Last week, the House Subcommittee on Capital Markets, Securities, and Investment held a hearing titled “Ensuring Effectiveness, Fairness, and Transparency in Securities Law Enforcement.”
Several of the issues discussed at the hearing were Foreign Corrupt Practices Act relevant such as disgorgement, statute of limitations and tolling agreements, the long time periods associated with issuer scrutiny, and “regulation by enforcement.”
This Committee memorandum stated:
“The purpose of this hearing is to comment on the U.S. Securities and Exchange Commissions’ (SEC) approach to enforcing the Federal securities laws and whether its activities and initiatives are complimentary to all three prongs of its statutory mission to protect investors, to maintain fair, orderly, and efficient markets, and to facilitate capital formation. The hearing will discuss areas of the law that would benefit from greater clarity to ensure that SEC investigations have an appropriate scope and minimize instances of the practice known as regulation by enforcement. Additionally, the hearing will examine the role of administrative proceedings in the enforcement of the Federal securities laws, including whether Congress should advance legislation like H.R. 2128, the “Due Process Restoration Act of 2017.” The hearing also will explore whether Congress should clarify the SEC’s authority to seek disgorgement, including what is the appropriate statute of limitations for disgorgement sought by the SEC.”
Bradley Bondi (Cahill Gordon & Reindel LLP and former counsel to SEC Commissioners) testified at the hearing and his FCPA relevant testimony is excerpted below (his testimony also provides a nice overview of the history of SEC corporate penalties and background on SEC administrative actions).
“The SEC’s approach to issuer penalties and disgorgement is an area that could threaten the balance of the SEC’s three-part mission. In recent years, the SEC has focused on bringing large numbers of enforcement cases and obtaining large financial settlements. At the end of its 2016 fiscal year, the SEC issued a press release announcing that the 868 enforcement actions it filed in 2016 were a “new single year high.” It also announced that it had obtained approximately $4 billion in disgorgement and penalties that year. This was the third year in a row that the SEC announced a record number of enforcement actions.
The number of enforcement actions and the amount of disgorgement and penalties purportedly demonstrate the success of the SEC’s enforcement program. But if the aim of the program is to protect investors and deter wrongdoing, then the high numbers of enforcement actions and penalties are, at best, a poor way to measure that protection and deterrence. At worst, record numbers are an indication that securities law violations are increasing in number and severity. After all, few would consider a local police force successful in deterring crime if it announced record numbers of arrests year after year.
An overemphasis on enforcement statistics also may lead the SEC to develop and pursue theories of liability that exceed the bounds of the SEC’s congressionally-authorized enforcement power. An emphasis on obtaining large penalties against corporations creates incentives that may be misaligned with the core mission of the SEC to protect investors, namely the innocent shareholders who must bear the cost of a corporate monetary penalty.
There also has been growing uncertainty over the SEC’s treatment and approach to the equitable remedy of disgorgement. The SEC can seek to force defendants to disgorge ill-gotten gains. Courts have required the SEC to demonstrate a causal connection between the property to be disgorged and the wrongdoing. The remedy of disgorgement is used often in insider trading cases to recover the profits made by trading on material, nonpublic information. The remedy also is applied in areas where investors have been defrauded by fraudulent investment scams. In other areas, however, the remedy of disgorgement has become untethered from the underlying offense, which creates unpredictability and the potential for harm to shareholders. For example, in cases involving payments to foreign government officials, disgorgement has been applied as a remedy for violating the books and records and internal controls provisions of the Securities Exchange Act of 1934. But in cases in which the SEC has not charged any violation of the FCPA’s anti-bribery provisions, the connection between the incorrect recording of a payment to a foreign official and any ill-gotten gain resulting from that payment is tenuous. It is the bribe, not the misrecording of it, which caused the ill-gotten gain; so a violation of the recording provision should not provide a sufficient causal link for disgorgement. This tenuous approach and the imprecise “reasonable approximation” standard for determining the amount of disgorgement creates the potential that a disgorgement sanction will not be commensurate with the amount of ill-gotten gains. Unfortunately, the SEC’s approach to disgorgement often goes unchallenged and unreviewed by a court. As a result, the standard for obtaining disgorgement is less predictable.
This lack of transparency and predictability with respect to monetary penalties and disgorgement is contrary to the SEC’s mission to maintain fair, orderly, and efficient markets and to facilitate capital formation. In July 1934, Joseph P. Kennedy, the first chairman of the SEC, stated there would be no concealed punishment for businesses subject to the SEC’s jurisdiction. In that spirit of transparency, the SEC should provide clear, principled guidance regarding when it will seek a penalty or disgorgement and how it will calculate the amount.
One area of the securities laws in which there has been a welcome clarification is the statute of limitations applicable to cases in which the SEC seeks disgorgement and penalties. The Supreme Court’s recent unanimous decision in Kokesh v. SEC held that the Commission’s disgorgement remedy constitutes a “penalty” and is therefore subject to the five-year statute of limitations in 28 U.S.C. § 2462. I understand that in the wake of Kokesh there has been discussion about extending the statute of limitations for disgorgement and penalties.
Although I believe it is critical for the SEC to pursue those who commit fraud, I am concerned that the costs of extending the applicable statute of limitations may greatly outweigh the benefits. Statutes of limitations and statutes of repose serve a vital societal interest in providing stability and certainty, and preventing the litigation of stale claims. Five years is the longest period of limitations or repose found in any of the federal securities laws. Extending the Section 2462 statute of limitations beyond that would create uncertainty for the investing public because of the possibility of the SEC prosecuting stale claims. It also could open the door for inefficiencies in the way the SEC investigates cases if more time is allotted to bring actions.
Investigations are costly on those responding. A July 2015 Chamber of Commerce report cited a survey indicating that the average costs for responding to a formal investigation surpassed $1 million for 70% of the formal investigations surveyed; and they surpassed $20 million for 10% of those investigations. In my two decades of experience as a defense lawyer, an SEC enforcement investigation into potential securities law violations by a public company—even an investigation that ultimately does not find any violations of law—can take several years, distract management, and cost the company tens of millions of dollars. The cost of that investigation is borne directly by the shareholders of the company. Of particular concern are SEC enforcement investigations that begin after a news story about a high-profile company, prompting the Enforcement Staff to pursue one theory of liability, but then morph into open-ended investigations that wander into other areas of a company in search of a potential violation. This is particularly disconcerting when it comes to new companies, start-ups, and technology companies that oftentimes find that scrutiny in the press translates into scrutiny by the Enforcement Staff. SEC investigations can impede entrepreneurship and innovation. I understand the current leadership of the SEC is cognizant of these concerns and has been working to address them. Policies and procedures in this area could be improved.
In considering any proposed legislation to extend the applicable statute of limitations, it would be helpful for the SEC to explain to this Committee and to the public what, if any, cases the SEC has failed to bring as a result of being time barred. As a practical matter, and speaking from experience, the SEC has the ability to seek a tolling agreement from a person or entity under investigation, thereby stopping the running of the limitations period. It may be that few cases, if any, are missed by the SEC as a result.”
Professor Andrew Vollmer (University of Virginia School of Law and former Deputy General Counsel of the SEC and partner in the securities litigation and enforcement practice of Wilmer Cutler Pickering Hale and Dorr LLP) also testified at the hearing and his FCPA relevant testimony is excerpted below.
“One of my concerns about the SEC enforcement process is with the length of investigations. This is an area in which attention from Congress could be helpful. In my experience, the length of SEC investigations is strongly correlated to the five-year limitations period for fines, penalties, and forfeitures in 28 U.S.C. § 2462. The Supreme Court decisions in Gabelli v. SEC, 568 U.S. 442 (2013), and Kokesh v. SEC, 137 S. Ct. 1635 (2017), addressed the application of section 2462 to SEC enforcement cases. The Commission and the staff have an incentive to complete investigations in time to commence enforcement proceedings before the five-year statute of limitations for monetary penalties and disgorgement expires.
Too frequently, however, the Commission does not complete an investigation within five years and initiates an enforcement action based on alleged misconduct many years old. The staff of the Division of Enforcement often avoids the effect of the limitations period by entering into one or more tolling agreements. In a tolling agreement, the person being investigated agrees with the staff to suspend the running of time for purposes of calculating any limitations period.
Long investigations and the use of tolling agreements signal a need for stricter application of limitations periods. “Statutes of limitation are vital to the welfare of society and are favored in the law. They are found and approved in all systems of enlightened jurisprudence. They promote repose by giving security and stability to human affairs.” Important public policies lie at their foundation: “repose, elimination of stale claims, and certainty about a plaintiff’s opportunity for recovery and a defendant’s potential liabilities.” “A federal cause of action “brought at any distance of time” would be “utterly repugnant to the genius of our laws.” As time goes by, evidence becomes less reliable, and the results of investigations and litigation become less accurate. “Just determinations of fact cannot be made when, because of the passage of time, the memories of witnesses have faded or evidence is lost. In compelling circumstances, even wrongdoers are entitled to assume that their sins may be forgotten.”
Long investigations cause other social harms. They create uncertainty, which can lead businesses to fail or postpone research and investment in potentially beneficial goods and services. Individuals suffer. They can be fired or put on administrative leave during investigations even when no misconduct occurred. The existence of an investigation can become public, injuring reputations and causing investors to withdraw money and customers to abandon a company. The longer an investigation, the worse these problems are.
For these reasons, Congress should be reluctant to lengthen limitations periods for SEC cases. It should lengthen the limitations period for the SEC only if it receives convincing data that a substantial problem with the current five-year cases because of the limitations period? Even if some such cases exist, does that justify extending the limitations period for all SEC cases? A longer limitations period is likely to lead to longer and longer investigations. A ten-year period seems inordinately long given the catalogue of ills from lengthy investigations and litigation based on old conduct.
If Congress is convinced that the five-year period prevents obtaining effective relief in a sufficient number of cases, the better approach would be to define specific exceptions from the five-year period. Exceptions should be few. The SEC should be obliged to prove that a case involved serious and widespread misconduct and that the SEC could not reasonably have commenced an action within a five-year period for an alleged violation occurring more than five years ago.
Congress also should address additional matters if it is inclined to reconsider the limitations period for SEC cases. First, a limitations period should apply to the power of the SEC to commence an enforcement case and should not apply to any particular form of relief. The statute of limitations should not be tied to fines, disgorgement, injunctions, or other relief. That is how section 2462 operates now, but that statute presents a variety of interpretive difficulties and is not the best approach. The expiration of a limitations period should stop the SEC from suing.
Second, a limitations period should apply to SEC enforcement cases brought in district court or as administrative proceedings. The litany of social harms from long investigations and ancient misconduct exists no matter what forum the SEC uses.
Third, a limitations period should not be connected to compensation for investor losses. The Kokesh opinion did that for purposes of analyzing the language in section 2462, but Congress has no reason to connect the two. It has authority to set a limitations period of reasonable length and reasonable terms without linking the period to the return of funds to harmed investors.
Congress has never given the SEC power to calculate a monetary recovery based on investor loss or damage. Congress has given the SEC many different forms of relief, but they have all related to prevention and deterrence, such as injunctions, civil penalties, and revocation of a person’s registration as a broker-dealer or investment adviser. Private actions recover loss, but private actions provide a defendant with a variety of procedural protections not available in SEC enforcement cases. Those protections include the plaintiff’s need to prove reliance, loss, and loss causation and to meet higher pleading standards. Granting the SEC the power to sue for compensation for investor damage would be a sharp break from precedent with unpredictable consequences.
Fourth, a new statute of limitations should restrict and control tolling agreements. The staff currently uses them to prolong the five-year limitations period. Congress might not want to prohibit all tolling agreements, but they should be rare.”
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