Securities Law Prof Blog

Cox Ends CSE Program; SEC's Inspector General Criticizes SEC Oversight of Bear Stearns

On Sept. 26 SEC Chair Cox announced that the Consolidated Supervised Entities (CSE) program, created in 2004 as a way for global investment bank conglomerates that lack a supervisor under law to voluntarily submit to regulation, was ending.  This is not surprising since the 5 major investment firms that were not regulated by the Federal Reserve are now defunct (Bear Stearns, Lehman) or are now coming under Federal Reserve regulation (Merrill Lynch, Goldman Sachs, Morgan Stanley).  Chair Cox also admitted that SEC's oversight of these firms failed.  While it would be hard to deny that fact in the face of two reports by the SEC's Office of Inspector General that identify the SEC failings in the context of the Bear Stearns collapse, it is somewhat refreshing to hear a government official candidly admit failure.  Cox blames the failure on the voluntary nature of the program, stating: 

The last six months have made it abundantly clear that voluntary regulation does not work. When Congress passed the Gramm-Leach-Bliley Act, it created a significant regulatory gap by failing to give to the SEC or any agency the authority to regulate large investment bank holding companies, like Goldman Sachs, Morgan Stanley, Merrill Lynch, Lehman Brothers, and Bear Stearns.

Because of the lack of explicit statutory authority for the Commission to require these investment bank holding companies to report their capital, maintain liquidity, or submit to leverage requirements, the Commission in 2004 created a voluntary program, the Consolidated Supervised Entities program, in an effort to fill this regulatory gap.

As I have reported to the Congress multiple times in recent months, the CSE program was fundamentally flawed from the beginning, because investment banks could opt in or out of supervision voluntarily. The fact that investment bank holding companies could withdraw from this voluntary supervision at their discretion diminished the perceived mandate of the CSE program, and weakened its effectiveness.

While it is true that the CSE program was "voluntary" because it was not mandated by U.S. law, nevertheless, the 5 investment banks needed the CSE program so that, for purposes of EU regulation, they would be regulated by U.S. regulator (the SEC only has statutory authority over the broker-dealer entities).  Thus, Chair Cox's assertion that the firms could opt out of the CSE program at any time, thus undermining the agency's effectiveness, strikes me as a bit too facile an explanation.

It is worth taking a look at the two reports of the SEC's Office of Inspector General.  One, entitled SEC Oversight of Bear Stearns and Related Entities: The Consolidated Supervised Entity Program, looked at the CSE Program with the emphasis on the agency's oversight of Bear Stearns.  The report's findings are blunt.  Finding it "indisputable that the CSE program failed to carry out its mission in the oversight of Bear Stearns," it noted "serious deficiencies" in the program and "significant questions" about the adequacy of the CSE Program requirements.  In addition, it found that the SEC's Division of Trading and Markets (TM) became aware of "numerous potential red flags" prior to Bear Stearns' collapse, including (among other things) "its concentration of mortgage securities, high leverage, [and] shortcomings of risk management in mortgage-backed securities," but took no action.

The second report, entitled SEC's Oversight of Bear Stearns and Related Entities: Broker-Dealer  Risk Assessment Program, follows up on OIG's 2002 report of the SEC's Risk Assessment Program and to determine whether improvements were needed.  In particular, the report focuses on Section 17(h) of the Exchange Act and temporary rules 17h-1T and 17h-2T that require broker dealers that are part of a holding company structure with at least $20 million in capital to file with the SEC disaggregated, non-public information on the broker-dealer, the holding company, and other entities within the holding company.  One of the significant recommendations of the 2002 report was to update and finalize these two temporary rules, which still have not been accomplished.  As a result, "several aspects of these rules are not effective mainly because they do not require firms to file pertinent information with the Commission and many filings are not reviewed by TM staff."  In addition, only 20 of the 146 firms filing 17(h) were filing electronically; the rest filed paper documents.  (This during the watch of the technology-loving SEC Chair?)  The Report concludes:

TM's failure to carry out the purpose and goals of the Broker-Dealer Risk Assessment program hinders the Commission's ability to foresee or respond to weaknesses in the financial markets.  This may impact TM's ability to protect customers from financial or other problems experienced by broker-dealers.

Former Biopure Executive Indicted for Lying to SEC

On September 24, 2008, Howard Richman, the former head of regulatory affairs of Biopure Corporation, was indicted by a grand jury convened by the United States Attorney for the District of Massachusetts for lying and obstructing justice in an SEC action against him.  According to the Indictment, from October 26, 2006 through July 17, 2007, Richman represented to a federal judge that he was terminally ill with colon cancer and could not participate in an ongoing civil case that was brought against him by the SEC.  The Indictment alleges that in reality, Richman did not have cancer. Rather, according to the Indictment, he falsely claimed to be terminally ill in order to avoid discovery in the SEC's case against him and to obtain a favorable settlement. The Indictment alleges that, to perpetuate his lie, Richman provided the Court with false affidavits and fabricated letters from a physician. If convicted, Richman faces up to ten (10) years imprisonment, to be followed by three (3) years of supervised release, and a $250,000 fine.

Previously, in September 2005, the Commission filed an enforcement action against Biopure, Richman and three other executives alleging that beginning in April 2003, Biopure received negative information from the FDA regarding its efforts to obtain FDA approval of its synthetic blood product Hemopure but failed to disclose the information, or falsely described it as positive developments in its filings with the Commission.

After Richman's lie was revealed, the Commission reached a settlement of its case with him and the Court entered a final judgment by consent against Richman on August 6, 2008 permanently enjoining Richman from violating the antifraud and other provisions of the federal securities laws, permanently barring Richman from serving as an officer or director of any public company and ordering him to pay a $150,000 civil penalty.

SEC Charges Pump & Dump Scheme Against Electronics Tech Company

The SEC filed a civil injunctive action against Video Without Boundaries, Inc. (also known as China Logistics Group Inc.) (Video), an electronics and entertainment technology company, its former CEO and Principal Financial and Accounting Officer, Vernon Jeffrey Harrell (Harrell), and Video's largest shareholder, David J. Aubel (Aubel), in connection with accounting fraud related to Video's annual and quarterly filings and the issuance of false and misleading press releases.  The Commission's complaint, filed in the United States District Court for the Southern District of Florida, alleges that from at least April 2003 to November 2005, Video, at the direction of its then sole officer and director, Harrell, filed annual and quarterly reports with the Commission that materially overstated its revenues, improperly accounted for a failed acquisition, and understated its net losses. Harrell maintained Video's books and records, created its financial statements and, as sole principal executive and financial officer, certified Video's annual reports for 2002 and 2003, and quarterly reports for 2002 to 2004, filed with the Commission, that he knew, or was severely reckless in not knowing, contained material misstatements and omissions.

The complaint further alleges that from November 2003 to September 2006, Harrell and Aubel issued a series of false and misleading press releases about Video. Taking advantage of Video's artificially inflated stock price, Aubel dumped millions of shares of Video stock (acquired at a steep discount from Video) into the market, reaping millions of dollars. Harrell participated in the scheme by signing bogus stock issuance resolutions that allowed Aubel to sell the shares immediately after he received them. Moreover, throughout this time, neither Harrell nor Aubel reported their ownership of Video stock, or changes in their ownership.

The Commission's complaint seeks relief in the form of permanent injunctions against Video, Harrell, and Aubel enjoining them from future violations of the provisions charged, an order requiring that Video and Aubel disgorge their ill-gotten gains, with prejudgment interest, and imposing civil penalties against Harrell and Aubel. The Commission also seeks a penny stock bar against Harrell and Aubel and an officer and director bar against Harrell.

In a related settled action, the Commission filed a complaint against Norman Stumacher, CPA, who conducted audits of Video's financial statements for 2002 and 2003.

Bally Technologies Settles Accounting Charges

The SEC settled charges that Bally Technologies, Inc. (Bally) materially misstated its reported revenue in its financial statements for the fiscal year ended June 30, 2003, the first two quarters of fiscal 2004, and the second and third quarters of fiscal 2005.  According to the SEC, some of Bally's misstatements were due to its improper recognition of revenue on a bill and hold basis. In addition, Bally recognized revenue on other transactions that were improper under GAAP where payment was not reasonably assured and the earnings process was not complete. Finally, Bally failed to disclose its recognition of revenue on a bill and hold basis, made a misleading disclosure when it discontinued the bill and hold practice, and made a further misleading disclosure regarding the reason for its restatement. 

Bally consented to the issuance of the Order without admitting or denying any of its findings.

In addition, the SEC filed a civil injunctive action against two former accounting executives of Bally Technologies, Inc., based on the same allegations.  The SEC alleges that Bally's former chief accounting officer and former chief financial officer Steven M. Des Champs and former vice president of finance Martha W. Vlcek fraudulently recognized revenue on bill and hold transactions, made misleading disclosures and omissions regarding revenue recognition, and made materially false statements to the company's outside auditors when they represented the transactions were proper under generally accepted accounting principles. The Commission's complaint seeks permanent injunctions, disgorgement of ill-gotten gains, third tier civil penalties, prejudgment interest, and an officer and director bar against both defendants.

Sirios Capital Management Settles Reg M Charges

The SEC settled charges against Sirios Capital Management, L.P. (Sirios).  According to the SEC, on two occasions on or about Aug. 7, 2003, and on or about March 13, 2006, Sirios willfully violated Rule 105 of Regulation M in connection with short sales made in advance of public offerings by Centene Corporation and Las Vegas Sands Corporation. The Order further finds that Sirios sold short securities within five business days before the pricing of each offering and covered the short sales, in whole or in part, with shares purchased in the offerings, resulting in profits of $198,069.

In view of the foregoing, the Order censures Sirios, requires it to cease and desist from committing or causing any violations and any future violations of Rule 105 of Regulation M, requires Sirios to pay disgorgement of $198,069, plus prejudgment interest of $38,989.69, and to pay a civil penalty of $50,000. Sirios consented to the issuance of the Order without admitting or denying the Commission's findings

Beazer Homes Settles Fraudulent Earnings Management Charges

Atlanta Homebuilder, Beazer Homes USA, Inc., Settled SEC charges For fraudulent earnings management.  According to the SEC, between 2000 and 2007, Beazer fraudulently misstated its net income for the purpose of improperly managing its quarterly and annual earnings. Specifically, the Order finds that between approximately 2000 and 2005, a period of strong growth and financial performance for Beazer, Beazer decreased its reported net income by improperly increasing certain reported operating expenses. This created improper accruals, or reserves, in Beazer's books and records. In certain quarters, the existence of these reserves had the effect of smoothing Beazer's earnings, i.e., allowing Beazer to report earnings that still met or exceeded analysts' expectations for its quarterly net income and earnings per share (EPS) while permitting it to improperly defer a portion of its income to future periods. Beginning in the first quarter of fiscal year 2006, Beazer's financial performance began to decline. In order to continue to meet or exceed analysts' expectations for its quarterly net income and EPS, Beazer began reversing many of its previously created, improper reserves. In certain instances, Beazer also began purposefully not recognizing certain current period expenses. These actions had the effect of reducing Beazer's operating expenses and thereby improperly increasing its net income. Additionally during fiscal 2006 and the first two quarters of fiscal 2007, Beazer, again acting through certain of its officers and employees, improperly recognized income from the sale of approximately 360 model homes to three separate investor pools compiled and sponsored by a third party entity.

In May 2008, as a result of its earnings management and other errors, Beazer restated its financial statements to reflect adjustments for the fiscal years 1998 through 2006, as well as the first and second quarters of fiscal year 2007.

SEC Charges Biotech Start-Up with False Claims About Anti-Aging Treatments

The SEC charged Telomolecular Corp. and two of its former executives for their roles in a stock scheme based on false claims to investors that the biotechnology start-up company was on the verge of financial and scientific success in developing anti-aging treatments and cancer cures. The SEC alleges that Telomolecular and its founder and former CEO, Matthew A. Sarad, induced hundreds of investors nationwide to purchase $6.5 million worth of shares of Telomolecular stock. The SEC also charged Telomolecular's former Director of Investor Relations, Jeremy D. Jobe for his role in the stock sales. The SEC's complaint, filed in federal district court in Sacramento, further alleges that Jobe improperly sold approximately $2.5 million in Telomolecular stock to investors without being registered as a broker. Without admitting or denying the SEC's allegations, Telomolecular, Sarad and Jobe have agreed to settle the SEC's charges

SEC Settles Charges That Illegal Day Trading Operation Targeted Hispanic Community

The SEC filed a civil injunctive action in federal District Court for the Southern District of Florida against Ricardo H. Goldman for fraudulently operating an unregistered securities day trading firm that primarily targeted investors in the Hispanic community. According to the Commission’s complaint, from approximately May 2004 through at least February 2006, Goldman solicited traders to invest approximately $2.1 million in a day trading operation he ran through his company, E Trade Fund LLC (“E Trade”). Goldman provided securities day trading capability to E-Trade Fund’s more than 110 traders and permitted them to day trade securities in E Trade Fund’s own brokerage account at a registered broker-dealer through sub-accounts created for each trader.   The complaint alleges that Goldman held investment seminars in Spanish, which he advertised in Spanish periodicals, to solicit traders for his day trading operation.

Upon filing of the Commission’s complaint, and without admitting or denying the allegations in the complaint, Goldman consented to the entry of a Judgment that permanently enjoins him from violating the above-mentioned provisions of the federal securities laws. The partial settlement with Goldman leaves unresolved the issue disgorgement and a civil penalty.

SEC Announces Roundtable on Disclosure

The SEC will hold a roundtable on October 8 to discuss ways to modernize its disclosure system to give investors more useful and timely information for investment decision-making.  The roundtable is part of the SEC's 21st Century Disclosure Initiative launched by SEC Chairman Christopher Cox in June. The roundtable's discussions will help guide the Commission as it examines how the agency acquires disclosure information from public companies, mutual funds, and other market entities as well as how that information is being made available to investors and the markets.

The roundtable will be organized into two panels. The first panel will explore the data, technology, and processes that companies and other filers use in satisfying their SEC disclosure obligations. It also will consider the data and technology that investors use in making their investment decisions. The second panel will consider how the SEC could better organize and operate its disclosure system so that companies enjoy efficiencies and investors have better access to high-quality information. The Commission will invite investor representatives, company officials, information intermediaries, practitioners, and academics to participate as panelists.

SEC Posts Final Rules on Foreign Issuer Reporting Enhancements

The SEC's final rules on FOREIGN ISSUER REPORTING ENHANCEMENTS are now posted on its website.

SEC Charges 4 with Stock Loan Fraud

On September 24, 2008, the SEC filed a civil injunctive action in the United States District Court for the Southern District of New York charging three individuals and a corporate entity involved in the securities lending, or “stock loan,” business with securities fraud. The Commission’s complaint alleges that from July 2003 through April 2005, the four defendants defrauded two securities brokerage firms out of a total of at least $1.16 million through the payment of sham finder fees and undisclosed kickbacks that ultimately came out of the pockets of the two brokerage firms.  SEC v. Melvyn Nathanson, et al., Civil Action No. 08-8205 (SDNY)

SEC Charges Six in Stock Loan Fraud

On September 24, 2008, the SEC filed a civil injunctive action in the United States District Court for the Eastern District of New York charging four individuals and two corporate entities involved in the securities lending, or “stock loan,” business with securities fraud. The Commission’s complaint alleges that over a period of nearly four years from 2000 through 2004, the six defendants defrauded Schonfeld Securities, LLC (“Schonfeld”), a Long Island, New York, brokerage firm, out of a total of at least $1.66 million through the payment of sham finder fees and undisclosed kickbacks that ultimately came out of Schonfeld’s pocket.  SEC v. Kenneth Suarez, et al., Civil Action No. 08-3900 (EDNY)

SEC's Guidance on Short-Selling

The SEC's Division of Corporation Finance, Division of Investment Management, and Division of Trading and Markets posted on its website Guidance Regarding the Commission's Emergency Order Concerning Disclosure of Short Selling.

SEC Charges Investment Adviser with Failure to Disclose Conflict of Interest

The SEC charged WealthWise LLC and its principal Jeffrey A. Forrest with fraud for failing to disclose a material conflict of interest when recommending that their clients invest in a hedge fund that made undisclosed subprime and other high-risk investments.  According to the SEC, WealthWise and Forrest recommended that more than 60 of their clients invest approximately $40 million in Apex Equity Options Fund, a hedge fund managed by Thompson Consulting, Inc. (TCI). According to the SEC's complaint, WealthWise and Forrest failed to disclose a side agreement in which WealthWise received a portion of the performance fee that Apex paid TCI for all WealthWise assets invested in the hedge fund. From April 2005 to September 2007, WealthWise received more than $350,000 in performance fees from TCI. Apex collapsed in August 2007, and WealthWise clients lost nearly all of the money they invested.

The SEC seeks an injunction, an accounting of the total amount of performance fees WealthWise received from TCI, disgorgement of those fees, and financial penalties.  On March 4, 2008, the SEC filed a civil action in federal district court in Salt Lake City against TCI and three of its principals in connection with the collapse of Apex and another hedge fund.

Court Finds for SEC in Hedge Fund Fraud Case

A federal district court granted the SEC's motion for summary judgment against Michael Lauer, the architect of a massive billion-dollar hedge fund fraud.  The court found that Lauer’s fraud as head of two Connecticut-based companies – Lancer Management Group and Lancer Management Group II – that managed investors’ money and acted as hedge fund advisers was “egregious, pervasive, premeditated and resulted in the loss of hundreds of millions of dollars in investors’ funds."

Lauer raised more than $1.1 billion from investors and his fraudulent actions caused investor losses of approximately $500 million. The SEC initially won emergency temporary restraining orders and asset freezes against Lauer and his companies, which were placed under the control of a Court-appointed receiver after the SEC filed its enforcement action in 2003. During the protracted litigation, the SEC successfully stopped Lauer from diverting or hiding millions of dollars of assets from the Court’s asset freeze.

The judge’s order entered a permanent injunction against Lauer and reserved ruling on the SEC’s claim for disgorgement with prejudgment interest against Lauer, and on the amount of a financial penalty Lauer must pay. The SEC is seeking a financial penalty and disgorgement of the more than $50 million Lauer received in ill-gotten gains from his fraudulent scheme.

Buffett Bails Out Goldman Sachs

Goldman Sachs announced that it has reached an agreement to sell $5 billion of perpetual preferred stock to Berkshire Hathaway, Inc. in a private offering. The preferred stock has a dividend of 10 percent and is callable at any time at a 10 percent premium. In conjunction with this offering, Berkshire Hathaway will also receive warrants to purchase $5 billion of common stock with a strike price of $115 per share, which are exercisable at any time for a five year term. In addition, Goldman Sachs is raising at least $2.5 billion in common equity in a public offering.

Who needs a federal bailout when there's Warren Buffett?

AmSouth Settles Action Alleging Improper Use of Administrative Fees

The SEC issued an enforcement action against AmSouth Bank and AmSouth Asset Management (AmSouth) for defrauding AmSouth mutual funds by secretly using a portion of administrative fees paid by fund shareholders for marketing and other unrelated expenses that should have been paid by AmSouth itself.  The SEC's order finds that AmSouth entered into improper and undisclosed side agreements with BISYS Fund Services (BISYS), the administrator of the AmSouth Funds. BISYS rebated approximately $16 million of its total $49 million administration fee for AmSouth to pay marketing expenses, with the understanding that AmSouth would continue to recommend BISYS as an administrator for the AmSouth Funds to the AmSouth Funds' board of trustees. The SEC's order also finds that money was used to pay expenses entirely unrelated to marketing, including the salary, bonus, benefits, and country club membership of the president of the AmSouth Funds.

AmSouth, now part of Regions Bank, agreed to settle the SEC's enforcement action by paying a total of $11.4 million, which will be placed in a Fair Fund that Regions Bank will distribute to the funds, now managed by the Pioneer Group.  According to the SEC's press release, this is the SEC's first case against a mutual fund adviser that secretly used a portion of the administrative fees paid by the fund's shareholders to pay for marketing expenses that should have been paid out of the adviser's own pocket.

The SEC's order finds that in addition to the side agreements, BISYS and AmSouth agreed that in exchange for AmSouth recommending to the trustees that BISYS provide securities lending services to the AmSouth Funds, BISYS would rebate some of the fees it charged the funds for securities lending back to AmSouth in the guise of consulting fees. Under this consulting agreement, AmSouth purportedly provided general marketing advice to BISYS to market AmSouth's own funds. AmSouth received $1.161 million in total consulting fees. Neither the existence of side and consulting agreements nor the terms of these agreements were disclosed to the AmSouth Funds' independent trustees or to the Funds' shareholders.

AmSouth Bank and AmSouth Asset Management consented to the issuance of the order without admitting or denying any of the findings.

Treasury Secretary Paulson Testifies before Senate Banking Committee

From Treasury Secretary Paulson's Testimony before the Senate Banking Committee on Turmoil in US Credit Markets: Recent Actions regarding Government Sponsored Entities, Investment Banks and other Financial Institutions, Sept. 23, 2008:

Over these past days, it has become clear that there is bipartisan consensus for an urgent legislative solution. We need to build upon this spirit to enact this bill quickly and cleanly, and avoid slowing it down with other provisions that are unrelated or don't have broad support. This troubled asset purchase program on its own is the single most effective thing we can do to help homeowners, the American people and stimulate our economy.

Earlier this year, Congress and the Administration came together quickly and effectively to enact a stimulus package that has helped hard-working Americans and boosted our economy. We acted cooperatively and faster than anyone thought possible. Today we face a much more challenging situation that requires bipartisan discipline and urgency.

When we get through this difficult period, which we will, our next task must be to address the problems in our financial system through a reform program that fixes our outdated financial regulatory structure, and provides strong measures to address other flaws and excesses. I have already put forward my recommendations on this subject. Many of you also have strong views, based on your expertise. We must have that critical debate, but we must get through this period first.

Bernanke's Testimony Before Senate Banking Committee

From Chairman Ben S. Bernanke's Testimony on U.S. financial markets, before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, September 23, 2008;

At this juncture, in light of the fast-moving developments in financial markets, it is essential to deal with the crisis at hand.  Certainly, the shortcomings and weaknesses of our financial markets and regulatory system must be addressed if we are to avoid a repetition of what has transpired in our financial markets over the past year.  However, the development of a comprehensive proposal for reform would require careful and extensive analysis that would be difficult to compress into a short legislative timeframe now available.  Looking forward, the Federal Reserve is committed to working closely with the Congress, the Administration, other federal regulators, and other stakeholders in developing a stronger, more resilient, and better regulated financial system.

Cox Testifies on Need for Regulation before Senate Banking Committee

Chairman Cox testified this morning  on Turmoil in U.S. Credit Markets: Recent Actions Regarding Government Sponsored Entities, Investment Banks and Other Financial Institutions, before the Committee on Banking, Housing, and Urban Affairs, United States Senate.  He addressed, among other things, the SEC's recent actions to ban short-selling in financial securities, enforcment investigations in the subprime and ARS area, and the sale of the assets of the Lehman brokerage unit to Barclays.  As to the SEC's own Consolidated Supervised Entity Program, he stated:

But beyond highlighting the inadequacy of the pre-Bear Stearns CSE program capital and liquidity requirements, the last six months — during which the SEC and the Federal Reserve have worked collaboratively with each of the CSE firms pursuant to our Memorandum of Understanding — have made abundantly clear that voluntary regulation doesn't work. There is simply no provision in the law that authorizes the CSE program, or requires investment bank holding companies to compute capital measures or to maintain liquidity on a consolidated basis, or to submit to SEC requirements regarding leverage. This is a fundamental flaw in the statutory scheme that must be addressed, as I have reported to the Congress on prior occasions.

Because the SEC's direct statutory authority did not extend beyond the registered broker dealer to the rest of the enterprise, the CSE program was purely voluntary — something an investment banking conglomerate could choose to do, or not, as it saw fit. With each of the remaining major investment banks now constituted within a bank holding company, it remains for the Congress to codify or amend as you see fit the Memorandum of Understanding between the SEC and the Federal Reserve, so that functional regulation can work.

The failure of the Gramm-Leach-Bliley Act to give regulatory authority over investment bank holding companies to any agency of government was, based on the experience of the last several months, a costly mistake.

Chair Cox also addressed the need to regulate the credit default swaps (CDS) market:

There is another similar regulatory hole that must be immediately addressed to avoid similar consequences. The $58 trillion notional market in credit default swaps — double the amount outstanding in 2006 — is regulated by no one. Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market. This is an area that our Enforcement Division is focused on using our antifraud authority, even though swaps are not defined as securities, because of concerns that CDS offer outsized incentives to market participants to see an issuer referenced in a CDS default or experience another credit event.

Economically, a CDS buyer is tantamount to a short seller of the bond underlying the CDS. Whereas a person who owns a bond profits when its issuer is in a position to repay the bond, a short seller profits when, among other things, the bond goes into default. Importantly, CDS buyers do not have to own the bond or other debt instrument upon which a CDS contract is based. This means CDS buyers can "naked short" the debt of companies without restriction. This potential for unfettered naked shorting and the lack of regulation in this market are cause for great concern. As the Congress considers fundamental reform of the financial system, I urge you to provide in statute the authority to regulate these products to enhance investor protection and ensure the operation of fair and orderly markets.