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Revenue Service. We will also examine the rationale for the removal by IRS of the foreign bank account question from all income tax returns.
The Bank Secrecy Act of 1970 was enacted after hearings disclosed that the use of secret foreign bank accounts for illegal purposes created grave regulatory and tax enforcement problems in the United States. Secret foreign bank accounts were utilized by organized crime and narcotics traffickers in their operations. They were reported to be a haven for unreported income of Americans. They were used to defeat our corporate securities laws in the purchase of securities in our market or in the acquisition of substantial interests in U.S. corporations by unidentified persons.
The Bank Secrecy Act of 1970 is designed to avoid interference with the laws of any foreign country. So that the free flow of international commerce will not be unduly burdened, the Secretary of the Treasury, in carrying out his functions under the act, was given certain exemptive powers.
Today we will hear from Roderick Hills, Chairman, Securities and Exchange Commission; accompanied by Stanley Sporkin, Director, Division of Enforcement, SEC; and from David Macdonald, Assistant Secretary of the Treasury for Enforcement, Operations and Tariff Affairs.
The SEC testimony in 1968 and 1970 helped bring about the Bank Secrecy Act.
We are interested to determine whether the problems against which the act was directed still persist; if so, why they still persist.
Mr. Chairman, we are pleased that you could join us this morning. We will be happy to hear your statement.
STATEMENT OF RODERICK M. HILLS, CHAIRMAN, SECURITIES AND
EXCHANGE COMMISSION; ACCOMPANIED BY STANLEY SPORKIN, DIRECTOR, DIVISION OF ENFORCEMENT
Mr. HILLS. Mr. Chairman and members of the subcommittee, Mr. Sporkin and I appreciate this opportunity to discuss the effects of activities of foreign financial facilities on U.S. securities markets.
Let me begin by noting the obvious. Our capital markets are the best in the world. Their acceptance throughout the world is, in large part, the result of their integrity and reputation for fair dealing. The key to their integrity is the ability of the regulatory mechanism, particularly the Securities and Exchange Commission, to obtain full information concerning all transactions effected in the marketplace.
For the most part we have access to information required for appropriate market surveillance of domestic transactions. This is not generally the case with foreign transactions. We are particularly concerned that U.S. citizens may be using foreign intermediaries to evade the regulatory mechanism.
Nonetheless, we are hopeful that you will consider our testimony about abuses of the system in the context of the actions that we propose, both legislatively and otherwise. We are concerned that solutions could be proposed which will be counterproductive and harmful to the flow of capital between this country and others.
That there are now and that there have been abuses is evident, but Government's response to those abuses should be measured. Foreign investors should not be discouraged from investing capital in American business.
Our domestic securities firms and brokers should not be placed at a competitive disadvantage by laws that could provide incentives for foreign investors or American investors to purchase American securities through foreign investment firms rather than American firms.
Our own proposals and approach to the problem are modest:
We believe that our ability, the ability of the Commission, to secure equitable relief from Federal courts where violations seem apparent should be spelled out with some detail to give better guidance to the courts.
We believe we should accelerate our discussions with representatives of certain foreign countries to secure greater cooperation from them, both through the administration of existing laws and perhaps from the change of a law or two in some countries.
We also believe that we should make further efforts, both at the Commission and elsewhere in government, to explain the purposes and objectives of our laws to those foreign financial institutions which we believe will respond positively.
With these preliminary thoughts in mind, let me address the 18 questions that you have raised in your letter to the Commission in five general areas:
MANIPULATION AND INSIDER TRADING The first is manipulation and insider trading. Manipulation and insider trading in violation of the law is very difficult to prove when foreign financial institutions are utilized.
For example, the Commission's market surveillance functions have on numerous occasions uncovered suspicious situations where heavy trading of securities through foreign financial institutions preceded a major news announcement concerning the issuer of those securities.
Upon investigation, the trail too often leads to a U.S. bank's omnibus account for a foreign bank. We are unable to learn from the foreign bank the names of the beneficial owners of the securities who so timely bought or sold. We are left only with the suspicion that they may be in some way closely connected with the issuer.
In one case, a block of more than a quarter of a million shares of stock of a well-known U.S. company was sold by a Swiss bank on a major U.S. securities exchange just prior to the public disclosure of significant adverse news concerning the company. We were unable to learn the identity of the sellers.
In a second situation, approximately 40,000 shares of stock were purchased by a number of European banks, mostly Swiss, in the period just prior to the public announcement of a tender offer for that stock at a price substantially above its recent market price. The purchase of the 40,000 shares yielded a profit of more than a quarter of a million dollars. Again, because of the foreign secrecy laws, we have so far been unable to ascertain the names of the beneficial owners of those shares.
TAKEOVERS AND BENEFICIAL OWNERSHIP A second area is takeovers and beneficial ownership.
The U.S. securities laws, of course, do not and, in our judgment, should not prohibit purchases by foreigners of controlling interests in U.S. corporations, but they do require disclosure whenever a foreign or domestic investor acquires more than 5 percent of the shares of a public U.S. corporation or makes a public tender or exchange offer for the same mínimum amount. As long as the required disclosure is made, there is nothing improper with existing laws about a tender offer because it is made
by a foreign interest. However, abuses of our disclosure requirements have occurred where foreign interests acquire a substantial interest in a U.S. corporation without making a public tender offer.
For example, the Commission is presently inquiring into a situation where a foreign bank, holding in excess of 5 percent of the stock of a U.S. company, sought to sell what it claimed was effective control of the company to several potential purchasers. American shareholders were unaware of the attempt to sell control of the company because the bank had not made the required disclosure of its ownership interest or its negotiations to sell that ownership interest.
In another case, one now on appeal, the General Refractories case, the Commission charged that a foreign individual had concealed a substantial ownership interest amounting to more than 10 percent of the stock of a New York Stock Exchange listed company, and that a major Swiss bank had aided and abetted this violation by breaking up the stock into smaller blocks to evade the U.S. disclosure requirements.
In this case the lower court entered a preliminary injunction which restricted transfer of the foreign controlled stock and prohibited it from being voted. Subsequently, the Swiss bank consented to a final judgment enjoining it from further violations of the relevant securities laws and ordering it to adopt procedures to prevent recurrence of that conduct.
The circumstances of this case may not be unique. We are currently looking at situations which may have involved the breaking up of large blocks of stock of U.S. companies in order to disguise the need for filings with the Commission.
In sum, we do have reason to believe that foreign financial institutions, intentionally or unintentionally—and probably there are examples of both—permitted substantial ownership or control of U.S. corporations to be accumulated without complying with the disclosure requirements of the U.S. securities laws.
A third area of concern is credit arrangements.
Current credit regulations in the United States restrict the extension of credit for the purpose of purchasing securities to 50 percent of the market value of the securities purchased. However, the Commission has found examples of credit extended by foreign financial institutions to U.S. citizens or residents well in excess of amounts allowed by our own credit regulations.
The problem is twofold:
First, a foreign bank generally does not obtain purpose statements from a borrower, which would be required in this country, so the bank does not know necessarily what the money may be used for.
Second, the foreign bank is not likely to comply with our requests for information. Consequently, it is possible that substantial trading
in our securities markets is being conducted outside the effective reach of, and in possible violation of, our credit regulations.
QUESTIONABLE CORPORATE PAYMENTS AND CAMPAIGN CONTRIBUTIONS
The fourth area is questionable corporate payments and campaign contributions including bribery.
As this subcommittee knows, our recent report to the Senate Banking, Housing and Urban Affairs Committee refers to the use by U.S. citizens and corporations of secret foreign financial facilities to carry out corporate bribery and other questionable and improper activities.
Some of the practices uncovered in our investigation include the use of Swiss bearer stock corporations as depositories for secret kickbacks and bogus payments to foreign consultants. In turn, these payments are diverted by the foreign consultants through foreign financial institutions for illegal political contributions or payments to government officials. Similarly, foreign entities and financial institutions have been used to hide the sources of corporate contributions to domestic political campaigns.
It should be noted that foreign financial institutions have been used in more direct ways by American corporations in generating secret slush funds. A company might simply issue instructions to a domestic bank to wire funds to a correspondent bank overseas where a disbursement is made in accordance with specified confidential instructions. A messenger then picks up the cash and returns it secretly to the United States.
Much of the information that we do have in this area has been developed because of the cooperation of individuals directly involved in these practices. Even with such cooperation, the use of secret foreign financial facilities often makes it nearly impossible to obtain a reliable accounting of all payments and receipts. Without such cooperation, efforts to get behind foreign financial secrecy laws are of little avail.
The final area of concern is laundered funds. Although we have received some information that foreign financial facilities have been utilized to funnel funds from illegal enterprises into legal businesses and vice versa, we have not alleged this type of conduct in any enforcement action. Nonetheless, our investigations here, particularly our investigations involving organized crime have produced some information that individuals have used funds from illegal activities to acquire interests in public corporations.
Mr. Chairman, as a result of the difficulties, which I have tried to spell out briefly, involved in investigating securities transactions emanating from abroad, enforcement of the U.S. securities laws is not as effective as in a purely domestic transaction. This tends, obviously, to lead to a double standard in the application of our securities laws.
REMEDIAL MEASURES We do believe that measured steps can be taken to improve our enforcement efforts against the small element of investors utilizing foreign financial facilities to engage in undesirable activities in our markets.
Our proposals fall into two major categories: legislative measures and increased international cooperative efforts.
We have suggested certain legislation previously in the Senate, which we believe should be enacted to spell out the powers of the Federal courts to grant ancillary relief in cases of refusal to comply with subpenas of the Commission. Such relief would permit a court to restrict transfer of shares, to revoke or suspend the right to vote shares, to prohibit payment of or impound dividends, or to require public sale of the securities involved- obviously only with court order and only in the case where an alleged violation had occurred.
Currently, the penalty for refusal to comply with a judicial order enforcing a subpena of the Commission is a fine of up to $1,000 and imprisonment for up to 1 year. These sanctions are too often meaningless to a foreign financial institution.
The provision which we are suggesting was considered last year by the staff of the Senate Committee on Banking, Housing and Urban Affairs as part of the proposed Domestic and Foreign Investment Improved Disclosure Act of 1975. We strongly urge that this kind of proposal be reconsidered.
In another area, we recommend that the committee consider legislation which would restore to the Commission authority to censure foreign financial institutions engaged in securities laws violations. That authority was removed by the Securities Act Amendments of 1975.
Prior to the amendments, the Securities Exchange Act provided that the Commission could, after notice and hearing, censure, and bar from association with a registered broker-dealer, "any person” who had committed specific violations of the Federal securities laws. The term "any person" clearly included foreign banks and domestic banks.
The legislative history is silent as to the reasons why the 1975 amendments eliminated this authority, which we believe was of significant benefit in deterring violations by foreign institutions.
I should add that there is presently pending before Congress a billthe Tax Reform Act—which would severely restrict the Commission's ability to obtain from the Internal Revenue Service and utilize tax return information.
While we understand the concern for privacy which underlies this aspect of the bill, we know of no information or no cases of abuse which would justify this kind of restriction upon the ability of the Commission to get this kind of information.
We urge this committee to review carefully this restrictive provision which would reduce our access to investigatory information. It would severely limit our capacity to deal with white-collar crime.
In addition to these legislative matters, the Commission is currently considering the adoption of a package of rules and form changes which would modify our requirements for the disclosure of beneficial ownership by clarifying the definitions of a beneficial owner. The proposals would be the first major exercise of the Commission's ruleking authority under the Williams Act and will include guidelines
determining when a person is a beneficial owner; and will require itional disclosure in filings currently required in takeover and