an observer effect. First, the rules aren’t written in a vacuum. Public comments are collected from interested observers. Other agencies and even brethren regulators in other countries are consulted. Whenever those things occur, rules and regulations are bound to change from those originally envisioned.

So, now let me go through all 60 rules and show you how the observer effect has affected them—just joking. What we can do is to summarize the types of things we are doing and put them into three categories: Transparency, Market Integrity and Accountability.

1—Transparency: Has anyone heard of the Snellen Scale? It’s the eye chart you read when you visit the optometrist. Well, for years hundreds of trillions of dollars’ worth of trading taking place in the over-the-counter (OTC) space was totally off the chart. We regulators couldn’t see it. We needed an eye chart. Fortunately, Dodd-Frank has provided us with one. After all, it was those very markets that were a major part of the problem that caused those two catalysts (that we discussed earlier) to react.

To put it in perspective, the CFTC previously regulated around $5 trillion in annualized trading on registered exchanges. That was our universe. OTC trading, however, accounts for upwards of $650 trillion! Off the chart again! That’s globally, to be fair, but a lot of it is here in the U.S.

With Dodd-Frank, that OTC trading will be conducted on regulated exchanges—many on Swaps Execution Facilitates, or SEFs. Swap Data Repositories, or SDRs, will—guess what—collect data. Those SDRs will afford the transparency in the particular markets that got us into trouble in 2008.

2—Market Integrity: Like in scientific experiments, you can’t be sure of your results until you have integrity in your testing regime. Same is true for markets. They need integrity to be worth much. Therefore, we also want to guarantee that people don’t take risks that undermine the integrity of markets or the entire financial system.

Risk is part of markets; you guys know that better than anyone. Folks should be able to take as much risk as they’re comfortable with. But, if they give themselves too much rope and hang themselves with it, the whole economy can’t be left swinging, too. Therefore, we’re instituting new capital and margin requirements and clearing.

Most of us want markets to perform the fundamental functions originally envisioned: to manage risk and discover prices. That’s good for commercial hedgers and, ultimately, it is good for consumers—heck it’s good for scientists!

One area under market integrity I’ll just mention quickly is speculative position limits. As some of you may know, this has been a particular area that has concerned me. We suffered a little setback in court last month. All I’ll say now is that we need to appeal the court’s ruling and I expect we will do so very soon. Simultaneously, we need to propose a new, revised position limits rule. There’s no reason for a long comment period. We already received more than 13,000 comment letters so we have a good idea of what people think.

I’m convinced, as are a lot of other folks, that there can be a speculative premium in markets and that skews the price discovery tenet of them and that’s not a good thing. So yes, for my part, I’ll keep fighting for position limits.

3—Accountability: The third and final Dodd-Frank grouping is accountability. Once a scientist has demonstrated something, he or she wants to put it out for peer review. It needs to be subject to the views of others. Similarly we need to listen to others as we oversee these financial markets. Here’s a question I’ve listened to many times: why is it that nobody went to prison for what took place in 2008? Unfortunately, the answer is that nobody violated the law. Well, that’s changing with Dodd-Frank. There will now be financial firm accountability, and not a moment too soon.

Most of us can’t even keep track of all the shenanigans going on in the financial sector. We saw both Goldman Sachs and Citi establish these fake-out funds where they pressed their customers to participate, then, once the fake-out funds were populated with their own customers’ money, the banks themselves took the opposite positions. There’s something wide of the scale with that. Wells Fargo entered into a $175 million settlement with the Department of Justice for charging higher fees and rates to minority customers. Barclays attempted to manipulate Libor rates. And of course, there’s MF Global where, oops, millions-and-millions of customer bucks went missing. And, there’s Peregrine Financial Group which appears to have been a $200-plus million fraud.

There are a lot of other examples of what the financial market mad scientists have done, but I bring up those few to illustrate why accountability is the needed third leg of the stool under Dodd-Frank.

Just recently, we proposed a package of accountability and customer protection rules. I’m not going to get into the technicalities of each of those proposals due to time, but suffice it to say we need them and need them now.

Insurance

There is, however, one thing that we cannot do to help futures customers. This can only be done by Congress. That is: a futures insurance fund.

How unfair is it that MF Global security customers were paid first compared to the futures customers? How unfair is it that banking and security customers both have insurance funds, yet, if you’re a futures customer, you’re outta luck.

Up until MF Global and Peregrine, I suppose people would argue there has never been a problem and that the remedy was not needed. Well, that’s a tough argument to make now. People were really harmed and I think it is irresponsible that there is not such an insurance fund for futures customers.

So that’s the big three: transparency, market integrity and accountability.

A Culture Shift

While Dodd-Frank will go a long way toward remedying the chaos created in 2008 and beyond, it won’t address all of the ills in our financial system…unfortunately. We also need a little observer effect to change the culture of Wall Street. That may mean that people should walk with their wallets if they don’t want to do business with poor corporate citizens. That’s a hefty mandate, but one that I believe is absolutely necessary. Let me explain.

I’ve been suggesting that we engage in a culture shift conversation, a shift in focus in our financial sectors. Both the government and the private sector need to be in on the discussion. This isn’t a very scientific discussion I’m suggesting. It is more about morality and good business ethics and practices. After all, government can’t regulate morality. The cultural mindset in many financial firms is something that needs to change.

What I’m suggesting is simply an effort to improve the system and move away from the Gordon Gekko "greed is good" culture in which we appear to, on many occasions, be sliding into. It will take some time and should take place in executive suites, board rooms, lunch rooms, hearing rooms, and perhaps even in court rooms.

Compensation Systems

So, what’s to be done? Well, for one, just look at the bonuses and compensation structures of these large financial firms. Of the firms I mentioned earlier, many of their CEO’s were paid extravagant amounts in 2011—from $10 to $23 million. So, they are being rewarded for how they have been operating. Way to go.

However, it surely isn’t just the people at the top. The difficulty is more deeply-rooted at firms. Lots of times, firms have been rewarding the cowboy traders. Did you read last week about the high-flying UBS trader who lost billions in London? His compensation rose dramatically, totally based upon a bonus and compensation system of rewarding high-flying trades. The problem there was he wasn’t really making money—sort of like the London Whale with JP Morgan earlier this year. There is something called a "failure to supervise" on the part of firms. Not sure what is up with the firms on these things. But the larger point is that the traders have been propelled by a compensation and bonus system which is out of whack. The firm’s short-term profit motive has been so fantastically strong—for the next quarter or next year—that they have been risking their entire firm’s reputation and existence on short-term gain.

The irony is this belief system of "profit is everything" won't generate the long-term gains the firm shareholders seek. I’m sure the boards are smarter than to only see a few months ahead. What they want is sustainable longer-term economic business growth.

Hiring and Recruitment

Here’s another thing. Rather than hiring a lot of cowboy traders, how about getting more risk professionals—those actually good at risk management. That means recruiting and hiring strategies need to change.

There needs to be a better sense of balance between profit and risk centers. The executive suite folks need to understand and create this balance as part of the corporate culture.

Government
As I said, government can’t be culture cops and mandate morality in financial firms, but we can set the stage for avoiding bad behavior. More importantly, we can incentivize good behavior through our laws, rules and regulations. The Dodd-Frank Act goes a long way in this regard. Specifically, we can help establish an environment in which these firms operate with appropriate transparency, integrity, and standards of conduct.

And finally, in order to help spur this culture shift conversation, we need to re-focus ourselves as regulators on fines and penalties that actually mean something. Fines can’t simply be a cost of doing business. Government is strapped for funding and that means we don’t have the staff to do all that we would want. We could use more investigators and attorneys. The cost of us not having adequate resources is that we often would prefer to enter into a settlement with a firm or individual that has violated the law. That saves us scarce resources. At the same time, the nogoodniks know our deal and they continually try to low-ball on settlement amounts. They have done such a good job; executives at firms are making crude calculations about fines. When the fine is minuscule compared to what can be gained through the illegal activity, that’s not a true deterrent. Merrill Lynch, for example, over-charged their own customers for debit and over-draft fees by $32.2 million. The fine (and this was not the CFTC) was only $2.8 million. That seems like an economic no-brainier. Government needs to do better and we don’t need any scientific experiments to tell us so.

The New Frontier: SEFs
Finally, let’s discuss the Swaps Execution Facility rule.

First (my attorney always makes me say this) I’m not pre-judging what the Commission will do on this rule. I’m just going to comment on about my preferences—which, of course, happen to be correct.

This challenge is really different from just about any experiment we’ve ever conducted. It’s not like drafting regulations for the securities and futures markets that were already well-established when rules governing them were put in place. In this instance, while we had a robust swaps market in the U.S., prior to Dodd-Frank, we did not have a system making the platforms registered entities. Therefore, it’s been a challenge to design the right rules, to carry out the intent of Congress and to ensure that systems intended to be covered by the law are not over- or under-regulated.

For me, ensuring that existing systems, like appropriate voice brokerage, can continue to be used in the SEF environment, is crucial. I also want to ensure that processors—those folks who were truly just facilitating trading, not actually hosting the trading—don’t fall under the SEF umbrella. Again, that’s not what Congress intended. Finally, under the law we are not only supposed to ensure pre-trade price transparency, but at the same time we are to promote the trading of swaps on SEFs. Neither goal outweighs the other. If we pass a final rule which embodies these things, we will have done a good job in my view. And this experiment will be a success not for just a short time, but SEFs will exist for a long time. So, I’m looking forward to getting this final rule out, and moving on from there.

Conclusion
It has been a pleasure to be with you and run through all of these issues. I know it is a lot, but as you may have observed, there’s a lot going on in our markets today and a lot being done in financial regulatory reform.

Maybe you can recall another Einstein quote: "The world is a dangerous place to live; not because people are evil, but because of the people who don’t do anything about it." I’m glad you guys are here and are involved in all of this. I commend you.

We’re trying to make the implementation process as transparent—as observable—as possible. We had a financial crisis caused by those catalysts – government and Wall Street. The effect was Dodd-Frank. Our work is to ensure that the new law addresses the problems in an appropriate fashion. To use another scientific rule, that there is an equal and opposite response. As I’ve tried to illustrate, the pieces of financial reform are relative to one another and relevant to all of us. I hope that in the not too distant future, we can observe this period as having been a crucial time for improving our markets and thus, the economic engine of our democracy.

Thank you.