Remarks Before the FINRA Institute at Wharton Certified Regulatory and Compliance Professional (CRCP) Program
Commissioner Elisse B. Walter
University of Pennsylvania
November 8, 2011
Thank you very much, Professor Orts, for that very kind introduction. I am delighted to be part of the CRCP Program. I was at FINRA—or NASD at the time—when this program was created, and it has more than fulfilled the very high expectations we had at the time. And, I’m pleased to see that it continues to attract people from a wide variety of FINRA members, as well as the regulatory community—at this session from the New York Fed and FINRA itself.
The topic I will address in my prepared remarks this evening is important to the Commission, and to me as a Commissioner and former staff member of the SEC, the CFTC and FINRA: and that is the implications of the interrelationship between public and private enforcement of the federal securities laws.
I will, of course, be happy to address in the Q&A session any other topics you may be interested in. Before I begin, however, I must remind you that my remarks represent my own views, and not necessarily those of the Commission, my fellow Commissioners, or members of the staff.2
Let me start with what I believe should be a non-controversial first principle: A statute is merely a suggestion, rather than a mandate, if it cannot be enforced. Thus, for the federal securities laws to be effective, they need to be enforceable. I am referring to enforcement both by public and quasi-public action, such as that taken by the Securities and Exchange Commission, criminal authorities, state authorities, and self-regulatory organizations like FINRA, and action taken privately by investors in class actions and other litigation.
I believe that both the public and private aspects of securities enforcement are critical, that they complement each other, and that they are interrelated. The Commission as an institution has taken this view for quite a long time—in fact, I wrote more than a few Commission amicus briefs expressing it during my first tour of duty at the agency. Recent court decisions have led me to revisit this topic and to focus anew on the implications of the interrelationship between private and public rights of action.
History of Private Rights of Action
Let me take you on a brief trip into the past, to take a look at the history of private rights of action under the federal securities laws.
Congress’ enactment of the seminal federal securities laws took place in the fallout of the stock market crash of 1929. In enacting these laws to establish the national securities regulatory scheme, Congress recognized the importance of private citizens’ having an ability to seek redress for the harm they suffer from securities law violations.
In the Securities Act of 1933, Congress provided expressly for private rights of action against signers of registration statements containing material misstatements or omissions,3 and against those violating the registration and misrepresentation or omission provisions.4 A year later, in the Securities Exchange Act of 1934 (“Exchange Act”), Congress also provided expressly for private rights to sue for manipulation or deception,5 to recover short-swing trading profits of corporate insiders,6 and to recover damages for false or misleading statements.7 Limits on these express rights were set by Congress, through statutes of limitations and other means such as provisions for costs and attorneys fees.8
For other provisions, including those that are the primary tools against fraud--Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act--Congress did not provide an express private right of action. Nevertheless, as courts interpreted and applied the new statutes in the coming years, they did so in a manner that, in my view, buttressed—although some would say expanded—investor protection. They did this through “implying” private rights of action by recognizing a right to sue under provisions where there were no express private rights.
In 1947, a Pennsylvania district court adopted this principle in a private action to recover damages for violations of Section 10(b) of the Exchange Act and Rule 10b-5. Specifically, in the well-known Kardon v. National Gypsum decision, the court stated that the Exchange Act “does no more than forbid certain types of conduct . . . [and] does not even provide in express terms for a remedy, although the existence of remedy is implicit under general principles of law.”9 Thus, the court in effect took the position that protection of investors required remedies beyond those contained in the literal words of the statute.
The Supreme Court also adopted this approach, as reflected in its 1964 decision in J.I. Case v. Borak. The Borak Court looked beyond the words of Section 14(a) of the Exchange Act, which governs federal regulation of proxies, to Congress’ broad remedial purposes. It noted that while the language of Section 14(a) “makes no specific reference to a private right of action, among its chief purposes is the ‘protection of investors,’ which certainly implies the availability of judicial relief where necessary to achieve that result.”10 The Court also noted its belief that “it is the duty of the courts to be alert to provide such remedies as are necessary to make effective the congressional purpose.”11
The Borak Court seemed to be driven by the public good underlying the private-public partnership in enforcing the federal securities laws, stating that “[p]rivate enforcement of the proxy rules provides a necessary supplement to [Securities and Exchange] Commission action,” and that “the possibility of civil damages or injunctive relief serves as a most effective weapon in the enforcement of the proxy requirements.”12
Seven years later, in 1971, the Supreme Court considered the implied private right of action under Exchange Act Section 10(b) and Rule 10b-5 (which by then had been part of the Commission’s rulebook for 30 years). In its decision in Superintendent of Insurance v. Bankers Life & Casualty, the Court treated the existence of the implied right in a perfunctory manner, simply recognizing its existence and, in a footnote, noting: “It is now established that a private right of action is implied under [Section] 10(b),” looking to, among other sources, its Borak decision.13
By the mid- to late-1970s, however, judicial sentiment regarding implied rights began to change, apparently due to increasing concerns about private litigation. Just four years after reaffirming the interpretive flexibility and judicial support for Congressional remedial purposes in Superintendent, the Supreme Court in Blue Chip Stamps v. Manor Drug Stores shifted its analytical framework to strict constructionism, at least with respect to private claims under Rule 10b-5.
In ruling that private rights of action under Rule 10b-5 are limited to actual “purchasers or sellers” of securities, the Blue Chip Court focused on the statutory language of Section 10(b) and voiced its belief that Rule 10b-5 “vexatious” litigation needed to be constrained.14 Let me repeat that word, “vexatious,” and point out that I am just quoting the Court.
And, during the 1970s, the Supreme Court did not limit its narrow construction to the scope of private rights under Section 10(b) and Rule 10b-5; rather, it also rejected outright implied rights under other provisions of the federal securities laws. In 1977, for example, the Court refused to recognize an implied private right of action for bidders under Section 14(e) of the Exchange Act.15 Two years later, the Court also declined to recognize a private right under both Section 17(a) of the Exchange Act,16 and Section 206 of the Advisers Act of 1940.17
In the 1990s, the Supreme Court continued its restrictive approach to implied rights. Significantly, in 1994, the Court ruled in Central Bank v. First Interstate Bank of Denver that aiders and abettors could not be sued by private parties under 10(b).18 In reaching this result, the Court looked primarily to the language of the statute, finding the lack of express aiding and abetting liability to be dispositive.19 It again rejected its earlier approach in Borak, stating that “[p]olicy considerations cannot override our interpretation of the text and structure of the [Exchange] Act,” and noted that “[e]xtending the 10b-5 cause of action to aiders and abettors no doubt makes the civil remedy more far reaching, but it does not follow that the objectives of the statute are better served.” 20 And once again, the Court expressed concerns about the danger of “vexatious” litigation under Rule 10b-5.21
As an aside, I would also note that, although Central Bank did not address directly the Commission’s ability to bring actions based on aiding and abetting, the Court’s focus on the language of the statute created uncertainty for Commission cases.
Like the Supreme Court, in the 1990s Congress also acted to address concerns about private litigation. In 1995, Congress enacted the Private Securities Litigation Reform Act (“Litigation Reform Act”), seeking to cut back private actions on a number of fronts—arguably with particular aim at class actions, through lead plaintiff requirements and other reforms.22 And, apparently agreeing with the Central Bank Court, Congress did not restore private rights of action for aiding and abetting violations of Section 10(b). It did, however, provide that the Commission may pursue under the Exchange Act any person who knowingly provides substantial assistance to someone who commits fraud.23
Despite the broad sweep of the Litigation Reform Act, to this day the Supreme Court continues to demonstrate what I would characterize as hostility towards private rights.
In 2008, for example, the Court returned to the scope of the implied right of action under Section 10(b). It concluded in Stoneridge Investment Partners v. Scientific-Atlanta, Inc. that private plaintiffs could not bring a 10(b) suit against companies that were suppliers of an entity committing fraud, because (even though the suppliers’ conduct was deceptive) investors did not rely on their statements or representations.24
The Court analyzed the case as aiding and abetting, looking to its Central Bank decision and the fact that Congress had not overturned that decision in the Litigation Reform Act despite calls to do so. The Court expressed concerns that an extension of the cause of action would lead to increased private litigation, and seemed determined to not let that occur.25
In 2010, the Supreme Court held in Morrison v. National Australia Bank that Section 10(b) did not apply to provide a private cause of action against foreign and American defendants for misconduct in connection with securities traded on foreign exchanges, and that it applied only to transactions in securities listed on domestic exchanges, and domestic transactions in other securities.26 As with Central Bank and Stoneridge, the Court determined that the statutory text controls its scope, explicitly rejecting a policy-based approach, which had been followed by various lower courts for decades.
In contrast to Stoneridge, the Court did not cast its decision in terms of reliance, one of the various elements of Section 10(b) that private plaintiffs (but not the Commission) must show.27 Instead, the Court interpreted the statutory language itself, simply looking to see whether it expressly provided for “extraterritorial” application, and finding it did not, concluding that that the statute does not apply in that context.28
I would note that, as it did after the Central Bank decision, following Morrison Congress once again distinguished between the Commission and private plaintiffs. In Section 929P of the Dodd-Frank Act following Morrison, it confirmed the Commission’s authority to enforce Section 10(b) in cases involving transactions outside the United States. But, for private rights, in Section 929Y Congress required the Commission to solicit public comment and conduct a study to determine the extent to which private rights under the antifraud provisions of the Exchange Act should be extended across international boundaries, and submit a report of the study to Congress by early 2012.
Just a few months ago, the Supreme Court issued a decision that reflects what I would characterize as its strictest construction to date. In Janus Capital Group v. First Derivative Traders, the Court again looked to the language of Rule 10b-5, holding that an investment adviser cannot be liable under the rule for false statements included in its client mutual funds’ prospectuses because it did not “make” the statements.29 The Court acknowledged the implied right of action under the rule, but expressed concerns about its scope, saying that private rights should have “narrow dimensions.”30 In my view, given the relationship between funds and their advisers, in which the adviser effectively acts for the fund, Janus represents not only its strictest of the statute, but also one that is shockingly out of line with the realities of the marketplace.
Interrelationship with Public Actions
Because I believe that enforcement, and therefore statutory effectiveness, depends on a public-private partnership, I also believe that this judicial and Congressional trend away from private rights affects the Commission’s ability to enforce the securities laws. Admittedly, the agency’s reasons for bringing a case are broader than those of private litigants, and the standards associated with the agency’s cases differ from those in private actions. Nevertheless, public and private rights are the two pillars on which enforcement rests.
The Commission has long recognized the relationship between public and private enforcement and the critical importance of judicial developments concerning private actions. Over the years, it has participated successfully as amicus in many private actions. This started in 1936, with efforts to defend a constitutional challenge to the Public Utility Holding Company Act of 1935.31 The Commission’s role as amicus, however, became much broader over time.
For example, there have been many important judicial decisions in private litigation involving issues that overlap with Commission cases. They have included decisions on core issues including the definition of “security,” such as Reves; when fraud is “in connection with” securities purchases or sales, such as Superintendent; the degree of intent needed to violate the antifraud provisions of the Securities laws, such as Hochfelder; and the contours of the element of materiality under Rule 10b-5, such as Basic v. Levinson. Commission amicus participation has not been limited to the Supreme Court; the Commission has expressed its opinions frequently in the U.S. Courts of Appeals and, with less regularity, in district courts. Also, the Commission has participated in private cases where the issues could have an indirect effect on the functioning of the federal securities laws, such as challenges to state takeover statutes in numerous instances.32
I’d particularly like to highlight the Commission’s efforts as amicus that have a different focus—enhancing private enforcement of the securities laws. Examples include private cases regarding the scope of Section 10(b) and Rule 10b-5, the contours of the element of reliance in showing a violation of 10b-5, and the proper way to measure recovery of profits under Section 16(b) of the Exchange Act.33
The Commission has been particularly active in seeking to enhance private enforcement through implied rights of action. In the 1940s, the Commission began to advocate for implied rights of action under the theory that persons intended to be protected by a statute should have a judicial remedy for harm resulting from the breach of the statute. The Commission was quite successful in obtaining court recognition of private rights, especially through the 1960s.34
In doing so, the Commission has pointed to the role private actions played in supplementing Commission enforcement. In its amicus brief in Borak, for example, the Commission argued that “limitations of manpower present the Commission from bringing enforcement actions for all violations. Private actions based upon violation of the proxy rules thus are an important supplement to the Commission’s own enforcement activities in accomplishing fair corporate suffrage which the statute is designed to promote.”35
The Commission continues its amicus efforts today, weighing in on private cases that address the appropriate scope of liability under 10b-5. For example, last year the Commission filed an amicus brief in Matrixx Initiatives v. Siracusano,36 addressing the materiality element of Rule 10b-5.
Until quite recently, the trend to constrain private rights has not had significant direct effects on Commission action. For example, the Stoneridge Court cast the issue in terms of whether the plaintiff had met the reliance element of a private right under 10(b), an element that does not apply to Commission actions. And, following the Supreme Court decisions in Central Bank and Morrison, Congress took action to address the impact of those decisions on public enforcement.
But, that may have changed. In its recent Janus decision, the Supreme Court focused simply on the language of Section 10(b) and Rule 10b-5, which of course apply to Commission actions as well as private actions. This change may have the unfortunate and ironic result of throwing the proverbial baby out with the bathwater. What I mean is that by limiting implied private rights through strict statutory interpretation, the Court has also potentially limited the express public rights of action contained in the statute.
Implications for Public Enforcement
Given these developments, what are the implications for the federal securities laws? I speak only for myself, but I believe strongly that the public, Congress, courts, and even the securities bar do not fully appreciate the interrelationship between public and private enforcement. The impact of changes in the parameters or existence of private actions on the enforceability of the federal securities laws is simply not well understood. And yet, it is critical to investors, our securities markets, and our economy overall that these laws remain fully enforceable.
The contraction of private rights means that their ability to supplement government enforcement is limited, and they become less sturdy support for the overall enforcement process. This means that Commission and other public enforcement of the federal securities laws must “take up the slack,” so to speak. Thus, the need for strong governmental and self-regulatory enforcement has never been greater.
In other words, I believe that the trend away from private rights of action under the securities laws has placed more and more pressure on the Commission and other regulators to be the sole guardians of the statutes. It is a vast understatement to say that the Commission has a big job to do. If private rights are cut back further, or further constrained, that puts an increasing burden on already scarce governmental resources.
The ebbs and flows of our appropriations process mean that the Commission has been faced repeatedly with budgetary constraints. The Commission is quite adept at using the resources it is given, and has and will rise to the occasion. But, it is far from clear that we will be able to reach an optimal level of enforcement where both private rights of action are contracting and public rights are limited unduly, and quite artificially, by resource deficiencies—both technological and in terms of number of staff.
Aside from budgetary constraints, there are also limitations on the Commission’s authority. For example, it cannot seek damages for violations of the federal securities laws, although it can require wrongdoers to disgorge their “ill-gotten gains.” Thus, while the agency can require wrongdoers to give up the benefits they have received from violations, it cannot necessarily make the victims whole. And, the extent of the harm suffered by victims when the law is broken is not necessarily the same as the benefits derived by those breaking the law. Although, after the passage of the Sarbanes-Oxley Act of 2002, the Commission now has the ability to also provide victims with penalties paid by defendants, victims still may not be fully compensated.
Further, even with ideal resource availability, the Commission cannot bring every case. The contraction of private rights enhances the importance of the Commission’s choice of which cases to bring. In making case decisions, the Commission traditionally considers a number of factors, including the extent of the harm, the deterrent impact of the case on future conduct across the market, and the egregiousness of the conduct. Arguably, continuing contraction of private rights should mean that the Commission should weigh more heavily the extent of monetary harm. But, that may not be realistic, given the broad societal interests the Commission must serve.
The notion that there is both a long-term contraction in private rights and an inherent limited ability to maximize public enforcement should be a cause for significant concern. At a minimum, the Commission and other regulators should have the resources they need to carry out their public missions. And, in an era of shrinking private rights, the needed governmental resources may well be substantially greater.
To be clear, I believe that the agency’s Enforcement program is doing a wonderful job maximizing the resources it has. Rob Khuzami and his staff have made significant strides in this regard by undertaking the most significant restructuring of the division since it was created 40 years ago. They have introduced new national specialized investigative units with expertise in high-priority areas of Asset Management, Market Abuse, Structured Products, Foreign Corrupt Practices Act violations, and Municipal Securities and Public Pensions.
They have also brought more cases, recovering more money for investors and imposing more penalties than ever before. Enforcement filed 681 cases in fiscal year 2010, more than in any of the five previous years. There was $2.85 billion in disgorgement and penalties ordered in fiscal year 2010, an increase of 176% over fiscal year 2008. And, the cases Enforcement brings to the Commission are the right cases, with resources targeted at important areas of concern.
I wholeheartedly support these efforts and the leadership of the Division of Enforcement. Just think, however, of how their efforts could be enhanced if the agency were given significant additional resources, especially with the Commission on track to becoming the sole enforcer of enforcement rights under the federal securities laws.
Once again, it has been a pleasure to be with you this evening to discuss public and private enforcement of the federal securities laws. Please know that my door and phone lines are always open, and I hope that you will not hesitate to reach out with your views on the important issues facing the Commission. Thank you.
1 The author would like to thank members of the Commission staff for their contribution to these remarks, including Ethiopis Tafara, Elizabeth Jacobs, Jake Stillman, Joe Brenner, Rich Levine, Richard Humes, Matt Martens, John Avery, Mark Pennington, Eric Pan, Suzanne Ashley, and Brooks Shirey. The author gave a similar speech at the Los Angeles County Bar Association’s 44th Annual Securities Regulation Seminar held on October 28, 2011.
2 The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publications or statements by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission, other Commissioners, or the staff.
3 See Section 11 of the Securities Act of 1933.
4 See Section 12(a)(1), (a)(2) of the Securities Act of 1933.
5 See Section 9(f) of the Securities Exchange Act of 1934.
6 See Section 16(b) of the Securities Exchange Act of 1934.
7 See Section 18(a) of the Securities Exchange Act of 1934.
8 See, e.g., Section 13 of the Securities Act (statute of limitations for Section 11 and 12(a)(2) liability); Section 9(f) of the Exchange Act (provisions for costs and attorney’s fees).
9 See Kardon et al. v. National Gypsum Co. et al., 73 F.Supp. 798, 802 (E.D Penn.)(1947).
10 See J.I. Case Company v. Carl H. Borak, 377 U.S. 426, 431-32 (1964).
11 See id. at 433.
12 See id. at 432.
13 See Superintendent of Insurance of the State of New York v. Bankers life and Casualty Company et al., 404 U.S. 6, 13 & n.9 (1971).
14 See Blue Chip Stamps et al. v. Manor Drug Stores, etc., 421 U.S. 723 (1975).
15 See Piper v. Chris-Craft Indus., Inc., 430 U.S. 1 (1977).
16 See Touche Ross & Co. v. Redington, 442 U.S. 560 (1979).
17 See Transamerica Mortgage Advisors, Inc. v. Lewis, 444 U.S. 11 (1979).
18 See Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994).
19 See id. at 175-77.
20 See id. at 188.
21 See id. at 189.
22 See, e.g., Litigation Reform Act, 109 Stat. at 738-39, 743-44 (adding Section 27(a)(3) to the Securities Act and Section21D(a)(3) to the Exchange Act).
23 See Litigation Reform Act, 109 Stat. at 757 (adding subsection (f) to Section 20 of the Exchange Act).
24 See Stoneridge Investment Partners, LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008).
25 See id. at 157-58; 165-66.
26 See Morrison v. National Australia Bank Ltd., 130 S.Ct. 2869 (2010).
27 See Stoneridge at 159.
28 See Morrison at 2881-83.
29 See Janus Capital Group, Inc. et al. v. First Derivative Traders, Opinion No. 09-525 (2011).
30 See id. at 6.
31 See David S. Ruder, The Development of Legal Doctrine Through Amicus Participation: The SEC Experience, 6 Wisc. L. Rev. 1167, 1170 (1989).
32 See id. at 1183, 1189.
33 See id. at 1187-88.
34 See id. at 1173-74; 1184-85.
35 See Brief for the Securities and Exchange Commission, as amicus curiae, at 2, J.I. Case v. Borak, 377 U.S. 426 (1964) (No. 402).
36 See Matrixx Initiatives v. Siracusano, Opinion No. 09-1156 (2011).