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legitimate businessmen and prop up nonexistent corporations. During earlier hearings before the subcommittee in July and September 1973, we learned that sloppy procedures, inadequate security, outmoded handling of certificates, inadequate checking and cross-checking of securities, ineffective or tardy communications between financial institutions, and unwitting and sometimes conscious associations with criminal elements have led to a situation where some observers feel that the integrity of the entire financial community is at stake. We have had a great deal of cooperation from the financial community in identifying abuses which they themselves have very candidly recognized exist. I certainly wish to express appreciation for the cooperation which has been provided to the members of the subcommittee as well as to the members of the staff during the course of this investigation.

Our earlier investigation was meant as a fact-finding effort but also as a signal to leaders in the financial community. In my view, self-regulation by those who fully understand the intricacies of this complicated business would be the best course. We should resort to government last and certainly not first in this case. But if it appears that the financial community is not yet serious about cleaning its own house, more stringent Federal regulation or intercession may be needed. We constantly have warned that we do not want to undertake this. We hope the initiative will be taken by the financial community. This is one area where we would much prefer that leadership be offered by the financial community itself.

Various proposals have been made concerning our efforts to end the huge influx of illicit securities into legitimate financial markets. These include:

The establishment by the securities industry, or by legislation if necessary, of a central computerized securities validation system; The requirement that all financial institutions participate in this securities validation system and be held to an extremely high standard in validating the securities they accept;

The development of a fully-computerized book entry system for handling all securities transactions as is being done by the Federal Reserve System and the Treasury Department in the Government securities and Government agencies securities markets;

Making the theft, counterfeiting, or criminal possession of securities a Federal crime; and

Tightening the accounting and auditing procedures used in the securities industry and holding the accounting firm to a much higher standard of accuracy than is now the case.

I look forward to hearing the reaction of all of our witnesses to these recommendations. I also hope to hear that the securities industry has made considerable progress during the past year in selfregulation and eliminating a $50 billion threat to the fundamental soundness of the American economy.

Mr. Chairman, we join in welcoming, I know, our distinguished witnesses today. I ask unanimous consent that a statement prepared by Senator Edward J. Gurney for submission to the record, together with certain exhibits which I think are extremely valuable, a great contribution having been made by Senator Gurney and his staff, be incorporated in the record at this point.

Senator HUDDLESTON [presiding]. Without objection, it is so ordered.

STATEMENT OF SENATOR EDWARD J. GURNEY

Senator GURNEY. Three years ago, this subcommittee began a series of hearings which ultimately disclosed a thriving underworld market in stolen and counterfeit securities.

Witnesses told of securities being stolen from brokerage houses, banks, and from the mail with the aid of organized crime. They described a wide range of methods by which securities are utilized, including the sale, hypothecation, and renting of securities to shady businessmen wanting to bolster their balance sheets in order to obtain loans.

Just last year, in continuing hearings before this subcommittee, we examined how the investing public has been victimized by the creation of "paper" investment companies, banks, and insurance firms whose assets include stolen, counterfeit, or worthless securities. Since then, our investigation of the securities industry has revealed further impediments to the elimination of the stolen securities market. Such things as international bank secrecy laws, the acceptance of the bona-fide purchaser defense, the absence of a national clearinghouse for stolen securities, the refusal of banks, brokerage firms, and insurance companies to quickly report securities losses and thefts to law enforcement authorities, the neglect of stock transfer and back-office functions, and most important, the reluctance of the financial community to undertake measures which would validate securities presented as collateral or as assets in the balance sheet of a corporation or individual have all contributed to the problem.

Three years ago, the justice department reported that upwards of $400 million in stolen securities had yet to be recovered for the years 1969 and 1970. At that time, we heard testimony from the New York Stock Exchange, plus several brokerage firms and banks promising that corrective action would be forthcoming. We were told that the joint bank securities industry committee on securities protection was in the process of understanding major efforts to stem the tide of securities thefts. Furthermore, this special industry committee had endorsed the creation of a private company designed to provide a centralized facility for the validation of lost, stolen, and counterfeit securities reported to it by brokerage firms, banks, insurance companies, and other subscribing members.

However, I can now say-notwithstanding the efforts of the financial community-that the problem has gotten much worse. Statistics obtained from the Federal Bureau of Investigation show approximately $156 million in U.S. Government securities were reported stolen in the year 1973-which represents a 120 percent increase over 1972 figures, and the largest amount ever reported stolen since the inception of the FBI's stolen securities file. Likewise, data reported to the Depository Trust Co. by both stock exchanges, several banks, and other financial entities shows that $104 million worth of securities were reported as lost or stolen in 1973. This new figure represents a 434 percent increase over 1972, and again, the largest sum ever reported since 1967.

In 1971, Securities Validation Corp.-the firm endorsed by the industry's own committee on securities protection-testified before this subcommittee that its data bank contained some $1.2 billion worth of stolen, counterfeit, or missing securities; 2 years later, that data base had increased to $5.4 billion. In 1974, I am informed that representatives of this same private firm will testify that the data base has nearly doubled to $11.1 billion in little over a year. $2.5 million dollars worth of securities were detected by subscribers of Securities Validation Corp. in 1973. Today, 1 year later, the detection and recovery figure exceeds $12 million. Based on these figures, it is not surprising to hear testimony before this subcommittee indicating that some $50 billion in stolen or lost securities are floating around in our economy.

Within the last year, we have experienced an alarming number of financial frauds overshadowed only by the equity funding scandal and the failure of the U.S. National Bank in California. The National Association of Insurance Commissioners has reported that the overwhelming major cause of life insurance insolvencies can be attributed to dishonesty-with 79 percent of the cases resulting from inflated assets. In this instance, spurious or overinflated stock values were listed as significant factors to the insolvency.

It is now clear that the financial community has failed to heed our warnings during the last 3 years, and in so doing, has brought up the possibility of Federal legislation.

In this final set of hearings, the subcommittee will examine the inability of the financial community to reduce securities thefts, as well as explore the reluctance of brokerage firms and banks to validate securities due to their fear of voiding the bona-fide purchaser defense an important legal concept which permits a bank or brokerage firm which has unknowingly accepted stolen securities as collateral to retain title to these instruments should a loan be placed in default.

Furthermore, the subcommittee will consider proposed legislation to require the reporting of all lost or stolen securities to one central facility, as well as legislation to establish better means of validating all securities used as collateral for a loan, or as assets by banks, insurance companies, brokerage firms, and other financial entities. Finally, we intend to recall a number of Federal regulatory and law enforcement agencies to ascertain their views on this growing area of criminal activity.

James J. Needham, chairman of the New York Stock Exchange, recently stated in an essay titled, "The Threat to Corporate Growth," that U.S. corporations will need some $2 trillion in new capital within the next decade, and perhaps $200 to $300 billion in new stock issues. However, if our economy is to gain greater confidence from the American public, some basic reforms will be necessary to insure the integrity of our debt markets in the face of organized criminal activity. As a member of the Permanent Subcommittee on Investigations, I intend to support legislation to put an end to the thriving market in spurious securities.

To complete the record for these hearings, I would request, with the permission of the Chairman, inclusion of the following exhibits: A letter from the Department of Justice indicating that the secu

rities industry is reluctant to report securities losses to the national crime information center, and more importantly, to inquire through NCIC as to whether or not securities presented as collateral or as assets have been reported stolen.

This same letter also shows that the SVC (Securities Validation Corp.) data bank contains about nine times more items directly relating to lost or stolen stocks than the FBI's stolen securities file (NCIC). Furthermore, the NCIC facility does not include counterfeits whereas the SVC system does, and over 95 percent of the items included in the NCIC stolen securities file represent lost or stolen U.S. savings bonds of nominal monetary value.

[The letter referred to was marked "Exhibit No. 154" for reference and follows:]

EXHIBIT No. 154

DEPARTMENT OF JUSTICE,
Washington, May 1, 1974.

Hon. EDWARD J. GURNEY,
U.S. Senate,

Washington, D.C.

DEAR SENATOR: This is in reply to your letter of October 16, 1973 in which you requested our findings regarding the operations concerning stolen and counterfeit securities of the National Crime Information Center and Sci-Tek, a private commercial enterprise providing computer services.

The National Crime Information Center (NCIC) is a computerized information system established as a service to law enforcement agencieslocal, state, and Federal. Its objective is to improve the effectiveness of law enforcement through the more efficient handling and exchange of documented police information. A resolution adopted May 15, 1967, by the Committee on Uniform Crime Records, International Association of Chiefs of Police (IACP), provided that the controls governing access to police information must remain, as they have been historically placed, with law enforcement agencies. The NCIC Advisory Policy Board concurred with the resolution at its meeting in Washington, D.C. on June 4, 1969.

NCIC, being basically a law enforcement tool, is dedicated to providing information for decision-making by investigators and patrolmen. To assure the proper operation of the system, the standards, procedures, formats, and criteria must be strictly adhered to; that is, both the content and source of information must be credible since the information often forms the basis for probable cause for arrest or search and seizure. Thus, the data stored in NCIC is documented police information and access to that data is restricted to duly authorized law enforcement agencies only and is not available for private commercial use. However, banking institutions and brokerage houses can generally avail themselves of limited assistance by bringing questionable securities to the attention of appropriate law enforcement agencies who in turn will query NCIC to determine whether or not they have been previously reported stolen.

The Securities Validation Corporation (SVC), a private corporation, is an off spring of Sci-Tek. Both corporations are headquartered at Wilmington, Delaware. The primary operating office of SVC is located at 56 Pine Street, New York, New York. SVC representatives have stated that they are currently handling participants in twenty-seven states and Canada. These participants include brokers, banks, transfer agents, municipalities, state and Governmental agencies, bank note companies, and exchanges. In effect, its services are addressed specifically to the securities industry both private and Governmental.

Currently, SVC has approximately 630,000 items in its data base, with a capability of storing 4 million records if needed.

SVC is available to legitimate members of the private securities industry for a fee on a contractual basis. SVC sets out its membership criteria as follows: “... subscribing (paying) customers and participating (non-paying) members, must be either (a) a member of a national securities exchange

registered with the Securities and Exchange Commission under Section 6 of the Securities Exchange Act or specifically exempted from such registration, or (b) a broker or dealer registered with the Securities and Exchange Commission under Section 15 of the Securities Exchange Act, or (c) a bank chartered under state or Federal law, or (d) an insurance company, or (e) a transfer agent, or (f) a national security exchange and/or a stock clearing corporation affiliated with such exchange, or (g) within other category or subscriber deemed responsible by Securities Validation Corporation." Participating membership includes municipalities, and Governmental agencies such as state and local police departments, etc. Technically, based upon available storage capacity and hardware, SVC appears capable of, or could be capable of meeting the needs of the securities industry for an effective, centralized securities validation system.

Addressing our attention to your query concerning the response of private industry to Government campaigns to use the NCIC Stolen Securities file, we have been advised that victim organizations and other financial institutions are reluctant to report securities losses and to inquire through law enforcement agencies as to whether or not the securities have been previously reported stolen. Some of the alleged reasons advanced by the banks and brokerage houses for this reluctance to become involved with a law enforcement agency include:

(a) Banks and brokerages in local communities are hesitant to report securities as stolen until they are certain that a theft has occurred because of possible legal liability attaching to inaccurate or erroneous reporting, and also the attendant adverse publicity resulting therefrom.

While local authorities might possible insist upon treating a report of unaccounted for securities as a possible theft to justify the expenditure of manpower for an investigation, the NCIC Securities file format does allow for the reporting of missing securities when a theft or embezzlement has not been conclusively established. Further, it is the reporting law enforcement agency and not the victim bank or brokerage house which is solely responsible for the accuracy and up-date of the data in NCIC. It thus appears extremely remote that legal liability for inaccurate or erroneous reporting by a law enforcement agency could be attributable to the victim unless the representations made to the law enforcement agency were deliberately misleading, grossly careless, or made with a total disregard for the consequences of such action.

The prospect of adverse publicity and its consequences resulting from the disclosure of a large securities loss appears to be a more realistic consideration by the banks and brokerage houses rather than the possible liability (however remote) arising from erroneous reporting. Hesitancy to report securities losses to the authorities because publicity generates governmental inquiry and a bad business reaction has in the past influenced victim banks and brokerage houses to absorb their losses rather than report them. Industry is fully cognizant that the responsible governmental regulatory agencies may suspend the victim's business operation, impose stringent operating restrictions, or apply other sanctions where the capital position has been seriously impaired because of a loss. The victim organization also runs the risk of being charged with significant violations of applicable regulations by the regulatory agencies where it is established that the victim organization has violated their regulations and thus precipitated, or at least, inadvertently facilitated the loss. (b) There is a delay of input into the system, and lack of control of the information once it has been communicated to a law enforcement agency. Such a two-step process is more time consuming, less private in nature, and depends entirely upon the goodwill and administrative capacity of the local law enforcement agency-which varies drastically in different communities. There is merit to this contention.

(c) Banks in particular, are reluctant to routinely verify ownership of securities pledged as collateral for fear of jeopardizing their holder in due course status, and also because of the delay and added expense involved in processing. (See Attachment I. for a further amplification of Holder In Due Course.)

As for the added expense involved in processing, a number of transfer agents charge the banks a fee to verify the authenticity of stocks for them

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