The two Washington banks are Riggs and American Security and Trust. 6. Senator HUDDLESTON. Now go to the bottom of page Mr. DU PONT. The $15 million loss was Chase Manhattan, and the next one, of course, is Franklin National. Senator HUDDLESTON. Are you aware of whether any of these discoveries were reported to the law enforcement agencies? Mr. DU PONT. I do not know if they were reported to them. Mr. FELDMAN. Mr. du Pont, in the attachments to your testimony, you give other instances of thefts or unaccounted for securities, some of which name banks and brokerage houses and some or which do not; is that correct? Mr. DU PONT. That is correct. Mr. FELDMAN. I think, Mr. Chairman, we should use all the banks and brokerage houses which appear in Mr. du Pont's system in which there has been a recovery made so that we can put any particular recovery in perspective, at least to this system. Mr. Chairman, the chart is an exhibit to the record. I would request that we adhere to the same procedure followed in Mr. du Pont's opening statement-identifying institutions and that he amend to that statement after the hearing the name of each banking organization involved. Senator HUDDLESTON. Is that agreeable with you? Mr. DU PONT. We will be happy to supply you with that information. [When the information referred to is furnished, it will be retained in the files of the subcommittee.] Senator HUDDLESTON. I have just one last question. Does your system have the capacity or could it develop the capacity to receive and store information from all of the banks in the United States and all of the brokerage houses in the United States? Mr. DU PONT. Yes, it could. Senator HUDDLESTON. Minority counsel? Mr. SLOAN. You said you don't know if any of these incidents have been reported to the law enforcement authorities? Mr. DU PONT. Some of them have been reported, obviously, because the FBI has gotten into them. But our staff does not contact the law enforcement agency. Mr. SLOAN. Do you have any responsibility to let them know? Mr. DU PONT. We tell the bank or brokerage firm or whoever has the bad security that it is stolen and missing. Mr. SLOAN. But you do not contact the FBI? Mr. DU PONT. Mr. Stern says in some cases he has informed the law enforcement agency. Generally, the person who has tried to have a conversion used on them is responsible for contacting the law enforcement agency. Mr. SLOAN. I just want to ask one final question. If most of the major financial institutions were to subscribe to your system, would there be a tremendous backlog of time as far as having securities validated? Mr. DU PONT. No. It would not be a major time frame of getting caught up. Mr. SLOAN. Even with the thousands of transactions that occur daily? Mr. DU PONT. That is correct, because you are working in manosecond speeds. Mr. SLOAN. Thank you. Senator HUDDLESTON. Thank you, Mr. du Pont. Now we have five representatives of financial institutions. Mr. FELDMAN. Will each of you gentlemen come up to the table? We are going to rank you by order of assets. That is the fairest way. We have five seats, Mr. Chairman. Could we have the main speakers at the five seats and their supporting personnel or assistants behind them? Senator HUDDLESTON. Would you gentlemen be sworn? Do you swear the testimony you are about to give will be the truth, the whole truth, and nothing but the truth? Mr. BREEN. I do. Mr. KLEMME. I do. Mr. KAESTNER. I do. Senator HUDDLESTON. Gentlemen, I believe the rules we would like to proceed under this morning have been outlined to you. We will begin with statements by each of you, starting with Mr. Breen. I will have each of you identify yourself when you give your statement. Your statements are limited to 10 minutes. We will, of course, accept a longer statement for the record. The questioning will take place after the statements have been completed. Mr. Breen, would you proceed? TESTIMONY OF WILLIAM J. BREEN, VICE PRESIDENT, BANK OF AMERICA NATIONAL TRUST & SAVINGS ASSOCIATION OF SAN FRANCISCO, CALIF., ACCOMPANIED BY CAMERON JARRET, CHIEF AUDITOR, AND JOHN W. BLACK, VICE PRESIDENT Mr. BREEN. Mr. Chairman, I am William J. Breen, vice president of Bank of America National Trust and Savings Association of San Francisco, Calif. I am the bank's State-wide head of corporate agency and business services. I have been with the Bank of America since 1936 and have served in a variety of capacities, including head of personnel relations, State-wide and head of administration operations at the bank's Los Angeles headquarters. In 1968 I assumed my present position in which I have overall responsibility for the bank's Los Angeles and San Francisco stock transfer operations. I would like to introduce Mr. Cameron Jarrett who has accompanied me to Washington and will be available to answer your questions. Mr. Jarrett has been chief auditor of Bank of America since 1967 and is responsible for bank security, fraud investigation. and loss investigation and control. He has served on the National Audit Commission of the Bank Administration Institute, including a term as chairman of that commission. Mr. Jarrett and I are accompanied today by Mr. John W. Black, vice president and the bank's assistant Washington representative. Mr. Chairman, I appreciate the opportunity to appear before you and members of this subcommittee in connection with your investigation into the theft of securities by organized crime and its effect on the financial community. I hope that my statement may be of value to this subcommittee in preparing its report. I am sure that I speak for all members of the banking community in expressing Bank of America's concern over securities theft and fraud. Unquestionably, a major cooperative effort is needed to develop reasonable safeguards to further protect the integrity of this country's securities markets. Mr. Chairman, we were requested in your letter to our bank to offer our views on the underlying causes of massive securities thefts as well as our recommendations on various remedial measures. In one sense it can be said that the cause of such theft and fraud derives from the existence of opportunities to remove or otherwise misappropriate valuable securities. To the extent that such opportunities can be reduced within the financial community, securities theft and fraud should diminish proportionately. As I will explain in my statement today, the control of theft and fraud may best be accomplished through the ultimate development of a "certificateless society" in the securities area. I will turn first to a brief review of our protective security measures that restrict access to securities in the bank's possession. The bank's preventive measures are under continuous review to further improve the design of our security and control systems. We believe that experience to date justifies our claim to an effective bank security system. A key element of our internal control system is simply that no one person, no matter what his rank or station, can process any transaction to completion unaided. Double custody of all securities within our possession is the absolute and uncompromising rule. To this are added what we believe are sound internal accounting and auditing procedures, conducted at both regular and irregular intervals, resulting in the creation of sophisticated audit trails and inventory systems. In the stock transfer operation, we require special identification and security mantraps along with a double custody system and maintenance of complete audit trails for all transactions. All unissued certificates in blank form are stored in vaults maintained under double custody, with verified accurate records of the certificates. maintained under separate custody. When delivery of certificates for daily processing is made, it is again accomplished under conditions of double custody, and each delivered certificate is accounted for by number. Overall, total bank-wide losses from securities theft and fraud in the last 3 years have been minimal. In the late 1960's, however, we did experience two sizable losses which subsequently were largely recovered by the outstanding efforts of the FBI and our own internal investigators. Those losses prompted a major review of our internal security and control system to insure that we would have an effective system to counter the activities of organized crime. We believe that as a result of these strengthened procedures there has been only one significant loss since 1971. In this case a shareholder requested a replacement certificate, claiming the original was lost in the mail. An indemnity bond agreement was executed by the shareholder, and the bank's insurance carrier authorized issuance of a replacement certificate. In fact, it was later determined that the original certificate was not lost but was pledged as collateral for a loan at another institution. The total loss was $114,848 with an actual bank loss of $14.848 due to a clerical mailing error which reduced the insurance reimbursement to $100,000. I would like to briefly review the bank's practice concerning stop orders in the operation of the stock transfer department. Stop payments are received from both individual stockholders and the principals of accounts for which we serve as transfer agent. We presently have approximately 150,000 stop orders on file as a result of reports of lost certificates. It is our practice to maintain all stop orders of record until they are released. It is also our practice to notify any cotransfer agents of the stop payment at the time we receive such order and subsequently at the time of release. I will turn now to the recommendations previously received by the subcommittee which were summarized in the chairman's letter to our bank. The major area of concern, and it appears the focus of the subcommittee's interest, involves the validation of securities and securities ownership. This issue takes us beyond internal preventive measures to an evaluation of the most appropriate means to prevent what is known as "bad paper" from being used once it has been illegally obtained or successfully counterfeited. Bank of America has considered this serious problem at length. We believe that there is no practical system presently available that would substantially eliminate the use of stolen or bogus securities from financial markets. Being cognizant of the dimensions of this problem, we accordingly exercise careful judgment in receiving securities from outside sources both at our vault locations and in the bank's community offices throughout California. We have considered and decided against participating voluntarily in a privately offered central securities validation system for several reasons, including some which may well be unique to Bank of America. One important distinction is that our bank is headquartered in a State which has long permitted statewide branch banking. Thus, in addition to an active and expanding corporate banking effort, Bank of America maintains over 1,000 community offices throughout the State of California and is a leading force in the retail banking market. Over the years, and particularly when the rash of incidents were. reported in which banks were being victimized by accepting stolen or fictitious securities as collateral for loans, all staff members handling securities transactions at the community office level have been directed to do so with extreme caution. Perhaps the major reason why we have not suffered losses from bogus collateral is the bank's policy that loans are to be made on the condition that lending officer first assure themselves that other primary sources of repayment exist. A loan officer should not depend upon the prospective sale of collateral in deciding whether or not to make a loan. Thus, as a matter of policy, a borrower's collateral should not serve as justification for extending credit. Additional considerations which are required to be observed at each community office include the acceptance of securities as collateral only from persons whose identity and responsibility can be well established. Securities accepted are, of course, visually inspected for forgeries and mutilation and matched against stolen securities circulars when they are received. The bank has its own statewide warning system which involves the use of emergency phones and circulars. I hope this subcommittee will give due consideration to our experience as a large retail bank operating within the policies I have just described. In our considered opinion, it would be far too unwieldy for our 1,000 community offices and numerous other operating units to be part of a central securities validation system designed to apply to all transactions. Were a centralized validation system to be required of all banks, brokerage houses, insurance companies, and other transfer agents and registrars, we respectfully submit that neither the securities industry nor the banking industry could function under a system that required mandatory checking prior to the acceptance of any security as collateral or as an asset in investment and trust portfolios. The business community in this country is not presently equipped with the interdependent telecommunications facilities that would be required under a mandatory reporting system where every individual and office dealing in securities would report misplaced documents and search a computer file whenever a new security is accepted. Although in our opinion a mandatory central security validation system would be ill advised at this time, that is not to say that there is no validation in the banking system at present. There is in the first instance the indirect access that financial institutions have to the National Crime Information Center (NCIC). As an alternative to expending substantial amounts of time and money to fully implement a central securities validation system, Bank of America would like to encourage a concentrated effort to develop book-entry systems and, ultimately, a certificateless society. Rather than improve the accountability of a system dependent upon the transfer of certificates, the long-term solution lies in immobilizing and eliminating certificates to the maximum extent. The success of the book-entry procedures for Treasury securities undertaken by the Treasury Department and Federal Reserve Banks in the last few years is a hopeful sign of what can be developed in the corporate and local government sectors. The advent of depositories, such as the Depository Trust Company, where brokers deposit shares held in their street name with the depository and trades are subsequently handled by book-entry, provides one important vehicle for removing the opportunity from those who would engage in securities theft or fraud. The mutual fund industry presents a further example of the successful replacement of stock certificates with statements which in themselves are nonnegotiable. Much work remains to be done in this area. We submit that an investigation of these prospects with a view toward possible legislation to hasten the arrival of the certificateless society would be a more valuable and far-sighted endeavor than to encourage an unwieldly system based upon the continued existence of securities certificates. A second recommendation to this subcommittee is to make the theft, counterfeiting or other criminal possession of securities a Federal crime. Bank of America has no objections to this proposal and would favor it to the extent that it could lead to the systematic |