SEC Enforcement Proceedings Under Section 15(c)(4) of the Securities Exchange Act of 1934
William R. McLucas and Laurie Romanowich, 41(1): 145–74 (Nov. 1985)
The SEC has administrative powers under section 15(c)(4) of the Exchange Act to enforce certain reporting provisions of the Act. In a 1984 amendment to the statute, the SEC's enforcement authority under section 15(c)(4) was broadened to include violations of section 14 of the Exchange Act, which now brings proxy and tender offer violations within the reach of the agency's administrative enforcement powers. Further, the amendment expressly empowers the agency to pursue administrative remedies against individuals who were "a cause of" violations of certain provisions of the Act. This Article analyzes the SEC's past use of this administrative enforcement power, as well as several issues the agency has confronted in connection with these proceedings, and explores some of the questions that may arise as a result of the recent expansion of the scope of section 15(c)(4).
Collateral Estoppel Implications of SEC Adjudications
Edmund H. Kerr and Robert J. Stillman, 42(2): 441–86 (Feb. 1987)
The Supreme Court held in Parklane Hosiery Co. v. Shore , 439 U.S. 322 (1979), that issues decided in an SEC district court enforcement action could be used offensively and be given preclusive (collateral estoppel) effect against the defendant in a later private action for damages under the securities laws. In University of Tennessee v. Elliot , 478 U.S. 788 (1986), the Court recently gave ringing endorsement to the issue preclusive effect of administrative adjudications. These decisions suggest that findings made by the SEC in an administrative proceeding will bind the respondent when the respondent is later sued for damages for securities fraud. This Article analyzes that possibility and adduces federal case law and theory that might confound the case for preclusion.
Report of the ABA's Section of Business Law Task Force on SEC Section 15(c)(4) Proceedings
Task Force on Section 15(c)(4) Proceedings, 46(1): 253–95 (Nov. 1990)
In its Report on SEC section 15(c)(4) proceedings, the Task Force provides an overview of section 15(c)(4)'s legislative history and operation to date; describes various procedural aspects of a section 15(c)(4) proceeding and the collateral consequences of a section 15(c)(4) order; discusses the elements predicate to the issuance of a section 15(c)(4) order; examines the SEC's power to order relief beyond the correction of the particular filing or condition that gave rise to the section 15(c)(4) proceeding; and examines the SEC's power to institute a section 15(c)(4) proceeding when such a correction has already been effected or in the face of other indications of mootness.
SEC Enforcement: A Look at the Current Program and Some Thoughts About the 1990s
William R. McLucas, Stephen M. DeTore, and Arian Colachis, 46(3): 797–848 (May 1991)
Senior members of the staff of the SEC's Division of Enforcement discuss both new and continuing trends and priorities in the SEC's enforcement program, particularly in light of the additional remedies and sanctions provided by the Securities Enforcement Remedies and Penny Stock Reform Act of 1990. Specific topics discussed include: insider trading, false disclosure and financial fraud by public companies, market manipulation and penny stock fraud, violations by securities professionals, securities offerings cases, and violations related to changes in corporate control. Along with this review of specific topics, the Article discusses the issue of "criminalization" of federal securities law enforcement and the topic of naming attorneys in enforcement proceedings.
Report of the Task Force on SEC Settlements
Committee on Federal Regulation of Securities, 47(3): 1083–1212 (May 1992)
In this new era of aggressive enforcement of the federal securities laws, the SEC has stated that "the duration and complexity of settlement negotiations will increase greatly as the Commission seeks to impose new and stronger remedies." This Report, which is issued at the culmination of a study spanning a period of over three years, describes the remedies currently available to the SEC in enforcement cases and then outlines a variety of settlement-related issues, recommending adjustments to increase the likelihood of a fair and efficient settlement process.
Regulatory Expectations Regarding the Conduct of Attorneys in the Enforcement of the Federal Securities Laws: Recent Developments and Lessons for the Future
James R. Doty, 48(4): 1543–66 (Aug. 1993)
Recent administrative proceedings by federal regulatory agencies against attorneys and law firms have rekindled debate over the extent to which lawyers are themselves the proper subject of administrative investigation and prosecution. The securities bar has for more than a decade engaged in a sustained colloquy, among themselves and federal regulators, regarding the circumstances under which a lawyer's advisory activities may invoke the administrative process. The author, formerly General Counsel of the SEC, addresses the implications of recent SEC administrative proceedings for the law, attorney liability, and the standards that would guide the SEC in the evolving era.
A Tale of Two Instruments: Insider Trading in Non-Equity Securities
Harvey L. Pitt and Karl A. Groskaufmanis, 49(1): 187–258 (Nov. 1993)
The prosecution of insider trading has been a centerpiece of the SEC's regulation of equity markets. Extending this regulation outside the equity markets has confronted a quandary: courts have linked insider trading violations to a breach of a fiduciary duty— a duty notably absent between issuers and investors in the options and debt markets. The SEC, however, has relied on the malleability of its enforcement tools to extend its enforcement efforts to options trading and, more recently, to trading of corporate and municipal debt securities.
The Role of Financial Economics in Securities Fraud Cases: Applications at the Securities and Exchange Commission
Mark L. Mitchell and Jeffry M. Netter, 49(2): 545–90 (Feb. 1994)
This Article illustrates how financial economics has been and can be (event study) developed by academic financial economists, relates this event study methodology to the relevant areas of securities fraud law, and shows its application in SEC enforcement actions to establish materiality and calculate disgorgement.
The Appeal of Rind: Limitations of Actions in Securities and Exchange Commission Civil Enforcement Actions
Christopher R. Dollase, 49(4): 1793–1821 (Aug. 1994)
The Supreme Court denied certiorari in SEC v. Rind , 991 F.2d 1486 (9th Cir.), cert. denied, 510 U.S. 963 (1993), leaving standing the Ninth Circuit's holding that the SEC was not bound by any limitations period in an enforcement action for disgorgement. Some commentators have challenged the Ninth Circuit's holding, mostly on policy grounds. The author reviews the Rind decision within the context of the legislative history of the securities laws, the nature of SEC civil enforcement actions, and the case law on the limitations period for federal agencies. The author concludes that the SEC should be bound by a limitations period but that only Congress can impose such a period after balancing the conflicting rights of litigants.
Misappropriation Theory Liability Awaits a Clear Signal
Jay G. Merwin, Jr., 51(3): 803–23 (May 1996)
In United States v. Bryan, 58 F.3d 933 (4th Cir. 1995), the Fourth Circuit broke ranks with its sister circuits by rejecting the misappropriation theory of securities fraud liability under rule 10b-5 of the Exchange Act. After more than fifteen years of applying the misappropriation theory in civil and criminal enforcement actions, courts have yet to define with precision and predictability the range of relationships that can be breached to produce the predicate fraud for securities fraud liability under the theory. The split among the circuits calls for resolution by the Supreme Court. ( Editor's note: See United States v. O'Hagan, 521 U.S. 642 (1997)).
Common Sense, Flexibility and Enforcement of the Federal Securities Laws
William R. McLucas, Mark B. Lewis, and Alma M. Angotti, 51(4): 1221–39 (Aug. 1996)
This Article discusses the SEC's flexible application of broad legal principles to implement several important enforcement initiatives to most efficiently and effectively react to significant changes in the securities markets and the securities industry.
Compliance Inspections and Examinations by the Securities and Exchange Commission
Lori A. Richards and John H. Walsh, 52(1): 119–58 (Nov. 1996)
This Article discusses the SEC's inspection program, including its compliance mission, its organization and operations, features of an examination that may be of interest to registrants and practitioners, some issues faced by the program, and some of its recent initiatives.
SEC Enforcement and the Internet: Meeting the Challenge of the Next Millennium; A Program for the Eagle and the Internet
Joseph J. Cella III and John Reed Stark, 52(3): 815–49 (May 1997)
The information revolution orchestrated by the Internet has created fantastic opportunities in the areas of securities, investments, and commerce, bringing about a remarkable boom for investors. Investors can now communicate with almost every conceivable market participant and find libraries of information about companies—all at little cost, with little effort, and from the comfort of their own living rooms. Unfortunately, a small minority of Internet users are attempting to ruin it for the rest, using this extraordinary and exciting futuristic medium to commit securities fraud and steal from investors. This Article (i) provides an introduction to the Internet and its many uses for investors; (ii) analyzes the Internet as it relates to the federal securities laws; and (iii) discusses the SEC Division of Enforcement's Internet program to combat the use of the Internet to commit securities fraud. The Internet program, implemented during the past year, needs no new laws, rules, or regulations and has emerged as one of the most successful programs to date amongst federal, state, and local law enforcement agencies.
EnforceNet Redux: A Retrospective of the SEC's Internet Program Four Years After Its Genesis
John Reed Stark, 57(1): 105 (Nov. 2001)
In May of 1997, in this publication, the genesis of the SEC Internet Enforcement Program was synthesized and elaborated upon in an article entitled "SEC Enforcement and the Internet: Meeting the Challenge of the Next Millennium. A Program for the Eagle and the Internet." Back then, Internet Enforcement strategies remained the subject of intense debate, and "Enforcenet" was, for the most part, just a theory. Now, more than four years later, the same author revisits the SEC's Internet Program, this time using a litany of empirical evidence from which to draw conclusions. In this Article, the author: (i) provides some general background on the Internet and how it has transformed (and empowered) today's investment community; (ii) analyzes the history of Internet-related securities fraud, tracing its evolution to date; (iii) explains the SEC's significant and expansive efforts to combat securities related Internet fraud; and (iv) offers some conclusions about the overall efficacy of the SEC's Internet program. Given its now hefty track record of close to 300 Internet related enforcement actions charging close to 950 entities and individuals, the SEC's enforcement efforts appear to have succeeded even better than expected, keeping Internet users safe from online con artists-all while actually enhancing or even bolstering (rather than, as some theorized four years ago, constricting or even hindering) the rapidly growing flow of legitimate Internet commerce.
SEC Debarment of Officers and Directors After Sarbanes-Oxley
Jayne W. Barnard, 59(2): 391–419 (Feb. 2004)
The Sarbanes-Oxley Act provides that a securities law violator may be suspended or barred from serving as an officer or director of a public company, provided the violator is found to be "unfit." Suspension and bar orders may be entered by a federal district court at the conclusion of a litigated proceeding. Under Sarbanes-Oxley, a suspension or bar order may now also be issued by the Commission at the conclusion of a cease-and-desist proceeding. In either case, the standard is the same-"unfitness." This Article examines the new suspension and bar regime established under the Act. It suggests some arguments that might be made in opposition to the threat of a suspension or bar order, and also proposes some procedural guidelines to govern suspension and bar cases.
Report of the Task Force on Exchange Act Section 21(a) Written Statements
Committee on Federal Regulation of Securities, ABA Section of Business Law, 59(2): 531–68 (Feb. 2004)
Cautious Evolution or Perennial Irresolution: Stock Market Self-Regulation During the First Seventy Years of the Securities and Exchange Commission
Joel Seligman, 59(4): 1347–87 (Aug. 2004)
One of the most significant concepts in federal securities regulation is that of SEC supervision of industry self-regulation. As developed during the New Deal, securities industry self-regulation was based on two concepts. First, the impracticality of direct SEC regulation of several thousand broker-dealer firms and business corporations subject to SEC jurisdiction and second, a preference for business with its greater practical knowledge of its own affairs to participate in the development and application of SEC rules and reduce the likelihood of unnecessary disruption or inefficiency. Far from being a panacea, industry self-regulation subject to SEC supervision historically has repeatedly been beset by significant dysfunction beginning with the need for a reorganization of the New York Stock Exchange in 1937–1938. The enactment of the Sarbanes-Oxley of 2002 offers a new approach to the self-regulation of public accountants that includes greater separation of the industry from the self-regulator; new funding mechanisms; and a single self-regulator for an entire industry. This article analyzes the extent to which such an approach may be appropriate for stock market self-regulation.
Legal Opinions in SEC Filings
Special Report of the Task Force on Securities Law Opinions, ABA Section of Business Law , 59(4): 1505–12 (Aug. 2004)
Section 7(a) of the Securities Act of 1933 (the "Securities Act") requires a registration statement to contain the information specified in Schedule A to the Act. Paragraph 29 of Schedule A requires the filing of "a copy of the opinion or opinions of counsel in respect to the legality of the issue." The Securities and Exchange Commission (SEC) has addressed that requirement in Item 601 of Regulation S-K. Under paragraph (b)(5) of Item 601, a registration statement must include as an exhibit "[a]n opinion of counsel as to the legality of the securities being registered, indicating whether they will, when sold, be legally issued, fully paid and non- assessable, and, if debt securities, whether they will be binding obligations of the registrant." The opinion on legality appears as Exhibit 5 to a registration statement and is thus often referred to as an "Exhibit 5 opinion." This Report examines Exhibit 5 opinions.
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.
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.
The Erosion of the Materiality Standard in the Enforcement of the Federal Securities Laws
Richard C. Sauer, 62(2):317-358 ( 2007)
The disclosure requirements at the heart of the federal securities involve a delicate and complex balancing act. Too little information provides an inadequate basis for investment decisions; too much can muddle and diffuse disclosure and thereby lessen its usefulness. The legal concept of materiality provides the dividing line between what information companies must disclose-and must disclose correctly-and everything else. Materiality, however, is a highly judgmental standard, often colored by a variety of factual presumptions. Recent years have witnessed an effort by the Securities and Exchange Commission to recast certain such presumptions to make the standard more inclusive. This article examines the practical effects of this development on corporate disclosure obligations and considers how well it squares with judicial pronouncements on the materiality standard.
At the Crossroads: The Intersection of Federal Securities Laws and the Bankruptcy Code
Wendy Walker, Mike Wiles, Alan Maza, and David Eskew, 63(1): 125–146 (November 2007)
This Article examines the ways in which the federal securities laws and the U.S. Bankruptcy Code do—and, at times, do not—work together, with an emphasis on the potential conflict between the Fair Funds Provision of the Sarbanes–Oxley Act of 2002, which permits the U.S. Securities and Exchange Commission to distribute penalties and disgorged funds collected from debtor–corporations to shareholders, and the "absolute priority rule," which prevents distributions to equity holders in Chapter 11 reorganization cases absent payment in full of creditors. Although touched upon in some of the largest bankruptcy cases in recent years, including Enron, WorldCom, and Adelphia, this potential conflict has not been squarely addressed by the courts and presents issues which should be examined by Congress.
Should the SEC Be a Collection Agency for Defrauded Investors?
Barbara Black, 63(2): 317–346 (February 2008)
One of the important functions of the U.S. Securities and Exchange Commission ("the SEC") is enforcing the securities laws and punishing violators. Collecting damages for defrauded investors was not, historically, an important part of the agency's mission; rather, that was the function of private securities fraud class actions. Section 308 (the "Fair Fund provision") of the Sarbanes–Oxley Act of 2002 gives the SEC a more prominent role in compensating investors and allows the agency, in some circumstances, to distribute civil penalties to defrauded investors. The SEC has established Fair Funds in a number of high–profile cases and has taken pride in the large amounts of money it has obtained for investors. Meanwhile, section 308 has become an instrument in the business community's campaign against private securities fraud class actions.
This Article reviews the background of the SEC's disgorgement and penalty powers, the history and language of section 308, and SEC enforcement actions against corporations in financial fraud cases and then looks at the business community's reaction to section 308 and recent SEC enforcement actions. The Article concludes that the SEC's increased emphasis on section 308 could lead to a weakening of its effectiveness as an enforcement agency and further erode support for private securities litigation—an unfortunate outcome for investors.
Disgorgement: Punitive Demands and Remedial Offers
Elaine Buckberg and Frederick C. Dunbar, 63(2): 347–382 (February 2008)
U.S. Securities and Exchange Commission ("SEC") enforcement actions against corporate executives accused of securities fraud have become more visible since the Sarbanes–Oxley of 2002 set new standards to ensure that executives are held individually responsible for corporate fraud. Although long available to the SEC, the disgorgement remedy gained greater prominence because of the Sarbanes–Oxley Act requirement that the chief executive officer and chief financial officer of any company restating its financials due to material non–compliance disgorge incentive or equity–based compensation and profits from sales of stock following the false reporting. The SEC may also seek disgorgement from other executives and of other benefits, including any increment to pension or other retirement plans. Traditionally, class actions were the primary means by which shareholders sued officers and directors for securities claims. But the deterrent value of such lawsuits is arguably compromised because these cases almost always settle—and the employer and its directors' and officers' liability carrier usually fund the full settlement.
Computing accurately the benefits to the executive from the fraud requires an analysis of causation similar to that performed by the U.S. Supreme Court in Dura Pharmaceuticals, Inc. v. Broudo. In the case of an executive benefiting from inflated shares, the approach to measuring the inflation per share at the time of the purchase and sale is the same one as would be used in a shareholder class action. If the wrongdoing included fraudulent accounting leading to higher executive pay, then a similar causation standard applies—namely, how did the defendant's compensation change as a direct result of the fraudulent financials. For some types of accounting violations, such as recognition of revenue in the wrong year, the gains in executive compensation in the year the revenue was recognized are offset, at least to some extent, by the loss in compensation in the year the revenue should have been recognized. The principles of proximate cause and offsetting in disgorgement are grounded in both economics and securities fraud case law.
The Clawback Provision of Sarbanes-Oxley: An Underutilized Incentive to Keep the Corporate House Clean
Rachael E. Schwartz, 64(1): 1-36 (November 2008)
The Sarbanes-Oxley Act of 2002, passed in the wake of corporate scandals involving misstated financial reports, included a provision for certain compensation and profits from the sale of company stock to be "clawed back" from chief executive officers and chief financial officers of companies that are required to restate their financials, due to material non-compliance with any financial reporting requirement of the securities laws as a result of misconduct. Courts have determined that only the Securities and Exchange Commission may sue to enforce this clawback provision. In the six years following passage of the law, there have been Sarbanes-Oxley clawbacks in only a small number of cases, each one an options backdating case involving allegations that the officer affected personally committed fraud. This Article takes the position that the clawback provision has no scienter requirement and its application should not be limited to officers who have personally engaged in misconduct. Rather, the wording of Sarbanes-Oxley, its legislative history, and the policies it serves call for the clawback to be applied to the chief executive officers and chief financial officers of companies that are required to restate their financials due to material non-compliance with any financial reporting requirement of the securities laws as a result of misconduct, regardless of whether those officers actively participated in the wrongdoing, knew of and failed to correct the wrongdoing, or were oblivious to wrongdoing by employees subject to their control. This general rule can be made subject to an exemption for circumstances involving certain misconduct by non-management employees.
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.
Nibbling at the Edges—Regulation of Short Selling: Policing Fails to Deliver and Restoration of an Uptick Rule
Douglas M. Branson, 65(1): 67–94 (November 2009)
For several decades, most commentators' mantra on short selling has been promotion of informational efficiency, which translated into minimal regulation. Individual investors, the U.S. Securities & Exchange Commission ("SEC"), and other groups of observers believe that escalating amounts of short selling, including naked short selling, have been a substantial cause of market volatility, investors' wholesale retreat from the stock markets, and severely declining market indexes and share prices, particularly in financial stocks. This Article reviews recent SEC proposals and enactments, including restoration of an uptick or similar "sales price restriction" rule, or installation of circuit breakers adding restrictions on short selling of stock following a precipitous price decline in the stock, and enactment of formerly temporary regulations requiring market participants (broker-dealers mostly) to close fails to deliver after three days rather than thirteen days. Open fails to deliver often are evidence of naked short selling and stock price manipulation, which the SEC has battled since adoption of Regulation SHO in 2004. The Article concludes that these are Main Street versus Wall Street issues. Damping down market volatility is more important to Main Street traders than is promotion of high degrees of informational efficiency, while for professional traders, hedge funds, and high volume short sellers, informational efficiency is more important. The SEC's objective is not to serve one goal rather than the other but to regulate so as to achieve a balance between the two policy objectives.
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.
Closing Time: You Don’t Have to Go Home, But You Can’t Stay Here
Richard D. Bernstein, James C. Dugan, and Lindsay M. Addison, 67(4): 957 - 976 (August 2012)
In a significant trend, U.S. courts are increasingly rejecting cases involving foreign plaintiffs or foreign conduct. This trend was accelerated by the U.S. Supreme Court’s decision in Morrison v. National Australia Bank Ltd., which established that U.S. securities laws cannot be applied extraterritorially. Lower courts have extended the presumption against extraterritoriality to other federal and state statutes.
General Counsel Buffeted by Compliance Demands and Client Pressures May Face Personal Peril
E. Norman Veasey and Christine T. Di Guglielmo,68(1): 57 - 80 (November 2012)
In the "New Reality" of the world of corporate general counsel, the challenges and tensions thrust upon one holding that office have intensified exponentially. Not only does the general counsel uniquely straddle the world of business and law in giving advice to the management and directors of her client (the corporation) but also she may find herself personally in the crosshairs of regulators, prosecutors, and litigants. So, as the rhetoric and real pressures increase to target the general counsel, she must have and use the skills, balance, independence, and courage to be simultaneously the persuasive counselor for her corporate client while being attuned to the need for self-preservation. The lessons from the past targeting of general counsel and other in-house lawyers are ominous. But the quintessential general counsel, acting as both persuasive counselor and a leader in setting the corporation's ethical tone, will do the right thing and thus be prepared to deal with these challenges and tensions.
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.
Equity Receivers and the In Pari Delicto Defense
Hon. Steven Rhodes and Kathy Bazoian Phelps; 69(3): 699-716 (May 2014)
Federal equity receivers are creations of equity. The in pari delicto doctrine is similarly a defense based in equity. When equity receivers are called upon to administer the assets of a receivership entity for the benefit of defrauded victims, courts sitting in equity must balance the needs of the victims with the rights of the defendants to assert the in pari delicto defense to litigation claims brought by the receiver against them. The competing equities reveal the great discretion that courts can exercise in permitting litigation claims to proceed in the face of the assertion of the in pari delicto defense. Courts, however, must also be mindful of a variety of issues and obstacles in deciding whether to allow the in pari delicto defense.
Fiduciary Society Unleashed: The Road Ahead for the Financial Sector
Edward J. Waitzer and Douglas Sarro, 69(4): 1081-1116 (August 2014)
Informational asymmetries, misaligned incentives and artificially elongated chains of intermediation have created a disconnect between the financial sector and the “real economy” that is detrimental to the public interest. Courts and regulators are increasingly intervening to break the cycle. We argue that fiduciary law offers a conceptual framework both for understanding and responding to this trend, and that the financial sector, rather than waiting for this trend to develop and reacting to new rules in a piecemeal way, should be proactive and try to shape the way in which this trend develops. We describe some elements of what such an approach might look like, and consider how regulators and political institutions can encourage financial institutions to adopt this approach, and in so doing support a broader transition to a more sustainable economy.
Massey Prize for Research in Law, Innovation, and Capital Markets Symposium—Foreword
70(2): 319-320 (Spring 2015)
Financial Innovation and Governance Mechanisms: The Evolution of Decoupling and Transparency
Henry T. C. Hu; 70(2): 347-406 (Spring 2015)
Financial innovation has fundamental implications for the key substantive and information-based mechanisms of corporate governance. “Decoupling” undermines classic understandings of the allocation of voting rights among shareholders (via, e.g., “empty voting”), the control rights of debtholders (via, e.g., “empty crediting” and “hidden interests”/ “hidden non-interests”), and of takeover practices (via, e.g., “morphable ownership” to avoid section 13(d) disclosure and to avoid triggering certain poison pills). Stock-based compensation, the monitoring of managerial performance, the market for corporate control, and other governance mechanisms dependent on a robust informational predicate and market efficiency are undermined by the transparency challenges posed by financial innovation. The basic approach to information that the SEC has always used—the “descriptive mode,” which relies on “intermediary depictions” of objective reality—is manifestly insufficient to capture highly complex objective realities, such as the realities of major banks heavily involved with derivatives. Ironically, the primary governmental response to such transparency challenges—a new system for public disclosure that became effective in 2013, the first since the establishment of the SEC—also creates difficulties. This new parallel public disclosure system, developed by bank regulators and applicable to major financial institutions, is not directed primarily at the familiar transparency ends of investor protection and market efficiency.
As starting points, this Article offers brief overviews of: (1) the analytical framework developed in 2006−2008 for “decoupling” and its calls for reform; and (2) the analytical framework developed in 2012−2014 reconceptualizing “information” in terms of three “modes” and addressing the two parallel disclosure universes.
As to decoupling, the Article proceeds to analyze some key post- 2008 developments (including the status of efforts at reform) and the road ahead. A detailed analysis is offered as to the landmark December 2012 TELUS opinion in the Supreme Court of British Columbia, involving perhaps the most complicated public example of decoupling to date. The Article discusses recent actions on the part of the Delaware judiciary and legislature, the European Union, and bankruptcy courts—and the pressing need for more action by the SEC. At the time the debt decoupling research was introduced, available evidence as to the phenomenon’s significance was limited. This Article helps address that gap.
As to information, the Article begins by outlining the calls for reform associated with the 2012−2014 analytical framework. With revolutionary advances in computer- and web-related technologies, regulators need no longer rely almost exclusively on the descriptive mode rooted in intermediary depictions. Regulators must also begin to systematically deploy the “transfer mode” rooted in “pure information” and the “hybrid mode” rooted in “moderately pure information.” The Article then shows some of the key ways that the new analytical framework can contribute to the SEC’s comprehensive and long-needed new initiative to address “disclosure effectiveness,” including in “depiction-difficult” contexts completely unrelated to financial innovation (e.g., pension disclosures and high technology companies). The Article concludes with a concise version of the analytical framework’s thesis that the new morphology of public information—consisting of two parallel regulatory universes with divergent ends and means—is unsustainable in the long run and involve certain matters that need statutory resolution. However, certain steps involving coordination among the SEC, the Federal Reserve, and others can be taken in the interim.
SEC Administrative Proceedings: Backlash and Reform
Alexander I. Platt, 71(1): 1-52 (Winter 2015/2016)
The Securities and Exchange Commission’s aggressive prosecution of securities violations inside administrative proceedings (APs) has generated backlash. Key stakeholders are now attacking the agency’s enforcement program as illegitimate and a growing number of respondents charged in APs have launched broad constitutional challenges. Though these suits target deeply entrenched features of administrative adjudication, they have already begun to prove successful, and threaten significant transformations to the SEC and beyond.
Historically, the SEC’s enforcement architecture embodied respect for the principle that, holding all else equal, procedures ought to be commensurate with the stakes of the adjudication. After Dodd-Frank, the agency abandoned this principle. The backlash is, at least in part, attributable to and justified by this reversal.
The SEC should have done after Dodd-Frank what it had done after previous expansions of its administrative penalty powers: reestablish the equilibrium between penalties and procedures by revising its rules of practice that govern APs. The SEC’s recently proposed amendments to these rules are too little, too late. A bolder approach is required.
Disclosure Reform—The SEC Is Riding Off in Two Directions at Once
Roberta S. Karmel, 71(3): 731-834 (Summer 2016)
The U.S. Securities and Exchange Commission (“SEC”) is being buffeted by diametrically opposing forces with regard to disclosure policy rulemaking. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 required the SEC to pass rules to compel public companies to make disclosures about conflict minerals, mine safety, and certain payments to foreign governments, all for the purpose of advancing societal goals. Proponents of sustainability metrics have been urging the SEC to adopt standards relating to environmental and other similar matters, and a petition on disclosure of corporate contributions and lobbying expenses by public companies would involve the SEC in another political quagmire. Yet, forces that would deregulate disclosure mandates are also pressuring the SEC, and the JOBS Act of 2012 included some such deregulatory measures. Also, the SEC has embarked on its own initiative for streamlining disclosure obligations. This article discusses these conflicting disclosure initiatives and some of the current academic papers and theories with regard to SEC disclosure policy. I suggest a few possible ways for the SEC to move forward, including scaled and tiered disclosure.
The Post Dodd-Frank Act Evolution of the Private Fund Industry: Comparative Evidence from 2012 and 2015
Wulf A. Kaal, 71(4): 1151-1206 (Fall 2016)
This comparative survey study examines the private fund industry’s reactions and adjustments to a rapidly evolving regulatory framework, three years after the first application of mandatory registration and disclosure rules for private fund advisers under the Dodd-Frank Act. Using two datasets (2012: N = 94; 2015: N = 69) for a population of 1267 registered investment advisers to add an historical time series perspective, the author analyzes and compares survey respondents’ short- and long-term estimations of industry effects. The data suggest that immediate and short-term concerns have given way to adaptation to the changes.
The Promise of Unfavorable Research: Ramifications of Regulations Separating Research and Investment Banking for IPO Issuers and Investors
Benjamin J. Catalano; 72(1): 31-60 (Winter 2016/2017)
The trend in Securities and Exchange Commission and Financial Industry Regulatory Authority rulemaking and enforcement to insulate research from investment banking influence has led to the removal of research analysts from the underwriting process with adverse consequences for new issuers and their investors. The approach conflicts with the congressional objective under the Jumpstart Our Business Startups (JOBS) Act to incorporate research fully in public offerings for emerging growth companies, which now comprise the vast majority of IPO issuers. Faced with these competing objectives, broker-dealers should have written policies and procedures that are carefully crafted to service their underwriting and investor clients appropriately and to take advantage of the JOBS Act privileges with respect to research.
New FASB Rules on Accounting for Leases: A Sarbanes-Oxley Promise Delivered
Donald J. Weidner, 72(2): 367-404 (Spring 2017)
Congress responded to the first financial accounting scandals of the new millennium by enacting the Sarbanes-Oxley Act of 2002, which required the Securities and Exchange Commission (“SEC”) to study issuers’ filings and report on whether their financial statements reflect the economics of off-balance sheet arrangements to investors in a transparent fashion. In 2005, the SEC reported that there “may be approximately $1.25 trillion in non-cancellable future cash obligations committed under operating leases that are not recognized on issuer balance sheets, but are instead disclosed in the notes to the financial statements.” Accordingly, the SEC requested that the Financial Accounting Standards Board (“FASB”) craft new rules to record more lessee liabilities on the balance sheet.
In 2016, the FASB issued sweeping new rules that affect virtually every firm that leases assets “such as real estate, airplanes, and manufacturing equipment.” In a dramatic change in approach, every lease extending more than twelve months will be capitalized and recorded on the lessee’s balance sheet as reflecting both a “right-of-use asset” and a corresponding liability. The new rules move away from the formalism of bright-line rules and toward an affirmative obligation to record economic substance. This article provides an overview of the history, policy, and mechanics of the new rules, which are likely to have a significant economic impact on many companies.
SEC Cybersecurity Guidelines: Insights into the Utility Risk Factor Disclosures for Investors
Edward A. Morse, Vasant Raval, and John R. Wingender, Jr., 73(1): 1-34 (Winter 2017/2018)
In October 2011, the SEC issued new guidelines for disclosure of cybersecurity risks. Some firms responded to these guidelines by issuing new risk factor disclosures. This article examines the guidelines and cybersecurity disclosures in the context of existing laws governing securities regulation. It then examines empirical results from firm disclosures following the new guidelines. Evidence shows a relatively small proportion of firms chose to modify their risk factor disclosures, with most firms choosing not to disclose any specific cybersecurity risk. Moreover, disclosing firms generally experienced significant negative stock market price effects on account of making new disclosures. Rather than viewing disclosure as a positive signal of management attentiveness, investors apparently viewed it as a cautionary sign.
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.
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.