Time	Speaker	Text
00:00:17	REP. KANJORSKI	(Gavel sounds.) The committee will come to order. Without objection, the rules of the House and of the Committee on Financial Services for the 110th Congress will apply to today's proceeding. The committee is meeting today to discuss "Assessing the Madoff Ponzi Scheme and the Need for Regulatory Reform." Without objection, all members' opening statements will be made a part of the record.
00:00:38	REP. SPENCER BACHUS (R-AL)	Mr. Chairman?
00:00:38	REP. KANJORSKI	The gentleman?
00:00:40	REP. BACHUS	Reserving the right to object, I do not intend to object. And I'm glad you raised the issue of process. Because the 110th Congress has officially concluded, and the new Congress will not be sworn in until tomorrow, today's proceeding is being held in what I would call a "parliamentary gray area," because the Financial Services committee, as a technical matter, does not exist. Any record of today's proceedings will not count as an official record of the committee. And while all of us want to get to the bottom of the Madoff scandal as quickly as possible -- and I commend the chairman for calling for this hearing, in fact, immediately following the stories breaking about it, I asked Chairman Frank to hold a hearing as soon as possible after the 111th Congress convenes -- and we all also want to follow regular order, if at all possible, and operate in a way that does not cast doubt on the legitimacy of our proceedings. And for that reason, I wish we had waited until after tomorrow's swearing in of the new Congress, until the formal organization of the committee, to hold this hearing. But, having said that, I don't object to the conducting today's proceeding as if it is an official hearing of the committee, and I, therefore, withdraw my objection to the committee's unanimous request -- unanimous consent request.
00:02:21	REP. BARNEY FRANK (D-MA)	Mr. Chairman, I would reserve the right to object, although if -- I'm not sure of the procedure, given what the gentleman said -- reserving the right to object would appear to be, in a positive sense, we're just a bunch of guys talking. But, I'm glad we are because that's important. First of all, I don't see any possible harm that could come from having this meeting. I don't see even the suggestion of procedural irregularity, when the gentleman says "regular order." We are a group of members. We're here voluntarily. Members who don't want to participate can leave. He says that the record will have no formal role. Frankly, I haven't seen that it has had (yet ?). (Even though we ?) have a hearing, I'm not sure what it would be, unless you're trying to prosecute someone for perjury, and we've never sworn people in during the chairmanship here. The other thing I would say is this, the gentleman said --
00:02:21	REP. BACHUS	-- (inaudible) --
00:02:21	REP. FRANK	-- wait, here's the real point I wanted to make -- in January of 2007 we were not officially constituted a committee with our new members until January 31st. That is, we would not have overcome the obstacle the gentleman raised, to it being the regular committee, if we had waited until tomorrow or the day after, because the swearing in of the members does not constitute the committee under the rules of the House. We don't yet know who the new members will be on our side. I'm not sure -- I'm told by the Republican side they may not seat your new members until next week. So, I want to say this is the initiative of the gentleman from Pennsylvania, who was chairman of the subcommittee in the last Congress -- and I will go out on a limb and predict will be chairman of the subcommittee in the next Congress, although I acknowledge that's an open question, I don't want to prejudice things, but I think he's well in the lead now for that job. And if we had not done it today, at his initiative, we would not have been able to do it for several weeks, possibly, to meet that requirement. So, for that reason, I just wanted to say that I think what the gentleman from Pennsylvania did was very appropriate. And nothing here will prevent us from reconvening at a later time, or convening as the official committee for whatever we want to do.
00:04:21	REP. MEL WATT (D-NC)	Would the gentleman yield on his --
00:04:21	REP. FRANK	Yes.
00:04:21	REP. WATT	I would just observe that everybody else here is overdressed for this occasion. (Laughter.) So, it's obvious that I thought it was less than formal, so -- (Cross talk.)
00:04:36	REP. FRANK	Oh, I appreciate it.
00:04:36	REP. WATT	-- I yield back to the gentleman.
00:04:36	REP. FRANK	Taking back my time, could I get a testimony from the gentleman in writing that I showed up overdressed? (Laughter.)
00:04:44	REP. WATT	I think I would ask unanimous consent that we recognize that. (Laughter.)
00:04:48	REP. FRANK	I thank the -- I thank the gentleman, and I withdraw my (reservation ?).
00:04:51	REP. BACHUS	Yes, Mr. Chairman, I'd like unanimous consent to introduce my letter of December 17th calling for this -- for calling for a hearing, not a meeting. But, having said that, I think a meeting is great.
00:05:03	REP. KANJORSKI	Without objection, it will be entered into the record. All right, but a little note on the gentleman from Alabama's question: it is the intent of the chair, that as soon as our committees are constituted, to make the appropriate motions to incorporate, by reference, this meeting today to make it have the full force and effect of a committee hearing. I think that's under the rules -- (inaudible) --. So, we were aware of the fact that -- quite frankly, and in all honesty, I was hoping we didn't lose the time -- that there seems to be a great deal of information that can be gained now, and a lot of insight, that (it would ?) start very early. So, that's why we took these unusual steps. I think we're also proving to the American people that the Congress has the capacity to work even when we're not officially yet constituted as a body, or as a committee.
00:05:58	REP. BACHUS	And, thank you. Mr. Chairman, all I was pointing out is that -- is the hearing, technically, it's (just ?) not a hearing.
00:06:06	REP. KANJORSKI	It will be in the future.
00:06:06	REP. BACHUS	And I commend the -- I commend the chairman for calling this meeting.
00:06:13	REP. KANJORSKI	Thank you. We meet today to begin to understand how Bernard Madoff allegedly swindled thousands of innocent investors, effectively stole billions of dollars and evaded securities regulators already tipped off about this unprecedented alleged Ponzi scheme. The allegations that Mr. Madoff stands at the center of a $50 billion scam simply shock the conscience. These deeply disturbing events have raised even more troubling questions about the effectiveness of our regulatory system. I have long stressed the need for pursuing comprehensive regulatory reform, and I have convened hearings to advance these initiatives in the past. But, before we act on legislation in the 111th Congress to restructure the regulatory system for the financial services industry and enhance investor protection, we need to understand how Mr. Madoff organized his many business operations and how he perpetrated his alleged fraudulent acts. Today we will hear from experts in the financial world, including the inspector general, the head of the Securities Investor Protection Corporation, and the academics. They will help the Congress begin to unravel this tangled web. We will also hear from a Madoff victim to help us all understand the dire implications this ruse has had for individual investors, charitable organizations, and pension funds. This meeting to discuss the Madoff affair will also be the first of several public proceedings. At future hearings, we will hear from senior officials at the Securities and Exchange Commission, and from Harry Markopolos, who has asked us to temporarily postpone his testimony so that he can better prepare for our questions. We will need to hear from other financial services regulators as well. We also need to hear from auditors and their overseers to elaborate -- to this elaborate Ponzi scheme fell through the cracks of our regulatory system. From what we have all learned in the Press, it now appears that regulators should have detected the Madoff wrongdoing earlier because of red flags raised by others. Authorities received information about potential problems when outsiders like Mr. Markopolos could not create a model that matched the results of Mr. Madoff's purported strategy. Others published articles, as early as 2001, raising questions about Mr. Madoff's firm. Other red flags include unrealistically steady investment returns; and an auditor the size of a mouse examining the fund the size of an elephant. Perhaps most shocking, after Mr. Madoff misled government examiners, and after he was then forced to register as an investment adviser, the Commission did not conduct any subsequent inspections. Moreover, in its prior examinations, the Commission failed to effectively use its subpoena powers to obtain any records other than those voluntarily offered. In the wake of this unprecedented financial crisis, we now know that our securities regulators have not only missed opportunities to protect investors against massive losses from the most complex financial instruments, like derivatives, but they have also missed the chance to protect them against the simplest of schemes, the Ponzi scheme. Clearly, our regulatory system has failed miserably and we must rebuild it now. As we resurrect our regulatory structure, we must ensure that regulators have the resources that they need to get the job done. A former chairman of the Commission, Arthur Levitt, has noted that the agency's enforcement unit is chronically understaffed. Whereas, it had had 433 people in the Office of Compliance and Examinations looking at 8,000 advisors two years ago, today it has 400 people looking at 11,000 advisors, and thousands of mutual funds. Moreover, the number of investment advisers subject to the Commission's oversight has doubled since 1997. While we do not know if the Commission's oversight in this case can be blamed on a lack of resources, we can certainly work to make sure adequate staff and powers are available in the future. As an adjunct to that comment, may I point out that this is done for the purposes of our recognition that sometimes our overzealousness has caused us a major problem. And that overzealousness was (caused ?) in -- or 2001, when this Committee entertained legislation and adopted that legislation at the Committee level, sent it to the House and passed it, where we cut appropriations and fees paid to the Commission over 10 years of $14 billion, when it was said by the majority at that time that these funds were not necessary, that there was sufficient staffing at the Securities and Exchange Commission. And now we see that that is not the case. Now, I point that out not from a blame standpoint or a political standpoint, but I point it out that all of us better check our memories and remember what we did these last 10, 12, or 15 years and how this Committee -- perhaps even the Congress, but certainly some people that are responsible for oversight and control perhaps missed the boat in this situation. I hope we don't do that again, and that's the reason I want us to consider that. We must also take action to better protect all investors, from elderly widows to sophisticated market participants. There are many ideas on how we can accomplish this objective. The Congress will review these options. In the Madoff case, legal authorities will be tasked with finding a way to help aggrieved investors (too ?). Finally, it is important to note that this is a real crisis with real victims. I, for one, was saddened to learn of a gentleman who, because he lost the money of his family and his clients in the Madoff financial scandal, took his own life. Life is always more precious than money. I therefore hope we will see no more tragic fallouts from this messy, sordid affair. In closing, I thank our witnesses and my colleagues for joining me here today. Together, I hope that we can learn from this terrible event, figure out how we can improve our regulatory structure, and undertake the most substantial re-write of the laws governing the U.S. financial markets since the Great Depression. The gentleman from Alabama is recognized for five minutes.
00:13:44	REP. BACHUS	I thank the chairman for convening this meeting to begin the Committee's examination of the alleged 50 billion-dollar Ponzi scheme perpetrated by Bernard Madoff. And the Ponzi scheme designation, in connection with his activities, is not a recent coinage. It was first used by Harry Marcopolis some 10 years ago in a complaint to the SEC, and it would have only taken one staffer pursuing that claim to have, I think, uncovered quite a lot of fraud. Let me respond to one thing that the chairman said, and that's about a reduction of money for the SEC. There was no reduction of money for the SEC. What -- that money had been diverted (by ?) the Appropriations Committee and -- in the general fund for -- into the general fund. So the monies were -- not getting to the SEC. It didn't get to the SEC before that action. In fact, a year after that action, the SEC received greater funding than they did the year before that action. So this is not a question of funding. One thing we do know about the Madoff affair and one agreement that I have with the chairman and the chairman of the full Committee is that the Madoff affair is yet another indication that what is needed is a statutory and regulatory structure for the 21st century. We don't have that. Had we -- if we had that in place, I think we may not have been having that hearing today. And I hope this hearing will not be as much about -- be about the Madoff affair, but it should also be about a new regulatory structure. As we learned earlier this decade when the Enron episode was followed in short order by WorldCom and other corporate scandals, events like Mr. Madoff's scam do not typically occur in isolation. More recently, the troubles at Bear Stearns were indicative of similar troubles at other investment banks. We were told it was a one-firm event; it obviously wasn't. And there's no reason to think that this time is different. It seldom is, and therefore, there's every reason to believe that other cases of fraudulent investment schemes may exist. At a time when the government is trying to stabilize markets, the Madoff affair and concern that other similar frauds lurk over the horizon or under the surface threaten to further undermine investor confidence. It is for that reason that I wrote Chairman Frank four days after the scandal broke to request that the Committee convene hearings early in the 111th Congress to examine the effectiveness of government and self-regulatory efforts to protect investors and police fraud. Every day brings more news of devastating impact of the Madoff affair on charities, private foundations, government entities, as well as individual and corporate investors. Although every detail about the Madoff scandal is yet to emerge, enough is known at this time to conclude that one factor that allowed this alleged fraud to continue as long as it did was the differential regulatory treatment of broker- dealers and investment advisers. The financial industry regulatory authority, FINRA, inspected Madoff's broker-dealer, which supported his market-making and proprietary trading operations, at least every other year, beginning in 1989. But because FINRA's jurisdiction is limited to broker- dealers, it had no authority to inspect his affiliated investor adviser, and that's where the fraud was perpetrated and operated from that shop. And while the SEC has authority to inspect investment advisers, it typically inspects only a small percentage of the 11,000 federally registered firms in any given year. In fact, Mr. Madoff's firm was never subjected to such an examination, and that's despite the fact that Mr. Marcopolis had, in some detail, described to the SEC the operation as a Ponzi scheme. In its Blueprint for Regulatory Reform issued last March, the Treasury Department highlighted, and I quote, "the rapid and continued convergence of the services provided by broker-dealers and investment advisers and the resulting regulatory confusion due to a statutory regime reflecting the brokerage and investment advisory industries of long ago." And they asked for changes, statutory changes, from this Committee and from others. Independent studies have reinforced this conclusion, finding that many investors simply cannot distinguish between the obligations and responsibilities of brokers, investment advisers, financial planners, financial advisers or consultants. As part of its consideration of reforms to our financial regulatory structure, this Committee should examine whether the Madoff scandal argues for harmonizing the regulation of broker-dealers and investment advisers so that schemes such as the Madoff scheme do not go undiscovered and are limited in their scope before causing such catastrophic consequences. All parties must commit to making every good-faith effort to see that this alleged fraud of epic proportions is not repeated. Chairman Cox should be commended for immediately commissioning an investigation into the SEC's handling of this matter, and we look forward to hearing today from the inspector general who is conducting that probe. One of the inspector general's tasks will be to assess the performance of the SEC's Office of Compliance, Inspections and Examinations, which appears to have missed several red flags that might have led to earlier detection of the alleged fraud. The fact that the accounting firm responsible for auditing Madoff's 50 billion-dollar enterprise of complex trading activities was a three-person shop operating out of a suburban New York storefront should have been one very large red flag. Let me conclude, Mr. Chairman, with a word of caution. While the failures of regulatory and private-sector due diligence exposed by the Madoff matter are obvious, they do not lead me to conclude at this stage of the inquiry that what is needed are broad, new legislative or regulatory mandates on the rest of the securities industry. What we may have in the Madoff case is not necessarily a lack of enforcement and oversight tools, but a failure to use them. What we certainly have is yet another indication, as I said in my earlier statement, that what is needed is a statutory and regulatory structure for the 21st century, one that the minority has urged for two years now. Thanks to our witnesses for being here today, and we look forward to your testimony.
00:22:03	REP. KANJORSKI	Thank you very much. Now we'll hear from the chairman of the full committee, Mr. Frank of Massachusetts.
00:22:11	REP. BARNEY FRANK (D-MA)	Thank you, Mr. Chairman-to-be. I would note, according to procedural regularities here, that I have in fact been selected by the Democratic caucus as the chairman of the committee even though I will continue -- but I do not, at this point, technically have a committee to chair, but I anticipate one very soon in the regular order. Two things: First, I want to elaborate on the position of Harry Marcopolis, who appears to be the hero in this, who is a man who, early on, notified the Boston office of the Securities and Exchange Commission of the problem. And maybe with a little provincial pride on behalf of my fellow New Englanders on the panel, I will note that Mr. Marcopolis reports that the Boston office responded appropriately -- that they took him seriously and forwarded it on and, at some point later on, there was a failure. I also want to say, because I've spoken to people who are in the enforcement division of the SEC in the Boston office and elsewhere, no one should infer from this terrible situation that the working personnel at the SEC were at fault. There's no suggestion that any of them were less than diligent; there were some structural flaws here, but in my experience, it would not be appropriate to blame any of them. And we will be talking further about the funding situation. I will note that in 2003, when I became the ranking member on the minority side of the full committee, we had just passed and the president, President Bush, had signed into law the Sarbanes-Oxley Bill, which came out of this committee under the chairmanship of Mr. Oxley. And we felt there wasn't adequate funding for it, and we had, frankly, some partisan fights on the floor in 2003 and 2004 in which some of us tried to add funding for SEC enforcement. We were defeated a couple of times, finally, I believe, in 2005. Mr. Wolf, who was then the chairman of the appropriations subcommittee with jurisdiction here agreed, and so there was then a further move up. I also just wanted to note that we had invited, of course, Mr. Marcopolis to be here and he had originally said he was going to do it, and I will, frankly, say that I was pleased that he indicated that he thought coming to this committee to have these conversations was a useful way to advance his interests and he thought that we would be a hospitable and useful forum for the conversations. And as my two colleagues have mentioned, our focus here is not so much to find out who to blame for what happened -- there will be other institutions of the government that will do that -- our main job is to do what we can to see that this doesn't happen again. We're a legislative body, and our role will be, in part, to see whether the mistakes -- you have to look at what happened to be able to prevent its repetition -- but that's what we're working on. But Mr. Marcopolis did write back and say, first of all, he's understandably physically ill and worn-down -- we'll release his letter -- he's been through a great deal of stress. He also has been talking to lawyers and this is a very complex subject, and he asked for more time to prepare. Actually, the staff of the gentleman from Pennsylvania did respond to him and ensure him that we would be completely cooperative in meeting these conditions. So as I read Mr. Marcopolis' letter and our conversations, he will be testifying -- I want to make that clear; this is not a refusal to testify -- but on a subject of this importance, he wants to make sure that he can condition himself and that he's got the -- he's been able to do the appropriate amount of study. Finally, I will say that there had been arguments, previously, in our public policy that investor protection could be confined to people of lower income -- not directly relevant, but analogous -- when we talked about hedge funds, for example, the main defense we've had in place, legally, regarding hedge funds, has been the requirement that you had to have at least $1 million to invest to be eligible to invest in a hedge fund -- that was an SEC rule; Mr. Cox explained that. The theory was, for others, the principal caveat investor could apply if people had more than $1 million, but we've seen here -- and we saw it also, although not nearly as negative an impact in the auction-rated securities market -- that it is not simply people who have less than $1 million to invest who need to have rules put into place by the government that ensure fairness. Investors are at risk, and they have to make judgments about what is or isn't a good idea, but it is not reasonable to expect them, in every individual case, to be the detectors of fraud, and so there is a requirement, I believe, if the system is to work, for the government to act. I would just say, finally, this Madoff situation is an example of why regulation done properly is very pro-market. The Madoff damage inflicted on so many innocent people and in turn, on many of the causes that many of these innocent people, who were very charitable, tried to help out -- clearly, we have people who are worried about investing anywhere; this country will not work if we are not able to restore the confidence of investors that there are places they can put their money that will be both remunerative to them and productive for the society, and allowing the money to be put into productive places. So this is one more example of why we need to adopt, in this coming Congress, a set of rules that will give investors in America the confidence that many of them have lost, unfortunately, because of these scandals, and which has to be restored if we're to have a return to the prosperity that the market, functioning well, can give us.
00:28:08	REP. KANJORSKI	I know recognize the gentleman from Texas for two minutes. Mr. Paul.
00:28:14	REP. RON PAUL (R-TX)	Thank you, Mr. Chairman. The ranking member made some important points early on about the timing of these hearings, but nevertheless, I'm glad we're having these hearings, because it gives me the opportunity to make a few points regarding this whole system and the tragedy that we have faced here in this past year, especially, and of course, symbolically, the Madoff scandal is a glaring example of something seriously wrong. But unfortunately, I don't think too many people will gather the same answer from this problem that I and others have gotten, and that is, for a good many years now -- since the 1930s -- every time a problem like this comes up, like in the Depression, we think it's a lack of regulation, so we introduce regulatory agencies like the SEC. And like after Enron -- that was a major problem, so we appropriate more money and hire more people -- it doesn't do any good. But this circumstance, I think, really makes my point that the approach is completely wrong, that the regulatory agencies pre-empting people from doing bad things just doesn't work. There are millions and millions and millions of transactions; you can't do it -- all they do is give a false sense of security. This is a perfect example of it. The SEC was involved with Madoff over the last decade and it sort of gives the stamp of approval and says, ah, it must be okay. So everybody's guard is let down; this creates the moral hazards -- it allows people to make these mistakes and not to assume responsibility for themselves. Does that mean that we should ignore the problem? No, the problem comes because people commit fraud, and fraud laws are on the books. All the people involved with Enron were prosecuted under the state laws of fraud and the market took care of the stocks. But just adding on new regulations and spending millions and millions if not billions of dollars on regulating enterprise doesn't do any good. It contributes to it; it is the problem. We should look more to how the atmosphere is created by the Congress -- if you look at the principal fractional reserve banking, that in a way, is a Ponzi scheme -- this gets people doing things and building a mountain of debt -- debt on debt -- it's done in this manner. Also, if you really just want to look at a big Ponzi scheme -- and it's said too often, that people end up doing what governments do, as we set examples -- and believe me, everybody knows the Social Security system is a Ponzi scheme. So, yes, $50 billion is horrendous, but what about an $8 trillion loss in the stock market? So what do we do? We rush and pump in $8 trillion. Where do we get the money? We create it out of thin air, furthering this whole idea of moral hazard, believing that we can create a unmanageable system -- it's not the fault of the individuals at the SEC -- they have an impossible job and they have to pretend they're doing something to feel relevant, the same way we do here, in the Congress. We have to feel relevant in this. Instead of saying what we need is the market to work, we need to get rid of the bad policies, the monetary system, and this mountains of debt. We say, well, we're relevant because we're going to hire more bureaucrats and we're going to appropriate more money that we don't have and we're going to solve all our problems. We've been doing this for 78 years and we'll do it again, but, believe me, this will not solve our problems. We need to think about eliminating this whole regulatory process and actually we don't need the SEC at all. And we could thrive even better and we would dwell on self-reliance, self-policing and the idea that people can't commit fraud, but the government should not commit fraud either. We should not set an example. I yield back.
00:32:18	REP. KANJORSKI	Thank you. The gentleman from New York, Mr. Ackerman, is recognized for two minutes.
00:32:32	REP. GARY ACKERMAN (D-NY)	(Off mike, laughter.) Thank you, Mr. Chairman, or whatever you are. (Laughter.) Bernard Madoff victims collectively paid hundreds of millions of dollars in federal and state taxes yet the federal government did not use any of this tax or any other tax dollars to properly oversee or discover any deceitful, fraudulent activity in the Madoff empire in time to mitigate potential losses or to protect investors. In fact, the government stands to become the ultimate beneficiary of ill-gotten gains. After having failed to protect the American public from Mr. Madoff's scheme while simultaneously taxing the phantom profits on unreal investments by real people and charities, many of whose life savings, whose actual lives and dreams are now in ruins. So you thought your brokerage account was ensured for $500,000? Wrong. With the collapse of the Madoff Ponzi scheme, thousands of investors lost that half-million dollar bet along with their life savings and along with millions of other Americans, their trust in their government. Under SIPC's liquidation plan, claims related to Madoff's fraudulent scheme may be limited only to those investors who can prove they sent money to Madoff after December 11, 2007. SIPC's plan is simply inadequate. Forget the Stephen Spielbergs and Kevin Bacons who aren't worrying that the bank is going to foreclose on their house at the end of the month. What about people like Alan Goldstein, who is testifying before our committee today? The Alan Goldsteins of our country who lost everything to Mr. Madoff aren't billionaires with seaside villas or tropical islands and more money than anyone can spend in a lifetime. The Alan Goldsteins of this country put their entire life savings, their diversified -- they thought -- account for years depended on their dividends that they received to pay for their mortgages and their medical bills. Mr. Chairman, the inability of the SEC to detect any wrongdoing at Madoff Securities for well over a decade undoubtedly has had a significant impact on investor confidence at an already difficult time in our financial markets. The SEC's failure and the inequity of SIPC's plan, the refusal or the inability by SIPC or the federal government to provide comprehensive fair insurance for the victims of the fraud will only serve to exacerbate cynicism among the investors and further discourage our economy and its recovery. And I thank you for calling this meeting today and look forward to hearing from all of our witnesses. I yield back the balance of my time.
00:35:06	REP. KANJORSKI	The chair thanks the gentleman from New York and now we'll hear from the gentleman from Illinois, Mr. Manzullo, for two minutes.
00:35:13	REP. DON MANZULLO (R-IL)	Thank you, Mr. Chairman. The -- as I go over and review exactly what happened here -- at least I think what happened -- there are plenty of red flags in -- there are plenty of indications that there were problems going on, but somebody just didn't do their job. Now, you can add resources and personnel and money, but when the red flags were there and people weren't doing their jobs now, how do we know they'll do their jobs in the future if you just throw money at the situation? I mean, you can't create competence by spending money. That's not the issue. Perhaps the issue here, the larger issue, is with a myriad of organizations and commissions and government entities that are supposedly involved in protecting the investor. Perhaps we need to take a look at the big picture, from the eyes of the investor and not from the eyes of the investment house, to see how the protection of the investor can be made paramount to try and accommodate the investment houses, even though it's possible to do the same. So I hope that this -- we have the opportunity in this committee or meeting, whatever we want to call it today, to begin a new look at how we do the regulatory process and that's all we need on top of the fact that we have a crushing economy. I have 11.5 percent unemployment in the largest city in my congressional district. The Chrysler plant, that's really smarting, with thousands of people who look to Washington for guidance each day. Perhaps we can straighten this out in a manner consistent with the fundamentals of free enterprise and also protect the small investors that are out there.
00:37:14	REP. KANJORSKI	The gentleman from California, Mr. Sherman, is recognized for two minutes.
00:37:17	REP. BRAD SHERMAN (D-CA)	Thank you, Mr. Chairman. The Madoff scheme would still be in operation today and perhaps for decades into the future had it not been for the meltdown on Wall Street that brought it to public notice. Chairman Arthur Levitt (sp) now says that the SEC should be a law-enforcement agency or have a law- enforcement agency. This is a proposal that he resisted when he was chairman of the SEC and all of his successors continue to oppose. Four-fifths of the commissioners of the SEC insist upon staying on, even after the SEC failed with regard to mortgage-backed bonds and now has failed with regard to Madoff. You would think that all members of the SEC would at least offer President Obama a resignation and have him decide whether this agency needs a complete change. There is a myth that Madoff's only falsehoods were on the 17th floor; it is investment-advisor business. Nothing could be further from the truth. His broker-dealer business filed financial statements with the SEC and with FINRA every year and they were off by about $17 billion. The SEC has briefed me privately and has said that for many years, the Madoff broker-dealer operation filed annual financial statements with both the SEC and FINRA. These financial statements show $17 billion in assets and a one-man accounting firm. That means that if somebody glanced at that statement, for even a couple of minutes, the fraud is there on its face because there are ethics rules dealing with public accountants that say that if they are going to be regarded as independent public accounts, they can't get more than five or 10 percent of their revenue from any one client. So to look at this financial statement, you would have to believe that somebody can audit a $17 billion enterprise, one guy can do it in a couple of weeks. Either that's true or the statements are fraudulent on their face. But the SEC never bothered to read the financial statements, not even for half an hour; neither did FINRA. SIPC is with us today. They are well known because you go into your broker's office and you see that you're protected by SIPC up to half-a-million dollars. I know that for many of the Madoff clients, that may be a problem. But I've got investors in my district -- 10, 20, $30,000 at the broker- dealer. What they're not told by that decal is that SIPC has virtually zero net worth. You're ensured by an insurance company that has nothing in the safe because, while they had 1.5, $1.6 billion, virtually all of that is going to be wiped out by the Madoff claims and, of course, if some individual investors are able to claim it, the SIPC may owe them many billions more. I yield back to the chairman.
00:40:38	REP. KANJORSKI	The gentleman from New Jersey, Mr. Garrett, is recognized for three minutes.
00:40:42	REP. SCOTT GARRETT (R-NJ)	And I thank the chairman for holding this important hearing this afternoon. I also want to thank Ranking Member Baucus for his diligence in requesting that this hearing be held as soon as this issue came to light. You know, I think it's safe to say that Mr. Madoff put together the largest Ponzi scheme in history. I doubt that even the Ponzi scheme's namesake, who was Charles Ponzi, ever foresaw that someday, somebody would be hoodwinking investors to the tune of $50 billion. So maybe it's appropriate that, due to the breadth, size and longevity of the scheme, we change the name of the Ponzi scheme that we all use in the future to the Madoff scheme. Unfortunately, the media has portrayed this story as one that has only affected the wealthy, multi-millionaires and those who socialized with the Madoffs at lavish charity events and such. As we've heard before and I'll hear today at this committee meeting, that is unfortunately not the case. And I've heard it personally at home as well. Friday I received a call from a constituent. Her 86-year-old mother, suffering from illness, has had her life savings invested with Mr. Madoff. Now, due to how long it may take to unwind with matter, she faces the very real possibility of never receiving any of it. And what's most unfortunate is that the SEC regulators had numerous chances to uncover the scheme and that they continually either didn't see the multiple warning signs, didn't follow up on them or simply chose to ignore them. I think there's three takeaways that you can take from what's about to happen in the committee and going forward in Congress on this. First of all, to those who advocate that there's a need for increased federal regulation of the hedge fund industry from this occurrence, let me remind them that there were a number of hedge funds that did, in fact, become victims of this. And so I think it's a stretch to believe that the same SEC regulators who were directly tasked with overseeing Mr. Madoff's firm would have been able to uncover this scheme had they been simply reviewing the books of those very same hedge funds. Furthermore, to those who advocate, as we've heard here already, for more regulation and increased budget, increased spending, you know, there was an article recently, just the other day, in The Wall Street Journal that addresses this. He says -- they say in there, "How can it be that if the two sons of Mr. Madoff apparently did not become aware of this, despite the fact that they were working in the firm for some two decades, if they were not aware of it, how then can we call for increased regulations and think that some outside regulator would have been able to become aware of it?" The third take-away is from the comment made by the chair of the committee when he says that he finds no fault with SEC personnel specifically with regard to this situation. And while I certainly sit here and hope that is not the case, quite honestly, I think it is premature for any of us to jump to any conclusions as to who is or who is not responsible for a failure to act on the red flags that came up numerous times. So in conclusion, I look forward to our witnesses' testimony today and learning more on this scheme and how it was able to continue for so long. But also, very importantly, I look forward to figuring out just how we can help those people, those poor middle-class -- not poor, but those middle-class people such as the elderly lady I mentioned, how they can recoup as much as they can as quickly as possible. I yield back the balance of my time.
00:44:06	REP. KANJORSKI	Thank you. The gentlelady from New York, Ms. Maloney, is recognized for one minute.
00:44:14	REP. CAROLYN MALONEY (D-NY)	Thank you very much. In contrast to the seeming ease with which Bernard Madoff vastly overstated the contents of his clients' accounts, it would be almost impossible to overstate the pain his scheme has caused. The loss accrues not only to Madoff's clients but to literally millions of others who, in one way or another, had depended on the false promise of his financial stewardship. I just came back from meeting with unions that invested their pension funds. I would like to place in the record letters from constituents who lost their entire life savings, investors large and small. Two have taken their lives. And my sympathy really goes out today to one of our witnesses, Mr. Goldstein, a retired New Yorker who also lost his life savings. I believe that markets run as much on confidence as they do on capital, and this is a serious blow to investors' confidence at a critical time in our economic challenges. I thank you for holding this hearing and I look forward to working with you for better oversight and regulation.
00:45:34	REP. KANJORSKI	Thank you, Ms. Maloney. The gentleman from New York -- or, I'm sorry, the gentleman from Nevada, Mr. Heller, for three minutes.
00:45:42	REP. DEAN HELLER (R-NV)	Thank you very much, Mr. Chairman, and to the ranking member, for holding today's meeting and focusing our attention on this issue, the Madoff scandal. This scandal has serious effect not only on affected investors, but the enforcement and oversight failures also rattle the confidence of investors everywhere when our financial system is already wracked with problems. I see three major failures here. First, clearly the SEC had a major failure of huge proportions. According to testimony, the SEC has warned about this problem and ignored it for years, if not decades. In fact, I took a look back at their highest-profile investigation for 2008 and it was a $750,000 inside-trading case. Seven hundred fifty thousand dollars was the biggest case that I'm aware of, at least the highest-profile case for the SEC last year; that versus a $50 billion Ponzi scheme was the decision. I can only assume someone in the SEC does not like the Dallas Mavericks. Second, state regulators, that call themselves the local cops on the beat, they like to take a tremendous amount of credit for the work they do, and most of them do a great job, but they also failed. And my question was, why were they not doing their job? And finally, but not all, individual investors did not do their due diligence. Manners and expensive suits do not necessarily equate to honesty and integrity, and we must always trust but verify, and clearly that failed. Like all Ponzi schemes, this one crashed, even if it took decades. I'd like our witnesses to suggest how these three levels -- federal, state and individuals -- can work to prevent future scandals like this one in the future. Thank you. I look forward to testimony. I'll yield back.
00:47:29	REP. KANJORSKI	Thank you very much, Mr. Heller. The gentleman from New York, Mr. Meeks, is recognized for two minutes.
00:47:34	REP. GREGORY MEEKS (D-NY)	Thank you, Mr. Chairman. I thank you and the ranking member for conducting this hearing today. I guess we can call it a hearing. To me, what we're confronted with today is a situation, first of all, when we talk about the Madoff scandal, it's really to deal with -- we're dealing with a crook. We're dealing with an individual who took people's money and lost it. He's a crook. He deserves to go to jail. And to the degree that we can make any individuals whole who lost their money, as in any other fraud case, we need to figure out how we get that done. That is the bottom line here. Now, in the course of that investigation, and what I'm looking to hear and why I think these hearings that we're having are tremendously important, is what can we learn from it? As in any kind of crime that has been committed, there should be something that we can learn from it so that we can prevent it from happening again and to make sure that we shore up our rules and laws and regulations if it will help prevent it. You don't get rid of the laws. Somebody commits bank robbery, you say, "Okay, we're going to get rid of all the laws with reference to bank robbery." We don't do that. We figure out how we make them stronger so that we don't have another bank robber. And that's what we're dealing with here today. We've got to figure out -- listen, now, if there is an investigation and we find that someone within the SEC was complicit with it, well, then, that person is a crook and needs to go to jail. But if we find that there is some other -- that they were not properly trained or they were inexperienced or we didn't put the appropriate amount of money in there, then it is our job, as members of the United States Congress, to fix that. If we find, through the hearing, in listening and learning from people what takes place, that there is new rules and regulations that we can put in place so that no one else is scandalized again, it is our job to do that. And the only way to do that -- because I know I'm not the ultimate expert -- is to have the kinds of witnesses that the chairman has decided is necessary to be here today so that we can listen, we can learn, we can evaluate, and we can do something intelligent to try to make sure that a crook like Madoff can't get away with it again. I yield back.
00:50:07	REP. KANJORSKI	(Off mike.)
00:50:07	REP. DAVID SCOTT (D-GA)	Thank you very much, Mr. Chairman. I'm delighted you're having this meeting. I think that the fundamental issue has to be what went wrong, how it went wrong, and what we're going to do about it. But I think that we've got to look at these red flags that just came up -- first, the stability of getting 10 to 12 percent of return when the economy was going up and down; the fact that they used relatively obscure small auditing firms when most sizable brokerages use auditors that are sanctioned by the public accounting oversight, another red flag. Mr. Madoff himself kept several books, false documents. He even lied to regulators when they questioned him in previous examinations of his firm. Why did investigators never use subpoena powers to obtain truthful information? Instead they only relied upon information voluntarily produced by Mr. Madoff. That's sort of like asking a thief if he's stealing. Well, the thief is going to tell you, "No, I'm not stealing." I mean, it just begs the question of time after time after time, when the SEC was looking at these things, even the case down in Florida -- (inaudible). There was a possibility of a $400 million fraud case there. They looked at it, gave a wink and a nod, and it was gone. We've got a credibility problem with the SEC. We've got to find out exactly what happened. The American people are expecting the confidence. Confidence is the key buzz word going forward. We've got to get confidence and reclaim our economic system, and this is a way to start. And Mr. Chairman, I appreciate this hearing and I look forward to the questions as we go forward.
00:51:49	REP. KANJORSKI	Thank you very much, Mr. Scott. The gentleman from Florida, Mr. Klein, is recognized for two minutes.
00:51:54	REP. RON KLEIN (D-FL)	Thank you, Mr. Chairman, and I thank the ranking member for holding this committee meeting today and certainly reflect on a lot of the good comments that have already been made. I come from a part of the country, South Florida, which was hit particularly hard. Mr. Madoff spent a lot of time down there and preyed through his social engagements on a lot of people who bought into what he was doing, and unfortunately a lot of charitable organizations. We had a large group called the Pickhour (sp) Foundation that had over a billion dollars of assets that funded everything from educational philanthropies, school systems, science, all the things that everyone in this country believes in and who knows that government can't do everything, but we rely on philanthropy to help with that. It's now closed. And there are many other organizations which I think we're all familiar with. And I think the question is not what was lost -- we understand that, or are beginning to understand that -- but why, what went wrong. And I think, as you've already heard -- and I certainly agree with this in my background as a securities lawyer -- there were red flags that were presented to the SEC, probably red flags to investors as well. But the question, of course, that's been raised is why did not the SEC follow up on these? The SEC has admitted that it received credible allegations about fraud nine years ago, but nothing really was done with them. So if there's anything we've learned from the Madoff scandal, we certainly know that in a global economic crisis, as we have right now, we need smarter regulation and greater oversight to restore confidence of investors in the market. This doesn't mean the government will be checking up on every move of every investor or every seller of an investment, but this does mean that someone like Madoff should never, ever be able to get away with this type of activity again. And finally, there is the human question of how much money can Bernie Madoff's victims expect to recover? A couple that I know from Boynton Beach, Florida, who lost their retirement savings to Madoff and now have only enough money to live on by Social Security, they're saying, how much and when? These are obviously scary times, and I do think we need to get to the bottom of this, not only for what went wrong in the past, how much money can be recovered, and how much money can be given back to the people who lost it in the charitable organizations, but also what we can do to prevent it in the future. Thank you, Mr. Chairman.
00:54:11	REP. KANJORSKI	Thank you, Mr. Klein. Now the gentleman from Texas, Mr. Green, is recognized for one minute.
00:54:17	REP. AL GREEN (D-TX)	Thank you, Mr. Chairman, for hosting this hearing. I, Mr. Chairman, don't know what should happen to members of the SEC, but I do know what would happen to members of the district attorney's fraud division -- Welfare Fraud Division if welfare mothers were able to perpetrate a similar kind of circumstance. My suspicion is the members of the Welfare Fraud Division not having caught welfare mothers perpetrating fraud, they would be dismissed. I don't want to prevent investors from investing. I don't want to make it difficult for them. I do want to make it difficult for criminals to steal. We make it difficult for welfare mothers to steal. I think we have to make it difficult for people who perpetrate these kinds of frauds to do it. I yield back the balance of my time.
00:55:30	REP. KANJORSKI	Thank you very much. And now finally, for one minute, Mr. Perlmutter of New Hampshire (sic).
00:55:30	REP. ED PERLMUTTER (D-CO)	Thanks, Mr. Chairman. Colorado, we had a -- our fire and police pension fund was one of the entities that lost money, and they were an investor through Fairfield Greenwich, so when Congressman Paul was talking about, you know, the enforcement side of this doesn't make sense and we really don't need it, lots of money from many, many individual investors -- policemen, firemen from Colorado -- into another fund, into this, and without an enforcement mechanism that's really solidly in place, the confidence, as Mr. Heller said, in the system as whole is shot. Now, obviously Mr. Madoff was a confidence man. He gained the confidence of many investors and he gained the confidence of the regulators. The regulators have to have the tools and they have to be no-nonsense and they have to be regulators, and they can't be conned, as we see so many other entities were. So I hope the testimony we're going to hear from you gentlemen today talks about putting some teeth back into this regulatory system so people aren't conned in the way they were this time. With that, I yield back.
00:56:52	REP. FRANK	Thank you, Mr. Perlmutter. I just want to assure you I know you're from Colorado, but I got confused on the great skiing in New Hampshire. (Laughter.) The gentleman from New Hampshire, Mr. Hodes.
00:57:18	REP. PAUL HODES (D-NH)	Thank you, Mr. Chairman, and I thank you and the ranking member for holding this hearing. Ponzi schemes aren't new, and neither are crooks and shysters. What is new, I think, are the conditions under which this Ponzi scheme occurred. We have the complexity of modern securities markets and an explosion of global wealth, combined with regulators who, over the past few years, haven't been doing their jobs. Arthur Levitt, in the Wall Street Journal, argues persuasively today that risk assessment must be central to the SEC's efforts. There has to be robust oversight and inspection capability and effective enforcement, which requires a commitment of appropriate resources. And without going into the numbers of what those appropriate resources are, I am interested to hear my colleagues on the other side of the aisle apparently arguing that we don't need more regulations or oversight. And I don't know what world they might be living in because in the world we're living in, with the global financial collapse, people who have lost their life savings, the Madoff scandal is really like the cherry a bad sundae, and it is time that we have a 21st century regulatory scheme for the 21st century. So I look forward to the testimony, which will enlighten us about how and what we need to do in the SEC, and then we're going to move on to what we need to do for the rest of the financial markets. Thank you.
00:58:51	REP. KANJORSKI	I thank the gentleman from Colorado. I think that's fair. (Laughter.)
00:58:57	REP. HODES	New Hampshire, New Mexico, Colorado; they all have snow, Mr. Chairman.
00:59:04	REP. KANJORSKI	Right. The chair makes the point Mr. Obama carried them all, so that's -- (laughter). I will now introduce the panel, and thank you all for appearing before the committee today. Without objection your written statements will be made part of the record. You will each be recognized for a five-minute summary of your statement. First we Mr. David Kotz, inspector general of the U.S. Securities and Exchange Commission. Mr. Kotz.
00:59:34	MR. KOTZ	Good afternoon. Thank you for the opportunity to testify today before this committee on the subject of "Assessing the Madoff Ponzi Scheme" as the inspector general of the Securities and Exchange Commission. I appreciate the interest of the chairman, as well as the other members of the committee, in the SEC and the Office of Inspector General. In my testimony today, I am representing the Office of Inspector General, and the views that I express are those of my office, and do not necessarily reflect the views of the Commission or any commission. I would like to begin my brief remarks this afternoon by discussing the role of my office and the oversight efforts that we have undertaken since I was appointed as the inspector general of the SEC approximately one year ago, in late December 2007. The mission of the Office of Inspector General is to promote the integrity, efficiency and effectiveness of the critical programs and operations of the SEC. I firmly believe that this mission is best achieved by having a vigorous and independent Office of Inspector General to investigate and audit commission activities and to keep the commission and Congress informed of significant issues and findings. The office has staff in two major areas: audits and investigations. Our audit unit conducts, coordinates and supervises independent audits and evaluations related to the commission's internal programs and operations. The office's investigations unit responds to allegations of violations of statutes, rules and regulations, and other misconduct by commission staff and contractors. I am proud to report that notwithstanding a small staff, the Office of Inspector General at the SEC has issued numerous reports over the past year involving issues critical to SEC operations and the investing public. Two examples of recent audit reports are an analysis of the commission's oversight of the SEC's Consolidated Supervised Entity program, which included Bear Stearns, Goldman Sachs, Morgan Stanley, Merrill Lynch and Lehman Brothers, that provided a detailed examination of the adequacy of the commission's monitoring of Bear Stearns, including the factors that led to its collapse, and a review of the commission's Broker-Dealer Risk Assessment program. We also have a vibrant and vigorous investigative unit that is conducting or has completed over 50 comprehensive investigations, several of which involved senior-level commission employees and represent matters of great concern to the commission, congressional officials and the general public. It is with this background in mind that I wish to discuss our planned efforts to investigate matters related to Bernard Madoff and affiliated entities. On the late evening of December 16, 2008, SEC Chairman Christopher Cox contacted me and asked my office to undertake an investigation into allegations made to the SEC regarding Mr. Madoff, going back to at least 1999, and the reasons that these allegations were found to be not credible. The chairman also asked that we investigate the SEC's internal policies that govern when allegations of fraudulent activity should be brought to the commission, as well as staff contact and relationships with the Madoff family and firm, and any impact such relationships had on staff decisions regarding the firm. Early on December 17, 2008, we opened an official investigation into the Madoff matter. Since then, we have been working at a rapid pace to begin this important work. On December 18, 2008, we issued a document preservation notice to the entire agency, informing them that we had initiated an investigation regarding all commission examinations, investigations or inquiries involving Bernard Madoff and any related individuals or entities. We formally requested that each employee and contractor in the commission preserve all potentially responsive electronic and paper records in their original format. Over the next few days, we met with senior officials from the commission's Division of Enforcement and the Office of Compliance Inspections and Examinations, known as OCIE, to ensure their cooperation in our investigation and our ability to gain access to their files and records. We also met with the chairmans office to seek information and documentation relevant to the investigation. On December 24, 2008, we sent comprehensive document requests to both the division of enforcement and OCIE specifying the documents and records we required to be produced for the investigation. In addition, we made several formal expedited requests to the SECs Office of Information Technology for searches of the e-mails of former and current employees for information relevant to the investigation, both at headquarters and the New York and Boston regional offices, and have already received and are in the process of reviewing these e- mails. We have also begun identifying the particular issues that need to be investigated, and are reviewing and updating daily the list of witnesses that we plan to interview. We intend to begin conducting these interviews immediately and, for example, have already scheduled a meeting with Harry Marcopolis for later this month for an in-depth interview on the record. We have also already met and spoken with numerous individuals informally as part of our initial investigative efforts. It is our opinion that the matters that must be analyzed may go well beyond the specific issues that Chairman Cox has asked us to investigate, and we believe our oversight efforts must include an evaluation of broader issues regarding the overall operations of the division of enforcement and OCIE that would bear on the specific questions we are examining and provide overarching and comprehensive recommendations to ensure the commission fulfills its mission and goals. At this early stage, I thought it would be useful to identify the specific issues related to Bernard Madoff that, as a preliminary matter, we intend to investigate or review. Obviously, as the investigative efforts are just beginning, Im not in a position to provide any conclusions or findings with respect to the allegations that have been raised, and do not wish to provide any preliminary judgments before we have had a chance to analyze all the information. In addition, as underlying evidence could also be relevant to the pending criminal or SEC investigations into possible violations of the securities laws, I am being mindful not to comment on anything that may affect or interfere with those investigations. The following are specific issues that we currently intend to investigate. One, the SECs response to all complaints it received regarding the activities of Bernard Madoff. We plan to trace the path of these complaints through the commission from inception, reviewing what, if any, investigative or other work was conducted with respect to these allegations, and analyze whether the complaints were handled in accordance with commission policies and procedures and whether further work should have been conducted. Two: allegations of conflicts of interest regarding relationships between any SEC officials and members of the Madoff family and whether such relationships in any way affected the manner in which the SEC conducted its regulatory oversight of Bernard Madoff. Three: the conduct and examinations and/or inspections of Bernard Madoffs firm by the SEC and an analysis of whether there were red flags that were overlooked by SEC examiners that could have led to a more comprehensive or timely examination. And, four, the extent to which the reputation and status of Bernard Madoff and the fact that he served on SEC advisory committees, participated on securities industry boards and panels and has social and professional relationships with SEC officials may have affected commission decisions regarding investigations and examinations of his firm. In addition to these specific issues, and depending upon the information that we learn during the course of our investigation, we plan to consider analyzing the following broader issues as well: one, the complaint handling procedures of the division of enforcement, including a review of how complaints are processed, internal incentives that may affect the decision whether to take action with respect to a complaint, an analysis of which complaints are brought to the commissions attention and whether tangible and specific complaints are actually being reviewed and followed up on appropriately; two, the OCIE examination and inspection procedures, including an analysis of what policies and procedures were then, and are currently, in place, what policies and procedures are being followed and/or whether there are gaps in these policies and procedures relating to operations involving private investment pools such as hedge funds, because they are subject to limited oversight by the SEC, and whether any such gaps may lead to fraudulent activities not being detected; and three: the relationships between the different divisions and offices within the commission, and whether there is sufficient intra-agency collaboration between the agency components to ensure comprehensive oversight of regulated entities. Obviously, this is an ambitious investigative agenda, but I firmly believe that the circumstances surrounding the Bernard Madoff matter may very well dictate a more expansive analysis of commission operations. Moreover, it is my view that, at the end of these investigative efforts, there needs to be more than just the potential identification of individuals who may have engaged in inappropriate behavior or potentially failed to follow-up appropriately on complaints, but rather an attempt to provide the commission with concrete and specific recommendations to ensure that the SEC has sufficient systems and resources to enable it to respond appropriately and effectively to complaints and detect fraud. Of course, even with a limited staff and many of our auditors and investigators already engaged in ongoing matters, I understand that it is critical that our investigative efforts be conducted expeditiously. I fully understand that it is crucial for the commission that Congress and the investing public that answers be given to the very serious questions regarding the SECs efforts relating to Mr. Madoff in a prompt and swift manner. For this reason, I am mobilizing additional resources to ensure that our office makes every possible effort to conclude our investigations and reviews as soon as possible. We are considering preparing reports on a rolling basis, assuming that we can identify discrete issues that may be resolved separately and expeditiously, so that some conclusions may be provided very shortly. Finally, I can assure you that our investigation and review will be independent and as hard-hitting as necessary. While we approach these efforts with an open mind, and at this stage of the investigation, we have not reached any conclusions or reached any findings, the matters that have been brought to our attention require careful scrutiny and review. We will conduct our work in a comprehensive and thorough manner, and if we find that criticism of the SEC is -- (audio break) -- facts, we will not hesitate to report the facts and conclusions as we find them. I think that if you review the reports issued by our office over the past year, you will see that where we have found that criticism of the SEC or SEC officials was warranted, we have reported our findings and concerns in a frank manner. In conclusion, we appreciate the chairmans and the committees interest in the SEC and our office. We believe that the committees and Congresss involvement with the SEC is helpful to strengthen the accountability and effectiveness of the commission. We intend to conduct our investigative efforts promptly and thoroughly. Thank you.
01:10:47	MR. KANJORSKI	Thank you very much, Mr. Kotz. And next, we will hear from Mr. Stephen P. Harbeck, president of the Securities Investor Protection Corporation. Mr. Harbeck?
01:10:56	MR. HARBECK	Thank you, Mr. Chairman. Chairman Kanjorski, Chairman Frank and ranking member Bachus and members of the committee, thank you for the opportunity to appear before you today to discuss the work of the Securities Investor Protection Corporation, which is known as SIPC. My name is Stephen Harbeck, and I have been the president and CEO of SIPC for the last six years. Ive worked at SIPC for 33 years and was general counsel prior to becoming the president and CEO. SIPC was created by an act of Congress, the Securities Investor Protection Act of 1970 -- its known as SIPA. It provides financial protection to customers of failed broker/dealers. Although created by a federal statute, SIPC itself is not a government organization. The statute provides that we are a membership corporation, the members of which are all brokerage firms -- virtually all brokerage firms -- which are registered as such with the Securities and Exchange Commission. Membership is not voluntary; it is required by law. In terms of our funding, we currently have a fund of $1.6 million of Treasury obligations, we have a commercial line of credit, and we have a $1 billion line of credit with the United States Treasury, which we have never used. SIPC has no authority to examine or investigate its members. We receive information from the Securities and Exchange Commission and from FINRA, and when either one of those organizations, or for that matter, a state regulator, informs us that a brokerage firm has failed to meet its obligations to its customers, we initiate a very specialized form of bankruptcy. SIPC uses funds to replace cash and securities missing from customer accounts within statutory limits. We can advance up to $500,000 per customer, of which as much as $100,000 can be based upon a claim for cash. I think it's important to note that no customer funds are ever used for payment for administrative expenses, lawyer's fees, accountant's fees, or the fees of a trustee in one of these specially narrow focused bankruptcies. 2008 was unlike any previous year in SIPC's history. In addition to starting three small brokerage firm liquidations, we initiated the liquidation of Lehman Brothers. The holding company for Lehman Brothers filed for bankruptcy on September 15. The holding company owned the SIPC member brokerage firm Lehman Brothers Inc. And on September 19, in order to facilitate the transfer of customer accounts to other brokerage firms, including Barclay Bank's brokerage firm arm, SIPC initiated a liquidation proceeding for Lehman Brothers Inc. I am very pleased to report that over the weekend -- we initiated the proceeding on a Friday, the matter was immediately removed to a bankruptcy court for the southern district of New York, and we transferred over the weekend, pursuant to a bankruptcy court order, $142 billion worth of customer securities. And those customers had a rather seamless event, with respect to the failure of Lehman Brothers. Much remains to be done but I am very proud of the initial opening situation there. With respect to Madoff, the situation could hardly be more different. Where Lehman Brothers began as a result of a systemic failure in the sub-prime securities markets, the Lehman Brothers failure is theft pure and simple, and nothing more and nothing less. As a result, no transfer of customer accounts as occurred in Lehman Brothers was possible. SIPC, I am pleased to report, that the trustee and SIPC have collaborated and published orders -- pardon me, published a claim form and a notice which are available today to the customers who have been victimized in the Madoff situation. Those claim forms are available on the trustee's website, at SIPC.org, on our website, and we urge customers to fill them out and return them to the trustee immediately. This fraud was of a completely different order of magnitude of anything in SIPC's history. We won't know the extent or the call on SIPC's resources for some time. The trustee has identified $29 million dollars which he has recovered from a bank and further identified an additional $830 million that he seeks to recover in fairly short order. I can assure the committee that SIPC and trustees appointed under the Securities Investor Protection Act are exceedingly aggressive in recovering assets from wrong doers. With respect to the claim form and the Madoff case, I'd like to speak specifically to Congressman Ackerman because he mentioned something that was widely reported in the New York Post and that report was in error. When we went to the United States Bankruptcy Court for permission to publish a notice and send a mailing to customers, we received what we call a housekeeping order, which grants us authority and instructs the trustee to make a mailing to every customer who had done business with the firm during the last calendar year. It was first reported in the New York Post and later misreported once again that there would be a limit on returns to customers, only to people who did business with the Madoff firm in the last 12 months. That is absolutely incorrect and I just wanted to assure you and your constituents that that is the case. The effects on the Madoff case, or the effects on SIPC of the Madoff case will be profound and I look forward to working with Congress and keeping Congress in touch with what we perceive as the ongoing matters in the case. And I'd be pleased to take any questions from the committee.
01:16:58	REP. KANJORSKI	Thank you very much, Mr. Harbeck. I certainly will start the questions and have a few. Look, in some respects I may be a little too reserved here. I think I speak for all my colleagues on the committee and I certainly speak for my constituents, they are absolutely shocked by this scandal. They want action and I think I speak for that too. I -- Mr. Kotz, I applaud your methodical approach. You've analyzed what has to be done and the schedule in which it will be done. And Mr. Harbeck you sort of talk of it that way too. But I'm not sure that with a $50 billion price tag with literally tens or hundreds of thousands of people that will suffer. But not only those directly that lost their money. Think about all the charities that aren't going to finance the research at labs and universities all over this country to cure everything from Alzheimer's to cancer, and ultimately the thousands of people that will suffer or die because of this activity. It seems to me, it seems to me what's being asked for is out of regular order, that they don't expect the cop on the beat to take the normal process. And let me give you an example what I'm speaking to. The other day I had the occasion to talk to one of our enforcement agencies on the environment. And there's illegal occurrence going on somewhere in this country that's brought to my attention by affidavit form. So it was my obligation to forward it to the agency to see how this can be handled. And after they had it for a few days and I hadn't heard from them I called them, the person that had the complaint. I said, well, how long will it take you to examine this and determine what's there? He said, I think we'll have an answer in two years. And I'm -- I don't know if that's what I'm hearing from your agencies. I think under normal order we'll have a real bound volume of a study and examination made six months or a year from now, or two years from now. But really, gentlemen, I want to impress you, I don't think the American people are going to want that. I myself don't want that. The question I'm directing to you, what can this Congress do to give you additional authority or additional funds to get this thing done as quickly as possible? And how fast is that quickly as possible? When do you think you can adequately complete these examinations so that we can start knowing what happened, when it happened? Because I think the ranking member pointed out, and I fundamentally believe it, if it were done in this instance, when the water of the recession is still going down, the flood is going down, we're going to find a lot of disasters across this country. And it'll be a lot more people, probably not as wealthy a group of people that will be seriously hurt. We've got to find out what's there so that we can do our jobs, as Mr. Meeks pointed out earlier, and make sure the laws and authorities are in place and the funding's in place to see that this never happens again. Mr. Kotz, what's your answer to that?
01:20:16	MR. KOTZ	Sure. Certainly with respect to my area, which is looking at the SEC, looking at the potential red flags that were in place and how these things could have been missed, I absolutely agree that this matter has to be dealt with very expeditiously. It is not, nothing ordinary or normal about it and, you know, we are acting in that manner. We are bringing in new people simply for this task. In terms of those issues, looking at the SEC's different divisions, looking at the enforcement division as to complaints that came in, looking at the compliance division as to examinations, I believe we can do that with the resources we have in an swift manner. I would not think it would take two years to come up with some large --
01:21:02	REP. KANJORSKI	What do you think it will take, Mr. Kotz?
01:21:02	MR. KOTZ	Well, I hesitant to give you an exact amount of time because we just started the investigation. We need to, you know, we've come up with a list, a very long list of potential witnesses, we have lots of documents to review. It's only been a couple weeks. But I would hope that we would be able to get something out in a matter of months, certainly not years. As I said, we're looking to try to issue reports on a rolling basis so that if we can identify a particular discreet issue we can have a report on that issue without waiting for something that is, you know, 500 pages that comes years from now.
01:21:36	REP. KANJORSKI	Well as you get these issues resolved, very quickly, I assume, will you provide that information to this committee and to the Congress so we can act to close those loop holes, those problem areas, or enforce and provide the funding for better enforcement and the SEC? Or do you anticipate that we're going have -- most studies, I mean, I have to be honest with you, I've been in Congress a few years now, most studies come back that we make requests on urgent material, it takes several years for us to get the study back to find out what the Congress is expected to do to solve a problem. I don't think the American people will tolerate that, under these circumstances.
01:22:13	MR. KOTZ	I agree with you, absolutely. That's not the case in my office. That hasn't been the case in the reports we've issued previously. That won't be the case here. So absolutely, as we can identify issues and we can thoroughly investigate them and come to a conclusion, we will absolutely issue a report. So I understand, definitely, that this is not something that can sit and we can work on for years and years and years and then issue some 500 page report many years down the road. I understand, absolutely, that this is a matter that has to be dealt with immediately. I mean, I think we've made progress already in two weeks, given that those two weeks were, you know, included the week between Christmas and New Year's. So, I understand very much this matter has to be looked at very carefully, but also very quickly and we intend to do that.
01:22:59	REP. KANJORSKI	Okay, just -- I know my time has expired, but do both of you gentlemen -- are you appointeds (sic) of the president and will the change of administration affect your position, or can we rely on the fact that you'll be there?
01:23:10	MR. KOTZ	No, I'm not. I'm not. The change in administration won't affect my position.
01:23:14	REP. KANJORSKI	Okay, Mr. Harbeck?
01:23:14	MR. HARBECK	SIPC is not a government organization, and I will be here as long as the board of directors allows me to serve.
01:23:21	REP. KANJORSKI	Very good. So I'm going to turn it over to our hound dog from Alabama, ranking member --
01:23:30	REP. BACHUS	Inspector general, let me ask you about four areas for investigation. The first one that -- to me, I described it as a three-person shop -- but there's actually only one accountant that's employed by the auditor for Madoff. Will you be looking at whether that should have been a red flag?
01:23:52	MR. KOTZ	Absolutely. I mean, that is one of the most central issues here that we have to look at, which is, was that information known to SEC officials and if so, what did they do about it? How could it possibly be that they became aware of that -- I mean, there have been certain reports about just Googling it would be able to find out that information -- and so that is something that we will absolutely look at very carefully and try to figure out how it could be possible that, if they were aware of that information that that wouldn't have been a matter that they would have acted upon immediately.
01:24:25	REP. BACHUS	I appreciate that, because you couldn't have a fraud of this magnitude without involvement of auditors or accountants. You've asked for document and e-mail preservation, not only by Madoff but also by their contractors and related parties. Would that include the auditors?
01:24:46	MR. KOTZ	Well, we're initially asking for SEC documents, so I -- SEC employees and contractors -- but yeah, we would certainly look to obtain other documents --
01:24:57	REP. BACHUS	Yeah, I'd be interested to see -- I'd urge you as soon as possible to expand that to contractors, related parties or associates because that can obviously, get away from you in a hurry. The custodial relationship was very odd in that, you know, you had the same person functioning as a broker/dealer and as an investment advisor. Is that a red flag?
01:25:20	MR. KOTZ	Yeah, I mean, that's something that we have to look at as well. I mean, there were forms that were filled out that identified specific information, including information related to that, from what I understand, and we need to look at to see if those were something that should have immediately jumped out at you and that required further review, based on the examination work that was done. So I mean, that was something that, again, you know, seems on its face to be something that requires very careful scrutiny.
01:25:46	REP. BACHUS	You know, it appears that's a red flag, and then when you couple that with the fact that, although he was an investment advisor, obviously -- known to everyone that he was managing billions of dollars worth of assets -- he didn't register, although he was managing, by public information, hundreds of times the assets which would have required him to register. So my next question was, is that not a red flag when you catch someone who's failed to register, although the operation would dictate him to register, you know, obviously, is there not an audit or examination at that time, by people who fail to register?
01:26:29	MR. KOTZ	I mean, I think the issue of aggressive oversight -- was there aggressive oversight in place such that if information was brought to the attention of the examiners and auditors, action was taken immediately -- the question of whether they took this individual's word for it or whether they followed up appropriately. And as I indicated, we're going to look at whether Mr. Madoff's stature and reputation had any impact. Was there a question of, well, this is Bernard Madoff and so we don't have to worry about him not following up and giving us the documentation.
01:27:04	REP. BACHUS	In fact, I guess that would be my last red flag, in that Madoff claimed to do something that very few people claim, publicly, to do, and that's a guaranteed high rate of return, and yet, the SEC had people that actually laid out to them that this was impossible to do, and if you look at it, just the number of puts and calls that he was utilizing, the whole flow -- the whole market for him -- was insufficient to have, you know, minimized a downturn. So are there people at the SEC that have the expertise and, maybe, what we might call trading expertise to realize that what he was claiming is impossible if you just look at those documents published every day or those facts published in the Wall Street Journal on a daily basis.
01:27:55	MR. KOTZ	In my personal view, there should be folks at the SEC who have that expertise, and you know, as we look at it, we may look at the issue of whether there is that expertise or training in place, and perhaps make recommendations for further training and to ensure that expertise. So, I mean, there has to be a situation in the SEC where those folks would be able to see the information that was provided and make determinations. And so we will look carefully, following complaints that were brought to the SEC's attention, and looking at how the SEC dealt with it, who dealt with it, what was the expertise level of the individuals who dealt with it and why the actions that were taken or not taken happened.
01:28:38	REP. BACHUS	I appreciate that. Do you have the authority to contact former employees as well as former commissioners or chairmen of the SEC, or is your -- are your powers only to interview those people that are presently with the SEC?
01:28:53	MR. KOTZ	Well, we could certainly contact, and have on many occasions contacted, former employees. We don't have subpoena power, per se, to require them to appear like we do with current employees, but generally, folks have been willing to cooperate, and there are certainly investigative methods you could use to ensure their cooperation.
01:29:13	REP. BACHUS	I hope you will, because, you know, some of this would extend back at least 10 years. Mr. Harbeck, have you been able to identify any legitimate documents, which are going to allow you to help process claims in this matter?
01:29:29	MR. HARBECK	Well, one of the first things that we did with respect to this was to modify our standard claim form to make sure that we asked the claimants themselves what evidence they had in terms of money in and money out, because that's going to be one of the critical factors. In one of these situations where the books and records are completely unreliable, that's our best source, so we've urged people to give us as much documentation as they can.
01:29:57	REP. BACHUS	Has Madoff supplied you with any -- or his associates or the firm -- supplied you with what you'd call legitimate documents?
01:30:04	MR. HARBECK	The trustee has taken over the books and records of the brokerage firm and by the way, the investment advisor and the brokerage firm were one legal entity, so we have the records of what was actually in the securities inventory, and we also have some semblance of an idea of what the customers thought they had, at least in aggregate figures if not in individual accounts.
01:30:28	REP. BACHUS	When they're one entity, does that create some, maybe, opportunities for mischief?
01:30:35	MR. HARBECK	I'm not an examiner, I'm a bankruptcy attorney. I think you may be right, however.
01:30:40	REP. BACHUS	Okay, thank you. You've got a $1 billion line of credit with the Treasury.
01:30:46	MR. HARBECK	Yes, we do.
01:30:46	REP. BACHUS	You've had that since 1970. Obviously, is that --
01:30:52	MR. HARBECK	Adjusted for inflation -- the number has never changed since 1970 -- adjusted for inflation using the consumer price index, that number would be somewhere in the vicinity of $4.3 billion. When you take into account the vast expansion of the securities markets themselves since 1970, that's certainly something we will look at as we determine how deep into SIPC's resources this event will take us.
01:31:20	REP. BACHUS	Let me just close by asking you this -- no, that's fine, I can --
01:31:29	REP. KANJORSKI	Thank you very much. Something the ranking member brought up, the broker/dealer being required to register, or using an auditing firm that is registered with PCAOB -- expired on December 31st of this last year. I understand, now, that the broker/dealer must be audited by a registered firm, but there's no enforcement authority by the PCAOB for auditors of non-public broker/dealers. Are you aware of this, Mr. Kotz? And if so, what do you think about it?
01:32:09	MR. KOTZ	Yes, I mean, I know that there's been an issue that has been raised of the limited authority of the PCAOB. And that is something that we would look into as well.
01:32:19	REP. KANJORSKI	Well isn't this the very point, though, that the three-man auditing group that Mr. Ackerman talked about -- that if they had to be registered, they wouldn't have been allowed to be a party to this thing?
01:32:33	MR. KOTZ	Yeah, I mean, it would certainly seem that if the PCAOB had this information, that they would have been able to take action --
01:32:39	REP. KANJORSKI	But the SEC gave an exemption since 19 -- or since 2003 -- three or four times.
01:32:46	MR. KOTZ	Right, no, absolutely, there's an issue there about, number one, what was the reason for that rule, but also number two, whether the SEC, even without the PCAOB, should have been able to see these red flags and take appropriate actions.
01:32:59	REP. KANJORSKI	I understand, but what I'm not gathering is if you or your predecessor knew of this -- isn't the inspector general supposed to notify either the chairman of the commission that there is a failure here in the law as it's drafted, and it will allow some important parties to escape registration, and if no action is taken and no request for additional change or authority of the Congress -- wouldn't you come to Congress and say, we've got a gaping hole here. We've got people with billions and billions and billions of dollars that don't have a registered auditor?
01:33:34	MR. KOTZ	I can only speak for the time I was as the inspector general, but I agree that certainly if, in the context of this investigation and our audit that we conduct, we identify gaping holes like that, we would certainly put that in our report and that would be brought to Congress' attention, so I agree with you.
01:33:53	REP. KANJORSKI	But these gaping holes existed for five years and an exemption has been given three times and nothing ever happened until this thing hit. If this thing -- if it had been changed, if the exemption weren't there it seems to me this couldn't have happened.
01:34:10	MR. KOTZ	Yeah, I mean I -- we have not looked carefully at that specific exemption issue, so it's difficult for me to comment. But I do agree with you that we need to look carefully at the regulatory gaps and if there are regulatory gaps that we have looked at carefully and we've reviewed and find that they exist that we would actually believe it would be incumbent upon us to bring that to your attention.
01:34:32	REP. KANJORSKI	The junior lady from New York, Ms. Maloney.
01:34:32	REP. CAROLYN MALONEY (D-NY)	Thank you very much. My district is home to many of Madoff's victims and as a representative from a state with millions of jobs dependent on the financial sector, I'm mindful that protecting this industry's reputation and integrity from predators and thieves like Madoff is absolutely crucial to maintaining our country's economic leadership. Some of our country's most sophisticated investors were duped by Madoff. This leads me to ask you a few questions. Madoff's firm was unusual in that it performed custody, trade- clearing and statement-generation functions in addition to managing clients' funds. If custodial, clearing and statement reporting were done by a reputable third-party or -parties, would this not have made it far more difficult for Madoff to dupe his clients and to fool regulators?
01:35:46	MR. KOTZ	Yeah, I think that that's something that we would look at very carefully as part of our review. I don't know that can answer that question today before having completed the audits and investigations, but that is something, certainly, that must be carefully scrutinized.
01:35:59	REP. MALONEY	Also it has been suggested that Madoff's tiny and little-known auditor was a red flag. What minimum standards should we set for qualifications of accountants to the money-management business?
01:36:18	MR. KOTZ	Yeah, I understand the point and as I indicated, we're going to look not only at the specific situation, but what rules we could recommend or policies such as you mentioned to ensure that where there are red flags potentially or information that is out there, that they're responded to immediately. So I agree with you.
01:36:36	REP. MALONEY	Now additionally, many people threw up red flags and one of them was that Madoff's returns typically hovered between 10 and 12 percent. People even wrote articles about don't ask, don't tell -- raising concerns about his investment strategy. One in May of 2001 by Erin Arvedlund, which was in Barron's -- it should have thrown up a red flag to investigators, to the SEC, to the general public. Why didn't these questions that he raised alert the regulators? In addition, Harry Markopolus (ph), he was in regular communications with the SEC, raising red flags, asking questions, he contacted them in 2000. In 2005, he sent the SEC a 19-page report entitled "The World's Largest Hedge Fund is a Fraud". Why in the world didn't anyone respond to his allegations, what happened to his report and did the SEC investigate his allegations?
01:37:46	MR. KOTZ	Yeah, I mean that's exactly what I intend to find out. Certainly, the articles that you mentioned initially are things that we have to look at to see if the SEC examiners were aware of the articles, reviewed the articles, how they viewed the articles and whether they factored that into their determinations or if they weren't aware of the articles, why weren't they aware of the articles? And certainly Mr. Markopolus -- who as I said I'm meeting with later this month -- we need to trace that complaint through the different offices that it went to to determine what individuals dealt with that, what were there determinations that were made, why was it that they took the action that they took. So I will tell you that my investigation and audit efforts will get to the bottom of exactly those issues.
01:38:29	REP. MALONEY	And when the key regulator is totally asleep even when whistleblowers are calling and trying to alert them, as was the case before us with the Madoff case, we would like to think that there were some checks and balances in our complex regulatory system that would alert other regulators, the administration or Congress. Why did that not happen in this case?
01:38:57	MR. KOTZ	Yeah, absolutely. I mean, we need to look at what was the information that the individuals within the SEC were aware of and why was it that they took or didn't take the appropriate action? So that is going to be the focus of my efforts.
01:39:11	REP. MALONEY	Well, many of us have lost confidence in the SEC. It's pretty pathetic when a major newspaper, major periodicals, when whistleblowers issue reports and warnings, when they have a system that they won't explain to anyone and an auditor that no one every heard of -- that this should be raising some concerns. So my question is, for those of us who don't trust the SEC anymore, what additional authority should be given to other regulators to provide a better safeguard against the sort of agency failure that occurred with the SEC? What is so frustrating about this -- we could not do anything as a government to prevent 9/11 -- we could have prevented this if we responded to whistleblower complaints, articles raised by other investment bankers and a model that no one understood and an auditor that no one every heard of. So where can we go to get the proper oversight? I do not believe we got it in the past from the SEC; I don't have trust in them for the future.
01:40:20	MR. KOTZ	Well, I can certainly understand the concerns and my efforts will be to find out exactly what happened: How it could be that where it was spelled out in such a way -- the world's biggest Ponzi scheme -- that wouldn't be sufficient information to look into a potential Ponzi scheme. So I can understand the concern about the credibility; all I can do is find out what happened, report back in terms of what failures were caused in this case and then determine or make recommendations about what action should be taken as a result.
01:40:54	REP. MALONEY	I look forward to your report -- my time is expired -- on why no one read the report on the world's largest Ponzi scheme and now we have the world's largest Ponzi scheme.
01:41:06	REP. KANJORSKI	Thank you, Ms. Maloney. And now we'll recognize the gentleman from Texas, Mr. Paul.
01:41:12	REP. PAUL	Thank you, Mr. Chairman. I'd like to follow up on my opening comments to Mr. Kotz. The contention is that the system didn't work. It didn't work -- I don't think there's any argument about it, but I go one step further and I maintain it can't work because it's a flawed system. The argument goes that if we have to use this system what we have to do is get more money, more people and more efficieny. So the money will come, the people will come and you'll promise more efficiency and the congressmen will say we got to be more efficient. But my argument is that the approach is completely wrong. There is always a cost that we don't talk about -- there's a money cost, but of course there's a cost to regulation that injures businesses. In the Depression the SEC actually helped prolong the Depression and Sarbanes-Oxley didn't do anything to prevent this from happening and we've been in a slump for a long time, so regulations aren't the solution. Does that mean that we have to be soft on fraud? No, fraud we have to really crack down on, which we seem to ignore. But too often we have these regulations out there that sort of protects us and say oh, well the SEC will take care of us. We don't really have a responsibility. A good analogy to this is where people are safe in their homes. The least-safe place in this country is where the most laws are and the most policemen are: in the inner-city. The people who are the safest are the ones who assume responsibility for themselves, have their own weapons for their homes and live in rural areas and there's no policemen within miles. So that whole attitude is completely different. But the point I want to make and get you to respond on is, in some areas we don't do it this way -- we don't preempt with regulations. If we deal with habits or religious cults or intellectual pursuits we're very protective of the First Amendment and say oh yeah, a lot of harm can come from it, but we're never going to regulate you. When it comes to the press: The press can do great deal of harm to any one of us and frequently politicians suffer from libel and slander. But we never go and say what we need is prior restraint to make sure nobody's ever injured. But we don't do that, we assume there's a recourse and we don't because there's a cost. There's a loss of liberty in that sense, because if we have people snooping around on everybody's habits and anticipating it, then we have lost something. But on economic issues all of a sudden we say oh, this is okay. We can do this and there's never a downside. But what I don't understand is why don't we treat economic liberty the same as we do with personal liberty and religious liberty, intellectual liberty -- we even have the First Amendment split in two. We talk about intellectual freedom of speech, but commercial freedom of speech needs regulation. But why is this not a unit? And so my question to you is how -- don't you have any doubts whatsoever that regulations aren't the answer? Why isn't it that we couldn't monitor ourselves and our system with a determination to prevent fraud and deal with the fraud and the corruption and the ponzi schemes within our own system? And pyramiding debt contributes to this, the financial system that we manage is -- our fiat system contributes to it. All the insurance programs that we have teaches people that it's okay and we allow this moral hazard to occur. So instead of this being the answer, I see this as the problem -- the cause -- and not in a personal sense, because I think people who work at the SEC are probably as determined as anything, but I think you have an impossible task. You might say, "oh, no!" and you might be able to come with some examples -- "We did a, b, c and we protected such and such." But we could do that if we monitored religion and said "Look at what we prevented!" Do you have a comment on this and why we couldn't treat everything equally?
01:45:23	MR. KOTZ	Sure. I don't go into this with any preconceived notions that increased regulation or increased resources or increased individuals is the answer. I mean, what we need to look at is a holistic and comprehensive view as to whether the SEC can respond appropriately. So I certainly wouldn't go into the process thinking that the answer is a particular matter, whether it's increased regulation or increased individuals. We need to look at the process, as you say, and see if the SEC is able to do the job that it needs to do.
01:45:55	REP. PAUL	The budget for the SEC nearly -- probably doubled in the last seven or eight years. I think in '01 it was about 400 million (dollars) and now it's over 900 billion (dollars). And the personnel went up by about 20 percent, but we had like 100 percent increase in the budget. Where did that money go if we didn't hire more people? Do you have a general idea on where most of that money went if it wasn't for hiring more personnel?
01:46:18	MR. KOTZ	Yeah. I'm not that familiar with the overall budget of the SEC. I could talk more about our office. But certainly, we need to look at where money went and whether there were additional people or what was used with the resources.
01:46:31	REP. PAUL	Do we do contracting out? Could that have been hiring individuals where they were not called government employees? Do you think that might have been part of it?
01:46:40	MR. KOTZ	There is some contracting out in the SEC, yes.
01:46:45	REP. KANJORSKI	Thank you very much.
01:46:45	REP. PAUL	I yield back. Thank you.
01:46:45	REP. KANJORSKI	Thank you very much, Mr. Paul. Okay. The gentleman from North Carolina: Mr. Watt.
01:46:45	REP. WATT	Thank you, Mr. CH airman. Mr. Kotz, were you in the Inspector General's Office, prior to becoming the inspector general?
01:47:00	MR. KOTZ	No.
01:47:00	REP. WATT	Okay. Is there anything that you, during your tenure or your predecessor, could have done that you can suggest to us that might have prevented this?
01:47:15	MR. KOTZ	I mean, I'm not aware specifically. Obviously, I think it's the job of the inspector general to be aggressive in their oversight and to be vigilant to the agency. And there have been reports that we've issued over the past year that have --
01:47:28	REP. WATT	Yeah, but on this issue, is there anything that you or your predecessor could have done? For example, could you have made sure that Mr. Madoff and his company didn't exercise these exemptions that they were getting from the Investment Advisers Act?
01:47:54	MR. KOTZ	Yeah, I don't believe that --
01:47:54	REP. WATT	Would that have been an appropriate role for the inspector general?
01:48:00	MR. KOTZ	I don't believe that there is something specifically we could have done. Now, we could have done an audit of a particular area, and if we had done an audit of a particular area, we could have made recommendations regarding that area.
01:48:12	REP. WATT	Okay. I'm not trying to blame you for any of this, but it just seems to me that everything that you've talked about today is kind of, I'm going to take a look at the horse after the horse is gone from the barn. And I'm trying to find out what somebody could have done to have stopped this from happening. Mr. Harbeck -- Harbeck, I take it that your agency is pretty much like the FDIC of brokers?
01:48:50	MR. HARBECK	There are analogies and there also differences.
01:48:50	REP. WATT	Okay. I understand that, but you get appointed by the members that you supervise, right?
01:49:03	MR. HARBECK	No. First of all, we do not supervise anyone.
01:49:03	REP. WATT	Who's on your board?
01:49:03	MR. HARBECK	Our board of directors is composed of five individuals. Pardon me, seven individuals, five of whom are presidential appointees.
01:49:14	REP. WATT	Okay, all right.
01:49:14	MR. HARBECK	Three must be in the securities industry; two are not permitted to be in the securities industry. There's representatives of --
01:49:21	REP. WATT	Okay. Is there anything that came to your attention over the last five to 10 years about Mr. Madoff's operation? I mean, do you all do any audits of the people that you insure?
01:49:39	MR. HARBECK	No, sir. We do not. That rule is --
01:49:39	REP. WATT	You're not required to do any audits or --
01:49:44	MR. HARBECK	We're not permitted to.
01:49:44	REP. WATT	-- you're not expected to do any audits?
01:49:44	MR. HARBECK	We're not expected to or permitted to under the statute we administer. That role falls to the SEC and to FINRA.
01:49:53	REP. WATT	Okay. What happens if you exceed the $1 billion in -- I think you testified that you have $1 billion in Treasury accounts and a line of credit of 1.5 billion (dollars). What happens if the extent of the claims exceed that amount?
01:50:18	MR. HARBECK	I believe this committee would be among the first to know that. But we have $1.6 billion in Treasuries. Our commercial line of credit is currently $1 billion and then we also have a line of credit with the Treasury. We will not know --
01:50:37	REP. WATT	I'm not asking you how much the claims will be. I know you don't know that. But if you exceed the amount of assets that you have, what will be the recourse that you have?
01:50:50	MR. HARBECK	Well, speaking to your point about who is on our board of directors, we also have a director from the Treasury and from the Federal Reserve. And we will go there.
01:50:57	REP. WATT	That's not the question I asked you, Mr. Harbeck. That was the prior question. I'm asking you a new question now. What will happen if the legitimate documented claims exceed the assets that you have?
01:51:15	MR. HARBECK	We will come to Congress.
01:51:15	REP. WATT	And so the taxpayers will end up being responsible for whatever that overage is on the claims, is that correct?
01:51:28	MR. HARBECK	That would be the case if we did come to Congress. We've not done so for 38 years and have never used government funds.
01:51:33	REP. WATT	Okay. But under the statute is there either an explicit or an implicit guarantee by the federal government of what you do?
01:51:46	MR. HARBECK	There is nothing explicit beyond the $1 billion line of credit with the Treasury that's currently in the statute.
01:51:46	REP. WATT	Is there anything implicit or has anything been written about that over the years?
01:51:56	MR. HARBECK	There really has not. And the reason is that this event is such a remarkable outlier in terms of its expense. We've liquidated 317 brokerage firms over 38 years.
01:52:11	REP. WATT	I appreciate you volunteering all that information, but I'm trying to -- if we -- would it be a good idea to give your agency audit authority or some kind of authority, since you are writing the check if somebody ends up doing something like Madoff did. You've got to write the check to cover it. What would be the downside of giving your agency the authority and responsibility for going in and policing these accounts? Doesn't FDIC have that authority?
01:52:49	MR. HARBECK	Yes. And they are a regulator.
01:52:49	REP. WATT	All right. So is there a downside that you see to doing that?
01:52:56	MR. HARBECK	The question you've asked was asked in 1970 --
01:52:56	REP. WATT	I didn't ask you that, now, Mr. -- I'm already out of my time. I'm saying, can you articulate for me a downside of doing what I just suggested?
01:53:12	MR. HARBECK	I don't think we could do any better job than the people who are currently assigned to do it. We would hire those --
01:53:18	REP. WATT	Which is the SEC?
01:53:18	MR. HARBECK	The SEC and FINRA.
01:53:18	REP. WATT	You're saying you couldn't have done a better job. Even though your money and taxpayer money was on the line, you couldn't have done a better job in this case than the SEC did?
01:53:32	MR. HARBECK	I would have hoped anybody could have done it, but I'm not confident, since it's outside our current area of expertise, that we could have done it.
01:53:40	REP. WATT	Okay. Thank you, Mr. Chairman. I yield back.
01:53:44	REP. KANJORSKI	Thank you, Mr. Watt. Mrs. Biggert.
01:53:44	REP. JUDY BIGGERT (R-IL)	Thank you, Mr. Chairman. Mr. Kotz, looking over the number of the years that something came up from 1999, 2004, again in 2005 -- and then November 2005 and then in 2006, it really troubles me. We've got that the SEC investigators in New York meet with Harry Markopoulos and has a 21- page presentation, which then seems like nothing happens to that. I think it troubles me, and probably others, that how can we be sure that the SEC is really going to be able to accomplish an investigation now? Is there something in protocol where if there's somebody outside of, you know, the examiners looking into -- or when they're looking at a group, such as this, that they don't take into account the outside information?
01:55:00	MR. KOTZ	Well, I think we'd need to look at both those issues. First of all, how could it have been that this information was brought to the SEC's attention, to trace it through all the process, but also to look at what the policies and procedures were. I do think it's important to look at what were the policies and procedures in place at the time. Were they violated? If they were violated, clearly we have to take action with respect to that. And if they were not violated, then the question is why weren't the policies and procedures different at the time, in order to ensure that this be done correctly.
01:55:31	REP. BIGGERT	Well, in your testimony you say that where allegations of criminal conduct are involved, we notify and work with the Department of Justice and the FBI as appropriate. Wouldn't you think that -- well, first of all, do the FBI and the Department of Justice have the expertise to investigate and prosecute securities funds?
01:56:01	MR. KOTZ	Well, when I mentioned that, I was talking about my office, the Office of Inspector General. If -- For example, if we were to do this investigation that we're currently undertaking and we were to find criminal conduct on the part of someone in the SEC vis-a-vis the Madoff matter, we would follow up with the FBI and the Department of Justice. I do believe that the Division of Enforcement, which is the entity that does investigations such as what was brought to their attention by Harry Marcopolis, does also coordinate with the FBI and the Justice Department. I couldn't speak to what they do vis-a-vis the Justice Department and the FBI.
01:56:36	REP. BIGGERT	Well, do you think that they should be more involved in this investigation, then? Wouldn't it help if it seems to be that the -- we've talked about you don't have the people to do it; they don't have the expertise.
01:56:53	MR. KOTZ	Well, the investigation that the SEC Division of Enforcement is undertaking, with regard to the criminal case against Mr. Madoff, certainly the FBI and the Department of Justice should be more involved. With respect to our investigation that we're undertaking, with respect to what the SEC did or didn't do when the Madoff allegations came in, we would certainly bring them in if there was a criminal-type issue that would -- they would be able to assist us. I certainly would like to get assistance from whoever I could -- to try to unravel the situation.
01:57:28	REP. BIGGERT	Thank you. Well, Mr. Chairman, if -- may I suggest that we invite the FBI and the Department of Justice to testify before this Committee about their efforts to -- related to securities fraud as well as other forms of financial fraud? For example, mortgage fraud last year grew by 42 percent. Since 2000, it's grown by an astounding 1200 percent. I think that this might be something that would be of value to us, and I would request that.
01:57:59	REP. KANJORSKI	I think that's an excellent suggestion. I will certainly take it under consideration.
01:57:59	REP. BIGGERT	Then just one other question -- the focus about the relationship between the SEC staff and Mr. Madoff and his family. Does the SEC have current rules and procedures governing permissible relationships and standards of conduct?
01:58:20	MR. KOTZ	Yes, I believe they do. And we have to look very carefully at those rules to see if any rules were violated and, again, even if rules were not violated, to see whether those rules must be supplemented. There are allegations in this case regarding potential conflicts of interest, and one of the areas that we'll look at very closely is were there conflicts of interest, were the rules in place sufficient to deter those conflicts of interest, and whether further rules are necessary.
01:58:46	REP. BIGGERT	Thank you. I yield back.
01:58:46	REP. KANJORSKI	Thank you very much. And our next, Mr. Ackerman of New York.
01:58:57	REP. GARY ACKERMAN (D-NY)	Thank you, Mr. Chairman. I'm trying to figure out what we got here. We got the president of the Securities Investor Protection Corporation, who's been that for the last six years. Security investor protection, it seems to me, hasn't protected any of the security investors. And we have the inspector general of the Securities and Exchange Commission, which is the inspector of the watchdog agency that didn't watch out for anything, which makes you the Jacques Cousteau of the Keystone Kops. And looking at this whole program that we and so many investors thought that they had some modicum of protection with some official eyes upon it, with something called the Security Investor Protection Corporation. I want to know who is responsible for protecting the security investor. Because I want to tell that person, or those people whose job it is that they suck at it. So whose job is it to protect the security investor?
02:00:32	MR. HARBECK	Congressman, the Securities Investor Protection Corporation becomes involved only after it has been determined that a brokerage firm has failed. We have no role prior to that.
02:00:42	REP. ACKERMAN	So you're not protecting the consumer. So you're not protecting the security investor, is what you just told me.
02:00:52	MR. HARBECK	With respect, I disagree.
02:00:52	REP. ACKERMAN	And it's not until Mr. Madoff turned himself in, or had his children turn himself in, that you discovered that people were being defrauded and one of the members of the corporation that you're the president of, this -- whatever it is.
02:01:05	MR. HARBECK	With respect, I disagree with your characterization that we're not protecting investors.
02:01:05	REP. ACKERMAN	I got 50 billion dollars' worth of investors that would disagree with you, but go ahead.
02:01:14	MR. HARBECK	And we are going to use the maximum extent of the law to return funds to them. But we have no role --
02:01:20	REP. ACKERMAN	What funds? What funds?
02:01:20	MR. HARBECK	From SIPIC's funds.
02:01:20	REP. ACKERMAN	How much money is there in SIPIC?
02:01:26	MR. HARBECK	We have $1.6 billion.
02:01:26	REP. ACKERMAN	I got $50 billion to cover. How're you going to do it? You got a Ponzi scheme?
02:01:31	MR. HARBECK	Most -- a great deal of those funds are false profits that never existed.
02:01:31	REP. ACKERMAN	False profits?
02:01:31	MR. HARBECK	Yes, sir.
02:01:37	REP. ACKERMAN	So the government has been taxing people on false profits?
02:01:42	MR. HARBECK	I think -- I think your point on that is very well taken, and I believe there are tax remedies for people who've paid taxes on those funds. I'm not a tax expert.
02:01:54	REP. ACKERMAN	Mr. Inspector General?
02:01:54	MR. KOTZ	Yes, well, I can certainly understand what your concern is, and I'm going to ask those very same questions. If the facts are as --
02:02:06	REP. ACKERMAN	What do you do before the Bernie Madoffs and the mini-Madoffs turn themselves in?
02:02:13	MR. KOTZ	Right. Well, we need to make sure that the SEC has enforcement and examination divisions in place --
02:02:20	REP. ACKERMAN	Do they?
02:02:20	MR. KOTZ	Well, that's what my investigation and audits will determine.
02:02:20	REP. ACKERMAN	You don't know that they have it or not?
02:02:20	MR. KOTZ	Well, I don't know that they had it --
02:02:25	REP. ACKERMAN	You had a -- you've been doing this for over a year. Someone else has been doing it for a year before you and years and years and years before that, and we still don't know if they have the ability to do what we're paying them to do with taxpayer dollars?
02:02:35	MR. KOTZ	Well, I could certainly say that if the allegations are as they say, then there's great concern that they do, I will report that back and -- (inaudible).
02:02:43	REP. ACKERMAN	So after the fact, we're going to know if you were able to do your job all these years and the SEC was able to do their job. This is worse than a nail in the coffin. This is a spike in the heart of the investment community that makes America run, at a time that we can ill afford it. Confidence in government and its agencies are at stake here. Now, you had Mr. Madoff turn over a list of all of his assets. There are people with 50 billion dollars' worth of claims; whether these are false profits or not, there're certainly real investments that built up to $50 billion, maybe more, maybe -- we don't know the extent of it yet. This may be the tip of the iceberg, and besides -- how many other icebergs there might be floating out there that you won't know until somebody confesses to the crime. In the assets that you had him turn over on December 31st at Midnight, while much of America had no champagne bottles to pop, how much assets did he turn over that you have sealed, and why haven't you turned that over to the bankruptcy court so that people can see what's happening, as in normal bankruptcies?
02:03:51	MR. KOTZ	Yeah, I didn't have anything to do with instructions about assets. That was the enforcement --
02:03:57	REP. ACKERMAN	Good. Will you make them -- would you turn that -- will you turn that over to this Committee?
02:04:02	MR. KOTZ	I don't have that information, but certainly everything that will be in my report I will seek to --
02:04:02	REP. ACKERMAN	Mr. Harbeck, do you have it?
02:04:09	MR. HARBECK	I know that the Securities and Exchange Commission has it. SIPIC itself does not have the --
02:04:14	REP. ACKERMAN	Duuhhhhhh.
02:04:14	MR. HARBECK	What I can tell you, sir, is that the trustee will work with the SEC, get those assets, and we are very aggressive about liquidating assets.
02:04:23	REP. ACKERMAN	Will you turn it over to this Committee? The public has a right to know. There's a bankruptcy, which is a very public thing, with legitimate investors, who have a right to know what's there, what they might reasonably expect to have if they can do the math and divide by the number of them and the number of dollars.
02:04:37	MR. HARBECK	I can promise to you that if it is the Committee's pleasure to have that report, I will get it to you as soon as I receive it.
02:04:43	REP. ACKERMAN	I'm making that request. Will you get it to me and the Committee as soon as you can?
02:04:43	MR. HARBECK	Yes, sir.
02:04:43	REP. ACKERMAN	Can you do that within a week, because you turned it over to the court already?
02:04:50	MR. HARBECK	If the SEC has not given it to me, they will.
02:04:50	REP. ACKERMAN	And you will give it to us within a week?
02:04:50	MR. HARBECK	Yes, sir.
02:04:55	REP. ACKERMAN	Now, what happens to this clawback thing that are making a lot of people petrified? Why is there a difference between an investor who invested six months ago or eight months ago and an investor who invested six years ago? Are we going to see the government go after them? I represent the north shore of Long Island, called -- you know, made famous in many novels as the Gold Coast. And I probably represent more people than -- I know dozens of people who are absolutely destitute now, who were the biggest philanthropists in this country, making the world of charity work, who now don't know what to do. One guy called me up with tears in his eyes. His wife's dying of cancer; his kid has a debilitary (sic) disease. He's going to get through this somehow, but what's going to happen to the hospital that he promised $12 billion to in his next contribution, a children's hospital?
02:05:52	MR. HARBECK	Your question with respect to clawbacks is that, under the law, all customers participate in what's known as a "pool of customer property." It's the trustee's duty to expand that pool and distribute it equitably. If a customer, for example, has received many times more than the customer put in, he is far more advantaged than someone who, for example -- and this is a true example, someone who put in $10 million last week.
02:06:18	REP. ACKERMAN	Well, my constituent put in $10 million the day before Mr. Madoff turned himself in, and people are telling him it doesn't exist anymore. Does he get his money back?
02:06:26	MR. HARBECK	He is part of that common pool and, unfortunately, he will not get his $10 million back any more than someone who put it in six weeks ago.
02:06:32	REP. ACKERMAN	Is there a government clawback for his $10 million?
02:06:32	MR. HARBECK	No. Those funds are already in the Madoff enterprise.
02:06:40	REP. ACKERMAN	The insurance that people have with SIPC -- the $500,000 insurance that they think that they have, if they've put in $500,000, regardless of when, can they expect their money back? And you're going to hear a witness -- if you care to stay here after you testify, you're going to hear a witness who can't pay his mortgage next month.
02:07:00	MR. HARBECK	I've heard many such stories, and the answer to your question is --
02:07:00	REP. ACKERMAN	Two-and-a-half years?
02:07:06	MR. HARBECK	No, sir. We'll do it faster than that.
02:07:06	REP. ACKERMAN	Can he make his mortgage payment before he loses his house and have to go live with his children and his grandchildren?
02:07:11	MR. HARBECK	If he can demonstrate that he put money in, and did not take money out, we will get money back to him as fast as possible.
02:07:18	REP. ACKERMAN	Ask unanimous consent, with the witnesses, to (count ?) permission, which I have, to put his statement of this last month in the record in its entirety?
02:07:27	REP. KANJORSKI	Without objection, so ordered.
02:07:27	REP. ACKERMAN	Yield back whatever time I might have.
02:07:27	REP. KANJORSKI	The gentleman from Nevada, Mr. Heller, for five minutes.
02:07:35	REP. HELLER	Thank you very much, Mr. Chairman. And I want to thank the witnesses for attending. I know this isn't -- can't be easy at times. Inspector General, could you explain what a split-strike conversion strategy is?
02:07:48	MR. KOTZ	That's, unfortunately, not in my area of expertise.
02:07:48	REP. HELLER	Do you anticipate someone in your agency would know what a split-strike?
02:07:56	MR. KOTZ	Absolutely. I mean, that's certainly the areas within the agency, not the watchdog office, that would be involved in those matters. But, unfortunately, that's not me.
02:08:04	REP. HELLER	Because I believe this is the basis of it. Okay, I can't ask you the question, then, if you don't understand the strategy. Let me move to another direction. Besides marrying into the family, did the SEC employees -- are you aware of any SEC employees that ever worked for Madoff Securities Investment?
02:08:24	MR. KOTZ	I'm not at the moment. But, again, that's something that we need to look at in the investigation, and determine whether that happened. So, that is something that's certainly within the list of matters we're going to look into.
02:08:33	REP. HELLER	Are you aware if there's a cool-down period for SEC employees working in the industry?
02:08:41	MR. KOTZ	I believe that the standard rules -- standards of conduct apply to SEC employees like every other employee in the federal government. I'm not specifically aware of special rules for the SEC. I'm not an ethics officer. But, one of the things that we do need to look at is -- and one of the things that we've already looked at is that relationship between SEC employees and when they leave SEC, and when they go into private industry; and the questions of whether there are relationships caused by that that have an impact on what the SEC folks do. And so, you know, as I said, we're going to look at the stature of Mr. Madoff; whether his reputation had any effect on the actions that were done here; and, you know, whether the different employees within the SEC had any expectations, or even wished to go to private firms that could have impacted --
02:09:39	REP. HELLER	Right.
02:09:39	MR. KOTZ	-- their decisions.
02:09:39	REP. HELLER	And I appreciate that comment, and I would hope that you would take a good close look at that. I want to talk about your auditing process. What do you, in your opinion, consider to be an ideal period of time between audits of an investment advisor or a securities firm? Is it every two years, every four years? Do you have -- does the SEC, or does your office have a goal?
02:10:01	MR. KOTZ	We don't do -- our office is the watchdog office of inspector general, so we don't do audits of investment advisory firms. I know that there is an issue in this matter about the frequency of those audits and examinations. And one of the things we're going to look at is: How does the office that does those audits and examination, what is their frequency? And is there -- is that an issue of resources, that they don't have enough resources in order to do more frequent examinations? But also, whether these examinations are done appropriately, so that even if you have further resources, then you could do more examinations; if the examinations aren't yielding the results, then additional examinations aren't done. So, that's not something that our office does, but that is something we will look at to see: what is the frequency of the audits, and whether the frequency should be changed, and whether the audits should be changed.
02:10:47	REP. HELLER	So, you're anticipating that you would propose some level of audit standards, or frequency of audits in the future?
02:10:55	MR. KOTZ	Yeah, well, we would make recommendations regarding the office's policies, potentially, about the frequency of audits -- if we determine that those examinations or audits are fruitful.
02:10:55	REP. HELLER	Sure.
02:10:55	MR. KOTZ	First, I think we need to determine that the examinations would find what they're supposed to find. And then if that becomes the issue -- that it's just a matter of the frequency, then we would make recommendations that they increase the frequency.
02:11:17	REP. HELLER	Thank you. I will yield back.
02:11:17	REP. KANJORSKI	The gentleman from California, Mr. Sherman.
02:11:17	REP. SHERMAN	Thank you. Mr. Harbeck, I want to thank you for pointing out that we're dealing with one legal entity, because there's this myth that the 16th floor was cool; the 17th floor was where the fraud was going on. The fact is, it's one entity, one fraudulent entity. And that entity was filing financial statements with the SEC and with FINRA every year for many years. Those financial statements were obviously false on their face because they involved large amounts of money being reported by a tiny accounting firm -- or tiny auditing firm. And so I want to thank you for pointing that out. A number of my colleagues are questioning why you didn't do the enforcement job. And, as I understand it, you're basically like my life insurance company. You're not going to keep me alive, but if I die you're supposed to pay off.
02:12:27	MR. HARBECK	That is correct, sir.
02:12:27	REP. SHERMAN	And in contrast, it's FINRA and the SEC that's supposed to be doing the enforcing. They're the ones that received these financial statements that were obviously false on their face. They're the ones that the intelligent tipsters went to. They didn't come to you and say, hey, there's fraud going on at Madoff. They were sophisticated enough to know that they should go to the SEC. And I look forward, Mr. Chairman, to bringing the SEC enforcement people and FINRA before this subcommittee. But, Mr. Harbeck, the one thing I count on my life insurance company to do is to stay solvent so that they can pay off when I do die. I look to other people to keep me alive. Now, you (mention in ?) your lines of credit, but the right to borrow money is not net worth. Your net worth is about $1.5 billion, minus what you lose on this Madoff case. And do you have any reason to think that -- well, and we talked about this earlier, you're going to lose, under even a conservative estimate, a billion dollars on the Madoff case?
02:13:42	MR. HARBECK	It all depends on the claims, which we haven't yet received, Congressman. And I --
02:13:42	REP. SHERMAN	Okay, but everybody who has one of these statements -- where they directly invested in Madoff, and there's, and the positions are here listing the securities they're supposed to have -- is ensured up to half a million dollars, correct?
02:14:02	MR. HARBECK	They are protected. We don't use the word "insurance" because of the fact that we don't protect against the underlying value of a securities portfolio -- (inaudible) --
02:14:09	REP. SHERMAN	Okay. (Well, but ?) you do form an insurance company function --
02:14:09	MR. HARBECK	Yes.
02:14:09	REP. SHERMAN	-- and any insurance regulator in this country who looked at the fact that you're standing behind well over a trillion dollars worth of accounts, and you have, after this Madoff thing, well less than a billion dollars, would close you down in a second as being an undercapitalized insurance company. There is no more obvious fraud than somebody selling insurance, or claiming to be providing insurance that doesn't have any capital to pay anybody off. Should your members put an asterisk by that decal that they all have on their window saying, "Yes, SIPC Corporation provides the protection, but there is virtually no net worth." And we can argue here whether you're net worth is $500 million, or $800 million, or negative $17 billion, you're net worth is trivial, or negative, compared to the well-over a trillion dollars of security that you're supposed to be providing the investors in all of our districts, right?
02:15:23	MR. HARBECK	We look at the issue of our solvency every board meeting. And what I can tell you is --
02:15:23	REP. SHERMAN	I'm not asking for solvency, I'm asking for your net worth -- your assets, minus your liabilities, including the liabilities you have on the Madoff situation. Your net worth is less than a billion (dollars), and we have over a trillion dollars of accounts with securities brokers here in the United States that are under the half -- and I'm only counting the ones that are under the half million-dollar limit.
02:15:56	MR. HARBECK	The answer to your question is that historically these frauds have been found before it costs SIPC, net, $1 million in any given case.
02:16:04	REP. SHERMAN	That's ancient history. Now we're in the new history, the history of 1,000-point drops in the market on occasion, the history of Madoff and $50 billion losses to investors. And you've got decals all over the 27th district telling my constituents that they have protection and I'm not asking you to be a law-enforcement agency -- that's the other agency -- but you're supposed to be able to write the checks to protect them and your account, your net worth is under a billion dollars.
02:16:44	MR. HARBECK	The first thing that happens when our fund falls below $1 billion is we automatically institute assessments on the securities industry based on their net operating --
02:16:54	REP. SHERMAN	But you haven't done that yet even though you're clearly going to lost at least $500 million out of this Madoff thing. You're below a billion dollars; you just haven't told your members that.
02:17:05	MR. HARBECK	I would expect our board will move on that in January, sir.
02:17:05	REP. SHERMAN	In January. Okay, let me shift to Mr. Kotz. There are some -- you're going to write this great report and it's going to take you months or years to do it, but a couple of things are already obvious. One is that the SEC did not do a good job when it got tips from outsiders, very sophisticated tips. And zero percent of the tips about Madoff were handled correctly. What assurance do you have as inspector general that at least half of the tips that the SEC receives are handled correctly?
02:17:48	MR. KOTZ	Well, that's right. And what we are planning to do is not just look at the tips that were provided in the Madoff case.
02:17:54	REP. SHERMAN	But, as of now, we don't know whether half of them are handled correctly or maybe zero percent are handled. Right now, you don't know.
02:18:03	MR. KOTZ	Right. And so we need to look at all of the tips and look at the process to ensure that --
02:18:03	REP. SHERMAN	Okay. Likewise, do you know whether the SEC even today is giving even an extra half-hour of scrutiny to financial statements where the auditor is not a PCAOB audit firm?
02:18:22	MR. KOTZ	I don't know, but will get back --
02:18:22	REP. SHERMAN	I'd sure like to find out. I yield back to the chairman.
02:18:22	REP. KANJORSKI	The gentleman from Alabama.
02:18:29	REP. BACHUS	Thank you. Mr. Harbeck, I want to compliment you on a good work over a very difficult year, first with Lehman and now with Madoff. I think it's important -- you don't ensure against market loss?
02:18:46	MR. HARBECK	That is correct.
02:18:46	REP. BACHUS	And a lot of what has been lost as far as assets by investors will be due to market loss, will they not?
02:18:56	MR. HARBECK	Well, we're looking at this as a missing asset case because assets were put in; there's no -- the assets aren't there. So that is the kind of thing that we can protect people against. What we can't protect people against is a 99-percent decline in any particular stock.
02:19:15	REP. BACHUS	Right. He has acknowledged that he actually stole money from investors.
02:19:15	MR. HARBECK	Yes, he did. Yes, he has.
02:19:15	REP. BACHUS	So -- but I think it's going to be very difficult and complex because you have no records or you don't have accurate records. I mean, that's almost acknowledged in this case, is it not?
02:19:33	MR. HARBECK	Well, certainly the records are -- don't match one hand with the other in terms of the actual securities inventory with what the customers expect to receive.
02:19:43	REP. BACHUS	Do you have auditors and forensic experts on staff? Are you able to hire --
02:19:43	MR. HARBECK	The trustee has hired forensic accountant, computer experts and attorneys who specialize in this kind of asset recovery to make sure that we know exactly what we have and what went where.
02:20:01	REP. BACHUS	Right. I guess it's going to be very hard, in just a matter of weeks, to start processing claims, though, is it not?
02:20:10	MR. HARBECK	It is going to be hard and we're going to do it.
02:20:10	REP. BACHUS	What?
02:20:10	MR. HARBECK	It is going to be hard and we're going to do it. That's why I certainly have urged customers to give us as much information as they can. If they do that then we will be able to move very rapidly.
02:20:24	REP. BACHUS	Okay, so there is some expectation on your part that some could start getting reimbursed within a matter of weeks?
02:20:32	MR. HARBECK	We have a meeting with the Securities and Exchange Commission division of trading and markets later in the week to hammer out exactly how best to do this because I want their support as well.
02:20:44	REP. BACHUS	All right. And I guess small investors may actually have more promise of getting at least all or a greater percentage of their investment?
02:20:53	MR. HARBECK	Well, the investors who are going to have the easiest trail are the people who have been in the scheme for the shortest amount of time.
02:20:53	REP. BACHUS	Okay. And let me close by asking you this: Mr. Ackerman asked you to share records with us but now this is a judicial proceeding that you're involved in akin to bankruptcy. Is that right?
02:21:09	MR. HARBECK	It is a bankruptcy and certainly, you know, if the records are filed under seal, I cannot produce them.
02:21:09	REP. BACHUS	Yeah, not only that, but I think you also couldn't produce it to us before you produce it to the court, could you not? Or --
02:21:21	MR. HARBECK	I don't know under what terms the Securities and Exchange Commission was given the authority to receive this report. I'll find out.
02:21:31	REP. BACHUS	Yeah. I think that the fact that -- the judicial proceeding is going to limit you somewhat, I would think.
02:21:31	MR. HARBECK	Yeah. I will get it to the committee as soon as I legally may.
02:21:40	REP. BACHUS	Thank you.
02:21:40	REP. KANJORSKI	Mr. Meeks, gentleman from New York.
02:21:40	REP. MEEKS	Thank you, Mr. Chair. Let me find out from Mr. Kotz -- I was recently looking and we saw that the Bayou Management, a Connecticut hedge fund that collapsed in a scandal in 2005 as well as Enron and others, they used nearly 900 offshore entities, mostly in the Cayman Islands, to conceal bogus trades and accounting fraud. And I know that some federal prosecutors are looking more and more at some of the offshore business to see whether or not this is a mechanism that makes it easy or easier for individuals to conduct schemes to defraud the public. So I was wondering if in fact you could let us know or let this committee know whether or not the SEC has the capacity, first, to monitor the use of offshore fund operations and, also, as to your knowledge on how many enforcement and oversight actions the SEC has taken to ensure investor protections from the manipulation of offshore fund operations since 2001.
02:23:05	MR. KOTZ	Yeah, I can certainly look into what the SEC does vis- -vis these offshore operations and that's -- I appreciate the information in order to follow up on that. But I couldn't determine whether in this case the enforcement division had any issues related to offshore operations or whether generally the enforcement division of the SEC treats accordingly and appropriately those kinds of issues.
02:23:30	REP. MEEKS	But you can't -- you -- have you done any internal investigations thus far of the SEC with how they are currently monitoring some of the offshore funds and whether or not giving them any guidelines or guidance, looking into whether or not they're doing it correctly, whether they're -- (inaudible) -- whether they have the proper training or not. Have you, as the inspector general, have you done that at all?
02:24:00	MR. KOTZ	I have not looked at that specific issue, no, but I certainly can.
02:24:00	REP. MEEKS	So you're saying that's something that you will do in the future, but it hasn't happened in the past.
02:24:07	MR. KOTZ	Right.
02:24:07	REP. MEEKS	You know, also, in addition there, too, if you look at the SEC's annual report, the SEC cites that there's been 671 enforcement acts in fiscal year 2008; insider trading actions increased by 25 percent and market manipulation actions increased by 45 percent. And between 2004 and 2008 the SEC has ordered $12.9 billion of penalties and disgorgements. The largest group of this 3,500 employees assigned to enforcement, and then after that compliance and then corporate compliance with federal securities lawsuits. Given the explosive growth of the financial sector in both the United States and abroad and the levels of global financial market interconnectivity and the rise of infractions and fraud, you know, can you give us your opinion on whether the SEC is adequately prepared to face the challenges of the new millennium marketplace?
02:25:03	MR. KOTZ	Well, I can't today as we're sitting here, but part of the process of the investigation and audits that we're going to undertake is to look at the overall complaint procedures and the enforcement operations and to determine that very question: whether it is a question of resources -- that they simply don't have sufficient resources in order to look at all of those issues given the multiplication that you've indicated -- or whether the process simply is broken such that even with additional resources, it wouldn't make a difference?
02:25:31	REP. MEEKS	So all of this is going to be what you're looking at now and you're going to come back with us, too, as Mr. Sherman has indicated, but we don't know when, whether that's going to be within a month or whether that's going to be a two-year process because this is the kind of information I think that I know that we need in trying to determine whether or not there needs to be some new resources or what kinds of regulations we should be putting in place. We need that kind of information. What about the fact that, you know, you look at the interconnecting individuals from various firms that go from one firm to another? You know, some say, because of the status of Mr. Madoff, you know, because he was the former this or he -- that that had something to do with people who might have just accepted his reports without looking any deeper than they should have. Have you, as the inspector general, looked into any interconnectedness with reference to people in the industry who have gone from one position to the other and whether they just check it off because they know somebody personally?
02:26:37	MR. KOTZ	Well, I mean, that is an issue that's come up in other specific investigations and that is an issue that has to be looked at very carefully here. I think that's a great concern, about the relationship of certain individuals. But there have been situations where we have issued reports where we have felt like the reputation of individuals had an impact on how the SEC did its job. We've reported that. We've recommended action in those types of cases and if we find that in the Madoff case, we find that generally, we will do the same thing.
02:27:07	REP. MEEKS	Mr. Harbeck, let me just ask you one last question. And I know that in your testimony you've indicated that, you know, because of the Lehman Brothers' whole thing, you discussed the liquidation and how you protected a lot of the people that they could control their portfolios. But as you know, in the Lehman Brothers' procedures, there's still over, some say, $700 billion stuck because it hasn't been so smooth in London, where people, United States citizens and various funds are stuck there. Have you -- and I've asked and sent letters to the SEC inquiring about them, because there are a number of individuals who have invested whose money is still stuck in London. Have you looked into that or do you have any suggestions or recommendations how they can get access to their portfolio in London and that bankruptcy proceedings?
02:27:54	MR. HARBECK	The bankruptcy proceedings of LBIE, which is the European subsidiary of Lehman Brothers, are completely different and separate. But the trustee for Lehman Brothers Inc. and the trustee for Lehman Brothers Holding meet frequently with the Lehman Brothers European branch conservators, I believe they're called, to try to iron this thing out. Those offshore funds are simply not under the control of either the Lehman Brothers Holding Company or the Lehman Brothers brokerage firm. So I don't have a lot of hope that they can untangle the British scheme as fast as we were able to untangle the American.
02:28:43	REP. KANJORSKI	The gentleman from Texas, Mr. Hinojosa.
02:28:43	REP. RUBEN HINOJOSA (D-TX)	Thank you, Mr. Chairman. Chairman Kanjorski, I want to thank you for having done this congressional hearing. And I wanted to take the opportunity to acknowledge all the work that you and your staff have done over the years to try to ensure that our capital markets remain vibrant and strong. I particularly want to thank you for holding this hearing in a solid effort to determine what changes your subcommittee or this whole committee should make to the financial services regulatory system to ensure that this type of Ponzi scheme is detected much sooner than that of Mr. Madoff and his company. At this point, Mr. Chairman, I ask unanimous consent to enter into today's record a copy of the complaint of the United States of America against Bernard L. Madoff.
02:29:51	REP. KANJORSKI	Without objection, so ordered.
02:29:51	REP. HINOJOSA	I would also like to insert into the record a copy of today's Bloomberg, Wall Street Journal and Financial Times articles on this Ponzi scheme.
02:30:03	REP. KANJORSKI	Without objection, so ordered.
02:30:03	REP. HINOJOSA	Thank you. I have a question for Mr. David Kotz. Does your Office of Inspector General need extra federal funding to ensure that this type of scheme is detected sooner rather than later?
02:30:24	MR. KOTZ	Well, our office is the one that looks at what happened with respect to whether these things were detected appropriately. So we don't feel that -- I've asked for and I've received additional resources for our office to conduct the investigation. One of the things we'll determine in our investigation is whether the Division of Enforcement would require additional funds in order to detect these things or whether the compliance divisions of the SEC would require additional funds in order to identify issues or whether it's a question of the processes that are in place that are simply broken and such that additional resources wouldn't help. So in my office, in terms of my investigative component, we don't need additional resources to conduct the investigation. With respect to whether the SEC as a whole needs additional resources in order to do its job, that's something we would look at in our report.
02:31:19	REP. HINOJOSA	Mr. Kotz, I'm sure that you're going to do a good job. But like my colleagues have pointed out, it's going to take time, maybe several months. It's odd that the organization, the entity that dropped the ball, which is the SEC, is investigating itself. How can we rely on they investigating themselves? Tell me about that.
02:31:47	MR. KOTZ	Sure. Well, and I think if you look at the track record of my office, Office of Inspector General, over the past year, you will see that we have issued critical reports where appropriate. There have been numerous occasions where we've issued reports that were very critical of the SEC -- audit reports about the CSE program, Consolidated Supervised Entity programs, that found that there were flaws in the process involving the Bear Stearns collapse, that there were red flags that were not followed up on by the SEC. We've issued investigative reports that were very critical of the SEC and SEC employees and officials. So, I mean, I think if you look at what we have done over the year, you can be assured that our office doesn't pull any punches. Our office is very aggressive and our office issues candid and sometimes very critical reports. At the next stage, the effort will need to be to ensure that the SEC follows up appropriately with respect to the reports that we issue. But our track record is very strong in terms of the reports we've issued that have pulled no punches and simply told the facts as we found them. And that's what we intend to do in this case. I can assure you that we will report the facts exactly as we find them, and then it will go to the SEC in order to implement those.
02:33:10	REP. HINOJOSA	At this point, Mr. Kotz -- Kotz -- (corrects pronunciation) -- since you have already seen some of the information, are you aware of any collaboration between the SEC employees and Mr. Madoff that resulted in him managing to conduct his business as usual despite it being a Ponzi scheme?
02:33:28	MR. KOTZ	We haven't gotten into the stage of the investigation where I can say definitively either way. I can say that that's an issue that we're going to look at very carefully to see what potential collaboration there was between SEC employees and Mr. Madoff's firm. And if we find that that was the case, we will recommend the strictest form of disciplinary action, potentially criminal action if we find that appropriate, whether it's existing employees or former employees. So these matters are very serious. We take them very seriously. We will not hesitate to recommend termination, refer matters for criminal prosecution, follow up on criminal prosecution, to ensure that if the facts warrant, those who engaged in inappropriate actions pay for what they did.
02:34:12	REP. HINOJOSA	My time has run out. And Mr. Chairman, I yield back.
02:34:12	REP. KANJORSKI	Thank you very much, Mr. Hinojosa. Mrs. McCarthy of New York.
02:34:24	REP. CAROLYN MCCARTHY (D-NY)	Thank you, Mr. Chairman. Mr. Kotz, the question I want to ask you is -- an awful lot of the questions that I was thinking of have already been asked and answered to some extent. How large was the corporation of Madoff? How large of a corporation was it?
02:34:42	MR. KOTZ	Yeah, I wouldn't know the answer to that question. That would be a matter that --
02:34:42	REP. MCCARTHY	Ten employees? Fifteen employees? Twenty?
02:34:42	MR. KOTZ	No, I wasn't involved in any of the issues relating to -- any actions taken against Mr. Madoff. So that would be something that --
02:34:55	REP. MCCARTHY	All right, with that being said, say it was a fairly large corporation, being that it seems to have an awful lot of money and customers. Are there any SEC rules about the ruling of an accounting firm doing accounting of the firm itself?
02:35:14	MR. KOTZ	Yeah --
02:35:14	REP. MCCARTHY	From what I understand, they only had a small firm with one or two people.
02:35:14	MR. KOTZ	Yeah. I mean, I think that there are some serious questions about whether that information about the accounting firm was known to the SEC officials, and if that was the case, why they didn't take any action. So absolutely, as I said, we're going to look into how it could possibly be that such a large entity involving so many dollars, high-level volume of dollars, could have an accounting firm that was so small without there being a red flag that would be clearly obvious to all who could see that that was an issue that needed to be further investigated. And if we find that, we will certainly report, as we've done in the past, that the SEC failed to follow up on a red flag.
02:36:00	REP. MCCARTHY	One other thing. Number one, I want to say thank you both for your patience in front of this committee, and certainly to the second committee -- the second panel that will be coming up. Unfortunately I have to leave. But the testimony of Mr. Metzinger (sic/means Metzger) is excellent, and I advise people to actually read it. Going back to -- so basically both of you, you actually come in after the fact. After a crime has been done or a fraud has been done, you come into the investigation at that point.
02:36:31	MR. KOTZ	That's correct. The Office of Inspector General looks at matters after they've occurred to try to find lessons learned to ensure that these things don't happen again.
02:36:41	REP. MCCARTHY	I think what's going to be interesting as we go forward -- my husband worked for a brokerage firm most of his life. He was actually in compliance for a long time. And one of his biggest beefs was, as he went around the country looking at the different brokerage firms, on how much corruption was actually going on. His feeling at that particular time is that nobody should get a commission; pay them a good salary, but the commissions makes you buy and sell and actually cheat the investor out, one way or the other. One of the other things which is common sense is, if it sounds too good, it usually is too good. So you had an awful lot of smart people investing in this firm when he was talking about 9, 9 and a half percent constantly. No one, especially the SEC, who had to be knowing that he was giving out these particular amounts of money, saw or even felt there was something wrong?
02:37:40	MR. KOTZ	Right. No, I mean, absolutely, that's a very significant issue. And, you know, one could look at an investor perhaps not wanting to ask too many questions, not finding information. But certainly the SEC's job is to find that information. The SEC's job is to look at things that are too good to be true and to make that determination that if it's too good to be true, we have to audit, examine and investigate it to ensure that it is actually true. So, it is something that is logically hard to understand, and that's why we need to look very carefully to see how the facts are as they say, how it could have happened that these returns, that this information, to the extent it was brought to the SEC's attention, how could it have not triggered an immediate, full-blown, full-scale investigation, audit and examination -- all the tools that the SEC has -- in order to see how this could have happened.
02:38:37	REP. MCCARTHY	My concern is, being that this went on for so many years, how many other organizations, firms are actually doing the same thing and just haven't gotten caught yet?
02:38:48	MR. KOTZ	Yeah, and as was indicated, you know, the market collapse obviously had a lot to do with the circumstances at the end, so, clearly -- which is why we need to not just look at the Madoff matter, but we need to look at whether this situation could replicate itself. And if a situation like this, that seemingly, on its face, was obvious in terms of red flags, we need to look at whether there are other problems that occur as well. And so we plan to do a comprehensive overview of both the enforcement division and the compliance unit to ensure that we don't just, at the end of the day, say, have some findings with respect to Mr. Madoff, but that we look at the whole system in place to see if it can adequately detect fraud.
02:39:35	REP. MCCARTHY	I think that also, as we go forward on the full committee and the subcommittees, obviously the SEC, even Wall Street and the investors, I don't even think anybody knew the extent, not only of this particular case, but the whole collapse. It looks like we're going to have to modernize or somehow look at the whole financial system because no one expected this -- nobody.
02:40:01	MR. KOTZ	Yeah.
02:40:01	REP. MCCARTHY	With that, I yield back.
02:40:01	REP. KANJORSKI	Thank you very much, Ms. McCarthy. Now the gentleman from Massachusetts, Mr. Lynch.
02:40:01	REP. STEPHEN LYNCH (D-MA)	Thank you. Now, with the greatest respect to my colleague, let me just pick up on that point that nobody saw this coming; we have to modernize. The short-sellers saw this coming. The short-sellers saw this coming and they invested in it, and they made billions. What's troubling here is that -- and, as you say, Mr. Kotz, it's the SEC's job to find the information. In this case, though -- in this case the SEC was given the information. The SEC had repeated reports. The SEC had a whistleblower with a very long analysis. We had repeated attempts to contact the SEC and the analysis was all given to it, but in the end they really did nothing until it was too late. And I don't think you have to stay up late to figure out whether or not there are other occasions of this. You know, there was a case earlier in the year, and, you know -- it was within the last year, so while you were there -- Gradient Analytics came up and reported about Washington Mutual's problems. And they pointed out that WaMu, over a year before it got in trouble, was not setting aside sufficient assets. A lot of short-sellers came into the market and bet against them. AIG, their own auditor, Pricewaterhouse -- again, long before problems developed there they reported that the company had, quote, unquote, "significant shortcomings" because of the way they were valuing the credit default swaps. They reported it to the SEC. It was public information. That's the most troubling aspect of this for me, that the cops were informed, the law enforcement was informed and yet nothing happened. That's the difficult part. And, you know, I'm wondering -- you know, I've met with former SEC officials to ask them, what's the real problem here? Some of them have suggested to me that they're over-lawyered at the SEC and we don't have enough financial people. You know, these short-sellers, financial people, were able to diagnose this, bet on it in significant ways and make a killing here -- billions of dollars -- and yet the SEC, with the same information, refused to act, and that is troubling. Some former SEC officials also suggested to me that in many cases the investigators are right out of school, very new, inexperienced, and they were simply -- in this case with Mr. Madoff, they were overmatched. The guy was on the SEC advisory board. That must be very intimidating for those, you know, newer investigators coming into that situation. Now you've been there a year and you see how these investigations go, and you know the personnel, you know who's doing these investigations, you know how much experience they have. Are they lacking in experience? Is this one of the shortcomings that we have? Do we have to shore this up? God knows there's going to be drastic change here. The SEC is going to be totally reformed. Maybe it's going to go away or merge with something else because this is just inexcusable, but is that something we have to look at? Are these investigators inexperienced, and is that costing us in the long run?
02:43:25	MR. KOTZ	Yeah, I would say absolutely that is something we need to look at, and that is a major issue that we are going to consider ourselves, which is the expertise level: Are they equipped and do they have the expertise and the training and ability to keep up with this? And it is very alluring sometimes to be dealing with somebody who's on this panel or that panel, very famous, very rich. One aspires to be like that person. You know, the person is a junior- level SEC attorney, he sees this very impressive individual, and it's very easy to even subconsciously think, this guy couldn't be lying to me. This guy is a great man. He's made all this money. He's a genius. And so we need to look at whether they are equipped to ask the tough questions.
02:44:07	REP. LYNCH	Let me ask you one other thing, Mr. Kotz. In your investigations -- you know, a couple of weeks ago we had five billionaires sitting at that table. A lot of them had made a lot of money, Mr. Paulson and others, on short-selling against these type of deals. They recognized the weakness in the market in these firms and basically, though credit default swaps, were able to make a killing. Have you ever thought about pulling in some of those short-sellers who are so -- I mean, they are really -- they're much more informed and seem to be investigating the strength of these firms to a level of detail that I wish the SEC was investigating them. Did you even think of pulling some of these people in? I'm sure they would cooperate. You know, some of them would. Some of them are making too much money, but I'm sure some of them we could lure away, and, you know, help us -- help us strengthen this market because we've lost our credibility here, and this is all about restoring trust in the markets. That's your job and that's our job. And I do want to say, I thank you for your patience in coming before the committee and helping us voluntarily -- because this isn't an official committee hearing -- but I do appreciate that both of you gentlemen have come here to help us with our work. I yield back, Mr. Chairman.
02:45:21	REP. FRANK	Thank you very much, Mr. Lynch. Mr. Scott of Georgia.
02:45:28	REP. SCOTT	Thank you, Mr. Chairman. You know, Mr. Kotz, I've been sitting here trying to grab my hands around what really seems to me to be the big problem, and that is this, that it's the credibility of the SEC. It is amazing for anybody to sit here and think that there is not some level of complicity in this with the SEC. This is plain as the nose on your face. I mean, you have a situation here where 29 red flags came up -- not one, not two, but over and over again. This guy has been examined eight times in the last 16 years. And every time you go and you ask, or your question is about this, you wait and you ask him a question, are you stealing? No, I'm not stealing. Are you -- and there's no further investigation of this. He knows the loopholes, he says he's a hedge fund operator and not a business investment advisor, and you accept that. He trades on foreign markets at certain amounts of time. You go, oh, yeah, that's true too. Okay, that's fine. How sure are you that there is not some complicity with an inside person or persons at the SEC that has enabled this man to do this?
02:46:54	MR. KOTZ	Yeah. No, I'm not sure -- absolutely not -- and that's something we will look at. I can tell you that when we complete our investigation I will have the answers to those questions. But, you're right, on its face it certainly looks as if there may be that kind of possibility, and that's something that we have to look into. We have to look into the question of how it was that it seems as though the word of Mr. Madoff was taken. What were the tools that were used? Why wasn't subpoena power used, for example? Why was it all voluntary, and whether that was because of his reputation or simply lack of aggressiveness, or perhaps complicity, as you say. So those are answers that I'm looking to provide.
02:47:35	REP. SCOTT	And also, in each of the reports, even when the SEC looked at some of this stuff, none of that was made public. None of that was made public.
02:47:45	MR. KOTZ	Right.
02:47:45	REP. SCOTT	So I think that there is something with this. I think that -- and I would hope -- I think one of the greatest justices that you can do, at least -- we may not be able to get all of the money back -- and I want to ask you about that in my follow-up question, Mr. Harbeck, about the money end of it -- but there needs to be a singular effort to get the heads that enabled this guy to do this at the SEC. He could not have done it without some complicity, with some people at work at the SEC. It goes in line with the greed of Wall Street that has been one of the primary factors as to why we're in the economic condition that we're in now. That needs to be the first order of business of the SEC, to get the confidence of the American people. Get the culprits. You've got some folks working for you in the SEC that worked with Mr. Madoff to allow this to happen. Their heads have got to roll. Now, Mr. Harbeck, let me ask you about the ability of trying to get some restoration for the investors. Is it an accurate figure of $50 billion? Is that the accurate figure?
02:49:14	MR. HARBECK	It's far too early to say, but we believe that the $50 billion figure includes the inflated profits that Mr. Madoff said. The best example I can give you is that Yeshiva University put in $14 million into this scheme -- this is publicly available knowledge -- and the records that they have indicated that they held a securities portfolio of $110 million. So there's a gigantic gap between what was put in and what was reflected on the statements, and of course, the longer you were in this deal, the bigger that gap was. So having said that, and having said that the $50 billion figure is probably quite high, whatever it is, we will find it, the administrative expenses of that will not come out of customer property -- to find those assets, to find the accurate dollar amount -- and then we'll go try to get whatever we can.
02:50:20	REP. SCOTT	Okay, so we're talking about ill-gotten gains, we're talking about loss and gains that, to some degree, may be fake; in the Ponzi scheme -- I want to get this right -- what happens is that he takes one investor's money and uses that investor's money to give some return to the investment on the other fellow's money without it going through a trading process. Is that --
02:50:52	MR. HARBECK	That's correct, and the way this was perpetuated for so long is people did not withdraw their funds from this Ponzi scheme; they just kept letting him roll over the supposed profits into even further supposed profits.
02:51:09	REP. SCOTT	Now, there are what we call -- there's a management firm for these -- what's left of these assets -- there's somebody that you've engaged or somebody's engaged to determine these, and I think the figure that's been put on that expense has been about $28 million.
02:51:31	MR. HARBECK	No, that's -- the trustee has received $29 million back from a bank account. Some of that will be used for administrative expenses, but if that is determined to be customer money, SIPC will reimburse it.
02:51:44	REP. SCOTT	Okay, does this cover liquidation costs?
02:51:44	MR. HARBECK	Yes, and that is not all costs that have, thus far, been incurred -- that's more than what has, thus far, been incurred.
02:51:44	REP. SCOTT	All right, so that's a false figure that's out there -- this $29 million?
02:51:54	MR. HARBECK	It's somewhat correct in that that is an amount of money that has been returned to the trustee from a bank account.
02:51:54	REP. SCOTT	Okay, my --
02:52:02	REP. KANJORSKI	Mr. Scott, your time has expired.
02:52:02	REP. SCOTT	All right. Thank you, sir.
02:52:02	REP. KANJORSKI	The gentleman from Texas, Mr. Green.
02:52:09	REP. GREEN	Thank you, Mr. Chairman, and again, I thank you for hosting this event. Mr. Kotz, permit me to ask you a few questions, and I want to say from the outset, I've had an opportunity to peruse your resume, and it's quite impressive. You were with the Peace Corps before coming to this current position, and you have an outstanding record as a scholar and a student of jurisprudence. So let us start, if we may, with your comment that you investigate after the fact. I think we need to bring some clarity to what, "after the fact" means, because you received a letter from Senator Grassley on April 2nd asking that you look into Bear Stearns and there has been no arrest or reported crime as it relates to Bear Stearns. Is this correct?
02:53:07	MR. KOTZ	Yes, well, we were asked to do an audit of Bear Stearns to determine whether the SEC misread flags in their oversight of Bear Stearns.
02:53:15	REP. GREEN	Exactly, which means that you can receive intelligence from sources about inappropriate conduct at the SEC and, as a result, you can look into whether or not the SEC is properly conducting itself, true?
02:53:45	MR. KOTZ	Right.
02:53:45	REP. GREEN	Is it true or not true that your office received some degree of intelligence prior to the arrest of Mr. Madoff with reference to reports that were sent to the SEC concerning the so- called Ponzi scheme?
02:54:01	MR. KOTZ	No, no, to my knowledge, it's not true. There was never a complaint; we actually searched back our records going back to years beyond when I was there, and there is no record of any complaint filed with our office about Madoff. And in fact, the investigation that was begun, from what I understand, was not brought to the commission's attention, but certainly, nothing was brought to our office's attention.
02:54:25	REP. GREEN	The investigation that was begun with reference to Mr. Madoff was never brought to the attention of the SEC?
02:54:25	MR. KOTZ	Well, there was an enforcement investigation, not an investigation that our office does.
02:54:35	REP. GREEN	I understand, but you said that the investigation that was begun with reference to -- and I'm adding with reference to Mr. Madoff -- was not reported to the SEC, meaning the SEC commissioners?
02:54:49	MR. KOTZ	Right, what the chairman stated in his request for me to conduct an investigation was the concern -- one of the things we've got to do is determine whether that's true -- but the concern that he had that the Madoff matter that was looked at by the enforcement division had not been brought to his -- the chairman -- and the other commissioners' attention.
02:55:08	REP. GREEN	And the enforcement division of which you speak is one other than the enforcement division that you happen to head?
02:55:15	MR. KOTZ	Yes, I head the Office of Inspector General that is separate from the enforcement division.
02:55:21	REP. GREEN	And so the enforcement division of the SEC received its complaint, made its investigation, but did not give a report to the commission itself?
02:55:32	MR. KOTZ	That's the allegation that the chairman asked me to look into and what we will confirm, if it turns out to be the case, in our report.
02:55:40	REP. GREEN	So the allegation is made by whom?
02:55:40	MR. KOTZ	Well, the chairman of the SEC, when he asked me to conduct the investigation, he stated that one of the things that he wanted me to look at was why or whether/if the information --
02:55:54	REP. GREEN	Uh, there's a difference between why and whether.
02:55:54	MR. KOTZ	You're correct, sir.
02:55:54	REP. GREEN	Okay, so which was it?
02:56:00	MR. KOTZ	It was why -- he asked why was, in his view, he did not believe that the information regarding the Madoff investigation conducted by the enforcement division was brought to his attention, and therefore the other commissioners' attention. And so he asked me to look at this specific question in the Madoff case and in general, why enforcement cases are decided not to be brought to the larger attention of the commissioners and the chairman.
02:56:29	REP. GREEN	To your knowledge, has there been any report, or complaint, I should say, against the SEC with reference to the Madoff scheme that was forwarded to your agency?
02:56:48	MR. KOTZ	Yes, I mean, certainly, there have been reports that Mr. Marcopolis met with folks from the SEC to report information about Mr. Madoff --
02:56:58	REP. GREEN	And did Mr. Marcopolis give his report -- his report was forwarded to your agency?
02:57:04	MR. KOTZ	To the agency in which I work, correct -- not my office, but yes, my agency.
02:57:04	REP. GREEN	But not -- yeah, this is not about you, personally, okay. It came to the attention of your office.
02:57:12	MR. KOTZ	My -- the agency.
02:57:12	REP. GREEN	Or your agency, all right. I'm sorry, your agency -- I'll get my diction correct. Sometimes, it's not superb. If it came to the attention of your agency and if all of these things that you, today, contend were red flags for the SEC, why were not these things red flags for the watchdog of the watchdog? You're the watchdog for the SEC; the SEC is the watchdog for the public -- the investor -- why were they not red flags for your office -- your agency, excuse me?
02:57:49	MR. KOTZ	Right, because we were never made aware of them. In other words, the SEC can undertake actions -- the SEC --
02:57:57	REP. GREEN	But you said you received the same report that we are contending the SEC should have acted upon, you have just indicated that your agency received that same report.
02:58:08	MR. KOTZ	My office never did, though.
02:58:08	REP. GREEN	Not your office, your agency.
02:58:08	MR. KOTZ	Right, but it's a large agency, so because a particular division of the agency received a report wouldn't mean that anyone in my office had received it. The watchdog of the watchdog wouldn't receive something before it happens. Once a complaint is brought to our attention, we can look into it.
02:58:29	REP. GREEN	Okay, so your office never received the report from Mr. --
02:58:29	MR. KOTZ	No, we didn't receive it until now, as we're doing the investigation.
02:58:35	REP. ACKERMAN	Mr. Chairman?
02:58:35	REP. KANJORSKI	Yes.
02:58:35	REP. ACKERMAN	Could I ask unanimous consent that the gentleman have one more minute so that the witness can clarify and make a distinction to us and the public, the difference between the inspector general's office and the enforcement office, because I think that's what we all assumed you were -- or some of us assumed. You are not the enforcement office; it went to the inspector --
02:59:01	MR. KOTZ	Correct.
02:59:01	REP. GREEN	I will yield that one minute that you have asked that I receive to you.
02:59:01	REP. ACKERMAN	I was just following up on your excellent, excellent question -- so when you say your office, your office has nothing to do, and the inspector general doesn't ever see these complaints?
02:59:18	MR. KOTZ	Right. Right, no, we are not the --
02:59:18	REP. ACKERMAN	So they go to the enforcement, which is something completely different, which is basically an in-house -- you're the outside auditor -- is that fair the characterize it -- you're the outside auditor and the enforcement guys are inside players with the SEC, and they can decide to just bury the darn thing and not show it to you?
02:59:39	MR. KOTZ	Right. I mean, we would never see a document that suggests that there was securities fraud or a violation of securities laws. That would never come to us. That would come to the enforcement division, which is a very large, several-thousand people division.
02:59:52	REP. ACKERMAN	Mr. Chairman, I would suggest, if there is confusion here on the committee that we would hope that you would initiate some legislation that could possibly require any complaints that are made in-house to the inspectors because the public doesn't know who to complain to. Obviously they complained to somebody who had no interest because they found nothing wrong in a $50 billion scheme until the guy who did it confessed to it, that they share it with the outside auditors, in effect, and share that with the inspector general's office.
03:00:26	REP. KANJORSKI	I think it's a very good point taken, Mr. Ackerman.
03:00:26	REP. ACKERMAN	And I yield the gentleman back his time.
03:00:26	REP. GREEN	Thank you. And I would adopt the comments of the gentleman and I have one final question, Mr. Chairman. Just to make this absolutely clear, your office, by whatever name, never received any report from Mr. Harry Makopoulos (sp).
03:00:50	MR. KOTZ	Right, not that I -- no, that's correct. We have now because we've initiated the investigation, but not until -
03:00:50	REP. GREEN	But prior to this investigation, Mr. Harry Makopoulos or no other person concerning the Ponzi scheme of which we are here to investigate or look into today? No one ever gave -- sent to your office any information concerning that?
03:01:12	MR. KOTZ	That's my understanding, right.
03:01:12	REP. GREEN	Thank you.
03:01:12	REP. KANJORSKI	The gentleman from Missouri, Mr. Cleaver.
03:01:17	REP. EMANUEL CLEAVER (D-MO)	Thank you, Mr. Chairman. Most of the questions that I was going to raise have already been raised. Actually, the follow-up by Mr. Ackerman to Mr. Green's comments is exactly where I was going to go with regard to some clarity, although I understand that -- and I think the frustration that I hear is because, you know, people out in the world are angry and we actually probably it would be better if we had SEC members in here instead of the inspector general. But you're here and so, you know, this is the frustration of the public. P.T. Barnum once said, "There's a sucker born every minute." And I'm not a linguist, but, you know, that seems a little unfair, makes it seem like the victims are suckers. And I think, you know, in most instances, particularly with Wall Street, you know, the victims are the suckees (sp) and the Madoffs are the suckers. And, you know, we are trying to find out why the SEC seems soft on suckers. And it's not going to be answered by you. I mean, we need them here and it creates at least some frustration for me because they are not here to answer the questions. And I'm -- I don't know, neither of you can probably answer the main question that I want to ask, which is, do you believe that all of the SEC members ought to resign? I understand. Next question, what -- you mentioned, Mr. Kotz -- is it Kotz or -
03:03:22	MR. KOTZ	Kotz.
03:03:22	REP. CLEAVER	That we need a holistic and comprehensive approach. You said that earlier. Give me an alternative for what you think. You're there; you've been looking at what's going on. What do we need? If there was one thing you would like for Congress to do to empower someone -- you or someone -- to do something differently that might eliminate, you know, the damage done to the suckees?
03:03:57	MR. KOTZ	Yeah, I mean, I would rather be able to answer that question after I've -- after I've conducted my investigation and review. I mean, I think once I do that, I will come up with, you know, more than one matter than could be done. You know, I think we need to look very carefully at what happened. We need to look very carefully at the whole operation of the SEC and then make determinations. It's a little premature at this stage -- the investigation just began two weeks ago -- to make that determination.
03:04:21	REP. CLEAVER	How long do you think the investigation is going to last? Of course, I guess it's difficult to know how long it's going to last because what I'm curious about is, how do you do an asset search on this whole -- in this issue?
03:04:38	MR. KOTZ	Yeah, I mean, I understand the need for the investigation to be conducted very quickly. And so I do plan to do that. It's hard to give you a definitive timeline on how long our investigation will take place. Our investigation will yield recommendations about the SEC. Viewing the assets would be what the enforcement division would do and, for that, I couldn't speak to..
03:05:00	REP. CLEAVER	Mr. Harbeck, do you have any idea, how do you assess that, the assets? I mean, it seems to me that's going to -- you know, that's like almost unraveling the sub-prime loans.
03:05:14	MR. HARBECK	The first thing that the trustee, one of the first things that the trustee for the liquidation did was to get subpoena power for a wide variety of witnesses who will be testifying as to what happened to the assets. So he has received those subpoenas, he has sent them out.
03:05:32	REP. CLEAVER	How do we know -- I mean, how will we find out who is owed what?
03:05:38	MR. HARBECK	Well, on the who is owed what, the best source of information is the claimants themselves.
03:05:45	REP. CLEAVER	All right. Thank you, Mr. Chairman.
03:05:45	REP. KANJORSKI	Thank you very much, Mr. Cleaver. Gentleman from Colorado, Mr. Perlmutter.
03:05:51	REP. PERLMUTTER	Thanks, Mr. Chairman. Mr. Harbeck, a question was asked of Mr. Kotz whether he knew what a split-strike strategy was. Do you know what a split-strike strategy is?
03:06:03	MR. HARBECK	The only options trading I'm familiar with is covered calls. So the answer is no.
03:06:03	REP. PERLMUTTER	I guess kind of what we're talking about here -- and Mr. Paul sort of talked about personal responsibility -- there's the personal responsibility piece, there's the government oversight piece. I'm a bankruptcy lawyer, as you are, and a lot of times people will come up with terms. And I've been hearing terms these last few weeks on this committee that I've never heard of before. And you've got to say, now, what is that, really? That's the personal responsibility side of this. Am I just getting a bunch of gobbledygook and they're coding some kind of gambling strategy with some kind of terminology that nobody really understands, which is what a Ponzi scheme is. I've got a little black box, not going to tell you what's in the black box, but boy does it have great returns. You know, the money comes out the other end. And that's what this Ponzi scheme was about. So there's a personal responsibility piece, but Mr. Ackerman, he's got his retiree who's in trouble; I've got firefighters and police officers who may have lost substantial amounts with respect to their pension. I don't know what the exact amount is. And my firefighters may be fighting with his retiree to take from this pool that your bankruptcy trustee is going to try to gather and then spread it out evenly among everybody. In your bankruptcy -- and I know you didn't have a specific amount, but I saw some numbers in there -- do we have any idea at this point what the illiquid assets are that were in the bank that could be taken by the trustee, and then any other kind of portfolio stocks that could be liquidated?
03:07:45	MR. HARBECK	The liquid assets, as far as we know, are in the neighborhood of 830 (million dollars) to $850 million. Those have not yet all been secured but the trustee is working on that. After that, it becomes a job of hunting them down, to see where, you know, a source and application of funds.
03:08:06	REP. PERLMUTTER	Okay. And just -- let's talk about the claw- back and then I'd like to move to Mr. Kotz, real quick. Claw-back meaning if somebody -- let's say they put $100,000 into Mr. Madoff's investments and they received, over time, $50,000 back. Is the claw- back going to take that $50,000 away from them even though they haven't even gotten their investment back?
03:08:27	MR. HARBECK	The fraudulent transfer-preference and insider- preference provisions of the bankruptcy code apply to that fund of customer property, so -- to take a more extreme example -- someone who put $1 million and took out $5 million over time may, within the statute of limitations, be called upon to pay back so that someone who put in $1 million and got back nothing would have something to share. It's a matter of equity. That has been the law since the case of Cunningham vs. Brown, which was the original Ponzi-scheme case on fraudulent preferences and transfers.
03:09:09	REP. PERLMUTTER	So my firefighters who, say, got nothing back -- I mean, I don't know what the status is, but let's say they got zero back, Mr. Ackerman's constituent who -- I mean, this retiree has received payments over time -- may end up being at odds.
03:09:24	MR. HARBECK	That's what the law is. The statute of limitations helps those retirees in one respect. And the rule of reason also applies as well.
03:09:34	REP. PERLMUTTER	All right. Next question: Does your agency every talk to the SEC about fears that you see from an underwriting kind of a context about wait a second -- what is a split-strike strategy? We never heard of this stupid thing.
03:09:50	MR. HARBECK	In that particular instance, that didn't come to our attention. I know that for example in the Bayou Securities Ponzi scheme when you read the description of the investment strategy and you see the incredible returns that were theoretically made, those were red flags that a layman could see. The reason this scheme went on as long as it did, at least at first blush, is that Mr. Madoff did not try to hit a homerun. He tried to be a doubles-hitter. He kept himself looking like a steady hand rather than a spectacular winner.
03:10:31	REP. PERLMUTTER	But here's where the SEC, I think -- and we're all saying the same thing -- has fallen down on the job, terribly. This return went on, this 8 to 10 to 12 percent went on forever, which is unlikely, in good times and bad. And the SEC didn't pick up on it. And where I believe Mr. Paul is just dead wrong is that my firefighter in Colorado or his retiree along the Gulf Coast, they don't know because they're sort of investing through other people or whatever. That's where the SEC comes in. And I'm just curious why nobody brought this to anybody's attention. That's what you're going to find out, huh, Mr. Kotz?
03:10:31	MR. KOTZ	Yes.
03:10:31	REP. PERLMUTTER	Should the Bear Stearns incident have brought this Madoff kind of thing to anybody's attention? Or are they just so different that the SEC problems are that different? And then I'll yield back, Mr. Chairman.
03:11:24	REP. KANJORSKI	Thank you very much, Mr. Perlmutter.
03:11:24	MR. KOTZ	Yeah, I think that they are different, although we did find in the Bear Stearns case that there were red flags that were not followed up on, albeit different red flags. If we were to determine in this case that there were red flags that weren't followed up on, then I think that would represent some sort of pattern, although it would be different types of issues.
03:11:43	REP. PERLMUTTER	Thank you.
03:11:43	REP. KANJORSKI	Thank you, Mr. Perlmutter. Next we'll have the gentleman from Indiana, Mr. Donnelly.
03:11:43	REP. JOE DONNELLY (D-IN)	Thank you, Mr. Chairman. Mr. Kotz, as the inspector general for the SEC, you keep an eye on their operations, make sure they're doing things by the book. Do they, when they go into a firm, the enforcement arm, is there a checklist that they use where they, say, check, accounting situation makes sense, check, custodial relations make sense? Is there any set form they use when they go in? Obviously, they're going to look at a number of things. But is there any list of, hey, here's the things we're at least going to make sure we check these 10 things?
03:12:30	MR. KOTZ	Yeah, I mean, that would be that particular office. But as part of our investigation and audit, we will look at exactly that. I do believe that there are policies in place. There are procedures. I don't know if it's checklist, per se, but certainly procedures as to what they should be reviewed for different types of situations. And what we plan to do is analyze what they were, determine whether they were met and (triggered ?) in this case. If they were triggered, why wasn't the resulting action taken? And if there was nothing that was triggered, then why weren't those trigger mechanisms put on the policies?
03:13:00	REP. DONNELLY	And I guess that's where I'm leading to is we've heard talk that the custodial relations didn't make sense here, that the accounting relations did not make sense, that there was no registration. At what point, if these are being checked, do they look up and say, five of these are completely out of whack, we've got to go much deeper into this?
03:13:24	MR. KOTZ	Yeah, I mean, in my view it would be one of them.
03:13:24	REP. DONNELLY	Right.
03:13:24	MR. KOTZ	It would be one of them.
03:13:24	REP. DONNELLY	And here we see one after another after another, and this goes on for year after year and is not found by the SEC but by the fact that there's no money left.
03:13:40	MR. KOTZ	So if that's the case, either there are problems in terms of how the forms are being used or the forms are problematic. But there's a significant issue.
03:13:49	REP. DONNELLY	And as inspector general, how would we find out, as Congress, what forms there are? And we'd love to get copies of those.
03:13:59	MR. KOTZ	Well, we will certainly, as we produce our reports, incorporate the forms, cite them and analyze them to see what were the potential issues that one would look at and provide all that information in our reports.
03:14:15	REP. DONNELLY	And I guess part two of this question is, what other organizations that the SEC audits, enforces also may not have had these different check marks ticked off? Who else has an accounting situation? And as the inspector general, I hope that, and I'm sure it is, one of the things that you're looking into now is where else are there red flags so that no other person in my home state of Indiana or in any other state, who works so hard to put a few bucks away, that they're not going to put it in next week and get burned by another organization.
03:14:58	MR. KOTZ	Right. No, we need to look at whether it's the forms that are problematic such that they need to be revised or whether the way the forms are reviewed is problematic, such as we need to deal with that issue. So yes, as I said, we're planning to look at way beyond just the Madoff situation. Because as you say, if the form was not appropriately used in that case, then it would be not appropriately used in many other cases. And in that way, we can actually see things that are coming in the future rather than what is often the case with an inspector general office, which your only ability is to see things after it was brought to your attention.
03:15:32	REP. DONNELLY	Right. It would seem that we almost have to go right back to ground zero with every organization that the SEC works with.
03:15:42	MR. KOTZ	Right. Well, I certainly think we need to look at how the SEC deals with those organizations, what is their process for examining or auditing or reviewing those organizations and figure out whether that process works. If this information is correct, it seems it didn't work at all in this case. Well, if it didn't work in this case, then it likely doesn't work in any case. And so we need to look at that and suggest, recommend reforms to ensure that it does work.
03:16:10	REP. DONNELLY	Well, I think -- I know, personally for me, I'd love to get a copy of what the SEC does for each of the inspections that they do, what steps are followed, what do they look into, so that we can get an in-depth idea of that. And Mr. Chairman, thank you for your time.
03:16:27	REP. ACKERMAN	Mr. Chairman?
03:16:27	REP. KANJORSKI	Yes?
03:16:27	REP. ACKERMAN	Could I just make some information before this panel leaves. And I know Mr. Foster is yet to have his turn.
03:16:37	REP. KANJORSKI	Yes.
03:16:37	REP. ACKERMAN	Something that I think is of critical importance at this junction, based on our colleague's questions, if I can have one minute?
03:16:46	REP. KANJORSKI	You're recognized.
03:16:46	REP. ACKERMAN	You're talking about red flags. Up until now, nobody has seen any of the monthly statements that Mr. Madoff sent out. And I think these will be made available by the law firm that's representing the witness that we'll hear from. But for the sake of Mr. Kotz and the committee, people got these detailed statements at the end of the month. Mr. Madoff turned everything into Treasuries, and we believe he did this with every account, or almost every account. At the end of the reporting period with everything in Treasuries, he did not have to report to the SEC, escaped the scrutiny of your agency. And perhaps nobody was watching him. And the question that should be asked of all of the members of SIPC, all of the brokerages, how many of them, at the end of the month, show that they've turned every account into Treasuries and aren't reporting? There may be many other people that have come across this brilliant way of flying under the radar and basically reporting forms to no one other than we're holding Treasuries and not securities. Thank you, Mr. Chairman.
03:18:15	REP. KANJORSKI	Thank you. The gentleman from Illinois, Mr. Foster.
03:18:15	REP. BILL FOSTER (D-IL)	Thank you. Inspector General Kotz, I was interested in a related question, but it has to do with whether the SEC has systematic, written procedures for just dealing with complaints like Mr. Markopoulos generated. That when one of these is received, you know, are there written procedures for cataloging these, for assigning responsibility for follow up, for tracking them and eventually dispensing with these type of complaints?
03:18:41	MR. KOTZ	Yes. I mean, I believe that the Enforcement Division does have procedures in place. And what I am going to look at is whether those procedures are working, whether those procedures need to be revised, or whether those procedures are simply not being utilized appropriately.
03:18:53	REP. FOSTER	Okay. And you'll be getting us copies or references of just how you handle complaints so we can see where it got dropped in the (system ?)?
03:19:00	MR. KOTZ	Absolutely.
03:19:00	REP. FOSTER	Okay. And in Mr. Markopoulos' November 7, 2005 complaint or tip to you guys, they had the sentence here that says, "due to the sensitive nature of the case I detail below, its dissemination within the SEC must be limited to those with a need to know," which must be a very common situation because the obvious effect on markets and so on. Do you have any idea of the order or magnitude of the number of people inside the SEC that were actually privy to the details of this?
03:19:31	MR. KOTZ	Yeah. I don't know that right now, although I would say that it certainly seems as though there were sufficient people who knew about it, who were in a position to do something about it. So I don't think it was a question of not enough people became aware of it. It seems as though it was brought to the right place, and that was the place that has the responsibility to follow up. I don't know exactly how many people. We will obviously talk to every person who became aware of it and find that out. But it certainly seems as though it was brought to enough people that action could have been taken.
03:20:05	REP. FOSTER	Okay. So this was more than 10 people and less than 100, as a guess?
03:20:05	MR. KOTZ	Yeah, I don't know for sure, but I would think that that would be the case.
03:20:15	REP. FOSTER	Okay. Oh, one other question. What is the scope of your e-mail that you'll be looking into here? Are these limited to official SEC e-mails by current and former employees? Or do they include the private e-mails of current and former employees, and so on?
03:20:34	MR. KOTZ	Initially, we've requested all the public e-mails, the SEC computer e-mails. And you'd be surprised how much information is on a government e-mail. Now, as we further gain information, we can try to take steps to get personal e-mails as well. And that may be something we need to do in a couple of cases here.
03:20:52	REP. FOSTER	All right, and you have the authority to do that?
03:20:52	MR. KOTZ	We can -- we have in the past dealt with different internet providers and gotten the information that we've needed, yeah.
03:21:03	REP. FOSTER	All right, thank you. (Inaudible.)
03:21:03	REP. KANJORSKI	Thank you very much, Mr. Foster. And now this panel is concluded, finally. Thank you, gentlemen, very much.
03:21:11	MR. KOTZ	Thank you.
03:21:11	REP. KANJORSKI	We're holding up a panel of three more and they've been kind enough to remain here and be available. May I ask the question: Is there any travel difficulties with the next three -- panel?