involvement of Federal investigative agencies at the outset of a reported loss.

The third area of recommendations presented to your subcommittee deals with accounting and auditing procedures. In particular, it has been proposed that audited financial statements contain serial numbers or other identifying numerals of all stocks and bonds listed as assets on a company's financial statement. Based on our experience, it appears that this proposal would contribute little to the reduction of securities theft and fraud.

This concludes my statement. We have attempted to set forth Bank of America's experience and protective measures and to deal with the several proposed remedial measures. My colleagues and I will be pleased to address any questions you may have. Thank you, Mr. Chairman."

Senator HUDDLESTON. Thank you, Mr. Breen.

Mr. Ahrens?

TESTIMONY OF CONRAD F. AHRENS, SENIOR VICE PRESIDENT, FIRST NATIONAL CITY BANK, ACCOMPANIED BY ARNOLD Y. CLAYMAN, VICE PRESIDENT IN THE COMPTROLLER'S DIVISION Mr. AHRENS. Mr. Chairman and members of the subcommittee: My name is Conrad F. Ahrens. I am senior vice president of First National City Bank and head of securities administration in Citibank's Investment Management Group.

With me is Arnold Y. Claman, vice president in the comptroller's division.

I would like the complete statement to be placed in the record, but I will paraphrase or eliminate some portion of that statement in the interest of time.

Senator HUDDLESTON. It is so ordered.

Mr. AHRENS. We are here in response to Senator Jackson's letter to Walter B. Wriston, chairman of Citibank, requesting our views in connection with your investigation.

My office oversees safekeeping arrangements for all securities held by the Investment Management Group, both those for which we have investment authority and those for which we act merely as custodian. Mr. Claman's office is responsible for investigating and reporting to appropriate authorities when securities held by Citibank are unaccounted for.

Our testimony today will be confined to Citibank's own experience. For that reason, our information and our conclusions may differ from those of other institutional investors or from those of the subcommittee and the subcommittee staff.

Altogether, Citibank has custody of securities amounting to about $60 billion. Considering the volume of transactions handled every business day and the inevitability of some clerical errors, any paper based system is bound to have certain problems inherent in its operation.

Thus, we always have an inventory of investigations under way to identify bookkeeping errors which must be rectified, securities that may have been misfiled, misdescriptions either due to internal mis

take or to incorrect information supplied to us at the time of delivery, and a variety of other problems. Most such investigations are successfully concluded.

We are currently investigating the whereabouts of unaccounted for securities worth approximately $2 million. This is substantially less than 1/250th of 1 percent of our $60 billion in holdings.

All but about 1 percent of these securities are in registered form and therefore cannot be negotiated without a subsequent intervening criminal act; namely, obtaining the signature guarantee of a bank or member of the stock exchange to a forged stock power.

Based on our experience, virtually all of the securities that ultimately prove to be missing will be replaced without loss. Our recovery rate therefore runs almost 100 percent.

Theft or misappropriation is highly unusual as a cause of disappearance. As evidence of this fact, over the past several years, there have been no instances in which we have been called upon to respond by a transfer agent or paying agent under an indemnity for missing securities because the original has been negotiated successfully.

With respect to the incidence of thefts from Citibank itself, we have had a total of four over the past 3 years, with a net loss of about $20,000. In all cases, the culprit has been identified and prosecuted by Federal or State authorities.

At the present time, there are no investigations outstanding involving suspected wrongdoing by employees in connection with missing securities.

From a dollar standpoint, the most significant theft in the past several years occurred earlier this year when a clerk in the department which issues Citibank negotiable certificates of deposit stole seven short-term certificates totaling $11,650,000.

Instead of delivering them to our vault, he passed them to an outside accomplice. The disappearance was quickly discovered, and stops were placed against payment.

They became due within a period of 60 days. Five pieces for $4,150,000 were presented on the due date by two small banks in Andorra.

We immediately notified both banks, and the attempt to negotiate them was frustrated. No loss was sustained by ourselves or by either of the banks abroad. The persons responsible were identified and apprehended through the efforts of the Federal Bureau of Investigation. Two pieces for $7,500,000 have never turned up, but they could not now be passed.

In the case where we lost $20,000 in 1971, the person responsible, a 10-year employee, worked in the receive section of our securities department. He stole four certificates registered in our nominee name, induced another employee to place the bank's signature guarantee stamp on the stock, had them reregistered in his own name and sold them. These certificates never reached the vault. The culprit was convicted.

The other two cases involved minor amounts and both persons were apprehended.

The subcommittee also asked about stop orders in our transfer department. Approximately 160,000 stops are outstanding on securities for which we are the transfer agent, some of them dating back to the early 1920's.

When a holder learns that a security is missing, he notifies the appropriate transfer agent-in our case Citibank. A stop order is placed on the security and, against appropriate indemnity, a substitute security is issued.

If the missing security fails to turn up, the stop order remains in effect. Frequently, even if the security is found, the person who placed the stop order neglects to withdraw it. Thus, the 160,000 is to a substantial extent a cumulative total. Citibank has not suffered any losses through theft or misappropriation for many years in our stock transfer operation.

At this point, perhaps the most useful contribution I can make is to describe Citibank's procedures for handling securities and for tracking them while they are in our custody.

When we receive securities, each certificate and its accompanying documents are physically examined by an experienced securities clerk to ensure that the securities are precisely those we expected to receive and that the accompanying documents are complete and in good order. At this point, the security certificate numbers are recorded on microfilm.

All registered securities are sent within 24 hours to the appropriate transfer agent for reregistration in our nominee name to facilitate income collection, the handling of proxies and the delivery of the securities if later sold.

When returned, the newly issued securities are deposited in an individually numbered account folder belonging to the client for whom the transaction was conducted. Bearer securities are given the same thorough examination on receipt and go directly into our vault.

At that time they are deposited in the vault, we can be certain that the registered securities are valid because any counterfeit securities or securities reported as stolen would have been recognized as such by the transfer agent.

In the case of bearer securities, we do not know for certain when they are received if a stop has been issued against those certificates. But since bearer bonds normally pay interest semi-annually, we would discover the stop as soon as we presented the coupon for payment.

In other words, we are certain that all registered securities and all bearer securities which we have held more than 6 months are authentic and free from encumbrance. In practice, I do not recall a single case of our ever having received and paid for a bearer instrument which later proved to be counterfeit or stolen.

The operations I have generally described are controlled by a real time computer system that assigns a unique number to each transaction and that subsequently tracks the movement of the securities through each step in our processing system, minimizing the possibility of theft, loss or misdirection.

If at any point the security fails to arrive in timely fashion at the next processing station, the failure to arrive is flagged and an investigation is promptly commenced. This system gives us com

prehensive control of each security movement until it is either filed in our vault or delivered from the vault to our customer or his bank or broker.

These controls operate while securities are being processed for receipt or for delivery. But what happens when a security is discovered to be missing from the vault? When a vault custodian attempts to withdraw a security-for example to cut a coupon or to deliver it to the buyer-and he can't find it, he immediately advises a vault investigator.

The investigator institutes a preliminary search for the security, for example, looking for the security in an adjoining account or an account with similar number, or rechecking the account to see if the custodian may simply have missed the security because he thought it was something else.

Failing this, the investigator will check our records to see if the security was accurately described in the first place and will then make whatever additional checks the search of the records suggests. If he cannot find the security or determine what went wrong within 15 days, he files a potential loss memorandum with the comptroller's department.

Under our interpretation of the Federal banking laws and the regulations of the Comptroller of the Currency, we report missing securities to the Federal Bureau of Investigation, the U.S. attorney and the Comptroller of the Currency.

The information we supply is entered in the FBI's National Crime Information Center system. Stops, of course, are also lodged with the transfer or paying agent. The FBI, on identifying a missing security and learning it is in unauthorized hands, is in position to take immediate action.

Meanwhile, our internal investigation continues as long as necessary, utilizing original documents and other records, until the security is found, replaced or some other disposition is made. When the case is resolved-and most such missing securities turn out to be misfiles and are later discovered in other accounts-the potential loss memorandum is rescinded.

We immediately notify the agencies listed earlier to clear their records so as to allow subsequent negotiation of the instruments. If we cannot locate the security, it is replaced, and we take an operating loss covering the cost of replacement.

As this description of our procedures makes clear, the figure of $2 million in unaccounted for securities which I gave you earlier represents a constantly changing aggregate figure. We are continually receiving notice that certain securities may have been lost or misplaced; we investigate those losses; we recover most of the lost items. Meanwhile, we receive notice of other unaccounted for items, resulting in additional searches and additional recoveries. At least at Citibank, very few items remain permanently unaccounted for. Now, as to our recommendations: It has been suggested that Congress require the establishment of a central validation system to which information on missing securities would be reported by all institutional investors and which all institutional investors would be required to query before completing a transaction.

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The query requirement would represent a bottleneck of extremely serious proportions. The system would have to respond to hundreds of thousands of inquiries each business day, almost all of them coming during the same 2- or 3-hour period.

Moreover, the cost to the user would be astronomical and, in our case, largely duplicative of assurances that are the byproduct of the securities transfer process.

Equally important, we simply do not believe it would solve the central problem. The loss of a security cannot be reported until someone discovers it is missing. Criminal rings, as opposed to casual thieves, are organized precisely to convert securities to cash before any alarm is raised. Thus, the proposed system would lock the vault after the theft occurs.

Contrary to what you may have been told, the holder in due course problem is not our reason for questioning the value of a central validation system.

Much more productive than the establishment of a central validation system would be the adoption by all institutional investors of certain standard operating procedures, with increased audit, internal controls, and, first of all, the know-your-customer rule.

All reputable financial institutions, whether they are banks, brokerage houses or insurance companies, should avoid dealing with persons or companies whose reputation is in the slightest way questionable. To be sure, all of us have first-time customers, but we have a special obligation in such cases to check their credentials with the utmost care. While any institution which handles large numbers of securities cannot conduct a physical inventory of its holdings every day, it should adopt systematic audit procedures. The Comptroller of the Currency requires a complete audit of every security for which we are responsible at least once every 3 years.

In addition, checks are conducted in connection with regular portfolio activities such as purchases, sales and income collection. The tracking system which I described earlier also plays an important part in assuring that theft or misplacement is discovered at an early stage.

The subcommittee has also asked for our opinion on revision of Title 18 of the U.S. Code to make the theft, counterfeiting or criminal possession of securities a Federal crime. We support such legislation and think it would be useful.

Ultimately, however, we are convinced that the best solution is the universal adoption of a central depository system, ending the reliance on paper certificates for "proof" of ownership.

As the members of the subcommittee know, at the end of the 1960's, when "back office" problems were creating serious difficulties, the banks in New York and the securities industry worked together to create the Depository Trust Co. allowing securities to be received and delivered by electronic bookkeeping entry. Such a system is today used for U.S. Government securities, and similar systems are being developed in other parts of the country.

This approach of "immobilizing" the securities is, we feel, the only real answer to the risks inherent in trading in negotiable instruments, and we hope the subcommittee will lend its support to this joint industry effort.