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SECURITIES AND EXCHANGE COMMISSION,

Washington, D.C., June 11, 1976. Re H.R. 10612, 94th Congress. Hon. RUSSELL B. LONG, Chairman, Finance Committee, Washington, D.C.

DEAR CHAIRMAN LONG: It has recently come to my attention that on Wednesday, May 26, 1976, the Senate Finance Committee voted to add a provision to H.R. 10612, the proposed tax reform act passed by the House of Representatives last December, which would greatly limit the ability of agencies such as the Securities and Exchange Commission to obtain access to tax returns in connection with official investigations into possible violations of federal law. The Commission believes that, if enacted, legislation of this nature would constitute a serious impediment to effective enforcement of the federal securities laws, and we urge that the Committee reconsider its action in this regard.

Although the precise language of the amendment in question has apparently not yet been drafted, I understand that the intended consequences of the Finance Committee's amendment on the work of agencies such as the Commission would be generally these :

1. In connection with investigations or proceedings to enforce “nontax criminal statutes," the Commission would be able to obtain access to tax information only upon the issuance of an order by a United States District Court. Such an order could, in turn, be issued only upon a showing that there was probable (or, as a possible amendment, reasonable) cause to believe, on the basis of the Commission's investigation, that a specified criminal act had been committed ; that there were reasonable grounds to believe that the information contained in the return would be probative of the commission of the crime; and that there were no reasonably available alternative sources of the information sought (or, as a possible amendment, that it was believed not to be reasonably available elsewhere). Only those parts of the return determined by the Court to be necessary to the investigation or prosecution would be subject to disclosure.

2. Once the Commission had received tax return information pursuant to a court order as described above, further disclosure thereof in an administrative hearing or judicial proceeding relating to the violation of the “nontax criminal law” would be prohibited unless there were a showing to the presiding hearing officer or judge that such information would be directly probative of the defendant's guilt (or, as a possible amendment, the word "directly" would be stricken).

3. In connection with investigations and proceedings involving "nontax civil matters" the Commission would be entirely precluded from obtaining tax returns or return information from the Internal Revenue Service under

any circumstances. Under present law, the Commission is able to obtain, upon the written request of its Chairman, access to income tax returns directly from the Internal Revenue Service. Both the request itself and the access to, and use of, returns are, how: ever, subject to stringent internal safeguards. It has been our experience that the white collar criminal who is frequently the subject of Commission investigations is financially sophisticated, and that evidence of law violations by such persons can usually be developed only through the careful study of records such as tax returns. Moreover, the white collar criminal is frequently scrupulous in complying with the requirements of the federal tax laws due to an awareness of his vulnerability to prosecution in that area. Thus, information crucial to a Commission investigation may already have been disclosed on a federal tax return. For these reasons, while the Commission shares the Committee's concern regarding the potential for abuse with respect to access to tax information, it also believes that overly severe restrictions on the availability of income tax information would have a significant adverse impact on its enforcement program.

It would also like to bring the Committee's attention to the fact that the distinction which the Committee apparently proposes to draw between “nontax criminal statutes" and "nontax civil statutes" may be very difficult to apply in practice. Since a willful violation of any of the substantive provisions of the federal securities laws may be prosecuted as a crime, any Commission investigation has the potential of resulting in a criminal prosecution. The Commission, however, conducts a single investigation, neither specifically civil nor criminal

in focus. Thus, during the early stages of an investigation, it is frequently difficult to predict whether the investigation is likely to culminate in administrative, civil, or criminal action, some combination thereof, or even no enforcement action at all. Similarly, early in an investigation it may be impossible to establish with certainty that particular tax information would be probative of the commission of a crime, as opposed to being of use in establishing noncriminal illegal activity.

Enclosed is a copy of a statement concerning the draft recommendations of the Privacy Protection Study Commission on Federal Tax Return Confidentiality which the Commission's Associate General Counsel, Paul Gonson, and the Director of the Division of Enforcement, Stanley Sporkin, recently delivered on behalf of the Commission. The Privacy Protection Study Commission's draft recommendations are generally similar, in effect, to the Finance Committee's amendments, and, therefore, I believe that this statement, which describes the Commission's existing procedures regarding access to tax returns and outlines the reasons why we believe that limitations on such access would not be in the public interest, will be of use to the Finance Committee in its further consideration of H.R. 10612.

For these reasons, the Commission is opposed to the adoption of the proposed amendment to H.R. 10612. Because of the time factor involved, we have not, however, attempted to propose specific drafting changes, although we would, of course, be available to work with your staff on drafting a suitable modification to the proposed amendment.

If we can provide any further information or assistance concerning this matter, please do not hesitate to call on us. You will, of course, understand that the views expressed herein are those of the Securities and Exchange Commission and do not necessarily represent the views of the Administration. Sincerely yours,

RODERICK M. HILLS, Chairman. Enclosure.

PREPARED STATEMENT OF PAUL GONSON, ASSOCIATE GENERAL COUNSEL, AND STANLEY

SPORKIN, DIRECTOR, DIVISION OF ENFORCEMENT, ON BEHALF OF THE SECURITIES AND EXCHANGE COMMISSION

RE DRAFT RECOMMENDATIONS OF THE PRIVACY PROTECTION STUDY COMMISSION ON

FEDERAL RETURN CONFIDENTIALITY

Mr. Chairman and members of the Commission, we appreciate this opportunity to appear before you on behalf of the Securities and Exchange Commission ("SEO”), to comment on this Commission's Draft Recommendations on Federal Income Tax Return Confidentiality, which propose amendments to Section 6103 of the Internal Revenue Code. In substance, the amendments, if enacted, would prohibit, except in limited situations, disclosure of tax "returns" of individual taxpayers (as defined in the Draft Recommendations) to federal and state agencies, except with the prior written consent of the individual taxpayer.

Section I.D. of the Draft Recommendation would permit disclosure of tax return information to federal agencies, including the SEC, for use in the investigation and prosecution of criminal violations of non-tax laws provided a judicial warrant was obtained consistent with the Federal Rules of Criminal Procedure. The effect of the Draft Recommendations would be to terminate the Commission's current practice, which is discussed infra, of requesting that the Internal Revenue Service make specifically identified tax returns available to selected staff members for a particular investigative purpose. In addition, under the Draft Recommendations the SEC probably could not issue an administrative subpoena duces tecum to obtain an income tax return because such a subpoena probably would not qualify as a "judicial warrant.” 1. The Commission's awareness of the potential for abuse and the acquisition

standards it has voluntarily adopted As we all have come to recognize, there have been abuses in the past with respect to access to the Federal income tax returns of individuals. We would hope, however, that proposals for limiting such accessibility would be designed to prevent actual abuses, and would not undermine the efficient operation of, or be an inhibitant to, the needs of law enforcement agencies, such as the SEC. Increased procedural safeguards should allow tax return information to be made available for legitimate law enforcement needs while, at the same time, provide sufficient accountabiilty in order to prevent abuses and thus protect the rights of individuals.

The Commission believes that overly severe restrictions on the availability of income tax information would have a significant adverse impact on its enforcement program. The Commission is also of the opinion that the Draft Recommendations, if implemented, would significantly inhibit its ability to obtain information which is required to complete successfully certain ongoing investgatons and would significantly handicap an increasing number of future investigations.

In the history of the Commission we are not aware of any instance in which there has been any abuse of tax return information. The Commission has traditionally been sensitive to the potential for misuse of information derived from income tax returns obtained by the Commission in the course of an investigation. Accordingly, the Commission long ago adopted standards governing the acquisition and retention of income tax returns for investigative purposes. We believe that these standards preclude any unnecessary or abusive acquisition of income tax returns and insure that information derived from such returns is utilized only for legitimate investigative purposes and is not available for other reasons.

The Commission's staff has been instructed that, in seeking to obtain access to income tax returns, the staff has to have a reasonable basis for the request, namely, that the information was reasonably necessary for proof of violations of the Federal securities laws, and that appropriate measures would be taken to prevent unwarranted disclosure of information derived from such returns to persons other than those concerned with the particular investigator. In 1965, the Chairman of the SEC cautioned all staff members for the need for strict controls in obtaining and using Federal income tax returns in connection with Commission enforcement programs. Periodically thereafter, staff members have been reminded of these obligations.” 2. The Commission's current practice and procedure

The Commission's procedures for requesting income tax returns and other taxpayer information directly from the Internal Revenue Service, without prior notice to the taxpayer, which have been consistently followed to the best of our knowledge since at least 1964, require that the request be made by letter from the SEC's Chairman to the Commissioner of Internal Revenue.*

Prior to any request being made to the SEC's Chairman that he seek to obtain a Federal income tax return, senior staff officials in the requesting office review each staff request to assure that the request meets certain standards. These standards are: (1) the request is necessary for, and the information sought is material to, an ongoing investigation; (2) the subjects of the returns are persons who are participants in, or who have a material connection with, the particular subject matter under investigation; (3) the tax years for such requested returns are pertinent to the scope of the inquiry; and, (4) repeated requests involving the same person are to be avoided.

The letter from the SEC Chairman requesting tax return information generally sets forth (i) the specific staff members of the Commission for whom access is sought; (ii) the name of the individual or corporation and the tax period; (iii) the specific purpose for requesting the information; and, (iv) how such information is to be used. Assurances also are provided to the IRS that the information will not be made public except to the extent necessary for introduction in litigation and that access to the information will be on a “need-to-know" basis, that is, limited to the Commissioners and those employees who are actively engaged in the relevant investigation or subsequent litigation."

Upon receipt of the income tax information, the receiving office has the duty to insure that such returns are properly retained in the investigative files, that they are made available only to members of the staff who are directly involved in the investigation or related matters, and that persons having access to the returns have been cautioned both as to their confidential nature and the prohibitions set forth in the Internal Revenue Code and the United States Code regarding un

1 Attachment A.
2 Attachment B.
3 See Attachment C.

* In certain limited circumstances. such as where IRS returns are obtained during the course of an administrative proceeding, the General Counsel of the Commission will sign the letter to IRS in order to avoid any issue as to "prejudgment” of the respondent by the Chairman.

5 See Attachment C. The IRS regulations require that the head of the requesting agency transmit a letter setting forth, in general, these same requirements. Treas. Regs. 301.6103 (A)-2.

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authorized disclosure of such information, 18 U.S.C. | 1905; 26 U.S.C. 8 7213.

At the time that an investigation is commenced, the staff does not know whether it will be necessary to request access to income tax information, and, as noted above, such information is requested only where it is essential to an investigation. During calendar year 1974 when the SEC had about 1400 open investigations in various stages, the SEC made 15 requests to the IRS for income tax information involving 82 taxpayers. During calendar year 1975, when the SEC had about 1580 open investigations the SEC made 12 requests to IRS for tax returns involving 21 taxpayers.

Tax returns are requested by the Commission for use in investigations being conducted to ascertain whether there have been violations of the statutes which the SEC has been mandated to enforce. Primarily these investigations are conducted to determine whether there have been violations of the Securities Act of 1933, Securities Exchange Act of 1934, the Investment Advisers Act of 1940, and the Investment Company Act of 1940.

The SEC customarily issues a formal order of investigation based upon information received from the staff that tends to indicate that there may have been violations of the Federal securities laws and authorizes designated staff members to issue subpoenas to compel testimony and obtain documents. During the conduct of such investigations, staff members interview witnesses and potential subjects of the investigation and request or subpoena documents from various persons.

The SEC enforces the securities laws either in the form of an administrative proceeding, a civil injunctive action in a federal district court, or by referral of its information and files to the Justice Department or appropriate U.S. Attorney for possible criminal prosecution. During the course of an investigation, particularly in the early stages, it is difficult to predict whether any enforcement action will result, and, if so, whether it will be administrative, civil or criminal, or a combination thereof. Since willful violations of any of the substantive provisions of the Federal securities laws may be prosecuted as crimes any SEC investigation has the potential of resulting in a criminal prosecution.

The white collar criminal who frequently is the subject of our investigations is sophisticated in financial methods and techniques. Furthermore, the successful conclusion of an investigation often significantly relies upon linking a “paper trail” of documentary evidence proving the violative conduct. The documents that are most often relevant to our inquiries are filings with the Commission, brokerage firm records, corporate records, bank records, personal documents, or telephone records. It has been our experience that, while the subject of an investigation may have violated the Federal securities laws by making, for example, false and misleading statements, the white collar criminal is frequently very scrupulous in complying with the requirements of federal tax laws due to an awareness of the vulnerability to federal prosecution in that area. Thus, a witness or subject of an investigation may fail to supply certain information to the Commission when in fact he has already disclosed that, or other inconsistent, information on a Federal income tax return.

Tax return information can be of invaluable assistance in the conduct of an investigation by either establishing proof of certain facts or providing leads to further information. For instance, a manipulator of the market price of a security may use various accounts in several different brokerage firms in order to buy and sell the same security thereby generating the appearance of market activity and increasing the market price of that security. Alternatively, this market manipulator may use nominee names or various associates to conduct the illegal transactions. Even though the market manipulator may attempt to secrete his activities from the SEC, the tax returns of this individual or his associates, may (i) accurately reflect the purchase and sales of the securities, (ii) provide leads as to the location of brokerage accounts which may have been used for the manipulation, or (iii) yield information as to various bank accounts that have been used to pay for the purchase or receive the proceeds from the sale of the securities. In other instances, tax return information may provide leads as to otherwise undisclosed remuneration to officers and other “inside" individuals of public corporations, or identify "silent partners" in various business entities and transactions, or otherwise assist in the tracing of corporate funds to individuals who may bave misappropriated them.

The foregoing types of information are often difficult to obtain directly from other sources, particularly in cases where there is organized crime participation or where corporate looting is suspected. Furthermore, it may be impossible to ohtain documents directly from the taxpayer because, for example, it may be claimed that a copy of the tax return was not retained or that it has since

been lost or destroyed. In some cases where the circumstances warrant, access to Internal Revenue tax information may be necessary to confirm the accuracy of a tax return previously obtained from a subject of an investigation. 3. Recent investigations where the availability of an income tax return has been

beneficial to the SEC While we are reluctant in a public forum to disclose the details of ongoing or recently completed SEC investigations, we nevertheless believe that it is important for this Commission to understand how accessibility to income tax returns may play an important role in the SEC's enforcement activities. Accordingly, we have summarized below several investigations in which income tax returns were of significant assistance to the SEC.

1. In a recent investigation involving the overseas activities of a large oil company, the income tax return of one individual disclosed the identity of foreign persons who had received compensation which had not been reported in the corporation's filings with the SEC.

2. In another investigation, an individual's income tax return disclosed inconsistent treatment by him of a particular securities transaction in that he denied to the SEC that he had sold a particular security, but he reported the proceeds of that sale to the Internal Revenue Service as "income.” Income tax returns have also disclosed to the SEC the diversion of corporate funds to company officials and the misuse of corporate assets for personal benefit.

3. In another investigation into possible stock manipulation of a security listed on a national securities exchange where possible organized crime figures were involved, the capital gains schedules of one of the main suspects of the investigation indicated the existence of more than a dozen brokerage accounts in addition to those which had been discovered by the SEC's staff in its investigation. Correlating these schedules with records of brokerage firms implicated other persons who had acted as nominees. In addition, itemized business expenses sub-' mitted to the Internal Revenue Service helped to establish that the potential defendants had acted in a common scheme.

4. Finally, in a complex investigation into the operations of a large oil and gas drilling fund, the income tax returns of certain of the subjects of the investigation was invaluable in determining the actual income and expenses of the persons involved. With this information, the SEC's staff was able to trace the flow of large amounts of capital and property. In addition, the income tax returns and other information derived from the Internal Revenue Service established that the subjects of the investigation had not fully complied with the staff's requests for information and documents.

In addition, a primary investigative procedure for the conduct of an SEC investigation is the taking of testimony under oath and on the record. Determining the credibility and veracity of the witness by the availability of information that independently confirms or contradicts his testimony may be a significant factor to be considered in deciding whether to take enforcement action. In this context, the availability of income tax information and developing investigative leads from such information is an important aspect of the SEC's investigatory technique, especially since the SEC has no means of independently verifying information provided by individuals other than documents, such as income tax returns, which the individuals have themselves prepared.

Thus, while the SEC's requests for access to income tax information are selectively made and are not an integral aspect of every investigation, but occur only in a very limited number of investigations where it is believed that the tax returns will be of particular assistance to the SEC's staff, the right of access to such returns and related information is most important to the SEC's law enforcement activities.

In this context, the SEC is of the opinion that its current practices afford individual taxpayers adequate protection against an unwarranted acquisition of income tax information and safeguard the retention of otherwise confidential information derived from such returns.

The SEC investigates and refers for criminal prosecution classic white collar crimes. In these financial crimes, tax return information can be crucial. Because of our related interests, the SEC has developed a close working relationship with the IRS. The assistance that we provide to each other is perhaps best illustrated by the fact that our request to the IRS for tax information often leads that agency to independently conclude that it should open a tax investigation of the subject. As we move into the investigation of cases involving domestic and foreign bribery and pay-offs, this assistance will become increasingly more im

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