S. Hrg. 105±266 FRAUD IN THE MICRO-CAPITAL MARKETS INCLUDING PENNY STOCK FRAUD HEARING BEFORE THE PERMANENT SUBCOMMITTEE ON INVESTIGATIONS OF THE COMMITTEE ON GOVERNMENTAL AFFAIRS UNITED STATES SENATE ONE HUNDRED FIFTH CONGRESS FIRST SESSION SEPTEMBER 22, 1997 Printed for the use of the Committee on Governmental Affairs ( U.S. GOVERNMENT PRINTING OFFICE 44±227 cc WASHINGTON : 1997 For sale by the Superintendent of Documents, Congressional Sales Office U.S. Government Printing Office, Washington, DC 20402 1 VerDate 22-SEP-99 11:58 Sep 28, 1999 Jkt 010199 PO 00000 Frm 00001 Fmt 5011 Sfmt 5011 E:\HEARINGS\44227 txed02 PsN: txed02 COMMITTEE ON GOVERNMENTAL AFFAIRS FRED THOMPSON, Tennessee, Chairman SUSAN M. COLLINS, Maine JOHN GLENN, Ohio SAM BROWNBACK, Kansas CARL LEVIN, Michigan PETE V. DOMENICI, New Mexico JOSEPH I. LIEBERMAN, Connecticut THAD COCHRAN, Mississippi DANIEL K. AKAKA, Hawaii DON NICKLES, Oklahoma RICHARD J. DURBIN, Illinois ARLEN SPECTER, Pennsylvania ROBERT G. TORRICELLI, BOB SMITH, New Hampshire New Jersey ROBERT F. BENNETT, Utah MAX CLELAND, Georgia HANNAH S. SISTARE, Staff Director and Counsel LEONARD WEISS, Minority Staff Director MICHAL SUE PROSSER, Chief Clerk PERMANENT SUBCOMMITTEE ON INVESTIGATIONS SUSAN M. COLLINS, Maine, Chair SAM BROWNBACK, Kansas JOHN GLENN, Ohio PETE V. DOMENICI, New Mexico CARL LEVIN, Michigan THAD COCHRAN, Mississippi JOSEPH I. LIEBERMAN, Connecticut DON NICKLES, Oklahoma DANIEL K. AKAKA, Hawaii ARLEN SPECTER, Pennsylvania RICHARD J. DURBIN, Illinois BOB SMITH, New Hampshire ROBERT G. TORRICELLI, New Jersey ROBERT F. BENNETT, Utah MAX CLELAND, Georgia TIMOTHY J. SHEA, Chief Counsel and Staff Director JEFFREY S. ROBBINS, Chief Counsel to the Minority MARY D. ROBERTSON, Chief Clerk (II) VerDate 22-SEP-99 11:58 Sep 28, 1999 Jkt 010199 PO 00000 Frm 00002 Fmt 5904 Sfmt 5904 E:\HEARINGS\44227 txed02 PsN: txed02 C O N T E N T S Opening statements: Page Senator Collins ................................................................................................. 1 Senator Cleland ................................................................................................ 4 Prepared statement: Senator Collins ................................................................................................. 55 Senator Cleland with additional copy ............................................................. 58 Senator Glenn ................................................................................................... 107 WITNESSES MONDAY, SEPTEMBER 22, 1997 Arthur Levitt, Jr., Chairman, U.S. Securities and Exchange Commission ........ 9 Emile O. Murnan, St. Louis, Missouri ................................................................... 21 Helen Sprecher, Philadelphia, Pennsylvania; accompanied by Henry Ian Pass. Esq. ........................................................................................................................ 23 Louis Poggi, Pembroke, New Hampshire .............................................................. 27 Joseph P. Borg, Director, Alabama Securities Commission, and Member, North American Securities Administrators Association, Inc. (NASAA) .......... 39 Barry R. Goldsmith, Executive Vice President, NASD Regulation, Inc. ............. 43 ALPHABETICAL LIST OF WITNESSES Borg, Joseph P.: Testimony .......................................................................................................... 39 Prepared Statement with attachments ........................................................... 158 Goldsmith, Barry R.: Testimony .......................................................................................................... 43 Prepared Statement ......................................................................................... 252 Levitt, Arthur, Jr.: Testimony .......................................................................................................... 9 Prepared Statement ......................................................................................... 112 Murnan, Emile O.: Testimony .......................................................................................................... 21 Prepared Statement ......................................................................................... 145 Poggi, Louis: Testimony .......................................................................................................... 27 Prepared Statement ......................................................................................... 154 Sprecher, Helen: Testimony .......................................................................................................... 23 Prepared Statement ......................................................................................... 147 APPENDIX EXHIBIT LIST * May Be Found In The Files of the Subcommittee Page 1. Cold Calling Alert, a brochure prepared by the North American Securities Administrator Association, Inc. (NASAA) and the Securities and Ex- change Commission (SEC) ............................................................................... 269 2. Memorandum prepared by Ian Simmons, Counsel, Permanent Sub- committee on Investigations, dated September 17, 1997, to Permanent Subcommittee on Investigations' Membership Liaisons regarding micro- cap fraud hearing .............................................................................................. 279 (III) VerDate 22-SEP-99 11:58 Sep 28, 1999 Jkt 010199 PO 00000 Frm 00003 Fmt 5904 Sfmt 5904 E:\HEARINGS\44227 txed02 PsN: txed02 IV Page 3. GAO Report, Penny Stocks: Regulatory Actions to Reduce Potential for Fraud and Abuse, February 1993, GAO/GGD±93±59 .................................... * 4. GAO Report, Securities Markets: Actions Needed to Better Protect Inves- tors Against Unscrupulous Brokers, September 1994, GAO/GGD±93±208 .. 297 5. Wall Street Journal, September 4, 1997, ``Despite Reforms, Penny-Stock Fraud Is Roaring Back'' .................................................................................... 345 6. Materials and news articles submitted to the Permanent Subcommittee on Investigations by the North American Securities Administrator Asso- ciation, Inc. (NASAA) regarding May 1997 State enforcement actions to address the problem of fraudulent sales practices in the micro-cap marketplace 347 7. Wall Street Journal, November 19, 1997, ``Departure of Many Lawyers at SEC Stretches Its Resources, Delays Cases'' ............................................. * 8. Bond Buyer, November 10, 1997, ``Merrill Official Calls for Securities Firms To Take Tough Stand on Compliance'' ................................................ * 9. New York Times, October 30, 1997, ``S.E.C. Schedules A Meeting As Small-Stock Fraud Soars'' ................................................................................ * 10. Wall Street Journal, September 26, 1997, ``Bear Stearns Takes Stand on Clearing-Firm Says Regulation Could Hurt Industry'' and additional news articles regarding Bear Stearns ............................................................. * 11. Wall Street Journal, September 22, 1997, ``SEC Plan Assault on Small- Stock Fraud'' and additional news articles on Permanent Subcommittee on Investigations' September 22, 1997 hearing ............................................. * 12. Barrons, September 15, 1997, and Kiplinger's Personal Finance Magazine, July 1996, regarding the CRD System ........................................................... 422 13. Wall Street Journal, September 8, 1997, ``Big Board Tightens Clearing- Firm Rules'' ....................................................................................................... * 14. Wall Street Journal, June 2, 1997, ``Securities Regulators Cracking Down On Sales Fraud at Brokerage Firms'' ............................................................. * 15. Correspondence to Chairman Susan M. Collins, Permanent Subcommittee on Investigations, September 24, 1997, from Barry R. Goldsmith, Execu- tive Vice President, NASD-Regulation, Inc., forwarding supplemental ma- terials for the hearing record regarding NASD-R's public disclosure pro- gram and NASD's strengthening of examination requirements for reg- istered representatives. (Supplemental materials not reprintedÐmay be found in the files of the Subcommittee) .......................................................... 430 16. Supplemental Questions and Answers for the Record of The Honorable Arthur Levitt, Jr., Chairman, U.S. Securities and Exchange Commission . 432 17. Supplemental Questions and Answers for the Record of Joseph Borg, Director, Alabama Securities Commission, and Member, North American Securities Administrator Association, Inc. (NASAA) ..................................... 466 18. Supplemental Questions and Answers for the Record of Barry R. Gold- smith, Executive Vice President, NASD Regulation, Inc. (Attachments to supplemental questions not reprintedÐmay be found in the files of the Subcommittee) ............................................................................................ 475 19. Wall Street Journal, December 9, 1997, ``Nasdaq, in Newest Clean-Up Plan, Might Remove 3,400 OTC Stocks'' and Baltimore Sun, December 10, 1997, ``Nasdaq looks to pull 3,400 small stocks'' ...................................... 553 VerDate 22-SEP-99 11:58 Sep 28, 1999 Jkt 010199 PO 00000 Frm 00004 Fmt 5904 Sfmt 5904 E:\HEARINGS\44227 txed02 PsN: txed02 FRAUD IN THE MICRO-CAPITAL MARKETS, INCLUDING PENNY STOCK FRAUD MONDAY, SEPTEMBER 22, 1997 U.S. SENATE, PERMANENT