[Senate Hearing 111-369]
[From the U.S. Government Publishing Office]
S. Hrg. 111-369
EVALUATING S. 1551: THE LIABILITY FOR AIDING AND ABETTING SECURITIES
VIOLATIONS ACT OF 2009
=======================================================================
HEARING
before the
SUBCOMMITTEE ON CRIME AND DRUGS
of the
COMMITTEE ON THE JUDICIARY
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
----------
SEPTEMBER 17, 2009
----------
Serial No. J-111-46
----------
Printed for the use of the Committee on the Judiciary
EVALUATING S. 1551: THE LIABILITY FOR AIDING AND ABETTING SECURITIES
VIOLATIONS ACT OF 2009
S. Hrg. 111-369
EVALUATING S. 1551: THE LIABILITY FOR AIDING AND ABETTING SECURITIES
VIOLATIONS ACT OF 2009
=======================================================================
HEARING
before the
SUBCOMMITTEE ON CRIME AND DRUGS
of the
COMMITTEE ON THE JUDICIARY
UNITED STATES SENATE
ONE HUNDRED ELEVENTH CONGRESS
FIRST SESSION
__________
SEPTEMBER 17, 2009
__________
Serial No. J-111-46
__________
Printed for the use of the Committee on the Judiciary
U.S. GOVERNMENT PRINTING OFFICE
55-898 WASHINGTON : 2010
-----------------------------------------------------------------------
For Sale by the Superintendent of Documents, U.S. Government Printing Office
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PATRICK J. LEAHY, Vermont, Chairman
HERB KOHL, Wisconsin JEFF SESSIONS, Alabama
DIANNE FEINSTEIN, California ORRIN G. HATCH, Utah
RUSSELL D. FEINGOLD, Wisconsin CHARLES E. GRASSLEY, Iowa
CHARLES E. SCHUMER, New York JON KYL, Arizona
RICHARD J. DURBIN, Illinois LINDSEY GRAHAM, South Carolina
BENJAMIN L. CARDIN, Maryland JOHN CORNYN, Texas
SHELDON WHITEHOUSE, Rhode Island TOM COBURN, Oklahoma
AMY KLOBUCHAR, Minnesota
EDWARD E. KAUFMAN, Delaware
ARLEN SPECTER, Pennsylvania
AL FRANKEN, Minnesota
Bruce A. Cohen, Chief Counsel and Staff Director
Matt Miner, Republican Chief Counsel
------
Subcommittee on Crime and Drugs
ARLEN SPECTER, Pennsylvania, Chairman
HERB KOHL, Wisconsin LINDSEY GRAHAM, South Carolina
DIANNE FEINSTEIN, California ORRIN G. HATCH, Utah
RUSSELL D. FEINGOLD, Wisconsin CHARLES E. GRASSLEY, Iowa
CHARLES E. SCHUMER, New York JEFF SESSIONS, Alabama
RICHARD J. DURBIN, Illinois TOM COBURN, Oklahoma
BENJAMIN L. CARDIN, Maryland
AMY KLOBUCHAR, Minnesota
EDWARD E. KAUFMAN, Delaware
Hanibal Kemerer, Democratic Chief Counsel
Walt Kuhn, Republican Chief Counsel
C O N T E N T S
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STATEMENTS OF COMMITTEE MEMBERS
Page
Leahy, Hon. Patrick J., a U.S. Senator from the State of Vermont,
prepared statement............................................. 164
Specter, Hon. Arlen, a U.S. Senator from the State of
Pennsylvania................................................... 1
WITNESSES
Coffee, John C., Jr., Adolf A. Berle Professor of Law, Columbia
University School of Law, New York, New York................... 2
Giuffra, Robert J., Jr., Partner, Sullivan & Cromwell LLP, New
York, New York................................................. 4
Pritchard, Adam C., Frances and George Skestos Professor of Law,
Director, Empirical Legal Studies Center, University of
Michigan Law School, Ann Arbor, Michigan....................... 6
Solov, Tanya, Director, Illinois Securities Department, Office of
the Illinois Secretary of State, on behalf of the North
American Securities Administrators Association, Washington,
D.C............................................................ 8
Szymanski, Patrick J., General Counsel, Change to Win,
Washington, D.C................................................ 9
QUESTIONS AND ANSWERS
Questions submitted by Senator Specter to John C. Coffee, Jr.,
(Note: Responses to questions were not received as of the time
of printing, April 22, 2010)................................... 18
Responses of Robert J. Giuffra to questions submitted by Senator
Specter........................................................ 22
Responses of Adam C. Pritchard to questions submitted by Senator
Specter........................................................ 25
SUBMISSIONS FOR THE RECORD
AFL-CIO, Richard L. Trumka, Secretary-Treasurer, Washington,
D.C., letter................................................... 26
Business Roundtable, brief....................................... 28
Chamber of Commerce, R. Bruce Josten, Executive Vice President,
Government Affairs, Washington, D.C., letter and brief......... 61
Coffee, John C., Jr., Adolf A. Berle Professor of Law, Columbia
University School of Law, New York, New York, statement........ 102
Dodd, Hon. Christopher J., a U.S. Senator from the State of
Connecticut:
Letter to Solicitor General Paul Clement..................... 114
Letter to Christopher Cox.................................... 116
Letter to President George W. Bush........................... 118
Giuffra, Robert J., Jr., Partner, Sullivan & Cromwell LLP, New
York, New York, statement...................................... 120
Government Affairs Subcommittee, Enron's Collapse................ 136
Lacorte, Dagan A., Village Trustee, Village of Suffern, Suffern,
New York, letter............................................... 163
Levitt-Amicus Brief Stoneridge 2007,............................. 165
Logan, Brendel, on behalf of Hudson Valley Environmental Action
Fund, Albany, New York, letter................................. 182
Miller, Arthur R., National Law Journal, September 24, 2007 case. 184
NYSE Euronext, John K. Halvey, Group Executive Vice President &
General Counsel, New York, New York, letter and brief.......... 186
New York Times, July 28, 2009, article........................... 215
Pritchard, Adam C., Frances and George Skestos Professor of Law,
Director, Empirical Legal Studies Center, University of
Michigan Law School, Ann Arbor, Michigan, statement and article 216
SEC v. Bank of America, U.S. District Court Southern District of
New York, Memorandum order..................................... 262
Securities Industry and Financial Markets Association (SIFMA),
Scott DeFife, Senior Managing Director, Government Affairs,
Washington, D.C., letter and brief............................. 274
Solov, Tanya, Director, Illinois Securities Department, Office of
the Illinois Secretary of State, on behalf of the North
American Securities Administrators Association, Washington,
D.C., statement................................................ 320
Soskin, Philp, Chair, Multi-Services Committees, Budget & Finance
Committee, Government Operations Committee, Treasurer, Rockland
County Solid Waste Management Authority, letter................ 324
Specter, Hon. Arlen, a U.S. Senator from the State of
Pennsylvania, letter........................................... 326
Szymanski, Patrick J., General Counsel, Change to Win,
Washington, D.C., statement.................................... 328
Wall Street Journal, New York, New York:
July 17, 2009, article....................................... 351
August 10, 2009, article..................................... 352
Westlaw, Thomson Reuters:
Central Bank amicus brief.................................... 353
In re Refco.................................................. 375
EVALUATING S. 1551: THE LIABILITY FOR AIDING AND ABETTING SECURITIES
VIOLATIONS ACT OF 2009
----------
THURSDAY, SEPTEMBER 17, 2009
U.S. Senate,
Subcommittee on Crime and Drugs,
Committee on the Judiciary,
Washington, DC.
The Subcommittee met, pursuant to notice, at 5 p.m., in
room SD-226, Dirksen Senate Office Building, Hon. Arlen
Specter, Chairman of the Subcommittee, presiding.
Present: Senator Specter.
OPENING STATEMENT OF HON. ARLEN SPECTER, A U.S. SENATOR FROM
THE STATE OF PENNSYLVANIA
Chairman Specter. Good afternoon, ladies and gentlemen. The
hearing will proceed.
I regret the delay in beginning this hearing, but I know
you are fully aware of the circumstances which delayed it,
circumstances which made the delay unavoidable. The Senate has
its own tempo, and we have just finished a series of votes. And
this is a very important hearing, and I would like to see
legislation result from the hearing and think it important to
establish a record which can be reviewed by other Committee
members who are not here and by other Senators to establish a
basis for legislative action.
When I noted the decision in Stoneridge, I was more than
surprised; I was shocked. From my own experience as a district
attorney, knowing aiders and abetters are co-conspirators and
are liable, hard to understand. And in the context where the
circuits until 1994 were unanimous, with the arguable exception
of the Seventh Circuit, imposing such liability, two Supreme
Court decisions, really makes me wonder what the court is up
to. And there have been commentaries about this Court being
partial to big business. Hard to understand how aiders and
abetters are not liable. And in light of some of the recent
developments, consideration perhaps should be given to some
modification of our standards on the confirmation process.
The tradition has been that nominees are never asked how
they are going to decide cases. And when Chief Justice Roberts
testified that it was a matter for Congress to decide the
factual basis for decisions under the Supreme Court standard of
proportionate--proportionate and what? Very hard to remember
proportionate and congruent because it makes little sense. Then
the voting rights came up, and he appeared to disregard a very
extensive congressional record. And now we are looking at a
decision on corporate contributions which, if reversed, is
going to set the electoral process on its head in this country
if corporations can make contributions in political campaigns.
We would not countenance someone who would overturn Brown
v. Board of Education, and maybe we have to look beyond. This
issue raises in a sense that question.
Well, there is a lot that I have on my mind in this and
related subjects, but that has been about as brief as I can be.
I intend to make an extended floor statement on the subject
next week, if I can get to it. But we are going to proceed now
with the bare bones, with no introductions, which is something
I would like to take time to elaborate upon, but in view of the
hour, I am just going to turn to our first witness, Professor
John C. Coffee, Adolf A. Berle Professor of Law at Columbia,
the author of a textbook way back when I went to law school.
Professor Coffee, the floor is yours.
STATEMENT OF JOHN C. COFFEE, JR., ADOLF A. BERLE PROFESSOR OF
LAW, COLUMBIA UNIVERSITY SCHOOL OF LAW, NEW YORK, NEW YORK
Mr. Coffee. Thank you very much, and I am honored to be
here, and I will try to be quite concise.
You focused on an anomaly, Chairman Specter, and it is an
anomaly. For over a century, there has been criminal liability
for anyone who aids and abets a Federal violation of law. For
about a half-century, the Restatement of Torts, written by the
American Law Institute, has stated the rule that private
liability exists and a victim can sue not only the primary
violator but a secondary violator who provides substantial
assistance.
Many Federal statutes, including the Commodities Exchange
Act, which is something that closely parallels the Securities
Exchange Act, does provide for private actions against aiders
and abetters. But we have the Federal securities laws which,
since 1994, do not permit the victim to sue the aider and
abetter even if there is conscious, knowing assistance given to
the primary violation.
Now, it is time to reevaluate that. There are many--and I
fully acknowledge that in 1995, Congress, in passing the
Private Securities Litigation Reform Act, accepted the Supreme
Court's decision in Central Bank, but we have seen a lot of
water go over the dam since then. We have seen serious
developments and maybe some deterioration in the discipline and
our capital markets. Just thinking back over the last decade,
we have had the IPO bubble in 2000, Enron and WorldCom in 2001
and 2002; we have had the securities analyst scandals; we have
had the market timing abuses. And now we have this huge credit
crisis that dwarfs everything else.
All of this suggests that the critical gatekeepers in our
financial markets, the financial intermediaries, on whom
investors rely to do things that they cannot do for themselves,
such as the accountants, such as the credit rating agencies,
may be under-deterred, and if they are under-deterred, we
cannot expect to get back to equilibrium without some
discipline on actors whose role is absolutely essential in the
financial markets.
Now, from a policy perspective, I would suggest this entire
debate comes down to one critical issue: Do we think that
public enforcement standing alone can do the job of deterring,
disciplining, and obtaining compensation for victims from these
secondary participants? I am going to suggest to you that there
are at least three reasons why public enforcement, although
very important, is not sufficient to do that job by itself.
Public enforcement in the context of securities violations
means enforcement by the Securities and Exchange Commission. I
am an admirer of that body, for all of its recent problems, but
it has got at least three fundamental problems that I think we
have to recognize.
The SEC is authorized to sue aiders and abetters for
knowing violations, but it can only seek relatively modest
civil penalties plus disgorgement of ill-gotten gains. It
cannot sue for restitution on behalf of all the victims, and
that is the huge difference between disgorgement and
restitution.
Next, the SEC always has been, is now, and always will be
cost constrained and logistically underfunded, and they will be
the first to say that. The SEC is also not administratively
capable of handling the equivalent of a large class action in
terms of settling claims, dealing with all the class members,
and disbursing the proceeds. It would be an administrative
nightmare for them if they were to try to deal with the issue
of handling restitution.
Finally, the last point I would say about the Securities
and Exchange Commission is a sensitive one, and I do not want
to overstate it. Recent scandals--Mr. Madoff, the current Bank
of America issue--suggest that the SEC does not proceed quite
as zealously and vigorously against prominent figures and
established firms as they do against the outcasts and the out-
and-out crooks. But if we are going to have discipline in the
capital markets, there has to be someone who will take serious
disciplinary action, seek serious penalties against the major
gatekeepers. And I think private enforcement can do that better
than can public enforcement.
We have already seen that private enforcement. Look at the
Enron class action or the WorldCom class action. They both
settled for $7.5 billion and $6.5 billion, respectively. Those
are numbers that dwarf anything the SEC has ever received in
the way of penalties or in the way of class action recoveries.
The point here is really that the private enforcement bar can
chase the money, can get significant claims, and it is not
interested in simply getting headlines. For better or worse,
they do go where the money is, and that is what is needed if we
are going to get compensation for victims.
Let me make two last points in just a second or two. One is
that you are going to hear an awful lot about how authorizing
liability against aiders and abetters will open the floodgates
for frivolous and extortionate litigation. That might have been
true, arguably, once. But since the Private Securities
Litigation Reform Act of 1995, secondary participants are not
only protected, they are virtually insulated because of the
pleading rules under that act, because you cannot get discovery
unless you can plead with particularity facts giving rise to a
strong inference of fraud.
There is no realistic prospect of frivolous, extortionate
litigation brought against secondary participants. They can
have that action dismissed without discovery unless at the
outset you can show a very strong case that gives rise to a
strong inference of fraud.
And last, in just a sentence, in my proposal I suggest to
you that you couple restoring private liability with a ceiling
on damages. That is because the real goal here should be to
create a penalty that deters but does not destroy. We do not
want to see the loss of one more accounting firm like Arthur
Andersen or one credit rating agency, because they are both in
very concentrated markets. So I would suggest to you that the
Solomonic compromise here--and I try to give you a possible
model--is to restore aiding and abetting liability with a
realistic ceiling on damages for secondary participants in
securities violations.
Thank you very much.
[The prepared statement of Mr. Coffee appears as a
submission for the record.]
Chairman Specter. Thank you, Professor Coffee.
We turn now to Robert Giuffra--how do you pronounce that?
Mr. Giuffra. Giuffra. We met before, Senator. Giuffra.
Chairman Specter. Thank you. Partner of the prestigious law
firm Sullivan & Cromwell.
STATEMENT OF ROBERT J. GIUFFRA, JR., PARTNER, SULLIVAN &
CROMWELL LLP, NEW YORK, NEW YORK
Mr. Giuffra. Mr. Chairman, in 1995, the PSLRA was passed
with broad bipartisan support, including of Senators Dodd,
Kennedy, and Reed, and then-Representative Schumer. As chief
counsel to the Senate Banking Committee when Senator D'Amato
chaired it, I worked closely with Republicans, Democrats, and
then-SEC Chairman Arthur Levitt to develop a balanced law.
Congress should not revisit the bipartisan judgment made in
1995 in the PSLRA. That judgment was that the SEC and the
Justice Department are best suited to prosecute aiders and
abetters of securities fraud.
S. 1551 would greatly expand the existing securities class
action system, but this system benefits lawyers, often does not
help investors, and often is not fair.
Now, in the real world, where I practice law, motions to
dismiss and summary judgment do not weed out baseless claims.
In fact, less than 40 percent of all securities class action
cases are ever dismissed on a motion. Less than 40 percent.
More than 60 percent are settled, and, you know, one or two a
year are ever tried. Less than 30 percent are ever dismissed on
a motion to dismiss. In other words, by bringing a securities
class action lawsuit, a lawyer has a better than 60 percent
chance of getting fees through a settlement. Great odds.
Now, juries can be unpredictable. There is on deep-pocket
third party that wants to risk losing a multi-billion-dollar
jury verdict. And even where a case has no merit, companies
have to spend tens of millions of dollars defending those
cases, reviewing millions of e-mails.
Now, to eliminate settlements because a judge did not
dismiss a baseless securities case, what Congress should do, as
Senator Schumer has suggested, is permit parties as a right to
appeal lower-court decisions denying motions to dismiss. If S.
1551 is enacted, the plaintiffs' bar will routinely name
defendants all deep pockets who did business with a company.
Plaintiffs' lawyers do not need documentary evidence to survive
a motion to dismiss. They just need to cut a deal with one
criminal insider who will point the finger at a banker or a
lawyer. And today, when bankers, accountants, and lawyers
receive hundreds of e-mails a day, it is very easy for a lawyer
to blow one e-mail out of proportion.
Now, S. 1551 would hurt the competitiveness of U.S. capital
markets. In Europe and Asia, there are no securities class
actions. Non-U.S. companies do not think that our system is
fair, and they are leaving our markets.
I live and work in New York City. Enactment of this
proposal would be good for the city of London, but it would not
be good for New York, Philadelphia, or other U.S. financial
centers.
Now, since 1995, the SEC, the Justice Department, and State
Attorney Generals have investigated the banks, the accountants,
and the lawyers who provided services to Enron, WorldCom, Tyco,
Refco, and the other companies that suffered major frauds and,
when appropriate, they have taken action. Federal prosecutors
convicted the law firm partner involved in the Refco matter and
several Enron bankers, and the SEC obtained $50 million from
the cable box providers involved in the Stoneridge case.
Now, SEC lawyers and DOJ lawyers serve the public interest.
They have no incentive to bring strike suits. The SEC and the
DOJ are far better than private lawyers to exercise the
discretion and judgment that is needed to decide when a
banker's conduct crossed the line.
By contrast, plaintiffs' lawyers have every incentive to
sue deep-pocket third parties. The SEC can recover and the DOJ
can recover damages from wrongdoers. Since 2002, the SEC has
recovered more than a billion dollars and the DOJ billions
more. And the SEC and the DOJ do not have to pay as much as a
third of any recovery to lawyers, and there is no risk that SEC
or DOJ lawyers will pay kickbacks to plaintiffs or make
political contributions to pension fund administrators to get
control of cases. And the threat of 20 years in prison is a far
greater deterrent to securities fraud than civil litigation.
Finally, ``fraud'' is a very loose term. When a murder
occurs, we can all agree that a crime has been committed. Not
so with securities fraud. Prior to Central Bank, courts
required plaintiffs to prove that secondary actors actually
knew that the fraud they allegedly were assisting as going on.
In this proposal, Senator, by adopting an open-ended definition
of ``recklessness,'' this would force many companies to settle
baseless cases. The proposal of just pure recklessness without
any definition would be far more lenient than the existing
standard that judges across the United States have adopted.
So, to sum up, Congress should continue to rely on the SEC
and the Department of Justice to prosecute aiders and abetters.
The benefits of private enforcement are few, and the costs to
our economy was potentially very great.
Thank you.
[The prepared statement of Mr. Giuffra appears as a
submission for the record.]
Chairman Specter. Thank you very much.
I have to take a 2-minute break.
[Recess 5:19 p.m. to 5:22 p.m.]
Chairman Specter. Our next witness is Professor Adam
Pritchard, Frances and George Skestos Professor of Law at the
University of Michigan.
Professor Pritchard.
STATEMENT OF ADAM C. PRITCHARD, FRANCES AND GEORGE SKESTOS
PROFESSOR OF LAW, DIRECTOR, EMPIRICAL LEGAL STUDIES CENTER,
UNIVERSITY OF MICHIGAN LAW SCHOOL, ANN ARBOR, MICHIGAN
Mr. Pritchard. I want to thank you, Chairman Specter, for
inviting me to testify today.
There are two possible justifications for imposing
liability for securities fraud: compensation and deterrence.
Neither one of those rationales supports the extension of
liability to accountants, bankers, and lawyers that is proposed
in this bill.
To put it bluntly, the compensation rationale for
securities class actions is nonsense. Class actions provide
about 3 to 10 cents on the dollar of the losses that investors
have sustained, and that is a good thing. If we were to
actually provide compensation for the full losses that
investors suffered in securities class actions, it would be an
economic disaster. Shareholders are paying the compensation
that is paid out in securities class actions because the
settlement dollars come from the corporation itself or the
directors and officers' insurance that is paid for by the
corporation.
So we have an insurance scheme--an insurance scheme that
protects against fraud, but it is an insurance scheme in which
we have to pay 50 cents on every premium dollar for
administrative costs. Plaintiffs' lawyers get paid, the defense
lawyers get paid, and the shareholders get their own money
back, with a big haircut for the lawyers.
If you tried to sell this sort of insurance policy to a
shareholder, you would not be able to find anyone who would buy
it. If you tried to get an insurance commissioner to approve
it, you would not find any insurance commissioner in the United
States who would let you sell it.
Aiding and abetting liability would not change that
calculus. Shareholders are effectively paying the fees that go
to accountants, lawyers, and investment banks, and any
liability costs that we impose on those professionals are going
to be passed back to the shareholders in the form of higher
fees. There is no free lunch in adding new deep pockets. We
just will be able to employ more lawyers. As an educator of
future lawyers, I want to say that is a good thing, but it is
not enough to justify the bill. The only effective protection
against secondary market fraud is diversification.
The second rationale for imposing securities fraud
liability is deterrence. Given what we know about securities
fraud class actions based on the studies that have been done
over the last 10 years since the Private Securities Litigation
Reform Act was adopted, it is implausible that securities class
actions have any important deterrent impact at the margin above
and beyond reputational effects in the market and Government
enforcement efforts.
If you want to know what the predictors are of securities
fraud class actions--how can you predict who is going to be
sued--the relevant criteria are market capitalization, share
turnover, stock price drop, Government investigations, and
restatements of accounting statements. The class action bar
does not uncover fraud. It follows these very public
indicators. The stock price drop occurs. The class action bar
responds.
Secondary defendants are sued when the corporation is
bankrupt. The corporation is the easy settlement target.
Ordinarily, the plaintiffs' lawyers are happy to go after them.
That would not change if aiding and abetting liability were to
be introduced. If we protect shareholders against the effects
of bankruptcy by giving them a deep pocket to sue in the case
when the corporation has gone bankrupt, it is going to further
undermine the deterrent effect of securities class actions.
The problem with securities class actions is that the
individuals who commit fraud--the officers who lie--do not pay
in these class actions. If we take away the incentive to go
after those officers in bankruptcy, which is the only time that
the officers and directors pay, the plaintiffs' lawyers will
pursue the investment bankers and the accountants because they
can pay a lot more than the individual officers can.
If we want to reform securities fraud class actions, we
need to begin with the fundamental economic problem. We need to
fix the damages measure. There are two ways to do this.
Congress could reform the damages measure directly, or we could
allow shareholders to adopt the appropriate damages measure
through the company's articles of incorporation.
The appropriate measure is disgorgement. If you have
committed fraud, give back the benefits of the fraud, perhaps
with a multiplier to reflect the probability that not all fraud
would be detected. Maybe we would need to have attorney fee
shifting. If the corporation has not benefited from the fraud,
which is the overwhelming case, then there would be no damages.
If the officer has benefited in the form of bonuses or stock
options, the officer would have to pay. Apply the same rule to
the secondary defendants.
In conclusion, the capital markets and the U.S. Treasury
would be the victims if liability bankrupts an accounting firm
or a TARP recipient. Without reforming the damages measure, it
would be reckless to adopt aiding and abetting liability.
[The prepared statement of Mr. Pritchard appears as a
submission for the record.]
Chairman Specter. Thank you very much, Professor Pritchard.
Our next witness is Ms. Tanya Solov, Director of the
Securities Department of the Office of the Illinois Secretary
of State. Welcome and we look forward to your testimony.
STATEMENT OF TANYA SOLOV, DIRECTOR, ILLINOIS SECURITIES
DEPARTMENT, OFFICE OF THE ILLINOIS SECRETARY OF STATE, ON
BEHALF OF THE NORTH AMERICAN SECURITIES ADMINISTRATORS
ASSOCIATION, WASHINGTON, D.C.
Ms. Solov. Thank you, Chairman Specter. I am honored to
convey the support of the North American Securities
Administrators Association for S. 1551, the Liability for
Aiding and Abetting Securities Violations Act.
NASAA is the member association of State and provincial
securities regulators and maintains a corporate office in
Washington, D.C. State securities regulators, license broker-
dealers, and investment advisers, register local securities
offerings and conduct compliance examinations. Especially
important is their enforcement role: protecting the Nation's
investors by bringing thousands of actions every year against
the firms and individuals who have committed securities fraud.
In certain cases, regulators seek restitution or rescission on
behalf of investors. However, given the large number of
investors in the market today, private civil cases are a
necessary and important complement to State and Federal
actions. S. 1551 would restore the ability of defrauded
investors to seek damages from all of the entities that
substantially participated in the fraud.
My colleagues and I have witnessed firsthand the
devastation of financial fraud on victims and their families.
Investor education materials teach investors to conduct
research on companies prior to investing, but no amount of
research will allow investors to make appropriate decisions if
the financial and other public information provided by
companies is false or misleading. The integrity of the U.S.
markets depends on accurate information, and our laws must send
the message to corporate management, as well as their lawyers,
accountants, investment bankers, and other so-called secondary
actors, that they will be held accountable for aiding and
abetting in deception and fraud.
In passing the Securities Exchange Act, Congress implicitly
authorized a private right of action, and for decades
thereafter courts allowed private suits. As Professor Coffee
stated, the right to bring a private suit for aiding and
abetting has been severely restricted by the Supreme Court and
other courts. The decisions in these cases favor big business
over innocent investors. Corporations and secondary actors
often seek short-term profits, big bonuses, and large fees, and
many times these goals can be achieved by cooking the books or
engaging in sham transactions. Sham transactions are
fraudulent, and even the majority in Stoneridge acknowledged
that they are not baseless. If secondary actors are permitted
to avoid liability, there will be no deterrent to prevent them
from engaging in fraudulent schemes.
State and Federal regulators filed numerous cases against
corporations and secondary actors in the past decade. However,
many more cases of fraud were not pursued by regulators due to
resource limitations. The majority in Stoneridge contends that
aiding and abetting actions can be brought by the SEC on behalf
of shareholders. While it is true that Federal regulators can
pursue such cases, Chairman Mary Schapiro stated that the
agency's enforcement and examination resources have been
severely constrained in recent years. The SEC's immediate
agenda includes proxy access, compensation disclosure, hedge
funds, and others that need regulatory attention. Significant
SEC resources will be expended working on these priorities as
well as large Ponzi scheme cases and fraudulent activity having
national impact. Cases involving a limited number of
shareholders are less likely to be addressed.
Critics of private securities actions claim that such cases
provide little benefit to victims, they punish innocent
shareholders, and unjustly reward plaintiffs' lawyers. In
reality, over the years private actions resulted in greater
recoveries for shareholders than the compensation from
regulatory actions. The fact that victims were not able to
recover full damages is the result of a number of factors
including the shareholders' desire to settle for less rather
than to spend more time in litigation. The contention that
paying defrauded investors harms innocent, current shareholders
is not really applicable in cases involving secondary actors
such as accountants. The vast majority of shareholders want
accountability and the right to seek redress for wrongdoing. If
management is concerned about current shareholders, it might
strip away the bonuses, high salaries, and stock options
awarded to those who participated in the fraud and place those
assets in the victim restitution fund. With regard to
plaintiffs' lawyers' fees, it is important to remember that
class action settlements, including attorneys' fees, are
reviewed and approved by judges. The recent Bank of America
case is an example of a case where the judge refused to approve
a negotiated settlement.
Allowing investors to file aiding and abetting cases will
not open the floodgates of litigation and stifle business
development. Private suits were allowed prior to the Central
Bank and Stoneridge decisions, and businesses grew and
flourished during those years. Congress enacted Section 10(b)
of the Securities Exchange Act with the understanding that
Federal courts respected the principle that every wrong would
have a remedy. S. 1551 recognizes the right of defrauded
shareholders to bring private actions against aiders and
abetters and to seek remedies from wrongdoers.
In the interest of investor protection and market
integrity, NASAA supports S. 1551. Thank you.
[The prepared statement of Ms. Solov appears as a
submission for the record.]
Chairman Specter. Thank you very much, Ms. Solov.
Our final witness is the general counsel of Change to Win,
Patrick--Szymanski?
Mr. Szymanski. Szymanski, Your Honor--Senator Specter. I
think I am back in the court of appeals someplace.
Chairman Specter. Mr. Szymanski, I am not a ``Your Honor.''
[Laughter.]
Chairman Specter. Thank you for joining us.
STATEMENT OF PATRICK J. SZYMANSKI, GENERAL COUNSEL, CHANGE TO
WIN, WASHINGTON, D.C.
Mr. Szymanski. Thank you, Senator. And, again, thanks to
you for the invitation to testify. Let me confess at the outset
that, unlike the other people sitting up here, I have not spent
my career involved in securities litigation. I am a union
lawyer, and I spent a lot of time talking to workers, and I
have got to disagree with Mr. Giuffra when he basically says we
ought to leave things the way they are. I do not think what we
have seen since the mid-1990's indicates in anybody's mind that
things ought to stay where they were back then.
Professor Coffee catalogued very briefly and succinctly
many of the things that have happened since then that indicate
that it is time for a reexamination. And whether it is the
result of my talking to workers or just my own natural bias, I
have always thought that the law ought to make sense. I have
always thought that you ought to be able to explain things so
that a reasonably intelligent person can understand them. And
as far as I am concerned, any rule of law that does not make
sense has got a problem. And Stoneridge does not make any
sense.
In Stoneridge, two providers of cable TV converters--
Scientific Atlanta and Motorola--entered into sham contracts
with a cable TV service provider, Charter Communications, to
artificially inflate Charter's assets. There was no economic
reason for the contracts. They had a perfectly fine
relationship before these changes happened. The contracts were
back-dated to fool Charter's outside audit firm, and Scientific
Atlanta and Motorola knew that the additional fictional income
would be used to artificially inflate Charter's assets. In
short, the fraud on shareholders could not have been
accomplished in that case without the willing participation and
knowing participation of Scientific Atlanta and Motorola. But
the Supreme Court in Stoneridge held that because Scientific
Atlanta and Motorola had no duty to the shareholders and made
no public statements, they are not responsible for any of the
losses that were suffered by the Charter Communications
shareholders.
Now, my written testimony describes similar cases involving
Enron, Refco, Homestore.com, Pugh v. Tribune. Interestingly,
the judge in Refco is Judge Lynch. And in some of these cases,
the wrongdoing participants were convicted or pled guilty to
criminal charges, and they still completely escaped any civil
liability or responsibility for the losses suffered by the
innocent shareholders. Now, you just try explaining that to a
worker, someone who goes out every day and makes money, as John
Houseman used to say, ``the old-fashioned way.'' He and she
``earn it.''
This makes no sense. It does not make sense to me, and it
does not make sense to hard-working Americans who invest their
own funds in 401(k)s and IRAs and in pension funds in which
they participate. And let me make that point. We sometimes talk
about institutional investors as though they are something
different. They are not different than workers. They are simply
holding the funds that those workers earned in trust for a
purpose: to pay pensions that those workers are relying on when
it comes time for them to retire. And when they are injured,
the workers are injured, and that is worker money, not money
that belongs to anybody else. And the Government, their
Government, should be protecting them, not the wrongdoers who
are responsible for defrauding them. People ought to be
responsible for their actions, and the idea that these third-
party people are immune from liability is ridiculous.
So I am here to tell you that the organizations who
represent workers, who brought America the weekend, holidays,
the 40-hour work week, employer-paid health care, pensions, and
health and safety standards and more, and who are still
fighting to keep those standards on behalf of working people in
this country, support Senate bill 1551, which tries to bring
some common sense back into this area of the law.
I look forward to your questions, Senator. Thank you.
[The prepared statement of Mr. Szymanski appears as a
submission for the record.]
Chairman Specter. Thank you very much, Mr. Szymanski.
Professor Pritchard, in looking for deterrence, what would
you think about an active role by the Department of Justice to
utilize 18 U.S.C. Section 2 to send people to jail because the
Federal criminal law makes it a criminal violation to aid and
abet somebody who commits a crime? Fraud is a crime.
Mr. Pritchard. I think criminal enforcement is essential to
deterring fraud, and I have no complaint about it being applied
against third parties who have assisted, aided, facilitated the
fraud. As long as their guilt is determined beyond a reasonable
doubt to a jury and the standards for fraudulent intent are
met, then I think that is an excellent deterrent to fraud.
Chairman Specter. But proving that you think should be
insufficient for damages for the shareholder?
Mr. Pritchard. Insofar as the third party may have received
benefits from participating in the fraud, I think they
definitely should be made to pay those back.
Chairman Specter. Well, you have testified about
disgorgement, but you think even though their conduct is
sufficient to send them to jail, it is not sufficient to
compensate the party who has been injured by that conduct.
Mr. Pritchard. I think the compensation is irrelevant. What
is important is sending them to jail. Sending people to jail is
a very strong message that you should not do that.
Chairman Specter. There is some thinking on cases like
Pinto that it is insufficient to have the tortfeasor pay
damages. Pinto is a good illustration of the document showing
that Ford executives knew that putting the gas tank at the rear
to save money from putting it in a less exposed spot
constituted malice, supports a conviction for murder in the
second degree, and that that would be the way to really deal
with corporate executives who knowingly put into the stream of
commerce items which are reasonably expected to cause serious
bodily injury or death. Do you think that would be a
collaterally good approach?
Mr. Pritchard. A what kind of approach? I am sorry?
Chairman Specter. Well, a better approach than damages.
Mr. Pritchard. Sending people to jail if they----
Chairman Specter. I am calling it a ``collateral''
approach.
Mr. Pritchard [continuing].--Are knowingly trying to kill
people? Yes.
Chairman Specter. Well, they are not trying to kill people.
They are recklessly indifferent to it.
Ms. Solov, you talked about favoring big business, and in
the Stoneridge case the Court lined up 5-3--Justice Breyer
recused himself--which has all the contours of a traditional
ideological battle. Do you think that in favoring big business
this is a part of the liberal-conservative split on the Supreme
Court in the matter of ideology as opposed to justice, to pick
an abstract term?
Ms. Solov. Stoneridge is just one of several, of many
cases. Tellabs was another case, and there are many lower-court
cases where I think the courts are coming down in favor of big
business.
Chairman Specter. Never mind the lower courts. There are
many cases where, as the commentators have said, the Supreme
Court is favoring big business. But dealing with the Supreme
Court, do you think it is ideological?
Ms. Solov. Well, it is hard to say. I did find it
interesting in Stoneridge that, unlike the testimony that we've
heard about baseless cases, the Court did not say that these
transactions were baseless. I think in this case they were
saying that they are somehow constrained by the Private
Securities Litigation Reform Act from awarding damages and
looking to Congress. I think they are inviting Congress to make
some changes to allow for aiding and abetting liability. And
throughout the case, they write that Congress knew to include
the SEC as a party that can bring aiding and abetting actions,
but Congress did not include private rights of action.
So it is difficult----
Chairman Specter. You think they were really inviting
Congress to do something? To say that Congress could have done
it differently, do you really think it is an invitation?
Ms. Solov. Well, I think that they----
Chairman Specter. You think they would like to see Congress
change their decision?
I am coming back to my question on ideology, which you have
not answered yet. Yes or no?
Ms. Solov. I think that there seems to be a split with the
Justices, yes.
Chairman Specter. Mr. Giuffra, when you talk about the SEC
being the better agency to deal with it, Senator Grassley and
I, when he chaired the Finance Committee and I chaired the
Judiciary Committee, went after the SEC on failure to deal with
insider trading. And we had very much the same view that was
stated by Judge Rakoff in the celebrated refusal to accept the
settlement this week, castigating the SEC. I will not ask you
if you thought Senator Grassley and I were wrong. Let me ask
you if you think Judge Rakoff was wrong.
Mr. Giuffra. Senator, I respect all of you and I know Judge
Rakoff quite well. The SEC does a very good job. The SEC in
these big cases--the WorldComs, the Enrons--in those cases they
take a lot of testimony, and they would love to make a case
against a wealthy lawyer, a wealthy banker, and, in fact, they
do when the facts and circumstances warrant it.
The problem is what I am concerned about is the innocent
banker and the innocent lawyer and the innocent accountant in
the case that is not the high-profile case, but where a
plaintiff's lawyer names everyone who touched a company that
has a stock drop and essentially seeks hundreds of millions of
dollars in damages. The legal fees can be in the tens of
millions of dollars. And what happens is that third party has
no choice but to settle the case.
As I mentioned in my testimony, 60-plus percent of these
cases are settled; less than 40 percent are dismissed on either
a motion to dismiss or on summary judgment.
Chairman Specter. I recall your testimony. It was only a
few minutes ago.
Mr. Giuffra. Yes, I understand.
Chairman Specter. My memory is good for about 40 minutes.
Now, do you remember my question?
Mr. Giuffra. Yes, I think the SEC--we have an excellent SEC
enforcement person, Robert Khuzami. He is going to try to do
things to even strengthen the SEC further. Obviously, Congress
can give more money to the SEC. There are a lot of really
competent lawyers at the SEC, and those lawyers do not have a
conflict of interest. They are doing the public's work.
Class action lawyers are obviously motivated by getting
attorneys' fees, and so the problem becomes that they will
bring cases that do not have merit.
Chairman Specter. You have said that before several times,
but I would like to come back to my question. My question was:
Do you think Judge Rakoff was wrong?
Mr. Giuffra. I think in that particular case, what Judge
Rakoff was concerned about was the problem of the current
shareholders of Bank of America paying money to settle this
matter, and he thought that perhaps other people should pay the
money. And that is one of the problems with class actions
generally, because what happens with class actions is the
shareholders pay the money.
Chairman Specter. I will only ask it one more time.
Mr. Giuffra. Okay.
Chairman Specter. Was Judge Rakoff wrong?
Mr. Giuffra. I think that he identified an issue, but I
still think that the SEC does a very good job. And, in fact,
the point that was made----
Chairman Specter. Let the record show you have not answered
my question unless you want to dispute my conclusion.
Mr. Giuffra. I think the concern that he has focused on,
though, is the concern about these cases, which is the pocket-
shifting problem, which is that the shareholders essentially
pay the damages, as opposed to the people who did something
wrong. And I fully support criminal--if someone engages in--if
it is a banker or a lawyer or an accountant, if they engage in
real securities fraud, put them in jail. The SEC and the
Department of Justice can do that. The problem is the cases
that are far from the line, where people are innocent and maybe
they dealt with a company that was full of fraudsters and they
were lied to, and then what happens is the plaintiffs' lawyers
will do a deal with the fraudsters and have the fraudsters
blame the lawyers and blame the accountants.
Chairman Specter. OK, that is fine. I understand your
points made repetitively. But I would just have liked to have
had an answer to the question.
Mr. Szymanski, is the Court ideological? Is this another
aspect of the ideology which permeates the Court with all these
5-4 decisions?
Mr. Szymanski. I cannot help but think that it is. I see
decisions that are customarily with a bloc of voters on one
side and a bloc of voters on the other side, and it is the same
bloc. And you can have your viewpoint about who you agree with
and who you disagree with, but it seems to be the same bloc
ruling the same way every time.
Chairman Specter. What do you think about the conventional
wisdom of deference to the President as the appointing
authority? There are some Senators who will apply an
ideological test. I think most do not. Do you think Senators
should?
Mr. Szymanski. I think, unfortunately, we have had a series
of judges nominated by Presidents, and I would say Republican
Presidents, who are much more, I think, ideological than some
of the judges appointed otherwise or nominated otherwise. I
think, unfortunately, the initial obligation ought to be for
the President of the United States to appoint good, fair judges
to begin with.
Chairman Specter. Does empathy suggest an ideology?
Mr. Szymanski. I am sorry?
Chairman Specter. Does empathy suggest an ideology?
Mr. Szymanski. Empathy does not suggest ideology to me. The
difficulty--when you talk about ideology, I think you are
talking about ideology that overrules adherence to the law and
the Constitution.
We all know that there is interpretation to be done, and
interpretation is always done with a point of view. And as good
as people try to be honest to the law, there are going to be
judgments that are going to be made, and those judgments are
colored by somebody's viewpoint about how things ought to
operate.
You know, the Supreme Court listens to the election
returns, one famous wag used to say. And I think that is true,
although I think that most of the judges honestly try to do
their best in reaching their decisions.
Chairman Specter. Do you think the judicial appointments,
the appointments to the Supreme Court are appropriate for
Presidential campaigning, as a Presidential campaign issue?
Mr. Szymanski. If the President would say that he is
interested in appointing certain people to the Court for
certain reasons? I honestly do not think that that ought to be
something that is there, that they ought to be saying that they
are going to appoint good judges who are fair judges to----
Chairman Specter. Nominees have been doing that at least
since Nixon, haven't they?
Mr. Szymanski. And I think that is unfortunate, Senator. I
really think that that is where it begins. It would be much
easier for the Senate and these nominations would be much
easier for the Senate to address if they began from a point
that was more neutral than they have been.
Chairman Specter. If they all had the sterling academic and
professional qualifications like Chief Justice Roberts?
Mr. Szymanski. I cannot say that when I saw Chief Justice
Roberts' nomination that I had a sense about how I thought he
would rule in certain cases like these, if he had the
opportunity, if the law allowed him the ability to go one way
or another, how he would rule.
Chairman Specter. What do you think of his definition of
stare decisis that the Court should be modest, should not shock
the system, should consider the length of the decision, how
many times it had been reaffirmed, how much reliance there was,
whether a contrary decision would reflect on the integrity of
the Court? Do you think those are pretty good standards?
Mr. Szymanski. I think those are very good standards.
Chairman Specter. How do you think those standards would
apply if objectively applied to letting corporations engage in
campaign--make campaign contributions?
Mr. Szymanski. I would think that the Supreme Court ought
to leave the law the way it is instead of all of a sudden
finding that the First Amendment permits corporations to do
these----
Chairman Specter. Leave the law the way it is, but how
would you think those standards for stare decisis would apply
to that issue?
Mr. Szymanski. That is the way I think that those standards
would apply. I mean, that is the way the law has been.
I will tell you personally my gripe with the whole thing
about corporations are decisions that were done in the mid-
1800's that found that corporations were people with the rights
of people. I think, frankly, although there is a lot of stare
decisis since the mid-1800's, finding that corporations are
people and should be treated as though they have the rights of
people, I do not think they should, frankly. Corporations are
legal fictions, and I do not think they should have the rights
of people. And that is where I think we went wrong.
But if you are talking about overturning stare decisis, I
am talking about overturning now 150 years of it rather than
just 35 or 40 years of it.
And, by the way, Senator, let me say I think that Judge
Rakoff was right, and I do not think he was worried about who
was going to pay the money. I think what he was concerned about
was that the amount of the settlement did not come anywhere
near the size of the $3.5 billion of the violation that was
involved.
Chairman Specter. Let me thank you for answering the Rakoff
question.
Professor Coffee, do you think the securities laws are
fairly well balanced at the present time, if we move ahead and
enact S. 1551, would be pretty well balanced?
Mr. Coffee. I think 1551 does fill the void. I do think--
and you have heard this debate between myself and Mr. Giuffra--
that public enforcement cannot do it all by itself. We need
private enforcement to supplement public enforcement, and 1551
is directing private enforcement at secondary participants and
what I will call the ``gatekeepers of our capital markets.''
Chairman Specter. What do you think of the recent----
Mr. Coffee. What do I think what?
Chairman Specter. What do you think of the recent Supreme
Court decision, opinion by Justice Kennedy changing the
pleading rules?
Mr. Coffee. Which rules--I am just not hearing fully.
Chairman Specter. The recent Supreme Court decision,
opinion by Justice Kennedy requiring a lot more specificity on
pleading in----
Mr. Coffee. Well, that is going to weed out some
meritorious cases. It is going to weed out some frivolous
cases. I think on balance it is probably going to go in the
direction of making it much harder to get access to the Court.
Chairman Specter. What happened to notice pleading,
Professor Charles E. Clark and Dioguardi v. Durning and all
that sort of thing?
Mr. Coffee. I remember both Professor and Judge Clark from
a long time ago, and he had a very liberalized pleading rule. I
do think that there has been some evidence that we needed to
cut back on frivolous litigation. I think there were some
provisions in the PSLRA that were justified and were desirable.
But precisely because we have those protections, I now think
1551 is particularly justified because you are not turning
loose a huge litigation engine on innocent secondary
participants. They have great protection--great protection
under the PSLRA.
And let me point out we are talking about a world in which
there was obvious under-deterrence in some fields. To my
knowledge, no credit rating agency has ever been held liable
for damages for securities fraud. And I think they have made
some very serious errors.
I think your 1551 would greatly increase the possibility of
holding accountable some of the critical gatekeepers who today
are not deterred.
Chairman Specter. Do you think the 1995 legislation
established an appropriate balance in the necessity of
pleading?
Mr. Coffee. I think it went a little too far. I think there
were abuses that needed to be curbed. I think it went a little
too far. If it was up to me and I ruled the world, I would
correct the balance 10 or 15 degrees back in the direction of
making it slightly more pro-plaintiff. But I would not try to
simply reverse or throw out the PSLRA. I think it has a number
of provisions that should be retained.
Chairman Specter. My recollection is I offered an amendment
which would have struck a little different balance, which
passed the Senate 57-42. Do you remember----
Mr. Giuffra. I actually do remember that. I remember being
on the floor, Senator, when you made----
Chairman Specter. I tried to talk Senator D'Amato into
holding it in conference. He probably was listening more
closely to you than to me.
[Laughter.]
Chairman Specter. What did you think of that amendment?
Probably not much because it went down in conference and you
were counsel.
Mr. Giuffra. Respectfully, Senator, I think the problem is
that what was going on in those cases was that the plaintiffs'
lawyers would see a company's stock price drop; they would go
into their support system, literally, change the names on the
form complaints, and file them the next day. They did no
investigation, no consideration of actually whether fraud had
occurred.
Chairman Specter. Why not put some teeth into Rule 11 on
penalties for frivolous lawsuits, to deal with frivolous
lawsuits?
Mr. Giuffra. We tried to do that in the PSLRA, and there
was a lot of discussion about it. And, in fact, the House bill
had much tougher provisions to sanction lawyers. The Senate
bill reduced those provisions, and there is a provision in the
PSLRA that says that at the end of every case the judge should
consider whether Rule 11 sanctions should be imposed.
Typically, since most of these cases settle or are
dismissed, the defense lawyers do not want to really fight with
the plaintiffs' lawyers, and the cases where they are
dismissed, everybody just wants it to go away. And I, in fact,
was involved in a case recently where the judge basically said
it was a baseless complaint. We said let us try to see if the
judge will look and see whether Rule 11 sanctions should be
filed. And in that particular case, the plaintiff's lawyer and
I had a conversation, and the plaintiff's lawyer had filed a
motion to dismiss, and I decided it was better for my client,
rather than to litigate about sanctions, to just have the case
be dropped.
So sanctions are--you know, courts are not in the United
States very pro-sanctions. It is much more of a U.K. concept.
Chairman Specter. Yes, but you are a fellow who likes
deterrence. Wouldn't that have been a deterrent to some
lawyers?
Mr. Giuffra. Absolutely, but at least in the United States
we do not have a loser-pay rule, and that is one of the issues.
You can----
Chairman Specter. Well, it is not loser pay if you can
prove sanctions under Rule 11.
Mr. Giuffra. Absolutely. But there are so few cases where
lawyers are actually ever sanctioned, notwithstanding the----
Chairman Specter. It seems to me like you have one, as you
describe it, where it could have been done.
Mr. Giuffra. And I decided it was better for my client not
to pursue the sanctions because they would appeal, it would be
more money being spent on the case, and so it was better just
to have it end.
Chairman Specter. We are now at the 1-hour mark, and thank
you very much for staying. This is a very, very distinguished
panel. You are even more erudite than you are patient, which is
going some, on a 2 o'clock hearing which was rescheduled for 3,
then for 4, and started at 5. So thank you all very much for
coming.
[Whereupon, at 6:02 p.m., the Subcommittee was adjourned.]
[Questions and answers and submission for the record
follow.]
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