Mr. SIMON. And the other is the retail level of fraud-people in Southern California walking into their bank to do one thing and walking out with something entirely different.

Mr. DINGELL. A bait-and-switch operation.

Mr. SIMON. Bait-and-switch. Those people really were subject to two frauds at the same time. They didn't know it, but they were buying a security of a company which had false financial statements but they also were subject to what we have all been talking about the whole morning, which is the bait-and-switch.

Mr. DINGELL. Now the savings and loan was not subject to SEC regulation.

Mr. SIMON. The savings and loan was not but of course the holding company was. Remember that American Continental, a holding company which owned Lincoln and owned a series of other companies, was the actual seller of these subordinate debentures.

Mr. DINGELL. The SEC however had no authority to get in to observe the practices that were going on inside the premises of the SEC, did it or rather inside the premises of the savings and loan? Mr. SIMON. I don't know if they had the authority but they certainly didn't do it. The SEC does not as a matter of practice. It's probably a better question for the SEC people, but I have never understood the SEC as a matter of practice to go around and check up on how people sell securities. It has never come across my desk in 192 years of practicing law that the SEC does testing or checking or spot checking of how securities are sold. That is a matter left to other people.

Mr. DINGELL. Now I think we might view this with some surprise, and if you want to give me your comments, please, any of the members of the panel-what would you say if you learned that neither the FDIC, who provides the insurance, nor the Office of the Comptroller of the Currency, which allows these transactions within banks, use plainclothes testers to go into the bank to determine what is actually being said to the potential customers?

That flows sort of along with what you were telling us just 1 Or 2 seconds ago, Mr. Simon.

Mr. SIMON. I don't think any of them think it is their job. With all due respect, I think they would tell you that that is

Mr. DINGELL. The SEC's job?

Mr. SIMON [continuing]. Is somebody else's problem. I'm not sure who they would point to but I don't think either the FDIC or Office of the Comptroller would think that was within their role again of protecting the institution rather than the investors.

Remember, these people were treated-the problem here is that these people were treated like investors. They are not the bank. They are not the bank's officers. They are not the bank's depositors.

The day that they got bait-and-switched they became something different. They became investors in the bank

Mr. DINGELL. So they fell into a category about which the bank regulators thought very little.

Mr. SIMON. That's right and which normally the SEC would think the most. If you analogize it, you most closely analogize it to assume you had a reputable bank or savings and loan in Bethesda, Maryland and they had a holding company which sold stock on the

New York Stock Exchange and you could buy shares of the stock through Merrill Lynch. You might buy 100 shares of stock in the Bethesda National Corporation or something knowing it was a bank holding company or a savings and loan holding company and that would be subject to all of the regulations of the SEC and the Merrill Lynch salesperson who sold those shares to you would be subject to all of the regulations that the NASD, would have to be trained, licensed, supervised-you name it.

What Lincoln did

Mr. DINGELL. That doesn't change where it's done inside the bank or it's done inside the saving and loan.

Mr. SIMON. It shouldn't change but I think it did change here. I think because it was done inside the savings and loan they were allowed to do it without the appropriate personnel and without the appropriate oversight.

am not an expert on NASD regulation of brokers but I believe they essentially got around the rules on broker-dealers here by selling them with their own employees and that is really one of the areas of protection that we lost here.

We didn't have a registered NASD representative selling these securities.

Mr. DINGELL. So you are saying an NASD-regulated dealer.
Mr. SIMON. Right.

Mr. DINGELL. Now Ms. Hill, you have been nodding yes. Do you have a comment?

Ms. HILL. Anecdotally I wanted to share with you what we learned about what was happening at Lincoln.

To protect themselves against rumored testers you had mentioned blind testers coming in to the branches to try to see what the salespeople were stating.

Ray Fidel has told us that there would be rumors that the Department of Corporations would send testers in to the bank to make sure that they were not misleading investors and a notice would be sent to every bond representative to be on good behavior. Attached to Mr. Zipperstein's testimony is a tombstone that appeared right at the teller window for a bank customer to look at regarding an ACC bond. Those would be removed from the branches when there was a rumored tester about to visit. I simply thought the chairman might be interested in the fact that the testers, whether they appeared or not, did not really deter in this case the kind of behavior we have been talking about.

Mr. SCHAEFER. These are company testers you are telling me about?

Ms. HILL. The president of the bank believed that the California Department of Corporations testers would be entering the bank, posing as customers, Lincoln customers, interested in purchasing an American Continental Corporation bond.

To fool the testers they would remove all of the information that was near the teller windows used to lure customers to purchase the ACC bonds. They would essentially clean up their act for a few days and then as soon as they believed the tester had left they would lapse back into the same practices.

Mr. SCHAEFER. Were these testers actually employees of American Continental of Lincoln? Who were they?

Ms. HILL. They were regulators.

Mr. SIMON. They were State of California regulators. So once again the State was involved.

Mr. SCHAEFER. The State was involved.

Mr. SIMON. The State was involved.

Mr. SCHAEFER. But how did these people know ahead of time they were coming?

Ms. HILL. It was rumors. They simply would be preparing-there would essentially be a bulletin shot in the branch saying, "You may be tested." They would, therefore, clean up their act.

Mr. SCHAEFER. There wasn't any indication there was any collusion between the State and the

Ms. HILL. No, the State would suspect nothing.

Mr. SCHAEFER. Thank you, Mr. Chairman.

Mr. DINGELL. But at that point all the FDIC logos were moved to a more appropriate place?

Ms. HILL. Well, the tombstones were removed that were near the teller windows that shouldn't have been there. It was cleaned up. Mr. HODGMAN. If I may, Mr. Chairman, just to augment Ms. Hill's anecdote, this is an example of where marketing in the lobbies of the banks or the saving and loans can allow those who operate the banks or savings and loan who are marketing various types of securities to circumvent the testers because one of the central precepts of the marketing program was to get to know your customers.

They knew who their customers were because they were the Lincoln depositors. So in this instance, most of the people, the bond representatives who were selling the bonds, knew who their customer base was. They knew them by sight. They knew them because they had been tellers at the branch.

Furthermore, I seem to recall from some of Mr. Fidel's interviews that when it was removed that the testers would be coming by, the cry went out, "Beware of the suits" because the testers would come in wearing suits and not disguised as normal customers.

Mr. DINGELL. Now, we have talked a little bit about the folks who were dealt with by the savings and loans because there was a desk in the lobby of the bank. But there is nothing to prevent the bankers from saying:

"Now, you don't have to deal with us in the lobby. Just come on down the hall. We have a special little office that is going to give you this wonderful good deal of 1 or 2 percentage points better than you can get in our regular CD by just buying this particular wonderful subordinated debenture"; isn't that right?

Mr. HODGMAN. That is correct, sir.

Mr. DINGELL. You get the same effect because they go in there and they see the same friendly face that they have been dealing with on the other side of the tellers' cage?

Mr. HODGMAN. And as in the case of the ACC/Lincoln, the separate satellite bond office-and I would have to say the orbit of the satellite was never far from the bank itself-the lobby of the satellite bond office would be in an identical decor as with the bank. Mr. DINGELL. Would it have FDIC logos up, too?

Mr. HODGMAN. No, sir.
Mr. DINGELL. They did?

Mr. HODGMAN. No, sir; they did not.
Mr. DINGELL. They did not.

I'm sorry. Ms. Hill?

Ms. HILL. Mr. Chairman, with regard to moving the sale of the bonds from the branches, that did occur in the Lincoln case in December of 1988. The physical location of the bond sale desk was moved outside the branches.

Initially there was cross selling permitted, that is, allowing Lincoln employees to pump the bonds to Lincoln customers, to direct them to the office down the hall, or around the corner, cross the street, or wherever. That was stopped in the fall of 1988.

As a result of that, it appears that the bond sales dropped dramatically. Once there was no more cross-selling permitted, and once the bond sales were outside the Lincoln branches, the number of purchases by Lincoln customers dropped dramatically.

You should note, however, that during that time Lincoln also showed its first loss, ever. So that may also have deterred customers. But there was a significant drop. That is when Keating instructed his bank president, "Can't we cheat a little?" meaning, "Can't we cross-sell more bonds? Have the Lincoln tellers pump the bonds to our Lincoln customers."

Mr. DINGELL. So they had them pumped from behind the tellers' cage; or what?

Ms. HILL. From anywhere in the branch, essentially, they would be pumping the bonds.

Mr. DINGELL. So business went down, or at least the bond sales went down when they made the real separation?

Ms. HILL. That's correct.

Mr. DINGELL. Then Mr. Keating applied a remedial measure which was to encourage people to pump the bonds, which they did at all places in the bank's facilities?

Ms. HILL. Well, eventually the cross-selling was stopped as well. The bank president believed on the advice of counsel that that should not occur. So, once that happened, there was no more crossselling. The sale of bonds dropped very, very precipitously.

Then Keating's response to that was to fly all the bond representatives from Southern California to Phoenix, Arizona, have them stay or visit the hotels owned by the parent corporation, and encourage them, as Mr. Hodgman has said, to sell more bonds.

"Sell, sell, sell" was the theme of that meeting. There were two separate meetings in late 1988 for that purpose to try to pump up the sales people to sell more bonds since the sales had been moved outside the branches.

Mr. DINGELL. Now, Mr. Zipperstein, do you agree that the most important element of the transaction is not what is hanging on the wall, or what is in the prospectus, but what is being told to the potential customers in the conversation with this sales person?

Mr. ZIPPERSTEIN. Certainly that was our experience in the Lincoln case; yes, Mr. Chairman.

Mr. DINGELL. That appears to be also the view of Mr. Simon, Mr. Hodgman, and Ms. Hill?

Mr. HODGMAN. Absolutely, so, sir.

Ms. HILL. Yes, sir.

Mr. SIMON. And especially so if the person doing the selling is known to and trusted by the person doing the buying.

Mr. DINGELL. Are you concerned, ladies and gentlemen of the panel, that the Federal regulators currently do not use testers? That certainly brought about a period of momentary good behavior on the part of Lincoln when they thought the testers were coming by?

Mr. HODGMAN. Well, yes, sir. I share that fear and concern. Viewing the Mellon-Dreyfus transaction, I would state this, that I think the regulations that apply in that type of situation have to be front-loaded in a sense, that this body as well as others have to have the strictest possible regulations in place beforehand in order that the consumer, the little guy, does not get harmed.

I would think those regulations would have to include, based upon the lessons of the Keating/ACC/Lincoln tragedy, first of all, a physical separation of the marketing office from the lobbies of the bank, and second, very strict guidelines regarding verbal representations made with regard to the security or whatever it is that is being sold.

With regard to the testers, that is something that obviously has some deterrent effect. Whether we have enough of it to prevent the type of fraud that we have seen here; I don't know, sir.

Mr. DINGELL. Now, Mr. Simon, did your clients tell you that it was the representatives made during the sales pitches and not the information in the prospectus or other written information that gave them their basic understanding of the transaction?

Mr. SIMON. Yes, sir.

Mr. DINGELL. Mr. Hodgman, tell us what you think has gone wrong here? How do we protect consumers if the art of the deal is in the conversation between the salesman and the potential customer?

Mr. HODGMAN. Mr. Chairman, as I have stated, the paper is not sufficient to protect the people. The prospectus is simply not enough. Even in the Keating example where on the face of the prospectus it was stated that these securities were not insured, the bond purchaser never had a clear understanding of that.

More often than not, the bond purchaser who testified at trial, or who was interviewed would state that they did not rely upon the prospectus, they relied upon what they were told. That is why I would assert to you and to the subcommittee that you have to have the strongest possible guidelines and regulations in place up front before any type of merger of a Mellon or a Dreyfus or anything else that may come on down the road be approved.

Mr. DINGELL. Now, what are you thoughts on that, Ms. Hill, Mr. Zipperstein, and Mr. Simon?

Mr. ZIPPERSTEIN. Mr. Chairman, as Federal prosecutors in a U.S. Attorney's office, we are somewhat reluctant to suggest policy or legislation.

We want the community of businessmen/would-be Keatings who come into our District, the largest Federal district in the country in terms of population, to know that if they break the laws that this Congress passes, that we will prosecute them and we will put them in jail.