Fighting on Behalf of Investors Despite Efforts to Weaken Protections

Editor’s Note: Luis A. Aguilar is a Commissioner at the U.S. Securities and Exchange Commission. This post is based on Commissioner Aguilar’s remarks at the North American Securities Administrators Association’s Annual NASAA/SEC 19(d) Conference; the full text, including footnotes, is available here. The views expressed in the post are those of Commissioner Aguilar and do not necessarily reflect those of the Securities and Exchange Commission, the other Commissioners, or the Staff.

This Annual Conference is an important opportunity for representatives of NASAA and the SEC to come together to discuss how best to accomplish our common goal of protecting investors. These annual conferences provide an opportunity to increase collaboration, communication, and cooperation for the benefit of investors, and to promote fair and orderly markets. I have been honored to have served as the SEC’s liaison to NASAA for the past four years. I know and appreciate NASAA’s mission of protecting main street investors and the critical role that state securities regulators play in the enforcement of the securities laws. You are often the first to receive complaints from investors and identify the latest scams devised to steal from investors.

I want to take this opportunity to highlight some of the recent achievements of NASAA’s members. According to the latest statistics, as of October 2012:

  • State securities regulators conducted 6,121 investigations;
  • The states reported filing more than 2,600 administrative, civil, and criminal enforcement actions involving nearly 3,700 respondents and defendants;
  • The states reported criminal actions that resulted in 1,662 years of incarceration, which is a 47% increase over the previous year;
  • The states imposed more than $2.2 billion in investor restitution orders and levied fines or penalties and collected costs in excess of $290 million; and
  • A total of nearly 2,800 licenses were withdrawn due to state action, and 774 licenses were denied, revoked, suspended, or conditioned.

These statistics are impressive – particularly given the lack of resources faced by many state securities regulators. Just as the SEC has struggled without adequate resources, state regulators have had to deal with the challenges of doing more with less.

And, as NASAA knows well, in meeting our challenges, we also need to be a voice for pro-investor legislation and rulemaking. I want to focus my remarks on (1) certain efforts that I believe have weakened investor protection; and (2) legislative and rulemaking initiatives that I believe are critical to strengthening investor protection. In particular, I would like to highlight the importance of:

  • Listening to the voices of investors and regulators – with a particular focus on the recent SEC proposal to allow heretofore private offerings to be mass-marketed;
  • Moving forward to implement rulemaking that would disqualify felons and other bad actors from Rule 506 offerings;
  • Strengthening private remedies for victims of fraud; and
  • Prohibiting or limiting pre-dispute mandatory arbitration.

Efforts to Weaken Investor Protection

As many of you know, the Jumpstart Our Business Startups Act (the “JOBS Act”) requires the SEC to amend Rule 506 to eliminate a ban on the general advertising of private securities offerings. Companies using the Rule 506 exemption can raise an unlimited amount of money without registering the offering with the SEC, as long as they meet certain standards. Rule 506 has allowed many legitimate companies to raise money and prosper. At the same time, however, the Rule 506 exemption has resulted in significant fraudulent activities. Reports from state and federal securities regulators have shown that Rule 506 offerings are frequently the subject of enforcement investigations and actions. In fact, just in 2011, state regulators and the SEC, collectively, filed more than 324 enforcement actions related specifically to Rule 506 offerings.

The removal of the ban on “general solicitation” has resulted in widespread fear that offerings mass-marketed under Rule 506 will expose investors to even greater risk of fraud and abuse. Yet, to my profound disappointment, when the removal of the ban was proposed by the Commission, a majority of the SEC’s Commissioners proactively excluded from discussion many of the practical and cost-effective suggestions made by investors and other regulators, including comments from NASAA, that could serve to reduce the anticipated harm to investors.

The Commission received comments, both before and after the proposal, urging that we consider various amendments, alternatives, and recommendations to better align the mass-marketing provisions with investor protection. Yet, in a departure from the Commission’s standard practice of allowing proposals to include a fulsome discussion of reasonable alternatives, the proposing release did not request comment on any of those recommendations and, contrary to the Commission staff’s own guidance for economic analysis, the proposing release did not consider whether including any of the recommendations would be a reasonable alternative to the approach in the proposed rule. In addition, some may argue that under the Administrative Procedures Act this failure may prevent the Commission from even considering any of those suggestions unless there is a re-proposal. In all my time at the Commission, I’ve never seen a more aggressive effort to exclude pro-investor initiatives.

Because of the decision to ignore the recommendations by investors and other regulators, I consider the Commission’s proposal to be fatally flawed. I was left with no choice but to vote “no” on the proposal. In my view, the only viable alternative is for it to be re-proposed so that we can provide for a fulsome discussion of how best to allow general solicitation under Rule 506 while, at the same time, considering the needs of investors. To me, it is clear that Congress did not expect the SEC to ignore investor protection issues. Instead of enacting a self-implementing provision to allow general solicitations, Congress gave the SEC the obligation to determine how best to do so. A re-proposal that allows for a real discussion of reasonable alternatives is the only path forward that will adequately address investor protection issues. To say that I was disappointed in the Commission’s action would be an understatement.

Disqualifying Felons and Other Bad Actors from Rule 506 Offerings

I must also say that I am disappointed in the Commission’s apparent lack of urgency in implementing the Dodd-Frank Act’s mandate to prevent crooks and so-called “bad actors” from utilizing Rule 506 (the “Bad Actor Rule”). It does not seem controversial for the Commission to prevent felons and other law-breakers from pitching private investment deals to investors. However, it has been almost two years since the Commission’s proposal to disqualify “bad actors” from 506 offerings, and the Commission has yet to adopt the Bad Actor Rule. I agree with U.S. House Financial Services Ranking Democrat Maxine Waters when she said:

[t]he Commission should work swiftly to impose the “bad actor” disqualification before expanding the availability of general solicitation and advertising, particularly since Congress directed the Commission to institute this disqualification provision nearly two years before the JOBS Act.

The adoption of a disqualification provision would provide much needed investor protection and would not be detrimental to legitimate issuers. The continuing delay only hurts investors.

Strengthening Private Remedies for Victims of Fraud

In light of the SEC’s actions to shut out investors’ voices, and in unduly delaying the adoption of investor-friendly rulemaking, it is now more important than ever that defrauded investors have the ability to seek redress against those who participate in defrauding them. Unfortunately, a series of Supreme Court cases has restricted aiding and abetting liability in private actions. I agree with NASAA’s request that Congress amend the Securities Exchange Act of 1934 (“Exchange Act”) to allow for a private civil action against a person that provides substantial assistance in violation of the Exchange Act. In 2009, former Senator Arlen Specter introduced legislation that would have amended the Exchange Act so that any person who “knowingly or recklessly provides substantial assistance to another person would be subject to liability in a private action to the same extent as the person to whom such assistance is provided.” I join with NASAA in calling on Congress to reintroduce this legislation.

Congress has long recognized the importance of private actions under the federal securities laws. In the Private Securities Litigation Reform Act of 1995, or PSLRA, Congress reaffirmed that “[p]rivate securities litigation is an indispensable tool with which defrauded investors can recover their losses without having to rely upon government action. Such private lawsuits promote public and global confidence in our capital markets and help to deter wrongdoing and to guarantee that corporate officers, auditors, directors, lawyers and others properly perform their jobs.”

Private actions give fraud victims the ability to recover their losses. It is unrealistic to expect that state regulators or the SEC will have the resources to police all securities frauds or go after every fraudster. Investors should have the ability to protect themselves.

Pre-Dispute Mandatory Arbitration Weakens Investor Protection

Investors also should have the unencumbered right to seek redress in all available forums. This is why I want to spend a few moments discussing pre-dispute mandatory arbitration provisions. Currently, almost all customer agreements with brokerage firms include an arbitration clause requiring customers to arbitrate their claims in an arbitration forum – and they’re now popping-up in the investment advisory industry. By adding such provisions, brokerage and advisory firms are essentially requiring their clients to give up their legal rights before the client even knows about the nature of a dispute, and before the client has had the opportunity to consider whether giving up those rights would be in their interest. The inclusion of such provisions in brokerage and advisory contracts diminishes investor protection.

I do not intend to discuss the merits of whether arbitration is a better or worse system than going through the federal and state court systems, except to note that the relative merits and benefits of the arbitration processes are still the subject of debates in the industry. Arbitration may be a viable option after a dispute arises and both parties knowingly agree to go into arbitration. However, my main concern with pre-dispute mandatory arbitration is the denial of investor choice; investors should not have their option of choosing between arbitration and the traditional judicial process taken away from them at the very beginning of their relationship with their brokers and advisers.

A client’s right to go to court to recover monetary damages is an important right that should be preserved and kept in the client’s toolkit. A client’s right to bring private actions under the Exchange Act is meaningful, and the client should not be required to waive – prematurely – their legal rights, including their rights to bring an action in federal or state court. Let me give you some statistics. In fiscal year 2012, the SEC brought 147 investment adviser-related cases. This is roughly 20% of all enforcement cases, and accounted for the largest category of enforcement cases during that fiscal year. Of these enforcement cases, approximately 88 out of 147 cases, or 60%, involved allegations of fraud under the Exchange Act.

Similarly, in fiscal year 2012, the SEC brought 134 broker-dealer cases. This is about 18% of all enforcement cases, and accounted for the second largest category of enforcement cases during that fiscal year. Out of these 134 broker-dealer enforcement cases, roughly 95 cases, or 71%, involved allegations of fraud under the Exchange Act.

In many of these cases, clients may be able to pursue claims against their advisers and brokers for fraud. However, if the clients had signed a pre-dispute mandatory arbitration agreement at the inception of the relationship, the clients’ ability to pursue claims through the judicial process is extinguished. My point is simply this: by providing investors with the ability to choose the forum in which to bring their legal claims and protect their legal rights, we enhance investor protection and add more teeth to our federal securities laws.

The concerns about mandatory pre-dispute arbitration are not new. For example, in April 2007, U.S. Representative Barney Frank, then the Chairman of the House Committee on Financial Services, sent a letter to the SEC Chairman to share his concerns that mandatory arbitration imposed limits on investor rights and required investors to “risk losing their rights under federal securities laws in order to invest in our public markets.” It is, therefore, not surprising that during the legislative process that resulted in the passage of the Dodd-Frank Act, members of Congress voiced their concerns about mandatory pre-dispute arbitration and noted the concerns that they were “unfair to the investors.”

In passing the Dodd-Frank Act, Congress recognized the need to protect investors from abusive practices in the financial services industry. As many of you know, Section 921(a) of the Dodd-Frank Act authorizes the Commission to prohibit or restrict mandatory pre-dispute arbitration provision in customer agreements, if such rules are in the public interest and protect investors. The authority covers broker-dealers and investment advisers. I believe the Commission needs to be proactive in this important area. We need to support investor choice.


Before I end my remarks, I want to highlight an additional pro-investor initiative that is long overdue. As this group knows well, the Dodd-Frank Act reinforced the Commission’s need to be more focused on investor advocacy issues by mandating that the SEC establish an Office of the Investor Advocate. Yet, almost three years after Dodd-Frank became law, the Commission still has not created the Office of the Investor Advocate. I hope this is one of the first matters addressed by the new SEC Chairman.

The results of a recent survey reported in March 2013 show that, by an overwhelming margin, 84% of Americans want the federal government to play an active role in protecting investors. As my remarks have shown, the Commission’s leadership can do more to respond to the needs of investors.

The recognition that the Commission’s leadership can do a better job in addressing the needs of investors, however, does not in any way distract from the hard work and the commitment of the SEC staff to fulfill the SEC’s mission of protecting investors; maintaining fair, orderly and efficient markets; and facilitating capital formation. They are among the finest individuals I’ve had the privilege of working with every day.

In closing, I want to commend the SEC staff and NASAA members for all your efforts in enforcing the federal and state securities laws and for working to preserve the integrity of our financial markets. I think that the partnership between NASAA and the SEC has been, and can continue to be, a powerful force to protect investors.

As the SEC’s NASAA liaison, I am also aware of the benefits of cooperation between the SEC and NASAA. For example, during the past two years, approximately 2,400 investment advisers made a smooth transition to state regulation as a result of the Dodd-Frank Act, which expanded state authority over mid-sized investment advisers to those with up to $100 million in assets. This is a testament to the cooperation by the staffs of the SEC and state securities regulators.

I know that the Commission can count on NASAA’s support to work together on behalf of investors. I am honored to be working with you to protect investors. Though we may be outmanned and outgunned as state and federal securities regulators, I know that the people in this room have the resolve and commitment to fight on behalf of investors every single day.

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