THE FINANCIAL INSTRUMENTS

ANTI-FRAUD ACT-S. 1009

WEDNESDAY, JULY 17, 1996

U.S. SENATE,

COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS,

Washington, DC.

The Committee met at 10:10 a.m., in room SD-538 of the Dirksen Senate Office Building, Senator Alfonse M. D'Amato (Chairman of the Committee) presiding.

OPENING STATEMENT OF SENATOR ALFONSE M. D'AMATO The CHAIRMAN. The Committee will come to order.

The Committee meets today to examine the use of fictitious financial instruments by criminal organizations and anti-government groups.

Over the past several years, innovative criminals have exploited a loophole in the Federal anti-counterfeiting laws. These laws do not specifically criminalize the production or passing of a phony check, bond, or security if the check, bond, or security is not a copy of an actual financial instrument. Criminals are now making and passing completely fictitious financial instruments. These instruments may involve, for example, a bank, an asset, or a security that does not even exist. We have several examples of these instruments here today. Let's look at example number one. We have it posted up top there. It says, "U.S. Dollar Bond."

Senator Bond, U.S. Dollar Bond. He is the real thing. [Laughter.]

Senator BOND. I am not a loophole. [Laughter.]

The CHAIRMAN. He is not a loophole. [Laughter.]

Take a look at this, though. Not long ago, a criminal attempted to pass this U.S. dollar bond with a face value of $5 million. Federal prosecutors declined to take the case because this note is not technically a counterfeit instrument. It is not a copy of an existing instrument. Fortunately, the fraud was detected before anyone took a loss. Some of these phony instruments are for enormous sums of money.

Let's look at example number two. This is a "Georgian Imex International Bank Letter of Credit" with a face value of $500 million. There is no Georgian Imex International Bank, and that's what makes this something that cannot be prosecuted. They will create a bank. They will create a phony, a fictitious payee.

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Example number three is the "Gold Dore' Delivery Certificate," supposedly worth $250 million, or 40,000 tons of gold. This instrument also does not exist.

All of these instruments are complete frauds, but you would never know it by looking at them. They are technically not counterfeits because they are not copies of actual instruments.

Under existing Federal and State laws, in order to prosecute a criminal who produces or passes a completely fictitious instrument, the criminal must use the wires or mails or deposit the instrument in the bank. These laws simply do not prohibit the making and passing of these fictitious financial instruments.

Clearly, Congress must act to close this loophole. The International Chamber of Commerce estimates that frauds involving fictitious financial instruments cost investors around the world $10 million on a daily basis-$10 million a day. To date, investors and Government agencies, including The Salvation Army, the National Council of Churches, and the Chicago Housing Authority, have lost more than $1.5 billion in these scams. The Office of the Comptroller of the Currency reports that in the first 6 months of 1996, con artists have tried to pass more than $3 billion in fictitious instruments in the United States.

Anti-government groups use these fictitious financial instruments to commit economic terrorism against Government agencies, private businesses, and individuals. Prior to their 81-day siege, the Montana Freemen passed fictitious instruments called "Comptroller Warrants." The Freemen used these instruments to stockpile food, water, gasoline, and even vehicles.

This past April, a California woman, Elizabeth Broderick, was arrested for mail fraud and conspiracy for passing Comptroller Warrants to banks, automobile dealers, bail-bondsmen, and even the IRS. Ms. Broderick, who calls herself the "lien queen," has held seminars in how to produce and pass these phony instruments. She charges her "students" $125 each. Federal authorities monitored the lien queen's activities for several years and they were finally able to arrest her only after she slipped and used the mails to send some of her phony checks. Fictitious instruments are an important source of funds for some of these groups. The lien queen attempted to pass more than $124 million in phony checks.

LeRoy Schweitzer, one of the founders of the Montana Freemen, successfully passed more than $85 million in phony notes and netted a profit of $670,000.

Armed anti-government groups such as the Montana Freemen use fictitious instruments to undermine the banking and monetary system of the United States. These groups believe that the Federal Government has declared war on its citizens and that Federal institutions such as the Federal Reserve must be destroyed.

Under existing law, the Secret Service and the FBI can act only if the fraudsters use the mails or wires or if the fictitious financial instrument is deposited in a bank. I have cosponsored legislation, along with Senators Bryan, Lieberman, Grassley, and Johnston, to close this loophole. That is S. 1009, which will give Federal agents the tools necessary to prevent millions of dollars in losses to banks and to innocent individuals.

Under S. 1009, criminals found guilty of trafficking in fictitious financial instruments would face up to 25 years in prison. This Banking Committee has included this legislation in S. 650, the regulatory relief package now pending before the Full Senate.

I am not sure that we are ever really going to get that bill to the Floor. And if not, I intend to move this legislation by way of amending a bill that does come through so that we can give to our citizens the protection that they are entitled to.

The Banking Committee has worked closely with the Treasury Department and with our Secret Service, in order to develop this legislative package. Federal law enforcement officials need this weapon to combat this new brand of financial fraud and to protect our financial institutions.

I look forward to hearing from the witnesses today.
Senator Bond.

OPENING STATEMENT OF SENATOR CHRISTOPHER S. BOND Senator BOND. Thank you very much, Mr. Chairman. I thank our distinguished panel for appearing before us today on this important issue.

I commend you and the other sponsors of this measure and I am delighted that we have a range of securities and legal experts here and hope to benefit from their collective wisdom.

Mr. Chairman, as you have noted, S. 1009 attacks the narrow but growing sector of securities fraud, the production, sale, and trafficking of fictitious financial instruments. And these instruments, as you have already demonstrated, might be called such seemingly innocent and legitimate names as prime bank notes, prime bank guarantees, Japanese yen bonds, and United States Treasury warrants. They all sound legitimate. The reality, however, as you have indicated, is much different. The sale and manufacture of these fictitious financial instruments has resulted in hundreds of millions of dollars of losses of innocent investors, some of whom are represented here today.

Mr. Chairman, S. 1009 closes the loophole that permits the sale and the manufacturing of fraudulent financial instruments and protects the investment of innocent citizens, charities, and corporations. I share your concern and I ask that I be included as a cosponsor of S. 1009. I applaud your efforts to address this situation in a timely fashion. I look forward to working with you to move this legislation through Congress.

The CHAIRMAN. Well, thank you, Senator. I certainly appreciate your cosponsorship of this legislation.

Our first panel consists of a number of people who represent organizations that have had, I think, the unfortunate experience of running into the problems that we have talked about as a result of the use of some of these instruments. We have: the Reverend Albert Pennybacker, Associate General Secretary of the National Council of Churches; Don Bell, Major of The Salvation Army; and Richard Furr, Executive Vice President and Chief Operating Officer of the Central Carolina Bank.

Reverend Pennybacker.

OPENING STATEMENT OF REV. ALBERT M. PENNYBACKER ASSOCIATE GENERAL SECRETARY

NATIONAL COUNCIL OF CHURCHES OF CHRIST IN THE U.S.A.

Rev. PENNYBACKER. Well, thank you, Mr. Chairman.

My name is Albert Pennybacker. I am an Associate General Secretary of the National Council of Churches. I wish to express to you my gratitude, Mr. Chairman, for the opportunity to testify before this Committee.

The CHAIRMAN. Thank you. You may proceed.

Rev. PENNYBACKER. The National Council of Churches of Christ in the U.S.A. (NCCC) is the principal ecumenical organization in the United States through which 33 Protestant, Orthodox, and Anglican church bodies with a combined membership of 51 million Christians make a common witness to their faith and work together to service the churches and the world.

I wish to make three principal points in my remarks, based on the experience of the NCCC with investment fraud.

First, given the tremendous need for capital in the Third World, and the rapidly developing countries of the former Soviet Union, and given the corruption and lack of sophistication of those involved in these financial markets, there is ample opportunity and drive for financial fraud.

Second, in the experience of the NCCC, those who are involved in the marketing of foreign fraudulent financial instruments are not prosecuted criminally.

Third, those who peddle these fictitious or fraudulent instruments often use legitimate U.S. financial institutions to give legitimacy to the scam.

As background, in late 1993, the NCCC was defrauded of $8 million as part of a scheme to market tens of millions of dollars in "Prime Bank Guarantees" issued by a bank in Prague, Czech Republic. Staff unauthorized to make such investments became caught in an intricately woven web. Thankfully, the NCCC has recovered $5 million of the loss to date and has instituted legal action to recover the balance.

As soon as the NCCC discovered that it was holding fraudulent instruments, it notified the SEC, the Federal Reserve, and the Czech Central Bank. As a result of prompt action by all who were brought in to assist, particularly then-Ambassador Basorda and his economic officer, Mr. Russell Trowbridge, who were very helpful to us, the Czech bank involved in the scheme was investigated and subsequently has been closed down. Bank officials who were involved in the fraud were removed from office and criminally charged. At least one of them is still a fugitive.

The point of lack of prosecution. The fraud involving the NCCC involved individuals in the United Kingdom, Germany, and the United States. In most instances, they seemed to be part of a group that specialized in this type of activity. Many had been involved in prior scams and were known to authorities.

The center of operation appears to have been in the United Kingdom. It appeared to have direct contact in a continuing way with the Prague bankers. There was no criminal prosecution of the principals in the United Kingdom, although one of them has been prosecuted on another scam.

In the United States, all of those involved were identified and interviewed by the SEC and/or the FBI. While there were civil consent judgments that were entered with certain of the individuals, there were no criminal prosecutions. Each of the main participants pleaded ignorance of the fraud.

Those who prey on unsuspecting investors using such scams should be criminally prosecuted. In this case, any extensive pursuit of those who have engaged in these actions now rests on the civil action instituted by the NCCC. At least one of the individuals said in an interview with the Bloomberg News Service that he was going to bring these "financial instruments" to all of Eastern Europe.

The second point deals with the need for capital. There are a multiple of institutions throughout the world that are susceptible to seemingly legitimate offers to raise capital in the West. In our case, there were secret payments that were apparently made to officials of the bank. However, there would also appear to be many well-meaning bank officials who are desperate for additional capital and therefore, are vulnerable to these kind of schemes.

Law enforcement mechanisms for dealing with white-collar crime are woefully deficient in the former Soviet-bloc countries and for this reason, there does not appear to be much fear of prosecution. Developing U.S. law to deal with the intrusion of such fraudulent instruments into our country needs to take overseas banking deficiencies into account.

Third is the use of legitimate institutions. One of the reasons this scam proceeded was that the institutions involved did not raise a red flag and refused to deal with anyone dealing in prime bank guarantees. For example, the fraudulent instruments involved were for a time listed by Bloomberg. United States financial institutions have to be more vigilant to ensure they do not harbor or assist in any way, knowingly or unknowingly, those who are attempting to deal in fraudulent or fictitious instruments.

These con artists operate by opening accounts in legitimate banks. They send confirmations of money transfers from one account to another. The point is that legal accountability may be needed to encourage evaluation of these instruments and reporting as to their appropriateness and quality.

Schemes conceived overseas may not be subject to U.S.A. laws at origin; but they require U.S.A. financial houses for effective operation here. When I consider the anguish of the NCCC in this event and the negative fall-out, I want to confirm the urgency of addressing this important issue. Religious and other nonprofit institutions, when victimized by such fraud, suffer in ways that reach far beyond monetary loss.

The NCCC commends the Committee and its Chairman for its pursuit of these criminal activities in whatever context they occur. Thank you.

The CHAIRMAN. Thank you very much, Reverend.

Major Bell.