FDIC CHAIRMAN'S SPEECH AT ABA GOVERNMENT RELATIONS SUMMIT

The following speech given by the FDIC Chairman was excerpted from the FDIC web site:

"Remarks by FDIC Chairman Sheila C. Bair to the ABA Government Relations Summit, Washington, DC
March 16, 2011

Good morning. I am pleased to have the opportunity to join you for this year’s ABA Government Relations Summit.

We are, in many ways, at a crossroads in terms of the future of the commercial banking industry -- how it is regulated, and whether it will in fact fulfill its promise as an engine of growth for the U.S. economy. The past few years have taught all of us some painful lessons.

In 2008, our financial markets and institutions came literally to the brink of systemic collapse. Despite a massive infusion of federal support, our economy still experienced its worst recession since the 1930s. Economists tell us that the recession ended almost two years ago, and it’s true that overall business activity has continued to trend higher since then.

But 13.7 million people remain officially unemployed, and millions more are underemployed. Six million Americans have been officially out of work for more than six months. The banking industry is indeed recovering, but that process remains incomplete.

Problem loans are declining, as are loan-loss provisions. But bankers remain concerned about rebuilding their earnings capacity in the wake of the crisis. And many of you are pointing to heightened regulatory oversight as a primary source of concern in the earnings outlook.

We have heard:

that higher capital standards will reduce lending and economic growth,


that restrictions on capital markets activities will push business overseas, and
that the impending Dodd-Frank reforms are both creating unresolved uncertainty for banks and moving along too fast for comfort.
This may be my last opportunity to speak with you before the end of my term in June.

I would like to take this opportunity to discuss with you what I think are some real challenges facing the banking industry, and how the industry can play a more constructive role in the economic recovery and the reform process. Despite the sometimes heated rhetoric about the direction of regulation, I think bankers, regulators, and the public really do share many of the same goals and concerns for the future.


Short-Term Challenges and the Long-Term Economic Future

First, I would like to propose to you a radical-sounding notion. And it is that increasing the size and profitability of the financial services industry is not – and should not be – the main goal of our national economic policy.

Yes, as we found out in the Fall of 2008, banking is critically important to the ability of our economy to function. And in the wake of the crisis, it looks like bank lending will have to be an even more important ingredient in financing economic activity than it was just a few years ago.

But, in policy terms, the success of the financial sector is not an end in itself, but a means to an end – which is to support the vitality of the real economy and the livelihood of the American people. What really matters to the life of our nation is enabling entrepreneurs to build new businesses that create more well-paying jobs, and enabling families to put a roof over their heads and educate their children.

In our national economic life, your contribution as bankers, and ours as regulators, can only be measured against this yardstick. And let’s be completely honest – in the period that led up to the financial crisis we did not get the job done. FDIC-insured institutions booked record earnings in each of the first six years of the last decade.

But in the recession that followed, the U.S. economy lost over 8-and-a-half million jobs, of which only about 1.2 million have been regained in the recovery. There are almost two million fewer private-sector jobs in this country today than there were in December 1999, eleven years ago. More than nine million residential mortgages have entered foreclosure in the past four years, and the backlog of seriously past due mortgages stands at more than two-and-a-half million.

The lesson for policymakers is that having a profitable banking industry, even for years at a time, is not sufficient on its own to support the long-term credit needs of the U.S. economy. Instead, the industry also needs to be stable, and its earnings must be sustainable over the long term. This, quite simply, is why regulatory changes must be made.
Is the Problem Regulation – or Confidence?

While it is clearly recovering, our economy continues to face some significant challenges.
The balance sheets of households, depository institutions, state and local governments and the federal government all suffered serious damage as a result of the recession. All of these sectors are taking steps to repair that damage, but in some cases it will be a long, painful process.

In some respects we have seen a dramatic improvement in investor confidence and the functioning of financial markets. Credit spreads are down, stock prices are up, and lending standards have eased a little. We’re finding that troubled institutions have recently been better able to raise capital or find an acquirer before failure, and we have also been getting better bids for failed banks that have good retail franchises.

But not every part of our financial system is working the way it is supposed to.

The issuance of private mortgage-backed securities last year was just $60 billion, the same as in 2009 and down almost 95 percent from the peak years of 2005 and 2006. Let’s be clear – the collapse in this market is not the result of actual or anticipated regulatory intervention. Instead, it is the result of a crisis of confidence on the part of investors who lost hundreds of billions of dollars in the mortgage crisis.

And this is not the only area of lending where volume has declined sharply.

The issuance of non-mortgage asset-backed securities is down by well more than half. And in the last three years, the volume of loans for the construction and development of real estate, or C&D loans, held by FDIC-insured institutions also has fallen by half. Net charge-offs of C&D loans during this period now exceed 10 percent of the loans that were on the books at year-end 2007.

There are some who continue to point to over-zealous regulators as the reason for rising charge-offs and declining balances in C&D portfolios. But the truth is that small and mid-sized institutions held record-high concentrations of these loans when U.S. real estate markets began their historic slide in 2006 and 2007. Regulators have done what they can in the wake of the crisis to facilitate loan workouts that help borrowers and banks while conforming to accepted accounting principles.

But we cannot make the problem go away overnight.

The Industry Needs Regulation to Prevent Excesses

With the benefit of hindsight, I think we all can agree that the time for action would have been before the crisis – when rapid growth in subprime and nontraditional mortgage loans was undermining the foundations of our housing markets, and poorly-managed concentrations in commercial real estate and construction lending were making many small and mid-sized institutions highly vulnerable to a real estate downturn.

As you will recall, regulators did propose and issue guidance on managing commercial real estate concentrations and on nontraditional mortgage lending in 2006, and then extended the mortgage guidance to cover subprime hybrid loans in early 2007. In retrospect, it could have been very helpful if well-run institutions had supported these proposals.

But a review of comment letters sent to regulators by industry trade associations before the crisis shows a consistent pattern of opposition. With regard to commercial real estate concentrations, comments from the various trade associations asserted that:

new guidance was not needed and would only increase regulatory burden,


industry practices had vastly improved since the last real estate downturn, and
high levels of commercial real estate lending were necessary in order for small and midsized institutions to effectively compete against larger institutions.


When we issued proposed guidance on non-traditional mortgages, industry comments found the guidance too proscriptive, saying that it “overstate[d] the risk of these mortgage products,” and that it would stifle innovation and restrict access to credit. Later, when we proposed to extend these guidelines to hybrid adjustable-rate mortgages, which at that time made up about 85 percent of all subprime loans, we received a letter co-signed by nine industry trade associations expressing “strong concerns” and saying that “imposing new underwriting requirements risks denying many borrowers the opportunity for homeownership or needed credit options.”

For our part, I think it is clear in hindsight that while our guidance was a step in the right direction, in the end it was too little, too late. To be sure, most—but not all – of the high risk mortgage lending was originated outside of insured banking institutions. But many large banks funded non-bank originators without appropriate oversight or controls.

And CRE lending did not cause the crisis, though poor management of CRE concentrations made far too many institutions vulnerable to the housing market correction when it finally turned. I think we all missed some opportunities before the crisis to help protect well-run institutions from the high-fliers – both within and outside the banking industry – whose risky lending practices were paving the way for the real estate crisis.

This is where I think the regulators and the industry should stand on common ground, in our determination to prevent a race to the bottom in lending practices and portfolio structures. This will protect the Deposit Insurance Fund and well-managed banks from higher assessment rates in the midst of some future industry downturn. And I do see some recent signs of common purpose in the reforming bank regulation.

In comment letters we received earlier this year, the ABA, for example, has expressed its support for the implementation of the Orderly Liquidation Authority and other measures under Dodd-Frank that will help to restore competitive balance to the industry by ending the doctrine of Too Big To Fail. But when I hear some of the public statements of industry leaders about how stronger capital requirements or risk retention in securitization will stifle lending and douse the recovery, I do worry about the depth of that commitment.

I think there is great pressure to restore earnings to pre-crisis levels.

As we saw in the years leading up to the crisis, there is always the temptation to try to squeeze out a few more basis points in earnings now by watering down certain regulatory provisions that are designed to preserve the long-term stability of our financial system and the deposit insurance fund.

I’ll give one example.

Comments received earlier this year on our proposed change in the assessment base under Dodd-Frank said, in part, “it is best to err on the side of collecting less, not more, from the industry.” This comment was received at a time when the reported balance of the Deposit Insurance Fund was negative 8 billion dollars.

We need to get past rhetoric that implies that, when it comes to financial services, the best regulation is always less regulation.

We need to stand together on the principle that prudential standards are essential to protect the competitive position of responsible players from the excesses of the high-fliers.

And I would very much like to hear from the industry a constructive regulatory agenda that would use the provisions of Dodd-Frank to fix the problems that led to the crisis and help to protect consumers and preserve financial stability in the years ahead.

Public Perceptions of Banks in the Wake of the Crisis

This is not just my vision of how the regulators and the industry need to work together. My reading of recent polling data on how the public views banks also speaks to the need for a different approach from your industry. In April 2010, a Pew Research poll found that just 22 percent of respondents rated banks and other financial institutions as having “a positive effect on the way things are going in this country.”

This was lower than the ratings they gave to Congress, the federal government, big business, labor unions, and the entertainment industry. Even though Americans remain skeptical about government control over the economy, an April 2010 poll conducted by Pew Research found that some 61 percent of respondents supported more financial regulation, virtually unchanged from the spring of 2009.

If you narrow the focus of the questions just to Wall Street firms, the results are even more striking. In a Harris poll conducted in early 2010, some 82 percent of respondents agreed that “recent events have shown that Wall Street should be subject to tougher regulations.” Despite perennial concerns about the government’s role in the economy, only 25 percent of investors polled by Gallup earlier this month agreed that “new financial regulations” were doing a lot to hurt the investment climate.

Nearly three times as many felt that the federal budget deficit and high unemployment were major sources of concern. What really seems to stick in the craw of the public is the extraordinary assistance that was provided to financial companies while millions of Americans were losing their jobs and their homes.

A July 2010 poll conducted by the Pew Research Center and the National Journal shows that some 74 percent of respondents believed that government economic policies since 2008 had helped large banks and financial institutions “a great deal” or “a fair amount.” Only 27 percent thought these policies had helped the middle class, and only 23 percent felt they had helped small business. A Rasmussen poll published earlier this year shows that fully 50 percent of Americans believe the federal government is more concerned with making Wall Street firms profitable than with making sure the U.S. financial system works well for all Americans.



Manage Your Reputational Risk

Bank regulators are never going to be popular or glamorous in the eyes of the public. But the banking industry seems to have an even bigger image problem in the wake of the financial crisis.

What is important for you to recognize is that this type of reputation risk will eventually have implications for your bottom line and the confidence of your investors and customers. In this light, the biggest risk to the long-term success of the banking industry is not today’s difficult economic environment. That will improve over time.

And it is not the introduction of new regulatory rules that will curb the excesses that led to the financial crisis. The vast majority of well-run institutions will benefit from these changes. Instead, the biggest long-term risk to the success of the banking industry would be its failure to support the reforms needed to ensure long-term stability in our financial markets and our economy.

The American people have suffered enormous economic losses as a result of the financial crisis. In the years ahead, they will be asked to make more sacrifices to balance government budgets, repair public infrastructure, and rebuild our economic competitiveness. As this historical era unfolds, public opinion as to the role played by the banking industry seems unlikely to be neutral.

It is far more likely that banks will come to be viewed either as a group that supported the restoration of free enterprise and public responsibility in the American economy, or as a group that mainly looked out for its own short-term interests and resisted reforms that could have restored a sense of confidence and fairness in our financial markets.

Conclusion

Every one of your branches prominently displays the FDIC seal. It is a symbol of public confidence that assures the public that their money is safe if your institution should fail. But that seal also carries with it the expectation of your customers that they will be treated fairly and protected from unsuitable loan products and hidden service charges.

That public trust is sacred, and it is the very foundation of the long-term success of your industry.

If bankers and regulators are to uphold that trust, we must demonstrate the ability to work together and engage in long-term thinking that will protect consumers, preserve financial stability, and lay the foundation for a stronger U.S. economy in the years ahead.

Thank you."

FDIC PROPOSES NEW RULE TO RECOUP LOSSES FROM EXECUTIVES

The following is an outline obtained from the Federal Deposit Insurance Corporation web site regarding proposed new rules to reform Wall Street:


“The Board of Directors of the Federal Deposit Insurance Corporation (FDIC) today approved a Notice of Proposed Rulemaking (NPR) to further clarify application of the orderly liquidation authority contained in Title II of the Dodd-Frank Wall Street Reform and Consumer Protection Act, "Orderly Liquidation Authority" (OLA). The NPR builds on the interim rule approved by the FDIC on January 18, 2011, which clarified certain discrete issues under the OLA. The NPR approved today establishes a comprehensive framework for the priority payment of creditors and for the procedures for filing a claim with the receiver and, if dissatisfied, pursuing the claim in court. The NPR also clarifies additional issues important to the implementation of the OLA, including how compensation will be recouped from senior executives and directors who are substantially responsible for the failure of the firm. The NPR, along with the interim final rule, is intended to provide clarity and certainty about how key components of OLA will be implemented and to ensure that the liquidation process under Title II reflects the Dodd-Frank Act's mandate of transparency in the liquidation of covered financial companies.
"Today's action is another significant step toward leveling the competitive playing field and enforcing market discipline on all financial institutions, no matter their size. Under Dodd-Frank, the shareholders and creditors will bear the cost of any failure, not taxpayers," said FDIC Chairman Sheila C. Bair. "This NPR provides clarity to the process by letting creditors know clearly how they can file a claim and how they will be paid for their claims. This is an important step in providing certainty for the market in this new process."
In addition to the priority of claims and the procedures for filing and pursuing claims, the NPR defines the ability of the receiver to recoup compensation from persons who are substantially responsible for the financial condition of the company under Section 210(s) of the Dodd-Frank Act. Before seeking to recoup compensation, the receiver will consider whether the senior executive performed his or her responsibilities with the requisite degree of skill and care, and whether the individual caused a loss that materially contributed to the failure of the financial company. However, for the most senior executives, including those performing the duties of CEO, COO, CFO, as well as the Chairman of the Board, there will be a presumption that they are substantially responsible and thus subject to recoupment of up to two years of compensation. An exception is created for executives recently hired by the financial company specifically for improving its condition.
The NPR also ensures that the preferential and fraudulent transfer provisions of the Dodd-Frank Act are implemented consistently with the corresponding provisions of the Bankruptcy Code. The proposed rule conforms to the interpretation provided by the FDIC General Counsel in December 2010.
Finally, the NPR clarifies the meaning of "financial company" under OLA. Under the proposal, a financial company will be defined as "predominantly engaged" in financial activates if their organization derived at least 85 percent of its total consolidated revenue from financial activities over the two most recent fiscal years. This rule will enhance certainty about which financial companies could be subject to resolution under OLA.
The proposed rule will be out for comment 60 days after publication in the Federal Register.”

The way the above reads seems to indicate that a receiver managing a failed financial institution can attempt to get at least some money back from certain executives and corporate directors if they do not act as they should in their capacity as having a major input as to how a financial institution is managed. It also indicates that a financial institution is an entity that gets 85% of its revenue from financial activities. These clarifications to the Dodd-Frank act might help spare the government a great deal of money which is often needed to shore up failing financial institutions.

SEC CHARGES INDYMAC EXECUTIVES WITH FRAUD

The SEC occasionally brings charges against bank executives. The following excerpt from the SEC web site alleges that executives at IndyMac Bancorp lied to their investors:

“Washington, D.C., Feb. 11, 2011 — The Securities and Exchange Commission today charged three former senior executives at IndyMac Bancorp with securities fraud for misleading investors about the mortgage lender’s deteriorating financial condition.
The SEC alleges that former CEO Michael W. Perry and former CFOs A. Scott Keys and S. Blair Abernathy participated in the filing of false and misleading disclosures about the financial stability of IndyMac and its main subsidiary, IndyMac Bank F.S.B. The three executives regularly received internal reports about IndyMac’s deteriorating capital and liquidity positions in 2007 and 2008, but failed to ensure adequate disclosure of that information to investors as IndyMac sold millions of dollars in new stock.

IndyMac Bank was a federally-chartered thrift institution regulated by the Office of Thrift Supervision (OTS) and headquartered in Pasadena, Calif. The OTS closed the bank on July 11, 2008, and placed it under Federal Deposit Insurance Corporation (FDIC) receivership. IndyMac filed for bankruptcy protection later that month.
“These corporate executives made false and misleading disclosures about IndyMac at a time when the company’s financial condition was rapidly deteriorating. Truthful and accurate disclosure to investors is particularly critical during a time of crisis, and the federal securities laws do not become optional when the news is negative,” said Lorin L. Reisner, Deputy Director of the SEC’s Division of Enforcement.
According to the SEC’s complaints filed in U.S. District Court for the Central District of California, Perry and Keys defrauded new and existing IndyMac shareholders by making false and misleading statements about IndyMac’s financial condition in its 2007 annual report and in offering materials for the company’s sale of $100 million in new stock to investors. In early February 2008, IndyMac projected that it would return to profitability and continue to pay preferred dividends in 2008 without having to raise new capital. In late February 2008, Perry and Keys knew that contrary to the rosy projections released just two weeks earlier, IndyMac had begun raising new capital to protect IndyMac’s capital and liquidity positions. Specifically, Perry and Keys regularly received information that IndyMac’s financial condition was rapidly deteriorating and authorized new stock sales as a result. Yet they fraudulently failed to fully disclose IndyMac’s precarious financial condition in the 2007 annual report and the offering documents for the new stock sales.
The SEC further alleges that Perry knew that rating downgrades in April 2008 on bonds held by IndyMac Bank had exacerbated its capital and liquidity positions to the extent that IndyMac had no choice but to suspend future preferred dividend payments by no later than May 2, 2008. This material information was not disclosed in IndyMac’s ongoing stock offerings. Perry also failed to disclose in various SEC filings or a May 2008 earnings conference call that IndyMac would not have been “well-capitalized” at the end of its first quarter without departing from its traditional method for risk-weighting subprime assets and backdating an $18 million capital contribution.
According to the SEC’s complaint, Abernathy replaced Keys as IndyMac’s CFO in April 2008. He similarly made false and misleading statements in the offering documents used in selling new IndyMac stock to investors despite regularly receiving internal reports about IndyMac’s deteriorating capital and liquidity positions.
The SEC also alleges that in summer 2007 while serving as IndyMac’s executive vice president in charge of specialty lending, Abernathy made false and misleading statements about the quality of the loans in six IndyMac offerings of residential mortgage-backed securities (RMBS) totaling $2.5 billion. Abernathy received internal reports each month revealing that 12 to 18 percent of IndyMac’s loans contained misrepresentations regarding important loan and borrower characteristics. However, the RMBS offering documents stated that nothing had come to IndyMac’s attention that any loan included in the offering contained a misrepresentation. The SEC alleges that Abernathy failed to ensure that the quality of IndyMac’s loans was accurately disclosed and failed to disclose that information had come to IndyMac’s attention about loans containing misrepresentations.
Abernathy agreed to settle the SEC’s charges without admitting or denying the allegations. He consented to the entry of an order that permanently restrains and enjoins him from violating Section 17(a)(2) and 17(a)(3) of the Securities Act and requires him to pay a $100,000 penalty, $25,000 in disgorgement, and prejudgment interest of $1,592.26. Abernathy also consented to the issuance of an administrative order pursuant to Rule 102(e) of the SEC’s Rules of Practice, suspending him from appearing or practicing before the SEC as an accountant. He has the right to apply for reinstatement after two years.
The SEC’s complaint charges Perry and Keys with knowingly violating the antifraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and aiding and abetting IndyMac’s violations of its periodic reporting requirements under Section 13(a) of the Exchange Act and Rules 12b-20 and 13a-1 thereunder. Perry also is charged with aiding and abetting IndyMac’s reporting violations under Exchange Act Rules 13a-11 and 13a-13. The SEC’s complaint against Perry and Keys seeks permanent injunctive relief, an officer and director bar, disgorgement of ill-gotten gains with prejudgment interest, and a financial penalty.
The SEC acknowledges the assistance of the FDIC in this investigation.”

An executive lying to stockholders is very common in the United States. Seldom are any real penalties given or even charges brought against executives who lie. In fact lying seems to be a prerequisite for the post of CEO at most U.S. corporations that I look at as an investor. Perhaps stockholders believe they need a devious monster to run their company. The problem with devious people is that they tend to steal from everyone. A ruthless person when it comes to competitors is also a ruthless person when it comes to stockholders. To paraphrase Shakespeare a thief by any other name is still a thief.

SEC GOES AFTER UBS FINACIAL ADVISER

The problem with modern American capitalism is that stealing is a good business practice. Proponents of modern capitalism say that people act in their own self interests and therefore everyone you do business with is a thief and everyone should realize that they will be ripped-off every time they do any kind of business. Organizing societies around stealing will result in the long run in very bad results namely, murderous revolutions like the one led by Robes Pierre. The following is a case in which the SEC alleges that a man lived beyond his means by stealing from his clients. The following is an excerpt from the case.

Washington, D.C., March 3, 2011 – The Securities and Exchange Commission today charged a former financial adviser at UBS Financial Services LLC with misappropriating $3.3 million in a scheme that included bilking investors in a private investment fund he established.
The SEC alleges that Steven T. Kobayashi, who worked in UBS’s Walnut Creek, Calif., office, created a pooled investment fund to invest in life insurance policies. But he wound up stealing much of the money to support his extravagant lifestyle. Kobayashi concealed his fraud by liquidating his customers’ securities and funneling the money back to the fund and its investors.

In a parallel action, the U.S. Attorney’s Office for the Northern District of California today filed criminal charges against Kobayashi arising from some of the same alleged misconduct.
“Investors count on their brokers to safeguard their investments,” said Marc Fagel, Director of the SEC’s San Francisco Regional Office. “It’s difficult to imagine a more flagrant abuse of that trust than the manner in which Kobayashi pocketed his customers’ money and used it to feed his own habits.”
According to the SEC complaint filed today in federal district court in Oakland, Kobayashi established Life Settlement Partners LLC (LSP), a fund that invested in life settlement policies. He raised several million dollars from his UBS customers for the fund. Beginning in early 2006, Kobayashi used LSP’s bank accounts as his personal piggy bank, spending at least $1.4 million in investor funds on expensive cars, prostitutes, and large gambling debts.

The SEC alleges that in an attempt to repay LSP and its investors before they discovered his theft, Kobayashi induced several of his other UBS customers to liquidate securities in their UBS accounts and transfer the proceeds of those sales to entities that he controlled. In this manner, he stole an additional $1.9 million from these investors.
Kobayashi, who lives in Livermore, Calif., agreed to settle the SEC’s charges against him without admitting or denying the allegations. He agreed to a permanent injunction from further violations of the antifraud and other provisions of the federal securities laws, and consented to the institution of public administrative proceedings against him in which he will be permanently barred from associating with entities in the securities industry. The amount of ill-gotten gains and monetary penalties that Kobayashi will be required to pay will be determined by the court at a later date.

The SEC acknowledges the assistance of the U.S. Attorney's Office for the Northern District of California, the Federal Bureau of Investigation, and the Internal Revenue Service.”

Perhaps the modern capitalist state will one day be defined as an epitaph of evil. Real capitalism comes from the heart. It comes from the minds of people who want to better the lives of their fellow human beings. It has nothing to do with just cheating people as the vast number of current capitalist believe. Beat and cheat is the mantra of most capitalists today.

SEC ALLEGES FIRM PAID $2.5 MILLION IN BRIBES TO CHINESE OFFICIALS

The following case is one which involves the alleged bribing of officials in China by a U. S. based manufacturer. It is unfortunate that on occasion in some nations bribery takes place. The following excerpt is from the SEC web page:

“ Washington, D.C., Jan. 31, 2011 — The Securities and Exchange Commission today charged energy-related products manufacturer Maxwell Technologies Inc. with violating the Foreign Corrupt Practices Act (FCPA) by repeatedly paying bribes to government officials in China to obtain business from several Chinese state-owned entities.

The SEC alleges that a Maxwell subsidiary paid more than $2.5 million in bribes to Chinese officials through a third-party sales agent from 2002 to May 2009. As a result, the subsidiary was awarded contracts that generated more than $15 million in revenues and $5.6 million in profits for Maxwell. These sales and profits helped Maxwell offset losses that it incurred to develop new products now expected to become Maxwell's future source of revenue growth.
Maxwell — a Delaware corporation headquartered in San Diego — has agreed to pay more than $6.3 million to settle the SEC's charges. In a related criminal proceeding, Maxwell has reached a settlement with the U.S. Department of Justice and agreed to pay an $8 million penalty.
"Maxwell's bribery allowed the company to obtain revenue and better financially position itself until new products were commercially developed and sold," said Cheryl J. Scarboro, Chief of the SEC's Foreign Corrupt Practices Act Unit. "This enforcement action shows that corruption can constitute disclosure violations as well as violations of other securities laws."
According to the SEC's complaint filed in U.S. District Court for the District of Columbia, Maxwell's wholly-owned Swiss subsidiary Maxwell Technologies SA paid the bribes to officials at several Chinese state-owned entities. The bribes were classified in invoices as either "Extra Amount" or "Special Arrangement" fees, and were made to improperly influence decisions by foreign officials to assist Maxwell in obtaining and retaining sales contracts for high voltage capacitors produced by Maxwell SA.
The SEC's complaint alleges that the illicit payments were made with the knowledge and tacit approval of certain former Maxwell officials. For example, former management at Maxwell knew of the bribery scheme in late 2002 when an employee indicated in an e-mail that a payment made in connection with a sale in China appeared to be "a kick-back, pay-off, bribe, whatever you want to call it, . . . . in violation of US trade laws." A U.S.-based Maxwell executive replied that "this is a well know[n] issue" and he warned "[n]o more e-mails please."
The SEC alleges that Maxwell failed to devise and maintain an effective system of internal controls and improperly recorded the bribes on its books. The illicit sales and profits from the bribery scheme helped Maxwell offset losses that it incurred to develop its new products. Maxwell made corrections in its Form 10-Q filing for the quarter ended March 31, 2009.
Without admitting or denying the allegations in the SEC's complaint, Maxwell consented to the entry of a final judgment that permanently enjoins the company from future violations of Sections 30A, 13(a), 13(b)(2)(A), and 13(b)(2)(B) of the Securities Exchange Act of 1934, orders the company to pay $5,654,576 in disgorgement and $696,314 in prejudgment interest under a payment plan. The company also is required to comply with certain undertakings regarding its FCPA compliance program. Maxwell cooperated in the investigation.
Tracy L. Price and James Valentino of the SEC Enforcement Division's FCPA Unit conducted the investigation. The Commission acknowledges the assistance of the Department of Justice's Criminal Division-Fraud Section in its investigation, which is continuing.”

Clearly one way to get ahead of your competition is to pay bribes. It is a nasty situation when corporations pay bribes to foreign officials. However, it is even a nastier situation when corporations pay bribes to shameless U.S. lawmakers and judges in the form of campaign contributions and jobs for their relatives. It seems almost foolish to enforce laws overseas when the men who make and sit in judgment on such laws in the U.S. are perhaps some the most corrupt officials in the world.

SEC FILES CHARGES AGAINST FORMER GOLDMAN SACHS BOARD MEMBER

Insider information that comes from a low level insider might be hard to legitimize as a case worth pursuing if the insider has no financial gain from leaking information. However, when a high level executive or member of the board of directors of a major financial institution leaks the information to someone else in order to profit personally then, the case for insider trading can be easily made. The following is an excerpt from the SEC web site and it outlines a very compelling set of allegations against a former Goldman Sachs board member:

“Washington, D.C., March 1, 2011 – The Securities and Exchange Commission today announced insider trading charges against a Westport, Conn.-based business consultant who has served on the boards of directors at Goldman Sachs and Procter & Gamble for illegally tipping Galleon Management founder and hedge fund manager Raj Rajaratnam with inside information about the quarterly earnings at both firms as well as an impending $5 billion investment by Berkshire Hathaway in Goldman.
The SEC’s Division of Enforcement alleges that Rajat K. Gupta, a friend and business associate of Rajaratnam, provided him with confidential information learned during board calls and in other aspects of his duties on the Goldman and P&G boards. Rajaratnam used the inside information to trade on behalf of some of Galleon’s hedge funds, or shared the information with others at his firm who then traded on it ahead of public announcements by the firms. The insider trading by Rajaratnam and others generated more than $18 million in illicit profits and loss avoidance. Gupta was at the time a direct or indirect investor in at least some of these Galleon hedge funds, and had other potentially lucrative business interests with Rajaratnam.

The SEC has previously charged Rajaratnam and others in the widespread insider trading scheme involving the Galleon hedge funds.
“Gupta was honored with the highest trust of leading public companies, and he betrayed that trust by disclosing their most sensitive and valuable secrets,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “Directors who violate the sanctity of board room confidences for private gain will be held to account for their illegal actions.”
In the order that institutes administrative and cease-and-desist proceedings against Gupta, the SEC’s Division of Enforcement alleges that, while a member of Goldman’s Board of Directors, Gupta tipped Rajaratnam about Berkshire Hathaway’s $5 billion investment in Goldman and Goldman’s upcoming public equity offering before that information was publicly announced on Sept. 23, 2008. Gupta called Rajaratnam immediately after a special telephonic meeting at which Goldman’s Board considered and approved Berkshire’s investment in Goldman Sachs and the public equity offering. Within a minute after the Gupta-Rajaratnam call and just minutes before the close of the markets, Rajaratnam arranged for Galleon funds to purchase more than 175,000 Goldman shares. Rajaratnam later informed another participant in the scheme that he received the tip on which he traded only minutes before the market close. Rajaratnam caused the Galleon funds to liquidate their Goldman holdings the following day after the information became public, making illicit profits of more than $900,000.
The SEC’s Division of Enforcement alleges that Gupta also illegally disclosed to Rajaratnam inside information about Goldman Sachs’s positive financial results for the second quarter of 2008. Goldman Sachs CEO Lloyd Blankfein called Gupta and various other Goldman outside directors on June 10, when the company’s financial performance was significantly better than analysts’ consensus estimates. Blankfein knew the earnings numbers and discussed them with Gupta during the call. Between that night and the following morning, there was a flurry of calls between Gupta and Rajaratnam. Shortly after the last of these calls and within minutes after the markets opened on June 11, Rajaratnam caused certain Galleon funds to purchase more than 5,500 out-of-the-money Goldman call options and more than 350,000 Goldman shares. Rajaratnam liquidated these positions on or around June 17, when Goldman made its quarterly earnings announcement. These transactions generated illicit profits of more than $13.6 million for the Galleon funds.
The Division of Enforcement further alleges that Gupta tipped Rajaratnam with confidential information that he learned during a board posting call about Goldman’s impending negative financial results for the fourth quarter of 2008. The call ended after the close of the market on October 23, with senior executives informing the board of the company’s financial situation. Mere seconds after the board call, Gupta called Rajaratnam, who then arranged for certain Galleon funds to begin selling their Goldman holdings shortly after the financial markets opened the following day until the funds finished selling off their holdings, which had consisted of more than 120,000 shares. In discussing trading and market information that day with another participant in the insider trading scheme, Rajaratnam explained that while Wall Street expected Goldman Sachs to earn $2.50 per share, he had heard the prior day from a Goldman Sachs board member that the company was actually going to lose $2 per share. As a result of Rajaratnam’s trades based on the inside information that Gupta provided, the Galleon funds avoided losses of more than $3 million.
Gupta served as a Goldman board member from November 2006 to May 2010, and has been serving on Procter & Gamble's board since 2007.
As it pertains to insider trades by the Galleon funds in the securities of Procter & Gamble, the Division of Enforcement alleges that Gupta illegally disclosed to Rajaratnam inside information about the company financial results for the quarter ending December 2008. Gupta participated in a telephonic meeting of P&G’s Audit Committee at 9 a.m. on Jan. 29, 2009, to discuss the planned release of P&G’s quarterly earnings the next day. A draft of the earnings release, which had been mailed to Gupta and the other committee members two days before the meeting, indicated that P&G’s expected organic sales would be less than previously publicly predicted. Gupta called Rajaratnam in the early afternoon on January 29, and Rajaratnam shortly afterward advised another participant in the insider trading conspiracy that he had learned from a contact on P&G’s board that the company’s organic sales growth would be lower than expected. Galleon funds then sold short approximately 180,000 P&G shares, making illicit profits of more than $570,000.
The Division of Enforcement alleges that by engaging in the misconduct described in the SEC’s order, Gupta willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The administrative proceedings will determine what relief, if any, is in the public interest against Gupta, including disgorgement of ill-gotten gains, prejudgment interest, financial penalties, an officer or director bar, and other remedial relief.”

It is good to see the SEC investigating a board member at a major financial institution. However, it is hopeful that the SEC will pursue investigations of others at Goldman and other large institutions for financial malfeasance. It is best to be suspicious whenever a person of some importance is a target of an investigation. Sometimes wolves will sacrifice a pup in order to escape a bear.

SEC ALLEGES FORMER EXECUTIVE WITH BRIBING IRAQI OFFICIAL'S

The following is another case involving alleged bribery of foreign governments by an official working for a U. S. corporation. The charges are based upon the violation of the Foreign Corrupt Practices Act. For details please read the excerpt from the SEC web site:


The SEC “charged a former chief executive officer at Innospec, Inc., with violating the Foreign Corrupt Practices Act (FCPA) by approving bribes to government officials to obtain and retain business.
The SEC alleges that Paul W. Jennings learned of the company's longstanding practice of paying bribes to win orders for sales of tetraethyl lead (TEL) in mid- to late 2004 while serving as the CFO. After becoming CEO in 2005, Jennings and others in Innospec's management approved bribery payments to officials at the Iraqi Ministry of Oil (MoO) in order to sell the fuel additive to Iraq refineries. Innospec used its third-party agent in Iraq to funnel payments to Iraqi officials.

Jennings agreed to settle the SEC's charges against him. The SEC previously charged Innospec as well as its former TEL business director and its agent in Iraq with FCPA violations.
"This is the third enforcement action against an individual responsible for the widespread bribery that occurred at Innospec," said Cheryl J. Scarboro, Chief of the SEC's Foreign Corrupt Practices Act Unit. "We will vigorously hold accountable those individuals who approve such bribery and who sign false SOX certifications and other documents to cover up the wrongdoing."
According to the SEC's complaint filed in U.S. District Court for the District of Columbia, Jennings played a key role in Innospec's bribery activities in Iraq and Indonesia. Innospec, a manufacturer and distributor of fuel additives and other specialty chemicals, was charged last year for making illicit payments of approximately $6.3 million and promised an additional $2.8 million in illicit payments to Iraqi ministries and government officials as well as Indonesian government officials in exchange for contracts worth approximately $176 million.
The SEC alleges that Innospec made payments totaling more than $1.6 million and promised an additional $884,480 to MoO officials. For example, in an October 2005 e-mail copying Jennings, the agent said that Iraqi officials were demanding a 2 percent kickback and that "[w]e are sharing most of our profits with Iraqi officials. Otherwise, our business will stop and we will lose the market. We have to change our strategy and do more compensation to get the rewards." The kickback and later payments were paid by increasing the agent's commission, which Jennings approved. The SEC's complaint also alleges that Jennings was aware of the scheme to pay an official at the Trade Bank of Iraq in exchange for a favorable exchange rate on letters of credit. Another scheme involved a bribe to ensure the failure of a field test of a competitor product. A confidential MoO report for the field trial test was shared with Jennings. Bribes were offered to secure a 2008 Long Term Purchase Agreement that would have caused approximately $850,000 to be shared with Iraqi officials. The agreement, however, did not go forward due to the investigation and ultimate discovery by U.S. regulators of widespread bribery by Innospec.
According to the SEC's complaint, Innospec also paid bribes to Indonesian government officials from at least 2000 to 2005 in order to win contracts worth more than $48 million from state-owned oil and gas companies in Indonesia. Jennings became aware of and approved payments beginning in mid to late 2004. Various euphemisms to refer to the bribery were commonly used in e-mails and in discussions with Jennings and others at Innospec, including "the Indonesian Way," "the Lead Defense Fund," and "TEL optimization." Bribery discussions were held on a flight in the U.S. and even discussed at Jennings' performance review in 2005. In one bribery scheme with Pertamina, an Indonesian state owned oil and gas company, Innospec agreed, with approval by Jennings, to a "one off payment" of $300,000 to their Indonesian Agent with the understanding that it would be passed on to an Indonesian official.
The SEC's complaint also alleges that from 2004 to February 2009, Jennings signed annual certifications that were provided to auditors where he falsely stated that he had complied with Innospec's Code of Ethics incorporating the Company's FCPA policy. Jennings also signed annual and quarterly personal certifications pursuant to the Sarbanes-Oxley Act of 2002 in which he made false certifications concerning the company's books and records and internal controls.
Jennings has consented, without admitting or denying the SEC's allegations, to the entry of a final judgment that permanently enjoins him from violating Sections 30A and 13(b)(5) of the Securities Exchange Act of 1934 and Rules 13a-14, 13b2-1 and 13b2-2 thereunder, and from aiding and abetting Innospec's violations of Exchange Act Sections 30A, 13(b)(2)(A) and13(b)(2)(B). Jennings will disgorge $116,092 plus prejudgment interest of $12,945, and pay a penalty of $100,000 that takes into consideration Jennings's cooperation in this matter.
The SEC appreciates the assistance of the U.S. Department of Justice's Fraud Section, the Federal Bureau of Investigation, and the U.K.'s SFO in this matter. The SEC's investigation is continuing.”

It is good to see that there was cooperation between agencies in the investigation of this case. There have been many cases of bribery which violated the Foreign Corrupt Practices Act. It might be to the advantage of The United States if the State Department would seek severe punitive actions against nations that allow officials to seek out bribes.

BANKS ARE MAKING MONEY ACCORDING TO THE FDIC

The following excerpt from the FDIC shows that overall big banks are doing well and smaller banks are recovering:

"The fourth quarter 2010 FDIC Quarterly Banking Profile (QBP) is now available on line. FDIC-insured institutions reported an aggregate profit of $21.7 billion in the fourth quarter of 2010, a $23.5 billion improvement from the $1.8 billion net loss the industry reported in the fourth quarter of 2009. This is the sixth consecutive quarter that earnings registered a year-over-year increase. Almost two-thirds of all institutions (62 percent) reported improvements in their quarterly net income from a year ago. The average return on assets (ROA) rose to 0.65 percent, from negative 0.06 percent a year ago. Although community banks' aggregate return on assets lags the ROA for larger institutions, as a group they are recovering, as most community banks reported higher earnings than a year ago."

CANCER, A BIO-TECH COMPANY AND ALLEGED INSIDER TRAIDING

The Securities and Exchange Commission has a lot of territory to cover when it comes to uncovering insider trading frauds. The internationalization of securities trading has tempted many individuals to pass on insider information to friends and relatives living over seas. The hope of such fraudsters is to move their ill gotten profits along with themselves to a safe haven out side of the United States. In the following case the SEC alleges that a bio-tech manager arranged to have his relatives purchase stock options in the manager’s company after the manager became aware that there was a positive result for a cancer drug that his company was developing. The following excerpt came from the SEC website:

“Washington, D.C., Jan. 21, 2011 — The Securities and Exchange Commission today announced that it has obtained a court order freezing the bank and brokerage accounts controlled by an individual who made more than $800,000 in illegal profits by trading on inside information tipped to him by an employee of a Seattle-area biopharmaceutical firm.
In a complaint unsealed late Thursday by the U.S. District Court for the Western District of Washington, the SEC alleges that Zizhong (James) Fan, a manager at Seattle Genetics, told family member Zishen (Brandon) Fan about confidential positive trial results for the company's flagship cancer treatment. Zishen spent hundreds of thousands of dollars purchasing speculative stock options in the company as well as common stock, which skyrocketed in value when the news became public in late September 2010.

According to the SEC's complaint, the SEC staff contacted both Zizhong and Zishen last Thursday, January 13. Almost immediately after being contacted, Zishen attempted to wire several hundred thousand dollars to a bank in China while Zizhong informed his employer that he was leaving unexpectedly for China. The SEC thereafter filed an emergency enforcement action. On Wednesday, January 19, Judge Marsha J. Pechman of the Western District of Washington issued an order freezing brokerage and bank accounts containing the Seattle Genetics trading proceeds.

Marc Fagel, Director of the SEC's San Francisco Regional Office, explained, "While our investigation is at an early stage, when we have evidence of insider trading and the individuals involved respond to our investigation by trying to funnel their illicit profits offshore, we are prepared to take quick action to preserve those assets for recovery by the authorities."

The SEC's complaint alleges that Zizhong Fan, who lives in Bothell, Wash., was employed during 2010 as the manager of clinical programming at Seattle Genetics. He was involved in clinical trials for a development-stage product to be used in the treatment of Hodgkin's lymphoma. As Zizhong Fan began learning information about the success of those trials, Zishen Fan, who lives in Chino Hills, Calif., began amassing large quantities of risky stock options that would allow him to profit from a rise in the company's stock price.
The SEC's complaint alleges that on Sept. 24, 2010 — the day that Zizhong attended a series of meetings to finalize the results for presentation to the company's senior executives — Zishen made his largest options purchase to date (over 50 percent of the options trades in the entire market), while also buying $150,000 in stock. The next business day — September 27 — Seattle Genetics reported the positive results to the public, and its stock price rose nearly 18 percent. According to the SEC, Zishen ultimately realized net trading profits of more than $803,000.
The SEC's complaint charges Zizhong Fan and Zishen Fan with violating the antifraud provisions of the federal securities laws. The complaint seeks permanent injunctive relief, disgorgement of illicit profits with prejudgment interest, and monetary penalties. The SEC also named another family member Junhua Fan, who resides in the People's Republic of China, as a relief defendant in the case. His brokerage account was used by Zishen to make many of the illegal trades, according to the SEC's complaint.
The SEC's investigation was conducted by Jennifer J. Lee and Jina L. Choi of the San Francisco Regional Office. The case will be litigated by Robert L. Mitchell. The SEC would like to thank the Chicago Board Options Exchange for its assistance in this matter. The SEC also acknowledges the cooperation of Seattle Genetics.”

Insider trading is done all the time however; there is some debate about what information should constitute an actionable crime and what information may be justifiably obtained. If a business executive knows some secret information that he and his family try to profit from at the publics expense then clearly that could be considered a crime. But, what about a case where the businesses executive passes on the same information but does not profit in any way from its distribution? What if a low level accountant casually passes on insider information to an acquaintance about a large purchase the government just made from his company? Even a shipping clerk or truck driver might be privy to insider information regarding large purchases. The line between obtaining insider information from company personnel and doing research by talking to company personnel should make any investor feel uncomfortable.

SHEILA BAIR TESTIMONY ON DOOD-FRANK REFORM BILL

The following testimony of Sheila Bair, Chaiman of the FDIC was downloaded from the FDIC web site:

Statement of Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation on Implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act to the Committee on Banking, Housing, and Urban Affairs, U.S. Senate; 538 Dirksen Senate Office Building
February 17, 2011

Chairman Johnson, Ranking Member Shelby and members of the Committee, thank you for the opportunity to testify today on the Federal Deposit Insurance Corporation's (FDIC) progress in implementing the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act).
The recent financial crisis exposed grave shortcomings in our framework for regulating the financial system. Insufficient capital at many financial institutions, misaligned incentives in securitization markets and the rise of a largely unregulated shadow banking system bred excess and instability in our financial system that led directly to the crisis of September 2008. When the crisis hit, regulatory options for responding to distress in large, non-bank financial companies left policymakers with a no-win dilemma: either prop up failing institutions with expensive bailouts or allow destabilizing liquidations through the normal bankruptcy process. The bankruptcy of Lehman Brothers Holdings Inc. (Lehman) in September 2008 triggered a liquidity crisis at AIG and other institutions that froze our system of intercompany finance and made the 2007-09 recession the most severe since the 1930s.

The landmark Dodd-Frank Act enacted last year created a comprehensive new regulatory and resolution regime that is designed to protect the American people from the severe economic consequences of financial instability. The Dodd-Frank Act gave regulators tools to limit risk in individual financial institutions and transactions, enhance the supervision of large non-bank financial companies, and facilitate the orderly closing and liquidation of large banking organizations and non-bank financial companies in the event of failure. Recognizing the urgent need for reform and the importance of a deliberative process, the Act directed the FDIC and the other regulatory agencies to promulgate implementing regulations under a notice and comment process and to do so within specified timeframes. The FDIC is required or authorized to implement some 44 regulations, including 18 independent and 26 joint rulemakings. The Dodd-Frank Act also grants the FDIC new or enhanced enforcement authorities, new reporting requirements, and responsibility for numerous other actions.

We are now in the process of implementing the provisions of the Dodd-Frank Act as expeditiously and transparently as possible. The lessons of history – recent and distant – remind us that financial markets cannot function for long in an efficient and stable manner without strong, clear regulatory guidelines. We know all too well that the market structures in place prior to the crisis led to misaligned incentives, a lack of transparency, insufficient capital, and excessive risk taking. As a result, the U.S. and global economies suffered a grievous blow. Millions of Americans lost their jobs, their homes, or both, even as almost all of our largest financial institutions received assistance from the government that enabled them to survive and recover. Memories of such events tend to be short once a crisis has passed, but we as regulators must never forget the enormous economic costs of the inadequate regulatory framework that allowed the crisis to occur in the first place. At the same time, our approach must also account for the potential high cost of needless or ill-conceived regulation – particularly to those in the vital community banking sector whose lending to creditworthy borrowers is necessary for a sustained economic recovery.

My testimony will review the FDIC's efforts to date to implement the provisions of Dodd-Frank and highlight what we see as issues of particular importance.

Implementing the Resolution Authority and Ending Too Big To Fail

A significant number of the FDIC's rulemakings stem from the Dodd-Frank Act's mandate to end "Too Big to Fail." This includes our Orderly Liquidation Authority under Title II of the Act, our joint rulemaking with the Board of Governors of the Federal Reserve System (FRB) on requirements for resolution plans (or living wills) that will apply to systemically important financial institutions (SIFIs), and the development of criteria for determining which firms will be designated as SIFIs by the Financial Stability Oversight Council (FSOC).

Orderly Liquidation Authority

The Lehman bankruptcy in September 2008 demonstrated the confusion and chaos that can result when a large, highly complex financial institution collapses into bankruptcy. The Lehman bankruptcy had an immediate and negative effect on U.S. financial stability and has proven to be a disorderly, time-consuming, and expensive process. Unfortunately, bankruptcy cannot always provide the basis for an orderly resolution of a SIFI or preserve financial stability. To overcome these problems, the Dodd-Frank Act provides for an Orderly Liquidation Authority with the ability to: plan for a resolution and liquidation, provide liquidity to maintain key assets and operations, and conduct an open bidding process to sell a SIFI and its assets and operations to the private sector as quickly as possible.

While Title I of the Dodd-Frank Act significantly enhances regulators' ability to conduct advance resolution planning for SIFIs, Title II vests the FDIC with legal resolution authorities similar to those that it already applies to insured depository institutions (IDIs).

If the FDIC is appointed as receiver, it is required to carry out an orderly liquidation of the financial company. Title II also requires that creditors and shareholders "bear the losses of the financial company" and instructs the FDIC to liquidate a failing SIFI in a manner that maximizes the value of the company's assets, minimizes losses, mitigates risk, and minimizes moral hazard. Under this authority, common and preferred stockholders, debt holders and other unsecured creditors will know that they will bear the losses of any institution placed into receivership, and management will know that it could be replaced.

The new requirements will ensure that the largest financial companies can be wound down in an orderly fashion without taxpayer cost. Under Title II of the Dodd-Frank Act, there are no more bailouts. In implementing the Act's requirements, our explicit goal is that all market players should share this firm expectation and that financial institution credit ratings should, over time, fully reflect this fact. By developing a credible process for resolving a troubled SIFI, market discipline will be reinforced and moral hazard reduced.

From the FDIC's more than 75 years of bank resolution experience, we have found that clear legal authority and transparent rules on creditor priority are important elements of an orderly resolution regime. To that end, the FDIC issued an interim final rule implementing certain provisions of our Orderly Liquidation Authority on January 25, 2011. In the interim rule, the FDIC posed questions to solicit public comment on such issues as reducing moral hazard and increasing market discipline. We also asked for comment on guidelines that would create increased certainty in establishing fair market value of various types of collateral for secured claims. The rule makes clear that similarly situated creditors would never be treated in a disparate manner except to preserve essential operations or to maximize the value of the receivership as a whole. Importantly, this discretion will not be used to favor creditors based on their size or interconnectedness. In other words, there is no avenue for a backdoor bailout.

Comments on the interim rule and the accompanying questions will help us further refine the rule and bring more certainty to the industry as it navigates the recalibrated regulatory environment. This summer we expect to finalize other rules under our Title II authority that will govern the finer details of how the FDIC will wind down failed financial companies in receivership.

Resolution Plans

Even with the mechanism of the Orderly Liquidation Authority in place, ending "Too Big to Fail" requires that regulators obtain critical information and shape the structure and behavior of SIFIs before a crisis occurs. This is why the Dodd-Frank Act mandated in Title I that the FDIC and the FRB jointly establish requirements for these firms to maintain credible, actionable resolution plans that will facilitate their orderly resolution if they should fail. Without access to critical information contained in credible resolution plans, the FDIC's ability to implement an effective and orderly liquidation process could be significantly impaired.

As noted in my September testimony, the court-appointed trustee overseeing the liquidation of Lehman Brothers Inc. found that the lack of a disaster plan "contributed to the chaos" of the Lehman bankruptcy and the liquidation of its U.S. broker-dealer. Recognizing this, the Dodd-Frank Act created critical authorities designed to give the FDIC, the FRB, and the FSOC information from the largest potentially systemic financial companies that will allow for extensive advance planning both by regulators and by the companies themselves.

The Dodd-Frank Act requires the FDIC and the FRB jointly to issue regulations within 18 months of enactment to implement new resolution planning and reporting requirements that apply to bank holding companies with total assets of $50 billion or more and non-bank financial companies designated for FRB supervision by the FSOC.

Importantly, the statute requires both periodic reporting of detailed information by these financial companies and the development and submission of resolution plans that allow "for rapid and orderly resolution in the event of material financial distress or failure." The resolution plan requirement in the Dodd-Frank Act appropriately places the responsibility on financial companies to develop their own resolution plans in coordination with the FDIC and the FRB.

The Dodd-Frank Act lays out steps that must be taken with regard to the resolution plans. First, the FRB and the FDIC must review each company's plan to determine whether it is both credible and useful for facilitating an orderly resolution under the Bankruptcy Code. Making these determinations will necessarily involve the agencies having access to the company and relevant information. This new resolution plan regulation will require financial companies to look critically at the often highly complex and interconnected corporate structures that have emerged within the financial sector.

If a plan is found to be deficient, the company will be asked to submit a revised plan to correct any identified deficiencies. The revised plan could include changes in business operations and corporate structure to facilitate implementation of the plan. If the company fails to resubmit a plan that corrects the identified deficiencies, the Dodd-Frank Act authorizes the FRB and the FDIC jointly to impose more stringent capital, leverage or liquidity requirements. In addition, the agencies may impose restrictions on growth, activities, or operations of the company or any subsidiary. In certain cases, divestiture of portions of the financial company may be required. Just last month, Neil Barofsky, the Special Inspector General for the Troubled Asset Relief Program, recognized that this regulatory authority, including the ability to require divestiture, provides an avenue to convincing the marketplace that SIFIs will not receive government assistance in a future crisis.1 The FDIC is working with the FRB to develop requirements for these resolution plans. It is essential that we complete this joint rule as soon as possible.

SIFI Designation

The Dodd-Frank Act created the FSOC to plug important gaps between existing regulatory jurisdictions where financial risks grew in the years leading up to the recent crisis. An important responsibility of the FSOC is to develop criteria for designating SIFIs that will be subject to enhanced FRB supervision and the requirement to maintain resolution plans. To protect the U.S. financial system, it is essential that we have the means to identify which firms in fact qualify as SIFIs so we do not find ourselves with a troubled firm that is placed into a Title II liquidation without having a resolution plan in place.

Since enactment of the Dodd-Frank Act, experienced and capable staff from each of the member agencies have been collaborating in implementing the FSOC's responsibilities, including establishing the criteria for identifying SIFIs. The Dodd-Frank Act specifies a number of factors that can be considered when designating a non-bank financial company for enhanced supervision, including: leverage; off-balance-sheet exposures; and the nature, scope, size, scale, concentration, interconnectedness and mix of activities. The FSOC will develop a combination of qualitative and quantitative measures of potential risks posed by an individual nonbank institution to U.S. financial stability.

The nonbank financial sector encompasses a multitude of financial activities and business models, and potential systemic risks vary significantly across the sector. A staff committee working under the FSOC has segmented the nonbank sector into four broad categories: 1) the hedge fund, private equity firm, and asset management industries; 2) the insurance industry; 3) specialty lenders; and 4) broker-dealers and futures commission merchants. The Council has begun developing measures of potential risks posed by these firms. Once these measures are agreed upon, the FSOC may need to request data or information that is not currently collected or otherwise available in public filings.

Recognizing the need for accurate, clear, and high quality information, Congress granted the FSOC the authority to gather and review financial data and reports from nonbank financial companies and bank holding companies, and if appropriate, request that the FRB conduct an exam of the company for purposes of making a systemic designation. By collecting more information in advance of designation, the FSOC can be much more judicious in determining which firms it designates as SIFIs. This will minimize both the threat of an unexpected systemic failure and the number of firms that will be subject to additional regulatory requirements under Title I.

Last October, the FSOC issued an Advance Notice of Proposed Rulemaking regarding the criteria that should inform the FSOC's designation of nonbank financial companies. The FSOC received approximately 50 comments from industry trade associations, individual firms, and individuals. On January 26, the FSOC issued a Notice of Proposed Rulemaking, with a 30-day comment period, describing the criteria that will inform – and the processes and procedures established under the Dodd-Frank Act – the FSOC's designation of nonbank financial companies. The FDIC would welcome comments particularly on whether the rule can offer more specificity on criteria for SIFI designation. The FSOC is committed to adopting a final rule on this issue later this year, with the first designations to occur shortly thereafter.

Strengthening and Reforming the Deposit Insurance Fund

Prior to 2006, statutory restrictions prevented the FDIC from building up the Deposit Insurance Fund (DIF) balance when conditions were favorable in order to withstand losses under adverse conditions without sharply increasing premiums. The FDIC was also largely unable to charge premiums according to risk. In fact, it was unable to charge most institutions any premium as long as the DIF balance exceeded $1.25 per $100 of insured deposits. Congress enacted reforms in 2006 that permitted the FDIC to charge all banks a risk-based premium and provided additional, but limited, flexibility to the FDIC to manage the size of the DIF. The FDIC changed its risk-based pricing rules to take advantage of the new law, but the onset of the recent crisis prevented the FDIC from increasing the DIF balance. In this crisis, as in the previous one, the balance of the DIF became negative, hitting a low of negative $20.9 billion in December 2009. The DIF balance has improved in each subsequent quarter, and stood at negative $8.0 billion as of last September. Through a special assessment and the prepayment of premiums, the FDIC took the necessary steps to ensure that it did not have to rely on taxpayer funds during the crisis to protect insured depositors.

In the Dodd-Frank Act, Congress revised the statutory authorities governing the FDIC's management of the DIF. The FDIC now has the ability to achieve goals for deposit insurance fund management that it has sought to achieve for decades but has lacked the tools to accomplish. The FDIC has increased flexibility to manage the DIF to maintain a positive fund balance even during a banking crisis while maintaining steady and predictable assessment rates throughout economic and credit cycles.

Specifically, the Dodd-Frank Act raised the minimum level for the Designated Reserve Ratio (DRR) from 1.15 percent to 1.35 percent and removed the requirement that the FDIC pay dividends of one-half of any amount in the DIF above a reserve ratio of 1.35 percent. The legislation allows the FDIC Board to suspend or limit dividends when the reserve ratio exceeds 1.50 percent.

FDIC analysis has shown that the dividend rule and the reserve ratio target are among the most important factors in maximizing the probability that the DIF will remain positive during a crisis, when losses are high, and in preventing sharp upswings in assessment rates, particularly during a crisis. This analysis has also shown that at a minimum the DIF reserve ratio (the ratio of the DIF balance to estimated insured deposits) should be about 2 percent in advance of a banking crisis in order to avoid high deposit insurance assessment rates when banking institutions are strained and least able to pay.

Consequently, the FDIC Board completed two rulemakings, one in December 2010, and one earlier this month, that together form the basis for a long-term strategy for DIF management and achievement of the statutorily required 1.35 percent DIF reserve ratio by September 30, 2020. The FDIC Board adopted assessment rates that will take effect on April 1, 2011. The Board also adopted lower rates that will take effect when the DIF reserve ratio reaches 1.15 percent, which we expect will approximate the long-term moderate, steady assessment rate that would have been needed to maintain a positive fund balance throughout past crises. The DRR was set at 2 percent, consistent with our analysis of a long-term strategy for the DIF, and dividends were suspended indefinitely. In lieu of dividends, the rules set forth progressively lower assessment rate schedules when the reserve ratio exceeds 2 percent and 2.5 percent.

These actions increase the probability that the fund reserve ratio will reach a level sufficient to withstand a future crisis, while maintaining moderate, steady, and predictable assessment rates. Indeed, banking industry participants at an FDIC Roundtable on deposit insurance last year emphasized the importance of stable, predictable assessments in their planning and budget processes. Moreover, actions taken by the FDIC's current Board of Directors as a result of the Dodd-Frank Act should make it easier for future Boards to resist inevitable calls to reduce assessment rates or pay larger dividends at the expense of prudent fund management and counter-cyclical assessment rates.

The Dodd-Frank Act also requires the FDIC to redefine the base used for deposit insurance assessments as average consolidated total assets minus average tangible equity. Earlier this month, the FDIC Board issued a final rule implementing this requirement. The rule establishes measures for average consolidated total assets and average tangible equity that draw on data currently reported by institutions in their Consolidated Report of Condition and Income or Thrift Financial Report. In this way, the FDIC has implemented rules that minimize the number of new reporting requirements needed to calculate deposit insurance assessments. As provided by the Dodd-Frank Act, the FDIC's rule adjusted the assessment base for banker's banks and custodial banks.

Using the lessons learned from the most recent crisis, our rule changed the large bank pricing system to better differentiate for risk and better take into account losses from large institution failures that the FDIC may incur. This new system goes a long way toward reducing the pro-cyclicality of the risk-based assessment system by calculating assessment payments using more forward-looking measures. The system also removes reliance on long-term debt issuer ratings consistent with the Dodd-Frank Act.

The FDIC projects that the change to a new, expanded assessment base will not materially change the overall amount of assessment revenue that the FDIC would have collected prior to adoption of these rules. However, the change in the assessment base, in general, will result in shifting more of the overall assessment burden away from community banks and toward the largest institutions, which rely less on domestic deposits for their funding than do smaller institutions, as Congress intended.

Under the new assessment base and large bank pricing system, the share of the assessment base held by institutions with assets greater than $10 billion will increase from 70 percent to 78 percent, and their share of overall dollar assessments will increase commensurately from 70 percent to 79 percent. However, because of the combined effect of the change in the assessment base and increased risk differentiation among large banks in the new large bank pricing system, many large institutions will experience significant changes in their overall assessments. The combined effect of changes in this final rule will result in 59 large institutions paying lower dollar assessments and 51 large institutions paying higher dollar assessments (based upon September 30, 2010 data). In the aggregate, small institutions will pay 30 percent less, due primarily to the change in the assessment base, thus fewer than 100 of the 7,600 plus small institutions will pay higher assessments.

Strengthening Capital Requirements

One of the most important mandates of the Dodd Frank Act is Section 171—the Collins Amendment—which we believe will do more to strengthen the capital of the U.S. banking industry than any other section of the Act.

Under Section 171 the capital requirements that apply to thousands of community banks will serve as a floor for the capital requirements of our largest banks, bank holding companies and nonbanks supervised by the FRB. This is important because in the years before the crisis, U.S. regulators were embarking down a path that would allow the largest banks to use their own internal models to set, in effect, their own risk-based capital requirements, commonly referred to as the "Basel II Advanced Approach."

The premise of the Advanced Approach was that the largest banks, because of their sophisticated internal-risk models and superior diversification, simply did not need as much capital in relative terms as smaller banks. The crisis demonstrated the fallacy of this thinking as the models produced results that proved to be grossly optimistic.

Policymakers from the Basel Committee to the U.S. Congress have determined that this must not happen again. Large banks need the capital strength to stand on their own. The Collins Amendment assures that whatever advances in risk modeling may come to pass, they will not be used to allow the largest banks to operate with less capital than our nation's Main Street banks.

The federal banking agencies currently have out for comment a Notice of Proposed Rulemaking to implement Section 171 by replacing the transitional floor provisions of the Advanced Approach with a permanent floor equal to the capital requirements computed under the agencies' general risk-based capital requirements. The proposed rule would also amend the general risk-based capital rules in way designed to give additional flexibility to the FRB in crafting capital requirements for designated nonbank SIFIs.

The Collins Amendment, moreover, does more than this. While providing significant grandfathering and exemptions for smaller banking organizations, the amendment also mandates that the holding company structure for larger organizations not be used to weaken consolidated capital below levels permitted for insured banks. That aspect of the Collins Amendment, which ensures that bank holding companies will serve as a source of strength for their insured banks, will be addressed in a subsequent rulemaking.

The Dodd-Frank Act also required regulators to eliminate reliance on credit ratings in our regulations. As you know, our regulatory capital rules and Basel II currently rely extensively on credit ratings. Last year, the banking agencies issued an Advance Notice of Proposed Rulemaking seeking industry comment on how we might design an alternative standard of credit worthiness. Unfortunately, the comments we received, for the most part, lacked substantive suggestions on how to approach this question. While we have removed any reliance on credit ratings in our assessment regulation, developing an alternative standard of creditworthiness for regulatory capital purposes is proving more challenging. The use of credit ratings for regulatory capital covers a much wider range of exposures; we cannot rely on non-public information, and the alternative standard should be usable by banks of all sizes. We are actively exploring a number of alternatives for dealing with this problem.

Separately and parallel to the Dodd-Frank Act rulemakings, the banking agencies are also developing rules to implement Basel III proposals for raising the quality and quantity of regulatory capital and setting new liquidity standards. The agencies issued a Notice of Proposed Rulemaking in January that proposes to implement the Basel Committee's 2009 revisions to the Market Risk Rule. We expect to issue a Notice of Proposed Rulemaking that will seek comment on our plans to implement Basel III later this year.

Reforming Asset-backed Securitization

The housing bust and the financial crisis arose from a historic breakdown in U.S. mortgage markets. While emergency policies enacted at the height of the crisis have helped to stabilize the financial system and plant the seeds for recovery, mortgage markets remain deeply mired in credit distress and private securitization markets remain largely frozen. Moreover, serious weaknesses identified with mortgage servicing and foreclosure are now introducing further uncertainty into an already fragile market.

It is clear that the mortgage underwriting practices that led to the crisis, which frequently included loans with low or no documentation in addition to other risk factors such as impaired credit histories or high loan-to-value ratios, must be significantly strengthened. To this point, this has largely been accomplished through the heightened risk aversion of lenders, who have significantly tightened standards, and investors, who have largely shunned private securitization deals. Going forward, however, risk aversion will inevitably decline and there will be a need to ensure that lending standards do not revert to the risky practices that led to the last crisis.

In the case of portfolio lenders, underwriting policies are subject to scrutiny by federal and state regulators. While regulators apply standards of safe and sound lending, they typically do not take the form of pre-specified guidelines for the structure or underwriting of the loans. For these portfolio lenders, the full retention of credit risk by the originating institution tends to act as a check on the incentive to take risks. Provided that the institution is otherwise well capitalized, well run, and well regulated, the owners and managers of the institution will bear most of the consequences for risky lending practices. By contrast, the crisis has illustrated how the mortgage securitization process is somewhat more vulnerable to the misalignment of incentives for originators and securities issuers to limit risk taking, because so much of the credit risk is passed along to investors who may not exercise due diligence over loan quality.

The excessive risk-taking inherent in the originate-to-distribute model of lending and securitization was specifically addressed in the Dodd-Frank Act by two related provisions. One provision, under Section 941 of the Act, mandates that the FSOC agencies write rules that require the securitizers (and, in certain circumstances, originators) of asset-backed securities to retain not less than 5 percent of the credit risk of those securities. The purpose of this provision is to encourage more careful lending behavior by preventing securitizers from avoiding the consequences of their risk-taking. Section 941 also mandates that the agencies define standards for Qualifying Residential Mortgages (QRMs) that will be exempt from risk retention when they are securitized. An interagency committee is working to define both the mechanism for risk retention and standards for QRMs.

Defining an effective risk retention mechanism and QRM requirements are somewhat complex tasks that have required extensive deliberation among the agencies. Because securitization structures and the compensation of securitizers can take many alternate forms, it is important that the rule be structured in a way that will minimize the ability of issuers to circumvent its intent. While we continue to work to move these rules forward without delay, we are also determined to get them right the first time. The confidence of the marketplace in these rules may well determine the extent to which private securitization will return in the wake of the crisis.

Long-term confidence in the securitization process cannot be restored unless the misalignment of servicing incentives that contributed to the present crisis is also addressed through these rules. There is ample research showing that servicing practices are critically important to mortgage performance and risk.2 Regulators must use both their existing authorities and the new authorities granted under the Dodd-Frank Act to establish standards for future securitizations to help assure that, as the private securitization market returns, incentives for loss mitigation and value maximization in mortgage servicing are appropriately aligned.

The FDIC took a significant step in this regard when updating our rules for safe harbor protection with regard to the treatment of securitized assets in failed bank receiverships. Our final rule, approved in September, established standards for loan level disclosure, loan documentation, compensation and oversight of servicers. It includes incentives to assure that loans are made and managed in a way that achieves sustainable lending and maximizes value for all investors. There is already evidence of market acceptance of these guidelines in the $1.2 billion securitization issue by Ally Bank earlier this month, which fully conformed to the FDIC safe harbor rules for risk retention.

In short, the desired effect of the risk retention and QRM rules will be to give both loan underwriting and administration and loan servicing much larger roles in credit risk management. Lenders and regulators need to embrace the lessons learned from this crisis and establish a prudential framework for extending credit and servicing loans on a sounder basis. Servicing provisions that should be part of the QRM rule include disclosure of ownership interests in second-liens by servicers of a first mortgage and appropriate compensation incentives.

Better alignment of economic incentives in the securitization process will not only address key safety-and-soundness and investor concerns, but will also provide a stronger foundation for the new Consumer Financial Protection Bureau (CFPB) as it works to improve consumer protections for troubled borrowers in all products and by all servicers.

Additional Implementation Activities

While we have focused on the important ongoing reforms where the Dodd-Frank Act assigned a significant role to the FDIC, we have been pleased to work closely with the other regulators on several other critical aspects of the Act's implementation.

Earlier this month, the FDIC Board approved a draft interagency rule to implement Section 956 of the Dodd-Frank Act, which sets forth rules and procedures governing the awarding of incentive compensation in covered financial institutions. Implementing this section will help address a key safety-and-soundness issue that contributed to the recent financial crisis – namely, that poorly designed compensation structures and poor corporate governance can misalign incentives and induce excessive risk taking within financial organizations. The proposed rule is proportionate to the size and complexity of individual banks and does not apply to banks with less than $1 billion in assets. For the largest firms, those with over $50 billion in assets, the proposal requires deferral of a significant portion of the incentive compensation of identified executive officers for at least three years and board-level identification and approval of the incentive compensation of employees who can expose the firm to material loss.

Another important reform under the Dodd-Frank Act is the Volcker Rule, which prohibits proprietary trading and acquisition of an interest in hedge or private equity funds by IDIs. The FSOC issued its required study of proprietary trading in January of this year, and joint rules implementing the prohibition on such trading are due by October of this year. The federal banking agencies will be working together, with the FSOC coordinating, to issue a final rule by the statutory deadline.

In addition to these rulemakings, the FDIC has a number of other implementation responsibilities, including new reporting requirements and mandated studies. Among the latter is a study to evaluate the definitions of core and brokered deposits. As part of this study, we are hosting a roundtable discussion next month to gather valuable input from bankers, deposit brokers, and other market participants.

Preparation for Additional Responsibilities

The FDIC Board of Directors has recently undertaken a number of organizational changes to ensure the effective implementation of our responsibilities pursuant to the Dodd-Frank Act.

As I previously described in my September testimony before this Committee, the FDIC has made organizational changes in order to enhance our ability to carry out the Dodd-Frank Act responsibilities, as well as our core responsibilities for risk management supervision of insured depository institutions and consumer protection. The new Office of Complex Financial Institutions (OCFI) will be responsible for orderly liquidation authority, resolution plans, and monitoring risks in the SIFIs. The Division of Depositor and Consumer Protection will focus on the FDIC's many responsibilities for depositor and consumer protection.

In response to the Committee's request for an update about the transfer of employees to the new CFPB, I can report that we continue to work with the Treasury Department and the other banking agencies on the transfer process of employees to ensure a smooth transition. The number of FDIC employees detailed to the CFPB will necessarily be limited since the FDIC retains the compliance examination and enforcement responsibilities for most FDIC-regulated institutions with $10 billion or less in assets. Nonetheless, there are currently seven FDIC employees being detailed to the Treasury Department and the CFPB to work on a wide range of examination and legal issues that will confront the CFPB at its inception. There are also several more employees who have expressed interest in assisting the CFPB and are being evaluated by the Treasury Department. Recognizing that FDIC employees have developed expertise, skills, and experience in a number of areas of benefit to the CFPB, our expectation has been that a number of employees would actively seek an opportunity to assist the CFPB in its earliest stages, or on a more permanent basis.

Finally, consistent with the requirements of Section 342, the FDIC in January established a new Office of Minority and Women Inclusion (OMWI). Transferring the existing responsibilities and employees of the FDIC's former Office of Diversity and Economic Opportunity into the new OMWI has allowed for a smooth transition and no disruption in the FDIC's ongoing diversity and outreach efforts. Our plans for the OMWI include the addition of a new Senior Deputy Director and other staff as needed to ensure that the new responsibilities under Section 342 are carried out, as well as an OMWI Steering Committee which will promote coordination and awareness of OMWI responsibilities across the FDIC and ensure that they are managed in the most effective manner.

Regulatory Effectiveness

The FDIC recognizes that while the changes required by the Dodd-Frank Act are necessary to establish clear rules that will ensure a stable financial system, these changes must be implemented in a targeted manner to avoid unnecessary regulatory burden. We are working on a number of fronts to achieve that necessary balance. An example is the recent rule to change the deposit insurance assessment system, which relied as much as possible on the current regulatory reporting structure. Although some additional reporting will be required for some institutions, most institutions should see their reporting burden unchanged or slightly reduced as some items that were previously required will no longer be reported.

At the January 20 meeting of the FDIC's Advisory Committee on Community Banking, we engaged the members – mostly bankers themselves – in a full and frank discussion of other ways to ease the regulatory burden on small institutions. Among the ideas discussed at that meeting were:

Conduct a community bank impact analysis with respect to implementation of regulations under the Dodd-Frank Act,
Identify which questionnaires and reports can be streamlined through automation,
Review ways to reduce the total amount of reporting required of banks,
Impose a moratorium on changes to reporting obligations until some level of regulatory burden reduction has been achieved,
Develop an approach to bank reporting requirements that is meaningful and focuses on where the risks are increasing, and
Ensure that community banks are aware that senior FDIC officials are available and interested in receiving their feedback regarding our regulatory and supervisory process.
The FDIC is particularly interested in finding ways to eliminate unnecessary regulatory burden on community banks, whose balance sheets are much less complicated than those of the larger banks. Our goal is to facilitate more effective and targeted regulatory compliance. To this end, we have established as a corporate performance goal for the first quarter of 2011 to modify the content of our Financial Institution Letters (FILs) -- the vehicle used to alert banks to any regulatory changes or guidance -- so that every FIL issued will include a section making clear the applicability to smaller institutions (under $1 billion). In addition, by June 30 we plan to complete a review of all of our recurring questionnaires and information requests to the industry and to develop recommendations to improve the efficiency and ease of use and a plan to implement these changes.

The FDIC has challenged its staff to find additional ways of translating some of these ideas into action. This includes launching an intensive review of existing reporting requirements to identify areas for streamlining. We have also initiated a process whereby, as part of every risk management examination, we will solicit the views of the institution on aspects of the regulatory and supervisory process that may be adversely affecting credit availability.

Above all, it is important to emphasize to small and mid-sized financial institutions that the Dodd-Frank reforms are not intended to impede their ability to compete in the marketplace. On the contrary, we expect that these reforms will do much to restore competitive balance to the marketplace by restoring market discipline and appropriate regulatory oversight to systemically important financial companies, many of which received direct government assistance in the recent crisis.

Conclusion

In implementing the Dodd-Frank Act, it is important that we continue to move forward with dispatch to remove unnecessary regulatory uncertainties faced by the market and the industry. In passing the Act, the Congress clearly recognized the need for a sounder regulatory framework within which banks and other financial companies could operate under rules that would constrain the excessive risk taking that caused such catastrophic losses to our financial system and our economy during the financial crisis.

In the wake of the passage of the Act, it is essential that this implementation process move forward both promptly and deliberately, in a manner that resolves uncertainty as to what the new framework will be and that promotes long-term confidence in the transparency and stability of our financial system. Throughout this process, regulators must maintain a clear view of the costs of regulation – particularly to the vital community banking sector – while also never forgetting the enormous economic costs of the inadequate regulatory framework that allowed the crisis to occur in the first place. We have a clear obligation to members of the public who have suffered the greatest losses as a result of the crisis to prevent such an episode from ever recurring again.

Thank you for the opportunity to testify.

SEC CHARGES NEW YORK INVESTMENT FIRMS WITH FRAUD

Fraud is a common crime in the world of finance. The excerpt from the SEC website below covers a case where a company allegedly had officers that misled investors, misused funds and obtained fraudulent loans to cover the misuse of funds:

“Washington, D.C., Jan. 20, 2011 — The Securities and Exchange Commission today charged three affiliated New York-based investment firms and four former senior officers with fraud, misuse of client assets, and other securities laws violations involving their $66 million advisory business.

The SEC alleges that the operation’s investment adviser William Landberg and president Kevin Kramer — through the firms West End Financial Advisors LLC (WEFA), West End Capital Management LLC (WECM), and Sentinel Investment Management Corporation — misled investors into believing that their money was in stable, safe investments designed to provide steady streams of income. However, in reality West End faced deepening financial problems stemming from Landberg’s failed investment strategies. When starved for cash to meet obligations of the West End funds or for his personal needs, Landberg misused investor assets, fraudulently obtained more than $8.5 million from a bank, and used millions of dollars from an interest reserve account for unauthorized purposes.
The SEC also charged West End’s chief financial officer Steven Gould and controller Janis Barsuk for their roles in the scheme.
“The investment advisers here grossly abused the trust of their clients,” said George S. Canellos, Director of the SEC’s New York Regional Office. “They misappropriated and commingled their clients’ assets and sustained the illusion of a viable and successful business through a range of false representations.”
David Rosenfeld, Associate Director of the SEC’s New York Regional Office, added, “West End raised millions from investors by touting false positive returns while concealing fraudulent bank loans, cash flow problems, and the misappropriation of investor assets.”
According to the SEC’s complaint filed in U.S. District Court for the Southern District of New York, the misconduct occurred from at least January 2008 to May 2009. The SEC alleges that Landberg used substantial amounts of fraudulently-obtained bank loans to make distributions to certain West End fund investors, thereby sustaining the illusion that West End’s investments were performing well. During the same period, Landberg also misappropriated at least $1.5 million for himself and his family. Landberg’s wife Louise Crandall and their family partnership are named as relief defendants in the SEC’s complaint.
The SEC further alleges that Gould and Barsuk knew, or were reckless in not knowing, that Landberg was defrauding a bank that provided loans to a West End fund by misusing funds in a related interest reserve account. Both officers nevertheless participated in the fraud by facilitating Landberg’s misappropriations from that account. The SEC alleges that Gould conceived and used improper accounting methods to conceal aspects of the fraud, and he issued account statements to investors showing false investment returns. Barsuk facilitated Landberg’s uses of investor money to cover his personal obligations. Similarly, Kramer knew, or was reckless in not knowing, that West End faced severe financial problems and had difficulty obtaining sufficient financing to sustain its investment strategy. Nevertheless, Kramer failed to disclose those material facts to investors as he continued to market the funds to new and existing investors through April 2009.
The SEC charged Landberg, Kramer, Gould, WEFA, WECM, and Sentinel with violations of the antifraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. In addition, Landberg, WEFA, WECM, and Sentinel are charged with violating the antifraud provisions of the Investment Advisers Act of 1940. Kramer, Gould, and Barsuk are charged with aiding and abetting violations of the Advisers Act. Barsuk is also charged with aiding and abetting violations of the antifraud provisions of the Exchange Act. The SEC seeks to enjoin each defendant from future violations of the securities laws as well as monetary relief, the imposition of an independent monitor, and certain other sanctions.
The SEC acknowledges the assistance of the U.S. Attorney for the Southern District of New York, the Federal Bureau of Investigation, and the U.S. Commodity Futures Trading Commission.”

It should become clear that a lot of people who run financial organizations may not have their clients best interest at heart. It is not just corruption that makes organizations and individuals unfit in carrying out fiduciary obligations to their clients but, many times incompetence not fraud is the real problem.

MORE ALLEGED INSIDER TRAIDNG

Many people are still afraid of investing in the equities markets. It seems that many people believe that the securities market is really just a big fraud with certain traders with inside information making millions of dollars off the sinking investment accounts of hard working Americans. The following case alleges a grand conspiracy to trade on inside information which was not available to the general public:

“ Washington, D.C., Feb. 8, 2011 — The Securities and Exchange Commission today charged a New York-based hedge fund and four hedge fund portfolio managers and analysts who illegally traded on confidential information obtained from technology company employees moonlighting as expert network consultants. The scheme netted more than $30 million from trades based on material, nonpublic information about such companies as AMD, Seagate Technology, Western Digital, Fairchild Semiconductor, and Marvell

The charges are the first against traders in the SEC’s ongoing investigation of insider trading involving expert networks. The SEC filed its initial charges in the case last week against technology company employees who illegally tipped hedge funds and other investors with material nonpublic information about their companies in return for hundreds of thousands of dollars in sham consulting fees.
In its amended complaint filed today in federal court in Manhattan, the SEC alleges that four hedge fund portfolio managers and analysts received illegal tips from the expert network consultants and then caused their hedge funds to trade on the inside information.
“It is illegal for company insiders who moonlight as consultants to sell confidential information about their companies to traders, and it is equally illegal to buy that corruptly obtained information and trade on it,” said Robert Khuzami, Director of the SEC’s Division of Enforcement. “Instead of competing on a level playing field with other investors, these hedge fund managers sought to illegally trade today on what others would not learn until tomorrow.”
The SEC’s ongoing investigation is focusing on the activities of expert networks that purportedly provide professional investment research to their clients. While it is legal to obtain expert advice and analysis through expert networking arrangements, it is illegal to trade on material nonpublic information obtained in violation of a duty to keep that information confidential.
The technology company insiders who tipped the confidential information were expert network consultants to the firm Primary Global Research LLC (PGR).
The SEC’s amended complaint alleges:
Samir Barai of New York, N.Y., the founder and portfolio manager of Barai Capital Management, obtained inside information about several technology firms from company insiders, and then traded on the inside information on behalf of Barai Capital.
Jason Pflaum of New York, N.Y., a former technology analyst at Barai Capital Management, obtained inside information about technology companies and shared it with Barai. After Pflaum shared the confidential information with him, Barai used it to illegally trade on behalf of Barai Capital.
Noah Freeman of Boston, Mass., a former managing director at a Boston-based hedge fund, obtained inside information regarding Marvell and shared it with Donald Longueuil of New York, N.Y., a former managing director at a Connecticut-based hedge fund. Longueuil caused his hedge fund to trade on the inside information. Freeman also obtained inside information about another technology company and caused his hedge fund to trade on the nonpublic information.
The SEC’s amended complaint charges each of the defendants with violations of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and additionally charges Barai, Pflaum, Freeman and Longueuil with aiding and abetting others’ violations of Section 10(b) and Rule 10b-5 thereunder. The complaint also charges Barai, Pflaum and Barai Capital with violations of Section 17(a) of the Securities Act of 1933. The complaint seeks a final judgment permanently enjoining the defendants from future violations of the above provisions of the federal securities laws, ordering them to disgorge their ill-gotten gains plus prejudgment interest, and ordering them to pay financial penalties.”

Divining what is going to happen in the future is a key to financial success. If you were to invest in a company that makes horse shoes because you believe horses will replace automobiles in the near future then you might be making a bad investment. On the other hand, if you invest in a technology company because you know of a big contract that company was about to receive then you might just be making a good investment. Of course if you invest in the aforementioned company when only corporate officials knew about the contract then you will make lots of money with virtually no risk.