    [House Hearing, 116 Congress]
    [From the U.S. Government Publishing Office]

                        INSIDER TRADING AND STOCK OPTION
                      GRANTS: AN EXAMINATION OF CORPORATE
                       INTEGRITY IN THE COVID-19 PANDEMIC

    =======================================================================

                                    HEARING

                                   BEFORE THE

                      SUBCOMMITTEE ON INVESTOR PROTECTION,

                     ENTREPRENEURSHIP, AND CAPITAL MARKETS

                                     OF THE

                        COMMITTEE ON FINANCIAL SERVICES

                         U.S. HOUSE OF REPRESENTATIVES

                         ONE HUNDRED SIXTEENTH CONGRESS

                                 SECOND SESSION

                                   __________

                               SEPTEMBER 17, 2020

                                   __________

           Printed for the use of the Committee on Financial Services

                               Serial No. 116-110

                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                     MAXINE WATERS, California, Chairwoman

    CAROLYN B. MALONEY, New York         PATRICK McHENRY, North Carolina,
    NYDIA M. VELAZQUEZ, New York             Ranking Member
    BRAD SHERMAN, California             ANN WAGNER, Missouri
    GREGORY W. MEEKS, New York           FRANK D. LUCAS, Oklahoma
    WM. LACY CLAY, Missouri              BILL POSEY, Florida
    DAVID SCOTT, Georgia                 BLAINE LUETKEMEYER, Missouri
    AL GREEN, Texas                      BILL HUIZENGA, Michigan
    EMANUEL CLEAVER, Missouri            STEVE STIVERS, Ohio
    ED PERLMUTTER, Colorado              ANDY BARR, Kentucky
    JIM A. HIMES, Connecticut            SCOTT TIPTON, Colorado
    BILL FOSTER, Illinois                ROGER WILLIAMS, Texas
    JOYCE BEATTY, Ohio                   FRENCH HILL, Arkansas
    DENNY HECK, Washington               TOM EMMER, Minnesota
    JUAN VARGAS, California              LEE M. ZELDIN, New York
    JOSH GOTTHEIMER, New Jersey          BARRY LOUDERMILK, Georgia
    VICENTE GONZALEZ, Texas              ALEXANDER X. MOONEY, West Virginia
    AL LAWSON, Florida                   WARREN DAVIDSON, Ohio
    MICHAEL SAN NICOLAS, Guam            TED BUDD, North Carolina
    RASHIDA TLAIB, Michigan              DAVID KUSTOFF, Tennessee
    KATIE PORTER, California             TREY HOLLINGSWORTH, Indiana
    CINDY AXNE, Iowa                     ANTHONY GONZALEZ, Ohio
    SEAN CASTEN, Illinois                JOHN ROSE, Tennessee
    AYANNA PRESSLEY, Massachusetts       BRYAN STEIL, Wisconsin
    BEN McADAMS, Utah                    LANCE GOODEN, Texas
    ALEXANDRIA OCASIO-CORTEZ, New York   DENVER RIGGLEMAN, Virginia
    JENNIFER WEXTON, Virginia            WILLIAM TIMMONS, South Carolina
    STEPHEN F. LYNCH, Massachusetts      VAN TAYLOR, Texas
    TULSI GABBARD, Hawaii
    ALMA ADAMS, North Carolina
    MADELEINE DEAN, Pennsylvania
    JESUS ``CHUY'' GARCIA, Illinois
    SYLVIA GARCIA, Texas
    DEAN PHILLIPS, Minnesota

                       Charla Ouertatani, Staff Director
            Subcommittee on Investor Protection, Entrepreneurship,
                              and Capital Markets

                       BRAD SHERMAN, California, Chairman

    CAROLYN B. MALONEY, New York,        BILL HUIZENGA, Michigan, Ranking
    DAVID SCOTT, Georgia                     Member
    JIM A. HIMES, Connecticut            STEVE STIVERS, Ohio
    BILL FOSTER, Illinois                ANN WAGNER, Missouri
    GREGORY W. MEEKS, New York           FRENCH HILL, Arkansas
    JUAN VARGAS, California              TOM EMMER, Minnesota
    JOSH GOTTHEIMER. New Jersey          ALEXANDER X. MOONEY, West Virginia
    VICENTE GONZALEZ, Texas              WARREN DAVIDSON, Ohio
    MICHAEL SAN NICOLAS, Guam            TREY HOLLINGSWORTH, Indiana, Vice
    KATIE PORTER, California                 Ranking Member
    CINDY AXNE, Iowa                     ANTHONY GONZALEZ, Ohio
    SEAN CASTEN, Illinois                BRYAN STEIL, Wisconsin
    ALEXANDRIA OCASIO-CORTEZ, New York

                               C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on:
        September 17, 2020...........................................     1
    Appendix:
        September 17, 2020...........................................    35

                                   WITNESSES
                          Thursday, September 17, 2020

    Claypool, Rick, Research Director, Office of the President,
      Public Citizen.................................................     5
    Fisch, Jill E., Saul A. Fox Distinguished Professor of Business
      Law, and Co-Director, Penn Institute for Law & Economics,
      University of Pennsylvania Law School..........................     7
    Frenkel, Jacob S., Chair, Government Investigations and
      Securities Enforcement Practice, Dickinson Wright..............     9
    Martin, Granville, Senior Vice President and General Counsel,
      Society for Corporate Governance...............................    10

                                    APPENDIX

    Prepared statements:
        Claypool, Rick...............................................    36
        Fisch, Jill..................................................    59
        Frenkel, Jacob S.............................................    64
        Martin, Granville............................................    87

                  Additional Material Submitted for the Record

    Sherman, Hon. Brad:
        Letter from SEC Chair Clayton, dated September 14, 2020......    94
    Huizenga, Hon. Bill:
        Letter from SEC Chair Clayton, dated September 14, 2020......    94
        Reuters article entitled, ``U.S. SEC enforcement activity
          hits second-highest level ever in 2019''...................    97

                        INSIDER TRADING AND STOCK OPTION
                      GRANTS: AN EXAMINATION OF CORPORATE
                       INTEGRITY IN THE COVID-19 PANDEMIC

                                  ----------

                          Thursday, September 17, 2020

                 U.S. House of Representatives,
                   Subcommittee on Investor Protection,
                 Entrepreneurship, and Capital Markets,
                               Committee on Financial Services,
                                                       Washington, D.C.
        The subcommittee met, pursuant to notice, at 12:31 p.m.,
    via Webex, Hon. Brad Sherman [chairman of the subcommittee]
    presiding.
        Members present: Representatives Sherman, Maloney, Himes,
    Foster, Meeks, Vargas, Gottheimer, Porter, Axne, Casten,
    Ocasio-Cortez; Huizenga, Wagner, Hill, and Gonzalez of Ohio.
        Ex officio present: Representative McHenry.
        Chairman Sherman. The Subcommittee on Investor Protection,
    Entrepreneurship, and Capital Markets will come to order.
        Without objection, the Chair is authorized to declare a
    recess of the subcommittee at any time.
        Also, without objection, members of the full Financial
    Services Committee who are not members of this subcommittee are
    authorized to participate in today's hearing.
        Members are reminded to keep their video function open at
    all times, even when they are not being recognized by the
    Chair. Members are also reminded that they are responsible for
    muting and unmuting themselves, and to mute themselves after
    they are finished speaking.
        Consistent with the regulations accompanying H. Res. 965,
    the staff will only mute Members and witnesses as appropriate,
    when not being recognized by the Chair, in order to avoid
    inadvertent background noise. Members are reminded that all
    House rules relating to order and decorum apply to this remote
    hearing.
        Today's hearing is entitled, ``Insider Trading and Stock
    Option Grants: An Examination of Corporate Integrity in the
    COVID-19 Pandemic.''
        We know that we have votes on the Floor, but we will not
    have any further delays of this hearing in order to allow
    Members to vote. Rather, Members should go vote and return, and
    while we all have our part of the alphabet to vote in, I am
    sure there can be some accommodation made, so that if it is
    your turn to ask questions, you can vote with others not of
    your same alphabetic characterization. And when I am voting, I
    believe Mr. Meeks has agreed to serve as Chair until my return.
        I will now recognize myself for 5 minutes for an opening
    statement.
        Our capital market system is unique in history. Up until
    about 150 years ago, every business enterprise was made up of
    people who knew each other, were family members, who had
    personal trust, and a business could only be as large as a
    group of people could finance and put together, and investment
    opportunities were limited to those that you happened to know.
        You wouldn't trust your money with some enterprise of
    strangers and, of course, you didn't have liquidity since you
    could sell your investment pretty much only to somebody else
    who knew those who were in the syndicate.
        And so at that point, people could rely on personal trust.
    Today, investors turn their money over to anonymous insiders,
    corporate boards, and executives whom they have never met, and
    they know that the insiders have far more information,
    attention, and power.
        So, they don't have the bonds of personal trust. They rely
    on the law to make sure that the insiders are treating the
    investment fairly. [Inaudible] turn their money over
    [inaudible].
        I will continue. We had a little technical problem there.
        We now apply that system to the COVID pandemic in which
    nearly 200,000 Americans have lost their lives, and in which
    many firms affected by this pandemic are having sudden
    increases or decreases in their value.
        For many pharmaceutical firms, for example, even the
    suggestion of involvement in a Federal program can cause shares
    to shoot up in value.
        Following this sort of announcement, Kodak, Novavax, and
    Vaxart each saw their stock prices rise by over 400 percent.
    With this trend in mind, the SEC has reminded companies that in
    this pandemic, they should not only abide by the law, but
    practice, ``good corporate hygiene.''
        SEC Chair Clayton has reiterated these views in a recent
    letter regarding today's hearing, which will I submit for the
    record, and it will be made a part of the record, without
    objection.
        But admonishments are not laws and regulations.
    Admonishments will not deter the truly greedy, and so we have
    to design our laws and regulations to govern those who cannot
    be governed by mere admonishments.
        For example, while taxpayers have invested $3.1 billion in
    Federal contracts with Novavax and Moderna to develop vaccines,
    since April, executives of these firms have sold over $60
    million of their company stock. We need to know that they were
    not taking advantage of any inside information, that perhaps
    their stock had gone up too high, given the realistic
    possibilities.
        Of greater concern is suspicious activity involving Kodak
    with the announcement of a $765 million government loan that
    raised insider trader concerns. In particular, we have a
    concern there on stock options and their grant dates when all
    equity compensation to insiders needs to be approved by
    shareholders.
        When shareholders approve a plan which says that stock
    options will be granted with a stock option exercise price
    equal to fair market value on option grant date, they believe
    that executives who get these stock options will live by that.
        If, instead, the ``fair market value'' doesn't reflect
    material information, insider information that is going to be
    announced the next day or the next week, then shareholders have
    been duped into approving equity compensation that does not
    reflect real fair market value.
        I want to thank the insiders at Kodak who have added insult
    to injury. First, they granted stock options at what they knew
    to be an unfairly low price. Then, they spent a lot of
    shareholder money on a corporate law firm to tell them it was
    all legal.
        That memo tells us we have to change the law, because if
    any major firm can say this is legal, it shouldn't be. And so,
    we have to deal with the issues of what is called, ``spring-
    loading,'' where shareholders approve a compensation plan based
    on fair market value.
        It has to be fair market value where the market has
    knowledge of the material transactions that the insiders know
    about.
        I look forward to exploring this with our witnesses, I now
    recognize the ranking member of the subcommittee, Mr. Huizenga,
    for 4 minutes for his opening statement.
        Mr. Huizenga. Thank you, Mr. Chairman.
        It has famously been said that the definition of insanity
    is doing the same thing over and over again, and expecting
    different results. So, here we are once again holding a hearing
    on an issue on which we have already held a hearing.
        Additionally, three of the bills attached to this hearing
    have not only had a hearing; they have been passed by the House
    of Representatives. So I ask the committee, why are we spending
    precious time and resources on bills that have already passed
    the House of Representatives 9 months ago? Just because we keep
    having hearings on bills that have already passed doesn't mean
    that the Senate is going to take them up.
        Now, don't get me wrong. Insider trading is not only wrong,
    it is illegal, and not only does it hurt the integrity of our
    capital markets but it also hurts our Main Street investors as
    well as Mr. and Mrs. 401K.
        And yes, we also agree that insider trading should be and
    must be punished to the fullest extent of the law.
        However, this subcommittee should not be used as a name and
    shame game for companies for wrongdoing that has been perceived
    to have happened. And yes, the facts surrounding one company at
    first certainly appear to be suspicious and need to be fully
    investigated.
        But that is not our job. The Securities and Exchange
    Commission is tasked with ensuring market integrity, and under
    the Securities Exchange Act of 1934, the SEC already has the
    power to bring enforcement actions in instances of insider
    trading.
        In fact, during Fiscal Year 2019, the Commission brought
    862 enforcement actions to hold individual issuers, financial
    institutions, and others accountable, sending a clear message
    to market participants.
        Last year's results speak for themselves: 862 enforcement
    actions obtained judgments and orders totaling more than $4.3
    billion in disgorgement and penalties, obtained nearly 600 bars
    or suspensions against market participants, suspended trading
    in the securities of 271 issuers, and returned nearly $1.2
    billion to harmed investors.
        So instead of playing judge, jury, and executioner in the
    court of public opinion, this committee should be focused on
    the bipartisan solutions that support job creators of all
    sizes, particularly our hard-hit small businesses.
        These proposals would strengthen broader access to capital,
    reduce regulatory costs and burdens, and improve and expand
    access for investors to better put their money to work and
    create more investment opportunities for everyday Main Street
    investors.
        But I am not just going to curse the political darkness. I
    am going to try to light a policy candle here, and here is a
    partial list of what we should be discussing and working on
    today.
        H.R. 4860, the Crowdfunding Amendments Act, introduced by
    the ranking member. We have my legislation, H.R. 609, the Small
    Business Mergers, Acquisitions, Sales, and Brokers
    Simplification Act, something we have dealt with now for 4
    Congresses in a row.
        H.R. 1909, the Helping Angels Lead Our Startups (HALOS)
    Act, by Representative Chabot of the Small Business Committee.
    H.R. 2899, the Main Street Growth Act, introduced by
    Representative Emmer. Representative Loudermilk's H.R. 3987,
    the Alleviating Stress Test Burdens to Help Investors Act. H.R.
    4076, the Modernizing Disclosures for Investors Act, introduced
    by the vice ranking member, Representative Wagner.
        Another one of my bills, H.R. 2919, the Improving
    Investment Research for Small and Emerging Issuers Act.
    Representative Steil has one, H.R. 4918, the Helping Startups
    Continue to Grow Act. And H.R. 7834, the Regulation A+
    Improvement Act, introduced by the subcommittee vice ranking
    member, Representative Hollingsworth.
        I could go on and on. But the list is, as you can see,
    exhaustive, and we have much more to do. But instead of holding
    hearings on legislation that the House has already acted on,
    let us move forward on bipartisan solutions that deliver the
    results the American people deserve from the Financial Services
    Committee.
        We know that there are problems. We need to address those
    problems. This isn't going to do it, unfortunately.
        Chairman Sherman. I would point out that one part of this
    hearing is on my bill to deal with spring-loading, which has
    not been considered by this committee, let alone the full
    House, and which bans a practice that I think we will discover
    is both wrongful and, unfortunately, legal.
        And so, we do have a strong purpose to have this
    subcommittee hearing.
        I now recognize the ranking member of the full Financial
    Services Committee, the gentleman from North Carolina, Mr.
    McHenry, for one minute.
        Mr. McHenry. Look, insider trading is wrong. We can all
    agree on that. The SEC, I think we can all agree, is doing a
    really good job in pursuing bad actors.
        As my friend, Bill Huizenga, just said, we should be
    spending time on identifying solutions that strengthen our
    economy, strengthen our economic recovery, and help our workers
    come back safely to the workforce after the virus, after we get
    testing and treatment going.
        And today, I introduce a bill to do just that, H.R. 8280,
    the Gig Worker Equity Compensation Act. Today, an increasing
    share of our workforce does not want to be bound by traditional
    constraints such as an office or set hours or traditional
    employer/employee relationships.
        These gig workers are critical in our technology-driven
    world. My bill allows gig workers such as rideshare drivers or
    food delivery couriers to share in the same economic benefits,
    the upside potential of owning the businesses they are helping
    to improve.
        So today's hearing should be focused on that type of
    solution, not just a rear-facing set of issues in an election
    year.
        Thanks so much.
        Chairman Sherman. I will point out that spring-loading is
    legal until this committee makes it illegal, and it is just as
    wrong as the--
        Mr. McHenry. Regular order, Mr. Chairman. If you wish to
    debate, the Chair can debate. But you should not opine about
    everyone else's opinion. That is not in good form for the
    Chair.
        Chairman Sherman. You were not recognized, but you did make
    your point clear. But when people question whether this is a
    legitimate hearing, it is appropriate to spend 10 or 20 seconds
    responding.
        Today, we welcome the testimony of Mr. Rick Claypool, Dr.
    Jill Fisch, Mr. Jacob Frenkel, and Mr. Granville Martin.
        First, Mr. Claypool is a research director for the Public
    Citizen's president's office, where he focuses on corporate
    crime and wrongdoing and the ways in which corporate power
    distorts our democracy.
        Second, Dr. Fisch is the Saul A. Fox Distinguished
    Professor of Business Law, and co-director of the Institute of
    Law and Economics at the University of Pennsylvania Law School.
        Third, Mr. Frenkel is Chair of the Government
    Investigations and Securities Enforcement Practice at Dickinson
    Wright. He also previously served as Senior Counsel for the
    SEC's Division of Enforcement.
        And finally, Mr. Martin is senior vice president and
    general counsel for the Society for Corporate Governance, where
    he leads the Society's efforts related to corporate governance,
    securities laws, and regulations.
        Witnesses are reminded that your oral testimony will be
    limited to 5 minutes. A chime will go off at the end of your
    time, and I would ask you to respect our rules here by wrapping
    up your oral testimony. And without objection, your written
    statements will be made a part of the record.
        I now recognize our first witness, Mr. Claypool.

     STATEMENT OF RICK CLAYPOOL, RESEARCH DIRECTOR, OFFICE OF THE
                       PRESIDENT, PUBLIC CITIZEN

        Mr. Claypool. Thank you.
        Chairman Sherman, Ranking Member Huizenga, and members of
    the subcommittee, on behalf of more than 500,000 members and
    supporters of Public Citizen, many of whom are investors and
    who, like all Americans, are hopeful for the timely development
    of safe and affordable COVID-19 treatments, welcome this probe
    into insider trading during the pandemic.
        The reported events are concerning. Chair Sherman described
    the Kodak concerns well. Additionally, Moderna Therapeutics
    announced that all 45 participants in the first phase of its
    COVID-19 trial, who received its vaccine, developed some
    antibodies.
        This is good news, good news that pushed up the company's
    stock price 30 percent to an all-time high of $87. Prior to the
    announcement, several executives modified existing or adopted
    new 10b5-1 plans. In the days following the announcement,
    Moderna's CEO, other executives, and funds controlled by the
    board sold about $90 million worth of company shares.
        Now, remember, it is taxpayer money funding 100 percent of
    this work to develop a COVID-19 vaccine, all of it.
        A study published by a coalition that Public Citizen helps
    lead found that stock market value for the 8 biotech companies
    in the S&P 500 grew by $130 billion between January and August,
    and executives and insiders from just 3 of these companies--
    Moderna, Inovio, and Vaxart--sold at least $370 million in
    company stocks, inflated by news of government awards and trial
    results.
        Meanwhile, NPR is reporting that the number of SEC insider
    trading enforcement actions has plummeted to its lowest point
    in decades. Public Citizen research has documented declines in
    corporate and white-collar crime enforcement at the SEC and
    across the Federal Government.
        If the agency is following the Trump Administration's
    orders to stand down, as numerous government-wide policies such
    as a May Executive Order and subsequent August memo direct,
    then that alone deserves a hearing.
        As to legislation, we look forward to a full House passage
    of Representative Cynthia Axne's bill requiring the SEC and the
    CFPB to provide monthly reports on consumer and investor
    protection activities.
        Ideally, the SEC will want to report a significant
    enforcement increase against opportunistic insiders.
        We applaud the House for approving the Public Citizen-
    endorsed insider trading reform bill authored by Representative
    Jim Himes, establishing a clear law against illegal trading,
    that will serve prosecutors well.
        We also applaud passage of the 8-K Trading Gap bill
    authored by Representative Carolyn Maloney, and the 10b5-1
    trading plan authored by Chairwoman Waters.
        One particularly promising deterrent is compensation
    deferral mechanisms that requires recipients of Coronavirus
    Aid, Relief, and Economic Security (CARES) Act aid to place a
    significant percent of senior compensation in a collective
    pool.
        Should a corporation later be found to misuse CARES Act aid
    or aid from a successor law, or engage in any other misconduct
    that results in fines, then the pool of senior managers'
    deferred pay would be used to fund the funds.
        Such a concept already exists in separate bills sponsored
    by Representatives Tulsi Gabbard and Katie Porter.
        I think it is crucial for Congress to condition the
    trillions in Federal aid, purportedly with the intention of
    helping workers, so that it is not diverted into the pockets of
    pandemic profiteers.
        We applaud this committee's contributions to the Health and
    Economic Recovery Omnibus Emergency Solutions (HEROES) Act, and
    look forward to working with you as you fashion the next
    necessary round of recovery and stimulus legislation.
        I welcome your questions, and you may draw on Public
    Citizen issue experts with written responses where relevant.
        [The prepared statement of Mr. Claypool can be found on
    page 36 of the appendix.]
        Chairman Sherman. The Chair is amazed. This may be the
    first time in decades that a witness has concluded in well less
    than 5 minutes. The witness did not choose to yield his
    remaining time to me and, accordingly, I will now recognize Dr.
    Fisch.

    STATEMENT OF JILL E. FISCH, SAUL A. FOX DISTINGUISHED PROFESSOR
      OF BUSINESS LAW, AND CO-DIRECTOR, PENN INSTITUTE FOR LAW &
            ECONOMICS, UNIVERSITY OF PENNSYLVANIA LAW SCHOOL

        Ms. Fisch. Chairman Sherman, Ranking Member Huizenga, and
    members of the subcommittee, it is an honor to participate in
    today's hearing.
        Thank you to Chairman Sherman for the kind introduction.
    Just a point of clarification, I am just a lowly law professor,
    I am not a doctor, but thank you for the promotion.
        [laughter]
        But I want to take just a few minutes to put the reported
    events to which Chairman Sherman and Rick Claypool referred in
    a little bit of context.
        In the past 6 months, as we all know, the capital markets
    have experienced unprecedented levels of volatility and trading
    activity.
        I know SEC Chairman Jay Clayton has provided this
    subcommittee in earlier testimony with data on both the high
    levels of trades and the incredible price swings that we have
    seen, not just in pharmaceutical companies but across a range
    of industries that have been affected by the pandemic, and
    these fluctuations, obviously, create the opportunity for
    manipulation, for misconduct, and for self-dealing. They have
    also drawn considerable media attention.
        I have written about securities fraud, SEC enforcement, and
    insider trading, and I want to focus in my opening remarks on a
    review of the regulatory structure and the challenges that the
    market environment imposes on that regulatory structure.
        The activities that I understand the subcommittee to be
    interested in today involve three distinct sets of legal
    issues: disclosure integrity; the use of stock options; and
    insider trading.
        I will address those issues in turn. I will briefly
    conclude by addressing potential areas of regulatory reform.
        The first issue is disclosure integrity. Some news stories
    that we have heard say that the issuers have made distorted,
    inaccurate, or overly optimistic disclosures to drive up their
    stock prices, and this can be for various reasons ranging from
    enabling insiders to sell and make a lot of money, to
    increasing the value of stock options, or facilitating the
    issuer's access to the capital markets.
        Now, let me be clear. Existing securities regulation
    requires disclosures to be accurate. False and misleading
    statements, particularly those that are made with an effort to
    distort stock prices or create opportunities for personal gain,
    constitutes securities fraud. An issuer or a corporate official
    that makes false claims, claims about a pharmaceutical product
    that is under development or misstates the results of a
    clinical trial could face both an SEC enforcement action and
    private civil litigation, and false statements that are made
    willfully can subject the issuer and individual corporate
    officials to criminal liability. This is not a gray area.
        The existing market environment, however, creates a
    challenging disclosure environment. The scope of the pandemic,
    the lockdown, and the effect on the world's economy, are
    unprecedented.
        Pandemic-related information has the potential to have an
    enormous impact on the economy and on stock prices. Everyone is
    watching to see what is happening with these companies. And the
    SEC itself has encouraged issuers to provide as much
    information as possible about pandemic-related risks on
    businesses.
        But at the same time, we don't actually know what the truth
    is. The scientific community, and the public health community
    is still evaluating all of this.
        So, it is hard for businesses to predict what is going to
    happen in the future, what is going to be the effect on their
    stock prices, and so forth.
        Simply put, issuers are in a challenging environment. They
    are pressured to disclose as much information as possible. But
    premature disclosure of uncertain information may, in
    hindsight, prove inaccurate.
        At the same time, stock prices are reacting dramatically.
    Chairman Sherman identified the possibility that stock prices
    may be too high at the time that executives receive stock
    options.
        The concept that stock prices reflect fundamental value or
    that the fundamental value of these companies is even knowable
    at any given point right now is something that is very
    challenging from a market regulatory perspective.
        Now, let me say--I see, my time is running short, and as a
    law professor, I am always long-winded, so I will cut to the
    chase and talk further, perhaps, in response to your questions
    about stock options and insider trading.
        But let me just say a couple of words about potential
    regulatory reforms. As I said, the law doesn't prohibit
    accurate statements, even if those statements are forward-
    looking, even if those statements are not based on hard science
    about what a vaccine or what a product is going to do.
        The law, however, doesn't permit executives to create
    trading opportunities through their public statements, and
    here, I think, the potential, if I--Chairman Sherman, if I
    could just take a minute to wrap up.
        Chairman Sherman. Thirty seconds.
        Ms. Fisch. Here, I think the potential rethinking of 10b5-1
    plans, which I think the current market has exposed, is
    creating a potential regulatory gap, a potential opportunity
    for profitable manipulation of disclosures in order for the
    potential of self-gain is a really promising area and, I think,
    a scenario that legislation and regulation haven't fully
    recognized.
        And I would be happy to talk about that more in response to
    questions.
        Thank you.
        [The prepared statement of Ms. Fisch can be found on page
    59 of the appendix.]
        Chairman Sherman. Thank you for your testimony.
        I now recognize Mr. Frenkel.

    STATEMENT OF JACOB S. FRENKEL, CHAIR, GOVERNMENT INVESTIGATIONS
         AND SECURITIES ENFORCEMENT PRACTICE, DICKINSON WRIGHT

        Mr. Frenkel. Thank you.
        Good afternoon, Chairman Sherman, Ranking Member Huizenga,
    and distinguished members of this subcommittee.
        Thank you for giving me the opportunity to testify on
    critical issues impacting our capital markets. My perspective
    comes from 32 years of professional experience in capital
    markets enforcement, investigations, governance, and integrity
    issues, including my work at the Securities and Exchange
    Commission's Division of Enforcement, as a Federal prosecutor
    of public corruption and securities violations, and as an
    actively practicing defense and governance lawyer for more than
    21 years.
        I believe that in 2020, unlike 20 or more years ago, pre-
    Enron, most corporate boards and management want to get it
    right.
        Nevertheless, we still see capital markets activity that
    gives rise to questions about commitments to compliance and
    fundamental common law duties that are the responsibility of
    corporate custodians.
        This committee has identified insider trading, Rule 10b5-1
    plans, stock option grants, spring-loading, and bullet dodging
    as issues of heightened interest, warranting consideration of
    legislation.
        Beyond these undeniable vital areas of concern, I suggest
    to the committee, respectfully, that COVID-19 solutions-related
    capital markets activities also should invite scrutiny of
    several other issues.
        They include, first, regulation FD and its inapplicability
    to foreign private issuers. We saw the effect of the exemption
    2 weeks ago when AstraZeneca's CEO disclosed, on a nonpublic
    call arranged by JPMorgan, about its suspension of vaccine
    clinical trials as a result of an unexplained illness in a
    trial participant.
        If AstraZeneca had been a U.S. issuer, then there likely
    would have been an obligation for prompt public disclosure of
    what appeared to be an unintentional selective disclosure.
        Second, is the SEC's 10-day trading suspension authority,
    which operates like a court-imposed temporary restraining
    order. However, it is not an enforcement action, but operates
    as an administrative arrow through the heart of legitimate
    small entrepreneurial public companies.
        For trading suspensions that issuers contest, the SEC takes
    months if not longer to resolve the challenge. Legislation
    should dictate a precise and narrow timeframe for making the
    decision.
        Third, is delegation of authority to authorize formal
    orders of investigation at the SEC. For decades, the Commission
    alone made the decision. Post-Madoff, the authority was
    delegated into the Enforcement Division, what I and others
    viewed as the out-of-control practice in the previous SEC
    administration.
        Although SEC Chairman Clayton has reined in this delegation
    of authority, I believe the Congress intended for the
    Commissioners to decide whom to investigate and to make the
    solemn decision about authorizing subpoena power much like a
    Federal Judge reviews and approves search warrant applications.
        And fourth, is trade clearance and conflict-of-interest
    disclosure policies and whether they should apply to NIH
    advisory panels.
        The question for consideration is what level of
    transparency should exist to enable you on Capitol Hill, and
    the public, to assess possible conflicts of interest among
    scientific and technical peer review advisors who are not
    subject to the Federal Advisory Committee Act.
        These are not instead of, but are in addition to, the
    important issues already identified by this subcommittee. I
    hope that we will be able to discuss each of these issues this
    afternoon.
        Finally, you have asked that we address the importance of
    corporate integrity during the COVID-19 pandemic and the impact
    it has on investor protection and overall market integrity. I
    believe that is too narrow.
        Corporate integrity, a commitment to best practices and
    proper governance, including a conscientious discharge of
    common law fiduciary duties and a constant focus on investor
    protection and market integrity was, is during the pandemic,
    and always will be and must be the guiding principles of
    corporate boardrooms and C-Suites for U.S. capital markets
    participants.
        I compliment the committee for highlighting the importance
    of and addressing these issues with this hearing. I look
    forward to answering your questions this afternoon.
        Thank you.
        [The prepared statement of Mr. Frenkel can be found on page
    64 of the appendix.]
        Chairman Sherman. Thank you.
        As described earlier, Mr. Meeks will be taking over while I
    vote. So, I am hoping to encourage Mr. Meeks to vote in the
    next few minutes, since I will be turning the gavel over to him
    in about 20 minutes.
        Mr. Meeks. Very well. I will run to vote now, and I will be
    back.
        Chairman Sherman. Good. See you in 15 or 20 minutes.
        With that, I now recognize Mr. Martin.
        Mr. Martin?

       STATEMENT OF GRANVILLE MARTIN, SENIOR VICE PRESIDENT AND
           GENERAL COUNSEL, SOCIETY FOR CORPORATE GOVERNANCE

        Mr. Martin. I, of course, didn't unmute myself. You would
    think I would be used to this by now, 6 months into this. My
    apologies.
        I am also wearing a tie for the first time in many months.
    So, thanks for the opportunity to do that.
        Chairman Sherman, Ranking Member Huizenga, and members of
    the subcommittee, thanks for the opportunity to testify today.
        I am Granville Martin, general counsel for the Society for
    Corporate Governance, the Society's professional association of
    approximately 3,500 corporate and assistant secretaries serving
    approximately 1,000 public companies.
        Our members support the work of corporate boards and
    executive managements on corporate governance and disclosure
    matters.
        We traditionally focus on securities and corporate law
    issues, and in the last several years have broadened our
    perspective to also include environmental and social issues.
        Diversity, climate change, and human capital management are
    among the key issues which investors have sought greater
    disclosure on, and that public companies increasingly provide.
        At the outset, let me state clearly that the Society's
    public company members support a rigorous framework of insider
    trading regulation and enforcement. Ensuring that America's
    markets retain a reputation for transparency and fairness is in
    the interest of all public companies.
        A market where insiders can benefit from material nonpublic
    information at the expense of other investors is wrong, and we
    support the laws and enforcement necessary to prevent and
    punish such conduct.
        Most public companies have adopted policies that prevent
    illegal insider trading. Common features of such policies
    include a prohibition of trading at any time while in
    possession of Material Nonpublic Information (MNPI), a
    preclearance procedure of transactions, imposition of trading
    blackout periods, and limitations on the adoption of 10b5-1
    plans.
        It is worth noting that the company-imposed blackout
    periods restricting executives from selling stock generally
    begin several weeks prior to the end of the fiscal quarter, and
    last until a day or two after the publication of quarterly
    earnings.
        As a result, company officers and directors typically will
    have four open windows per year, with each window lasting just
    a few weeks.
        Section 10b of the Securities Exchange Act and the
    associated Rule 10b5-1 prohibit stock sales made on the basis
    of MNPI that is obtained through a breach of duty of trust that
    is owed to the issuer of that security.
        Rule 10b5-1 specifies that the sale of a security is made
    on the basis of MNPI, when the person making the sale was
    ``aware'' of that information when the sale was made.
        Rule 10b5-1 also provides an affirmative defense to Section
    10b insider trading allegations, when such trades are made
    pursuant to a preexisting written trading plan that complies
    with the rule.
        The rule's affirmative defense is only available, however,
    if the plan was entered into in good faith.
        Rule 10b5-1 does not operate in a vacuum. It does not alter
    the elements of a case under Section 10b. Scienter is still
    required.
        Additionally, transactions pursuant to a 10b5-1 plan must
    still comply with the volume limitations of Rule 144 of the
    short-swing profit rule 16b.
        In addition, executives are subject to the filing of
    ownership forms under Section 16a of the Exchange Act,
    including Form 4, which must be filed in connection with each
    transaction.
        The filing of Schedules 13d and 13g are also required where
    appropriate.
        The Section 10b and Rule 10b5-1 prohibition on insider
    trading when aware of MNPI, along with the related disclosure
    obligations and established company practices, provide, in our
    view, a comprehensive and effective legal framework. We do not
    believe that changes are warranted.
        Like so many other aspects of our lives, COVID-19 presents
    new and abrupt challenges to public companies, including
    related to insider trading law compliance.
        As companies grappled with the implications of the
    pandemic, the SEC issued guidance emphasizing market integrity
    and urging companies to provide detailed COVID-related
    disclosure.
        Based on our review of Society members' disclosures, we
    believe public companies have responded robustly to this
    guidance. COVID-related disclosure has been widespread and has
    covered a wide range of topics.
        In addition, many public companies reassessed their insider
    trading policy compliance programs, including whether their
    internal procedures were able to identify all of the executives
    who are now possibly in possession of COVID-related MNPI.
        Pre-pandemic, such concerns for supply chain and
    operational executives were minimal.
        Let me turn to some of the pending legislation. In general,
    the Society does not have a position on the appropriateness of
    the [inaudible] structure of executive compensation.
        Having said that, we have observed that the use of stock
    options by startups and other early-stage companies is common
    and essential. Boards of directors and their compensation
    committees are best-positioned to decide on the appropriateness
    of such options grants.
        Investors expressed their view on the appropriateness of
    compensation through required sale on payloads that incur in
    many cases annually. Transparent fairness exists under the
    current regulatory framework.
        Similarly, we believe the 8-K Trading Gap bill is
    unnecessary, given that Section 10b and Rule 10b5 already
    prohibit trading by insiders if the undisclosed significant
    event is material.
        We would note that the bill makes conduct that is already
    prohibited further illegal, if that is possible. We believe the
    regulation of insider trading is almost done.
        We believe the regulation of insider trading has been
    subject to some confusion. Having said that, the SEC study
    mandated by H.R. 624 could contribute to a common and well-
    founded understanding of 10b5-1 plans and whether any changes
    are warranted, and we support the enactment of H.R. 624.
        Thanks for the invitation for the invitation to testify,
    and I would be happy to answer any questions.
        [The prepared statement of Mr. Martin can be found on page
    87 of the appendix.]
        Chairman Sherman. Thank you.
        I now recognize myself for 5 minutes for questions. I want
    to commend the Chair and the ranking member for authoring
    legislation that has already passed the House dealing with
    instructing the SEC to focus on insider trading and certain
    aspects thereof, and one of the purposes of this hearing is to
    join forces with the ranking member and the Chair to make that
    statement very clear to the SEC.
        It is the hope that these hearings will inspire the Senate
    to act on that bipartisan legislation or, just as good, get the
    SEC to do what the legislation directs them to do, whether the
    statute directs them to do it or not.
        Insiders hold material information that is not known to the
    general public. We have insider trading rules that deal chiefly
    with transactions between the insider and outsiders through the
    market.
        We have much weaker rules dealing--or no rules dealing with
    insider trading and options or stock between the insider and
    the corporation itself.
        Now, I know that the Minority can be very popular in the
    boardrooms of this country by saying that it is illegitimate to
    have a hearing of this subcommittee except if the purpose of
    that hearing is to make it easier to market stock to the
    public, and there is a rule for us making it easier on business
    insiders to raise capital.
        But it is, certainly, legitimate for this subcommittee to
    explore the loopholes that caused insiders to be able to take
    advantage of the general public and the general investing
    public.
        We do have good laws on traditional false statements. The
    SEC has done many thousands of enforcement transactions dealing
    with traditional insider trading.
        But when insiders make use of material undisclosed
    information in stock option transactions and other transactions
    with the company, according to Kodak's lawyers and, frankly,
    including--and even in our discussions with the SEC can,
    generally, be legal, although wrongful.
        Ms. Fisch, as you know, the day before the Federal
    Government announced its plans to provide Kodak a $765 million
    loan, the company's CEO was granted 1.75 million stock options.
        Now, stock option plans legally need to be approved by
    shareholders, and the shareholders approved a plan that said
    that the option exercise price for these employee stock options
    needs to be set at, ``fair market value.''
        But here is where the shareholders may have gotten tricked,
    because that is defined as the latest closing price of the
    shares, and under normal circumstances, that is fair market
    value.
        But in this case, Kodak, undisclosed to the market, had
    just landed $765 million. Considering Kodak's share price rose
    by over 500 percent within hours after these options were
    granted, this seems to be a situation where the shareholders
    were fooled by the term, ``fair market value,'' which turned
    out to be a much lower--a value that didn't reflect the
    knowledge.
        Would you agree that legislation is appropriate to close
    this loophole by prohibiting users who use fair market value to
    set employee stock option exercise prices from doing so based
    on a market price that doesn't reflect information the company
    is about to disclose prior to disclosure?
        Ms. Fisch. Thank you, Chairman Sherman.
        Stock options, obviously, are a form of executive
    compensation, and as compensation, they have a number of
    problems. One of the problems that we see right now is there is
    a huge amount of volatility in prices. Prices are reacting--as
    you yourself observed, prices may be overreacting to
    information as well.
        So, I think a compensation structure that looks at market
    price as an indication of fair value is particularly
    problematic in this environment.
        That being said, the whole regulatory structure is designed
    to put safeguards into place, not just the shareholder vote but
    also the role of the compensation committee.
        Chairman Sherman. Thank you. My time has expired.
        I now recognize the ranking member of the subcommittee, Mr.
    Huizenga.
        Mr. Huizenga. Thank you, Mr. Chairman. I appreciate the
    opportunity, and I would ask unanimous consent to submit a
    letter for the record that is from Securities and Exchange
    Commission Chairman Clayton. It is addressed to you, and CC'd
    to me. I would like to put that into the record.
        Chairman Sherman. Without objection, it is so ordered for
    the second time, since I had already put it in the record. Now,
    it is in there twice. That is good.
        Mr. Huizenga. Double. Belt and suspenders.
        I appreciate it. And maybe, I will just start with where
    Professor Fisch had left off, and in this letter the chairman
    is very clear about some of his concerns about the 10b5-1 plans
    and, in fact, a couple of the headings on this are: Insider
    Trading Policies for Senior Executives and Board Members; Terms
    and Administration of Rules; and 10b5-1 Plans.
        He does say also in the letter that there is a joint
    explanatory statement accompanying the Fiscal Year 2020
    Financial Services and General Government (FSGG) Appropriations
    Act on the growth share repurchases and are considering this
    and other issues relating to Rule 10b5-1 as plans as part of
    that report.
        Under Issuing and pricing stock options, he very
    specifically says that a grant may also be inconsistent with
    existing accounting standards because, in short, the trading
    price of its stock is not a good indicator of fair market
    value, and he then goes on to ask to make sure that senior
    executives and board members keep that in mind, but also to
    have the Divisions of Corporation Finance and Enforcement look
    at it.
        So, Professor Fisch, I don't know if you would care to
    address that, very briefly, any more than where you had started
    to go down that path?
        Ms. Fisch. Thank you. I guess what I did want to say is you
    are absolutely right and, of course, SEC Chairman Clayton is
    absolutely right. Good corporate hygiene, I think, these days
    requires a corporation to think seriously about having explicit
    written policies in place with respect to its option grants,
    with respect to its executive trading in the company stock, and
    with respect to 10b5-1 plans. I think those are all important
    issues.
        But I just want to distinguish between good corporate
    hygiene, matters of good corporate governance, and even matters
    of a director's fiduciary duties and insider trading, because
    they are two different concepts, and lots of companies can be
    overpaying their executives right now based on salary or
    bonuses that are tied to stock prices without using stock
    options.
        The problem is the overpayment. The problem is using stock
    prices as a metric of value, and the problem is not necessarily
    in the option form itself.
        Mr. Huizenga. And the chairman says that may be
    inconsistent with existing accounting standards. So, is that
    something that the Public Company Accounting Oversight Board
    (PCAOB) needs to tackle?
        Ms. Fisch. That is an interesting question, and the problem
    is, I am not sure how you come up in this market environment
    with a concept of fair value and how a board or a compensation
    committee goes ahead and does that.
        Now, Chairman Sherman is right. If the company knows
    tomorrow it is going to release material information, the
    company is, obviously, going to suspect the stock price is
    going to be affected.
        But if you look at Kodak's trading price from the time
    before the first press reports until today, it is all over the
    place, and I don't know at which point of the trading price we
    could say with confidence, yes, that reflects fair market
    value.
        Mr. Huizenga. I think that point has been made. It is more
    than just one company. But the SEC, clearly, is very concerned
    about it, and the Chairman is.
        Quite honestly, when Mr. Claypool was, I would say,
    disparaging the SEC Chair, whether it is Mary Jo White or Jay
    Clayton, I don't think I have ever heard a SEC Chair even come
    close to thinking that insider trading or that enforcement is
    somehow not acceptable. So, that just was wrongheaded on that.
        Mr. Martin, specifically, companies participating in
    government assistance programs through the CARES Act have some
    guidance that has been put up, correct? Do you believe it is
    clear enough?
        Mr. Martin. Yes, I do. I think the company response to the
    SEC guidance, both the statements with respect to insider
    trading and subsequent statements by the Chairman and Director
    Bill Hinman, were well-received.
        It was very clear to the corporate community, and what you
    saw was a big increase, a needed increase in COVID-related
    disclosure, which the Chairman was very focused on, along with
    the Director.
        We can provide a few statistics about the increase of that
    disclosure and, appropriately--and I think Professor Fisch was
    alluding to this--companies were really struggling at the
    beginning and, to some degree still are, with understanding
    what the significance of particular events are to their own
    business operations and, indeed, their stock prices have been
    extremely volatile.
        And so, companies have struggled with that and their
    response, significantly, has been to very dramatically increase
    the amount of disclosure on COVID.
        For example, at the end of March, a National Association of
    Corporate Directors (NACD) study found that 50 percent of
    Russell 3,000 companies that filled out a Form 10K as of March
    30th--
        Chairman Sherman. I believe the--
        Mr. Martin. --were qualifiers for COVID-19--
        Chairman Sherman. --time of the gentleman has expired.
        Mr. Martin. Excuse me. I'm sorry. One last point.
        Chairman Sherman. Thank you. Mr. Himes, it is your turn.
    Have you already voted?
        Mr. Himes. No, I have not. But I think I have time. So, I
    will use my time now.
        Chairman Sherman. Ms. Porter, have you already voted or are
    you voting by proxy?
        Ms. Porter. I have already voted, sir.
        Chairman Sherman. Good. I am going to--since Mr. Meeks has
    not returned, and with your permission, I will make you
    temporary Chair as I go vote.
        Mr. Huizenga. And, Mr. Chairman, I guess I am looking to
    see if there is a Republican who is on as well to take the
    helm--the challenges of having committee hearings continue
    while we are doing extended voting. But I would love to hear
    one of my Republican colleagues let me know that they can take
    over as ranking member while I go vote..
        Chairman Sherman. Okay. I am going to call upon Ms. Porter
    to act as our temporary Chair and ask Mr. Himes to proceed for
    5 minutes.
        Mr. Himes. Great. Thank you, Mr. Chairman, and thanks very
    much to our witnesses today. This is an area of intense
    interest for me.
        My office has devoted a lot of time to crafting what was,
    as the ranking member pointed out, bipartisan legislation which
    passed the House in May 2019, with H.R. 2534, the Insider
    Trading Prohibition Act. I'm very, very interested in that. It
    was very steeped in the complexity of defining insider trading.
        I do have a question, but since it was a bipartisan bill, I
    want to suggest to my Republican friends that this is far from
    a waste of time, and it may not be exactly the way you want to
    promote business investment but there is, arguably, nothing
    quite so important to business investment as confidence in the
    capital markets, the confidence on the part of shareholders and
    others that they are playing in a fair market, which is why I
    have been very, very devoted to crafting a specific statute on
    the topic of insider trading.
        There is a need for this. My Republican friends know that
    only 14 percent of Americans directly own stocks, and so as the
    stock market has rocketed in these last couple of years,
    directly, a very small percentage of Americans have been able
    to participate in that upside.
        It is true that roughly half of Americans, of course,
    indirectly own some stock through pension plans and retirement
    plans.
        But we should all be looking to increase the number of
    Americans who feel like they have a stake in the equity of
    their economy, and critical to that, of course, is making sure
    that we can look people in the eye and say, this is a fair and
    level playing field.
        I don't want to get into the complexities of all that
    occurred in Kodak, and I understand they are complicated.
        Look, there is nothing wrong with stock prices going up,
    necessarily. There is nothing wrong with stock option plans,
    necessarily.
        What is wrong is when corporate insiders take advantage of
    inside information. We spend a lot of time in the bill defining
    transactions, the purchase and sales of securities.
        The fact that we are talking about spring-loading and
    bullet dodging, that pertains to, essentially, a transaction.
    But it is an indirect transaction. It is the conveyance of
    value, because a stock option is valuable.
        And so my question is--I am not quite sure which of my
    witnesses, maybe I will start with Mr. Frenkel.
        My question is, do you think we can alter insider trading
    law, broaden it to be about the conveyance of value, and would
    that capture what we are talking about here?
        Or do we need an entirely separate statute for value that
    is conveyed via option plans and programs as opposed to the
    purchase or sale of securities?
        [No response.]
        Mr. Himes. Mr. Frenkel, you are muted, I think.
        Ms. Porter. [presiding]. Mr. Frenkel, you are on mute.
        Mr. Frenkel. I'm sorry. Thank you, Congressman Himes, and I
    apologize for staying on mute.
        I think in the context of the insider trading laws, the
    focus has always historically been on the purchase and sale and
    the conveyance of information.
        To me, as Professor Fisch had indicated, the issues around
    spring-loading and bullet dodging are as much a part of
    executive compensation as they are the information.
        Insiders are always going to have access to information
    that is in balance with respect to the rest of the market. But
    that really is more an issue of timing and broader disclosure
    obligations than insider trading itself.
        Mr. Himes. No, I understand that, and I guess the point I
    am making--and I understand that we are really talking more
    about compensation than a purchase or a sale of a security.
        But at the end of the day, what is happening is that a
    decision about conveyance of value is being made possibly when
    there is an imbalance of information.
        So it is not clear to me that there is a radical
    categorical difference between an executive who is going to
    approve a stock option plan 3 weeks from now, but knowing that
    they are about to receive a loan accelerates that decision--
    there is not a categorical difference between that and that
    executive going out and purchasing the stock.
        There are differences of timing, et cetera. But it is,
    effectively, the same thing. It is conveying value wrongly
    because inside information is bad, right?
        Mr. Frenkel. I would agree, and really what--Congressman,
    you are correctly identifying the issue as being the use and
    application of that information as being subject to imbalance
    favoring that corporate executive.
        I still believe it is an issue that really should fall
    beyond insider trading, because it really does not relate to a
    trade itself. It really goes to disclosure issues, in my view.
        Mr. Himes. Yes. My time has expired. But I would be
    grateful if in this hearing, we got down to, how can we address
    legislatively spring-loading and bullet dodging most
    appropriately?
        But my time has expired, so I will yield back, and I thank
    the witnesses.
        Ms. Porter. The Chair now recognizes the gentleman from
    Ohio, Mr. Gonzalez.
        Mr. Gonzalez of Ohio. Thank you, Madam Chairwoman. And
    thank you, everybody, for your testimony today.
        I want to start with something that Mr. Claypool brought up
    that kind of perked my interest, and I am curious for
    everybody's take on it.
        You highlighted the Moderna situation where, upon getting
    good news, the stock price went up significantly. It sold
    stock. There's nothing in and of itself wrong with that.
        But it does sort of raise a question around specific COVID
    support. to me it does, anyway, specific COVID support and any
    additional disclosures we might want as a result of that.
        I think these are unusual times, and when we have the
    Federal Government, basically, funding 100 percent of R&D on a
    product that is going to be incredibly important, God willing,
    maybe there should be additional scrutiny there.
        I guess I would start first with Mr. Martin. Do you have
    any thoughts on how we could better inform investors with
    respect to these sorts of announcements or any changes you
    might make on a temporary basis? Not permanent, but on a
    temporary basis, as a result of COVID?
        Mr. Martin. I think the existing framework that
    necessitates the disclosure of material information to
    investors through the filing of an 8-K is the appropriate
    mechanism.
        To the extent that there is trading around or in advance of
    such disclosure, that is already illegal. So it is not
    immediately evident to me what an alternative framework can do
    beyond what the existing framework does, which is to mandate
    the disclosure of material information to investors.
        And I am sorry, but I don't have any particularly
    intelligent ideas as an alternative to that.
        Mr. Gonzalez of Ohio. Yes, that is a fine answer. I just
    wanted your perspective on it.
        And now, another thing from Mr. Claypool's testimony I
    would take issue with, which is around sort of a normative
    judgment around repurchasing of stocks, in particular.
        There is a quote in here: ``When managers repurchase stock,
    they are confessing they have no new promising ideas on which
    to invest.''
        Mr. Martin, again, what do you think of that statement? I
    will just say, as a--I don't want to set you up to be overly
    combative, but as somebody who has been an investor for my
    entire adult life, when companies I have invested in repurchase
    stock, that means that I own more of the company now.
        And so, that actually benefits all of the shareholders, is
    my personal belief. But I would be curious for your perspective
    on that as well.
        Mr. Martin. I agree with that. Share repurchases are a
    legitimate tool for capital planning for companies. Of course,
    companies can raise or lower their dividend as needed and share
    repurchases are an entirely legitimate use of shareholder funds
    for the benefit of existing shareholders.
        I know that there are conflicting feelings about that,
    particularly in the wake of some tax legislation a few years
    ago.
        I just disagree with that perspective and would hope that
    Congress will maintain the discretion that companies have to
    make those kinds of capital planning decisions and that boards
    and senior management are left to make those kinds of
    determinations.
        Mr. Gonzalez of Ohio. Thank you. I agree with everything
    you just said, and I yield back.
        Ms. Porter. Thank you. I am now going to turn over the
    chairing of this hearing to my colleague, the distinguished
    gentleman from New York, Mr. Meeks.
        Mr. Meeks. [presiding]. Thank you, Congresswoman Porter.
    Thank you for holding it down for us.
        I now yield 5 minutes to the gentleman from Illinois, Mr.
    Foster, for questions.
        Mr. Foster. Thank you. Professor Fisch, I would like to
    take you up on your offer to dig a little bit deeper on 10b5-1
    plans. Some of the stories that we have seen regarding
    pharmaceutical companies developing COVID-related products
    apparently involved executives modifying these plans right
    before some big announcement, which caused the stock to
    skyrocket.
        Some of these apparently have resulted in what might
    otherwise be considered suspiciously timed trades, but are
    given at least a partial safe harbor because they were done
    pursuant to 10b5-1 plans.
        So, very quickly, could you briefly describe what 10b5-1
    plans are and what they are intended to be and accomplish?
        Ms. Fisch. Thank you.
        Yes, 10b5-1 plans are designed primarily as a tool for
    executives to manage their stock trading over the long term. So
    today, executives increasingly are being paid in stocks, stock
    options, restricted stock.
        Obviously, they have liquidity needs, and the idea behind a
    10b5-1 plan is typically what this allows you to do is sell
    stock on a regular basis, right--they are usually used on the
    sales side--and not worry about the fact that before you sell
    the stock, you come into possession of material nonpublic
    information, and you would thereby be precluded from selling.
        Once you put the plan in place, once you commit to sell,
    you are insulated from liability even if you have knowledge at
    the time the sale actually occurs.
        Now, the loophole, Congressman, that you are referring to
    is the fact that these plans don't have to be disclosed, and
    practice among issuers varies dramatically in the type of
    disclosure that they make, or whether they disclose the
    existence of these plans at all. So, that is the first problem.
        The second problem is that the law allows you to modify or
    to terminate your 10b5-1 plan, and it doesn't restrict that
    termination to situations in which you don't have material
    nonpublic information.
        So, let us say I have a 10b5-1 plan. I am planning to sell
    my stock this week. I learn good news about my company or it is
    going to get a Federal grant or promising drug trials, and I
    say, okay, hang on, I am going to terminate my plan, I am not
    going to sell.
        Obviously, I am making use of inside information, but I
    have not traded. I am declining to trade, and as a result, it
    is a loophole that is not covered by existing law.
        Mr. Foster. Is there a downside in mandatory disclosure of
    these, either in real time or at quarterly intervals or some
    standardized time?
        Ms. Fisch. Frankly, sir, I don't see a downside and, in
    fact, there have been a couple of empirical studies that have
    looked at issuer disclosure practices and found that the
    issuers who disclosed these plans voluntarily also have better
    general corporate governance. In other words, disclosure seems
    to be a signal of good corporate hygiene, so to speak.
        Mr. Foster. And what about requirements that separate the
    decision time from the time of the actual purchases, so that
    you have to declare months or longer in advance that you are
    going to start or stop this program?
        Ms. Fisch. That would absolutely be a useful refinement as
    well. We haven't yet talked in this hearing about 16b and
    short-swing trading liability. That is a provision in the
    original Securities Exchange Act of 1934 that is supposed to
    limit the ability of executives to benefit from sort of short-
    term trading by buying and selling within a short time period.
        I think you could apply that same approach to 10b5-1 plans
    and say, look, given the intent behind these plans, you should
    have to put the plan into place for a period of time and,
    ideally, the plan should persist for a period of time so that
    there is less likelihood the executives will try to take
    advantage of short-term information asymmetries.
        Mr. Foster. And do any of the other witnesses have any
    comments on this area of potential improvements or fixing
    loopholes or other risks?
        [No response.]
        Mr. Foster. Okay. Deafening silence.
        Well, I appreciate all your help. As the son of a law
    professor, I just have a lot of sympathy for your life, and
    anyway, we will have that discussion offline.
        And with that, I yield back.
        Chairman Sherman. Thank you very much. I thank the
    gentleman for his questions, and commend to him and others the
    Waters-McHenry bill designed to focus on the problem he
    illustrates.
        I want to thank Ms. Porter and Mr. Meeks for acting as
    temporary Chair in my absence, and I now recognize Mr. Hill for
    5 minutes.
        Mr. Hill. Thank you, Mr. Chairman, and what a good
    discussion this is. I want to, of course, commend and thank all
    of the members who worked on insider trading topics over the
    years but, particularly, my friend, Mr. Himes of Connecticut,
    who has been such a thoughtful leader on this subject as our
    committee has navigated what is a very challenging subject in
    order to balance the needs for information in the capital
    markets, the flexibility of use, and really identify criminal
    behavior.
        So thanks, Jim Himes, for your work and for the bipartisan
    work that we have done together.
        Mr. Martin, I want to talk a little bit about the Society's
    survey on the members regarding insider trading preclearance
    policies.
        You say 90 percent of your members follow a preclearance
    policy. Could you highlight what your best practices would
    indicate that could have prevented or brought clarity to or
    remediated some of the challenges that we have read about in
    recent days and that we have talked about over the course of
    this hearing?
        Mr. Martin. Sure. In general, I think there is a suite of
    policies that corporates implement to, as was said at the
    outset, that 20 years ago, I think it was Mr. Franklin noted,
    that the change in most corporate suites to take insider
    trading and avoiding it and regulating it--companies are taking
    it very seriously.
        So, there is a suite of policies that they instituted to
    address that, including compliance training with executives
    that requires the executives to acknowledge the existence of
    the policies, that they understand what the limitations are
    including, obviously, that you can't trade while in possession
    of MNPI.
        The designation of particular brokerage houses to handle
    all transactions in company stock that allows Section 16
    executives and others who may have an MNPI to be flagged, and
    so those accounts can be monitored.
        You mentioned the survey that the Society conducted about 2
    years ago which indicated that approximately 90 percent of the
    companies surveyed require preclearance of trades by in-house
    legal.
        I mentioned in my opening remarks that virtually every
    company imposes blackout periods in advance of quarterly
    earnings. But it is more stringent than just that.
        Those windows will be closed in the event that new material
    information develops. It could be a leadership change, or it
    could be something with respect to a new product. And then, of
    course, some companies further regulate the adoption of 10b5-1
    plans when they can be adopted and cooling off periods and
    things like that.
        So, there is a suite of policies that companies have become
    much more conversant and frequent users of, because trying to
    avoid their executives becoming embroiled in an insider trading
    allegation or enforcement action is incredibly time-consuming
    and expensive for companies, and the incentives are really
    lined up for companies to try to avoid those kinds of outcomes.
        Mr. Hill. Yes. My limited experience in this area is also
    at a very active company that is growing and doing mergers and
    acquisitions and having executive management changes and maybe
    having a very periodic 8-K filing process is that the number of
    days somebody can actually trade their stock is very limited
    per quarter, just fractionally.
        Is there a better way? Now that we have seen the expansion
    of stock options over the past 30 years, is there a better way
    to provide long-term growth-based compensation to executives
    other than stock options? Have you all done any studies on
    that?
        Mr. Martin. I don't think we have done any particular
    studies on that. Obviously, the question of how long vesting
    periods are is pertinent to your question, and I can speak from
    my own personal experience in a limited amount of time, that
    those vesting periods for some executives have been pushed out.
        Mr. Hill. Thank you. I look forward to following up with
    you on that and I appreciate it.
        Mr. Chairman, my best regards for our panel. It was an
    excellent discussion.
        Chairman Sherman. Thank you.
        I now recognize my fellow Californian, Mr. Vargas.
        Mr. Vargas. Thank you very much, Mr. Chairman, and I
    appreciate very much the words of my good friend, French Hill.
        I was a little surprised when this hearing started, that I
    heard the ranking member and others say, basically, there is
    nothing here to see; why don't we just move along?
        IT seems to me that there is a lot here to see, at least
    from my perspective. I appreciate the effort that the
    pharmaceutical companies are putting forward to develop a
    COVID-19 vaccine and the treatment supply and, of course, they
    should be compensated.
        I believe that they should be. But I am also concerned
    about the large amounts of money that they are making when the
    rest of the country is having such a difficult time.
        And I guess I am very concerned about the legal but
    wrongful aspects of this. It really does seem to me that while
    what Kodak did was lega,l it is certainly wrongful, and I do
    not have great confidence in the SEC at the moment. Their
    enforcement is way down.
        So, I think that we have something here.
        Professor Fisch, could you comment on that? Is there
    nothing to see here? Should we move along?
        Ms. Fisch. No, I commend the subcommittee for raising what
    I think are very important topics, and I wouldn't say that you
    all should just move along.
        But what I think a number of the comments have suggested,
    though, is that you are actually focusing on two related but
    separate ideas.
        One is the conveyance or the wrongful misuse of
    information, and the other is sort of the compensation and
    whether companies that are facing speculation in their stock
    price and also companies that are the subject of government
    funding, whether they should be compensating their executives
    to the degree that they are.
        Stock options and some of the recent stock option
    experiences involve a combination of the two, and I think
    members of the subcommittee, at least some members, might be
    equally upset if these executives were getting huge grants just
    in the form of salary.
        Now, obviously, there is nothing wrong with a compensation
    committee deciding to pay an executive millions of dollars
    before the news of a government grant has been publicly
    released.
        The compensation committee knows about the government
    grant. It is not a misuse of nonpublic information. But you
    might say, well, gee, it smells bad. This is taxpayer funding.
        This isn't something the executives should profit from.
    That is a little bit different from the stock trading or the
    insider trading concept.
        Mr. Vargas. Well, Professor, I think it does smell pretty
    bad, to be frank.
        Mr. Frenkel, if you could speak a little bit about the
    spring-loading and bullet dodging you were talking about
    earlier?
        Mr. Frenkel. I would agree with all of the comments that
    have been made so far with respect to spring-loading and bullet
    dodging.
        I think the focus has been more on the spring-loading
    component, where the bullet dodging piece of it is about a
    company temporarily depressing the stock price by releasing
    information before a stock option grant date as opposed to
    holding back the release of the positive information until
    after the option date.
        I think one of the courts in Delaware, if I am not
    mistaken, a number of years ago referred to spring-loading and,
    really, in particular, spring-loading as being a matter of a
    corporate disclosure conduct issue involving an unclean heart
    but not necessarily in violation of the law.
        I think what we are really talking about here is moving the
    whole discussion into how to provide some form of disclosure
    and regulation around these concerns.
        The one thing, respectfully, that I think I should also
    address is the issue of SEC enforcement in this area, because
    while the SEC's numbers may be down, I would submit, as
    somebody who defends these investigations, that the Commission
    is very aggressive.
        There have been 40 trading suspensions that are
    specifically related to issuers in the COVID-19 solutions
    space. So, the Commission really has been very vigilant.
        On the other hand, as it has been dealing with staff
    reductions, that also has impacted its ability to be as broad
    in its application of, or choice of cases.
        But I think in terms of the gestation of investigations, we
    are still seeing a very active division, just sort of a
    reprioritization over the last 18 months.
        Mr. Vargas. My time is about up. Not to be confrontational
    or be difficult, but I would disagree with that, especially
    when you see what happened with Kodak.
        I don't know how you explain that to the American public.
        Thank you. My time has expired.
        Chairman Sherman. I now recognize the former Chair of this
    subcommittee, the gentlelady from New York, Mrs. Maloney, who
    is also the Chair of the House Committee on Oversight and
    Reform..
        Mrs. Maloney. I thank the gentleman for yielding, and thank
    you for this important hearing.
        Mr. Frenkel, I would like to address my question to you.
    Earlier this year, the House passed my legislation, the 8-K
    Trading Gap Act, with overwhelming bipartisan support.
        This bill would close the loophole in our current law that
    allows corporate executives to trade on information before it
    is disclosed to the public.
        And right now, when there is a significant corporate event
    at a public company, the company has to disclose that
    significant event to the public by filing a Form 8-K within 4
    days of the event occurring.
        Of course, during this 4-day gap, executives at the company
    know about the event but their investors don't. My bill would
    address this problem by simply prohibiting executives from
    trading during this 4-day gap.
        Given the recent controversial activities that my
    colleague, Congressman Vargas, just mentioned, the companies
    like Kodak, Novac, and Moderna, I believe it is important now
    more than ever to close this loophole.
        Since the start of the pandemic in mid-March, there have
    been over 10,000 8-K filings with the SEC.
        Mr. Frenkel, would you agree that during this crisis, when
    firms have increasingly made important public announcements, it
    is especially important that we close this loophole?
        Mr. Frenkel. I would agree. I would agree entirely, and I
    think your legislation is right on point, and I think it also
    goes to a point that Mr. Martin had made before regarding
    corporate blackout periods. And certainly, there is abuse.
        But, using the example that Mr. Vargas had raised with
    respect to Kodak, I also refer to the committee statement from
    yesterday.
        The fact is, the SEC has not yet begun, let alone
    completed, conducting its investigation, and the SEC certainly
    can come to entirely different conclusions than the findings of
    the internal investigation, because if you look at the report
    of the internal investigation, I believe the questions that
    were posed were extremely narrow, or at least that were
    addressed in the course of the internal investigation.
        So yes, back to the guts of your question, I do think that
    your proposed legislation around 8-K disclosures is right on
    point and, essentially, legislates the blackout period, which
    is something that really does impose a level of control that
    the market really warrants.
        Mrs. Maloney. Also, as Chair of the House Committee on
    Oversight and Reform, I launched an investigation with
    Chairwoman Waters, and Representatives Engel and Clyburn, into
    the Administration's $765 million loan to Kodak.
        As part of our investigation, the Oversight Committee
    continues to investigate the reasoning behind the U.S.
    International Development Finance Corporation decision to
    provide the loan, and whether they violated their own policies
    and procedures, and whether Kodak shared any material nonpublic
    information before the announcement was made public.
        Now, this was the International Development Finance
    Corporation. They gave it to a domestic corporation--that is a
    violation there--and to a company that had no experience, zero,
    in vaccines.
        Kodak itself has acknowledged that it is under
    investigation by the SEC, and this follows the unusual spike in
    the trading of its stock just one day prior to the July 28th
    announcement, on July 27th.
        More than 1.6 million shares of Kodak were traded, more
    than 6 times the average daily volume of shares a day during
    the previous 30 days.
        And while the increase in trading activity is reported as a
    result of Kodak inadvertently releasing the news of the loan to
    local news outlets--now, why did they do that--where it is
    headquartered, Kodak waited until the following day to publicly
    disclose the announcement.
        Unless its stockholders were paying attention to social
    media, Kodak effectively kept millions of shareholders in the
    dark from the spike in trading activity.
        So, Mr. Frenkel, do you see this as a potential violation
    of Regulation Fair Disclosure (FD), which states that when
    there is a, ``nonintentional disclosure,'' the issuer must
    publicly disclose the information promptly and, if not, can
    this sort of trading activity still be harmful to shareholders
    and the market?
        Mr. Frenkel. The answer, Congresswoman, is yes, there is a
    potential for a violation of Regulation FD, which I believe the
    SEC would include within the scope of its investigation.
        I would also point out that as we look at the price of the
    stock--I will be very brief on this--we are also dealing with
    issues such as potential stock manipulation but also tipping--
    were there other people who traded--and with the people who
    potentially were selling--were involved on the put option side.
        I believe all of these things are something that the SEC
    will look at during the scope of its investigation.
        Mrs. Maloney. When do you expect the investigation to be
    completed?
        Chairman Sherman. I believe the gentlelady's time has
    expired. If there could be a one-sentence answer, we will hear
    it, and then we will go on to Mr. Meeks.
        Mr. Frenkel. I think SEC investigations on allegations such
    as this easily could run 9 months to 12 to 15 months.
        Chairman Sherman. Thank you.
        Mrs. Maloney. I yield back. Thank you, Mr. Chairman.
        Chairman Sherman. I now recognize the gentleman from New
    York, Mr. Meeks.
        Mr. Meeks. Thank you, Mr. Chairman. And thank you for
    holding this important hearing.
        I have been listening off and on to some of the witnesses
    and some of my colleagues' questioning, and I think that what
    we have here is, in the middle of this pandemic that just
    killed hundreds of thousands of Americans, and I know that it
    has devastated the economy and a number of other things, the
    question that presents itself to us, though, is credibility,
    and when we have a time of everybody questioning things,
    especially when you have the President of the United States
    questioning the scientists and doctors and when we are going to
    have a vaccine and when we are not, whether or not everything
    is on the up and up. We also deal with lies as we deal with
    these pharmaceutical companies in the search for a vaccine.
        And I agree that we need one sooner rather than later, and
    I agree that individuals should be compensated for the
    appropriate amount of work that they do.
        As we know, there is no magic bullet. But a vaccine is an
    effective and safe thing that we need, as well as wearing our
    masks on a continuous basis as the doctor said in testimony
    yesterday.
        And so, I applaud all of the doctors, scientists, and
    companies working on this crucial project.
        So what it is is the importance of a vaccine is why it is
    so unfortunate that we have--as I had indicated, the President
    just yesterday contradicted his own CDC Director about when a
    vaccine would be ready. So, I think we need to be building up
    the confidence of the American people.
        That brings me to where we are now, because there is also a
    role, I think, for the capital markets and corporate governance
    to step up because they have to understand the credibility
    issue and have an important role to play here also.
        I believe that we need leaders of these companies to have
    their incentives structured toward producing a safe and
    effective vaccine, but we also need laws that can foster some
    productive arrangements while protecting the integrity of our
    capital markets.
        I will start with you, Ms. Fisch. What are some of the ways
    you think that we can use corporate governance and combine it
    with financial regulations to promote and encourage the
    development of a safe and effective vaccine while also
    protecting some of the market misbehavior that I hear a lot of
    my colleagues talking about?
        Ms. Fisch. Congressman, I wish I had an answer for that
    question. I think the challenge that we all face is that yes,
    in this environment we really want to preserve capital market
    incentives.
        We want to preserve compensation incentives. If some
    company or some executive comes up with a vaccine, the whole
    world is going to say yes, this is worth an awful lot of money
    to us.
        But corporate governance only gets you so far. Right now, I
    think sort of the gap between corporate governance and science
    is really wide and that is part of the struggle.
        A company is taking baby steps and I hear the debate about,
    well, companies should be precluded from awarding stock options
    until they file an 8-K. A company may not know if this baby
    step, the step with respect to testing progress, is going to
    pan out.
        Am I going to mislead investors if I say we are making
    progress? Am I going to mislead investors if I don't talk about
    the progress?
        So, that is why I talked about this disclosure environment
    being very challenging to manage, and I do think it comes down
    to good corporate governance practices. But a lot of those
    governance practices are internal.
        How much is the board riding herd on all of this? How much
    is the board paying attention both to what the company is
    saying and to what its executives are doing? And so to a
    certain degree, that is not about insider trading with
    securities. It is not about fraud. But it is about best
    practices.
        Mr. Meeks. Thank you.
        Mr. Martin. Can I just add something there?
        Mr. Meeks. Go ahead.
        Mr. Martin. I'm sorry, Congressman.
        Mr. Meeks. Go ahead. I am out of time, but go ahead.
        Mr. Martin. I would just add that a lot of our committees
    have been trying to figure out how to--and have revised how
    they use their procedures around their disclosure committees.
        They add to those disclosure committees to try to add the
    right kinds of perspectives, to get at what Ms. Fisch is
    saying, how do you assess the materiality or particular
    developments that, pre-pandemic, would not have risen to that
    level?
        Mr. Meeks. Thank you.
        Let me ask another quick question. What I am noticing--I
    had another one but I won't get to it--is that there has been a
    growing trend for companies to go public, not by using the
    traditional IPO process but, rather, through a reverse merger
    with a special purpose acquisition company (SPAC), and I have
    serious concerns about this new trend.
        I wanted to know if you see any particular implications for
    insider trading or other issues with SPACs. I'm just curious,
    you can say yes or no, you have some concerns.
        Mr. Frenkel. This is Jacob Frenkel. I could certainly
    address that, very briefly.
        Mr. Meeks. Please, if the chairman will allow.
        Mr. Frenkel. The issue with reverse mergers is not just
    SPACs. It is also with reverse mergers with, essentially,
    dormant public companies. That is something that is a hot topic
    issue for the SEC, and has been for probably 30 years, if not
    longer. It is not an insider trading issue. It really is more
    of a market structure issue.
        Chairman Sherman. Thank you very much. The time of the
    gentleman has expired. The next two questioners, I believe, are
    both voting, and at the suggestion of staff, we are going to
    take a 10-minute recess. We will reconvene in 10 minutes.
        Thank you.
        [brief recess]
        Chairman Sherman. We will reconvene, and I believe Mr.
    Gottheimer is next to be recognized for 5 minutes.
        Mr. Gottheimer. Thank you, Chairman Sherman, and thank you
    to all of our panelists for being here today.
        When the pandemic first hit, my district in northern New
    Jersey was in the eye of the COVID storm. New Jersey had the
    second-highest rate of cases in the country, and the supply of
    protective gear was uncertain.
        Some health care providers estimated that supplies would
    run out in a matter of days. Health providers called on the
    Administration to use the Defense Protection Act (DPA) to
    leverage America's manufacturing capacity to make sure the
    necessary equipment was ready to keep fighting the pandemic.
        Using the DPA is crucial in our fight against COVID.
    However, I was just as surprised as many of us when the
    International Development Finance Corporation (DFC) announced
    that they would issue their first DPA loan worth $765 million
    to Kodak to produce pharmaceutical components.
        The DPA is finally being utilized, but to a company that
    has only just recently left bankruptcy, with no proven success
    record in pharmaceuticals being entrusted with such a important
    task. Frankly, it is a joke.
        Still, we know who was not surprised. Kodak's CEO purchased
    46,737 shares of the company leading up to the announcement and
    received 1.75 million stock options from the Kodak board the
    day before the announcement was made.
        These stock options may have been worth as much as $50
    million just a few days later. I helped lead a letter from this
    committee to the SEC urging an investigation surrounding these
    transactions and market movement, and I was pleased to hear the
    SEC has opened an investigation, that the DFC's inspector
    general is investigating the origin of the loan.
        Mr. Frenkel, knowing the circumstances around the loan, the
    purchasing of the stocks by corporate insiders, the options
    granted, the early leak of the announcement, would you say
    there is a potential here for unlawful insider trading?
        Mr. Frenkel. I think I would go beyond that. I think in
    terms of potential violations, there is the potential that the
    SEC could find a range of violations including in a disclosure,
    in terms of trading, in terms of possibly even individuals
    involved in manipulation.
        We don't know, and I think the fundamental issue from my
    perspective is we have to give deference to the SEC to allow it
    to conduct its investigation.
        I also think that we have to be mindful of one other thing,
    which is that when we talk about the specific securities laws
    violations, if we go back to insider trading enforcement in the
    1980s and 1990s, those cases primarily were brought by the
    Southern District of New York, charging it as wire fraud and
    mail fraud.
        So, there is also a broad range of Federal criminal
    statutes that potentially can apply, even if there may not be a
    specific SEC law or regulation that could fall within the scope
    of a violation.
        In terms of the potential scope of the investigation, I
    think it is real. I think that, as I mentioned earlier, if you
    look at the questions that were posed in the internal
    investigation by outside counsel, they are very narrowly
    framed.
        I think to the committee's point, there still is plenty for
    the SEC to look at, and there is the potential for the
    Commission's Enforcement Division to find and recommend
    enforcement action. But only time will tell.
        Mr. Gottheimer. Thank you, sir. I appreciate that response.
        Would you discuss a little more kind of the harm this
    causes shareholders and potential harm here to shareholders and
    capital markets and the taxpayers?
        Mr. Frenkel. The core issue, one, is credibility.
    Interestingly, I actually go back to the language of the
    Securities Act of 1933.
        When you look at the preamble of the 1933 Act, it is full
    and fair disclosure of the character of securities sold to
    interstate and foreign commerce through the mails and to
    prevent frauds in the sale thereof.
        I think everything that this committee is doing on a
    bipartisan level is very much directed towards, and I support
    it fully, enhancing disclosure to ensure that there is a level
    of--the ability for the public, for participants, to have
    confidence in our markets, and I think that continues to be,
    really, the core issues: credibility; transparency; and
    confidence.
        Mr. Gottheimer. Thank you. Our country is clearly on the
    cusp here of many questions that we need to get answers to, and
    where I live, we are home to so many life sciences companies
    that have decades of experience and success.
        Now is not the time, clearly, to place bets, during a
    public health crisis, on unproven entities that are unprepared
    to help our nation through this pandemic, and I strongly agree
    that a corporate insider shouldn't profit from these misguided
    allocations of resources.
        So, I look forward to our continued oversight. Thank you
    very much for being here, sir.
        Chairman Sherman. Thank you.
        I now recognize the gentleman who brings extensive security
    law experience to his service on this subcommittee, Mr. Casten.
        [No response.]
        Chairman Sherman. Mr. Casten, you are recognized for 5
    minutes.
        Mr. Casten. I apologize, Mr. Chairman. I didn't recognize
    that I had all that extensive securities law experience and
    didn't realize you were talking about me.
        Thank you so much, Mr. Chairman, and thank you to our
    witnesses for being here.
        I want to start by making three statements that I think are
    just factual and should be fairly nonobjectionable.
        First, capital markets are not moral. Capital markets are
    not immoral. Capital markets are amoral. They amorally
    rationally allocate capital to places where we think there will
    be future cash flows.
        Second, rushing a vaccine to market too early is massively
    dangerous to public health. If it is not tested on populations
    who are healthy prior to taking the vaccine, it not only risks
    our health from the vaccine but risks future certainty about
    the trustworthiness of all vaccines.
        And the third statement of fact, Operation Warp Speed has
    distributed, I think, about $9 billion to developers of
    vaccines, and the President of the United States is openly
    touting that there will be a vaccine available by election day.
        Those are facts. Given that amorality, a question for you,
    Mr. Claypool, is it rational to assume that a company receiving
    cash from Operation Warp Speed, when the President of the
    United States is saying there will be a vaccine by the
    election, is it rational for an amorally rational investor to
    assume that that company might have an increase in near-term
    cash flows?
        Mr. Claypool. I think it is perfectly rational to think
    that, as a result of good news, the company's value is going to
    go up.
        With that said, there is not a place for--in the greater
    context of this crisis and seeing the idea that--I guess, one
    could also argue that it is rational for an insider to exploit
    insider information if they believe they could get away with
    it.
        Mr. Casten. I am not trying to ask you a ``gotcha''
    question. I am glad you agree with the first part. Is it not
    also rational to assume that if a company did see a surge in
    cash flows from that good news, and a surge in their equity
    value, but that the vaccine was subsequently proven to be
    dangerous, that that company might face longer-term
    liabilities, legal or otherwise, from bringing that to market
    too soon?
        Okay. So is it then not rational for an informed amoral
    insider, looking at that information, to say, it is in my
    amoral interest to participate in those markets? Buy now and
    cash out quickly before that future liability comes home to
    roost?
        Mr. Claypool. I could see if there was a logic to that sort
    of hedge. It strikes me as, I guess, more cynical than we would
    hope the companies that we are relying on to develop vaccines
    for all of us will be acting in this crisis.
        I think we expect good faith development from those who do
    the work. That is their core business purpose.
        Mr. Casten. Yet, and I am in no way--I don't mean my
    comments in any way to question the morality of the companies.
    I am just making a comment about the nature of markets, that
    are not immoral. But they are not moral either. They are just
    making judgments. And I have concerns about the public health
    risks of rushing a vaccine to market.
        When we have insiders trading on this information, and
    should the chickens come home to roost that we have rushed this
    out too soon, what concerns do you have about what that does to
    trust in our capital markets?
        Mr. Claypool. I think it is very dangerous, and I also
    would add that to the concern of spring-loading and those kinds
    of issues, it is worth being concerned that good news could be
    withheld until after those stock options are issued in a way
    that executives are most able to exploit.
        Mr. Casten. Thank you. I don't know what we do with this
    other than that back in the days when I was a CEO of a company,
    one of the--I had a professor in grad school who said the most
    dangerous type of leadership is leadership based on knowledge,
    because the preservation of power depends on limiting people
    around you's access to information.
        And I used to find, when I raised money on Wall Street, as
    the chairman was praising me for, that Wall Street is a place
    where information is power. Sadly, it is actually true of the
    current job I have.
        But I think we always need to keep our vigilance up in
    industries like that where withholding information from other
    people is a way to gain power.
        Thank you, and I yield back.
        Mr. Claypool. I agree.
        Chairman Sherman. The gentlelady from New York, Ms. Ocasio-
    Cortez, is recognized for 5 minutes.
        Ms. Ocasio-Cortez. Thank you, Mr. Chairman, and thank you
    for hosting this incredibly important hearing. I had a quick
    question. So much of what we are discussing today has to do
    with prospects of insider trading, and also tying CEO
    compensation to stock, and my question for Mr. Claypool is,
    when CEOs and corporate CEOs, pharmaceuticals and otherwise,
    are compensated with stock packages and packages where an
    enormous amount of money that they are being compensated in is
    in stock options, how does that potentially influence decision-
    making when it comes to the long-term health of a company or
    long-term decisions for pharmaceuticals?
        Mr. Claypool. Thank you, Congresswoman.
        That is an interesting question, because so often, the
    premise of issuing stock options as a way of paying executives
    is intended to align the interests of a company with the
    interests of shareholders.
        And what we are seeing in instances such as we are
    observing here, is that this intense short-termism encourages
    ways for companies to look for ways to quickly raise the stock
    price or to take advantage of volatile circumstances and pursue
    a short-term gain.
        There have been a variety of reforms that even companies
    have self-enacted. Most companies, in the aftermath of the
    scandal where companies were backdating their pay to--it was
    kind of the opposite where they were kind of--they knew the
    price of a stock would go up, so they would sort of shift the
    date of the award backwards in time, was that many companies
    sort of picked--in fact, I think most companies now pick a
    select date to award those stock options.
        That was a positive development. However, what studies are
    now showing is that companies are trying to find ways to, say,
    time bad news for before before the announcements or saving the
    good news for after the set date they know the stock options
    are made.
        Now, every individual instance of this may have a very
    plausible explanation for why they announced the news they did,
    when they did, and the timing of the options.
        But the reasons that I have just shown, 1,200 companies
    that have this sort of V-shaped pattern in how they are paid,
    and the pattern is even greater for companies who pay above
    average amounts of stock options and for companies that are
    hard to value because, like these pharmaceutical companies
    whose--their real destinies are based on just the success or
    failure of, often, a single drug being developed is a
    circumstance that invites shenanigans, and I am happy that the
    committee is looking into that, and hopefully will find ways to
    thwart it.
        Ms. Ocasio-Cortez. Absolutely.
        Ms. Fisch. Congresswoman, could I just weigh in on that?
        Ms. Ocasio-Cortez. Yes, absolutely.
        Ms. Fisch. I'm sorry to interrupt. You identified concerns
    about short-termism in trading opportunities. But I think the
    academic literature reveals a bigger problem with option-based
    compensation, which is that it makes operational decisions too
    risky, and I think that relates to Congressman Casten's concern
    about scientific development and particularly vaccines.
        If you have stock options, that is a really high-powered
    incentive to take risks so that your stock price balloons, and
    I think in this environment, that is an extra caution that we
    really have to worry about.
        Ms. Ocasio-Cortez. Absolutely. So, would you say it is fair
    to say that having these kinds of stock options could
    incentivize riskier behavior when it comes to an industry like
    pharmaceuticals, that could carry an elevated risk with it?
        Ms. Fisch. Absolutely, and I think where we see particular
    concern is in some of these companies that historically have
    not been profitable, where their stock price is very low to
    begin with and, therefore, the potential downside is very
    limited but the potential upside is enormous.
        Ms. Ocasio-Cortez. Thank you. Thank you very much.
        And I have one last question for Mr. Frenkel. You have been
    a prosecutor, and insider trading, and, perhaps, activities
    that mirror or appear like insider trading, are not exclusive
    to the private sector.
        We have seen some questionable activity right here in
    Congress, and I am really interested in your thoughts on the
    2012 Stock Act, how it may fall short, and what are some of the
    concerns that you think there are with respect to Congress and
    Members of Congress engaging in behavior that could be seen as
    or interpreted as insider trading?
        Chairman Sherman. I will ask you to answer in just a couple
    of seconds, because the time of the gentlelady has expired.
        Mr. Frenkel. Thank you, Mr. Sherman.
        I think the easiest way to answer that question succinctly
    is that we look to the SEC and the Department of Justice,
    through bringing their cases, to have a deterrent effect on
    certain behavior.
        So, absent there being such cases, there is always going to
    be a perception that the law may not be sufficiently effective.
    I think at this point, we have to defer to the investigations
    and see if they result in enforcement actions that, in turn,
    will send a message about the level of commitment to
    enforcement of such laws.
        Chairman Sherman. Thank you. Thank you very much.
        I see no other members who have not been recognized. I am
    informed that all members of the subcommittee who wish to
    participate have been able to ask questions.
        Mr. Huizenga. Mr. Chairman, I am trying to get your
    attention so that I can submit an article for the record.
        Chairman Sherman. The gentleman is recognized.
        Mr. Huizenga. Thank you, and it actually fits perfectly
    with what my colleague from New York was talking about, as well
    as Mr. Frenkel and others.
        This is a November 2019 Reuter's article. The headline is,
    ``U.S. SEC enforcement activity hits second-highest level ever
    in 2019,'' and the article goes on to explain what the SEC has
    been doing on enforcement.
        So, I would like to submit that for the record.
        Chairman Sherman. Without objection, it is so ordered.
        Mr. Huizenga. Thank you.
        Chairman Sherman. Again, seeing no Members who have not
    been recognized, I would like to thank our witnesses for their
    testimony. I think today, we have learned that, especially
    during an outbreak of COVID, we need to make sure that insiders
    don't deal unfairly with the investing public and don't profit
    from not-yet-disclosed material information.
        I look forward to working with my colleagues to achieve
    those objectives and, hopefully, the SEC will not only continue
    the enforcement efforts that Mr. Huizenga pointed out, but will
    look at some of the issues brought up in this hearing in the
    areas that are perhaps wrongful but legal.
        The Chair notes that some Members may have additional
    questions for this panel, which they may wish to submit in
    writing. Without objection, the hearing record will remain open
    for 5 legislative days for Members to submit written questions
    to these witnesses and to place their responses in the record.
    Also, without objection, Members will have 5 legislative days
    to submit extraneous materials to the Chair for inclusion in
    the record.
        This hearing is now adjourned. Thank you.
        [Whereupon, at 2:29 p.m., the hearing was adjourned.]

                                A P P E N D I X

                               September 17, 2020

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