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E-MailJames Park is Professor of Law at UCLA School of Law. This post is based on his recent article forthcoming in the Northwestern University Law Review.
Concerns about entrepreneurial enforcement have been particularly high in the context of securities fraud litigation. Public companies frequently are defendants in securities class actions alleging they issued materially misleading information that inflated their stock price. Skeptical courts have thus created various doctrines in an attempt to narrow the reach of Rule 10b-5 to reduce the costs of entrepreneurial securities litigation.
The Securities and Exchange Commission (SEC), the federal administrative agency that regulates securities markets, also has the power to enforce Rule 10b-5 against public companies. Commentators have generally viewed the SEC as a more responsible enforcer than private plaintiffs and their lawyers. Because the SEC and its enforcement attorneys do not personally profit from a successful enforcement action, the SEC has less incentive to aggressively file cases than entrepreneurial enforcers. Congress has thus explicitly exempted the SEC from some of the restrictions it has placed on private securities litigation. On the other hand, for proponents of vigorous enforcement, the private sector has significant advantages over government enforcement. Without entrepreneurial incentive, the SEC is often criticized for not bringing enough challenging cases and settling cases too quickly and for too little.
This Article argues that the perception that the SEC is a passive enforcer is dated, at least in the context of public company securities fraud enforcement. The SEC has become more entrepreneurial in that it has become more willing to bring ambitious cases that test the boundaries of the law. The SEC no longer limits itself to easy cases that can be settled with a modest fine. It routinely brings difficult and innovative cases and insists on significant sanctions. It often avoids or disagrees with doctrinal limitations that the courts have used to narrow the reach of Rule 10b-5. The SEC’s recent enforcement activity exhibits some similarities to the approach of entrepreneurial private enforcers. Even if the SEC is not as entrepreneurial as private plaintiffs, it is increasingly acting like a private plaintiff in testing the limits of Rule 10b-5.
Consider the case the SEC settled against in 2022 against Boeing, the aircraft manufacturer (which paid a $200 million penalty) and its CEO (who paid a $1 million penalty). The case arose out of statements issued by Boeing in November 2018 and April 2019 after the crashes of two of its 737 MAX airplanes. The SEC emphasized the failure of these parties to “exercise reasonable care” in ensuring the accuracy of these statements but also alleged facts suggesting that they deliberately issued false statements. An intentional misstatement generally would satisfy the standard for scienter. However, the SEC did not allege that Boeing violated SEC Rule 10b-5, which requires a showing of fraudulent intent, but instead proceeded under Subsections 17(a)(2) and (3) of the Securities Exchange Act, which do not. There is a question as to why the SEC did not choose to include 10b-5 claims in the settlement to signal its belief that Boeing acted with scienter through its CEO.
The first Boeing statement the SEC claimed was misleading was the assertion in a press release after the first 737 MAX crash that the model was “as Safe as Any Airplane that has Ever Flown the Skies.” The press release was allegedly misleading because it did not discuss a safety issue associated with the 737 Max’s flight control system. When Boeing issued the statement, it knew there was an “airplane safety issue” that required redesigning the system’s software. Boeing’s CEO reviewed the press release and “suggested removing discussion of the planned [flight control] software redesign from the Draft Press Release.”
The second statement highlighted by the SEC involved similar reassurances that did not acknowledge concerns about the 737 MAX’s safety. In an earnings call and press conference after the second crash of a 737 MAX in April 2019, Boeing’s CEO represented that its “certification process” for the airplane was consistent with prior “design and certification processes that consistently produce safe airplanes” The CEO did not acknowledge that a Boeing employee stated he had “lied to regulators (unknowingly)” about the system, despite being informed of the statement and noting that it was “concerning.”
The Boeing settlement sent a mixed message to the public. On the one hand, the seriousness of Boeing’s material misrepresentations was highlighted by a penalty of $200 million and the fact that the CEO was also charged. The various factual allegations described by the complaint suggested that the defendants knowingly issued misleading information. On the other hand, there was no allegation of Rule 10b-5 and thus Boeing can argue that it did not act with fraudulent intent.
There are two major explanations for the SEC’s more entrepreneurial enforcement approach. The first is the incentive to collect penalties. The SEC only began collecting substantial penalties against public companies about twenty years ago. It now frequently highlights the fact that it collected record penalties in its annual enforcement report. While the SEC and its staff do not keep the penalties it collects, the SEC can use its penalty collections to increase its standing by conveying competence and strong performance to the public. The second is that the SEC’s entrepreneurial enforcement reflects its ambitious regulatory agenda. The SEC is expanding the reach of its regulation of public companies to cover a broader range of issues such as Environmental, Social, and Governance (ESG) risk. It has become more entrepreneurial in its enforcement because it is seeking opportunities to support its agenda and expand the reach of its authority.
By becoming more entrepreneurial, the SEC has addressed persistent criticism that it is too passive and is overly deferential to private interests. The argument that SEC enforcement staff is captured by the private sector does not ring true today. The SEC’s willingness to challenge restrictions on the scope of Rule 10b-5 also can check the tendency of courts to arbitrarily limit that rule in order to shield public companies from private litigation. In doing so, it can enhance the impact of such private enforcement.
As SEC enforcement has become more entrepreneurial, the agency should do more to maintain the legitimacy of its enforcement program. If the SEC has an incentive to collect substantial settlements from corporate defendants, there is less reason to privilege it relative to private enforcers. The Article concludes with some suggestions to ensure that the SEC’s enforcement is more transparent and effective. The SEC should not levy substantial penalties for a material misstatement by a corporation without evidence of fraudulent intent or strong evidence of substantial investor harm.
A link to the article on SSRN: https://ssrn.com/abstract=4816803
