Report of the Task Force on Regulation of Insider Trading Part I: Regulation Under the Antifraud Provisions of the Securities Exchange Act of 1934
Committee on Federal Regulation of Securities, 41(1): 223–72 (Nov. 1985)
This is Part I of a comprehensive Report prepared by the Task Force on Regulation of Insider Trading. The chairman of the Committee on Federal Regulation of Securities appointed the task force early in 1984 and charged it with surveying existing federal statutory regulation of insider trading under the Exchange Act and the rules promulgated under the Act. This part of the task force's Report examines the regulation under the antifraud provisions of sections 10 and 14 (e) of the Exchange Act. Part II, to be published later, will examine the reporting and short-swing profits recovery provisions of section 16 of the Act.
Financial Statement Fraud: The Boundaries of Liability Under the Federal Securities Laws
Richard C. Sauer, 57(3): 955 (May 2002)
Accurate information about public companies is fundamental to the operation of our capital markets. The recent spate of major accounting scandals, however, reminds us that the reported performance of public companies can be highly vulnerable to manipulation. The result is the squandering of billions in investor funds and the erosion of faith in the securities markets. This Article describes common approaches employed to misrepresent the operating results of public companies. Taking examples from recent SEC enforcement actions, it discusses a range of earnings management techniques and analyzes their status under present standards of legal liability, with particular emphasis on those areas of financial reporting in which standards are unclear or evolving.
Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms
Henry T. C. Hu and Bernard Black, 61(3):1011–1070 (May 2006)
Most American publicly held corporations have a one-share, one-vote structure, in which voting power is proportional to economic ownership. This structure gives shareholders economic incentives to exercise their voting power well and helps to legitimate managers' exercise of authority over property the managers do not own. Berle-Means' "separation of ownership and control" suggests that shareholders face large collective action problems in overseeing managers. Even so, mechanisms rooted in the shareholder vote, including proxy fights and takeover bids, constrain managers from straying too far from the goal of shareholder wealth maximization.
In the past few years, the derivatives revolution, hedge fund growth, and other capital market developments have come to threaten this familiar pattern throughout the world. Both outside investors and corporate insiders can now readily decouple economic ownership of shares from voting rights to those shares. This decoupling—which we call "the new vote buying"—is often hidden from public view and is largely untouched by current law and regulation. Hedge funds, sophisticated and largely unfettered by legal rules or conflicts of interest, have been especially aggressive in decoupling. Sometimes they hold more votes than economic ownership, a pattern we call "empty voting." That is, they may have substantial voting power while having limited, zero, or even negative economic ownership. In the extreme situation of negative economic ownership, the empty voter has an incentive to vote in ways that reduce the company's share price. Sometimes hedge funds hold more economic ownership than votes, though often with "morphable" voting rights—the de facto ability to acquire the votes if needed. We call this "hidden (morphable) ownership" because under current disclosure rules, the economic ownership and (de facto) voting ownership are often not disclosed. Corporate insiders, too, can use new vote buying techniques.
This article analyzes the new vote buying and its corporate governance implications. We propose a taxonomy of the new vote buying that unpacks its functional elements. We discuss the implications of decoupling for control contests and other forms of shareholder oversight, and the circumstances in which decoupling could be beneficial or harmful to corporate governance. We also propose a near-term disclosure-based response and sketch longer-term regulatory possibilities. Our disclosure proposal would simplify and partially integrate five existing, inconsistent share-ownership disclosure regimes, and is worth considering independent of its value with respect to decoupling. In the longer term, other responses may be needed; we briefly discuss possible strategies focused on voting rights, voting architecture, and supply and demand forces in the markets on which the new vote buying relies.
Cross–Border Tender Offers and Other Business Combination Transactions and the U.S. Federal Securities Laws: An Overview
Jeffrey W. Rubin, John M. Basnage, and William J. Curtin, III, 61(3):1071—1134 (May 2006)
In structuring cross–border tender offers and other business combination transactions, parties must consider carefully the potential application of U.S. federal securities laws and regulations to their transaction. By understanding the extent to which a proposed transaction will be subject to the provisions of U.S. federal securities laws and regulations, parties may be able to structure their transaction in a manner that avoids the imposition of unanticipated or burdensome disclosure and procedural requirements and also may be able to minimize potential conflicts between U.S. laws and regulations and foreign legal or market requirements. This article provides a broad overview of U.S. federal securities laws and regulations applicable to cross–border tender offers and other business combination transactions, including a detailed discussion of Regulations 14D and 14E under the Securities Exchange Act and the principal accommodations afforded to foreign private issuers thereunder.
Independent Directors as Securities Monitors
Hillary A. Sale, 61(4):1375-1412 (August 2006)
This paper considers the role of independent directors of public companies as securities monitors. Rather than engaging in the debate about whether independent directors are good or bad, important or unimportant, the paper takes their existence and basic governance role as a given, focusing instead on what recent statements from Securities and Exchange Commission officials indicating an increased focus on independent directors and their role in preventing securities fraud. The paper notes that the SEC believes that independent directors are on the board to act, at least in part, as securities monitors. This securities monitor role is another aspect of the information-forcing-substance disclosure model that the SEC has used to achieve improved corporate governance. Although directors face heightened risk when they draft or sign disclosure documents, they also have an ongoing responsibility to be informed of developments within the company, ensure good processes for accurate disclosures, and make reasonable efforts to assure that disclosures are adequate. Independent directors with expertise should be involved in reviewing and, sometimes, drafting statements. All directors, however, should be fully aware of the company's press releases, public statements, and communications with security holders and sufficiently engaged and active to question and correct inadequate disclosures. In addition to defining the role of independent directors as securities monitors, the article reviews the liability independent directors might face under private causes of action and contrasts it with the SEC's enforcement powers and remedies. The article describes some of the SEC's prior statements that emphasize the role of independent directors as securities monitors and the importance of their providing both guidance and check and balance.
Internal Investigations and the Defense of Corporations in the Sarbanes-Oxley Era
Robert S. Bennett, Alan Kriegel, Carl S. Rauh, and Charles F. Walker, 62(1): 55–88 (Nov. 2006)
Internal investigations long have been an integral part of the successful defense of corporations against charges of misconduct, as well as an important board and management tool for assessing questionable practices. With the heightened standards of conduct and increased exposure created by Sarbanes-Oxley, this essential instrument for safeguarding corporate interests has become even more crucial in identifying and managing risk in the enforcement arena. This article examines from a practitioner's standpoint when and how internal investigations should be conducted in order to protect the corporation in criminal, civil and administrative proceedings. Particular attention is paid to the issues created by a concurrent government investigation and in dealing with employees and former employees in the course of an investigation. The article also addresses the role of the Audit Committee under Sarbanes-Oxley, and the important issue of reporting the findings of the investigation to appropriate corporate officials. The subject of self-reporting by the Company to enforcement authorities is considered as well. In this context, the article explores the SEC's position on crediting self-reporting and cooperation as set forth in the Seaboard report; Department of Justice policy as embodied in the Thompson Memorandum; and the impact of the Federal Sentencing Guidelines for Organizations.
As False Claim Penalties Mount, Defendants Scramble for Answers Qui Tam Liability, 31 U.S.C. § 3729 et seq. Tipton F. McCubbins and Tara I. Fitzgerald, 62(1): 103–134 (November 2006)
Claims against those who defraud the Federal Government particularly in the health care industry are on the rise. Whistleblowers are using the False Claims Act to reap windfall benefits by filing suit on behalf of both themselves and the government against the wrongdoers. Payouts in such cases frequently exceed $1 million, fueling an explosion in the number of whistleblower suits. This article discusses a number of issues critical to the question of recovery under the False Claims Act. Among these are determining which parties have standing to bring suit and conversely which potential defendants are immune from suit. Also discussed are the elements that a false claim must possess in order to be actionable, how the number of false claims an individual defendant has filed should be counted, and when the civil penalties associated with the cumulative number of claims becomes an unconstitutionally excessive fine. Finally, the potential jurisdictional bar to a plaintiff's suit is considered with special emphasis given to the application of the "original source" element of that bar.
Applying Stoneridge to Restrict Secondary Actor Liability Under Rule 10b-5
Todd G. Cosenza, 64(1): 59-78 (November 2008)
Although the U.S. Supreme Court's decision in Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., was widely viewed as a sweeping rebuke of the application of "scheme" liability to secondary actors, the Court's decision also raised some questions regarding the precise scope of secondary actor liability under section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. There is an obvious tension between the Court's holding that the secondary actors in Stoneridge could not be held liable because their "deceptive acts, which were not disclosed to the investing public, [were] too remote to satisfy the element of reliance" and its pronouncement that "[c]onduct itself can be deceptive" and could therefore satisfy a Rule 10b-5 claim. In particular, the question of what type of conduct satisfies the element of reliance in a claim against a secondary actor who assists in the drafting of a company's public disclosures remains open to interpretation.
This Article first discusses the general standards of section 10(b) liability and the Supreme Court's decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A. The next part of the Article compares the judicial standards of secondary actor liability under Rule 10b-5(b)—the bright line, substantial participation, and creator standards—that emerged in the post- Central Bank era. It then discusses Stoneridge and the Court's recent rejection of secondary actor "scheme" liability under Rule 10b-5(a) and (c). Finally, it reviews recent applications of Stoneridge and analyzes the implications of these decisions going forward.
Negative Assurance in Securities Offerings (2008 Revision)
Report of the Subcommittee on Securities Law Opinions, Committee on Federal Regulation of Securities, ABA Section of Business Law, 64(2): 395-410 (February 2009)
Disclosure Obligations Under the Federal Securities Laws in Government Investigations
David M. Stuart and David A. Wilson, 64(4): 973-998 (August 2009)
With the prevalence of government investigations into corporate conduct, public companies frequently face decisions about whether, when, how, and where to disclose to investors the existence of such investigations and the facts learned in the course of, or as a result of, those investigations. While the federal securities laws (and the rules and regulations promulgated thereunder) require disclosure of specific events that may arise during an investigation, neither those laws nor the courts that have interpreted them provide clear guidance for many of the disclosure decisions that must be made over the course of an investigation. As a result, counsel must carefully analyze numerous facts and circumstances, understand the company's previous disclosures, make "materiality" assessments, and determine whether to make disclosure in a current report or wait until the next periodic filing. This Article seeks to present, through an analysis of precedent disclosures, caselaw, rules, and practical ramifications, the considerations counsel must take into account in evaluating disclosure decisions in the context of an investigation. These considerations can help counsel avoid having a disclosure decision worsen the already difficult circumstances posed by the investigation itself.
Reforming the Regulation of Broker-Dealers and Investment Advisers
Arthur B. Laby, 65(2): 395–440 (February 2010)
A key component of financial regulatory reform is harmonizing the law governing broker-dealers and investment advisers. Historically, brokers charged commissions and were regulated under the Securities Exchange Act of 1934. Advisers charged asset-based fees and were subject to the Investment Advisers Act of 1940, which contains a special exclusion for brokers. In recent years, brokers have changed their compensation structure and many now market themselves as advisers, raising questions about whether they should be treated as such. The Obama Administration's 2009 white paper on regulatory reform and draft legislation call for a fiduciary duty to be imposed on brokers that provide advice. This Article explores the debate over regulating brokers and advisers, and makes four key claims. First, changes in brokers' compensation and marketing methods vitiate application of the broker-dealer exclusion and should subject brokers to the Advisers Act. Second, changes in the nature of brokerage, spurred by changes in technology, make the broker-dealer exclusion unsustainable and Congress should repeal it. The third claim is that imposing fiduciary duties on brokers is incompatible with their historical roles as dealers and underwriters. To resolve this tension, this Article suggests a compromise that enhances brokers' duties but does not hobble their ability to perform their traditional functions. Finally, regulating brokers as advisers would overburden the U.S. Securities and Exchange Commission. This Article offers alternatives to alleviate the strain.
The SEC and the Financial Industry: Evidence from Enforcement Against Broker-Dealers
Stavros Gadinis, 67(3): 679 - 728 (May 2012)
The Securities and Exchange Commission plays a central part in the U.S. regulatory framework for the supervision of the financial industry. How has the SEC carried out this mission? Despite recurrent crises, systematic studies of SEC performance data are surprisingly scarce. As the SEC reforms itself to address the shortcomings revealed in 2007–2008, a systematic examination of the agency’s past record can help identify priorities and evaluate the agency’s renewed efforts. This study takes a first step in studying empirically SEC enforcement against investment banks and brokerage houses, examining the agency’s record in the period right before the 2007–2008 crisis. This data suggests that defendants associated with big firms fared better in SEC enforcement actions as compared to defendants associated with smaller firms in three important dimensions. First, SEC actions against big firms were more likely to involve corporate liability exclusively, with no individuals subject to any regulatory action. Second, big-firm defendants were more likely to end up in administrative rather than court proceedings, controlling for types of violation and levels of harm to investors. Third, within administrative proceedings, big-firm employees were likely to receive lower sanctions, notably temporary or permanent bars from the industry. These patterns have important implications for major debates concerning corporate liability, regulatory capture, and the public and private enforcement of securities laws.
From Regulation to Prosecution to Cooperation: Trends in Corporate White Collar Crime Enforcement and the Evolving Role of the White Collar Criminal Defense Attorney
Robert S. Bennett, Hilary Holt LoCicero, and Brooks M. Hanner; 68(2): 411-438 (February 2013)
This article traces the steady growth of criminal law into fields that had previously been addressed by civil statutes, particularly in relation to the concept of corporate criminal liability. The article also describes the means through which the federal government has encouraged cooperation between corporations that are being investigated and their investigators. This fundamental shift in how corporate misconduct is treated by the federal government has reframed the role of a criminal defense attorney who defends corporations and executives. Any lawyer facing such a task must be willing to incorporate new strategies into daily practice while also evaluating the theoretical considerations governing what it means to “bet the company.”
SEC Enforcement Actions and Issuer Litigation in the Context of a "Short Attack"
Charles F. Walker and Colin D. Forbes; 68(3): 687-738 (July 2013)
Issuers faced with a short attack—short selling of the issuer’s stock combined with the spread of negative rumors—may contemplate defensive strategies such as litigation and contacting government regulators, in addition to the investor and public relations efforts that are typically utilized in the wake of negative media coverage. Precedent calls for caution in these circumstances, as the record shows that the results of such strategies are mixed, with the SEC often turning its investigative focus to the issuer, and with costly litigation frequently resulting in compromise. This article begins with a discussion of the recent history of regulatory and legislative efforts to address concerns around short attacks and “naked” short selling. It then turns to a discussion of the SEC enforcement cases and private litigation relating to short attacks, and concludes that the SEC has appropriately brought enforcement cases only in clear-cut instances of fraud, while policing the margins through enforcement of the technical requirements of Regulation SHO. The article shows that the SEC enforcement record in this area, and the proof issues generally attendant to these cases, present important considerations for issuers who perceive themselves under siege in a short attack.
Damages and Reliance Under Section 10(b) of the Exchange Act
Joseph A. Grundfest; 69(2): 307-392 (February 2014)
A textualist interpretation of the implied private right of action under section 10(b) of the Exchange Act concludes that the right to recover money damages in an aftermarket fraud can be no broader than the express right of recovery under section 18(a) of the Exchange Act. The Act’s original legislative history and recent Supreme Court doctrine are consistent with this conclusion, as is the Act’s subsequent legislative history. Section 18(a), however, requires that plaintiffs affirmatively demonstrate actual “eyeball or eardrum” reliance as a precondition to recovery and does not permit a rebuttable presumption of reliance. Accordingly, if the Exchange Act is to be interpreted as a “harmonious whole,” with the scope of recovery under the implied section 10(b) private right being no greater than the recovery available under the most analogous express remedy, section 18(a), then section 10(b) plaintiffs must either demonstrate actual reliance as a precondition to recovery of damages, or the U.S. Supreme Court should revisit Basic, as suggested by four Justices in Amgen, and overturn Basic’s rebuttable presumption of reliance. A textualist approach thus provides a rationale for either distinguishing or reversing Basic that avoids the complex debate over the validity of the efficient market hypothesis, an academic dispute that the Court is not optimally situated to referee.
A Call for the SEC to Adopt More Safe Harbors that Limit the Reach of Rule 10b-5
Allan Horwich; 74(1) 53-90 (Winter 2018/2019)
The SEC has often adopted regulations that describe conduct that is deemed not to violate the law or that effectively exclude specified conduct from the scope of particular provisions of the securities laws, such as the prohibition on deception imposed by SEC Rule 10b-5. This article examines the nature of and rationales for the provisions that have narrowed the reach of that rule, and proposes that this approach be applied more broadly, further reducing the exposure of issuers of securities and other persons to claims under Rule 10b-5 without impairing the SEC’s enforcement of the securities laws. This will reduce uncertainty regarding the scope of Rule 10b-5, including in the arena of private damage claims, directing the focus to misrepresentations and half-truths. Several specific proposals are made here. The intention is to focus attention on the utility of the safe harbor approach in today’s litigation landscape and generate discussion that might lead to broader application of this concept.
The Myth of Morrison: Securities Fraud Litigation Against Foreign Issuers
Robert Bartlett, Matthew D. Cain, Jill E. Fisch, and Steven Davidoff Solomon; 74(4) 967-1014 (Fall 2019)
Using a sample of 388 securities fraud lawsuits filed between 2002 and 2017 against foreign issuers, we examine the effect of the Supreme Court’s decision in Morrison v. National Australia Bank Ltd. We find that the description of Morrison as a steamroller, substantially ending litigation against foreign issuers, is a myth. Instead, we find that Morrison did not significantly change the type of litigation brought against foreign issuers, which, both before and after this case, focused on foreign issuers with a U.S. listing and substantial U.S. trading volume. Although dismissal rates rose post- Morrison, we find no evidence that this was related to the decision. Settlement amounts and attorneys’ fees remained unchanged post-Morrison. We use these findings to theorize that Morrison was primarily a preemptive decision about standing that firmly delineated the exposure of foreign issuers to U.S. liability in response to the Vivendi case, which sought to expand the scope of liability for foreign issuers whose shares traded primarily in non-U.S. venues. When Morrison is placed in its true context, it is justified as a decision in line with administrative and court actions that have historically aligned firms’ U.S. liability to be proportional to their U.S. presence. Although Morrison had this defining effect, it did not change the litigation environment for foreign issuers, which was the oft-cited import of the decision. More generally, our analysis of Morrison also underscores how the decision has been mistakenly characterized as a case primarily about extraterritoriality rather than standing.
State Section 11 Litigation in the Post-Cyan Environment (Despite Sciabacucchi)
Michael Klausner, Jason Hegland, Carin LeVine, and Jessica Shin; 75(2): 1769-1790 (Spring 2020)
In Cyan, Inc. v. Beaver County Employees Retirement Fund, the U.S. Supreme Court held that the Securities Litigation Uniform Standards Act of 1998 (“SLUSA”) preserved state courts’ jurisdiction to adjudicate cases brought under the Securities Act of 1933, with defendants having no right to remove a case to federal court. The result of this decision has been a dramatic increase in section 11 cases litigated in state court, often with a parallel case brought in federal court against the same defendants based on the same alleged misstatements.
Loss Causation and the Materialization of Risk Doctrine in Securities Fraud Class Actions
Richard A. Booth; 75(2): 1791-1814 (Spring 2020)
In the context of a claim for securities fraud under SEC Rule 10b-5, most federal circuit courts have ruled or recognized that loss causation can be proven by an event that demonstrates an earlier statement by a defendant company to be false. In other words, corrective disclosure need not take the form of speech. Rather, a statement can be shown to be false by the materialization of a risk that was concealed by the company, and investors can be compensated for any losses they suffer as a result. Although this doctrine is well established, its ultimate effect is to overcompensate investors, thus encouraging excessive securities litigation and chilling voluntary disclosure.
The Evolution and 2020 Status of Cooperation in SEC Enforcement Investigations
Dixie L. Johnson, Carmen J. Lawrence, and Jamie Stinson 75(4): 2427-2466 (Fall 2020)
When facing potential enforcement action from the Securities and Exchange Commission (“SEC”), companies often seek to mitigate the consequences by cooperating with the SEC in one or more of the following ways: self-policing, self-reporting, remediation, and cooperation. While a 2001 SEC report of investigation known as the Seaboard Report provides a roadmap for what steps to take in order to earn cooperation credit and describes generally the potential benefits to be received, no such report or guidance exists that details exactly what tangible benefits a company will receive in return for the earned credit and how it will be determined. In addition, outside of narrow exceptions where the SEC engages in self-reporting initiatives, companies looking for publicly available guidance on how best to cooperate face a lack of consistency in the SEC’s settlement documentation describing cooperation factors and what benefits may be earned.