June 13, 2018

House Financial Services Committee – Capital Markets Subcommittee “Ensuring Effectiveness, Fairness, and Transparency in Securities Law Enforcement”

Key Topics & Takeaways

  • H.R. 2128: During the hearing, Republicans generally defended H.R. 2128, while Democrats criticized it for allowing “fraudsters” to choose a venue. Rep. Warren Davidson (R-Ohio) the sponsor of H.R. 2128, argued that it is necessary to create parity in venue selection rights between defendants and the SEC, and several witnesses criticized the SEC’s administrative proceedings for having different evidentiary standards and defendant rights.
  • Disgorgement and Kokesh: Huizenga asked about the recent Kokesh decision, in which the Supreme Court found that a five-year statute of limitations applies to SEC disgorgement actions. Huizenga asked the witnesses to defend an extension of the statute of limitations to ten years. Bondi argued that expanding the statute of limitations will create the risk that SEC investigations will last longer, and that these lengthy investigations may not lead to an enforcement action but will cost companies tens of millions of dollars. Some Democrats seemed opened to expanding the statute of limitations.
  • H.R. 5037: H.R. 5037 attracted substantial attention at the hearing, with opponents generally arguing that the bill would sharply curtail the ability of state securities regulators from launching enforcement actions on civil or criminal cases and expose investors to harm.

Witnesses

  • Bradley J. Bondi, Partner, Cahill Gordon & Reindel LLP
  • Joseph P. Borg, Director, Alabama Securities Commission
  • Thomas Quaadman, Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce
  • Andrew N. Vollmer, Professor of Law and Director, John W. Glynn Jr. Law & Business Program, University of Virginia School of Law

Opening Statements

Subcommittee Chairman Bill Huizenga (R-Mich.)

In his opening statement, Huizenga said this hearing would focus on whether the Securities and Exchange Commission’s (SEC’s) enforcement methods are aligned with its mission. Huizenga said enforcement is a critical piece of the SEC’s mission as that ensures investors can safely invest. Huizenga also introduced the two bills considered at the hearing that he said would deal with administration by enforcement, the role of administrative courts, the importance of disgorgement as an enforcement tool, and the differences between federal and state securities laws and enforcement practices.

Subcommittee Ranking Member Carolyn Maloney (D-N.Y.)

In her opening statement, Maloney focused on H.R. 5037, which she called “deeply troubling” because of its preemption of most, if not all, state criminal and civil securities laws. Maloney said that companies do not need relief from securities fraud laws and that states should be free to regulate any form of securities fraud. Maloney specifically defended New York’s Martin Act as an example of a state law that protects investors and argued that state securities regulators are necessary to cover the entire market. 

Testimony

Bradley J. Bondi, Partner, Cahill Gordon & Reindel LLP

In his testimony, Bondi discussed the two bills covered by the hearing – H.R. 2128, the Due Process Restoration Act of 2017, and H.R. 5037, the Securities Fraud Act of 2018. Bondi also expressed reservations about extending the statute of limitations for disgorgement claims from five to ten years, noting that five years is already the longest statute of limitations in any federal securities law. Bondi said a lengthier statute of limitations could encourage the SEC to open up stale claims and change their enforcement incentives. Bondi also criticized SEC investigations that “morph” from topic to topic without clarity to the investigated party, as the SEC may launch an investigation on one topic and then investigate other matters. Bondi proposed several changes to H.R. 5037, including creating a “dollar threshold” for preemption to allow state securities regulators to handle small dollar and microfraud cases, and suggested amending the bill to preempt related cases against officers, directors, and underwriters, to prevent a federal/state split on litigation.

Joseph P. Borg, Director, Alabama Securities Commission

Borg used his oral testimony to defend state anti-fraud regulations and enforcement activities against issuers of securities as necessary for building confidence in the marketplace. Borg criticized H.R. 5037, saying “fraudsters would be pleased” with the results of the bill, which would remove the ability of wronged parties to choose a forum and require almost all securities fraud cases from being litigated in federal courts. Borg argued that state regulators are “closest to main street investors” and said that the North American Securities Administrators Association (NASAA) opposes the bill. Borg also said there was “no need” to pass H.R. 2128.

Thomas Quaadman, Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce

In his testimony, Quaadman criticized the SEC’s administrative proceedings and Administrative Law Judges (ALJs), saying they raise “serious” due process concerns, including a lack of discovery and lower evidentiary standards needed for convictions. Quaadman also criticized New York State’s Martin Act, which he argued empowers New York to act as a “de facto national securities regulator” and that bills like H.R. 5037 would limit the ability of states to impact the national securities enforcement landscape. Quaadman said H.R. 5037 would set up “common sense guard rails” and not impact the ability of states to pursue criminal securities fraud cases.

Andrew N. Vollmer, Professor of Law and Director, John W. Glynn Jr. Law & Business Program, University of Virginia School of Law

Vollmer used his oral testimony to address the disgorgement statute of limitations and the recent Kokesh decision. Vollmer argued that the current five-year statute of limitations is “already too long” and should not be extended unless the SEC provides empirical data about how the current statute of limitations limits the SEC’s ability to pursue a large number of important cases. Vollmer also criticized the length of SEC investigations, arguing that they can run on for years, unnecessarily, and cause serious harms to issuers. 

Question and Answer

H.R. 2128, the Due Process Restoration Act of 2017

During the hearing, Republicans generally defended H.R. 2128, while Democrats criticized it for allowing “fraudsters” to choose a venue. Rep. Warren Davidson (R-Ohio) the sponsor of H.R. 2128, argued that it is necessary to create parity in venue selection rights between defendants and the SEC. Quaadman agreed that this is necessary as administrative proceedings do not grant defendants the rights that federal courts do, including discovery. Davidson agreed that a jury trial for offenses is “constitutionally protected.”

Full Committee Ranking Member Maxine Waters (D-Calif.) also attended the hearing and asked Borg about H.R. 2128. Borg said the bill would impact the ability of the SEC to enforce securities laws, and securities cases could flood federal courts, delaying the resolution of cases, use up more SEC enforcement resources, and lead to inconsistent decisions in federal courts, even on cases with consistent fact patterns. 

Disgorgement and Kokesh

Huizenga asked about the Kokesh decision, in which the Supreme Court found that a five-year statute of limitations applies to SEC disgorgement actions. Huizenga asked the witnesses to defend an extension of the statute of limitations to ten years. Bondi argued that expanding the statute of limitations will create the risk that SEC investigations will last longer, and that these lengthy investigations may not lead to an enforcement action but will cost companies tens of millions of dollars.

Waters also asked the witnesses about the Kokesh decision. Borg used her question to criticize the five-year statute of limitations, noting that Alabama recently moved to a five-year statute from the date of discovery, instead of the date of the offense. Borg argued that a reliance on the date of the offense can push cases, which are difficult to discover, outside the statute of limitations.

Rep. Trey Hollingsworth (R-Ind.) asked the witnesses how the SEC could develop a reasonable framework for developing disgorgement requirements. Bondi argued that because many cases settle, there are not many opportunities for SEC-mandated disgorgement requirements from being challenged in Article III courts. Bondi agreed that a framework should be developed as today small books and record violations sometimes lead to (in his opinion) excessively large disgorgement orders.

H.R. 5037, the Securities Fraud Act of 2018

H.R. 5037 attracted substantial attention at the hearing, with opponents generally arguing that the bill would sharply curtail the ability of state securities regulators from launching enforcement actions on civil or criminal cases and expose investors to harm. In response to questions from Maloney, Borg argued that federal regulators will be the only ones empowered to try criminal securities fraud cases, that federal enforcement teams at the SEC and the Department of Justice are resource-strained, and small-dollar fraud cases would go unpunished. Borg defended state regulators’ ability to prevent wrongdoing by issuers, broker-dealers and investment advisors throughout the hearing.

Rep. Tom MacArthur (R-N.J.), the sponsor of H.R. 5037, asked the witnesses if they believed that duplicative state and government securities regulations chill capital formation, and for their thoughts on H.R. 5037 generally. Quaadman argued that there is a capital formation impact and that the Martin Act muddies the capital formation landscape by giving a state regulator enormous power to regulate issuers nationally. Bondi argued that H.R. 5037 is appropriately tailored and preserved a role for state securities regulators. Bondi also endorsed a dollar threshold for preemption in cases, noting that other federal financial regulations have similar thresholds, and that such a threshold would preserve the ability of the states to pursue microcap fraud cases.

Rep. David Scott (D-Ga.) said that he would be more willing to consider measures like H.R. 5037 if other changes occurred at the SEC, including an expansion of the SEC’s budget (especially for enforcement), an end to the hiring freeze, reversing a decision to limit the ability of SEC staff to issue subpoenas, and giving the SEC more power to require disgorgements.

SEC Investigations

Rep. Randy Hultgren (R-Ill.) noted that Section 881 of H.R. 10, the Financial CHOICE Act, would require the SEC to develop a process to close investigations. Hultgren asked the panel how this provision would prevent the SEC from abusing its investigative powers. Quaadman argued that the SEC should provide information to the public about how many cases are opened but never closed. Quaadman noted that investigations can go on for years, and at much cost to an issuer, and noted previous U.S. Chamber of Commerce recommendations on this topic. Vollmer also argued that the SEC should be forced to weigh the merits of investigations in their early stages.

Administrative Law Judges (ALJs)

Rep Tom Emmer (R-Minn.) defended the provisions in H.R. 2128 and asked the witnesses if they agreed that the SEC picks the ALJ as a forum for cases because they win more often there. Vollmer argued that the data does not necessarily bear out that claim, and that there is the question of how to count settled cases.

PCAOB Audits

Rep. French Hill (R-Ark.) noted that the Public Company Accounting Oversight Board (PCAOB) requires audits for small, non-custodial brokers, and that these audits are expensive and burdensome for smaller firms. Hill asked Quaadman if he supported his bill that would create a blanket exemption for that category of broker-dealers. Quaadman supported that direction and said that most of the brokers that would be impacted are not public companies, so the audits today do not match their model.

Cyan Decision

Hollingsworth asked witnesses about the Cyan decision, which found that under the Securities Litigation Uniform Standards Act, class action suits under the Securities Act of 1933 may be brought in state court and are not removable to federal courts. Hollingsworth asked if this decision would lead to forum shopping, and the case law on securities suits developing differently across the country. Bondi said that there is evidence that process has begun, as plaintiffs have begun targeting favorable forums for a large settlement.

For more information on this hearing, please click here.