U.S. GOVERNMENT PUBLISHING OFFICE

31–476 PDF WASHINGTON : 2018

ENSURING EFFECTIVENESS, FAIRNESS, AND 

TRANSPARENCY IN SECURITIES LAW 

ENFORCEMENT 

HEARING 

BEFORE THE

SUBCOMMITTEE ON CAPITAL MARKETS, 

SECURITIES, AND INVESTMENT 

OF THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED FIFTEENTH CONGRESS 

SECOND SESSION 

JUNE 13, 2018 

Printed for the use of the Committee on Financial Services 

Serial No. 115–100 

( 

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(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

PATRICK T. MCHENRY, North Carolina, 

Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

STEVE STIVERS, Ohio 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

KEITH J. ROTHFUS, Pennsylvania 

LUKE MESSER, Indiana 

SCOTT TIPTON, Colorado 

ROGER WILLIAMS, Texas 

BRUCE POLIQUIN, Maine 

MIA LOVE, Utah 

FRENCH HILL, Arkansas 

TOM EMMER, Minnesota 

LEE M. ZELDIN, New York 

DAVID A. TROTT, Michigan 

BARRY LOUDERMILK, Georgia 

ALEXANDER X. MOONEY, West Virginia 

THOMAS MACARTHUR, New Jersey 

WARREN DAVIDSON, Ohio 

TED BUDD, North Carolina 

DAVID KUSTOFF, Tennessee 

CLAUDIA TENNEY, New York 

TREY HOLLINGSWORTH, Indiana 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

WM. LACY CLAY, Missouri 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

JUAN VARGAS, California 

JOSH GOTTHEIMER, New Jersey 

VICENTE GONZALEZ, Texas 

CHARLIE CRIST, Florida 

RUBEN KIHUEN, Nevada 

SHANNON MCGAHN, Staff Director 

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(III) 

SUBCOMMITTEE ON CAPITAL MARKETS, SECURITIES, AND INVESTMENT

BILL HUIZENGA, Michigan, Chairman 

RANDY HULTGREN, Illinois, Vice Chairman 

PETER T. KING, New York 

PATRICK T. MCHENRY, North Carolina 

SEAN P. DUFFY, Wisconsin 

STEVE STIVERS, Ohio 

ANN WAGNER, Missouri 

LUKE MESSER, Indiana 

BRUCE POLIQUIN, Maine 

FRENCH HILL, Arkansas 

TOM EMMER, Minnesota 

ALEXANDER X. MOONEY, West Virginia 

THOMAS MACARTHUR, New Jersey 

WARREN DAVIDSON, Ohio 

TED BUDD, North Carolina 

TREY HOLLINGSWORTH, Indiana 

CAROLYN B. MALONEY, New York, 

Ranking Member 

BRAD SHERMAN, California 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

JAMES A. HIMES, Connecticut 

KEITH ELLISON, Minnesota 

BILL FOSTER, Illinois 

GREGORY W. MEEKS, New York 

KYRSTEN SINEMA, Arizona 

JUAN VARGAS, California 

JOSH GOTTHEIMER, New Jersey 

VICENTE GONZALEZ, Texas 

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C O N T E N T S 

Page 

Hearing held on: 

June 13, 2018 .................................................................................................... 1 

Appendix: 

June 13, 2018 .................................................................................................... 35 

WITNESSES 

WEDNESDAY, JUNE 13, 2018 

Bondi, Bradley J., Partner, Cahill Gordon & Reindel LLP .................................. 5 

Borg, Joseph P., Director, Alabama Securities Commission ................................ 7 

Quaadman, Thomas, Vice President, Center for Capital Markets Competitiveness, U.S. Chamber of Commerce ....................................................................... 9 

Vollmer, Andrew N., Professor of Law and Director, John W. Glynn Jr. 

Law & Business Program, University of Virginia School of Law .................... 10 

APPENDIX 

Prepared statements: 

Bondi, Bradley J. .............................................................................................. 36 

Borg, Joseph P. ................................................................................................. 114 

Quaadman, Thomas ......................................................................................... 129 

Vollmer, Andrew N. .......................................................................................... 140 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Maloney, Hon. Carolyn: 

Written statement from Community Bancorp of Santa Maria ..................... 155 

Written statement from The Freedom Bank of Virginia ............................... 157 

Written statement from First Resource Bank ................................................ 159 

Written statement from Meritage Hospitality Group .................................... 162 

Written statement from Mission Valley Bank ............................................... 164 

Written statement from OurPet’s Company ................................................... 166 

Written statement from OTC Markets Group Inc. ........................................ 168 

Written statement from Repro Med Systems, Inc. ........................................ 204 

Written statement from Royal Financial, Inc. ............................................... 207 

Written statement from The Singing Machine Company, Inc. ..................... 210 

Written statement from Tix Corporation ....................................................... 212 

Borg, Joseph P.: 

Responses to questions for the record from Representative Lynch .............. 215 

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ENSURING EFFECTIVENESS, FAIRNESS, 

AND TRANSPARENCY IN SECURITIES 

LAW ENFORCEMENT 

Wednesday, June 13, 2018 

U.S. HOUSE OF REPRESENTATIVES, 

SUBCOMMITTEE ON CAPITAL MARKETS, 

SECURITIES, AND INVESTMENT, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The subcommittee met, pursuant to notice, at 2:08 p.m., in room 

2128, Rayburn House Office Building, Hon. Bill Huizenga [chairman of the subcommittee] presiding. 

Present: Representatives Huizenga, Hultgren, Poliquin, Hill, 

Emmer, Mooney, MacArthur, Davidson, Hollingsworth, Maloney, 

Sherman, Lynch, Scott, Foster, Sinema, Vargas, Gottheimer, and 

Waters. 

Also present: Representative Capuano. 

Chairman HUIZENGA. The committee will come to order, and 

without objection, the Chair is authorized to declare a recess of the 

committee at any time. 

This hearing is entitled, ‘‘Ensuring Effectiveness, Fairness, and 

Transparency in Securities Law Enforcement.’’ 

I now recognize myself for 2 minutes to give an opening statement. 

Today’s hearing on ‘‘Ensuring Effectiveness, Fairness, and Transparency in Securities Law Enforcement’’ will focus on the Securities and Exchange Commission’s (SEC) approach to enforcing Federal securities law, and whether its activities and initiatives are 

complementary to all three prongs of its statutory mission, to protect investors, to maintain fair, ordinarily, and efficient markets, 

and to facilitate capital formation. 

According to the Division of Enforcement’s annual report issued 

November 2017, in Fiscal Year 2017, the SEC brought 754 enforcement actions, and obtained almost $3.7 billion in disgorgement and 

civil penalties resulting from those actions. Additionally, $1.07 billion was returned to harmed investors. 

Enforcement activities are an integral part of any regulatory 

agency, but especially for the SEC. Hardworking families in west 

Michigan and across the Nation rely on capital markets to save for 

everything from college to retirement. 

We must work to ensure the United States continues to maintain 

the most efficient capital markets so that Mr. and Mrs. 401(k) have 

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the opportunity to safely invest in a better future and receive the 

greatest return on their investment. 

This hearing will further discuss areas of the law that would 

benefit from greater clarity to ensure that the SEC investigations 

have an appropriate scope and minimize instances of the practice 

known as regulation by enforcement. 

Additionally, the hearing will examine the role of administrative 

proceedings in the enforcement of Federal securities laws, including whether Congress should advance legislation like H.R. 2128, 

the Due Process Restoration Act of 2017. 

We will also explore whether Congress should clarify the SEC’s 

authority to seek disgorgement, including what is the appropriate 

statute of limitations for disgorgement sought by the SEC. 

Last, we will examine whether the lack of clarity between Federal and various State standards for securities fraud, as well as 

other potential violations, is chilling participation in our capital 

markets. The United States capital markets are the gold standard. 

We can all acknowledge that our markets are widely recognized for 

being the deepest, most liquid, and the most competitive markets 

in the world, and Congress must identify any inconsistencies or disparities between State and Federal laws, and take appropriate action to ensure greater consistency and predictability in the application of these rules and regulations. 

I look forward to hearing from our witness today. 

The Chair now recognizes the Ranking Member of the subcommittee, the gentlelady from New York, Mrs. Maloney, for 5 

minutes for an opening statement. 

Mrs. MALONEY. Thank you, and I thank you for holding this important hearing, and I thank all of our panelists for being here. 

Proper enforcement of all the securities laws helps maintain investor confidence in our markets. Investors need to know that their 

rights will be protected and that bad actors, who try to take advantage of them, will be punished. 

It is for this reason that I would like to focus on one of the bills 

we are discussing in this hearing today, H.R. 5037, the Securities 

Fraud Act of 2018. 

This bill is deeply, deeply troubling to me. The bill would completely preempt all State civil securities fraud laws, and would actually preempt most, and likely all State criminal security fraud 

laws, too. 

I have very serious problems with both the premise of this bill 

and the drafting of the bill, which has managed to make a bad idea 

even worse. 

First, the premise of the bill is fundamentally flawed. Companies 

don’t need relief from State securities fraud laws; they need to stop 

committing securities fraud. The idea that securities fraud should 

be illegal and that States should be able to police securities fraud 

within their own borders should be uncontroversial. 

I believe that fraud is fraud, and that States should be free to 

regulate any form of securities fraud that they see fit. 

Second, the way the bill is drafted, it actually preempts all State 

criminal securities laws, in addition to civil securities fraud laws. 

The bill’s findings section says that States should retain the authority over criminal securities fraud, but then the bill proceeds to 

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strip States of the authority over all criminal securities fraud 

cases. 

The reason is simple: The bill says that no State, and I quote, 

‘‘Shall regulate securities fraud with respect to an issuer,’’ end 

quote. This preempts both civil and criminal security fraud laws. 

The bill then later states that States can bring criminal securities fraud cases, but only, and I quote, ‘‘Consistent with this section,’’ end quote. But that section of the bill has already stated that 

no State law can regulate any securities fraud, even criminal securities fraud. It is literally impossible for any criminal securities 

fraud case to be consistent with that section, which means that all 

criminal securities fraud laws at the State level would be preempted under this bill. 

But I am particularly opposed to this bill because in New York 

State, we have a powerful securities fraud law, called the Martin 

Act, which is a broader definition of fraud than other States, and 

therefore, serves as an effective deterrent for misconduct in the securities market. 

The Martin Act has been very successful, and I will strongly oppose any attempts to weaken this important law. 

For example, I have a letter here from the New York Attorney 

General’s Office, which opposes H.R. 5037, and they highlight several cases that they brought under the Martin Act that they would 

no longer be able to bring under this bill. 

For example, just last year, they brought a case under the Martin Act against a small-time investment advisor in Queens who had 

defrauded about 58 investors out of $11 million. These are the 

kinds of cases that only the State security regulators, like the New 

York Attorney General’s Office can bring, because the SEC simply 

doesn’t have the resources to pursue every small-time fraud like 

this. 

Unfortunately, H.R. 5037, seems to be aimed directly at the Martin Act, and by preempting these State laws, the bill would allow 

small-time fraud to run rampant. 

Before I close, I want to submit for the Record letters of opposition to H.R. 5037 from the North American Securities Administration Association, the New York Attorney General, the Massachusetts Secretary of the Commonwealth, New Jersey Attorney General, and the Council of Institutional Investors. 

Chairman HUIZENGA. So moved, without objection. 

Mrs. MALONEY. Thank you, and I look forward to this hearing 

from our witness, and especially from Mr. Borg, who is one of the 

State security regulators, whose authority would be weakened 

under this bill. 

Thank you, Mr. Chairman, and I yield back. 

Chairman HUIZENGA. The gentlelady yields back. 

While I have a moment, I had neglected to do one small point 

of business. I just ask unanimous consent for any member to participate in today’s hearing, although not a member necessarily of 

the subcommittee. As long as that Member is a member of the full 

committee, we welcome that participation today. 

With that, the Vice Chairman from Illinois, Mr. Hultgren, is recognized for 2 minutes for an opening statement. 

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Mr. HULTGREN. Thanks, Chairman Huizenga, for holding this 

hearing. Thank you to our witnesses for being here. 

I think we can all agree that our securities laws are critical to 

providing structure and certainty to both issuers and investors participating in our capital markets. In turn, this certainty drives the 

capital formation and investor returns that are foundations of our 

American economy. 

It is important that Congress regularly review how the securities 

laws are being enforced and identify opportunities for our regulators to be more effective. 

Today’s hearing is especially helpful in light of the testimony we 

heard in the subcommittee from the SEC’s Division of Enforcement 

last month. In their testimony, the co-directors of enforcement underscored a number of things that I hope our witnesses can provide 

some more insight into today. 

Specifically, I believe that enforcement of our securities laws 

should prioritize protecting the least sophisticated investors, in 

other words, those that are most susceptible to fraud. 

Similarly, I agree that the basis for enforcement of our securities 

laws should not be the broken-windows approach that has been 

used by the Commission in the past. I am concerned that this could 

cause the SEC to overlook more significant investor protection 

issues that require more long-term resources to investigate. 

Finally, the recent Kokesh decision has ignited an important debate about the statute of limitations for disgorgement by the Commission. 

Last April, now-SEC Commissioner Hester Peirce testified in our 

hearing on the Financial CHOICE Act about the importance of 

making reforms to the Commission’s approach to enforcement, such 

as increased transparency, expanding opportunities for parties to 

present their positions in person, and allowing parties to opt out 

of administrative proceedings and into district court. 

I hope these are ideas that our committee can further develop 

and advance. 

I look forward to our witness testimony today, and look forward 

to hearing the recommendations for improving the enforcement of 

our securities laws. 

With that, I yield back. 

Chairman HUIZENGA. The gentleman yields back. 

The Chair recognizes the gentleman from New Jersey, Mr. MacArthur, for 1 minute for an opening statement. 

Mr. MACARTHUR. Thank you, Mr. Chairman. 

I think we all know we have problem in our public markets. The 

year I graduated from college in 1982, there were about 5,800 public companies. It is about the same number we have today, except 

that our economy has more than doubled during that period. 

There are a lot of reasons why companies aren’t going public, but 

the one I hear most often, the one I have experienced in my own 

life, is that business people are scared to death of overzealous attorney generals that criminalize mistakes and make it difficult for 

businesses to go forward. 

It hurts Main Street investors, it hurts employees who want to 

invest in their companies, and I think there is a simple remedy. 

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tains in States policing power over criminal fraud, but it moves 

civil fraud to a single definition that requires intent, and it allows 

companies to repair to the Federal courts rather than being twisted 

in the wind in multiple States with different definitions, and I look 

forward to discussing that in more detail. 

I yield back. 

Chairman HUIZENGA. The gentleman’s time has expired. 

Today, we welcome the testimony of Mr. Bradley Bondi, who is 

a partner at Cahill Gordon & Reindel LLP. 

We also welcome Mr. Joseph Borg, who is the Director of Alabama Securities Commission. He is here on behalf of NASAA. This 

is the good NASAA, the Financial Services NASAA, North American Securities Administrators Association. 

We also welcome Mr. Thomas Quaadman, who is the Vice President for the Center for Capital Markets Competitiveness from the 

U.S. Chamber of Commerce. 

Professor Andrew Vollmer, who is a Professor of Law and Director of the John W. Glynn, Jr. Law and Business Program at the 

University of Virginia School of Law. 

Each of you will be recognized for 5 minutes to give an oral presentation of your testimony, and without objection, each of your 

written statements will be made part of the record as well. 

With that, Mr. Bondi, you are recognized for 5 minutes. 

STATEMENT OF BRADLEY J. BONDI 

Mr. BONDI. Good afternoon, Chairman Huizenga, Ranking Member Maloney, and distinguished members. 

My name is Brad Bondi, and I am honored to appear before you 

today. 

I am a practicing attorney and partner with the law firm Cahill 

Gordon & Reindel, where I lead the firm’s securities enforcement 

and regulatory practices. Much of my law practice is devoted to 

representing public companies and financial institutions in securities enforcement cases before the SEC. 

I previously served in senior positions in the Government, including as counsel to SEC Commissioner Paul Atkins, and then SEC 

Commissioner Troy Paredes. 

Although I am affiliated with a number of organizations, my 

views today are my own, and do not necessarily represent those of 

my law firm or my clients. 

The SEC is an agency that I greatly admire and respect. In my 

years of serving on the Commission and in private practice, I have 

worked with many talented, dedicated, hardworking professionals 

at the SEC. 

My observation is that the SEC, as a whole, overwhelmingly, has 

sought to abide by its mandate, and for the most part, has been 

successful in doing so. 

Nevertheless, there are some areas where the SEC can improve. 

One area where I believe the SEC has strayed from its mission is 

in its approach to financial penalties of public companies and 

disgorgement. 

A penalty against a company is directly borne by its shareholders. In other words, investors for whom it is the SEC’s mission 

to protect. 

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Previously, the Commission had a penalty statement that spelled 

out the circumstances in which it would seek a penalty against 

shareholders, but in 2013, several commissioners disavowed it. 

The amount of a monetary penalty is unpredictable because the 

SEC has nonarticulated criteria and metrics for calculating how 

much it will penalize a company, and, also, its approach to the 

remedy of disgorgement. This unpredictability negatively impacts 

companies. For example, the inability to predict the size of a potential penalty hinders the markets for mergers and acquisitions because potential bidders cannot accurately forecast regulatory exposure. 

I commend SEC Chairman Clayton and the current commission 

for taking what appears to be a more measured and thoughtful approach to assessing monetary penalties, and I encourage the Commission to release a renewed penalty statement explaining the circumstances in which the SEC will seek a shareholder penalty and 

articulating the standards for disgorgement. 

I understand that in the wake of the Supreme Court’s decision 

in Kokesh, there has been discussion about extending the statute 

of limitations for disgorgement and financial penalties. 

Although I believe it is critical for the SEC to pursue those who 

commit fraud, I am concerned that the cost of extending the applicable statute of limitations may greatly outweigh the benefits. Five 

years is the longest period of limitations and repose found in any 

Federal securities law. Extending the statute of limitations beyond 

that would create uncertainty for the investing public because of 

the possibility the SEC may prosecute stale claims. 

It also could open up the door for inefficiencies in the way the 

SEC investigates if more time is allotted to bring those actions. 

In my two decades of experience as a defense lawyer, an SEC investigation into potential securities law violations by a public company, even an investigation that ultimately does not find any violations of law, can take several years, distract management, and cost 

the company tens of millions of dollars. The cost of that investigation is directly borne by the shareholders of the company. 

Of particular concern are SEC enforcement investigations that 

begin after a news story about a high profile company, prompting 

the enforcement staff to pursue one theory of liability, but then 

morph into an open-ended investigation that wanders into other 

areas of a company in search of a potential violation. 

SEC investigations can impede entrepreneurship and innovation. 

I understand the current leadership at the SEC is cognizant of 

these concerns and has been working to address them. Policies and 

procedures in this area need to be improved. 

I have been asked to comment about H.R. 2128, the Due Process 

Restoration Act of 2017. H.R. 2128, I believe, is a step in the right 

direction, but it may, in fact, go a bit too far and cause the SEC 

to initiate all enforcement actions in Federal district court. 

Yet not all enforcement actions require the formality of Federal 

district court. Some cases, such as those involving disciplinary actions against registered investment personnel and so-called followon action could be adequately brought as administrative proceedings. 

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I have also been asked to comment on H.R. 5037, entitled Securities Fraud Act of 2018. From my experience, I generally agree with 

the observation in that bill that imposing different State regulatory 

requirements for civil securities fraud on national markets increases risk, creates inefficiencies, raises cost, and can harm the efficient operation of these critical markets without providing material investor protection. 

While I think that H.R. 5037 represents a thoughtful and encouraging effort toward greater uniformity and predictability, I would 

offer two suggestions. 

First, consider adding a dollar threshold above which the cases 

could be preempted by the Federal enforcement regime, and below 

which would still be within the State realm for enforcement. States 

are oftentimes the front line on these smaller micro cap fraud cases 

involving public companies. 

The second consideration would be to—with that added threshold—also add related cases such as those against underwriters, officers, and directors that would avoid the split Federal/State enforcement of what really is the same case in controversy. 

Chairman HUIZENGA. The gentleman’s time has expired. 

Mr. BONDI. Thank you, Mr. Chairman. 

[The prepared statement of Mr. Bondi can be found on page 36 

of the appendix.] 

Chairman HUIZENGA. Thank you. 

Mr. Borg, you are recognized for 5 minutes. 

STATEMENT OF JOSEPH P. BORG 

Mr. BORG. Thank you, and good afternoon. I am Joseph Borg, Director of the Alabama Securities Commission, and President of the 

North American Securities Administrators Association. 

I am privileged to have served as Director of the Alabama Securities Commission since 1994, and have been elected as NASAA’s 

president three times. 

State security regulators have protected Main Street investors 

for the past 100 years, longer than any other securities regulator. 

We are responsible for administering State securities laws that 

serve to protect your constituents from fraud. We are often referred 

to as the cops on the beat, because we are the regulators closest 

in proximity to your constituents. 

Thank you for the honor to testify before the subcommittee. 

The committee has requested NASAA’s views on two bills; H.R. 

5037, the Securities Fraud Act, would amend the Exchange Act to 

prohibit States from pursuing many civil securities fraud cases. 

The bill is drafted in such a way that a defendant would argue, 

and a court could find that States are preempted from pursuing 

civil fraud violations in connection with any transaction involving 

publicly traded securities. This will place all retail investors at risk 

because such securities are widely held by the investing public. 

State anti-fraud provisions serve as a powerful deterrent to improper conduct by companies of all sizes. States’ ability to pursue 

enforcement activity against issuers of securities, including independently, and when necessary and appropriate, is one of the reasons investors have confidence in America’s capital markets. 

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Further, under the bill, certain State criminal securities fraud 

prosecutions must quote, ‘‘comply in all respects,’’ end quote, with 

Federal legal requirements without defining what this means. 

Defendants in a State criminal prosecution will argue the broadest possible reading of this language. Thus, for practical purposes, 

this requirement will be preemptive and no State judge will agree 

to suspend all State criminal law procedures. 

Here is the way it would work. I am the prosecutor: Judge, you 

have to use Federal law here. Mr. Borg, this is a State court. I am 

a State judge. We apply State law. I suggest you go find yourself 

a Federal prosecutor. Federal courthouse is over in Birmingham. 

Case dismissed. 

No one will be left to protect Main Street investors. 

I imagine with the fraudsters, including the ones I have prosecuted, would be very pleased with such a result. 

Finally, 5037 will deprive defrauded investors of a choice of 

forum. It represents a direct threat to State pension funds and 

other investors who seek to opt out of shareholder class action litigation, and instead, advocate on their own, as it would require 

them in all cases to litigate exclusively in Federal courts. 

In summary, for all the reasons I just enumerated, which I have 

discussed further in my written testimony, 5037 is a misguided and 

dangerous bill, enacting policies that will make it more difficult, 

and, in some cases, impossible, for State regulators, the regulators 

closest to Main Street investors, to hold accountable the most powerful companies on Wall Street, and serves no valid interest. 

For all these reasons, NASAA opposes 5037 and strongly encourages the committee to reject it. 

Turning now to H.R. 2128, the Due Process Restoration Act, this 

bill would benefit SEC enforcement actions, the respondents in 

SEC enforcement actions, by providing them with a broad right of 

removal to Federal district courts, and raising the burden of proof 

in SEC administrative proceedings from preponderance of the evidence to clear and convincing evidence. 

This bill will have adverse consequences for the public interest. 

As detailed in my written testimony, NASAA sees no good reason 

for Congress to enact 2128, and several reasons why these changes 

would disrupt our securities markets and the efficient functioning 

of the Federal judiciary. 

My written testimony addresses other issues, including SEC enforcement resources, the expanding marketplace for private securities offerings, strong penalties as a deterrent to fraudulent conduct, 

and the need for legislation granting the SEC authority to bring 

Federal court claims for discouragement and restitution for the 

benefit of harmed investors. 

I will be happy to discuss these issues further. 

I will close by reiterating my opposition to 5037. In more than 

24 years as a securities regulator, I don’t believe I have ever seen 

a legislative proposal that so alarms and offends me. 

Should Congress pass this bill, my office’s efforts, as well as my 

colleagues in your States, to protect investors from serious violations of securities law will be eviscerated. Real investors in your 

districts, you can call them mom-and-pop investors, call them Mr. 

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and Mrs. 401(k), but real investors, real people, will suffer as a result of this misguided and irresponsible legislation. 

Thank you, and I will be pleased to answer any questions you 

may have. 

[The prepared statement of Mr. Borg can be found on page 114 

of the appendix.] 

Chairman HUIZENGA. With that, Mr. Quaadman, you are recognized for 5 minutes. 

STATEMENT OF THOMAS QUAADMAN 

Mr. QUAADMAN. Thank you, Chairman Huizenga, Ranking Member Maloney, members of the subcommittee. Thank you for holding 

this hearing today. 

A prosperous and growing economy needs efficient capital markets in order to grow, and those markets actually need a strong securities regulator to make sure that it is fair and balanced. Fair 

and balanced regulation of the capital markets provides certainty 

and confidence to invest and raise capital for both investors and 

businesses. In other words, we need a strong cop on the beat. 

We have seen the treatment of securities cases evolve over the 

last generation. We have seen a rise in the use of administrative 

proceedings that have made administrative law judges (ALJs) the 

primary means of adjudication. In fact, we have also seen these 

cases morph from being civil proceedings to being quasi-criminal 

proceedings. 

Before 2016, there were serious due process issues regarding the 

use of administrative proceedings. There is no discovery, no right 

to deposition, no jury trial, a lack of evidentiary rules, and the use 

of hearsay. 

Because of these concerns, in 2015, the Chamber issued a report 

with 20 recommendations to strengthen SEC enforcement and address some of these due process issues. 

We believe that there should be continued use of administrative 

proceedings in administerial matters such as stop orders as well as 

license revocations. 

If administrative proceedings are going to be used in more complex cases, then there need to be due process reforms such as discovery, deposition, rights that conform with the Federal rules of 

civil procedure. 

We also believe that there should be a right of removal for jury 

trial under limited circumstances so that a defendant, and not a 

Government agency, decide if a jury trial is appropriate for a defense. 

We believe that these reforms will make the SEC a stronger enforcement agency, as well as give defendants the right of appropriate due process in order to defend themselves. 

These recommendations led to amendments to SEC rules of practice for the first time in 20 years, and while some of those reforms 

were a good step forward, they are very limited and pale in comparison to those procedures that are in the Federal rules of civil 

procedure. 

Additionally, the constitutional issues regarding the use of administrative law judges were not addressed by the SEC at that 

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time, and may be addressed by the Supreme Court within the next 

several days. 

The Chamber strongly supports H.R. 2128, the Due Process Restoration Act. We believe that this right of removal under limited 

circumstances is an appropriate way for a defendant to remove a 

case, a complex case, to district court where more complex cases 

have historically been treated in article 3 courts. This would also 

allow for defendants to decide if they want to have a jury trial. 

We also believe that a standard of proof of clear and convincing 

is necessary, since many of these proceedings are actually quasicriminal in nature. 

The Chamber also supports the Securities Fraud Act. Under our 

constitutional system, we have a bifurcated system of regulation. 

Those transactions that happen in interstate commerce are regulated by the Federal Government, and those transactions that happen on an intrastate basis are regulated by the States. 

Under the 1921 Martin Act, the New York State Attorney General, through the listing of public companies on the New York 

Stock Exchange and NASDAQ, has become, over the last 15 years, 

a de facto national securities regulator. 

What is additionally troubling is that under the Martin Act, the 

New York State Attorney General does not have to prove intent to 

defraud. What we have also seen is litigation through press releases with selective press leaks being put out in the press in order 

to drive settlements. 

These name and shame campaigns are one of the reasons why 

we have seen a lack of desire of businesses to want to go public. 

H.R. 5037 sets up commonsense guardrails to preserve the distinction between national and State cases. H.R. 5037 would not impact the ability of any State to bring a criminal case, nor would it 

impact the ability of a State to pursue a case for a sale of securities 

that was not done through a national exchange. 

We believe that the passage of these bills would help provide for 

stronger enforcement and is certainly needed for healthy capital 

markets, and I am happy to take any questions you may have. 

[The prepared statement of Mr. Quaadman can be found on page 

129 of the appendix.] 

Chairman HUIZENGA. The gentleman yields back. 

Professor Vollmer, you are recognized for 5 minutes. 

STATEMENT OF ANDREW N. VOLLMER 

Mr. VOLLMER. Mr. Chairman, Ranking Member Maloney, members of the subcommittee, I appreciate having this opportunity to 

talk about some of the issues with SEC enforcement. 

My written statement addresses four separate topics. I am going 

to use this opportunity for oral comments to address two of them. 

One is the question about disgorgement and the limitations period, 

and the second is the role of SEC administrative proceedings. 

As I noted in my written statement, my comments are solely my 

own views and are not on behalf of any other person. 

I start out with a paragraph to try to set a tone for my written 

statement, and the theme running through all of my comments is 

that SEC enforcement of the Federal securities laws needs to be 

tough but fair. Fair treatment of defendants helps achieve the 

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11 

goals of the Federal securities laws. But it is sometimes a value in 

short supply. 

Let me talk about the disgorgement question and the possibility 

of extending the statute of limitations. 

We are thinking more about that issue because of the Kokesh decision. My view is that the 5-year period in 2462 is already too 

long, and it should not be extended absent compelling empirical 

data that the SEC is not capable of bringing a large number of important cases within the existing 5-year period. 

I don’t think we have that data, and I am dubious that it exists, 

but that is the research that the Congress would need to extend 

the statute of limitations. 

The reason I am opposed to extending the statute is because 5 

years is a very long time already. Limitations periods are extraordinarily important to society, and you never hear anyone talk 

about the values protected by limitations period except the Supreme Court when it analyzes statutes of limitation. 

The second reason that I urge you not to lengthen the limitations 

period is that, in my experience, there is a strong correlation between limitations periods and the length of investigations. One of 

the principal problems with SEC enforcement today is that the investigations are too long. 

There are serious social harms that occur from SEC investigations and from unduly long statutes of limitation, and my written 

statement describes what those social harms are. 

My written statement also refers to another problem that I think 

Congress needs to address, and that is the SEC staff’s use of tolling 

agreements to circumvent the current limitations period. 

If Congress is thinking about extending the statute, I would urge 

it to consider the following additional factors. 

First, as I said, obtain information about whether a problem really exists and the size of the problem. If the problem is limited to 

a certain category of cases, let’s address the category of cases as 

an exception. 

Second, I have heard various people try to connect disgorgement 

and extended limitations period to investor damage or investor 

loss. A limitations period should not be connected to investor loss. 

Congress has never given the SEC the power to calculate a monetary penalty based on investor loss or damage. It would be a dramatic break with the model that we currently use in the United 

States of allowing private plaintiffs to recover loss and having the 

SEC obtain different forms of relief. 

I will spend 10 seconds on the second topic, and that is the role 

of SEC administrative proceedings. 

The basic problem is that they are inherently unfair to defendants. If Congress agrees with that, it has a couple different paths 

it could follow. One would be a very broad removal right. I favor 

a very broad removal right, and that would be to let the SEC make 

the first choice of forum, but then give every defendant in an administrative proceeding an unqualified, unreviewable power to remove. 

[The prepared statement of Mr. Vollmer can be found on page 

140 of the appendix.] 

Chairman HUIZENGA. The gentleman’s time has expired. 

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12 

With that I recognize myself for 5 minutes for questioning. 

I appreciate the testimony that we have before us today, and 

maybe, Professor Vollmer, we will continue where you left off. 

Last month, the SEC’s Division of Enforcement co-directors testified in front of the subcommittee that the SEC has been unable to 

collect over $800 million in disgorgement since Kokesh, which is 

not an unmeaningful percentage, considering that they had imposed $4 billion in penalties and disgorgement since 2016. Fairly 

significant amount of money and percentage-wise, as well as 

money. 

But since Kokesh, many have called for extended statute of limitations, and I am just curious if you can briefly give some of that 

context and whether there just are not simply clear statutes of limitations, and what we can do to do that. Mr. Bondi, I would like 

you to address that as well. Does extending the statute of limitations for disgorgement run the risk of allowing more time for the 

SEC to just investigate and bring cases, as Professor Vollmer was 

drawing the correlation between that length of time, and maybe, 

Mr. Bondi, we can start with you. 

Mr. BONDI. Thank you, Mr. Chairman. 

I do think extending the statute of limitations is going to create 

a tremendous risk that the SEC will have investigations that linger 

on for multiple years, and these wandering investigations are really a threat to shareholders of public companies because, oftentimes, 

they don’t lead anywhere, and they don’t even actually lead to an 

enforcement case, but they cost the company and, in turn, its 

shareholders tens of millions of dollars. 

In terms of extending the statute of limitations, I agree wholeheartedly with Professor Vollmer that I think the SEC needs to actually demonstrate what cases it could not have brought within 5 

years. Five years is the longest statute of limitations or repose 

under Federal securities law. I would like to see them demonstrate 

which are the cases that they couldn’t bring. They have the ability 

to seek tolling agreements from companies or persons that are 

under investigation, and, oftentimes, they do. 

It would be really interesting to understand what are those cases 

that still linger and make up that amount. 

Chairman HUIZENGA. But certainly there has to be examples out 

there of fraud discovered beyond that 5 years, and then how do you 

go back and deal with that? Is this somehow inconsistent with the 

SEC’s traditional mission? 

Mr. BONDI. I would like to see what frauds haven’t been discovered after 5 years. I hear a lot about that, and I hear that there 

were frauds that were discovered many years back, but I do think 

that— 

Chairman HUIZENGA. Would you put the Madoff situation in that 

category? 

Mr. BONDI. They did discover within 5 years, brought it, and 

keep in mind too, the SEC does have the ability— 

Chairman HUIZENGA. My understanding of that was the fraud 

had been happening for far more than 5 years. 

Mr. BONDI. It was, but as I understand, they also brought an action and disgorged an amount that actually was greater than the 

amount that was even at Madoff. 

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But in any event, the SEC has the ability, in cases of extreme 

fraud like that, to seek penalties and to seek other types of remedies that could then be put into a fair fund under Sarbanes-Oxley 

and distributed to shareholders to make up for any amount that 

somehow lingered past the 5 year statute of limitations. 

Chairman HUIZENGA. I have a minute and 15, and I think, Professor Vollmer, you have been fairly clear both in your written and 

in your oral statements. 

Mr. Quaadman, how often do the State enforcement agencies 

bring State charges that are substantially the same as those 

brought against the same defendant by their Federal counterparts? 

Mr. QUAADMAN. There is a study from Professor Amanda Rose 

from Vanderbilt that shows that Federal enforcement agencies 

bring cases 91 percent of the time as State enforcement agencies 

do, and, in fact, there is even a split between those State securities 

regulators that are elected that bring four times as many cases as 

those who are appointed. 

Chairman HUIZENGA. Are there cases where States, then, have 

brought enforcement actions, even after a company has already settled with the SEC? 

Mr. QUAADMAN. That happens an awful lot. There is a lot of duplication that is going on, and one of the things we talked about 

in our 2015 report was actually to get at that duplication issue. 

Chairman HUIZENGA. Mr. Borg, I will let you address that a little 

bit as well, both that situation and then how do we further elaborate how these actually are investigations that are new and different than what has happened at the SEC? 

Mr. BORG. Mr. Chairman, with regard to those cases, the big 

cases that we work with, and I will give you examples, Comtronics, 

HealthSouth, Morgan Keegan, Enron, WorldCom. These are cases 

that my office was involved in. In each one of those cases, yes, 

there was a State component, but those cases were worked with 

the SEC, sometimes with FINRA, on occasion there might even be 

a CFTC (U.S. Commodity Futures Trading Commission) case. 

The question is not whether or not they were completely separate 

actions. Yes, we do work on a cooperative and collaborative basis. 

Chairman HUIZENGA. You don’t feel they were duplicative? 

Mr. BORG. No, sir, I don’t. Think about some of the cases that 

we have had in the past, especially the bigger cases, the Mutual 

One timings. That was all done cooperatively and collaboratively. 

Chairman HUIZENGA. My time has expired. 

With that, the Ranking Member is recognized for 5 minutes. 

Mrs. MALONEY. Thank you. 

Following up with Mr. Borg, I would like to ask you about H.R. 

5037. 

Do you believe you would be able to bring any criminal securities 

fraud cases if this bill were enacted? 

Mr. BORG. The way it is set up, it says I have to apply Federal 

law in all respects. I don’t know if that means Federal law in all 

respects including civil procedure, criminal procedure, and all the 

other items that go with prosecuting a case. 

I am a prosecutor. I know what needs to be done with regard to 

a judge. 

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14 

If I have a judge sitting in State court who has been trained for 

State law, trained for State procedures, he is not, I guarantee, is 

not going to listen to me when I say: Judge, suspend everything 

you have been elected to do here and apply Federal law. 

The times we apply Federal law is when we are looking for some 

other guidance or something to apply to State law, but not apply 

Federal law. 

At that point, his argument to me is going to be very simple: You 

are in the wrong court. The Federal court is over in Birmingham, 

go find yourself a Federal prosecutor. 

Now, I will have to find a Federal prosecutor to take the case, 

because they are the ones, DOJ, that prosecute those criminal 

cases in Federal court, not State securities regulators. 

Mrs. MALONEY. Under this bill, the Department of Justice would 

be the only agency with the authority to bring a criminal securities 

fraud case. Given that the Department of Justice has limited resources, and only brings a small number of criminal securities 

fraud cases per year, do you believe that this bill would effectively 

allow some securities fraud to go completely unpunished? 

Mr. BORG. Yes, ma’am, especially the smaller ones. Now, they 

may have an interest in some $10 million case, but as a practical 

matter, given the priorities of the U.S. Attorney’s Office right now, 

which include the opioid addiction issues, immigration issues and 

whatnot, there is insufficient staff there to worry about Mrs. Johnson in Elba, Alabama, who was taken on a $10,000 churning case 

in listed stock securities. That is not going to be a case they are 

going to try. 

In essence, I can’t bring it, they won’t bring it because they don’t 

have the resources or the inclination. That means that harm goes 

unresolved, and that is just too bad for Mrs. Johnson. We can’t 

have that. 

Mrs. MALONEY. Thank you. Stepping away from the criminal 

fraud issue, I am still extremely concerned about preempting even 

civil securities fraud laws. 

Mr. Borg, could you talk a little bit about what kinds of civil securities fraud causes this bill would prevent you from bringing? 

Can you talk about any specific examples of cases you have 

brought recently? 

Mr. BORG. Yes, ma’am. Let’s talk about listed company cases, 

and I will just list them. I gave some earlier. 

One of the first cases I prosecuted against a New York Stock Exchange company was Comtronics, it was actually located in Alabama, for fraudulent invoices. Basically they raised their stock 

price with phony information. 

We were involved in the HealthSouth case. We worked with the 

U.S. Attorney’s Office. 

Morgan Keegan was a subsidiary of one of the 15 largest banks 

in the country. 

Enron and WorldCom we worked on behalf of the retirement systems and made a recovery there. 

The types of cases on the smaller scale will include churning listed securities. I gave you the example of maybe Mrs. Johnson in 

Elba, Alabama. 

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On the broker/dealer side engaged in pump and dump to manipulate sales of securities, that happens a lot. Also on the broker/dealer side, recommending unsuitable listed securities, usually tied to 

a churning or just to make some commissions. 

On the advisor side again, pushing an overconcentration of listed 

company shares. 

These are cases we see on a regular basis, and we strive to enable our residents to recover their savings when they fall victim to 

such frauds. 

With a preemption, that is not going to happen, and I don’t know 

anybody else who will do it. 

Mrs. MALONEY. OK. Do you think that it is appropriate for the 

Federal Government to tell States how they can and can’t define 

fraud? 

Mr. BORG. I think that is for my legislature to decide. My legislature has decided what the elements are. 

Now, I will say this: 43, 44 States have the Uniform Securities 

Act, so we are fairly similar because we do—under the Uniform 

Act, same folks that brought you the Uniform Commercial Code, 

the Uniform Probate Code, the Uniform Gift to Minors Act, and 

whatnot. 

My legislature defines what it says is required in my State, and 

my job is to enforce that. Same as occurs in every other State. 

Mrs. MALONEY. Thank you. 

Finally, you said you thought this bill was particularly dangerous. Why do you think it would be particularly dangerous to 

enact this bill right now? 

Mr. BORG. You have already heard testimony from others about 

the decrease in the SEC’s case numbers with regard to bringing 

cases. We are the ones on the beat. We hear the first cases. We are 

the ones that know all the complaints. We are the ones that actually will bring those cases. If they are coming down in numbers, 

that is more duty on us. We have a duty to protect our citizens, 

and we intend to do so. 

Mrs. MALONEY. Thank you very much. My time has expired. 

Chairman HUIZENGA. The gentlelady’s time has expired. 

With that, the Vice Chairman of the committee, Mr. Hultgren 

from Illinois, is recognized for 5 minutes. 

Mr. HULTGREN. Thank you, Mr. Chairman. Thank you all again 

for being here. 

Section 881 of the Financial CHOICE Act would require the SEC 

to establish a process for closing investigations. Specifically, it calls 

for the Commission within a timely manner, two different things; 

one, to make a determination of whether or not to institute an administrative or judicial action in a matter or refer the matter to the 

DOJ for potential criminal prosecution; and number two, requires 

the Commission to inform the subject of the investigation that the 

matter is closed if the Commission does not pursue an action or 

refer it to DOJ for criminal prosecution. 

Mr. Quaadman, I wonder if I could address my first question to 

you. Can you discuss how this provision would prevent the Commission from abusing its investigation powers? Are there instances 

where investigations could remain open despite little or no reason 

to impose this burden and uncertainty on a market participant? 

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What are the effects on a public company when they are required 

to disclose an investigation, even when there is not necessarily a 

finding of guilt? 

Mr. QUAADMAN. The reason why we started looking at SEC enforcement in 2015 was that we had released a managerial reform 

SEC report in 2011, and one of the last recommendations in there 

was about this issue of cases being open and not being closed. 

There are numbers that are kept at the SEC as to cases being 

open, but they were never closed. As a result of that, we actually 

had one of our members come in and started to talk about how 

there was an issue that they had with internal control dealing with 

tax, and it was referred to the SEC by an employee. The SEC came 

back. What it then did is it created this whole situation where that 

company had to preserve all of its emails at the cost of $1 million 

a month. That case went on for years, and there was never indication from the SEC as to what direction that case was going in. 

Additionally, we should also understand too, for that company, 

they actually corrected the problem as soon as they were told about 

it, but again, this dragged on for years, and for a very long period 

of time. 

Mr. HULTGREN. Thanks. 

Professor Vollmer, your testimony notes the SEC enforcement 

process should, among other things, allow for an ability to bring 

cases that lack merit to a rapid close. 

Would you support legislation requiring the Commission to establish a process for closing investigations, and are there any specific criteria that the Commission should consider when establishing such a process? 

Mr. VOLLMER. Thank you, sir. I would support that. I think the 

principal issue is a time limit, and that is what the legislation 

needs. I connect the length of investigations to limitations periods. 

The SEC staff decides on how long cases can be investigated by 

whether they have a deadline set by the statute of limitations. I 

would be in favor of that. 

I referred specifically to early mechanisms for testing the merits, 

specifically during administrative proceedings, so during the litigation phase, and there is not currently the equivalent to a motion 

to dismiss. 

Mr. HULTGREN. Section 884 of the Financial CHOICE Act would 

require the SEC to institute a process to permit recipients of a 

Wells notice to appear before the Commission or its staff in person, 

and to vote on whether to bring an administrative or judicial action 

against an individual. 

Again, Professor, can you please discuss how this would improve 

due process or enforcement of the securities laws by the Commission, and are there any cases in which efficient delegation of authority to the Director or direction of the Division of Enforcement 

is inappropriate? 

Mr. VOLLMER. There are inappropriate delegations. In particular, 

the delegation to the Director about the ability to open what is 

called a formal order of investigation, or essentially, the power to 

issue subpoenas. 

That is wholly inappropriate for the commissioners to have delegated to the staff, and so, I would encourage you to look at that. 

mcarroll on FSR431 with DISTILLER

17 

Repeat the— 

Mr. HULTGREN. Yes, the first one was how would you improve 

due process for enforcement of the securities laws by the Commission? 

Mr. VOLLMER. I have addressed some of these topics in a Law 

Review article that I wrote. Rather than go over those points, let 

me address the one particular point that you mention, and that is, 

allowing commissioners to attend an oral Wells submission. 

I actually don’t think that would make a big difference in very 

many cases. Of course, it might in a few, but the lawyers always 

have the opportunity and take the opportunity to meet in person 

with the senior staff of the Division of Enforcement. You are correct, they do not get a chance to meet with commissioners. That 

might be useful in some circumstances, but generally, I think it is 

more effective for the lawyers to submit their views in writing, 

which is what they do. 

Mr. HULTGREN. Thank you. My time has expired. I yield back. 

Chairman HUIZENGA. The gentleman’s time has expired. 

The Ranking Member is recognized for 5 minutes for questioning. 

Ms. WATERS. Thank you very much. 

I would like to direct this question on disgorgement to Mr. Borg. 

In your view, is the Supreme Court’s decision in Kokesh versus 

SEC, that SEC disgorgement is a penalty subject to the 5-year Federal statute of limitations consistent with earlier jurisprudence on 

disgorgement? 

Mr. BORG. My opinion on the Kokesh case is that the SEC should 

do everything they can to get money back for investors. The statute 

of limitation issue, we actually faced that in Alabama not too long 

ago. The Supreme Court had issued a case that the decision that, 

of course, the cause of action for recovery and for criminal penalties 

and everything else started from the date of the inception of the 

crime, occurrence, whatever it was. 

We fixed that. We fixed that unanimously in my legislature by 

going to 5 years from date of discovery. That is one alternative you 

might want to consider. 

The question is how long did it take to discover it? I think that 

issue was mentioned earlier by the chairman. 

In the current frauds, it takes a long time sometimes to find 

these frauds. The fraudsters are hiding information, whether it is 

financial information buried in a financial statement of a company, 

or convincing the victims not to report. 

The statute of limitations, if it starts from the date of the occurrence, in many cases, is not going to allow for recovery. 

I do not believe a disgorgement or recovery to investors should 

be considered a penalty, and I do not think there should be a statute of limitations on recovering for the victims of a crime. 

The idea that the statute of limitations should be cutoff at 5 

years, no matter when it occurred or when anybody knew about it, 

only encourages those fraudsters to hide it as long as they can, and 

that is not in the public interest. 

Ms. WATERS. Thank you very much. 

Let me just move on to H.R. 2128, Due Process Restoration Act 

of 2018, continuing with you, Mr. Borg. 

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H.R. 2128 would help alleged fraudsters by allowing them to 

choose where their case is tried. What is more, this bill would further help these bad actors by subjecting the SEC to a heightened 

burden of proof when an enforcement is brought in an administrative form. 

Could you describe how this bill could affect the SEC’s ability to 

effectively enforce Federal securities laws, and how do administrative proceedings help ensure efficient policing of our capital markets? 

Mr. BORG. Yes, ma’am. This bill will benefit respondents in SEC 

enforcement actions by providing them the broad right of removal 

to Federal district courts. I have been a prosecutor a long time. 

Venue is usually selected in both Federal and State courts in the 

best interest of the public, not the best interest of the defendant. 

If I was a defendant and I could move to Federal court for significant delays and I was financed enough, that defendant could continue his business until that case is over. 

This will invariably lead the SEC, because of the change from 

preponderance of evidence to clear and convincing in the ALJ matters, to either go straight to Federal court, and therefore, overload 

the Federal courts, that is a possibility. The bill would raise that 

burden of standard to the point where we are going to have inconsistent decisions. The same fact pattern or the same type of interpretation of law, if you are in ALJ and you are clear and convincing, that is one standard, and let’s go to Federal court and 

have a different standard. The precedence on that is going to be 

difficult to resolve, and I think now you have set two different 

standards for one particular law. 

The SEC might likely forego bringing enforcement actions 

through the administrative process. If that is the case, litigating 

those actions will require a lot more time, a lot more money, and 

a lot more resources. 

Ms. WATERS. Thank you very much. 

I think we should all be concerned about any and all efforts to 

tie the hands of the SEC or to undermine their ability to do what 

it is they are mandated to do. I think that we need further clarification on some of these issues that are not only in 2128, but in 

some of the other legislation that may be coming down the pike, 

and I thank you for being here and I yield back the balance of time. 

Chairman HUIZENGA. The gentlelady yields back. 

With that, the gentleman from Minnesota, Mr. Emmer, is recognized for 5 minutes. 

Mr. EMMER. I thank the Chair. I thank the panelists for being 

here today. 

I would like to get into it this way: To have a valid and credible 

justice system, and maybe, Professor Vollmer, I will start with you, 

since you do this in the academic world, and you have to present 

this to folks, my perspective, to have a valid and credible justice 

system, number one, you need a clearly defined rule of law. Two, 

you need a fair and impartial process to resolve alleged violations 

of laws, disputed claims, and in short, that is the due process piece. 

People have to have the ability to have a fair and impartial arbiter, 

someone that decides it. Three, and I think this is incredibly important and often underestimated, you need the public’s confidence 

mcarroll on FSR431 with DISTILLER

19 

and legitimacy of the law and of the process that actually metes 

out justice. 

We have been asking—or I have listened to my colleagues ask a 

lot questions about the State and Federal systems today, and unlike some of the testimony I have heard today, I have a lot of confidence in our State court judges. Granted, I only practiced civil 

law, I wasn’t over on the criminal side very often, but if you went 

into a State district court, and you had a State district court judge, 

and you had a case that was going to be the State law preempted 

by Federal law, State judges are entirely capable of applying the 

Federal law. 

It is not that far of a stretch to imagine them being able to do 

it. But if you are on the other side of the bench and you have the 

State people you have to worry about, you have the Federal courts 

you have to worry about, and then you have the SEC too that you 

have to worry about. 

I would like to talk about these administrative proceedings at the 

SEC. 

Professor, do all of the Federal rules of civil procedure and the 

Federal rules of evidence apply to SEC administrative proceedings? 

Mr. VOLLMER. None of them do. 

Mr. EMMER. Do respondents in SEC administrative proceedings 

have the same discovery rights as defendants in Federal district 

court proceedings? 

Mr. VOLLMER. No, they don’t. 

Mr. EMMER. Just so anybody who hasn’t practiced in a court of 

law understands, that is the ability of the defendant to find out 

whatever the other side has if they are accusing them of violating 

or doing wrong. 

Mr. VOLLMER. More importantly, obtain information from third 

parties. 

Mr. EMMER. Right. Do respondents in SEC administrative proceedings have the right to a jury trial? 

Mr. VOLLMER. No, they don’t. 

Mr. EMMER. Mr. Quaadman, in your opening statement you referred to some of this. 

Are there time limits in terms of when an SEC administrative 

proceeding needs to be completed, Professor? 

Mr. VOLLMER. Yes. 

Mr. EMMER. How does this compare to the time limits in a Federal district court proceeding? 

Mr. VOLLMER. There are no time limits in Federal district court 

proceedings. 

Mr. EMMER. The argument that we are going to have different 

standards being applied if we pass some reform, we already have 

different standards being applied, correct? 

Mr. VOLLMER. There are many differences between administrative proceedings and Federal district court proceedings. 

Mr. EMMER. Are you concerned, Professor, that respondents in 

SEC administrative proceedings have fewer due process rights compared to those who are actually having their case or their future 

determined in a Federal district court proceeding? 

Mr. VOLLMER. Oh, I think that we should be deeply concerned 

about it. 

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Mr. EMMER. My colleague Warren Davidson from Ohio has a bill, 

H.R. 2128, called the Due Process Restoration Act. Have you taken 

a look at this, Professor? 

Ms. VOLLMER. I have, yes. 

Mr. EMMER. Can you just comment on how this could—let’s talk 

about facts first, because I talked about the perception. You have 

to perceive that you have a fair and impartial process. 

Isn’t it true that, over the past several years, the SEC has been 

picking its own forum, its administrative procedures, and then it 

has been winning more and more in its own forum? 

Mr. VOLLMER. I think the data is actually not entirely complete 

on that, those two questions. I think there are open issues about 

the data. 

Mr. EMMER. Prior to the passage of Dodd-Frank, the SEC historically brought approximately 60 percent of its new cases as administrative proceedings. In contrast, over 80 percent of the new enforcement actions in the first half of Fiscal Year 2015 were filed as administrative proceedings. 

They are clearly filing more as administrative proceedings. 

Mr. VOLLMER. Yes, I think you have to be careful about cases 

filed versus settled cases. 

Mr. EMMER. Let’s attack that quick, as my time is running out. 

That is the problem. They have been bringing them in administrative proceedings that they have the advantage, they have been winning on above-average numbers, and guess what, now they just file 

them or they threaten to file them, and you don’t want to go 

through that process, so you pay before it ever happens. 

Mr. VOLLMER. Actually, my point is slightly different. Defendants 

sometimes prefer to—when they are going to settle at the initiation 

phase, they would prefer to settle in an administrative case rather 

than a Federal district— 

Mr. EMMER. I appreciate it. You and I have a difference. I think 

many of them settle because the cost that they are going to have 

to put up to fight the Government just doesn’t make it worth it. 

That is why we should change this law. 

My time— 

Mr. VOLLMER. We don’t have a difference at all. 

Chairman HUIZENGA. The gentleman’s time has expired. 

Mr. VOLLMER. I agree with that completely. This is solely a question of what— 

Chairman HUIZENGA. The gentleman’s time has expired. 

Mr. EMMER. Thank you. I appreciate it. We will continue this offline. 

Chairman HUIZENGA. The gentleman from California, Mr. Sherman, is recognized for 5 minutes. 

Mr. SHERMAN. As we go down this road, I should comment that 

both the cost and the benefits of securities enforcement are far 

greater than we might think at first blush. The costs of securities 

enforcement not only include the salaries of Mr. Borg and his compatriots and those of his brethren at the SEC, but they include the 

private-sector cost of complying—but not just the private-sector 

cost of complying when there is an investigation, but, also, all of 

the business opportunities that aren’t pursued because one more 

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21 

reason not to do it is this whole expensive process. The jobs, not 

created. 

On the other hand, the benefits of securities enforcement are 

greater, because we tend to focus on, ‘‘A-ha, here is Enron, here is 

Madoff, here is how much money was recovered for investors.’’ That 

is just the tip of the iceberg on the benefits of enforcement. The 

chief benefit of enforcement are the frauds that don’t happen, the 

documents, the disclosures to investors that are made more clear, 

the corners that are not cut. 

Mr. Borg, you pointed out a number of areas in which the statute 

you criticize, or the proposed statute you criticize, is unclear. I 

would just say that we shouldn’t, at this stage, be urging people 

to vote against legislation because it is unclear; we should be urging the authors to make it clear. Your earlier testimony identifies 

certain areas where this statute should either do the extreme thing 

that you don’t think we should do or clearly not do that extreme 

thing. But we should clarify statutes and then decide. 

Mr. Quaadman, we have a unique history in this country that 

has led us to shared sovereignty between a Federal and subnational governments. So we have securities law enforcement at 

both the national and subnational level. Does any other country do 

it that way? It seems very peculiar to anyone not familiar with 

American history. 

Mr. QUAADMAN. No. Most other nations do it on a national level. 

Canada does do it a little differently, that they have their securities regulation done on the provincial level. 

But I do want to add that I— 

Mr. SHERMAN. But there is no country that does it at both levels. 

Mr. QUAADMAN. No. 

Mr. SHERMAN. There is no evidence that the German stock market or the British stock market is a place for fools who want to be 

defrauded because they benefit only from one level and not two levels of securities enforcement. 

Mr. QUAADMAN. Correct. In fact— 

Mr. SHERMAN. OK. I do want to go on. 

Mr. Borg, we tend to focus on the big companies that do register 

with the SEC, that do big things, that have big pots of money that 

we can go after and at least try or pretend to comply with our securities laws. 

I got an offering from an initial coin offering. Anybody can invest. No government official has ever been asked to review this document. There is no investor protection at all. They imitate, by calling it an initial coin offering, the documents that are filed when 

there is. 

Why haven’t you protected the people of Alabama from the DDF 

initial coin offering and similar complete failures to even acknowledge that securities laws exist except for the purpose of imitating 

those investment documents created in compliance? 

Mr. BORG. We have a number of cases ongoing. I can cite about 

eight— 

Mr. SHERMAN. These folks—shouldn’t this just be a slam dunk? 

They are offering an investment to the public, unregistered by anywhere. 

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Mr. BORG. We do have a number of cases pending. Some respond 

to our cease-and-desist as we do the investigations. A lot of them 

are considered securities. Some are considered commodities. We 

have jurisdiction for both. NASAA, 44 States just completed a 

crypto-sweep, with 75 potential defendants. 

Mr. SHERMAN. But the DDF initial coin offering is still taking in 

money right now. 

Mr. BORG. I am not familiar with that particular one. I could cite 

a lot of others. I would be more than happy to take a look at it 

and, if necessary, bring an appropriate action. I just don’t know 

that particular one. But considering the 75 that we have looked 

at— 

Mr. SHERMAN. Will you be putting people in jail or just stopping 

them from defrauding people of additional funds? 

Mr. BORG. That depends if they are overseas and we can get 

them or not, and that depends on whether or not there was an actual fraud where the money has been taken, received, and spent. 

In essence, if it is lying, cheating, and stealing, yes, we should. 

Can I get them? Do I have jurisdiction? That is something we 

will have to look at on a case-by-case basis. But we are not ignoring this section. We are— 

Mr. SHERMAN. Please propose any new legislation you need. 

Thank you. 

Mr. BORG. Yes, sir. We— 

Chairman HUIZENGA. The gentleman’s time has expired. 

The Chair recognizes the gentleman from New Jersey for 5 minutes. 

Mr. MACARTHUR. Thank you. 

Mr. Quaadman, do you believe that duplicative State and Federal regulation is chilling interest in our public markets? 

Mr. QUAADMAN. There is no question about it. As I said in my 

oral statement, it is one of the reasons why businesses aren’t going 

public. 

As I was going to mention before, I had a meeting with the deputy Governor of the Bank of England a few years ago where he was 

directly complaining about that and started to talk about how that 

is going to impact the ability of the U.S. to be competitive globally. 

Mr. MACARTHUR. Does it negatively affect our global competitiveness? 

Mr. QUAADMAN. It absolutely does, because you can have a situation where New York State, through the Martin Act, is suddenly, 

let’s say, with the financial analyst issue, is entering into a settlement that regulates things nationally that, also, international companies have to comply with. 

Mr. MACARTHUR. Mr. Bondi, are you familiar with the Securities 

Fraud Act? Have you reviewed it? 

Mr. BONDI. I am. 

Mr. MACARTHUR. Mr. Borg tried to make an argument that, because the bill doesn’t specify whether it is Federal procedural or 

substantive law that we are talking about, that it would effectively 

shut down any State AG prosecution of criminal fraud. I don’t concede that point, but if that were true, that is so easily remedied 

by amendment that that could be clarified in a moment. I think 

that is more of an excuse than a real reason. 

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But let me ask you, since you are familiar with the bill: Is this 

accurate, that all criminal fraud, whether it is public or not public 

companies, all criminal securities fraud would still be at the State 

level, that non-public companies would all be at the State level, 

that public companies that are not engaged in interstate commerce 

would all be at the State level? Is that true? 

Mr. BONDI. That is true. 

Mr. MACARTHUR. This is a narrowly defined bill that is only targeting public companies who have to report immediately if they are 

even accused of civil fraud—this trial by press release. If they are 

merely accused of civil fraud, they have to report it to their shareholders, with great negative effect on their companies, and it 

makes them less competitive on the world stage. 

Would you agree that this is a very narrowly defined bill that is 

simply protecting public companies engaged in interstate commerce? 

Mr. BONDI. Yes, Congressman, I think this is very narrow. 

I would disagree with Mr. Borg about churning cases as an example of something that would be preempted. As I understand in 

my reading of the case, those types of cases could continue at the 

State level. Congressman, I think that it could be even further narrowed and still achieve the goals by perhaps inserting a market 

capitalization— 

Mr. MACARTHUR. I want to explore that with you. That is actually what made me turn to you, is I heard that point, and I am 

concerned that we don’t take cops off the beat. I think that was Mr. 

Borg’s expression. That is not what I am after here. I am not trying 

to stop State AGs from going after bad actors. We have a responsibility to protect people. 

But there are a handful of States that do not use a uniform definition of fraud, and they are wreaking havoc on public companies. 

Since some of them, like New York, for example—there is a nexus 

between nearly every public company in the country and the New 

York AG—the lack of that State alone adopting a uniform standard 

gives that particular AG the ability to wreak havoc across public 

markets, which they have done successively AG after AG. 

But I do want to explore your suggestion. You mentioned in your 

opening remarks that you thought that a size limitation might 

help. Could you unpack that a little bit? 

Mr. BONDI. Yes, Congressman. 

In other areas, Congress has imposed certain capitalization 

amounts in terms of preemption. For example, in the registration 

of hedge funds, there is an amount above which the hedge fund has 

to be to be registered at a Federal level. Otherwise, if it is below 

that amount, it doesn’t have to register with the SEC. 

I would agree that, in many cases, especially with microcap fraud 

cases, very small public companies that are traded on national exchanges, the States are oftentimes the front line of those cases. I 

agree with that statement by Mr. Borg. 

I think one way to address this in the legislation is to put in a market capitalization amount about the issuer. Maybe it is $50 

million of market cap— 

Mr. MACARTHUR. I am running out of time. I would actually like 

to explore that with you. 

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One last question. Professor Vollmer, I have tried to strike a fair 

balance between protecting States’ policing powers and preserving 

regulators’ ability to pursue fraud within their borders and giving 

public markets a life here. Do you think that this bill strikes that 

balance? 

Mr. VOLLMER. I think it does excellent work in trying to strike 

a balance. I actually think it is too narrow. I think that there 

should be broader Federal preemption. But I understand there are 

competing considerations. 

Mr. MACARTHUR. Thank you. I yield back. 

Chairman HUIZENGA. The gentleman’s time has expired. 

The Chair now recognizes the gentleman from Georgia, Mr. 

Scott, for 5 minutes. 

Mr. SCOTT. Thank you, Mr. Chairman. 

I first of all want to preface my remarks by just sharing with the 

panel that there are some good points in this legislation. But I 

have a few troubling concerns here that alarm me since the Trump 

Administration has taken over. 

First, if you recall, in February 2017, then-Acting Chairman Michael Piwowar revoked subpoena authority from roughly 20 senior 

enforcement officials, which meant only the Director was left to approve any formal investigation. 

Then the second troubling point was that the Trump Administration made a decision, as you will recall, to stop all hiring, which 

resulted in the SEC imposing a strict hiring freeze, which has prevented the SEC from even replacing their departing staff. 

But it doesn’t stop there. There have been actions in our courts, 

with the Supreme Court ruling of Kokesh v. the SEC, that have resulted in significant crippling of the SEC’s disgorgement authority, 

according to current co-directors of the Enforcement Division. 

Finally, we mustn’t forget the Republicans’ efforts here in Congress to never increase the SEC funding for the SEC Enforcement 

Division, even though it has zero effect on our national deficit because the SEC is funded by fees. 

You can see, taken all together, it is very troubling. 

Now, Mr. Quaadman, I want you to know that I agree with you 

and the goal of the Chamber of Commerce. I have always been at 

the front of the spear here in this committee in making sure that, 

as you put it—I couldn’t have put it any better—quote, you said in 

your report that ‘‘there needs to be identifying problems and shortfalls of our financial regulatory system so that the United States 

can compete in the global economy’—and, I add, remain and always 

remain number one in the global economy. 

But with what is going on in the Administration, I get skeptical 

about whether legislative action is necessary. Let me ask the panel, 

do you think we have conclusive evidence here that H.R. 2128 and 

H.R. 5037 are solving serious problems in our markets? 

Especially you, Mr. Borg, do you think that these two bills are 

necessary? 

Mr. BORG. No, sir, I do not. 

I think that there is a misconception here about what is stopping 

IPOs or further development. Let’s take a look for a moment at history. 

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Back when I started 24 years ago, the private market for capital 

was very, very small. It has grown. Congress has mandated it. It 

has passed laws to encourage the shift from IPOs to private market. The private market now is bigger than the public market. That 

is one. The second thing, of course, is that the crowdfunding—Reg 

A, Reg A-plus—is another alternative vehicle for capital formation. 

The capital formation shift has occurred at Congress’ direction. 

I don’t pass a positive or negative on that. But to say that the capital has decreased in the public sector through IPOs or whatnot is 

incorrect unless you take into consideration what we have done to 

move that sector from public to private. I think that is an important factor that has not been considered. Just looking at the number of IPOs is not going to make it. 

Mr. SCOTT. Right. Yes, Mr. Quaadman. 

Mr. QUAADMAN. Yes, Mr. Scott, if I can answer, we think both 

bills are important. 

Number one, 2128. We don’t have due process in the administrative proceedings at the SEC. In fact, it has been reported where 

SEC staff has talked about the use of ALJs in administrative proceedings because it is the home-field advantage. This would correct 

a wrong where the Government, and not the defendant, decides if 

they should have a jury trial. 

5037 is also very important, too, because the Martin Act—you 

have to understand this: There is a confluence of the public companies being listed on the exchanges in New York and this law where 

now the New York State attorney general can be a national regulator and has sought to have that role. 

We should also remember that even yesterday the New York 

State Court of Appeals issued a ruling where they issued concerns 

about the fact that the Martin Act does not provide for proof to defraud or intent to defraud, which they have now limited the statute 

of limitations from 6 years from common law fraud to 3 years. 

Mr. SCOTT. Right. 

I wanted to just put this in to Mr. Davidson and the authors of 

the bill real quick, if they felt that—if they could, within the bill, 

increase the funding at the SEC Enforcement Division, and would 

you guys be willing to urge the Administration to lift the hiring 

freeze. If you could do that, then I would like to look at it more 

carefully. 

Chairman HUIZENGA. The gentleman’s time has expired. 

Mr. SCOTT. Is that possible? 

Chairman HUIZENGA. They will have a chance to respond at the 

questioning. 

Next, we will recognize the gentleman from Maine, Mr. Poliquin, 

for 5 minutes. 

Mr. POLIQUIN. Thank you, Mr. Chairman, very much. Appreciate 

it. 

Thank all for being here today. 

It is so important to make sure we do everything we can to help 

our businesses grow and expand and hire more workers and pay 

them more. You can see what is happening with the GDP growth 

now, which is about double what it was a short year and a half or 

so ago. Things are going in the right direction. 

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I am very interested in Mr. MacArthur, my terrific associate 

from New Jersey, his bill, 5037. I am sure you folks have been discussing it today. I have been in and out a little bit here. 

But, my concern here is a constitutional concern when it comes 

to the 10th Amendment and States’ rights and everything else, but, 

at the same time, making sure that we make it as easy as we can 

for businesses to sell themselves or part of themselves to the public. It gives an opportunity for small savers in the State of Maine 

to invest in America and, at the same time, allow these companies 

to raise the capital they need to be successful. 

Mr. Quaadman, if you don’t mind commenting on this, and then 

I will turn it over to Mr. Borg too. I would like to hear what you 

both have to say. Do you think that the SEC would still be able 

to do its job, enforcement job, effectively if they were the sole entity 

dealing with companies listed on national exchanges? 

Mr. QUAADMAN. Yes, so first off, I think we have to remember 

the Founding Fathers made this decision with the Constitution 200 

years ago that if there is a transaction in interstate commerce the 

Federal Government is going to regulate that; if it is intrastate, 

then it is going to be the State that is going to regulate that. I 

think that is a very important distinction that was made with the 

founding of the Constitution. 

I think it is also important to remember here, too, that 5037, 

number one, preserves the right—in our reading of it, preserves the 

right of States to pursue criminal actions. It preserves the right to 

take other actions. However, when you are dealing with a statute 

such as the Martin Act and, as I said earlier, with that confluence 

of those exchanges being listed in New York, that it would have 

those cases going to Federal court because we are dealing with an 

interstate commerce issue. 

That Vanderbilt study that I had mentioned earlier looked at 

2,000 public companies and found that the SEC was bringing 

cases—or Federal agencies were bringing cases in 91 percent of the 

cases that States were. We are not going to see a drop-off in enforcement. We are going to see the proper rationalization, as was 

mandated under the Constitution, with this bill. 

Mr. POLIQUIN. Uh-huh. Thank you very much, Mr. Quaadman. 

Mr. Borg, would you care to comment on this issue? 

We have a terrific State regulator in your space, Judith Shaw up 

in Maine. You might know Judith. She is wonderful. And— 

Mr. BORG. I do. 

Mr. POLIQUIN. She has weighed in on this. I am trying to sort 

this out and see— 

Mr. BORG. Yes, sir. She has sent to you a letter outlining her objections to 5031. 

With all due respect to Mr. Quaadman, there is one item in the 

Constitution he forgot about: The States have a right to protect 

their citizens from fraud and whatever it might be. 

Also, with regard to the fact that States are somehow impeding 

this process, this committee has had over 20 hearings in the last 

number of years talking about increasing IPOs or what is impeding 

the ability to go public, and not one of those hearings has ever 

brought up State involvement as an issue. We have talked about 

Reg D’s and everything else. This Congress alone, six hearings 

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have been held, and not one has ever said that the States are the 

problem. 

I think we are focusing on the wrong issue here. The fact of the 

matter is that, if States are going to protect their citizens from actions that affect their citizens, then they have a right to do so without being overridden by a Federal preemption such as 5037. 

Mr. POLIQUIN. Mr. Borg, before I run out of time, if you don’t 

mind, I would like to turn it back over to Mr. Quaadman. 

Because I know your body language was such that you might disagree a little bit with Mr. Borg. If you want to comment on that. 

Mr. QUAADMAN. Yes, I just have to disagree with that last statement, because I have testified at a couple of those IPO hearings 

here at this committee. We have raised these issues before, and we 

have raised the Martin Act before. This is not a new issue that is 

being raised. 

Mr. POLIQUIN. Mr. Borg, you have the last word. 

Mr. BORG. The Martin Act is a New York law. I think that is 

something that the folks in New York should decide. I think this 

argument over the Martin Act, if that is what we are talking about, 

the Martin Act, ought to be in Albany. 

I am addressing 5037 that is going to affect my State and 49 

other States. I am not here talking—I am no expert on the Martin 

Act. If this is a Martin Act issue, then I think it ought to be handled up in Albany or wherever their legislature meets. 

Mr. POLIQUIN. To be continued. Thank you, gentlemen. I really 

appreciate it very much. 

Thank you, Mr. Chairman. I yield back my time. 

Chairman HUIZENGA. The gentleman yields back. 

With that, we welcome our colleague and guest to the subcommittee, Mr. Capuano from Massachusetts, who is recognized. 

Mr. CAPUANO. Thank you, Mr. Chairman. I thank you for your 

indulgence. I appreciate it. I came over today because this is an important issue. 

Mr. Borg, could you tell me again what your title is? 

Mr. BORG. I am Director of the Alabama Securities Commission. 

I am the current President of the North American Securities Administrators Association. 

Mr. CAPUANO. What State was that again? 

Mr. BORG. Alabama. 

Mr. CAPUANO. Alabama. Has Alabama changed? Are you now the 

bastion of liberalism, like Massachusetts? 

Mr. BORG. We are there to protect our citizens, whatever it 

takes, and that is what we are going to do. 

Mr. CAPUANO. I am not aware—that is a lovely State, but I am 

not aware that you have a reputation for being a progressive or a 

liberal—not you, but the State. So that what you do is, in your estimate, within a conservative viewpoint, the protection of consumers. 

Mr. BORG. My legislature has passed the laws. They have seen 

fit to say that we need to enter this space and protect our citizens, 

and we have done so. 

Mr. CAPUANO. How many other States do this? 

Mr. BORG. I hope all the other States do this. 

Mr. CAPUANO. That is what I thought. I am under the impression 

that every State does this. 

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Now, we talk here regularly about insurance regulation. Now, on 

insurance regulation, I think I hear the mantra pretty much all the 

time to leave it to the States. Have you heard that argument relative to regulation of insurance companies? 

Mr. BORG. I have. I understand that there is exclusive jurisdiction to the States with regard to insurance regulation. 

Mr. CAPUANO. Right, because they do a decent job. 

Mr. BORG. There is no Federal regulator for insurance. 

Mr. CAPUANO. Right. 

I came today because all the nice talk is one thing, but the concept of taking protections away from small investors just strikes 

me as anathema. It just strikes me as—look, if the SEC is doing 

a great job, the truth is we don’t need the States. But they have 

to look me in the eye and tell me the SEC has done a great job 

all the time and they haven’t missed anything and that the States 

are nothing but doubling up. If that is the case, I haven’t heard 

that from anybody, and I don’t quite know why we are here. I am 

not sure what the problem is we are trying to solve, and I would 

really like to hear it. 

Look, every regulation is overregulation to some people. I get 

that. But, in this particular case, especially when we have a gentleman from Alabama—no one has ever said that Alabama is guilty 

of overregulating anything. If all the States are overregulating, I 

would like to hear that from somebody on the panel. 

Are all the States overregulating? Or is it just a couple of States 

you are trying to target? 

Mr. QUAADMAN. Mr. Capuano, I would just say, as I mentioned 

earlier, I think what we have here is a situation where we have 

one State where you have a confluence of the two major exchanges 

of the United States being located in that State, we have the Martin Act being used over the last 15 years in such a way there is 

litigation through press release, there has never been a case 

brought into court except for once where New York State— 

Mr. CAPUANO. We are here targeting one State. 

Mr. QUAADMAN. I think that is where we have the biggest problem, because that is where we have—the New York State attorney 

general has set themselves up to be a de facto national regulator— 

Mr. CAPUANO. I get that. Then why don’t we have a bill just to 

stop New York State from doing this and leave the other 49 to do 

it? Leave Alabama alone. 

Mr. QUAADMAN. Our view is—and I have great respect for Mr. 

Borg and what he does down in Alabama. Our review of it is that— 

our reading of 5037 is that it would actually just do that. It would 

take care of those cases up in New York. If there is more clarity 

that is needed there, that is fine. 

Mr. CAPUANO. All of a sudden, if Massachusetts were to—now, 

one of reasons the other States don’t do it is because we know New 

York happens to be the biggest one of the bunch, and they take 

care of business for us, to a certain extent. 

At the same time, I am sure you know that when they move, 

many other States will join in with them. They are the lead dog 

because they are the biggest dog. 

Let’s assume for the sake of discussion that the entire State of 

New York were to go to sleep tomorrow and stop doing whatever 

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it is you don’t like about it. What if Mr. Borg stepped up and said, 

now that New York is not doing this, maybe we need to step up 

a little bit? What would that argument be? 

Mr. QUAADMAN. I also remember the Massachusetts State regulator saying that people shouldn’t by Apple stock because it was 

risky. 

I think it is really important to remember we have an SEC that 

is looking at these things from a national level, from an international level. We are talking about the sales of securities listed on 

national exchanges. If it is something that is not listed on a national exchange, that it falls within the purview of the States, we 

don’t have a problem with that. 

Mr. CAPUANO. The SEC has never issued a single ruling that you 

disagreed with. That is good, I guess. There is nothing wrong with 

that. That is a good thing, if you feel that comfortable with them. 

Because there are a couple of things they have done that I haven’t 

agreed with. 

Mr. QUAADMAN. We haven’t agreed with some things either, 

which is why we also support 2128, which I would hope you do too, 

in terms of due process. 

Mr. CAPUANO. I am all for due process. What I am not for— 

Chairman HUIZENGA. The gentleman’s time has expired. 

Mr. CAPUANO. —Is taking people’s protections away. 

Thank you, Mr. Chairman, for your indulgence. 

Chairman HUIZENGA. With that, the gentleman from Ohio, Mr. 

Davidson, is recognized for 5 minutes. 

Mr. DAVIDSON. Thank you, Chairman. 

To our guests, thank you for your expertise and for the preparation you have given, the testimony you have already given, and for 

the lengthy dialog that has already occurred. As one of the sponsors of one of the bills that has been talked about a bit, it is nice 

to be able to discuss it—and a cosponsor of Mr. MacArthur’s bill. 

I appreciate the committee for having this hearing and for devoting the time that it has taken. 

Mr. Quaadman, in your testimony, you state that the administrative proceedings have, quote, ‘‘created an imbalance within the system that endangers the right of defendants and undermines the 

use of appropriate enforcement tools while raising important questions regarding the separation of powers between the Executive 

and Judicial Branches of Government.’’ 

This is one of the reasons why I introduced H.R. 2128, the Due 

Process Restoration Act. This bill provides respondents in SEC enforcement cases with the ability to have their case removed from 

the SEC’s administrative proceedings and sent to a Federal district 

court. It essentially puts them at parity with the SEC. If the SEC 

can choose their venue, so can the defendant. 

Can you please elaborate more about the concerns regarding separation of powers? Specifically, how would legislation like H.R. 

2128 help alleviate this imbalance? 

Mr. QUAADMAN. If you take a look at the Federal Rules of Civil 

Procedure, none of the traditional things that you have seen in an 

Article III court exists in an administrative proceeding at the SEC. 

I think one example is very illustrative of that, and that is of 

Nelson Obus at Wynnefield Capital. See, he was involved in a case 

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that went on for at least 12 to 14 years, cost him millions of dollars, and he was one of last people to get into Federal district court 

before some of the changes with Dodd-Frank, which really shifted 

things into administrative proceedings. 

As a result of the right of discovery, he was able to uncover information that led to cross-examination that led to his exoneration. 

He has even said, had that case happened several years later, had 

it gone into administrative proceeding, he would have never had 

the right of discovery, he would have never gotten that information, he would have never had the cross-examination, he would 

never have been exonerated. 

I think we have to be very careful—let’s forget for a second about 

if this is a securities issue or not—if we are going to have American 

citizens being brought before American tribunals where they don’t 

have the right to defend themselves. 

I think what your bill does is it allows that defendant, under certain circumstances and limited circumstances, to go into Federal 

district court and to get a jury trial, which, in our view, is a matter 

of fundamental fairness and due process. 

Mr. DAVIDSON. Frankly, it is a constitutional protection, and I 

think it is core to the oath that we all swore. I think it should be 

a bipartisan thing to support and defend the Constitution in this 

way. 

As a huge supporter of the Ninth and Tenth Amendments, I respect some of the arguments that have been laid out here. But even 

as we talk about Mr. MacArthur’s bill, the idea that there could be 

no limited safe harbor as a condition of going public, as a consequence of a publicly traded stock on civil litigation, I think, 

misses the point. 

I respect the emphasis on the Martin Act, but if you look at the 

things that were done in the name of investor protection, it was 

really advancing a cause on climate change, not investor protection, 

that not just New York but Massachusetts, the Virgin Islands, Illinois, California, and others put pressure that affects investors, affects shareholders. You have this market-distorting behavior that 

hurts all shareholders, including shareholders in my State of Ohio. 

You have a need for legislative certainty here. 

I am particularly interested in initial coin offerings and working 

on a bill for that. These offerings can present another avenue for 

businesses to raise capital and increase liquidity. We have seen a 

myriad of State and Federal regulations, and now we are seeing 

enforcement action, and perhaps regulation by enforcement is one 

of the concerns that folks have expressed to our office. A hope that 

somehow the courts create some cohesive framework. 

Do you think these concerns about the patchwork hold water? Or 

do you see a role for Congress bringing clarity in this matter for 

the SEC and CFTC to create regulatory certainty, Mr. Quaadman? 

Mr. QUAADMAN. We think there is definitely a role for Congress 

here. We, in fact, are putting together our FinTech agenda, which 

we are going to look at ICOs, and we are going to release that next 

month. Treasury is going to do something like that, as well, this 

month. 

We think there needs to be a strong regulatory structure on this, 

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31 

ness. It is also important to remember this is also a matter of 

international competitiveness as well. 

Mr. DAVIDSON. Very well said. 

I see my time has expired, and I yield. 

Chairman HUIZENGA. The gentleman’s time has expired. 

With that, the gentleman from Arkansas, Mr. Hill, is recognized 

for 5 minutes. 

Mr. HILL. I thank the chairman. Thanks for holding this hearing. 

I appreciate our panel and your expertise, for coming down and 

spending the afternoon with us. We are grateful for your expertise 

on this topic. 

I have to say from listening to the excellent dialog, Mr. Borg and 

Mr. Quaadman, thanks for bringing that robust debate about these 

issue to the committee, and I appreciate all my colleagues’ involvement in it, because it really is helpful. We don’t always get to do 

that in these hearings. Being able to drill down and have some exchanges is helpful. 

I hear the concerns that Mr. MacArthur’s legislation is perhaps 

too broad for the North American securities administrators across 

the country and they have concerns about that and also their 

States’ rights. That is something that maybe needs more work in 

the bill, because the issue of interstate commerce and international 

exchange competitiveness for listing is a big concern to this committee too. It is a classic case of public policy where we are working 

to balance those interests. 

Mr. Borg, do you have a couple of narrowing suggestions, maybe, 

on further tailoring that would get at this issue of international 

competitiveness? Since our exchange and our listing entities are all 

in the State of New York; we are not moving them. I am not going 

to foot the bill for that project. Although New York tax structures 

may drive them out one day, but let’s assume they stay in New 

York for now. 

Do you have some suggestions? Because I know you all probably 

had to talk about this in preparation for the testimony. 

Mr. BORG. Certainly, I am looking at this bill as to how it affects 

my State and other States as well. I am not versed in the Martin 

Act, and there has been a lot of discussion today about where the 

Martin Act is and how it applies and how it doesn’t. I do know New 

York has filed with the committee a rather extensive letter on New 

York law, and I would be out of my territory to talk about New 

York law. 

With regard to the idea that foreign markets somehow are scared 

of this area, I will tell you that there are studies about—and I have 

heard this overseas as well—that the markets in the United States, 

because of the protections afforded, the amount of regulation, is 

one reason why they are attractive to good overseas— 

Mr. HILL. I agree. We have the rule of law. We have terrific liquidity and terrific players, diversity of players, a lot of expertise 

in bringing companies to the public market and sustaining their 

marketability. We are the biggest in the world. We also have the 

largest set of buyers of that market, for now. We have many competitors around the world. 

But there is also data about the barriers if you are comparing 

markets and litigation is a concern to you. I saw some recent data, 

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32 

I think in April or March, from the Business Roundtable and their 

corporate governance survey that indicated that there are some foreign markets that are more attractive for certain kinds of listers. 

I think this is an issue. I think Mr. MacArthur raises a good 

point and we ought to be sensitive to it and try to find the right 

spot where we are not impeding the administrative responsibilities 

in the private placement market and broker oversight and firm 

oversight that you have in our States. 

Mr. Quaadman, we have been working on our JOBS 3.0 here in 

the Congress, on things that can enhance capital formation. One 

that I noted in my last couple of decades of working in the securities industry is how Sarbanes-Oxley raised costs and didn’t get any 

concomitant increase in efficiency or compliance by requiring a 

PCABO-approved audit firm for small, noncustodial introducing 

brokers. 

I wondered, would you support our idea of making that—it has 

gotten waivers in the past umpty-ump years from Sarbanes-Oxley 

in 2002. But making a permanent waiver, would you support that? 

Mr. QUAADMAN. Yes, look, the Chamber is a strong supporter of 

internal controls, but we support a waiver and we support the direction that you are going in. 

I think one thing to remember, the first two letters in PCAOB 

stand for ‘‘Public Company.’’ Most of the brokers that you are talking about, number one, aren’t public companies, number two, don’t 

hold securities, so that the audit that they are being subjected to 

by the PCAOB doesn’t match their model. 

The other thing I would just say, too, is, when you are taking a 

look at a Bernie Madoff situation, what you need is the bank 

records and what you need is the revenue statements, and you put 

those two things together and you are going to find out if there is 

a problem. You are going to have that information. What we are 

trying to solve here is not going to prevent that information from 

being in the hands of regulators. 

Mr. HILL. Right. Thank you. 

Mr. Chairman, I yield back. 

Chairman HUIZENGA. The gentleman’s time has expired. 

With that, the gentleman from Indiana, Mr. Hollingsworth, is 

recognized for 5 minutes. 

Mr. HOLLINGSWORTH. Good afternoon. I really appreciate everybody being here and second what Representative Hill said about 

the vigorous debate that we have undertaken today. I think it is 

necessary. 

Something that Hoosiers have been concerned about for some 

time and continue to express to me every time I am back home in 

the district is some of the silent encroachment upon their rights of 

due process and ensuring that they have the opportunity to understand that which is being brought against them and they have the 

opportunity to defend themselves vigorously in a court of law. 

Mr. Bondi, I had a couple questions for you based on some of the 

testimony you have had, so we may bond here for a moment, if you 

might. 

I know that one of the things that you talked about before was 

some of the forum shopping, and that particularly concerns me 

with regard to—I think it was the Cyan decision earlier this year 

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33 

by the Supreme Court, in that 33 class actions could be brought in 

State court and are not removable to Federal court. 

I guess we had some concerns when that decision came down 

that, ultimately, this would lead to a lot of forum shopping. This 

would lead to, also, law being developed in different ways in different places versus a coherent system of law being developed all 

the way across the country, from sea to shining sea. 

I wonder if you might be able to elaborate on that. 

Mr. BONDI. Yes, I agree, Congressman. I think that is a real concern. What we are seeing, I think, in the defense bar is plaintiffs 

that are looking for the most favorable forum to extract the largest 

possible settlement. It exists also at the regulatory level, I think, 

what we are seeing here with the administrative law proceedings. 

Mr. HOLLINGSWORTH. Yes. 

I know one of things that Hoosiers are focused on—and, really, 

the previous Governor of Indiana, Mitch Daniels, really talked 

about this a lot—is we all want to make sure that the bad actors 

that exist out there get hit with a sledgehammer, but, ultimately, 

we don’t want to impede capital markets, we don’t to inhibit good 

actors from being able to service their customers, to be able to create new innovations, and ultimately be able to continue U.S. competitiveness around the world. 

I think that is really important, that we don’t develop law in a 

way that will continue to be a drag on overall capital markets’ effectiveness, but, instead, we create law that will ensure that bad 

actors are taken out of the market but ultimately we are not harming good actors in the market. 

Another question that I had for you is elaborating on the standard that the SEC demonstrate a ‘‘reasonable approximation’’— 

quotation marks around that—for its disgorgement calculation. 

Just better understanding of how the SEC might develop that, is 

there public guidance about that, what does that look like, but it 

certainly seems like a really wide spectrum. 

Mr. BONDI. Yes, Congressman. It definitely is a wide spectrum. 

The difficulty is most of the cases the SEC brings are settled cases. 

The standard that the SEC applies, this reasonable approximation 

standard, never really gets challenged in an Article III court. If it 

is an administrative proceeding, sometimes it never even reaches 

an Article III court and it is dealt with an ALJ judge. 

It is particularly poignant in the case of books and records and 

internal controls violations, where the SEC might take a books and 

records violation and then disgorge an extraordinarily high amount 

that was associated, for instance, with a foreign bribe. Where, instead of bringing an FCPA case for that foreign bribe, they bring 

a books and records internal controls case and say all of the ill-gotten gains from that foreign bribe were related to that one entry 

that was incorrect in the books. 

There needs to be some standard here. I think either Congress 

should impose it or the SEC should come up with a standard by 

the way it calculates disgorgement. 

Mr. HOLLINGSWORTH. We have talked a lot about forum shopping 

in the course of this testimony, but really talking about limiting 

the ability for these actions to be brought and really shop the different ways that they might be able to attack these actions to be 

mcarroll on FSR431 with DISTILLER

34 

able to get the largest penalty. I think that is what we are trying 

to hold back. 

We want to make sure that any nefarious activities by individuals, that they pay the price for that, but we don’t want to shop 

around so that they pay the largest possible price, in terms of the 

avenue taken. Is that fair? 

Mr. BONDI. That is fair. 

Mr. HOLLINGSWORTH. OK. Great. 

I think the other thing—this is something that you cited in your 

written testimony—is the NYU study that, in the first half of 2018, 

the percentage of new enforcement actions against public companies—and I want to make sure I get this right—that were brought 

as administrative proceedings declined to 80 percent, down from 94 

percent in the second half of 2017. 

Is this an encouraging trend that you see in response to some of 

the public outcry about this, some of the articles that have been 

about this, some of the challenges that have been brought to this 

process? Or, what do you attribute that decline to? 

Mr. BONDI. Yes, absolutely. I think the new Commission, particularly Chairman Clayton and the enforcement directors, are very 

much cognizant about this perception of unfairness associated with 

the ALJ proceedings. I think they are taking better courses to determine when and where to bring ALJ proceedings. I think the statistics are very, very encouraging. 

Mr. HOLLINGSWORTH. Great. 

Look, I know, a lot of times, on this committee we talk about esoteric financial products, we are talking about aspects of law that 

maybe don’t touch everyday lives for Hoosiers. But what does touch 

them every single day is making sure that they have due process 

and making sure they have confidence in the legal system and 

being able to defend themselves or an individual accused of a crime 

is able to defend themselves. 

Thank you all for being here. I appreciate the testimony. 

Chairman HUIZENGA. The gentleman’s time has expired. 

I would like to thank our witnesses today for their testimony. I 

think this was helpful. 

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. 

Again, we appreciate your time and your expertise, and we look 

forward to continuing these conversations. 

The hearing is adjourned. 

[Whereupon, at 3:52 p.m., the subcommittee was adjourned.] 

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(35) 

A P P E N D I X 

June 13, 2018 

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Statement before the United States House of Representatives 

Committee on Financial Services 

Subcommittee on Capital Markets, Securities, and Investment 

On Ensuring Effectiveness, Fairness, and Transparency in Securities Law 

Enforcement 

Statement of Bradley J. Bondi 

June 13, 2018 

The views expressed in this testimony are those of the author alone and do not 

necessarily represent those of any other individual or organization. 
37 

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STATEMENT OF BRADLEY J. BONDI 

BEFORE THE UNITED STATES HOUSE OF REPRESENTATIVES 

COMMITTEE ON FINANCIAL SERVICES 

SUBCOMMITTEE ON CAPITAL MARKETS, SECURITIES, AND INVESTMENT 

HEARING ON "ENSURING EFFECTIVENESS, FAIRNESS, AND TRANSPARENCY IN 

SECURITIES LAW ENFORCEMENT" 

JUNE 13, 2018 

Chairman Huizenga, Ranking Member Maloney, and Distinguished Members. My name is 

Bradley J. Bondi. I am pleased to appear before you today to share my views in this hearing on 

"Ensuring Effectiveness, Fairness, and Transparency in Securities Law Enforcement," and, in 

particular, my views on H.R. 2128 ("Due Process Restoration Act of201 7'') and H.R. 5037 

("Securities Fraud Act of2018"). 

BACKGROUND 

I am a practicing attorney and a partner with the law finn Cahill Gordon & Reindel LLP, where I 

lead my finn's securities enforcement and regulatory practices. I am admitted to the bars of New 

York, Washington, D.C., and Florida. Much of my law practice is devoted to representing public 

companies and financial institutions in securities enforcement matters before the Securities and 

Exchange Commission ("SEC"). 

I previously served in senior positions in government including as counsel to SEC Commissioner 

Paul Atkins and then to SEC Commissioner Troy Paredes. While at the SEC, I was detailed to 

the Financial Crisis Inquiry Commission where I served as deputy general counsel and led one of 

the three investigative teams examining the causes of the financial crisis. More recently, I served 

in a leadership role on President Trump's transition team, advising on financial services matters 

and leading the landing team to the Export-Import Bank of the United States. 

In addition to my law practice, I serve as an adjunct law professor at Georgetown University 

Law Center and George Mason University Antonin Scalia Law School where I teach courses on 

securities law and the SEC. I am also a senior fellow with the Center for Financial Stability, a 

nonprofit, nonpartisan, and independent think tank focusing on financial markets for the benefit 

of investors, officials, and the public. My writing and scholarship focuses on SEC enforcement 

matters. 

I have appended to my written testimony a relevant article that I authored last year entitled, 

"Improving the SEC's Enforcement Program: A Ten-Point Blueprint for Reform" and a stillrelevant article I co-authored 10 years ago with then-Commissioner Paul Atkins entitled, 

"Evaluating the Mission: A Critical Review of the History and Evolution of the SEC 

Enforcement Program," which was published by the Fordham Journal of Corporate and Financial 

Law. 

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Although I am affiliated with several organizations, I am testifying today in my individual 

capacity, and my views are my own. My views do not necessarily reflect those of my law firm 

or its clients. 

PRELIMINARY STATEMENT REGARDING THE SEC 

The SEC is an agency that I greatly respect and admire. In my years serving at the Commission 

and in private practice, I have worked with many intelligent, dedicated, and hard-working 

professionals at the SEC. My observation is that the SEC as a whole overwhelmingly has sought 

to abide by its mandate and for the most part has been successful in doing so. Nevertheless, 

there is always room for improvement, and I am here today to discuss a few areas where I think 

the SEC may have strayed from its mission and to offer suggestions on how to realign the agency 

with its mission. 

THE SEC'S THREE-PRONG MISSION IN THE CONTEXT OF ENFORCEMENT 

The SEC's mission is composed ofthree objectives: "to protect investors; maintain fair, orderly, 

and efficient markets; and facilitate capital formation." 1 In the area of enforcement, the SEC has 

focused historically on the investor-protection prong of the mission, with a particular focus on 

the retail investor. A robust enforcement regime to defend the markets against fraud is essential 

to encouraging capital formation. Enforcement almost always involves a balancing of competing 

interests both at a case-specific level and at a policy level. A decision aimed at protecting one 

group of investors could have a detrimental impact on a different group of investors. Similarly, a 

decision aimed at protecting investors could harm market efficiency or chill capital formation. 

The balancing of conflicting interests must be t,'Uided by the principles of predictability, 

transparency, and the rule of law. 

The SEC's approach to issuer penalties and disgorgement is an area that could threaten the 

balance of the SEC's three-part mission. In recent years, the SEC has focused on bringing large 

numbers of enforcement cases and obtaining large financial settlements. At the end of its 2016 

fiscal year, the SEC issued a press release announcing that the 868 enforcement actions it filed in 

2016 were a "new single year high."2 It also announced that it had obtained approximately $4 

billion in disgorgement and penalties that year. This was the third year in a row that the SEC 

announced a record number of enforcement actions. 3 

1 See Securities and Exchange Commission Agency Financial Report: Fiscal Year 2017 at 4 (Nov. 13, 2017), 

available at https:/fw\V\V.sec.gov/files/sec-2017-agenC\:-financial-repori.pdC 2 See Press Release, SEC, SEC Announces Enforcement Results for FY 2016 (Oct. II, 2016), Release No. 2016-212, 

available at https://www.sec.gov/news/pressrelease/20 16-212.html 3 See Press Release, SEC, SEC's FY 2014 Enforcement Actions Span Securities Industry and Include First-Ever 

Cases (Oct. 16, 2014), Release No. 2014-230, available at https:ilwww.sec.gov/news/press-releasei2014-230 ("In 

the fiscal year that ended in September, the SEC filed a record 755 enforcement actions .... ");Press Release, SEC, 

SEC Announces Enforcement Results for FY 2015 (Oct. 22, 20 15), Release No. 2015-245, available at 

https://v."\\W.sec.gov/newsiprcssrcleasc/2015-245.html ("In the fiscal year that ended in September, the SEC filed 

807 enforcement actions .... "). 

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The number of enforcement actions and the amount of disgorgement and penalties purportedly 

demonstrate the success of the SEC's enforcement program. But if the aim of the program is to 

protect investors and deter wrongdoing, then the high numbers of enforcement actions and 

penalties are, at best, a poor way to measure that protection and deterrence. At worst, record 

numbers are an indication that securities law violations are increasing in number and severity. 

After all, few would consider a local police force successful in deterring crime if it announced 

record numbers of arrests year after year. 

In addition, the SEC's focus on achieving record numbers could have the practical effect of 

disproportionately allocating scarce resources towards pursuing a large volume of minor or 

unintentional violations involving large companies (and thus leading to large penalty figures) at 

the expense of pursuing fewer but more complicated cases involving intentional wrongdoing 

such as Ponzi schemes, boiler rooms, and bucket shops, which have a disproportionately 

negative impact on retail investors. An overemphasis on enforcement statistics also may lead the 

SEC to develop and pursue theories ofliability that exceed the bounds of the SEC's 

congressionally-authorized enforcement power4 

An emphasis on obtaining large penalties against corporations creates incentives that may be 

misaligned with the core mission of the SEC to protect investors, namely the innocent . 

shareholders who must bear the cost of a corporate monetary penalty. I commend SEC 

Chairman Jay Clayton and his Enforcement Directors for their de-emphasis of statistics and for 

their work to better align the Division of Enforcement with the SEC's mission. I believe the 

SEC is heading in the right direction and I hope my constructive comments today will assist with 

that effort. 

EVALUATING THE STANDARDS FOR MONETARY PENALTIES AND 

DISGORGEMENT 

A review of the history of SEC corporate penalties is necessary to evaluate whether the agency's 

penalty scheme is aligned with the SEC's mission. The Remedies Act of 1990 enabled the SEC 

to seek monetary penalties against public companies. At the time, the Senate Committee on 

Banking, Housing, and Urban Affairs cautioned that the costs of monetary penalties might be 

passed on to shareholders, and the Committee expected that the SEC would seck a monetary 

penalty only when the securities law violation had resulted in an improper benefit to 

shareholders. 5 In cases in which shareholders are the principal victims of the violations, the 

4 This so-called "regulation by enforcement" is contrary to the SEC's rulemaking authority and violates fundamental 

principles of due process that require regulatory agencies to provide a notice and conunent period for new or 

modified rules. See Bradley J. Bondi, Dangerous Liaisons: Collective Scienter in SEC Enforcement Actions, 6 

N.Y.U. J. L. & Bus. I, 16 n.64 (2009) (quoting then-Commissioner Paul Atkins, who said, "[i]fwe are to enforce 

the rule of law, we must follow the rule of law in our approach"); see also Theodore W. Urban, SEC Administrative 

Proceeding File No. 3-13655, Initial Decision Release No. 402 (Sept 8, 2010), dismissed by Exchange Act Release 

No. 66359 (Jan. 26, 20!2). 5 SeeS. Rep. No. 101-337, at 17 (1990). 

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Committee expected that the SEC, when appropriate, would seek penalties from the individual 

offenders acting for a corporate issuer. 

In view of Congress's concern for shareholders, for the first 12 years after the passage of the 

Remedies Act, the SEC imposed issuer penalties sparingly. But, in April 2002, the SEC brought 

a case against Xerox Corporation that marked a sea change in the SEC's approach to seeking 

penalties. The SEC imposed an unprecedented $10 million penalty on Xerox for financial fraud, 

a penalty three times larger than any previous amount for a similar case.6 Since the Xerox case, 

the SEC has levied many civil penalties of$10 million or more. In 2003, the year after the 

Xerox case, the total amount of monetary penalties (excluding disgorgement) imposed by the 

SEC on companies increased to approximately $1.1 billion from approximately $101 million in 

the prior year.7 Since then, penalties against corporations have continued to climb. The highwater mark to-date is a $550 million penalty that the SEC obtained in a settlement with an 

investment bank in July 2010.8 

In January 2006, a unanimous Commission issued the Statement of the Securities and Exchange 

Commission Concerning Financial Penalties, often known simply as the SEC's "Penalty 

Statement."9 The stated purpose of the Penalty Statement was to provide the maximum possible 

degree of clarity, consisk'llcy, and predictability in explaining how the SEC exercises its 

corporate penalty authority. In the Penalty Statement, the SEC identified two principal 

considerations for determining whether a monetary penalty against a company is appropriate: 

(1) the presence or absence of a direct benefit to the company as a result of the securities law 

violation and (2) the degree to which the penalty will recompense or further harm the injured 

shareholders. After the Penalty Statement, annual aggregate monetary penalty amounts dropped 

significantly. In 2008, for example, the SEC imposed approximately $256 million in monetary 

penalties, 10 down from approximately $1.2 billion and $1.5 billion in 2004 and 2005, 

respectively. 11 

6 See Press Release, SEC, Xerox Settles SEC Enforcement Action Charging Company With Fraud (Apr. II, 2002), 

Release No. 2002-52, available at httns://\vw~'.sec.gov/ncws/hc"adlincs/xcroxscttlcs.htm; see also James Bandler 

and Mark Maremont, Xerox Will Pay $10 Million Penalty to Settle SEC Accounting Charges, Wall St. J. (Apr. 2, 

2002), available at https://www.wsj.com/articlcsi~lUQlJ682255642Q49000. 

7 See SEC 2002 Annual Report, at I (Jan. I, 2002,) available at hltQs://www.sec.gov/pdflannrep02iar02f.!!ltm!f 

("Civil penalties ordered in SEC proceedings totaled approximately $10 I million."); SEC 2003 Annual Report, at 15 

(Jan. I, 2003), available at https://www.sec.govipdf/annrcp03iar03fu1Lpdf ("Obtained orders in SEC judicial and 

administrative proceedings requiring securities violators ... to pay penalties of approximately $1.1 billion."). 8 See Press Release, SEC, Goldman Sachs to Pay Record $550 Million to Settle SEC Charges Related to Subprime 

Mortgage CDO, Release No. 2010-123, available at ht.tps:/lwww.sec.gov/news/pressi2010/2010-123.htm. 

Interestingly, in that case there was no allegation of any harm to a retail investor. 9 See Press Release, SEC, Statement of the Securities and Exchange Commission Concerning Financial Penalties 

(Jan. 4, 2006), Release No. 2006-4, available at )Jttps:!/www.sec.gov/news/press/2006-4.htm. 10 See Select SEC and Market Data Fiscal2008, available at )1ttps://www.sec.govifileslsecstats200g.pdi: 11 See United States Securities and Exchange Commission 2004 Enforcement and Market Data, available at 

https://www.sec.gov/files/secpar04stats%2CO.pdf; Select SEC and Market Data Fiscal2005, available at 

h!ms://v.-'W\v.sec.gov/files/secstats2005%2CO.pdf. 

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In recent years, some commissioners have disavowed the Penalty Statement. In September 2013, 

the then-Chair of the SEC observed that the Penalty Statement is non-binding and, while 

recognizing that it sets forth useful considerations, said that each commissioner has discretion 

within his or her statutory authority to reach a conclusion on whether a penalty is appropriate and 

how high it should be. 12 A few weeks later, another SEC Commissioner agreed and commented 

that the Penalty Statement "constituted a fatally flawed approach to assessing the appropriateness 

of corporate penalties" because it focused on whether the company had benefited from the 

misconduct and shareholder harm instead of punishing misconduct and deterring future 

violations. 13 Since 2013, the average annual amount of monetary penalties (excluding 

disgorgcment) imposed has been approximately $1.165 billion. 14 The disavowal of the Penalty 

Statement has created unpredictability regarding the criteria that the SEC considers when 

determining whether to impose a penalty. 

The amount of a monetary penalty is also unpredictable because in recent years the SEC has not 

articulated criteria or metrics for calculating how much it will penalize a company. This 

unpredictability negatively impacts companies. For example, the inability to predict the size of a 

potential penalty hinders the market for mergers and acquisitions because potential bidders 

cannot accurately forecast regulatory exposure. 

The current Commission appears to be taking a more measured approach to assessing monetary 

penalties. The aggregate amount of penalties in 2017 was $832 million, a decline of 

approximately 35% from the ncar-record $1.273 billion in penalties imposed in2016. 15 I 

commend the Commission for this more measured approach, and I encourage the Commission to 

release a renewed penalty statement explaining the circumstances in which the SEC will seek a 

monetary penalty. 

·n1ere also has been growing uncertainty over the SEC's treatment and approach to the equitable 

remedy of disgorgement. The SEC can seek to force defendants to disgorge ill-gotten gains. 

Courts have required the SEC to demonstrate a causal connection between the property to be 

12 Mary Jo White, Chair, SEC, Remarks before the Council of Institutional Investors Fall Conference: Deploying the 

Full Enforcement Arsenal (Sept 26, 2013), available at 

http:l/ww_jy.sec.gov;'New'iL_~ech/Q~tail/Speech/13 7053984120_~-

13 Luis A. Aguilar, Commissioner, SEC, Remarks before the 20th Annual Securities Litigation and Regulatory 

Enforcement Seminar: A Stronger Enforcement Program to Enhance Investor Protection (Oct 25, 20!3), available 

at https://www .sec.gov/newsispeech/20 13-spch 1 02513laa. 14 The penalty amount was $LI67 billion in 2013, $!.378 billion in 2014, $LI75 billion in 2015, $1.273 billion in 

2016, and $832 million in 2017. See Select SEC and Market Data Fiscal2013, available at 

=~~~::~::::~~~ Select SEC and Market Data Fiscal 2014, available at Select SEC and Market Data Fiscal 20/5, available at 

Select SEC and Market Data Fiscal 2016, available at 

hllll&' lwww.sec.gov/files/20 l7-031secstats20 1_fu22_f; and SEC Division of Enforcement Annual Report: A Look 

Back at Fiscal Year 2017, available at )illp_§:f/www~"'.£1'0V/files/enforcement-annual-repQ!t-2017.pQf. 15 See Select SEC and Market Data Fiscal 2016, available at bttps:/iwww.scc.gov/filesi20 l7-03isecstats20l.Q,_p_Qf; 

and SEC Division of Enforcement Annual Report: A Look Back at Fiscal Year 2017, available at 

lillPs :/ lwww.sec. govifiles-'enlorcement -annual-report-20 17 Jl91-

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disgorged and the wrongdoing. 16 The remedy of disgorgement is used often in insider trading 

cases to recover the profits made by trading on material, nonpublic information. The remedy 

also is applied in areas where investors have been defrauded by fraudulent investment scams. 

In other areas, however, the remedy of disgorgement has become untethered from the underlying 

offense, which creates unpredictability and the potential for harm to shareholders. For example, 

in cases involving payments to foreign government officials, disgorgement has been applied as a 

remedy for violating the books and records and internal controls provisions of the Securities 

Exchange Act of 1934. 17 But in cases in which the SEC has not charged any violation of the 

FCPA's anti-bribery provisions, the connection between the incorrect recording of a payment to 

a foreign official and any ill-gotten gain resulting from that payment is tenuous. 18 lt is the bribe, 

not the misreeording of it, which caused the ill-gotten gain; so a violation of the recording 

provision should not provide a sufficient causal link for disgorgement. This tenuous approach 

and the imprecise "reasonable approximation" standard for determining the amount of 

disgorgement19 creates the potential that a disgorgement sanction will not be commensurate with 

the amount of ill-gotten gains. Unfortunately, the SEC's approach to disgorgement often goes 

unchallenged and unreviewed by a court. As a result, the standard for obtaining disgorgement is 

Jess predictable. 

This lack of transparency and predictability with respect to monetary penalties and disgorgement 

is contrary to the SEC's mission to maintain fair, orderly, and efficient markets and to facilitate 

capital formation. In July 1934, Joseph P. Kennedy, the first chairman of the SEC, stated there 

would be no concealed punishment for businesses subject to the SEC's jurisdiction.20 In that 

spirit of transparency, the SEC should provide clear, principled guidance regarding when it will 

seek a penalty or disgorgement and how it will calculate the amount. 

EXTENDING THE STATUTE OF LIMITATIONS FOR DISGORGEMENT AND 

PENALTIES 

One area of the securities laws in which there has been a welcome clarification is the statute of 

limitations applicable to cases in which the SEC seeks disgorgement and penalties. The 

Supreme Court's recent unanimous decision in Kokesh v. SEC held that the Commission's 

16 See SEC v. First City Financial Cmp., Ltd., 890 F.2d 1215, !231 (D.C. Cir. 1989) ("Since disgorgemcnt primarily 

serves to prevent unjust enrichment, the court may exercise its equitable power only over property causally related 

to the wrongdoing."). 17 See 15 U.S.C. § 78m(b)(2)(A)-(B) (requiring public companies to make and keep accurate books, records, and 

accounts and to devise and maintain internal accounting controls). 18 See also In re Rockwell Automation Inc., Admin. Proc. No. 3-14364 (May 3, 2011) (imposing $1.7 million in 

disgorgement in an FCPA case); SECv. Chevron Cmp., No. 07-cv-10299 (S.D.N.Y. Nov. 20, 2007) (imposing $25 

million in disgorgement in an FCPA case); SEC v. Textron, No. 07-cv-1505 (D.D.C. Aug. 31, 2007) (imposing $2.3 

million in disgorgement in an FCP A case). 19 See SEC v. First City Financial Corp., Ltd., 890 F.2d 1215, 1231 (D.C. Cir. 1989) ("disgorgement need only be a 

reasonable approximation of profits causally connected to the violation."). 20 Joseph P. Kennedy, Chairman, SEC, Remarks before the National Press Club (Jnly 15, 1934) at 3, available at 

https:/ /www.sec. uov/ ne\vs/speech/ 19 3410725 34 kennedy. pdf. 

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disgorgement remedy constitutes a "penalty" and is therefore subject to the five-year statute of 

limitations in 28 U.S.C. § 2462?1 

I understand that in the wake of Kokesh there has been discussion about extending the statute of 

limitations for disgorgement and penalties. Title 28 U.S.C. § 2462 sets a five-year limitations 

period for the SEC in seeking any civil fine, penalty, or forfeiture. It states: 

Except as otherwise provided by Act of Congress, an action, suit or proceeding 

for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or 

otherwise, shall not be entertained unless commenced within five years from the 

date when the claim first accrued it; within the same period, the offender or the 

property is found within the United States in order that proper service may be 

made thereon.22 

Although I believe it is critical for the SEC to pursue those who commit fraud, I am concerned 

that the costs of extending the applicable statute of limitations may greatly outweigh the benefits. 

Statutes oflimitations and statutes of repose serve a vital societal interest in providing stability 

and certainty, and preventing the litigation of stale claims. 23 Five years is the longest period of 

limitations or repose found in any of the federal securities laws. Extending the Section 2462 

statute oflimitations beyond that would create uncertainty for the investing pub lie because of the 

possibility of the SEC prosecuting stale claims. lt also could open the door for inefficiencies in 

the way the SEC investigates cases if more time is allotted to bring actions. SEC investigations 

already are time and resource consuming affairs. In FY2016, the SEC planned to bring 65% of 

enforcement actions within the first two years of opening an investigation?4 It achieved a 53% 

rate.25 In FY2017, the SEC also targeted 65%. It achieved a 52% rate26 The SEC is targeting 

65% again in 201827 Investigations are costly on those responding. A July 2015 Chamber of 

Commerce report cited a survey indicating that the average costs for responding to a formal 

21 See Kokesh v. SEC, 137 S. Ct. 1635 (2017). Previously, in 2013, the Supreme Court held in Gabelli v. SEC that 

civil penalties sought by the SEC also are subject to a five-year statute of limitations under Section 2462. See 568 

U.S. 442 (2013). 22 See 28 U.S.C. § 2462. 23 Kokesh, 137 S. Ct. at 1641 ("Statutes of limitations 'se[t] a fixed date when exposure to the specified Government 

enforcement efforts en(d].' ... Such limits are '"vital to the welfare of society"' and rest on the principle that '"even 

wrongdoers are entitled to assume that their sins may be forgotten."') (citation omitted); see also Artis v. District of 

Columbia, 138 S. Ct. 594,607-08 (2018) ("We do not gainsay that statutes oflimitations are 'fundamental to a wellordered judicial system."'); Gabelli, 568 U.S. at 448 ("the basic policies of all limitations provisions [are] repose, 

elimination of stale claims, and certsinty about a plaintiffs opportunity for recovery and a defendant's potential 

liabilities") (citation omitted). 24 See Securities and Exchange Commission Fiscal Year 2018 Congressional Budget Justification Annual 

Performance Plan and Fiscal Year 2016 Annual Performance Report at 35 (May 23, 2017), available at 

!ill!1s:i/www.sec.gov/reports-and-publications/budget-reports/secfyl8cm)g_b.]!Qglli;;!. 

25 See id. 26 See Securities and Exchange Commission Fiscal Year 2019 Congressional Budget Justification Annual 

Performance Plan and Fiscal Year 2017 Annual Performance Report at 109 (Feb. 12, 20 18), available at 

https://v·.'Ww.sec.goy/reports-and-pubhcatjons/budgct-reports/secfy\.2.£.9llgbudgjust. 

27 Seeid. 

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investigation surpassed $1 million for 70% of the formal investigations surveyed; and they 

surpassed $20 million for 1 0% of those investigations28 

In my two decades of experience as a defense lawyer, an SEC enforcement investigation into 

potential securities law violations by a public company-even an investigation that ultimately 

does not find any violations oflaw--can take several years, distract management, and cost the 

company tens of millions of dollars. The cost of that investigation is borne directly by the 

shareholders of the company. Of particular concern are SEC enforcement investigations that 

begin after a news story about a high-profile company, prompting the Enforcement Staff to 

pursue one theory of liability, but then morph into open-ended investigations that wander into 

other areas of a company in search of a potential violation. This is particularly disconcerting 

when it comes to new companies, start-ups, and technology companies that oftentimes find that 

scrutiny in the press translates into scrutiny by the Enforcement Staff. SEC investigations can 

impede entrepreneurship and innovation. I understand the current leadership of the SEC is 

cognizant of these concerns and has been working to address them. Policies and procedures in 

this area could be improved.29 

Extending the statute of! imitations also could interfere with the SEC's ability to facilitate capital 

formation. As H.R. 5037 states in its findings, there is declining interest in the United States 

public market. Extending the statute of limitations would increase the regulatory risk and 

operating costs of accessing the United States' capital markets and could further chill interest in 

America's capital markets. 

In considering any proposed legislation to extend the applicable statute oflimitations, it would 

be helpful for the SEC to explain to this Committee and to the public what, if any, cases the SEC 

has failed to bring as a result of being time barred. As a practical matter, and speaking from 

experience, the SEC has the ability to seek a tolling agreement from a person or entity under 

investigation, thereby stopping the running of the limitations period. It may be that few cases, if 

any, are missed hy the SEC as a result. 

28 See U.S. Chamber of Commerce Center for Capital Markets Competitiveness, £xamining U.S. Securities and 

Exchange Commission Enforcement: Recommendations on Current Processes and Practices at 40 (July 2015), 

available at https:/ /www .ccn~~rforcapi1~l..!D_?rkets.com/wpcon!~tluploads/2015/071021882 SEC Reform F!Nl.pdf. 29 Relatedly, the SEC should remove the names of Enforcement Staff from SEC press releases announcing 

enforcement actions. Currently, these releases identify the individual attorneys who supervised, led, and assisted in 

the investigation. This individual recognition can incentivize the Enforcement Staff to pursue headline-grabbing 

enforcement actions and sanctions, such as a record penalty amount. Former Enforcement Staff members often tout 

these high-profile actions on their Jaw firm profiles after they leave government service. The incentive to seek 

recognition for bringing a high-profile enforcement action can cloud the Staff's focus when determining, for 

example, whether to commence an investigation against a high-profile company or individual, the scope of such an 

investigation, the appropriate time to close such an investigation, and the size of the penalty to be imposed if a 

securities law violation has occurred. The mission of the SEC would be better served by removing individual 

incentives to seek public recognition. 

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RESTORING CREDIBILITY TO ADMINISTRATIVE PROCEEDINGS 

The SEC's administrative proceedings also have garnered a significant amow1t of recent 

attention. The SEC has the authority to pursue enforcement actions in administrative 

proceedings over which an administrative law judge appointed by the SEC presides. Until the 

Dodd-Frank Act, only registered individuals and entities such as broker-dealers and investment 

advisers were subject to enforcement actions in administrative proceedings. By registering with 

the SEC, these entities effectively agreed to be subject to the SEC's administrative enforcement 

jurisdiction in a manner analogous to an attorney who agrees to be subject to the rules of the bar 

of the state where he or she is licensed to practice. 

Through the Remedies Act of 1990, Congress authorized the SEC to impose monetary penalties 

on regulated entities in administrative proceedings. It also authorized the SEC to pursue 

remedial relief such as "cease-and-desist" and disgorgement orders against non-regulated 

entities, but it did not authorize the SEC to seek monetary penalties against issuers and nonregulated persons in administrative proceedings. The concern among members of Congress and 

internally at the SEC was that if the same remedies against issuers were available to the SEC 

under both judicial and administrative proceedings, then the SEC might be perceived to have an 

incentive to conduct more enforcement actions through its own administrative proceedings, 

rather than before a federal district courtjudge. 30 The Dodd-Frank Act of2010 removed this 

important distinction by authorizing the SEC to impose monetary penalties against issuers in 

administrative proceedings and authorized the SEC to bring actions against non-regulated 

persons and entities. 

Since the enactment of Dodd-Frank, several respondents have challenged the constitutionality of 

the SEC's administrative proceedings by filing lawsuits in federal district court arguing that the 

SEC's administrative proceedings process is unconstitutional.31 Others argue that administrative 

proceedings threaten to deprive them of liberty and property without due process, and that the 

SEC had unfairly singled them out in administrative proceedings in violation of the equal 

protection clause. To date, most courts have rejected these arguments. Nevertheless, some 

market participants continue to believe that administrative proceedings are unfair because 

respondents in administrative proceedings do not enjoy all of the procedural safeguards that arc 

afforded to defendants in federal district court, particularly with respect to depositions, document 

discovery, rules of evidence, and the ability to confront accusers. 

This perceived unfairness may be due to the fact that the SEC appears to have won more 

frequently in administrative proceedings than in district court. In 2015, The Wall Street Journal 

reported that from October 2010 through March 2015, the SEC won 90% of its administrative 

proceedings, while in the same period the SEC prevailed in only 69% of the cases it brought in 

30 PaulS. Atkins & Bradley J. Bondi, Evaluating the Mission: A Critical Review of the History and Evolution of the 

SEC Enforcement Program, !3 FORDHA;\1 J. CORP. & FIN. L. at 393-94. 31 The issue of whether admiuistrative law judges of the SEC are officers of the United States within the meaning of 

the appointments clause of the Constitution is presently before the Supreme Court. See Lucia v. SEC, Docket No. 

17-130 (argued April23, 2018). 

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federal district court.32 Furthermore, a 2016 study suggested that, after Dodd-Frank, the SEC has 

shifted weaker cases from district court to administrative proceedings or has brought actions as 

administrative proceedings that it would not have brought at all before Dodd-Frank.33 

In July 2016, the SEC adopted amendments updating its rules of practice governing 

administrative proceedings.34 Most importantly, the amended rules extend the length of the 

prehearing period to allow respondents more time to prepare for administrative hearings; allow 

for depositions in complex cases (not just when witnesses are unavailable to testify at the 

hearing); and permit the exclusion of"unreliable" evidence. Although the amendments provide 

some new safeguards to respondents, they fall short of the procedural safeguards afforded to 

defendants in federal district court. And, above all, they do not establish criteria for determining 

when the SEC will bring a case in an administrative proceeding rather than in federal court. 

A recent report suggests that the SEC might be moving away from its reliance on administrative 

proceedings. According to a May 2018 report by the NYU Pollack Center for Law & Business 

and Cornerstone Research, in the first half of 2018, the percentage of new enforcement actions 

against public companies that were brought as administrative proceedings declined to 80%, 

which was down from 94% for the second halfof2017.35 According to the report, this is the 

lowest percentage since the first half of2014. 36 I commend the Commission for this encouraging 

trend. 

I have been asked to comment on H.R. 2128, The "Due Process Restoration Act of2017." H.R. 

2128 would allow respondents in an administrative proceeding to remove the proceeding to 

federal district court and thereby avail themselves of the procedural safeguards of federal court, 

namely the robust federal discovery system, pre-trial motions, and trial before a jury. It also 

would raise the standard of proof in an administrative proceeding from "preponderance of the 

evidence" to a higher "clear and convincing." In other words, the burden of proof for the SEC 

would be higher in an administrative proceeding than in federal court. 

32 Jean Eag1esham, SEC Wins Wi1h In-House Judges, Wall St. J. (May 6, 2015), available at 

http:/ /wvv·w. \VSj .com/ articles/sec-wins-with-in-hou~c- j ud~cs- 14 30965R03. 33 Adam C. Pritchard & Stephen Choi, The SEC's Shift to Administrative Proceedings: An Empirical Assessment 

(2016), Law & Economics Working Papers, Paper 119, available at 

_!lttp:i/repository.law.umich.cdulcgi/viev,:content.cgi?articl?=l::.;.ll~.cot~"5-J.::.hl\L~~911 current. 34 See Press Release, SEC, SEC Adopts Amendments to Rules ofPracticefor Administrative Proceedings (July 13, 

20 16), Release No. 2016-142, available at https://\V·ww.sec.gov/news.'pressreleasei2Q 16-142.html; see also Bradley 

J. Bondi eta/., SEC Adopts Amendments to Rules of Practice for Administrative Proceedings, Cahill Gordon & 

Reindel LLP (July 15, 2016), .\lttps://www.cahill.conipublicatiQ!ls'finnmemoranda/ 10130405/ res/id-=Attachments/index--0/CGR ?c'020Memo%20~ 

%20SEC%,20AdoptsfJ·o20A.mendments?-'020to%20Rules~Yo20ot~,020Practice?/020f0l~lo20AdmJnistrative%20Proceedin 

g;;,_pJ.!.f. 

35 See SEC Enforcement Actions against Public Companies Continue Sharp Decline, NYU Pollack Center for Law 

& Business and Cornerstone Research (May 15, 2018), available at ~i/www.stem.nvu.edu!experiencesteminews-events/sec-enforcemcnt-actions-against-public-companies-continue-sham-decline. 

1

" See id. at 2. 

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While I believe that reform of the administrative process is warranted, and H.R. 2128 is one 

attempt, the bill may go too far and have the effect of causing the SEC to initiate all enforcement 

actions in federal district court. Yet, not all enforcement actions require the formality of federal 

district court. Some cases, such as those involving disciplinary actions against registered 

investment professionals and so-called "follow-on" actions following a criminal prosecution, 

could be adequately brought as administrative proceedings, thereby avoiding adding to the 

already crowded federal docket. 

An alternative to consider is a return to the pre-Dodd-Frank jurisdiction of administrative 

proceedings (that is, to limit administrative proceedings to only those against registered 

individuals and entities such as broker-dealers and investment advisers); to provide additional 

due process safeguards such as the ability of respondents to take depositions and to make pretrial motions; and/or to limit administrative proceedings to disputes below a certain dollar 

amount. 

IMPOSITION OF FEDERAL JURISDICTION OVER CIVIL SECURITIES FRAUD 

ACTIONS 

I also have been asked to comment on H.R. 5037 entitled, "Securities Fraud Act of2018." H.R. 

5037 would provide the federal government with exclusive authority to prosecute civil securities 

fraud by preempting all state enforcement of civil securities fraud involving an issuer listed on a 

national securities exchange. H.R. 5037 also would require any criminal proceedings for 

securities fraud that are brought by the states to comply with the same legal requirements for 

bringing such claims under federal law. 

From my experience, I generally agree with H.R. 5037's observation that "[i]mposing differing 

State regulatory requirements for civil securities fraud on national markets increases risk, creates 

inefficiencies, raises costs, and can harm the efficient operation of these critical markets, without 

providing material investor protection benefits." 

At present, states may pursue civil enforcement of securities laws against public companies that 

are trading on national exchanges. That allows a single state to become a national securities 

regulator. There have been a few notable instances in which states have brought aggressive 

enforcement actions against public companies even where those companies already had settled 

with the SEC and paid substantial penalties. The inability of a public company to achieve 

certainty in a settlement with the SEC and the threat of another enforcement action by a state 

harms the investing shareholders who must bear the burden of any penalty. 

Fortunately, with only a few rare exceptions, the states have worked closely and cooperatively 

with one another and with the SEC to ensure the fair and just enforcement of securities laws, and 

I commend the North American Securities Administrators Association ("NASAA") and its 

President, Alabama Securities Commissioner Joe Borg, for their efforts to coordinate and 

develop a uniform set oflaws. 

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States serve an important role in the investigation and enforcement of securities laws. In 2016, 

the states conducted 4,341 investigations and brought 2,017 enforcement actions.37 In total, the 

states obtained $231 million in restitution for investors.38 Importantly, the vast majority of the 

matters investigated and brought by the states were not matters that also were being pursued by 

the SEC. 

While the underlying idea ofH.R. 5037 represents a thoughtful and encouraging effort toward 

achieving greater uniformity and predictability in the state and federal enforcement of securities 

laws, I have four primary concerns with the bill. First, the bill would prohibit state regulators 

from pursuing civil violations of law, no matter the size. At present, state regulators are often on 

the front line pursuing microcap fraud cases, much of which the SEC is not pursuing as a result 

of efforts by the states. Indeed, allowing state regulators to bring these localized enforcement 

actions conserves the SEC's resources and often serves as the most efficient avenue to pursue 

these cases. Second, the bill would place a tremendous burden on the SEC to pursue all actions 

involving publicly-traded companies that previously were pursued by the states. This would 

necessitate expanding the SEC's budget and resources. Third, the legislation might have the 

intended consequence of causing some state regulators to convert what otherwise might have 

been brought as a civil fraud case to a criminal case in order to avoid federal preemption. Fourth 

and finally, the legislation appears to preempt only actions against issuers, while presumably 

allowing states to pursue related matters against underwriters, officers, and directors. Any 

preemption should cover all related matters. 

As an alternative, the Committee may wish to consider preempting state law with a uniform 

federal standard for securities fraud, but to allow enforcement by both the states and the federal 

government with a "first in time" approach to avoid duplicate enforcement actions.39 A single 

federal standard would lower the uncertainty of having to deal with multiple state standards ru1d 

address the root concern with certain over-expansive state laws. If the Committee wishes to 

pursue the current legislation, it may wish to consider preempting only cases involving publiclytraded companies above a certain market capitalization amount to alleviate the potential 

overburdening of the SEC. 

CONCLUSION 

For the most part the SEC does an excellent job adhering to and fulfilling its mission. However, 

in furtherance of its mission to protect investors and facilitate capital formation, the SEC should 

adopt clear standards and be more transparent with respect to its approach to penalties, 

disgorgement, and administrative proceedings. 

Congress can help improve the SEC's enforcement program. The bills that I have commented on 

today represent encouraging and good faith efforts to do just that. But Congress should act 

37 See NASAA 2017 Enforcement Report, 

In developing a uniform standard, the drafters should be wary about creating any new causes of action. 

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cautiously and seek to strike an appropriate balance between administrative proceedings and 

federal court actions and between federal securities law enforcement and state securities law 

enforcement. H.R. 2128 helpfully seeks to address the important need for due process 

safeguards in SEC enforcement proceedings. But it potentially goes too far with respect to 

administrative proceedings and could result in overburdening the federal courts. H.R. 5037 

helpfully seeks to clarify the division of enforcement authority between the federal and state 

governments. But it potentially eliminates useful functions of state securities enforcement 

regimes that are complementary to the SEC. I am hopeful that as Congress deliberates over 

these bills it will find the appropriate balance. 

Thank you. I would be pleased to answer any questions. 

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APPENDIX 1 
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CE~Tl'R FOR FI;-;ANCl.\L ST,\B1LlTY 

Improving the SEC's Enforcement Program: 

A Ten-Point Blueprint for Reform 

Bradley J. Bondi 

August 17, 2017 

With any new Presidential administration comes a new Commission at the Securities and 

Exchange Commission ("SEC") and an opportunity to evaluate the regulatory priorities. The 

Division of Enforcement is a key component of the SEC's regulatory program and has enormous 

influence on the behavior of investors and other market participants. Since its creation, the 

Division of Enforcement has grown in size and power as Congress has authorized the SEC to 

enforce additional laws and to seek additional remedies. At the same time, the SEC's 

enforcement practices have shifted in response to various factors, including financial crises, 

significant financial frauds, and Congress's legislative priorities. 

With the transition to a new Commission, the SEC should take the opportunity to review, 

evaluate and improve its enforcement program. In light of the SEC's mission to protect 

investors; maintain fair, orderly, and efficient markets; and facilitate capital formation, the SEC 

should take steps to ensure it is allocating resources properly, striking an appropriate balance 

between regulation and enforcement, and protecting the rights of investors and industry 

participants. Below is a brief, ten-point summary of suggestions for improving the SEC's 

enforcement program. 

1. Establish Clear Enforcement Priorities Focused on Intentional Violations by Individuals 

Who Commit Significant Frauds and Refer Criminal Matters to Criminal Agencies 

The SEC should prioritize seeking out and penalizing those individuals, such as Bernie Mad off 

and Allen Stanford, who commit intentional wrongdoing through schemes designed to defraud 

investors. The "broken windows" approach, promoted by then-SEC Chair Mary Jo White, 

disproportionately emphasizes small and sometimes unintentional securities law violations in 

the hope that doing so will deter more significant violations. But a practical consequence of 

this is the disproportionate expenditure of the SEC's limited resources on small and 

unintentional violations, often against well-intentioned executives and chief compliance 

officers for negligence-based violations or honest mistakes. As a result, more significant and 

intentional violations, such as Ponzi schemes, boiler rooms, and bucket shops, may go 

undetected, unpunished, and undeterred. 

The SEC should coordinate more closely with other federal and state agencies, including the 

Department of Justice ("DOJ") and State Attorneys General, to pursue and bring to justice Ponzi 

schemers and other fraudulent schemers. In the past, competition between the SEC and DOJ 

has prevented the most severe charges from being levied against individuals as the SEC Staff 

has been reluctant to "lose" a case to the DOJ by involving the DOJ in the investigation. Under 
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an improved system, the SEC would consult the DOJ and the relevant State Attorney General 

during the SEC's investigation and not hesitate to refer matters where federal or state criminal 

charges clearly are warranted. 

2. Reconsider the "Broken Windows" Policy 

The SEC should reconsider its broad application of the broken windows policy for enforcing the 

securities laws. The broken windows approach, which is rooted in criminal law, is based on the 

idea that law enforcement's refusal to tolerate minor violations of the law will aid in preventing 

major violations of the law. While the broken windows philosophy may have worked well for 

law enforcement concerned with public safety, it is not an appropriate approach to securities 

regulation. Petty street crime and major crime share a common element: criminal intent. In 

contrast, not everyone who violates the securities laws intends to do so. For example, an 

investment adviser who pores over the lengthy, detailed, and complicated regulations 

applicable to her industry may, despite her best efforts, inadvertently violate a rule. That is 

much different than the state of mind of a Ponzi schemer who intentionally defrauds individuals 

out of their life savings. Yet a broken windows approach suggests taking a hard line to 

enforcement in each case and ignores the mental state of the alleged violator. The SEC should 

consider abandoning this policy as it applies to unintentional violations of securities law and 

instead focus its resources on identifying and punishing intentional misconduct while providing 

useful regulatory guidance to those in the industry who are earnestly trying to comply with the 

law. 

3. Place less Emphasis on Enforcement Statistics and Penalty Amounts 

The SEC should develop and use better metrics for measuring success. last October, at the end 

of its 2016 fiscal year, the SEC issued a press release announcing that the 868 enforcement 

actions it filed in 2016 were a "new single year high.''1 It also announced that it had obtained 

approximately $4 billion in disgorgement and penalties. This was the third year in a row that 

the SEC announced a record number of enforcement actions2 

The number of enforcement actions and the amount of disgorgement and penalties 

purportedly demonstrate the success of the SEC's enforcement program. But if the aim of the 

program is to protect investors and deter wrongdoing, then the high numbers of enforcement 

actions and penalties are, at best, a poor way to measure that protection and deterrence. At 

1 See Press Release, SEC, SEC Announces Enforcement Results for FY 2016 {Oct. 11, 2016), Release No. 2016-212, 

available at https:/!www.sec.gov/news/pressrelease/2016-212.html. 2 See Press Release, SEC, SEC's FY 2014 Enforcement Actions Span Securities Industry ond Include First-Ever Cases 

(Oct. 16, 2014), Release No. 2014-230, available at https://www.sec.gov/news/press-release/2014-230 ("In the 

fiscal year that ended in September, the SEC filed a record 75S enforcement actions .... "); Press Release, SEC, SEC 

Announces Enforcement Results for FY 2015 {Oct. 22, 201S), Release No. 2015-245, available at 

ht\~:Uwww.sec.gov/newe~srelease/2015-:Z45.html {"In the fiscal year that ended in September, the SEC filed 

807 enforcement actions .... "). 

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worst, record numbers are an indication that securities law violations are increasing in number 

and severity. After all, few would consider a local police force successful in deterring crime if it 

announced record numbers of arrests year after year. In addition, the SEC's focus on achieving 

record numbers could have the practical effect of disproportionately allocating scarce resources 

to pursuing a large volume of minor or unintentional violations involving large companies (and 

thus leading to large penalty figures) at the expense of pursuing fewer but more complicated 

cases involving intentional wrongdoing such as Ponzi schemes, boiler rooms, and bucket shops, 

which have a disproportionately negative impact on retail investors. A focus on enforcement 

statistics also may lead the SEC to develop and pursue theories of liability that exceed the 

bounds of the SEC's congressionally-authorized enforcement power-' 

The SEC's past emphasis on obtaining large penalties against corporations, coupled with press 

releases that identify its Enforcement Staff attorneys by name, 4 creates incentives that may be 

misaligned with the core mission of the SEC of protecting investors, namely the innocent 

shareholders who must bear the cost of a corporate monetary penalty. 

4. Update the Benefits for Assisting the SEC as Articulated in the Seaboard Report 

Since 2001, the SEC has had a written policy, often known as the Seaboard Report5

, for 

determining whether, and how much, to credit self-policing, self-reporting, remediation, and 

cooperation. When it issued the Seaboard Report, the SEC stated that such credit could range 

from the extraordinary step of taking no enforcement action to bringing reduced charges, 

seeking lighter sanctions, or including mitigating language in documents used to announce and 

resolve enforcement actions. 

3 This so-called "regulation by enforcement" is contrary to the SEC's rulemaking authority and violates 

fundamental principles of due process that require regulatory agencies to prowide a notice and comment period 

for new or modified rules. See Bradley J. Bondi, Dangerous Liaisons: Collective Scienter in SEC Enforcement Actions, 

6 N.Y.U. J. Law & Bus. 1, 16 n.64 (2009) (quoting then-Commissioner Paul Atkins, who said, "[i]f we are to enforce 

the rule of law, we must follow the rule of law in our approach"); see also Theodore W. Urban, SEC Administrative 

Proceeding File No. 3-13655, Initial Decision Release No. 402 (September 8, 2010), dismissed by Exchange Act 

Release No. 66359 (January 26, 2012). 

4 Similarly, the SEC should remove the names of Enforcement Staff from SEC releases. The University of Southern 

California famously does not put players' names on the back of its football jerseys. The purported reason is to 

emphasize the achievement of the team and not any individual player. The SEC should take a similar approach to 

its releases announcing enforcement actions. Currently, these releases identify the individual attorneys who 

supervised, led, and assisted in the investigation. This individual recognition can incentivize the Staff to pursue 

headline-grabbing enforcement actions and sanctions, such as a record penalty amount. Former Enforcement 

Staff members often tout these high-profile actions on their law firm profiles after they leave government service. 

The incentive to seek recognition for bringing a high-profile enforcement action can cloud the Staff's focus when 

determining, for example, whether to commence an investigation against a high-profile company or individual, the 

scope of such an investigation, the appropriate time to close such an investigation, and the size of the penalty to 

be imposed if a securities law violation has occurred. The mission of the SEC would be better served by removing 

individual incentives to seek public recognition. 5 Report of Investigation Pursuant to Section 21(a) of the Securities Exchange Act of 1934 and Commission 

Statement on the Relationship of Cooperation to Agency Enforcement Decisions, Exchange Act Rei. No, 44969 (Oct. 

23, 2001), available ot https://www.sec.gov/litigation/investreport/34-44969.htm. 

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For the SEC, the policy helps uncover and prevent activity harmful to investors that might 

otherwise go unreported. But companies likely will come forward only to the extent the 

cooperation policy provides predictable benefits for alerting the SEC to concerns. Some 

commentators have observed that, under the Seaboard framework, companies and their 

counsel are unable to assess the implication of self-reporting, which has resulted in a hesitation 

to take steps that ultimately would benefit the SEC and investors. Others have observed that 

the "carrots," which the SEC established to encourage cooperation and conserve government 

and shareholder resources, have become smaller or less certain while the "stick" for failing to 

cooperate has gotten larger. 

The SEC should revisit and update the Seaboard Report to clarify (1) the benefits available for 

companies that self-police, self-report, cooperate with the SEC, and remediate misconduct and 

(2) how companies can qualify to receive these benefits, leading to improved investor 

protection. 

5. Evaluate and Clearly Articulate the Reasons for Imposing a Monetary Penalty on 

Shareholders 

In 1990, Congress passed the Remedies Act, which enabled the SEC to seek monetary penalties. 

At the time, the Senate Committee on Banking, Housing, and Urban Affairs cautioned that the 

costs of monetary penalties might be passed on to shareholders, and the Committee expected 

that the SEC would seek a monetary penalty only when the securities law violation had resulted 

in an improper benefit to shareholders. 6 In cases in which shareholders are the principal 

victims of the violations, the Committee expected that the SEC, when appropriate, would seek 

penalties from the individual offenders acting for a corporate issuer. 

From 1990 to 2002, the SEC imposed penalties sparingly. The SEC's April 2002 case against 

Xerox Corporation marked a shift to seeking penalties more frequently and in higher amounts. 

The $10 million penalty imposed on Xerox for financial fraud was an unprecedented amount at 

the time and about three times larger than the previous record amount for a similar case. 7 

Since the Xerox case, the SEC has levied many civil penalties of $10 million or larger. In 2003, 

the year after the Xerox case, the total amount of monetary penalties (excluding disgorgement) 

imposed by the SEC on companies increased to approximately $1.1 billion from approximately 

$101 million in the prior year. 8 

6 S. Rep. No. 101-337, at 17 (1990). 

7 See Press Release, SEC, Xerox Settles SEC Enforcement Action Charging Company With Fraud (Apr. 11, 2002), 

Release No. 2002-52, available at https://www.sec.gov/news/headlines/xeroxsettles.htm; see also James Bandler 

and Mark Maremont, Xerox Will Pay $10 Million Penalty to Settle SEC Accounting Charges, Wall St. J. (Apr. 2, 2002), 

available at https:f/www.wsi.com/articles/SB1017682255642049000. 

8 See SEC 2002 Annual Report, at 1 (Jan. 1, 2002,) available at https:ljwww.sec.gov/pdf/annrep02/ar02full.pdf 

("Civil penalties ordered in SEC proceedings totaled approximately $101 million."); SEC 2003 Annual Report, at 15 

(Jan. 1, 2003), available at https://www.sec.gov/pdf/annrep03/ar03full.pdf {"Obtained orders in SEC judicial and 

administrative proceedings requiring securities violators ... to pay penalties of approximately $1.1 billion."). 

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CFNTFR FOR FI~,\NCl,\L ST,\BILlTY 

The total annual penalties in fiscal years 2004 and 2005 were approximately $1.2 billion and 

$1.5 billion, respectively.9 Then, in January 2006, a unanimous Commission issued the 

Statement of the Securities and Exchange Commission Concerning Financial Penalties, often 

known simply as the SEC's "Penalty Statement."10 The purpose of the Penalty Statement was to 

provide the maximum possible degree of clarity, consistency, and predictability in explaining 

how the SEC exercises its corporate penalty authority. In the Penalty Statement, the SEC 

identified two principal considerations for determining whether a monetary penalty against a 

company is appropriate: (1) the presence or absence of a direct benefit to the company as a 

result of the securities law violation and (2) the degree to which the penalty will recompense or 

further harm the injured shareholders. After the Penalty Statement, annual monetary penalty 

amounts dropped significantly. In 2008, for example, the SEC imposed approximately $256 

million in monetary penalties11 

In recent years, some commissioners have disavowed the Penalty Statement. In September 

2013, then-Chair Mary Jo White observed that the Penalty Statement is non-binding and, while 

recognizing that it sets forth useful considerations, stated that each commissioner has 

discretion within his or her statutory authority to reach a conclusion on whether a penalty is 

appropriate and how high it should be. 12 A few weeks later, then-Commissioner Luis Aguilar 

agreed with Chair White's assessment and stated that the Penalty Statement "constituted a 

fatally flawed approach to assessing the appropriateness of corporate penalties" because it 

focused on whether the company had benefited from the misconduct and shareholder harm 

instead of punishing misconduct and deterring future violations. 13 Since 2013, the average 

annual amount of monetary penalties (excluding disgorgement) imposed has been 

approximately $1.25 billion. 14 The disavowal of the Penalty Statement creates unpredictability 

regarding the criteria the SEC considers when determining whether to impose a penalty. For an 

agency that demands from companies that their disclosures be transparent, the SEC historically 

has offered little transparency of its own. 

'See United States Securities and Exchange Commission 2004 Enforcement and Market Data, available at 

hllils://www.sec.gov/files/secpar04stats%2CO.pdf; Select SEC and Market Data Fiscal2005, available at 

https://www.sec.gov/files/secstats2005%2CO.pdf. 

10 See Press Release, SEC, Statement of the Securities and Exchange Commission Concerning Financial Penalties 

(Jan. 4, 2006), Release No. 2006-4, available at https://www.sec.gov/news/press/2006-4.htm. 11 See Select SEC and Market Data Fisca12008, available at https://www.sec.gov/files/secstats2008.pdf. 12 Mary Jo White, Chair, SEC, Remarks before the Council of Institutional Investors Fall Conference: Deploying the 

Full Enforcement Arsenal (Sept. 26, 2013), available at 

http://www.sec.gov/News/SpeechfDetaii/Speech/1370539841202. 

13 Luis A. Aguilar, Commissioner, SEC, Remarks before the 20th Annual Securities Litigation and Regulatory 

Enforcement Seminar: A Stronger Enforcement Program to Enhance Investor Protection (Oct. 25, 2013), available 

at )illp~ww_sec.gov/news/speech/2013-spch1025131aa. 

14 The penalty amount was $1.167 billion in 2013,$1.378 billion in 2014, $1.175 billion in 2015, and $1.273 billion 

in 2016. See Select SEC and Market Data Fiscal2013, available at https:(/www.sec.gov/files/secstats2013.pdf; 

Select SEC and Market Data Fiscal2014, available at https://www.sec.gov/files/secstats2014.pdf; Select SEC and 

Market Data Fiscal2015, available at https:{(www.sec.gov/files/se~stats2015.pdf; and Select SEC and Market Data 

Fiscal2016, available at https://www.sec.gov/files/2017-03/secstats2016.pdf. 
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The amount of the monetary penalty is also unpredictable because the SEC in recent years has 

not articulated criteria or metrics for calculating how much it will penalize a company. This 

unpredictability negatively impacts companies. For example, the inability to predict the size of 

a potential penalty hinders the market for mergers and acquisitions because successor 

companies cannot accurately forecast their regulatory exposure. 

This lack of transparency and predictability with respect to monetary penalties is contrary to 

the SEC's mission to maintain fair, orderly, and efficient markets and facilitate capital 

formation. In July 1934, Joseph P. Kennedy, the first chairman of the SEC, stated there would 

be no concealed punishment for businesses subject to the SEC's jurisdiction. 15 In that spirit of 

transparency, the SEC should provide clear, principled guidance regarding when it will seek a 

penalty and how it will calculate the amount. 

6. Restore Credibility to Administrative Proceedings 

The SEC has the authority to pursue enforcement actions in administrative proceedings over 

which an administrative law judge appointed by the SEC presides. Historically, only registered 

individuals and entities such as broker-dealers and investment advisers were subject to 

enforcement actions in administrative proceedings. By registering with the SEC, these entities 

effectively agreed to be subject to the SEC's administrative enforcement jurisdiction in a 

manner analogous to an attorney who agrees to be subject to the rules of the bar of the state 

where he or she is licensed to practice. 

In 1990, the Remedies Act authorized the SEC to impose monetary penalties on regulated 

entities in administrative proceedings. It also authorized the SEC to pursue remedial relief such 

as "cease-and-desist" and disgorgement orders against non-regulated entities, but it did not 

authorize the SEC to seek monetary penalties against issuers in administrative proceedings. 

The concern among members of Congress and internally at the SEC was that if the same 

remedies against issuers were available to the SEC under both judicial and administrative 

proceedings, then the SEC might be perceived to have an incentive to conduct more 

enforcement actions through its own administrative proceedings, rather than before a federal 

district court judge.16 The Dodd-Frank Act of 2010 removed this important distinction by 

authorizing the SEC to impose monetary penalties against issuers in administrative proceedings. 

In recent years, several respondents have challenged the constitutionality of the SEC's 

administrative proceedings by filing lawsuits in federal district court arguing that administrative 

proceedings threaten to deprive them of liberty and property without due process and that the 

SEC had unfairly singled them out in administrative proceedings in violation of the equal 

protection clause. To date, most courts have rejected these arguments. Nevertheless, some 

15 Joseph P. Kennedy, Chairman, SEC, Remarks before the National Press Club (July 15, 1934) at 3, available at 

https://www.sec.gov/news/speech/1934/072534kennedy.pdf. 

16 Paul S. Atkins & Bradley J. Bondi, Evaluating the Mission: A Critical Review of the History and Evolution of the SEC 

Enforcement Program, 13 Fordham J. Corp. & Fin. L. at 393-94. 

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market participants continue to believe that administrative proceedings are unfair because 

respondents in administrative proceedings do not enjoy all of the procedural safeguards that 

are afforded to defendants in federal district court, especially with respect to depositions, 

document discovery, rules of evidence, and the ability to confront accusers. 

This perceived unfairness may be due to the fact that the SEC wins more frequently in 

administrative proceedings than in district court. In 2015, The Wall Street Journal reported that 

from October 2010 through March 2015, the SEC won 90% of its administrative proceedings, 

while in the same period the SEC prevailed in only 69% of the cases it brought in federal district 

courtP Further, a 2016 study suggested that, after Dodd-Frank, the SEC has shifted weaker 

cases from district court to administrative proceedings or has brought actions as administrative 

proceedings that it would not have brought at all before Dodd-Frank. 18 

In July 2016, the SEC adopted amendments updating its rules of practice governing 

administrative proceedings. 19 Most importantly, the amended rules extend the length of the 

prehearing period to allow respondents more time to prepare for administrative hearings; 

allow for depositions in complex cases (not just when witnesses are unavailable to testify at the 

hearing); and permit the exclusion of "unreliable" evidence. While the amendments provide 

new safeguards to respondents, they fall short of the procedural safeguards afforded to 

defendants in federal district court. And they do not establish criteria for determining when 

the SEC will bring a case in an administrative proceeding rather than in federal court. 

The SEC could enhance the perception of fairness of its administrative proceedings by adopting 

additional procedural safeguards that more closely align the proceedings with those in federal 

district court and by clearly articulating the criteria it uses for determining whether to bring a 

case in an administrative proceeding instead of in federal district court. 

7. Establish an Advisory Committee To Evaluate the Enforcement Program 

In July 2008, then-Commissioner Paul Atkins and I called for an independent advisory 

committee to evaluate the SEC's enforcement program. 20 Such an advisory committee could be 

useful at this stage to the SEC. In the spirit of the Wells Committee convened by Chairman 

William Casey in 1972, the new advisory committee could conduct an independent review of 

the SEC's enforcement program and recommend any changes needed to modernize 

enforcement practices. The charge to this advisory committee should be; "What changes 

17 Jean Eaglesham, SEC Wins With In-House Judges, Wall St. J. (May 6, 2015), available at 

http://www.wsj.com/articles/sec-wins-with-in-house-judges-1430965803. 

18 Adam C. Pritchard & Stephen Choi, The SEC's Shift to Administrative Proceedings: An Empirical Assessment 

(2016), Law & Economics Working Papers, Paper 119, available at 

http:l/repository.law.umich.edu/cgi/viewcontent.cgi?article=1233&context=law econ current. 

19 See Press Release, SEC, SEC Adopts Amendments to Rules of Practice for Administrative Proceedings (July 13, 

2016), Release No. 2016-142, available ot https://www.sec.gov/news/pressrelease/2016-142.html. 20 PaulS. Atkins & Bradley J. Bondi, Needed: Independent Panel to Evaluate SEC Enforcement Program, Forbes (July 

7, 2008), available at https://www.forbes.com/2008/07 /05/atkins-bondi-sec-oped-cx pabb 0707atkins.html. 

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should be made to make the SEC's enforcement program more effective in its efforts to deter 

misconduct and to encourage compliance with federal securities laws, while keeping with the 

SEC's stated mission of protecting investors; maintaining fair, orderly, and efficient markets; 

and facilitating capital formation?" As the Wells Committee did, this advisory committee also 

could examine whether the SEC is taking appropriate steps to protect the rights of respondents 

and to provide appropriate due process. The advisory committee could be composed of a 

diverse cross-section of private-practice attorneys, former SEC officials, economists, and 

academicians each bringing to the table a unique perspective. 

8. Rescind the Delegation of Formal Order Authority 

Historically, the Commission approved formal orders of investigation after the Enforcement 

Staff prepared a memorandum for the Commission summarizing the facts known at the time 

and the possible securities law violations. The historical process had at least three important 

benefits.21 First, under the prior system, before seeking a formal order the Enforcement Staff 

often would engage in informal detective work. This frequently involved seeking information, 

on a voluntary basis, from the entity under investigation. This informal work sometimes 

provided the Enforcement Staff assurance that there had been no wrongdoing and allowed the 

Staff and the entity to forego a more elaborate and costly investigation. Second, under the 

prior system the Commission was involved in the early stages of enforcement cases, allowing it 

to provide guidance to the Enforcement Staff prior to the time that the Staff was authorized to 

compel testimony and issue wide-ranging document subpoenas. The Commission's approval of 

a formal order also provided an important check on the Enforcement Staff's investigative power 

and may have prevented questionable investigations. Third, under the prior system, the fact 

that the Enforcement Staff had opened an investigation was raised to the highest levels of the 

SEC, including to the Commission, senior officers in the Division of Enforcement, directors of 

the other divisions, as well as anyone who attended the closed Commission meeting where the 

matter was discussed. This allowed enhanced communication and expertise to be incorporated 

into the early decision-making and formulation of the investigative plan. 

In 2009, the Commission delegated authority to the Director of Enforcement to open formal 

orders of investigation and issue subpoenas. The Director then subdelegated this authority to 

Regional Directors, Associate Directors, and Specialized Unit Chiefs. This delegation reduced 

the Enforcement Staff's incentive to conduct informal, initial detective work, removed the 

beneficial early involvement of the Commission, and eliminated a critical opportunity for the 

Enforcement Staff to communicate and cooperate regarding investigations. 

In February 2017, the Commission rescinded the subdelegation of formal order authority. Now, 

requests for formal orders will be approved by the Director of Enforcement. The Commission 

should go one step further and rescind the delegation of formal order authority entirely, 

21 For additional information, see Bradley J. Bondi, A Questionable Delegation of Authority: Did the SEC Go Too Far 

When It Delegated Authority to the Division of Enforcement to Initiate an Investigation? Center for Financial 

Stability, (Sept. 20, 2016), available at http://www.centerforfinancialstability.org/research/Bondi 092016.pdf. 

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CENTER F 0 R F 1 N ;\ N C 1 .\ L ST.\ B l L l T Y 

thereby restoring the benefits associated with encouraging the Enforcement Staff to conduct 

investigations informally, involving the Commission early in the investigative process, and 

communicating and cooperating with other Enforcement Staff. 

9. Re-evaluate the SEC's Admissions Policy 

The SEC should re-evaluate how it determines whether to require a party to admit fault as a 

condition of settlement. Since the establishment of the Division of Enforcement in 1972, the 

SEC routinely has allowed parties to settle enforcement actions without admitting fault. 22 The 

neither-admit-nor-deny concept grew out of the practical reality that the Enforcement Staff 

would be more likely to obtain a settlement and thus conserve SEC resources if the Staff did not 

insist on an admission of wrongdoing, which can have damaging collateral consequences. 

In 2013, the SEC modified this practice by announcing that it would seek more admissions of 

wrongdoing from individuals and entities as a condition of settling enforcement cases. And the 

Director of Enforcement at the time stated that the SEC would not consider the collateral 

consequences to an individual or entity when determining whether to seek an admission. This 

policy created four primary concerns. First, it marked a fundamental shift in emphasis from 

protecting investors to attempting to punish wrongdoers, which may be at odds with the SEC's 

goals of protecting investors and facilitating capital formation. An admission of wrongdoing 

may result in additional harm to shareholders by exposing a company to costly shareholder 

litigation or depriving it of the ability to obtain government contracts. Second, the admissions 

policy lacks clear guidance and fails to consider the collateral consequences to the shareholders 

of the alleged wrongdoer company. This makes the admissions policy susceptible to subjective 

application without considering the individualized conduct of the responding party. Third, the 

admissions policy is susceptible to being used directly or indirectly as a negotiating tool by 

which the SEC may seek a higher penalty in exchange for not seeking an admission. For 

example, the Enforcement Staff may make overtures that, if a party were to agree to a higher 

penalty, the Staff would not push for an admission of wrongdoing. Fourth, pursuing admissions 

of wrongdoing consumes valuable SEC time and resources. · 

One suggestion that would allow the policy to remain intact while taking into consideration the 

above observations would be to remove any discretion from the investigative staff and place 

that discretion into the hands of the trial unit to evaluate whether the evidence is so strong 

that it would risk taking the matter to trial. Another possible solution would be for the 

Enforcement Staff to obtain from the Commission at the start of settlement negotiations a 

determination regarding whether the Commission would insist on an admission of wrongdoing. 

That course would enable the parties to negotiate under the same understanding of whether 

an admission is, in fact, likely to be sought. 

"For additional information, see Bradley J. Bondi, An Evaluation of the SEC's Admissions Policy, Center for 

Financial Stability (July 7, 2016), availoble at 

http://www.centerforfinancialstability.org/research/Bondi 070716.pdf. 

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10. Expand the Division of Enforcement's Trial Unit and Integrate the Trial Attorneys into the 

Investigative Units 

Assuming the SEC focuses more on intentional wrongdoing by individuals, as recommended in 

Point 1 above, the SEC's trial load will increase. The SEC should increase the number of 

attorneys in its trial unit to meet the increased case load. 

At the same time the SEC expands the trial unit, SEC trial unit attorneys should be more fully 

integrated into the investigative units of the Division of Enforcement. During her tenure, Chair 

White made some progress in this regard after the SEC suffered a series of defeats at trial, but 

more integration can be done. 23 Structurally, the Division of Enforcement's trial attorneys are 

separate from the investigative attorneys. This antiquated organizational structure has resulted 

in inefficiencies and loss of information that have impacted the Division of Enforcement's 

effectiveness. With this bifurcated structure, enforcement actions run the risk of proceeding to 

trial without sufficient "trial" evidence obtained during the investigation. By more fully 

integrating trial attorneys into the investigative units, the attorneys tasked with proving 

securities law violations at trial will have a greater role in charging decisions and gathering 

evidence of violations early in investigations. 24 This likely will strengthen the development of 

admissible evidence during the investigation and result in stronger enforcement actions. In 

addition, trial attorneys provide an important check on the investigative staff to ensure that the 

elements of a securities law violation are met prior to initiating a lawsuit or settling an 

enforcement action. 

The Center for Financial Stability (CFS) is a private, nonprofit institution focusing on global finance and 

markets. Its research is nonpartisan. This publication reflects the judgments and recommendations of 

the author(s). They do not necessarily represent the views of Members of the Advisory Board or 

Trustees, whose involvement in no way should be interpreted as an endorsement of the report by either 

themselves or the organizations with which they are affiliated. 

23 See Jean Eaglesham, SEC Takes Steps to Stem Courtroom Defeats, Wall St. J. (Feb. 13, 2014), available at 

https:l/www.wsj.com/articles/sec-takes-steps-to-stem-courtroom-defeats-1392336091. 

24 See also Troy A. Paredes, Commissioner, SEC, Remarks at the 2009 Southeastern Securities Conference (Mar. 19, 

2009 ), available at https:l/www. sec.gov /news/ speech/2009/soch031909ta p. htm. 

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APPENDIX2 
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Fordham Journal of Corporate & 

Financial Law 

Volume 13, Number 3 2008 Article 1 

Evaluating the Mission: A Critical Review of 

the History and Evolution of the SEC 

Enforcement Program 

PaulS. Atkins* Bradley J. Bondit 

Copyright @2008 by the authors. Fordham Journal of Co1porate & Hnancial Law is produced 

by The Berkeley Electronic Press (bepress). http://ir.lawnet.fordham.edu/jcft 
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ARTICLES 

EVALUATING THE MISSION: A CRITICAL 

REVIEW OF THE HISTORY AND EVOLUTION OF 

THE SEC ENFORCEMENT PROGRAM 

By PaulS Atkins and Bradley J Bondi* 

' Paul S. Atkins is a commissioner of the United States Securities and Exchange 

Commission and is a member of the New York and Florida Bars. Bradley J. Bondi 

serves as counsel to Commissioner Atkins and is a member of the District of Columbia, 

New York, and Florida Bars. The views expressed herein reflect the views of the 

authors and do not necessarily reflect those of the SEC or other Commissioners. The 

authors wish to extend their thanks and appreciation for the advice and significant 

contributions of Kechi Anyadike, Jan Bauer, Brenden P. Carroll, W. Blair Hopkin, 

Hester M. Peirce, Mark T. Uyeda, and numerous others. All blame for any errors or 

omissions, however, resides solely with the authors. 

367 
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368 FORDHAM JOURNAL OF 

CORPORATE & FINANCIAL LAW 

Vol. XIII 

The United States Securities and Exchange Commission (the 

"SEC" or "Commission") is nearing its seventy-fifth anniversary, a 

milestone that will be marked by reflection on the past and 

contemplation of the future. 1 During this time of introspection, the 

Commission should take the opportunity to examine the manner in 

which it has reacted to the growth and changes in its regulatory authority 

and in the capital markets. One constant throughout its history has been 

the SEC's need to balance competing interests. The SEC's stated 

mission reflects this tension. Today, that mission is composed of three 

objectives: "to protect investors; maintain fair, orderly, and efficient 

markets; and facilitate capital formation." 2 

Historically, the SEC's mission has focused on investor protection. 

As the SEC and its regulatory powers have grown in response to the 

ever more complex and international financial services markets, the 

seemingly straightforward mission of investor protection has become 

more intricate and multidimensional, prompting questions such as, 

"Who are the investors that should be protected?" and "How should they 

be protected?" After all, investors range in sophistication, size, activity, 

goals, needs, and other attributes. They include traditional individual 

and institutional investors in the securities markets, traders, and foreign 

entities seeking to invest in the United States.3 Choices that the SEC 

makes in its rulemaking and other activities can favor or disfavor one 

group of investors over another. A rule beneficial for one investor may 

be detrimental to another, depending on an investor's investment 

strategy or changing circumstances. Indeed, because investors 

ultimately pay for inefficiencies arising from regulatory mandates 

I. The SEC was created on July 2, 1934 during a period of heated debate over the 

country's economic turmoil. That day was literally heated: 93 degrees Fahrenheit, to be 

exact. The Federal Trade Commission met in an unairconditioned, temporary building 

in Washington, D.C., located on the present site of the Federal Reserve Building, to 

vote the SEC into existence pursuant to the Securities Exchange Act of 1934. Frank V. 

Fowlkes, Agency Report/Congress Prods SEC To Get Firmer Grip on Nation's 

Securities Industry, NATIONAL JOURNAL, Feb. 20, 1971, at 385. 

2. U.S. SEC. & EXCH. COMM'N, 2006 PERFORMANCE AND ACCOUNTAB!L!TY 

REPORT 5, available at http://www.sec.gov/about'secpar/secpar2006.pdf [hereinafter 

2006 REPORT]. 

3. One group of foreign investors, sovereign wealth funds, has received much 

attention by the press in recent years. Sovereign wealth funds are estimated currently at 

$2.5 trillion and expected to grow to $10 to 15 trillion by 2015. Robert M. Kimmitt, 

Public Footprints in Private Markets, FOREIGN AFFAIRS, Jan.iFeb. 2008, at 1-2, 

available at http://www .foreignaffairs.org/20080 I 01 faessay871 09/robert-m-kimmitt/pu 

blic-tootprints-in-private-markets.html. 
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2008 EVALUATING THE MISSION 369 

through direct or indirect costs, diminished returns, and reduced choice, 

the rules must be made with careful analysis and deliberation. Congress 

acknowledged this potential harm in 1996 when it revised the SEC's 

statutory mandate to expressly require the SEC "to consider or 

determine whether an action is necessary or appropriate in the public 

interest" and to "consider, in addition to the protection of investors, 

whether the action will promote efficiency, competition, and capital 

formation." 4 

This multidimensional aspect of investor protection applies not only 

to rulemaking, but also to enforcement matters. Each enforcement 

matter involves in some degree a balancing of competing interests, some 

at a pragmatic, case-specific level and others at a higher policy level. 

For example, in distributing money recovered in an enforcement action 

against a bankrupt company, the SEC conceivably could decline a 

distribution to all investors and instead choose a distribution that favors 

one class of investor over another, such as common stockholders over 

senior debtholders, which by virtue of their preferred position may have 

had greater recovery per dollar invested than did common stockholders, 

but still fell short of their desired recovery. In its overall enforcement 

program, the SEC's decisions about resource allocation, charges to be 

brought, and relief to be sought may enhance the protection of one group 

of investors at the potential cost of another. Advancing a novel legal 

theory may protect the group of investors in a particular case, but have 

unintended detrimental consequences to investors as a whole. 5 

The enforcement decisions of the SEC must be guided by the 

multidimensional nature of the SEC's mission of protecting investors; 

maintaining fair, orderly, and efficient markets; and facilitating capital 

formation. The difficult choices of balancing conflicting interests must 

be guided by the transcendent principles of predictability, fairness, and 

transparency, culminating in the rule of law. These principles are the 

defining characteristics of the U.S. markets. 

In order to assess the SEC's application of these principles to its 

enforcement decisions, this Article investigates the shifting focus of the 

SEC's enforcement program from its inception to the present day. The 

Article explores the development and usage of the SEC's statutory 

enforcement powers in the context of due process and fairness. Finally, 

4. Securities Exchange Act of 1934 § 3(f), 15 U.S.C. § 78c(f) (2006). 

5. See, e.g., Stoneridge fnv. Partners, LLC v. Scient!fic-Atlanta, Inc.,- U.S.-, 

128 S.Ct. 761 (2008). 
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370 FORDHAM JOURNAL OF 

CORPORATE & HNANCIAL LAW 

Vol. XIII 

the Article calls for the Commission to appoint an independent advisory 

committee to conduct a detailed review and evaluation of the policies 

and procedures of the enforcement program in light of the changes in the 

SEC's statutory authority over the course of the last three decades. 

THE ORGANIZATION OF THE SEC 

The SEC is governed by five commissioners, all of whom are 

appointed by the President with the advice and consent of the Senate. 6 

One of the commissioners is designated as chairman by an executive 

order of the President. 7 To ensure bipartisanship, Congress specified 

that only three of the five commissioners can belong to the same 

political party. 8 

The SEC is organized into four primary operating divisions and 

nineteen "offices," or special service units, each of which is 

headquartered in Washington, D.C. The SEC's staff, numbering 

approximately 3500, is located in Washington, D.C. and throughout its 

eleven regional offices. 9 The SEC's largest division-and the focus of 

6. Securities Exchange Act of 1934 § 4, 15 U.S.C. § 78d (2006). 

7. See Reorganization Plan No. 10 of 1950, 15 Fed. Reg. 3175 (1950), reprinted 

in 5 U.S.C. 901 et seq. (2006), and in 64 Stat. 1265 (1950); see also 2006 REPORT, 

supra note 2, at 7. This power of the President to designate (or remove) the chairman 

by executive order does not apply to similar agencies. For example, the chairmen of the 

Board of Governors of the Federal Reserve and the Commodity Futures Trading 

Commission are separately nominated and confirmed to their positions as chairmen, 

although they have separate terms as governor or commissioner, respectively. See 12 

U.S.C. § 242 (2008) and 7 U.S.C. § 2(a)(2)(B) (2008). 

8. Securities Exchange Act of 1934 § 4. The first five commissioners were 

Democrats Joseph P. Kennedy, James M. Landis and Ferdinand Pecora, and 

Republicans George C. Mathews and Robert E. Healy. The commissioners elected 

Joseph P. Kennedy to serve as the first chairman. See Fowlkes, supra note I, at 385. 

9. See U.S. SEC. & EXCH. COMM'N, 2007 PERFORMANCE AND ACCOUNTABILITY 

REPORT 2, available at http://www.sec.gov/aboutlsccpar/secpar2007.pdf [hereinafter 

2007 REPORT]. The SEC has grown tremendously since its inception. In 1942, the SEC 

had a staff of 1700 employees. 1n order to make room for wartime agencies, the SEC 

was forced to relocate to Philadelphia in 1942. By the time it returned to Washington in 

1948, the staff had decreased to I 150. By 1955, there were only 666 employees. 

Fowlkes, supra note 1, at 383. 
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2008 EVALUATING THE MISSiON 371 

this Article-is the Division of Enforcement, which has more than 1100 

employees, and has grown by more than 40% in the past fifteen years. 10 

THE SEC's AUTHORITY UNDER THE FEDERAL SECURITIES LAWS 

Today, the SEC is charged with administering the Securities Act of 

1933, 11 the Securities Exchange Act of 1934, 12 the Trust Indenture Act 

of 1939, 13 the Investment Company Act of 1940, 14 the Investment 

Advisers Act of 1940, 15 and certain provisions of the Sarbanes-Oxley 

Act, 16 some of which fall outside of the earlier securities laws. 17 

The Commission is vested with statutory authority to conduct any 

investigation it deems necessary to determine whether a person has 

violated federal securities laws and the rules and regulations 

I 0. The Enforcement Division is currently the largest of the divisions and offices of 

the SEC, with more than I 100 personnel. See Christopher Cox, Chairman, Opening 

Remarks to the Practising Law Institute's SEC Speaks Series (Feb. 9, 2007), available 

at http://www.sec.gov/news/speech/2007/spch020907cc.htm. According to information 

provided by the SEC to Congress, the total number of employees in the Enforcement 

Division at the end of fiscal year 2008 is expected to be 1124---up from 781 in 1992. 

11. Securities Act of 1933, 15 U.S.C. §§ 77a-77aa (2006). 

12. Securities Exchange Act of 1934, 15 U.S.C. §§ 78a-78nn (2006); see generally 

Securities and Exchange Act of 1934, http://www.sec.gov/about/1aws.shtml#secexactl9 

34 (last visited May 8, 2008) (discussing some of the many powers granted by the 1934 

Act, including regulating corporate reporting, proxy solicitations and tender offers). 

13. Trust Indenture Act of 1939, 15 U.S.C. §§ 77aaa-77bbbb (2006) (focusing on 

debt securities such as bonds, debentures, and notes that are offered for public sale). 

14. Investment Company Act of 1940, 15 U.S.C. §§ 80a-1 to a-64 (2006) 

(regulating the organization of companies, including mutual funds, that engage 

primarily in investing, reinvesting, and trading in securities, and whose own securities 

are offered to the investing public). 

15. Investment Advisers Act of 1940, 15 U.S.C. §§ 80b-1 to b-21 (2006) 

(regulating investment advisors). 

16. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (2002) 

(codified in scattered sections of II, 15, 18,28 and 29 U.S.C.) (mandating a number of 

reforms to enhance corporate responsibility and financial disclosures and to combat 

corporate and accounting fraud). The Sarbanes-Oxley Act also created the Public 

Company Accounting Oversight Board to oversee the activities of the auditing 

profession .. 

17. On February 8, 2006, the repeal of the Public Utility Holding Company Act of 

1935 took effect, relieving the SEC of what once arguably was its primary focus. The 

Act provided for the regulation of multi-state utilities by the SEC. Public Utility 

Holding Company Act of 1935, 15 U.S.C. § 79 (repealed 2006). 
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promulgated thereunder. 18 As part of this investigative authority, the 

Commissioners-and any officer to whom the Commissioners' authority 

is delegated-have the power to "administer oaths and affirmations, 

subpena [sic] witnesses, compel their attendance, take evidence, and 

require the production of any books, papers, correspondence, 

memoranda, or other records which the Commission deems relevant or 

material to the inquiry." 19 The Commission has delegated these tasks to 

the Director of the Division of Enforcement, who undertakes them 

pursuant to formal orders that the Commission grants in individual 

matters. 20 If the Commission concludes that a securities law has been 

violated, the Commission may bring an action in federal court or in an 

administrative proceeding against the purported violators. 

THE ESTABLISHMENT OF THE ENFORCEMENT DIVISION 

Among its various other roles, the SEC acts to enforce the federal 

securities laws/ 1 and it has built a strong reputation for professionalism 

and effectiveness in its enforcement program. At the time the 

Commission was established in 1934, the Commission's "Legal 

Division" was responsible for conducting investigations pertaining to 

federal securities law violations. 22 Within the first two years, the 

Commission assigned that duty to its regional offices. 23 For the next 

four decades, the regional offices were primarily responsible for 

conducting investigations and bringing enforcement actions while the 

Commission's Trading and Markets Division "played a largely 

supervisory and coordinating role supporting the regions and referring 

criminal cases to the Justice Department for prosecution."24 By 1944, 

18. &e e.g., Securities Act §§ 8(e), 20(a); Securities Exchange Act § 2l(a); 

Investment Company Act§ 42(a); Investment Advisers Act§ 209(a). 

19. Securities Exchange Act§ 21(b). Congress has granted similar authority in 

other provisions of the federal securities laws. See Investment Company Act § 42(b ); 

Investment Advisers Act § 209(b ). 

20. 17 C.F.R. § 200.30-4(a)( I) (2008). 

21. 2007 REPORT, supra note 9, at 2. 

22. DANIEL M. HAWKE, A BRlEF HISTORY OF THE SEC's ENFORCEMENT PROGRAM 

!934-!981, at 2 (SEC Historical Society 2002), available at http://www.sechistorical.or 

g/collection/oralHistories/roundtables/enforcement/enforcementHistory .pdf. 

23. !d. A copy of the 1939 organization chart of the SEC is available at 

http://www.sechistorical.org/collection!papcrs/1930/1939 _SEC_ OrgChart.pdf. 

24. !d. During the SEC's first decade, the Justice Department had a 95% 

conviction rate from the indictments that it brought based on referrals from the SEC. !d. 
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after only a decade of existence, the SEC had gathered information 

"concerning an aggregate of 44,399 persons against whom Federal or 

State action had been taken with regard to securities violations" and had 

obtained permanent injunctions against 1,057 firms and individuals. 25 

The second decade of the SEC's existence was marked by World 

War II and its aftermath. During the war, the SEC's headquarters 

moved temporarily to Philadelphia to make room for wartime operations 

in Washington, D.C. 26 When the SEC finally returned to Washington in 

1948, it occupied temporary buildings that were erected during the 

war. 27 Despite the inconveniences caused by the war and post-war 

budget cuts, the SEC continued to bring a constant number of 

enforcement actions during this time. 28 

Beginning in the late 1950s and continuing through the 1960s, the 

enforcement program underwent a remarkable transformation, and the 

enforcement resources in the SEC's Washington, D.C. headquarters 

increased. With the added resources, the headquarters began to bring 

more actions for violations of the securities laws. During the entire 

decade of the 1950s, the home office brought a total of approximately 

fifty cases. Yet during the 1960s, that number escalated substantially -

the home office brought approximately forty cases per year. 29 

The 1960s witnessed landmark decisions in the field of securities 

law in cases brought by the SEC, such as SEC v. Texas Gulf Sulfur Co. 30 

and SEC v. VTR, Inc. 31 In Texas Gulf Sulfur, the Second Circuit adopted 

the SEC's application of Rule I Ob-5 to insider trading cases by requiring 

insiders in possession of material, nonpublic information either to 

abstain from trading on such information or to disclose such information 

at 13 (quoting TENTH ANNUAL REPORT OF THE SECURITIES AND EXCHANGE 

COMMISSION, at 3). 

25. !d. at 13 (citing TENTH ANNUAL REPORT OF THE SECURITIES AND EXCHANGE 

COMMISSION, at 2-3). 

26. !d. at 14. 

27. !d. 

28. !d. 

29. See JOEL SELIGMAN, THE TRANSFORMATION OF WALL STREET; A HISTORY OF 

THE SECURJTIES AND EXCHANGE COMMISSION AND MODERN CORPORATE FINANCE 360-

61, 363 (3d ed. 2003). The impetus for the transformation was the enforcement staffs 

massive investigation into fraudulent practices by the American Stock Exchange. See 

HAWKE, supra note 22, at 2-3. 

30. See SEC v. Tex. Gulf Sulfur Co., 401 F. 2d 833 (2d Cir. 1968), cert. denied, 

394 u.s. 976 (1969). 

31 See SEC v. VTR, Inc., 410 F. Supp. 1309 (D.D.C. 1975). 
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before trading. 32 In VTR, the SEC persuaded a federal district court to 

approve as a remedy for the securities law violation the appointment of 

independent directors and to order restitution. 33 The VTR decision 

marked the beginning of a long series of civil cases obtaining ancillary 

relief in addition to an injunction against further misconduct.34 

The growth in the number of actions being brought by the SEC 

sparked discussions, led by Chairman William J. Casey, about 

"concentrat[ing] resources by focusing all enforcement and investigative 

activity in one division."35 In August 1972, the Commission 

reorganized the operating structure of its divisions by combining the 

enforcement programs of the divisions of Trading and Markets, 

Corporation Finance, and Investment Management into a newly created, 

stand-alone division. 36 The new "Division of Enforcement" would 

oversee all enforcement actions brought by the SEC. 37 

32. See Tex. GulfSu/fitr, 401 F. 2d at 848-52. 

33. See VTR, Inc., 410 F. Supp. 1309. 

34. SELIGMAN, supra note 29, at 362. 

35. U.S. SEC. & EXGf. COMM'N, THIRTY-EIGHTH ANNUAL REPORT OF THE 

SECURITIES AND EXCHANGE COMMISSION xxvii (1972), available at 

http://www.sec.gov/aboutlannual_report/1972.pdf. It has been suggested that this 

reorganization was initially resisted on the 

belief that enforcement responsibility should not be separated from the divisions of 

the Commission that deal with substantive regulation. The belief was that as the 

regulators developed new principles of regulation, if enforcement became too separate 

from such development, it might reflect the uncertainties of the rules and the 

appropriate nature of regulation. 

Symposium, Securities Law Enforcement Priorities, 17 SETON HALL LEGIS. J. 7, 9 

(1993) (statement by Leonard M. Leiman). 

36. HAWKE, supra note 22, at 3. In 1971, there were 40 lawyers in the enforcement 

group of the Division of Trading and Markets. Fowlkes, supra note 1, at 380. The 

Commission, on November 14, 2007, restored the name of the "Division of Market 

Regulation" to the "Division of Trading and Markets." See Press Release, U.S. Sec. & 

Exch. Comm'n, SEC Renames Division of Market Regulation as Division of Trading 

and Markets (Nov. 14, 2007), available at http://www.sec.gov/news/press/2007/2007-

229.htm. The Commission changed the name of the "Division of Corporate 

Regulation" to the "Division of Investment Management" in 1972. See Interview by 

Richard Rowe with Allan Mostoff (Oct. 30, 2002), m•ailable at 

http://www.sechistorical.org/collection/oralHistories/interviews/mostoff/mostoffl 00202 

Transcript. pdf. 

3 7. HAWKE, supra note 22, at 3. 
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THE WELLS COMMISSION AND lTS RECOMMENDATIONS 

On January 27, 1972, in a speech to the New York State Bar 

Association underscoring the importance of cooperation and 

collaboration between the Commission and the securities bar, Chairman 

Casey announced the creation of an advisory committee 38 to "review 

and evaluate the Commission's enforcement policies and practices and 

to make such recommendations as they deemed appropriate."39 

Chairman Casey called upon the private securities bar to contribute to 

improving the enforcement program by developing procedural 

safeguards to protect against abuses of the rights of prospective 

defendants. 40 Stressing the value of input from the private sector, 

Chairman Casey explained: 

fi} consider it essential for the Commission to redouble its efforts to 

keep in touch with the best thinking on investor protection at the 

private bar, in the accounting profession, and in the financial 

community generally. As one step-- and I hope that it will prove a 

significant step toward that end, I have created . a special 

committee of three highly experienced practicing lawyers who will 

at my request examine the SEC's enforcement policy and practices, 

engage in frequent dialogue with the members of the Commission 

and with our staff, seek and sift the suggestions of the bar and make 

recommendations to the Commission for worthwhile improvements 

to our time-honored ways. 41 

Although the official name of the committee was the "Advisory 

Committee on Enforcement Policies and Practices," it is better known as 

the "Wells Committee" after its chairman, John A. Wells, a prominent 

lawyer and partner at the New York law firm of Royall, Koegel & 

38. William J. Casey, Chairman, U.S. Sec. & Exch. Comm'n, Address to the New 

York Bar Association (Jan. 27, 1972), available at http://www.sec.gov/news/speech/19 

72/0 12772casey .pdf [hereinafter Casey Speech}. 

39. U.S. SEC. & EXCH. COMM'N, REPORT OF THE ADVISORY COMMITTEE ON 

ENFORCEMENT POLICIES AND PRACTICES (June 1, 1972), reprinted in ARTHUR F. 

MATHEWS ET AL., ENFORCEMENT AND LITIGATION UNDER THE FEDERAL SECURITIES 

LAWS 1973, at 275 (Practicing Law Institute 1973) [hereinafter WELLS COMMITTEE 

ADVISORY REPORT}; Memorandum from John A. Wells et al., Chairman, SEC Advisory 

Committee on Enforcement Policy and Practices (Mar. 2, 1972), available at 

http://www.scchistorical.org/collection/papers/1970/1972 _ 0302 _Casey .pdf [hereinafter 

Wells Memo}. 

40. Casey Speech, supra note 38, at 4-5. 

41. !d. 
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Wells.42 The Wells Committee also included former SEC chairmen 

Ralph H. Demmler and Manual F. Cohen, both of whom had taken an 

active interest in the workings of the enforcement program. 43 Howard 

G. Kristol, who served as special counsel to Chairman Casey, acted as a 

liaison to, and unofficial member of, the Wells Committee. 44 

The Wells Committee's stated mandate45 was: first, "to advise on 

how the SEC's enforcement objectives and strategies may be made still 

more effective;"46 second, to assess the due process implications of the 

enforcement practices;47 third, to evaluate the enforcement policies and 

procedures;48 fourth, "to make recommendations on the appropriate 

blend of regulation, publicity and formal enforcement action and on 

methods of furthering voluntary compliance;"49 and fifth, "to make 

recommendations on criteria for the selection and disposition of 

enforcement actions and on the adequacy of ... sanctions imposed in 

Commission proceedings." 50 

The Wells Committee was composed of three of the brightest minds 

of the securities bar, but the Committee did not conduct extensive, 

independent research and analysis. Instead, the Committee solicited 

comments from persons outside the Commission who were affected by 

the SEC's enforcement activities to "determine whether fairness could 

be more certainly assured, consistent with the need for effective 

enforcement."51 The Wells Committee started its work in January 1972 

and published a detailed report with forty-three recommendations for the 

Commission in June of the same year-an impressive achievement by 

any measure. 52 The report represented a candid and honest assessment 

of the enforcement program and reflected the substantial input the 

Committee received from the private bar. 

42. !d. at 5-6. John Wells later fom1ed a well-known law firm called Rogers & 

Wells. 

43. !d. 

44. Howard G. Kristol-Biography, available at http://www.duanemorris.com/atto 

meys/howardgkristol.html (last visited May 9, 2008). 

45. Wells Memo, supra note 39. 

46. !d. at I. 

47. !d. 

48. !d. 

49. !d. at 2. 

50. !d. 

51. WELLS COMMITTEE ADVISORY REPORT, supra note 39, at 3. 

52. !d. at ii-viii. 
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The Wells Committee Recommendations 

The most significant recommendations, from the perspective of a 

person defending against an SEC enforcement proceeding, are numbers 

16, 17 and 20 of the report: 5

3 

16. Except where the nature of the case precludes, a prospective 

defendant or respondent should be notified of the substance of the 

staff's charges and probable recommendations in advance of the 

submission of the stafi memorandum to the Commission 

recommending the commencement of an enforcement action and be 

accorded an opportunity to submit a written statement to the staff 

which would be forwarded to the Commission together with the staff 

memorandum. 

17. The procedures whereby a prospective defendant or respondent is 

permitted to present to the Commission his side of the case prior to 

authorization of an enforcement action should be reflected in a rule 

or published release. 

* * * 

20. The Commission should adopt procedures pennitting discussions 

of settlement between the staff and the prospective defendant or 

respondent prior to the authorization of a proceeding. 54 

These three recommendations became the impetus for what is now 

known as the "Wells Submission." 

Providing prospective defendants with notice of potential charges 

and allowing them to respond, as reflected in Recommendations 16 and 

17, was not a novel concept within the walls of the SEC. Even prior to 

the report of the Wells Committee, the SEC, under Chairman Hamer 

Budge, had afforded prospective defendants an opportunity to be heard 

by the Commission. A September 1, 1970, internal directive of the 

Commission55 required the Enforcement staff to include within its 

53. Harvey L. Pitt et a!., SEC Enforcement Process, Internationalization of the 

Securities Markets- Business Trend~ and Regulatory Policy, C489 ALI-ABA 109, 238 

(1989). 

54. WELLS COMMITTEE ADVISORY REPORT, supra note 39, at iv-v. 

55. See Fowlkes, supra note 1 (describing the positions of the commissioners). It 

should be noted that this directive was supported by commissioners of both political 

parties. 
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memoranda recommending action by the Commission "any arguments 

or contentions as to either the facts or the law ... which have [been] 

advanced by the prospective respondents and which countervail those 

made by the staff .... " 56 The purpose of the procedure was "to afford 

the Commission an opportunity to consider the position of the 

prospective defendant or respondent on any contested matters prior to 

authorization of a proceeding."57 

The Wells Committee observed that "[a]s a practical matter, only 

experienced practitioners who are aware of the opportunity to present 

their client's side of the case have made use of [such] procedures." 58 

The Committee felt that the process of providing notice to prospective 

defendants and allowing them to respond to the allegations before the 

Commission formally charged them was critical to protecting their rights 

and ensuring overall fairness. 59 The Committee recommended that the 

Commission codify the procedure through formal rulemaking. 60 

Unlike Recommendations 16 and 17, Recommendation 20 of the 

Wells Committee-to allow the staff to engage in preliminary settlement 

negotiations with a prospective defendant before the Commission 

authorized a proceeding61 -was a significant departure from thenexisting procedure. The 1970 internal directive required the staff to seek 

approval from the Commission to bring an action or proceeding prior to 

discussing its settlement. 62 Under the J 970 internal directive, the 

Enforcement staff could allow a defendant or respondent to present 

proposals and arguments prior to Commission authorization, so long as 

that person initiated the discussions.63 The staff: however, was 

precluded from negotiating settlement terms or disclosing to the 

defendant or respondent the "recommendation it intend[ ed] to make to 

the Commission." 64 This process, which itself represented a departure 

from prior procedure for negotiating settlements, grew out of a concern 

56. This 1970 directive was made public solely as a result of pretrial discovery in 

SEC v. National Student Marketing Corporation. See SEC v. Nat'! Student Mktg. 

Corp., 68 F.R.D. 157, 166 appx. A (D.D.C. 1975) [hereinafter 1970 Internal Directive]. 

57. WELLS COMMITTEE ADVISORY REPORT, supra note 39, at 31. 

58. Jd. at31-32. 

59. /d. 

60. !d. at 32. 

61. WELLS COMMITTEE ADVISORY REPORT, supra note 39, at iv-v. 

62. 1970 Internal Directive, supra note 56, at 165. 

63. See id. The staff was permitted to discuss the facts and nature of the alleged 

violations. Jd. 

64. ld. 
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by the Commission that "its discretionary authority regarding the 

institution of proceedings [would be] substantially impaired."65 

According to Commissioner A. Sydney Herlong, the 1970 internal 

directive was designed to prevent the staff from "bludgeoning" 

companies into consent settlements by using the threat of public 

proceedings that might never be approved. 66 Commissioner Herlong, 

who was one of two Democrats on the Commission, explained: 

The staff sometimes is overly zealous and they sometimes want 

quick settlements to clear up their files. Sometimes they would beat 

people over the head for a consent decree. We had reports from 

some people who weren't pleased with the treatment. 67 

Responding to comment letters, the Wells Committee 

recommended that the Commission withdraw this mandate and return to 

the prior procedure of allowing staff leeway to negotiate settlements 

with prospective defendants prior to having the authority to commence 

an action or proceeding. 68 The Wells Committee believed that "frank 

discussions between the staff and opposing counsel concerning the 

staffs conclusions and probable recommendation to the Commission 

would encourage settlements."69 To address concerns with abuse, the 

Committee proposed that the Director of Enforcement or a regional 

administrator be responsible for supervising settlement negotiations and 

that the proposed defendant or respondent be shown the evidence that 

the staff has assembled in support of its case. 70 As the Wells Committee 

observed, "When the staff refuses to disclose its evidence or the theory 

of its case to the respondent's attorney before the hearing, the attorney, 

65. WELLS COMMJTTEE ADVISORY REPORT, supra note 39, at 35. Philip A. 

Loomis, then general counsel of the SEC, explained that the Commission abandoned 

the practice of considering settlements negotiated without prior Commission 

authorization because the Commissioners felt hindered by a pre-decided result. See 

Fowlkes, supra note 1, at 381. Commissioner Richard B. Smith "offered essentially the 

same reason, saying that he missed the opportunity to hear industry's side of a case and 

that it struck him as bad administrative procedure." !d. 

66. Fowlkes,supranote l,at381. 

67. Jd. 

68. WELLS COMMITTEE ADVISORY REPORT, supra note 39, at 35. 

69. ld. 

70. Jd. at 35-36. 
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not knowing what his client faces, may be unable or reluctant to 

recommend a settlement." 71 

The Wells Committee recommendation of a return to the pre-1970 

procedure of allowing staff to negotiate settlements prior to Commission 

approval was met with favor by many members of the securities bar. In 

a May 23, 1972 letter to the Wells Committee concerning the proposed 

change, Arthur F. Mathews, a former SEC enforcement lawyer, wrote: 

[T]he changed enforcement policy has, although unintended, worked 

to the severe detriment of many defendants and prospective 

defendants who wish to achieve an acceptable consent settlement in 

lieu of litigation and who are not concerned that the Staff might 

"bludgeon" them. Rather, such persons usually are concerned with 

the continuing blasts of adverse publicity showering upon them, first 

by public institution of charges by the Commission, and later upon 

the conduct of a hearing or the announcement of the terms and 

conditions of a settlement subsequently negotiated. Such continuous 

publicity may be extremely unfair, particularly where serious 

allegations publicized upon institution of an action, are dropped 

subsequently by Staff and the Commission in accepting a consent 

settlement of the action. 72 

The notable aspect of this debate is that both sides were concerned 

with fairness and due process. Those in support of requmng 

Commission approval prior to settlement were concerned with the 

uneven negotiating position of the Commission's staff and the 

prospective defendant. Those in support of allowing informal settlement 

procedures prior to Commission approval believed that fairness would 

be advanced by limiting the time under which a prospective defendant 

could be exposed to adverse publicity. The ultimate conclusion of the 

Commission, however, emphasized the due process concerns of 

Commission oversight. 

71. Id at 37. Today, there are no specific guidelines concerning the amount and 

type of information that staff must share with a prospective defendant, so practices vary 

among the staff and across the regional offices. 

72. Letter from Arthur F. Mathews of Wilmer, Cutler & Pickering, to the Advisory 

Committee on Enforcement Policies and Practices 30 (May 23, 1972). Stanley Sporkin, 

then an associate director, agreed, stating that "it saved everybody a lot of bother and 

was welcomed by many of the people we regulate because it gave them a means of 

settling quickly." Fowlkes, supra note 1, at 381. 
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The Commission's Response to the Wells Recommendations 

The recommendations of the Wells Committee were met with 

mixed responses within the agency. Although the private securities bar 

generally applauded the recommendations from the Wells Committee, 

the SEC staff disagreed with many of them, and the commissioners were 

reluctant to adopt fonnal rules. 73 With respect to Recommendations 16 

and 17, the Commission "agree[d] that the objective fwas] sound," but 

"concluded that it would not be in the public interest to adopt formal 

rules for that purpose." 74 The Commission apparently felt hamstrung by 

the mandatory-sounding nature of the phrase "except where the nature of 

the case precludes." The Commission believed that the formal adoption 

of the proposals "could seriously limit the scope and timeliness" of 

enforcement actions and inject issues "irrelevant to the merits." 75 As a 

result, the Commission indicated that, where "practical and appropriate," 

it would allow, on an informal basis, prospective defendants to provide 

written submissions before a charging decision was reached by the 

Commission. 76 

Although it did not immediately embrace Recommendations 16 and 

I 7, the Commission eventually adopted the substance of these 

recommendations in procedural rules in November 1972, formulating 

today's Wells submission process. The process as adopted provided a 

proposed defendant or respondent with the opportunity to respond to 

charges. 77 The Commission notified the public of the opportunity for 

prospective defendants or respondents to "submit a written statement to 

the Commission setting forth their interests and positions in regard to the 

subject matter of the investigation." 78 SEC procedural rules directed the 

staff, in its discretion, to advise prospective defendants or respondents 

"of the general nature of its investigation, including the indicated 

violations as they pertain to them, and the amount of time that may be 

available for preparing and submitting a statement prior to the 

73. See Pitt et al., supra note 53, at 63. 

74. Procedures Relating to the Commencement of Enforcement Proceedings and 

Termination of Staff Investigation, Securities Act Release No. 5310, [ 1972-1973 

Transfer Binder] Fed. Sec. L. Rep. (CCH) ~ 79,010, at 82,183-86 (Sept. 22, 1972) 

(emphasis added) [hereinafter SEC Release No. 5310]. 

75. !d. at 2. 

76. Stephen A. Glasser, SEC Adopts Rules Changes in Areas of Enforcement, 

N.Y.L.J., Sept. 29, 1972. 

77. See 37 Fed. Reg. 23,829 (Nov. 9, 1972) (codified at 17 C.F.R. § 202.5(c)). 

78. 17 C.F.R. § 202.5(c) (2006). 
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presentation of a staff recommendation to the Commission for the 

commencement of an administrative or injunctive proceeding.d9 The 

Commission, however, explained that a prospective defendant's 

opportunity to submit a response was not absolute, and the Commission 

expressly reserved the right to take any action while awaiting a 

submission by a proposed defendant or respondent. 80 

The Commission rejected Recommendation 20 of the Wells 

Committee, which would have permitted settlement discussions prior to 

authorization from the Commission to commence an action or 

proceeding. 81 Apparently, the Commission continued to harbor 

concerns that its discretionary authority regarding the institution of 

proceedings would be substantially impaired. 82 Irving Pollack, then 

director of the Division of Enforcement, explained the reason for 

rejecting the recommendation as two-fold: first, it would be difficult for 

the Commission to reject a settlement already reached between staff and 

a prospective defendant; second, there was concern that settlement 

discussions prior to Commission approval would give the staff the 

leverage to threaten prospective defendants into submission. 83 

Therefore, the procedure described in the 1970 internal directive of 

requiring the statT to seek Commission approval to bring an action prior 

to negotiating settlement of it remained in effect. 

In I 979, the Commission, under Chairman Harold Williams, 84 

formally adopted in the SEC procedural rules the requirement that the 

enforcement staff must have Commission authorization before engaging 

in settlement discussions. 85 The Commission reasoned that its 

involvement in settlement discussions was critical to ensuring a fair 

process and to protecting the rights of defendants. 86 

79. !d. 

80. See SEC Release No. 5310, supra note 74, at 2. 

81. WELLS COMMITTEE ADVISORY REPORT, supra note 39, at 34. 

82. Jd at 35. 

83. Glasser, supra note 76. 

84. Harold M. Williams~Biography, http://skadden.com/index.cfm?content!D=45 

&biolD=848 (last visited May 8, 2008). During his tenure, Chairman Williams 

increased the Office of the General Counsel from approximately a dozen attorneys to 

more than forty attorneys as an alternative source of advice to the Commission on 

issues such as enforcement matters. 

85. See 17 C.F.R. § 202.5(t) (2006). 

86. John M. Fedders, Dir., Div. of Enforcement, U.S. Sec. & Exch. Comm'n, 

Remarks to the 1981 SEC Accounting Conference Foundation for Accounting 
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Although the Commission did not adopt all of the forty-three 

specific recommendations, the most obvious legacy of the Wells 

Committee was the adoption of the "Wells Process," a process whereby 

prospective defendants or respondents are afforded an opportunity to 

submit a writing--essentially a brief-to the Commission and its staff 

after the staffs investigation is completed, but before the staff has made 

a recommendation to the Commission. Under this procedure, a 

prospective defendant or respondent enjoys due process-a hallmark of 

our Anglo-American judicial system. 

THE EVOLUTION OF THE ENFORCEMENT PROGRAM AND ITS PHILOSOPHY 

Prior to 1990, the SEC's statutory purpose for enforcing the 

securities laws was to provide remedial relief for aggrieved investors 

and to deter future violations. 87 The enforcement program began by 

serving primarily a remedial purpose, through the Commission's 

injunctive powers and the disgorgement remedies that the Commission 

fashioned. 88 In the decades following the Wells Committee, the 

Commission's enforcement actions began to shift from remedial to 

punitive in nature. This shift of emphasis arose from the new powers 

that Congress gave the SEC, such as the authority to impose officer and 

director bars, penalties against individuals and registered entities, and 

censures in administrative actions. 

In 1984, the SEC staff, in response to a congressional request, 

prepared a review of the adequacy of enforcement sanctions and 

remedies. 89 The resulting report stated that "[t]he federal securities laws 

are presently viewed by the courts as remedial rather than punitive" and 

Education: New York State Society of Certified Public Accountants 3-6 (Nov. 16, 

1981). 

87. See, e.g., Memorandum from John S.R. Shad, Chairman, U.S. Sec. & Exch. 

Comm'n, to Rep. Timothy E. Wirth, Chairman, Subcomm. Telecomms., Consumer 

Prot., & Fin. of the H. Energy and Commerce Comm. 350 (Feb. 22, 1984) [hereinafter 

Memorandum to Chairman Wirth]. 

88. See, e.g., SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1104 (2d Cir. 1972) 

("The deterrent effect of an SEC enforcement action would be greatly undermined if 

securities law violators were not required to disgorge illegal profits."); SEC v. 

Commonwealth Chern. Sec., Inc., 574 F.2d 90, 102 (2d Cir. 1978) ("[T]he primary 

purpose of disgorgement is not to compensate investors .... [l]t is a method of forcing a 

defendant to give up the amount by which he was unjustly enriched."). 

89. See Memorandum to Chairman Wirth, supra note 87 (transmitting "Results of 

the Review of the Adequacy of Enforcement Remedies and Sanctions"). 
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that the SEC's non-monetary remedies were "effective in most cases" in 

providing that remedial relief. 90 The staff reported that, aside from the 

area of insider trading, which Congress was addressing at the time/1 

"the Commission has been unable to identify a serious need for 

additional remedies to deter a specific type of conduct."92 

The report asserted that "the advantages of seeking additional civil 

penalties appear to be marginal" and "must be balanced against a 

number of potentially serious disadvantages."93 Chief among those 

identified disadvantages was the concern that giving the SEC the 

authority to seek or impose civil monetary penalties for violations of the 

federal securities laws would "change the character of the enforcement 

program from remedial to punitive, [and] might lead the judiciary to be 

less receptive to the SEC's injunctive actions." 94 Traditionally, the 

Commission relied on the Department of Justice to exercise these 

remedies through its criminal authority. 95 

By the late 1980s, these philosophical views substantially changed. 

In a memorandum in support of the Securities Enforcement Act of 1989, 

the Commission stated that "variable-penalty provisions are appropriate 

to penalize and deter the broad range qf conduct for which these 

penalties will be assessed." 96 The Commission conceded that moving to 

remedies that were more punitive in nature could result in one of two 

things: increased difficulty in obtaining settlements as a result of 

defendants' unwillingness to settle cases involving large civil penalties, 

thereby potentially harming aggrieved investors, or a greater likelihood 

of settlement by defendants hoping to avoid much larger civil monetary 

penalties after litigation. 97 The Commission's asserted need in 1990 to 

penalize a broad range of conduct was a significant departure from its 

90. !d. 

91. Congress was considering proposed legislation that eventually became the 

Insider Trading Sanctions Act of 1984. See Insider Trading Sanctions Act of 1984, Pub. 

L. No. 98-376, § 1, 98 Stat. 1264 (codified as amended in scattered sections of 15 

U.S.c.). 

92. 

93. 

Memorandum to Chairman Wirth, supra note 87, at 350. 

Jd 

94. !d. 

95. !d. 

96. U.S. Sec. & Exch. Comm'n, Memorandum of the Securities and Exchange 

Commission in Support of the Securities Law Enforcement Remedies Act of 1989, 

reprinted in H.R. No. 975, !Olst Cong., at 7 (emphasis added) [hereinafter SEC 

Memorandum in Support of Remedies Act]. 

97. Memorandum to Chairman Wirth, supra note 87, at 350-51. 
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representation to Congress only six years earlier that its existing 

remedies were effective. 98 

In 1990, former Director of Enforcement Gary Lynch, who had 

recently left the SEC, testified before the Senate Subcommittee on 

Securities. Although he testified in favor of providing additional penalty 

powers to the Commission, he cautioned: 

I think it is important for the Commission to maintain its historical 

focus on achieving remedial relief, rather than taking punitive action 

in every case, and that the Commission should still continue to judge 

the effectiveness of the Commission's enforcement program based 

on what it actually accomplishes, as opposed to what the dollar 

amount is that is ordered in a particular case. 99 

Congress provided the SEC with enhanced enforcement remedies, 

including expanded remedial powers and new penalty authority. These 

powers were included in the Insider Trading Sanctions Act of 1984, 100 

the Insider Trading and Securities Fraud Enforcement Act of 1988, 101 

and the Securities and Enforcement Remedies and Penny Stock Reform 

Act of 1990. 102 

As a result of these laws, the SEC gained three significant new sets 

of powers: (1) the ability to seek civil monetary penalties against 

persons and entities that may have violated federal securities laws; (2) 

the authority to bar directors and officers of public companies from 

serving in those capacities if they violated federal antifraud provisions; 

and (3) the authority to issue administrative cease-and-desist orders, 

temporary restraining orders, and orders for disgorgement of ill-gotten 

profits to violators of federal securities laws. These significant powers 

and laws enabling them are discussed in more detail below. 

98. !d. at 350. 

99. The Securities E11[orcement Remedies Act of 1989: Hearing Before the Sec. 

Subcomm. of the S. Banking, Hous., & Urban Affairs Comm. (Feb. 1, 1990) (statement 

of Gary G. Lynch, Fmr. Dir., Div. of Enforcement, U.S. Sec. & Exch. Comm'n). 

100. Insider Trading Sanctions Act of 1984, Pub. L. No. 98-376, § 1, 98 Stat. 1264 

(codified as amended in scattered sections of 15 U.S.C.). 

101. Insider Trading and Securities Fraud Enforcement Act of 1988, Pub. L. No. 

100-704, §I, 102 Stat. 4677 (codified as amended in scattered sections of15 U.S.C.). 

I 02. Securities Enforcement Remedies and Penny Stock Reform Act of 1990, Pub. 

L. No. 101-429, 104 Stat. 931 (1990). 
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In connection with its enhanced enforcement efforts with respect to 

insider trading, 103 the SEC submitted proposed legislation to Congress 

on September 27, 1982, that would authorize the SEC to seek (and a 

United States District Court to impose) civil monetary penalties of up to 

three times the profit realized or loss avoided in insider trading cases. 104 

At the time of the proposal, the SEC's primary weapons "against insider 

trading [were] injunctionl s] requiring a defendant to comply with the 

law in the future, and ancillary equitable relief in the form of 

disgorgement of illegal profits." 105 Previously, the power to seek 

"penalties" in the form of prison sentences, criminal fines and restitution 

resided solely in the Department of Justice ("DOJ") and state authorities. 

As a result of the growing number of insider trading cases, the 

Commission believed that its existing tools of injunctions and 

disgorgement were inadequate to deter persons from trading on material, 

nonpublic information. Injunctions, the Commission explained, merely 

order a defendant prospectively to comply with existing law, and do "not 

penalize the defendant for the illegal conduct for which the injunction 

was imposed." 106 The Commission viewed the remedy of disgorgemcnt 

as likewise inadequate because it merely "strips the defendant of the 

fruits of his unlawful trading and returns him to the position he was in 

before he broke the law.'' 107 Apparently discounting the possible 

criminal sanctions and the reputational harm associated with injunctive 

and ancillary relief, the Commission explained to Congress, "[A ]n 

insider who is caught improperly profiting from the use of material 

information is placed in no worse a position than the honest man who 

refuses to act." 108 

103. U.S. Sec. & Exch. Comm'n, Memorandum of the Securities and Exchange 

Commission in Support of the Insider Trading Sanctions Act of 1982, reprinted in H.R. 

REP. No. 98-355, 98th Cong., at 18 (1984), and in 1984 U.S.C.C.A.N. 2274, 2293 

[hereinafter SEC Memorandum in Support oflnsider Trading Sanction Act]. 

104. Letter from John Shad, Chairman, U.S. Sec. & Exch. Comm'n, to Hon. Thomas 

P. O'Neill, Jr., with accompanying memorandum (Sept. 27, 1982), reprinted in H.R. 

REP. No. 98-355, 98th Cong., at 18 (1984), and in 1984 U.S.C.C.A.N. 2274,2292. 

105. SEC Memorandum in Support oflnsider Trading Sanction Act, supra note 103, 

at 24. 

106. !d. 

107. Jd. 

108. ld (quoting HARVEY J. GOLDSCHMID, REPORT FOR THE U.S. ADMINISTRATIVE 

CONFERENCE: AN EVALUATION OF TilE PRESIDENT AND POTENTIAL USE OF CIVIL 
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In response, Congress passed the Insider Trading Sanctions Act of 

1984 ("ITSA"), which was signed into law on August l 0, 1984. ITSA 

authorized treble damages in insider trading cases 109 and increased the 

maximum criminal fine for Exchange Act violations to $100,000. 110 

ITSA was the first significant legislation that provided the SEC with the 

authority to penalize, and it was premised on the Commission's limited 

belief that penalties in the form of monetary sanctions were necessary to 

deter the specific securities law violation of insider trading. 111 At that 

time, the Commission believed that existing remedies were effective 

against other securities Jaw violations. 

Insider Trading and Securities Fraud EnfOrcement Act o(1988 

After the passage of ITSA, Congress continued to evaluate whether 

the legislation was sufficient to deter insider trading. 112 In the mid1980s, insider-trading scandals dominated the financial news and 

involved such high-profile Wall Street traders as Ivan Boesky, Michael 

Milken, and Dennis Levine. 113 Insider trading became the focus of 

Congressional hearings in June and July 1986 and continued to be the 

focus of hearings for the next several years. 114 

In 1988, members of the House Committee on Energy and 

Commerce introduced additional legislation "[a]fter learning of an 

increasing number of serious insider trading cases." 115 The new 

MONEY PENALTIES AS A SANCTION BY THE fEDERAL ADMINISTRATIVE AGENCIES 36 

(1972)). 

109. See Insider Trading Sanctions Act of 1984, Pub. L. No. 98-376, § 2, 98 Stat. 

1264 (codified as amended in scattered sections of 15 U.S. C.). 

110. See id § 3. Previously, the maximum criminal fine for Exchange Act 

violations was $10,000. !d. 

Ill. See Memorandum to Chairman Wirth, supra note 87 (transmitting "Results of 

the Review of the Adequacy of Enforcement Remedies and Sanctions"). 

112. See Thomas J. Woo, Legis/a/ion and Legitimation: Congress and Insider 

Trading in the 1980s (The Berkeley Electronic Press, Working Paper No. 941, 2006), 

available at http://law.bepress.com/cgi/viewcontent.cgi?article=4566&context=expres 

so. 

113. !d. at 7. 

114. /d. 

115. Stuart J. Kaswell, An Insider's View of the Insider Trading and Securities 

Fraud Enforcement Act of /988, 45 Bus. LAW. 145 (1989); see also H.R. REP. No. 100-

910, IOOth Cong., at 7 (1988), reprinted in 1988 U.S.C.C.A.N. 6043, 6044 ("The 

Insider Trading and Securities Fraud Enforcement Act of 1988 represents the response 

of [the House Committee on Energy and Commerce] to a series of revelations over the 
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legislation, the Insider Trading and Securities Fraud Enforcement Act of 

1988 ("ITSFEA"), was prompted by an "unstated premise that brokerdealers in particular, and others in general, were not doing enough to 

detect and deter insider trading." 1 16 

Congress passed ITSFEA and President Reagan signed it into law 

in November 1988. The new law extended the SEC's authority to 

impose penalties on persons who control a person who trades on 

material nonpublic information in violation of the law,m and it required 

broker-dealers and investment advisers to "establish, maintain, and 

enforce written policies and procedures reasonably designed ... to 

prevent the misuse ... of material, nonpublic information." 118 ITSFEA 

extended the DOJ's criminal authority by: (1) increasing maximum 

criminal fines for Exchange Act violations to $1,000,000 for individuals 

and $2,500,000 for non-natural persons;n 9 (2) increasing the maximum 

duration of imprisonment to ten years; 120 and (3) authorizing the 

payment of a reward to those "persons who provide information leading 

to the imposition of [a] penalty." 121 ITSFEA also vested private 

plaintiffs with authority to assist in the deterrence effort by creating an 

express private right of action against insiders who trade on material 

nonpublic information. 122 

The Securities EnfOrcement Remedies and Penny Stock 

Reform Act ofl 990 

ln October 1987, prior to the passage of the ITSFEA, the National 

Commission on Fraudulent Financial Reporting-dubbed the "Treadway 

Commission" after its chairman, former SEC Commissioner James C. 

Treadway, Jr.-published a comprehensive report that identified causes 

of financial reporting fraud and issued recommendations for their 

last two years concerning serious episodes of abusive and illegal practices on Wall 

Street."). 

116. Kaswell, supra note 115, at 156. 

117. Insider Trading and Securities Fraud Enforcement Act of 1988, Pub. L. No. 

100-704, § 3, 102 Stat. 4677 (codified as amended in scattered sections of 15 U.S.C). 

The penalty authorized for such control persons could not exceed the greater of three 

times the profit realized or Joss avoided or $1,000,000. I d. 

118. !d. 

119. Jd § 4. 

120. !d. 

121. !d. § 3. 

122. !d. § 5. 
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reduction. 123 The Treadway Commission Report recommended the 

creation of additional SEC enforcement remedies, namely the imposition 

of fines outside the limited context of insider trading cases, cease-anddesist orders and corporate officer and director bars or suspensions. 124 

The stated purpose of these proposals was to afford the Commission 

"[t]he ability to tailor enforcement actions more precisely to particular 

facts[,] [thereby] enabl[ing] the SEC to maximize its enforcement 

effectiveness."I 25 In response to the Treadway Commission Report, the 

chairman directed the staff to develop legislative recommendations in 

response to the conclusions of the Treadway Commission. 126 

Although the House Committee on Energy and Commerce 

anticipated taking up the SEC's legislative proposals in response to the 

Treadway Commission at the same time the House Committee 

considered ITSFEA, 127 the SEC was unable to complete its proposals in 

time for inclusion in that legislation. 128 To prompt the SEC to submit 

additional legislative proposals, Congress added section 3(c) to ITSFEA, 

which directed the Commission to submit to Congress "any 

recommendations the Commission considers appropriate with respect to 

the extension of the Commission's authority to seck civil penalties or 

impose administrative fines." 129 

After ITSFEA was passed, but before it was signed into law, the 

Commission submitted to Congress its first recommended legislative 

response to the recommendations of the Treadway Commission. 130 The 

Commission initially asked for the authority to seek civil penalties in all 

administrative proceedings, including in proceedings against issuers 

under explicit, limited circumstances. 

In a memorandum to Congress, the Commission, under Chairman 

David Ruder, set forth the factors that should be considered m 

determining whether to seek a civil penalty against an issuer in an 

123. See NAT'L COMM'N ON FRAUDULENT FIN. REPORTING, REPORT OF THE 

NATIONAL COMMISSION ON FRAUDULENT FINANCIAL REPORTING (1987), available at 

http://www.coso.org/Pub1ications/NCFFR.pdf. 

124. See id at 64-67. 

125. Jd at 64. 

126. Kaswell, supra note 115, at 171. 

127. ld 

128. Id 

129. Insider Trading and Securities Fraud Enforcement Act§ 3. 

130. See H.R. REP. No. 101-616, IOlth Cong., at 15 (1990), reprinted in 1990 

U.S.C.C.A.N. 1379. 
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administrative proceeding. 131 First, the SEC underscored that the 

proposed law would not "dictate" that the Commission must seek or 

impose a civil penalty against an issuer. 132 Instead, as the Commission 

explained, the Commission could proceed against culpable individuals 

and exercise discretion in not seeking an issuer penalty. 133 Second, the 

Commission stressed that it "may properly take into account its concern 

that civil penalties assessed against corporate issuers will ultimately be 

paid by shareholders who were themselves victimized by the 

violations." 134 The Commission explained that penalties should be 

assessed against issuers only in the rare situation where the issuer 

received a "direct economic benefit" from the fraud: 

In a typical case of financial fraud in which a[n] issuer overstates 

it[s] earnings and revenues, for example, the only shareholders who 

reap a direct economic benefit are those who sell their shares at an 

inflated price before the fraud is exposed. By the time that an 

enforcement action is brought, a large percentage of the shareholders 

may consist of persons who purchased shares at a price that was 

artificially inflated as a result of the fraud. To assess a civil penalty 

in such a case against the issuer. as opposed to the individual 

officers who were responsible for the fraud, would appear to he 

inequitable. 135 

The Commission further elaborated in a footnote on the limited 

instances where shareholders of a company might have received a direct 

economic benefit from fraud: 

The lack of a direct economic benefit to shareholders differentiates 

financial fraud from other types of violations for which public 

companies may be fined under other statutes. For example, if a 

corporation violates environmental standards relating to emissions 

control, it general~ realizes a cost saving that is ultimately realized 

by shareholders. 13 

Third, the Commission stated that a civil penalty should be imposed 

on an issuer "only where the violation resulted in an improper benefit to 

131. SEC Memorandum in Support oflnsider Trading Sanction Act, supra note 103, 

at4. 

132. Id. 

133. Jd. 

134. Id. 

135. 1d. (emphasis added). 

I 36. I d. at 4 n.5 
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shareholders," but that, even under those circumstances, the passage of 

time and resulting shareholder turnover may weigh against imposing a 

penalty. 137 

Central to the Commission's analysis of the propriety of seeking a 

penalty against an individual or an issuer was whether the penalty would 

serve a "public interest." 138 To that point, the Commission outlined 

several additional factors it would consider to determine if the penalty 

was in the public interest: 

• whether the act or omtsswn for which such penalty is 

assessed involved fraud, deceit, manipulation, or deliberate 

or reckless disregard of a regulatory requirement; 

• the harm to other persons resulting either directly or 

indirectly from such act or omission; 

• the extent to which any person was unjustly enriched, 

taking into account any restitution made to persons injured 

by such behavior; 139 

• whether such person previously has been found by the 

Commission, other appropriate regulatory agency, or selfregulatory organization to have violated the federal 

securities laws, state securities laws, or the rules of a selfregulatory organization, or has been enjoined by a court of 

competent jurisdiction from violations of such laws or rules; 

• the need to deter such person and other persons from 

committing such acts or omissions; and 

• such other matters as justice may require. 140 

In its February 1, 1990, "modified proposal" to Congress, the 

Commission removed its request for the authority to seek civil monetary 

137. Id at 5. 

138. ld at 9. 

139. !d. (emphasis added); compare Press Release, U.S. Sec. & Exch. Comm'n, 

Statement of the Securities and Exchange Commission Concerning Financial Penalties 

(Jan. 4, 2006) (omitting this clause), available at http://www.sec.gov/news/press/2006-

4.htm. 

140. SEC Memorandum in Support of Insider Trading Sanction Act, supra note 103, 

at 9. 
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penalties against issuers in administrative proceedings. 141 The 

Commission also removed its prior request for authority to impose 

officer and director bars in administrative proceedings. 142 The modified 

proposal added provisions that expressly authorized the SEC to issue 

cease-and-desist orders and to order disgorgement in administrative 

proceedings, and allowed federal courts to bar persons from serving as 

directors or officers. 143 The Commission· s "modified proposal" 

eventually became law through the "the Securities Enforcement 

Remedies and Penny Stock Reform Act of 1990," commonly referred to 

as "The Remedies Act." 

As enacted, the Remedies Act significantly expanded the 

pennissible enforcement remedies the Commission may seek in civil 

proceedings or impose in administrative proeeedings. 144 The Remedies 

Act formulated a three-tiered penalty framework, which sets forth the 

amount of a fine based on the number and nature of violations. 145 At 

each tier, the fine may not exceed the higher of the gross pecuniary gain 

or the maximum statutory amount. 146 This variable penalty framework 

was not in the original draft of the Remedies Act but was later included 

to reflect the Commission's belief that variable penalties would aid in 

141. See The Securities Lmv Enforcement Act of 1990: Hearings on S. 647 Before 

the S. Subcomm. on Sec., JOist Cong. 31 (1990) (statement by Richard C. Breeden, 

Chairman, U.S. Sec. & Exch. Comm'n). 

142. Jd. 

143. !d. 

144. For a general discussion of each class of remedies created by the Remedies Act, 

see Richard A. Spehr & Michelle J. Annunziata, The Remedies Act Turns Fifteen: What 

is its Relevance Today?, 1 N.Y.U J. L. & Bus. 587, 589-95 (2005). 

145. See The Securities Law Enforcement Remedies Act of 1990, S. REP. No. 101-

337, JOist Cong. (1990). Originally, there were three tiers of maximum penalty 

amounts separated according to the gravity and extent of harm caused by the violation, 

and each penalty is per violation. For SEC administrative proceedings, the first tier 

penalty was $5,000 for natural citizens and $50,000 for any other person. The second 

tier maximum penalty was $50,000 for natural persons and $250,000 for any other 

person and applies to violations involving fraud, deceit, manipulation or deliberate or 

reckless disregard of a regulatory requirement. The third-tier penalty for natural 

persons was $100,000 and $500,000 for any other person and applies to violations that 

either resulted in substantial losses to other persons or created the risk of such losses. 

These amounts have been increased by subsequent regulation. See 17 C.F.R. 201.1001, 

et seq. (citing the Debt Collection Improvement Act of 1996). 

146. See id. 
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tailoring the size of the penalty to fit the circumstances of individual 

cases. 147 

The Remedies Act further gave the SEC the power to seek (and an 

administrative law judge to impose) civil penalties through 

administrative proceedings against specified persons and entities directly 

regulated by the Commission, such as broker-dealers and investment 

advisors, when a penalty would be in the "public interest." 148 The 

Remedies Act also gave the SEC the power to seek civil monetary 

penalties against issuers, but only in federal court proceedings. 

Although Congress understood that imposing civil monetary penalties 

on issuers would hann shareholders, 149 Congress expected that the SEC 

would exercise discretion and seck civil monetary penalties against 

issuers only when a violation resulted in improper benefits to 

shareholders. 150 

Congress took comfort in the fact that federal judges would operate 

as an independent check to the Commission's decision to seek an issuer 

penalty and the amount sought to be recovered. The concern among 

members of Congress and internally at the SEC was that if the same 

remedies were available to the SEC under both judicial and 

administrative proceedings, then the SEC might be perceived to have an 

incentive to conduct more enforcement actions through its own 

147. See SEC Memorandum in Support of Insider Trading Sanction Act, supra note 

103, at 49; see also S. REP. No. 101-337, !Olst Cong. (1990) 

148. See Securities Enforcement Remedies and Penny Stock Reform Act of 1990, 

Pub. L. No. 101-429, § 202, 104 Stat. 931 (1990) (for certain Exchange Act violations); 

id. § 301 (for certain Investment Company Act violations); id. § 402 (for certain 

Advisers Act violations). 

149. See The Securities Lmv Enforcement Remedies Act of 1990: Hearings on S. 647 

Before the S. Subcomm. on Sec., !Oist Cong. 85 (1990) (statement by Sen. John Heinz) 

("Doesn't the imposition of a fine against a publicly held company penalize the 

shareholder?"). 

150. SeeS.REPNo.lOl-337, IOlstCong. 16-17(1990). EchoingtheCommission's 

intent, the Senate Committee on Banking, Housing, and Urban Affairs stated that it 

intends that a penalty be sought when the violation results in an improper benefit to 

shareholders. In cases in which shareholders are the principal victims of the 

violations, the Committee expects that the SEC, when appropriate, will seek penalties 

from the individual offenders acting for a corporate issuer. Moreover, in deciding 

whether and to what extent to assess a penalty against the issuer, the court may 

properly take into account whether civil penalties assessed against corporate issue[r]s 

will ultimately be paid by shareholders who were themselves victimized by the 

violations. 

Jd.at17. 
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administrative proceedings, rather than before a federal district court 

judge. The final legislation did not include penalty authority in 

administrative proceedings precisely because there would be no 

oversight by Article III judges as there would be in civil proceedings. In 

practice, however, public companies seldom choose to litigate with the 

SEC, and settled injunctive actions rarely receive any detailed judicial 

scrutiny. To guarantee the safeguards that normally accompany a 

judicial determination of a penalty, commissioners must exercise 

sufficient, policy-level scrutiny, such as the "public interest" analysis 

described above, in evaluating a penalty recommendation. 151 

After the Remedies Act was signed into law in 1990 and before the 

SEC's April 2002 Xerox case, 152 the Commission brought only four 

issuer-penalty cases, totaling less than $5 million. 153 The Xerox case, in 

which the company paid a $10 million penalty, is viewed by many as the 

beginning of the "corporate penalty era" at the Commission. Between 

the Xerox case and the date this Article was written, the Commission 

has imposed penalties against approximately sixty issuers, totaling 

billions of dollars. 

THE CORPORATE SCANDALS AT THE BEGINNING OF THE 21ST CENTURY 

In the first years of this century, the investing public was scarred by 

major corporate scandals leading to the demise of several large 

companies such as Enron Corp. 154 and WorldCom Inc. 155 that were 

151. In January 2006, the Commission issued a statement outlining the parameters 

under which it would consider seeking penalties against issuers. See il?fra, text 

accompanying notes 178-181. 

152. Xerox Corp., Litigation Release No. 17465, 77 SEC Docket 971, 2002 WL 

535379 (Apr. 11, 2002). 

153. There were large penalties against registered entities during this period. See. 

e.g., Press Release, Department of Justice and SEC Enter $290 Million Settlement with 

Solomon Brothers in Treasury Securities Case, available at http://W\.Vw.usdoj.gov/atr/pu 

blic/press _releases/1992/211182.htm. These penalties are not discussed in this Article 

because they were levied against registered entities for defrauding their customers or 

the market, as opposed to defrauding their shareholders. 

154. At the time that it declared bankruptcy in 2001, Enron was the seventh largest 

company on the Fortune 500 list by revenues. See Matt Moore, Bankrupt Enron No. 5 

in Fortune 500 List, HOUSTON CHRONICLE, Apr. 4, 2002, available at 

http://www.chron.com/disp/story.mpl/special/enron/1327642.html. 

155. Until the financial problems of WorldCom became acute in spring 2002, the 

bills under consideration in the Senate and House were not given much chance of 

passage. See Peter J. Wa!!ison, Sarbanes-Oxley as an Jnside-the-BeltJVay Phenomenon, 
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viewed previously as paragons of industry. Congress reacted to the new 

spate of corporate scandals in the same way that it did in response to the 

insider trading scandals of the 1980s-it provided the SEC with 

significant authority to enforce new and existing laws. 156 The SarbanesOxley Act of 2002 imposed significant, additional requirements on 

corporations and their officers and directors. 157 The Sarbanes-Oxlcy Act 

greatly expanded the Commission's enforcement powers and the 

criminal penalties for violating the federal securities laws. 158 

Section 1105 of the Sarbanes-Oxley Act permits the SEC to obtain 

officer and director bars in administrative proceedings, and section 

305(a) amended 15 U.S.C. § 78u(d)(2) and 15 U.S.C. § 77t(e) by 

lowering the standard for obtaining a bar from "substantially unfit" to 

"unfit." Prior to the adoption of the Sarbanes-Oxlcy Act, an officer and 

director bar was available only in civil injunctive actions after a showing 

that the officer or director was "substantially unfit" to serve in the 

position. 159 

Section 308(a) of the Sarbanes-Oxley Act contained a novel "Fair 

Funds" provision that allows the Commission to disperse the penalties 

obtained from wrongdoers to compensate harmed shareholders. 160 

Section 308 had no counterpart in the Senate bill, because it was added 

AMERICAN ENTER. lNST. FOR PUB. POLICY RESEARCH, June 2004, at 2, available at 

http://www .aei.org/publications/pub!D.20582/pub _detail. asp. The collapse of 

WorldCom, relatively close to the 2002 congressional election, which both political 

parties acknowledged as a rematch of the very close presidential election of2000, led to 

the eventual enactment of the Sarbanes-Ox!ey Act, with only three votes against it in 

the entire Congress. Some in Washington dubbed the Sarbanes-Oxley Act the "Bernie 

Ebbers Memorial Act" after the then-CEO ofWorldCom. 

156. In the intervening years following the Remedies Act, Congress did not adjust 

the SEC's enforcement authority to any great extent. The principal exception was the 

Private Securities Litigation Reform Act of 1995 §104, Pub. L. No. 104-67, 109 Stat. 

737 (1995) (codified at 15 U.S.C. 78t(e)). The PSLRA amended the securities laws to 

allow the SEC to bring actions against secondary violators that aid and abet securities 

law violations. Congress wisely declined to extend that right to private parties, out of 

concern over abusive securities litigation. 

157. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (codified in 

scattered sections of 11, 15, 18, 28, and 29 U.S.C.). 

158. The changes relevant to this Article are discussed below. The Sarbanes-Oxlcy 

Act included other provisions that are not discussed here. 

159. Sarbanes-Ox!ey Act§ 1105, 15 U.S.C. 7246 (2006). 

160. Id. § 308(a). 
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during the conference process. 161 Accordingly, the Senate Banking 

Committee report does not discuss this provision. 

Prior to Section 308(a), the Commission was permitted to remit 

amounts obtained in actions as disgorgement to injured investors, but 

was required to remit any penalties it received to the U.S. Treasury. 

Section 308(a) provided flexibility to the Commission to distribute both 

disgorgement and penalties through a Fair Fund, but the penalties cannot 

be dispersed absent disgorgement of ill-gotten gains. 162 Congress, 

joined by the Justice Department, wanted to avoid having penalties 

become a substitute for disgorgement. Disgorgement is the forfeiture of 

the ill-gotten gains received by the defendant; it is not inherently a 

mechanism to recompense aggrieved investors. By making 

disgorgement a prerequisite for adding penalties to the Fair Fund, 

Congress focused on depriving the defendant of its ill-gotten gains, not 

necessarily punishing wrongdoers. 163 Congress also may have been 

concerned with a possible windfall to investors if the defendant did not 

receive any ill-gotten gain from the wrongdoing. 

Congress also required the SEC to study ways to improve the Fair 

Funds process. Section 308( c) of Sarbanes-Oxley instructed the SEC to 

review and analyze enforcement actions over the course of the five years 

prior to enactment "to identify areas where such proceedings may be 

utilized to efficiently, effectively, and fairly provide restitution for 

injured investors ... including methods to improve the collection rates 

161. See Press Release, Baker Proposes New Federal investor Restitution Fund (July 

17, 2002), available at http://web.archive.org/web/200311 08035021/www.baker.hous 

e.gov/News/fair_fund.htm [hereinafter Baker!]. 

162. See Sarbanes-Oxley Act § 308(a). Within the first six months of having the 

authority, the Commission sought federal court approval ofF air Fund distributions on at 

least 12 occasions. Stephen Cutler, Dir. of Enforcement, U.S. Sec. & Exch. Comm'n, 

Testimony Concerning Returning Funds to Defrauded Investors Before the H. 

Subcomm. on Capital Mkts., Ins., & Gov't Sponsored Enters., Comm. on Fin. Servs. 10 

(Feb. 26, 2003) available at http://www.sec.gov/news/testimony/022603tssmc.htm 

[hereinafter Cutler Testimony]. 

163. See Press Release, Baker Statement to Open House-Senate Conference on 

Corporate Reform (July 19, 2002), available at http:l/web.archive.org/web/2003090603 

5258/www.baker.house.gov/News/conf_corprfm.htm. 

How is it possible for anyone to sit idly by while watching a corporate official move 

into his $20 million mansion, with hundreds of millions of dollars in retirement 

benefits, having generated this lifestyle by manipulating the books and defrauding 

shareholders? With the adoption of the FAIR plan, we will make this much less likely 

to occur and offer the hope to investors for a small reduction in their loss. 

!d.; see also Baker l, supra note 161. 
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for civil penalties and disgorgements." 164 Section 308(c) instructed the 

SEC to provide a report to Congress within 180 days of the enactment of 

the Act that included "a discussion of regulatory or legislative actions" 

that the SEC recommended or "that may be necessary to address 

concerns identified in the study." 165 

In response to Section 308( c), the Commission submitted a report to 

Congress on January 23, 2003. 166 In its report, the Commission 

described the limitations of the requirement in Section 308(a) for the 

SEC to obtain disgorgement before adding the penalty amount to the 

Fair Fund: 

Currently, the Fair Fund provision permits the Commission to add 

penalty money to distribution funds in limited circumstances. If a 

defendant is ordered only to pay a penalty, then that defendant's 

penalty amount cannot be added to the disgorgement fund. 

Moreover, if no defendants in a case are ordered to pay 

disgorgement, then no penalties may be distributed to injured 

investors. Some issuer financial fraud and reporting cases do not 

result in any disgorgement orders because no defendant received a 

tangible profit causally connected to the fraud. 167 

To alleviate these restrictions, the Commission recommended that 

Congress amend Section 308 to permit the penalties to be added to the 

Fair Funds even when no disgorgement is obtained. The Commission's 

report stated: 

By amending the Fair Fund provision to allow defendants' penalties 

to be distributed to investors irrespective of whether the defendant 

has been ordered to disgorge money, Con~ress could allow more 

monies to be returned to harmed investors. 16 

164. Sarbanes-Oxley Act § 308( c). 

165. !d. 

166. See U.S. SEC. & EXCH. COMM'N, REPORT PURSUANT TO SECTION 308(C) OF THE 

SARBANES OXLEY ACT OF 2002, available at http://www.sec.gov/news/studies/sox308c 

report. pdf. 

167. I d. at 34. 

168. !d.; see also Cutler Testimony, supra note 162. 

I d. 

[I]t would be beneficial if the Commission could distribute penalties collected from 

these defendants (as well as from defendants who are paying disgorgement) to harmed 

investors in that case .... We recommend making technical amendments to the Fair 

Fund provision to permit the Commission to use penalty moneys for distribution funds 

in these additional circumstances. 
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In response to the Commission's request, Chairman Richard Baker 

of the Subcommittee on Capital Markets, Insurance, and GovernmentSponsored Enterprises of the House Financial Services Committee 

introduced legislation in 2003 and 2006 to permit any penalty monies 

obtaining by the Commission to be added to a Fair Fund for the benefit 

of victims of the securities law violation. 169 Neither bill passed 

Congress. 170 

Proponents of corporate penalties argue that the Fair Funds 

provision of the Section 308 of the Sarbanes-Oxley Act alleviates the 

earlier concerns raised by the Commission in 1989 and Congress in 

1990 about harm to shareholders, because any penalties collected are 

distributed to shareholders. This argument is premised on flawed, 

circular reasoning. When the Commission obtains penalties from a 

corporation, there is always one group of shareholders that must pay. 

The Commission is taking from one group of shareholders to 

recompense another. 171 Whatever its characterization, ultimately the 

costs of making this circular distribution are borne by shareholders. 

There is no doubt that Section 308 was rooted in good intentions of 

attempting to help defrauded shareholders. Unfortunately, it has 

injected an element of uncertainty because penalties are inherently 

subjective, while disgorgement is rooted in the notion of illicit gain, 

which generally is quantifiable. In many instances, the SEC has 

avoided-some argue circumvented-the requirements of Section 308 

by assessing a "nominal" disgorgement amount of $1 in order to obtain 

the "hook" to justify seeking a large corporate penalty to put into a Fair 

Fund for distribution. 172 As a result, the Fair Fund provision, which was 

169. See Fair Fund Improvement Act, H.R. 5956, 109th Cong. (2006); Securities 

Fraud Deterrence and Investor Restitution Act of2004, H.R. 2179, 108th Cong. (2004); 

Dissenting Views to Accompany H.R. 2179, H.R. REP. No. 108-475 (Apr. 27, 2004); 

see also Press Release, Baker, Oxley Introduce Bill To Strengthen SEC Powers Against 

Securities Fraud, Return Funds To Defrauded Investors (May 21, 2003), available at 

http://wcb.archive.org/web/20030602 

192406/www.baker.house.gov/N ews/fair _ bill.htm. 

170. The bills did not advance in Congress because of the general unwillingness to 

re-open the Sarbanes-Oxley Act of2002. 

171. The Fair Fund distribution thus creates a circular situation: the Commission 

penalizes a corporation to put the money into a fund to reimburse the shareholders who 

were themselves just indirectly penalized. 

172. See, e.g., Bruce Carton, When a Dollar (of Disgorgement) Is Worth Millions, 

SEC. CLASS ACTION SERV., (Institutional S'holder Servs.), Dec. 3, 2004, available at 

http:/ /seas. issproxy. co miN ewsletter/i ssscasDecem ber2004. htm I #PO VEd itori a! (discus-
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designed to protect shareholders, has been used as a justification for 

obtaining large corporate penalties, which may harm shareholders. 

Therein lies the paradox: Fair Funds used to compensate injured 

shareholders are often funded largely through corporate penalties, which 

are paid by the corporation's current shareholders and result in 

additional adverse consequences for the company through depletion of 

its assets. 

AN ERA OF INCREASING PENAL TIES AGAINST SHAREHOLDERS 

The size of the penalties imposed by the Commission has increased 

markedly in recent years. 173 For example, in 2002, the SEC obtained its 

first $10 million penalty against a public corporation in its settlement 

with Xerox Corporation. 174 Since then, the Commission has levied 

many civil penalties in that amount or larger. In 2003, the Commission 

obtained twenty penalties in that range or greater, while in 2004, it 

sing recent settlements such as Symbol Technologies ($1 disgorgement; $37,000,000 

civil penalty), i2 Technologies ($1 disgorgemcnt; $10,000,000 civil penalty), Royal 

Dutch Petroleum ($1 disgorgement; $120,000,000 civil penalty), Bristol-Myers Squibb 

Co. ($1 disgorgement; $150,000,000 civil penalty), and Qwest ($1 disgorgement; 

$250,000,000 civil penalty)). Disgorgement is a remedy that, if available, is supposed 

to be exhausted before the SEC seeks a penalty. Therefore, only in the rarest of 

circumstances should the SEC seek a penalty that accomplishes the goal of stripping 

away an ill-gotten benefit. Unfortunately, that has not been the case in many SEC 

penalty actions. Many of those actions have blurred the distinction between "benefit" 

and "restitution." 

173. Not only have civil monetary penalties increased, the number of officer and 

director bars has also increased drastically over the last several years as has the 

involvement of criminal authorities, such as the Department of Justice, in securities Jaw 

violations. In 2004, 170 director and officer bars were entered·-more than three times 

as many as entered in 2001-·and the DOJ brought criminal proceedings against 302 

entities and individuals in SEC related matters. U.S. CHAMBER OF COMMERCE, REPORT 

ON THE CURRENT ENFORCEMENT PROGRAM OF THE SECURITIES AND EXCHANGE 

COMMISSION 25 (2006), available at http://www.uschamber.com/NR/rdonlyres/eodmud 

jqljq2lvttjhn56rn4uubva3yoyzeijj2sh4ugkxlo6xyrpu3cqismvuckpgea3o4gpn4utyo7uzs7 

ueqydmc/0603SECEnforcemcntStudy .pdf 

174. Xerox Corp., Litigation Release No. 17465, 77 SEC Docket 971, 2002 WL 

535379 (Apr. 11, 2002); see U.S. SEC. & EXCI!. COMM'N, 2004 ANNUAL PERFORMANCE 

PLAN AND 2002 ANNUAL PERFORMANCE REPORT (2003), available at 

http://www.sec.gov/aboutlgpra2004_ 2002.pdf. 
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obtained forty such penalties. 175 The total amount of issuer penalties in 

2003 and 2004 was greater than the total amount of all penalties 

imposed by the SEC for the prior fifteen years combined. From 2003 

through 2007, approximately $13.8 billion in disgorgement and civil 

penalties were ordered to be paid to the SEC, courts, or other appointed 

trustees. 176 

An essential consideration in deciding the appropriateness of any 

corporate penalty is determining who has profited from the illegal 

conduct. Sometimes, shareholders have benefited, as in cases of price 

fixing or bribery of foreign officials; without the bribe, the corporation 

would not have received a benefit. Regulated entities, such as brokerdealers or registered investment advisors, might increase profits or 

revenues, which in tum benefit shareholders, by failing to comply with 

regulatory requirements. 177 In the rare instances where disgorgement 

may be difficult to calculate, corporate penalties may be appropriate to 

reverse the ill-gotten benefit. 

On the other hand, there are situations where the shareholders did 

not benefit from the securities law violation. In a typical financial fraud 

case, management misrepresented the corporation's financial 

performance to the owners of the corporation. In the typical case, the 

shareholders have suffered from management's deception and received 

no ill-gotten gain. When the fraud becomes public, often the market 

reacts by depressing the value of the stock. In addition, an investigation 

and ensuing litigation distracts management from the business, drains 

corporate resources, and harms the corporation's reputation. A penalty 

would add further to shareholder injury. 

In the majority of SEC corporate penalty cases, the corporation has 

also been sued for the same transgressions in civil class action suits 

seeking restitution for allegedly harmed shareholders. Settlement 

proceeds from such private actions should be recognized by the 

Commission as an offset when determining whether to penalize a 

corporation in a financial fraud case. Indeed, by statute, the 

Commission must consider such restitution in its own administrative 

proceedings when a penalty is under consideration. 

175. See U.S. SEC. & EXCH. COMM'N, 2004 ANNUAL PERFORMANCE REPORT (2005), 

available at http://www.sec.gov/about/secpar/secpar04.pdf; U.S. SEC. & ExcH. 

COMM'N, ANNUAL REPORT 2003 (2004), available at http://www.sec.gov/pdf/annrep03/ 

ar03full.pdf. 

176. 2007 REPORT, supra note 9, at 26. 

177. Penalty figures in this Article do not include regulated entities. 
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Another essential consideration in seeking and imposing a penalty 

is the effectiveness of the sanction. There is an inherent conflict of 

interest between management and shareholders of a corporation. If 

senior managers are faced with the threat of enforcement actions against 

them or their former colleagues, the senior managers might be motivated 

by their self-interest to settle the action against the corporation for a 

large corporate penalty. The penalty obtained in settlement with the 

corporation may satisfY the SEC's desire to garner public awareness 

(and thus enhance the "deterrent" effect), causing the SEC to forgo 

seeking large penalties against individual managers. This willingness to 

forgo seeking penalties against individuals increases when the evidence 

against the individuals is relatively weak (indicating a greater risk of 

losing at trial), or when the individuals have negligible assets or name 

recognition (diminished publicity and deterrence value). 

Other potential conflicts of interest exist between management and 

shareholders that may interfere with the effectiveness of the sanction. 

New senior managers, who may have started after the departure of 

former employees tainted by the fraud, may feel compelled to settle the 

matter to minimize negative publicity from their being associated with 

the fraud. In addition, corporate boards, while exercising business 

judgment, may approve a settlement to avoid the costs and other 

negative effects of prolonged litigation with the SEC. 

As both a philosophical and practical matter, the effectiveness of a 

corporate penalty as a means for deterrence is questionable. 

Corporations do not act; individuals do. Senior managers who commit 

fraud undoubtedly do so with the knowledge that their actions, if 

exposed, will cause reputational and economic harm to their corporation, 

such as a depressed stock price, loss of customers and business partners, 

shareholder litigation, and legal and investigative costs. Often, what 

motivates the wrongdoer to commit the fraud is the potential personal 

pecuniary gain of increased stock price, personal advancement within 

the corporation, or masking the negative effects of strategic or tactical 

management decisions on the performance of the company. If 

wrongdoers have little concern for their company and shareholders when 

they commit the fraud, it is doubtful that the behavior of potential 

wrongdoers will be altered by the threat of a corporate penalty on the 

company and shareholders that they are seeking to victimize. Are 

would-be fraudsters more likely to be deterred by headlines trumpeting a 

multimillion dollar corporate fine, or by hearing that a senior executive 

was fired, lost his savings, became barred from serving as an officer or a 
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director, suffered irreparable harm to his reputation, and perhaps faces 

incarceration? 

Each of these considerations continues to be important when the 

Commission evaluates whether to seek a penalty against a corporation. 

In providing the SEC with the power to seek penalties against 

corporations, Congress recognized the need for the SEC to have the 

authority in limited and rare circumstances, and it trusted the SEC with 

the discretion to use that authority in accordance with the SEC's mission 

of protecting investors. In order to provide some transparency to the 

process, the Commission has issued guidance to the public concerning 

what factors the Commission considers and what prospective defendants 

may do to avoid a penalty or reduce the amount. 

THE 2006 STATEMENT OF THE SECURITIES AND EXCHANGE COMMISSION 

CONCERNING FINANCIAL PENALTIES 

Under a new chairman, the Commission on January 4, 2006, 

released a statement concerning the factors that the SEC would evaluate 

in assessing a monetary penalty. 178 In formulating the penalty statement, 

the Commission returned to first principles: it discussed the 1989 and 

1990 Commission and Congressional statements regarding penalties and 

attempted to set up a hierarchy of balancing considerations to guide 

future deliberations. It stated unequivocally that penalties against 

corporations can harm shareholders, a point that previously had been in 

dispute within the Commission. 

The Commission explained that the two most significant factors 

are: (I) the presence or absence of a direct benefit to the corporation as a 

result of the violation, and (2) the degree to which the penalty will 

recompense or further harm shareholders. 179 The first key factor 

focused on unjust enrichment to the corporation, and thus to the 

shareholders. Any improper benefit would have to be balanced against 

the losses incurred by the shareholders as a result of the fraud. 

The second key factor balances the possibility that the penalty will 

"recompense" investors with the injury that the penalty would do to 

them. In this factor, the Commission, unfortunately, was rather 

178. Press Release, U.S. Sec. & Exch. Comm'n, Statement of the Securities and 

Exchange Commission Concerning Financial Penalties (Jan. 4, 2006), available at 

http://www.sec.gov/news/press/2006-4.htm [hereinafter 2006 Penalty Statement]. 

179. !d. 
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imprecise with its terms. In every case, current stockholders pay for the 

penalty. The purpose of this language was to cover the cases in which 

other classes of investors may have been harmed for the benefit of the 

stockholders-for example, fraudulently enhanced financial statements 

may have resulted in lower coupon interest rates or yields to 

bondholders, to the benefit of the corporation and its common 

stockholders. 

The Commission also announced secondary factors for 

consideration. Those factors are: (1) "The need to deter the particular 

type of offense;" (2) "The extent of the injury to innocent parties;" (3) 

"Whether complicity in the violation is widespread throughout the 

corporation;" (4) "The level of intent on the part of the perpetrators;" (5) 

"The degree of difficulty in detecting the particular type of offense;" (6) 

"Presence or lack of remedial steps by the corporation;" and (7) "Extent 

of cooperation with Commission and other law enforcement." 180 

The penalty statement has served as a reminder of the fact that 

corporate penalties harm shareholders. Nevertheless, it has had some 

unintended consequences. In particular, the last factor-the extent of 

cooperation with the Commission and law enforcement-has been used 

along with other Commission guidance as a means to credit prospective 

defendants, particularly corporations, for waiving their attorney-client 

privilege and work-product protections. 181 

THE SEABOARD REPORT 

The SEC's explicit willingness to credit cooperation, even if it 

involves the waiver of the attorney-client privilege and work-product 

protection, predates the 2006 Statement on Penalties and the Sarbanes180. !d. 

181. The New York Stock Exchange lists waiver of the attorney-client privilege as a 

factor in evaluating whether a Member has exhibited "extraordinary cooperation."' See 

New York Stock Exchange, Information Memorandum No. 05-65 to All Members, 

Member Organizations and Chief Operating Officers 5 (Sept. 14, 2005). Members of 

the New York Stock Exchange are required as a condition for listing to cooperate and 

produce documents upon request by the Exchange, but that required cooperation does 

not include a mandatory requirement to produce attorney-client privileged information. 

FINRA (formerly NASD) Rule 8210 requires members and persons associated with 

members to produce non-privileged documents and provide testimony upon request by 

FINRA. See F!NRA Rule 8210, available at http://finra.complinet.com. As a general 

matter, the SEC does not impose any similar mandatory requirements to cooperate in its 

investigations. 
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Oxley Act. On October 23, 2001, the Commission released an 

investigative report pursuant to section 21 (a) of the Exchange Act, 

addressing the relationship of cooperation and agency enforcement 

decisions. 182 That report, called the "Seaboard Report" based on the 

name of the defendant at issue, marked the first time that the 

Commission announced the factors that it would evaluate in measuring 

cooperation and assessing whether to bring an enforcement action. 

The Commission intended this report to encourage companies to 

cooperate with the SEC in investigations. In that respect, the report was 

a major improvement in the transparency of the SEC in its enforcement 

investigations. Lacking a public manual of policies and procedures, the 

SEC in effect encouraged an informal body of knowledge to develop 

among long-time SEC enforcement practitioners as to what was 

expected of potential defendants in dealing with the Commission. 183 

The Seaboard report was a long-overdue attempt to open up the process. 

Among other issues, the Seaboard Report discussed disclosures to 

staff of confidential information protected by the attorney-client 

privilege or work-product doctrine. In a footnote, the Seaboard Report 

stated: 

The Commission recognizes that these privileges, protections and 

exemptions serve important social interests. In this regard, the 

Commission does not view a company's waiver of a privilege a'> an 

end in itself, but only as a means (where necessary) to provide 

relevant and sometimes critical information to the Commission 

staff. 184 

Waiver is not itself listed as one of the Seaboard criteria for 

determining whether, and how much, to credit self-policing, selfreporting, remediation, and cooperation. Nonetheless, the Enforcement 

Division and the Commission in the ensuing years often have 

misinterpreted the Seaboard Report as a basis for rewarding companies 

for waiving privilege. As a practical matter, rewarding companies for 

182. Report of Investigation Pursuant to Section 2l(a) of the Securities Exchange 

Act of 1934 and Commission Statement on the Relationship of Cooperation to Agency 

Enforcement Decisions, Exchange Act Release No. 44,969 (Oct. 23, 2001), available at 

http://www .sec.gov /liti gation/investreport/34-44 969 .htm#P54_1 093 5. 

183. The Wells Committee had the same concern with inexperienced practitioners 

being unaware of a prospective defendant's ability to provide written submissions that 

raised factual and legal defenses. See supra, text accompanying note 58. 

184. !d at n.3. 
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cooperating by waiving privilege has the same effect as punishing them 

for not waiving privilege-both effectively strip the attorney-client 

privilege, which is a fundamental component of our legal system. 18; 

Another problem with a permissive approach to waiver is that 

waiver becomes mandatory in practice. Faced with concerns over their 

fiduciary duties and the expense and risk of litigation to the corporation, 

a corporation's board of directors may feel compelled to take full 

advantage of any cooperation credit available to it by waiving the 

attorney-client privilege and work-product protection. Indeed, 

shareholders likely would be unable to establish that the board of 

directors breached its fiduciary duty by waiving the corporation's 

privilege in exchange for cooperation credit if the corporation faced the 

threat of a large penalty. 186 

185. See, e.g., The Thompson Memorandum's Effect on the Right to Counsel in 

Corporate Investigations: Hearing Before the S. Comm. on the Judiciary (2006) 

(statement of Edwin Meese lll, former Att'y Gen. of the United States and Chairman, 

Ctr. for Legal and Judicial Studies, Heritage Foundation), available at 

http://judiciary .senate.gov/testimony .cfm?id=2054&wit_id=57 41. 

[E]xperience has shown that the [Thompson] Memorandum has resulted in the 

dilution of essential rights encompassed by the attorney-client relationship .... [T]he 

Thompson Memorandum itself pressures companies to tulfill its nine factors, 

including by waiving their attorney-client privilege and cutting off their employees' 

attorney fees. Even if no prosecutor ever mentions either factor to a company, the 

fact that the Thompson Memorandum requires federal prosecutors to take all nine of 

its factors into consideration when deciding whether to indict a business organization 

necessarily places great pressure on the company to take these two steps. 

Jd. For a discussion of the Thompson Memorandum and other Justice Department 

memoranda regarding waiver of attorney-client privilege and work-product protection, 

see irifra note 187. 

186. Just as with any individual, corporations must not obstruct government 

investigations and must comply with duly issued subpoenas and court orders. 

Individuals and corporations, however, owe no duty to abandon all potential defenses 

and privileges in the face of government investigations. In fact, under state law, the 

directors of a corporation owe fiduciary duties to their shareholders. See, e.g, Smith v. 

Van Gorkom, 488 A.2d 858 (Del. 1985) (discussing the duties of directors). Under 

most state laws, including Delaware General Corporate Law, the board of directors of a 

corporation owes to its shareholders a duty of care and loyalty. See id. In some 

instances, cooperating with the SEC or another regulator may be contrary to the 

fiduciary duties of the directors because cooperation may lead to the corporation's 

being susceptible to meritless governmental actions and frivolous shareholder litigation. 

In those circumstances, it may be appropriate for the board of directors, in fully 

evaluating the situation and exercising business judgment, to decline to waive their 

attorney-client privilege with respect to a government investigation. 
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The idea of crediting the waiving of the attorney-client privilege or 

work-product protection originated with the Department of Justice. Two 

years prior to the Seaboard Report, the DOJ published the first 

memorandum-Df what would ultimately be several memorandailluminating on the meaning of cooperation and the general principles 

that the Department of Justice follows when investigating business 

organizations. 187 These DOJ memoranda stated explicitly that a 

corporation's willingness to waive the attorney-client privilege and 

work-product protection should be considered in determining whether a 

corporation has cooperated adequately with the government. Given the 

number of parallel investigations by the DOJ and SEC, the policies of 

one agency affect the conduct of the other's investigations and limit the 

possible range of choices available to a defendant. 188 

187. The first memorandum was sent hy Deputy Attorney General Eric Holder to all 

Department Component Heads and U.S. Attorneys on June 16, 1999 (the "Holder 

Memorandum"). The Holder Memorandum focused on the prosecution of corporate 

criminal activity and included a document called "Federal Prosecution of 

Corporations," which outlined factors and considerations to be taken into account when 

charging corporations. Memorandum from Eric Holder, Deputy Att'y Gen., to Heads of 

Department Components and United States Attorneys (June 16, 1999) (on file with the 

Department of Justice). The second memorandum, which was a response to the 

substantial controversy that arose over the Holder Memorandum, was sent by Deputy 

Attorney General Larry Thompson in January 2003 and included much of the same text 

from the Holder memo, with some changes to reflect findings of the Corporate Fraud 

Task Force. Memorandum from Larry D. Thompson, Deputy Att'y Gen., to Heads of 

Department Components and United States Attorneys (Jan. 20, 2003), available at 

http://www.usdoj.gov/dag/cftf/corporate_guidelines.htm. Mounting criticism regarding 

lack of policies and procedures in this regard led acting Deputy Attorney General 

Robert McCallum in 2005 to amend the U.S. Attorney's manual to require that U.S. 

Attorneys establish a written waiver review process for their respective districts. See 

Memorandum from Robert D. McCallum, Jr., Acting Deputy Att'y Gen., to Heads of 

Department Components and United States Attorneys (Oct. 21, 2005), available at 

http://www.usdoj.gov/usao/eousalfoia_readingJoom/usam/title9/crm00163.htm. 

Finally, the Justice Department, under the direction of Deputy Attorney General Paul J. 

McNulty, released a memorandum that attempted to draw distinctions on categories of 

privileged materiaL See Memorandum from Paul J. McNulty, Deputy Attorney General, 

to Heads of Department Components and United States Attorneys (Dec. 12, 2006), 

available at http://www.usdoj.gov/dag/speeches/2006/mcnulty _ memo.pdf. The 

McNulty memorandum still gives entities credit for turning over attorney-client 

privileged material and attorney work product. 

188. The implications extend to individuals as well. DOJ allows prosecutors to 

consider a company's willingness to punish employees who assert their constitutional 

rights and whether the company entered into joint-defense or information-sharing 

agreements with employees. This policy could cause an employee to face the difficult 

choice of losing his job or cooperating in an internal investigation without counsel and 

without constitutional protections. See, e.g., Proposed Amendment of Commentary on 
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The practices of the SEC and DOJ to credit cooperation for waiving 

the attorney-client privilege or work-product protection have met with 

significant criticism. On February 5, 2007, the American Bar 

Association ("ABA") submitted to the SEC a proposed "Revised 

Commission Statement on the Relationship of Cooperation to Agency 

Enforcement Decisions," which seeks to have the SEC revise the 

Seaboard Report with respect to the waiver of the attorney-client 

privilege and work-product protection. 189 The proposal amends the 

section of the Seaboard Report describing the factors by which 

cooperation may be measured to read: "provided, however, that a 

company shall not be required to take any of the foregoing actions to the 

extent that it would result in a waiver of the attorney-client privilege or 

work product doctrine." 190 The proposal also seeks to remove the 

ambiguous footnote 3 of the Seaboard Report that describes waiver as "a 

means (where necessary) to provide relevant and sometimes critical 

information to the Commission staff." The proposal adds a new 

paragraph and related footnote describing the importance of attorneyclient privilege and work-product protection and the adverse 

consequences when staff seeks the waiver. 191 The new paragraph states 

in part: 

Commission staff shall not take any action or assert any position that 

directly or indirectly demands, requests or encourages a company or 

its attorneys to waive its attorney-client privilege or the protections 

of the work product doctrine. Also, in assessing a company's 

cooperation, Commission staff shall not draw any inference from the 

company's preservation of its attorney-client privilege and the 

protections of the work product doctrine. At the same time, the 

voluntary decision by a company to waive the attorney-client 

Section 8c2.5 of the Federal Sentencing Guidelines Regarding Waiver qf AttorneyClient Privilege and Work Product Doctrine Before the United States Sentencing 

Commission (2006) (statement of Kent Wicker, Nat'! Ass'n of Criminal Def Lawyers). 

!d. 

This compelled waiver of the attorney-client privilege forced my client to give up the 

protection at the heart of our criminal justice system: The privilege under the Fifth 

Amendment against self-incrimination. It is not enough to say he could have just 

given up his job and retained his Fifth Amendment rights. This is a real person, with a 

real family to support. 

189. Letter from Karen J. Mathis, President, American Bar Ass'n, to Christopher 

Cox, Chairman, U.S. Sec. & Exch. Comm'n (Feb. 5, 2007), available at http://www.aba 

net.orglpoladv/letters/attyclient/2007feb05 _privwaivsec _!.pdf. 

190. !d. at 2. 

191. !d. at 2-3. 
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privilege and/or the work product doctrine shall not be considered 

when assessing whether the company provided effective cooperation. 

The Commission may consider, however, in assessing whether a 

company has provided effective cooperation, the degree to which the 

company has provided factual information to the Commission staff 

in a manner, to be worked out by the company and the Commission 

staff, that preserves the protections of the attorney-client privilege 

and work product doctrine to the extent possible. 192 

Similar criticisms by other groups have been, and continue to be, 

levied against using the Seaboard Report to encourage waiver of the 

attorney-client privilege or work-product protection. 193 

As the SEC and other Federal agencies press to have the attorneyclient privilege waived as they undertake investigations, the entire 

privilege is gradually weakened. As knowledge of its weakening 

spreads, corporate employees may become less candid and forthcoming, 

corporate internal investigations will be less trustworthy, and 

shareholders and government investigators will be frustrated in their 

efforts to prevent misdeeds. Given those outcomes, revisiting Seaboard 

and the SEC's approach to the attorney-client privilege and workproduct protection is long overdue. 

A CALL FOR A NEW ADVISORY COMMIHEE 

The SEC Enforcement Division is viewed with pride by 

Commissioners, stati, alumni, and many outsiders. The Division has a 

long history of stellar achievements and dedicated attorneys, 

accountants, and other staff. Thirty-six years after its creation, the 

Division is larger, stronger, and more visible than any member of the 

Wells Committee could have imagined. Thus, it makes sense that the 

192. Td at 3. The proposal recognizes that there are limited, specific exceptions 

where the staff, after obtaining advance approval from the Director of Enforcement or 

his/her designee, may seek privileged or work-product materials. Those exceptions 

arise when the company asserts the advice of counsel defense or the SEC staff 

establishes the elements for the crime/fraud exception. Id 

193. See, e.g., McLucas, Shapiro & Song, The Decline of the Attorney-Client 

Privilege in the Corporate Setting, 96 J. CRIM. L. & CRIMINOLOGY 621 (2006); Posting 

of Thomas 0. Gorman, The Rolling Stones Test: SEC And DOJ Cooperation Standards, 

SEC Actions Blog, http://www.secactions.com/?p=I90 (May 22, 2007, 01:07 EST) 

("Conversely no cooperation credit should be given for what the government says it 

does not usually need --privileged material and waivers."). 
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2008 EVALUATING THE MISSION 409 

Commission should consider whether it is time to convene a Wells-like 

committee to "bring to date" the best thinking on enforcement practices. 

The new advisory committee's mission would be to conduct an 

independent review of the Commission's enforcement program from 

multiple, diverse perspectives, and to recommend to the Commission, if 

warranted, any needed changes. We propose that the new advisory 

committee adopt the same mandate as that of the Wells Committee in 

1972. The tasks assigned to the Wells Committee are as important today 

as they were in 1972. If the same mandate is adopted, the new advisory 

committee would be charged with virtually the same tasks as the original 

Wells Committee, only slightly adapted to developments in the last three 

decades: 

(1) reviewing and evaluating the Commission's 

enforcement policies and practices in light of its 

statutory responsibilities and mtsston to protect 

investors; to maintain fair, orderly, and efficient markets; 

and to facilitate capital formation; 

(2) advising how the SEC's enforcement objectives and 

strategies may be made more effective; 

(3) examining the Commission's enforcement practices 

and procedures from the point of view of due process, 194 

respect for the prospective defendants' attorney-client 

privilege and work-product protection, 195 the relationship 

of enforcement action to notice of legal requirements, 

the attribution of responsibility for violations, and the 

194. The Committee should consider the Commission's current procedure regarding 

authorization of cases implicating potential corporate penalties, under which the 

Commission authorizes the staff to negotiate a settlement, before the staff engages in 

any settlement discussions with the prospective defendant. At issue is whether the 

Commission, at the time of authorization of negotiations, should also authorize the staff 

to litigate if the settlement negotiations prove unfruitful, or whether the staff should 

return to the Commission to seek litigation authorization. The issues hearken back to 

those that animated the debate armmd the original Wells Committee Recommendation 

20, namely whether authorizing staff to litigate before commencing settlement 

negotiations skews the negotiations through the implicit threat to litigate if no 

settlement is reached. ::..ee supra notes 61-72 and accompanying text. 

195. Included in this task would be the need to re-evaluate the 2006 Statement 

Regarding Penalties and the 2001 Seaboard Report, particularly with respect to the 

expectation of waiver of attorney-client privilege and work-product protection as a 

determinant of cooperation. 
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protection of reputation and rights of privacy of those 

with whom the Commission interacts; 196 

(4) making recommendations on the appropriate blend of 

regulation, publicity, and formal enforcement action and 

on methods of furthering voluntary compliance with 

securities laws; 

(5) making recommendations on criteria for the selection 

and disposition of enforcement actions, in particular, 

providing timely notice to parties of the closing of an 

investigation; and 

(6) advising on the appropriate uses of penalties against 

corporations in light of the SEC's mission of protecting 

investors. 

Among the many issues that would fall under this broad mandate 

would be the implementation of mechanisms to provide more efficacy, 

predictability and transparency to the enforcement program. The overall 

philosophy and management of the enforcement program should be 

examined to determine how best it can fulfill the SEC's mission, in light 

of resources and statutory authority. 

Predictability and transparency provide for a fair process that 

respects the rights of all parties involved and ensures adherence to the 

rule of law. 197 Of course, the Commission's discretion should not be 

eliminated in favor of rote application of a mathematical formula for 

calculating penalties. Discretion plays an important role in forgoing 

certain theories of liability or not bringing an action at all. For example, 

a company and its shareholders may have been punished enough through 

196. Beyond the scope of this Article is the ancillary issue of disclosure by issuers of 

the various stages of an SEC investigation. Although in large part a facts-andcircumstances determination as to materiality, guidance would be helpful to issuers and 

practitioners. 

197. With the increasing emphasis on a more punitive enforcement approach, are 

sufficient safeguards in place to protect the rights of prospective individual defendants? 

At the time of the Wells Committee, the SEC lacked the power to seek punitive 

damages against individuals, so the potential costs to the individual defendant were not 

as pronounced as they are today. Individual defendants are faced with high costs of 

defending an SEC action and severe consequences if they lose. These consequences at 

times can be tantamount to criminal sanctions, including large monetary payments and 

loss of livelihood. Often, the only option is a pro-se defense. Will a Commission one 

day decide that it should establish a system to provide representation to individual 

defendants who cannot afford to hire private counsel? 
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2008 EVALUATING THE MISSION 411 

other avenues or the securities law violation may have been merely an 

honest mistake. Indeed, the Wells Committee's Recommendation 14 

discussed this type of discretion: 

The Commission should give due consideration in cases which 

appear to involve honest mistake or good faith efforts at compliance 

to exercising its discretion against bringing a formal enforcement 

proceeding notwithstanding the appearance of a violation. 198 

The ability of the Enforcement Division to recommend to the 

Commission that no action be taken in a particular matter should be 

encouraged and institutionalized. This will require, among other things, 

a re-evaluation of the incentives for bringing actions and obtaining large 

penalties (such as through promotions, awards, and public recognition). 

Statistics, such as the number of cases brought and the penalties 

recovered, should play only a minimal role in assessing individual 

performance. Instead, an evaluation system should focus on rewarding 

high quality efforts and professionalism regardless of the outcome of 

particular actions. A decision to forgo bringing an enforcement action 

should not be treated automatically as a loss, but it should be evaluated 

qualitatively alongside other enforcement decisions. 

In some instances, exercising discretion may not be appropriate. 

There should not be institutional encouragement for using discretion to 

formulate theories of liability that overstep the boundaries of existing 

law. Law making is reserved for legislative process in Congress and the 

SEC rulemaking process under the strict requirements of the 

Administrative Procedure Act; it is not a function of the Enforcement 

Division. 

Another aspect that could be considered by the advisory committee 

is the implementation of a written and uniform "full-disclosure" policy 

for enforcement matters. 199 In criminal procedure, this is often referred 

to as an "open jacket" policy. Operating under such a policy, the 

enforcement staff would show defense counsel the evidence it has 

against the prospective defendant, which is the essence of due process. 

Some practicing lawyers have criticized the SEC Enforcement Division 

for failing to explain to defendants the allegations of wrongdoing and 

failing to share critical incriminating-and most importantly, 

198. WELLS COMMITTEE ADVISORY REPORT, supra note 39, at iv. 

199. The Wells Committee proposed the institutionalization of a similar policy. See 

supra note 71 and accompanying text. Currently, there is not a uniform practice among 

the various units in the Enforcement Division. 
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exculpatory--evidence that the SEC has gathered.200 Because no such 

policy is in place today, arguments in Wells Submissions often are based 

on defense counsel's best guess as to the conduct that enforcement staff 

has identified as violating federal securities laws. The sharing of 

information would promote the goal of fact-finding, which is paramount 

to due process and to the administration of justice. 

With the advent of additional remedies in the SEC's arsenal in the 

decades after the Wells Committee and a shift in approach towards a 

more punitive focus, the idea of a full-disclosure policy is even more 

important than it was when the Wells Committee made its 

recommendations. The SEC staff should inform fully individuals and 

companies about the allegations and the evidence at the time of a Wells 

call or, at the very latest, before entering into settlement discussions. 

Corporate boards, in particular, must be sufficiently informed so that 

they can apprise their shareholders and exercise good business judgment 

in determining whether to settle a matter with the SEC. 

Another aspect of the enforcement program that the new advisory 

committee should consider is the process for closing investigations. In a 

report to Congress by the General Accountability Office ("GAO"), the 

GAO harshly criticized the Enforcement Division for not closing 

investigations promptly and observed that the Division had a 

"potentially large backlog of investigations that are not likely to result in 

enforcement actions and for which closing packages have not been 

completed." 201 As a result, the GAO concluded that "the subjects of 

many aged and inactive investigations may continue to suffer adverse 

consequences until closing actions are completed." 202 

Enforcement Division officials told the GAO that their attorneys 

may believe that pursuing potential securities violations is a higher 

200. See, e.g., Kevin J. Hamishch & Natasha Colton, When the SEC Comes 

Knocking, 15 A.B.A. SEC. Bus. L. I (2005), available at http://www.abanet.org/buslaw/ 

blt/2005-09-1 0/colton.shtml. 

201. U.S. Gov'T ACCOUNTABILITY OFFICE, GA0-07-830, SEC: ADDITIONAL 

ACTIONS NEEDED TO ENSURE PLANNED IMPROVEMENTS ADDRESS LIMITATIONS IN 

ENFORCEMENT DIVISION OPERATIONS 22 (2007), available at 

http://www.gao.gov/new.items/d07830.pdf. For example, according to the GAO 

Report, one SEC regional office reported that as of March 2007 about 35% of its open 

investigations were "more than 2 years old, had not resulted in an enforcement action, 

and were no longer being actively pursued." !d. at 21. In response, the Enforcement 

Division has undertaken to review the backlog and streamline the closing process. !d. at 

46. 

202. !d. 
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2008 EVALUATING THE MISSION 413 

priority than closing investigations. 203 Officials also cited a scarcity of 

time, administrative support, and incentives to comply with established 

procedures for closing investigations. 204 Although the GAO recognized 

that resolving the potentially large backlog of investigations would 

impose resource challenges for Enforcement Division,205 the GAO 

recommended that the SEC chairman direct the Enforcement Division to 

"consider developing expedited procedures for closing 

investigations."206 

When the Commission or its staff determines that an investigation 

should be closed or action is not warranted, the agency promptly should 

send a closing letter. 207 Closing letters should be sent not only to those 

who have made a Wells Submission, but also to any significant nonparty that has provided documents, information, or testimony to the 

SEC. Similarly, if the enforcement staff views a person only as a 

witness or source of information in an investigation, staff should make 

that clear to the person. 

In its proposed mandate to examine enforcement practices and 

procedures from the point of view of due process, the new advisory 

committee should consider ways to improve the cherished Wells 

process. One way in which the Wells process should be bolstered is 

through a mechanism to allow a proposed defendant to appear before the 

Commission to oppose a proposed enforcement proceeding. Although it 

would likely be both unnecessary and unmanageable to allow such an 

"oral Wells submission" in every situation, it may be beneficial to both 

the Commission and proposed defendants for the Commission to have a 

discretionary avenue to hear from proposed defendants prior to taking 

action. Matters that might be appropriate for this procedure would 

include complex factual cases, such as those necessitating expert 

witnesses, disputes concerning the level of cooperation, or cases in 

which character assessment and credibility is particularly important. 208 

203. ld. 

204. Jd. 

205. fd. 

206. !d. at 7. 

207. The Wells Committee in Recommendation 8 proposed that the "Commission 

adopt in the usual case the practice of notifYing an investigatee against whom no further 

action is contemplated that the staff has concluded its investigation .... "and will not 

recommend an enforcement action. WELLS COMMITTEE ADVISORY REPORT, supra note 

39, at 20. 

208. For example, at both the Federal Trade Commission and the Federal 

Communications Commission, in-person presentations to commissioners and staff of 
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A review of the enforcement process would not be complete 

without a review of the costs to parties responding to an investigation. 

Responding to an SEC investigation is costly, particularly in the age of 

e-mails and electronic data. The SEC must ensure that its investigations 

and enforcement actions do not impose unnecessary costs. Overly broad 

subpoenas or document or interview requests add to a responding 

entity's costs, and not every responding entity becomes a defendant. 

Innocent parties pay the price of overly broad requests. Notices to 

preserve-and subsequent requests to produce--electronic data, 

including e-mails, voicemails, and server back-up tapes are particularly 

burdensome and costly to a company. While it is undoubtedly critical 

for the SEC to have certain electronic data to conduct an investigation 

and litigate a matter, preservation notices and requests for production are 

often generic and extend well beyond the boundaries of the existing 

investigation. It is difficult to justify imposing unnecessary costs on a 

company, particularly when the investigation may last many years and 

result in no action taken. 

The new advisory committee should recommend ways to minimize 

costs through the formulation of detailed procedures to address 

preservation notices and production requests for electronic data. In 

recommending the procedures, the advisory committee should take into 

account the burden and expense of preserving certain kinds of records, 

such as electronic voicemail, and producing data stored in long-term 

media such as back-up tapes. Preservation notices should be reasonably 

related to the matters under investigation, and prospective preservation 

of infonnation should be invoked only if misconduct is suspected or 

ongoing. 209 The use of generic preservation notices, covering data that 

the company might not otherwise preserve in the normal course of its 

operations, should be prohibited. 

Production requests should be narrowly tailored and should first 

seek information that is readily accessible. Requests should not demand 

the production of data stored on back-up tapes unless unavailable 

through other sources. As a measure to guard against overbroad 

requests, the advisory committee should consider ways to incorporate in 

enforcement procedures pre-approval of document requests by a senior 

member of the Enforcement Division. 

evidence and advocacy positions in advance of potential enforcement actions are 

routine. 

209. Subjects of investigation already have other legal obligations to preserve 

documents. See, e.g., 18 U.S.C. § 1512 (2006). 
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2008 EVALUATING THE MISSION 415 

The advisory committee also should explore the establishment of an 

ombudsman to review and evaluate complaints about the enforcement 

process and behavior of the Enforcement staff. An ombudsman would 

provide an avenue for persons to convey their grievances to the 

Commission without fear of reprisal. People should be able to make 

these complaints anonymously through a hotline. 210 

The new advisory committee should examine the usage, effects, 

amount, and appropriateness of issuer penalties in financial fraud cases. 

The committee should consider whether these issuer penalties are 

consistent with the SEC's mission of investor protection; maintaining 

fair, orderly, and efficient markets; and facilitating capital formation. 

For example, do penalties protect investors? Do they harm or benefit 

shareholders? Is the circularity of Fair Fund penalty distributions 

consistent with ensuring fair, orderly, and efficient capital markets? Is 

capital formation impeded by the threat of large, unpredictable issuer 

penalties? 

The advisory committee also should evaluate the moral hazards 

associated with issuer penalties. One moral hazard is the possibility that 

managers of companies might agree to a large corporate penalty in order 

to avoid or soften actions against culpable individuals. 211 Are 

individuals deterred from wrongdoing if they expect that shareholders 

will pay the penalties for the misconduct? 

The SEC also faces it own moral hazards when contemplating the 

assessment of issuer penalties. Does the prospect of large issuer 

penalties and the inevitable press coverage cause the SEC to misallocate 

210. The SEC's Office of Compliance Inspections and Examinations already has 

such a hotline. See U.S. Sec. & Exch. Comm'n, Office of Compliance Inspections & 

Examinations, Examination Hotline, http://www.sec.gov/about/officcs/ocie/ocie _ hotlin 

e.shtml (last visited May 9, 2008). 

211. See generally Donald C. Langevoort, On Leaving Corporate Executives 

"Naked Homeless and Without Wheels": Corporate Fraud. Equitable Remedies, and 

the Debate over Entity versus fndividual Liability, 42 WAKE FOREST L. REv. 627 

(2007). As Professor Langevoort explains: 

The corporate sanction avoids the need to attribute fault to any particular individual 

under circumstances where there is likely mutual finger pointing about who is to 

blame. For all these reasons. company sanctions are the path of least resistance; the 

SEC can claim its victory and move its resources to new matters that deserve 

attention. There is probably a publicity-related reason as well: sanctions against 

companies can be large enough to grab headlines, which is less likely to occur with 

respect to individual sanctions. even in the aggregate. 

!d. at 654. 
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resources to build these cases to the detriment of other types of 

enforcement actions? 

The Commission's 2006 penalty statement was a significant first 

step in setting forth a principled foundation for examination of many of 

these concems. 212 In applying the penalty statement, the Commission 

has encountered areas not addressed by the statement, such as the 

determination of the amount of penalty and the appropriateness of 

imposing penalties on new shareholders. 213 Taking the Commission's 

experience into consideration, the new advisory committee should reexamine these issues with the input of economists, legal scholars, and 

practitioners. 

These and any additional recommendations from the advisory 

committee that ultimately are approved by the Commission should be set 

forth in a publicly available Enforcement Manual. In 2007, the minority 

members of the Senate Finance Committee recommended that the SEC 

create such a manual, which would be similar to the U.S. Attomey 

Manual, "to address situations or issues likely to recur." 214 The public 

accessibility of the manual would ensure transparency and uniform 

application. The manual itself, and any later changes to it, should be 

reviewed and approved by the Commission. Deviations from the 

manual, while necessary in some instances, should be discouraged. The 

manual will serve as the goveming guidelines for the Enforcement staff 

at headquarters and in the regional offices. An Enforcement Manual that 

reflects the recommendations of an advisory committee, as adopted by 

the Commission, could serve as a useful framework for the 

Commission's enforcement program in the years to come. 

CONCLUSION 

The SEC's enforcement program serves a critical function in 

ensuring proper compliance with the U.S. securities laws. Throughout 

212. See 2006 Penalty Statement, supra note 178. 

213. Many of these same concerns were raised by the Commission during the 

legislative debate over the Remedies Act of 1990. See, e.g., SEC Memorandum in 

Support of Remedies Act, supra note 96. 

214. See Staff of S. Fin. Comm., !lOth Cong., Report on the Firing of an SEC 

Attorney and the Investigation of Pequot Capital Management 7 (Comm. Print 2007), 

available at http:l/finance.senate.gov/sitepages/leg/LEG%202007/Leg%2011 0%200803 

07%20SEC.pdf. 
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2008 EVALUATING THE MISSION 417 

its history, the SEC has protected investors and the general public from a 

wide array of fraudulent conduct. Given the importance of enforcement 

to the SEC's mission, a critical review of the enforcement programsimilar to that done by the Wells Committee in 1972-is long overdue. 

This article is intended to start a list of items for consideration, but does 

not purport to identify all the areas that should be evaluated by a new 

Wells-like advisory committee. The members of the advisory 

committee undoubtedly will draw from their own experiences and 

expertise to develop a full agenda. The Commission should be receptive 

to considering any new ideas for improving the enforcement program 

and furthering the SEC's mission. We are confident that the result will 

be an enforcement program that is more transparent, better embodies 

principles of due process, and more effectively combats violations of the 

federal securities laws. 
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WRITTEN TESTIMONY OF JOSEPH P. BORG 

PRESIDENT, NORTH AMERICAN SECURITIES ADMINISTRATORS 

ASSOCIATION, INC. 

AND 

DIRECTOR, ALABAMA SECURITIES COMMISSION 

BEFORE THE 

U.S. HOUSE COMMITTEE ON FINANCIAL SERVICES 

SUBCOMMITTEE ON CAPITAL MARKETS, SECURITIES, AND INVESTMENT 

"Ensuring Effectiveness, Fairness, and Transparency in Securities Law Enforcement" 

June 13, 2018 

WASIIINGTON, DC 
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I. Introduction 

Good Morning, Chairman Huizenga, Ranking Member Maloney, and members of the 

Subcommittee. I'm Joseph Borg, Director of the Alabama Securities Commission and President 

of the North American Securities Administrators Association ("NASAA"). 1 It's been a privilege 

for me to serve as Director of the Alabama Securities Commission since 1994, and to have been 

elected as NASAA's President three times, most recently for a term spanning 2017-2018. I am 

honored to testify before the Subcommittee today about effectiveness, fairness, lmd transparency 

in the enforcement of federal and state securities laws. 

In the United States, state securities regulators have protected Main Street investors for 

the past 100 years, longer than any other se1.-11rities regulator. 2 We are sometimes referred to as 

the "cops on the beat" as we are the securities regulators closest in proximity to your 

constituents. State securities regulators are responsible for administering state securities laws 

that both serve to protect your constituents from fraud while also providing re~;ulatory 

frameworks through which businesses can raise capital. My colleagues and l are responsible for 

enforcing state securities laws including investigating complaints, examining broker-dealers and 

investment advisers, registering certain securities offerings, and providing investor education 

programs to your constituents. Ten of my colleagues are appointed by Secretaries of State, five 

serve in the state Attorney General's office or under the direction thereof, and others are 

appointed by their Governors and other senior state officials. Some, like me, work for 

independent commissions or boards. We are proud to work alongside our colleagues at the U.S. 

Securities and Exchange Commission ("SEC"), Commodities Futures Trading Commission 

("CFTC"), and the Financial Industry Regulatory Authority ("FINRA") to police the securities 

markets and enforce our nation's securities laws. 

States are leaders in civil and administrative enforcement actions, as well as criminal 

prosecutions of securities violators. Our most recently compiled enforcement statistics reflect 

that in 2016 alone, state securities regulators conducted nearly 4,300 investigations, leading to 

more than 2,000 enforcement actions, including 241 criminal actions. Moreover, in 2016, among 

licensed financial professionals, NASAA members reported 186 enforcement actions involving 

broker-dealer agents, 133 actions involving investment adviser representatives, 144 involving 

broker-dealer firms, and 157 involving investment adviser firms. 

States also continue to serve a vital gatekeeper function by screening out bad actors 

before they have a chance to conduct business with unsuspecting investors. A total of2,843 

securities license applications were withdrawn in 2016 as a result of state action; and an 

additional537 licenses were either denied, revoked, suspended or conditioned. State securities 

The oldest international organization devoted to investor protection, NASAA was organized in 1919. Its 

membership consists of the securities administrators in the 50 states, the District of Columbia, Canada, Mexico, 

Puerto Rico and the U.S. Virgin Islands. NASAA is the voice of securities agencies responsible for grass-roots 

investor protection and efficient capital formation. 

Currently, 43 states have adopted a uniform securities act. 1he uniform securities acts were developed by the 

Uniforrn Law Commission for adoption by the states. 
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regulators continue to focus on protecting retail investors, especially those of your constituents 

who lack the expertise, experience, or resources to protect their own interests. 

In addition to serving as "cops on the beat," state securities regulators serve as the 

primary regulators of many small and local securities offerings. As such, state securities 

regulators often work with and assist local businesses that seek capital investment. Moreover, 

state securities regulators, acting within NASAA, have a long history of working closely with the 

SEC, FINRA, and other regulators to effect greater uniformity in federal-state securities matters. 

Finally, given the focus oftoday's hearing, it should be noted that state securities 

regulators are often first to discover and investigate our nation's largest frauds. In thinking about 

the role of state and federal enforcement authorities, it is instructive to look back at the 

regulatory responses to the major financial scandals over the past decade. From the investigation 

into the role of investment banks in the Enron fraud, to exposing securities analyst conflicts, 

"market timing" in mutual funds, and to uncovering problems in the auction rate securities 

market, state securities regulators have consistently been in the lead. 

II. State Securities Regulators & Enforcement 

The State Role in Securities Law Enforcement 

Our capital markets function and grow in large part due to the trust investors place in 

market participants and the regulators. Maintaining that trust is essential to the continued 

primacy of our markets in an ever-competitive global marketplace. And integral to maintaining 

that trust is the work of state securities regulators in investigating suspected investment fraud, 

and, where warranted, pursuing enforcement actions. Keeping the bad actors out of the markets 

serves not only the interests of investors, but the businesses that rely on markets to raise capital. 3 

The enforcement role of state securities regulators differs in some ways from the SEC 

and self-regulatory organizations ("SROs") such as FINRA. Because our local offices are often 

the first to receive complaints from investors, state securities regulators serve as an early warning 

system, working on the front lines, investigating potentially fraudulent activity, and alerting the 

public to the latest scams. 

States take aggressive enforcement actions against a wide variety of actors. From the 

fraudsters engaged in Ponzi or pyramid schemes to companies who mislead investors our 

For example, a report of the Group of20 countries (G-20) issued in response to the financial crisis of2008 

concluded that "[n]o matter how sound the rules are for regulating the conduct of market participants, ifthe 

system of enforcement is ineffective- or is perceived to be ineffective- the ability of the system to achieve the 

desired outcome is undermined. It is thus essential that participants arc appropriately monitored, that offenders 

are vigorously prosecuted and that adequate penalties are imposed when rules are broken. A regulatory 

framework with strong monitoring, prosecution, and application of penalties provides the incentives for firms to 

follow the rules. This, in the end, adds to the framework's credibility and enhances investor confidence in the 

financial system." See: G-20 Working Group 1, G20 Worl.ing Group on Enhancing Sound Regulation and 

Strengthening Transparency- Final Report (Mar. 25, 2009), accessible at 

http://www .gfintegrity. org/storage/ g up/documents/ g20%20working%20group%20 I %20report.pdf. 

2 
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message is simple- if you rip off or defraud investors we will take action. Whether acting 

independently or collaboratively, such as through the NASAA enforcement framework or in 

conjunction with our federal regulatory partners, state securities agencies have a long history of 

pursuing enforcement actions that affect not only the residents of our individual states, but also 

the citizens of our nation as a whole. 

State securities agencies are less bureaucratic and usually nimbler than our federal 

counterparts. Upon identifYing a problem, states can move quickly to halt ongoing investment 

frauds using a range of civil and administrative remedies. 

For example, states led the charge in exposing conflicts of interest and disclosure failures 

in the market for auction rate securities. These efforts led to the return of billions of dollars to 

retail investors. 4 For example, in Alabama the repurchase of auction rate securities totaled $1.3 

billion, saving Alabamians from defaulting on home loans, ruining their credit, and allowing 

them to pay their bills. States were similarly in the vanguard in exposing sell-side research 

analysts' conflicts of interest and abusive market timing practices by mutual fund investment 

advisers, which gave an unfair and illegal advantage to hedge funds and other large entities at the 

expense of retail investors. Working alongside the SEC, these matters resulted in significant 

settlements and, no less significantly, long-term changes in securities industry practices to 

prevent this conduct from recurring. 5 

In addition, state securities regulators recently have been acting at the intersections oflaw 

and technology. Last month, we announced preliminary results from "Operation Cryptosweep," 

a coordinated investigative effort of 40 NASAA members to target fraud and other securities law 

violations in the sale of initial coin offerings ("I COs") and cryptocurrencies. 6 State securities 

regulators have already brought dozens of enforcement actions involving I COs and other new 

and unique financial products. These actions are supportive of similar initiatives by federal 

regulators, and SEC Chairman Clayton applauded NASAA's efforts, saying they send a "strong 

warning to would-be fraudsters in this space that many sets of eyes arc watching, and that 

regulators arc coordinating on an international level to take strong actions to deter and stop 

fraud." 7 

See: NASAA Auction Rate Securities Information Center, httn:llwww.nasaa.org/regulatoryactivitvlenforcement-legal-activity/auction-rate-securities-information-center/. 

See: Press Release No. 2003-54, U.S. Securities and Exchange Commission, Ten of Nation~' Top Investment 

Firms Settle Enforcement Actions Involving Conflicts of Interest Between Research and Investment Banking 

(Apr. 28, 2003), accessible at https:llwww.sec.gov/newslpress/2003-54.htm. See also: Press Release, North 

American Securities Administrators Association, State, Federal Investigations Demonstrate 'Fundamental 

Unfairness' in Mutual Fund Industry (Nov. 4, 2003), accessible at http://www.nasaa.org/796l!state-federalinvestigations-demonstrate-%E2%80%98fundamental-unfairness%E2%80%99-in-mutual-fund-industry/. 

See: Press Release, North American Securities Administrators Association, State and Provincial Securities 

Regulators Conduct Coordinated International Crypto Crackdown (May 21, 2018), available at 

http://www.nasaa.org/45121/state-and-provincial-securities-regulators-conduct-coordinated-internationalcrypto-crackdown-2/. 

See: Public Statement of SEC Chairman Jay Clayton (May 22, 2018), available at 

https:llwww.sec.govlnews/public-statement!statement-nasaas-announcement-enforcement-sweey>-targetingfraudulent-icos-and. 

3 
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In addition to investigating cases and bringing enforcement actions, states work with 

federal regulators on market-wide solutions when needed. Such collaborations have repeatedly 

demonstrated their value to investors and markets. In fact, it has been shown that in cases where 

state and federal regulators work cooperatively and leverage resources, the involvement of state 

securities regulators can produce significant increases in the penalty and restitution components 

of the federal regulator's enforcement efforts. 8 

Finally, although states do not engage in rulemaking for the national markets- that is the 

purview of the SEC and the SROs under federal law state regulators are active participants in 

the SEC's rulemaking process and work to align federal and state securities regulations. 

Securities Enforcement Coordination: Federal and State 

State and federal securities regulators collaborate on a voluntary basis, usually at the 

regional level, with common goals of sharing information and leveraging resources efficiently. 

Collaboration includes ongoing informal quarterly or monthly meetings at the state or regional 

levels; regulators working on investigations and enforcement cases when the nature of the case 

warrants collaboration; and other initiatives, such as memorandums of understanding ("MOUs"). 

Recently, to facilitate federal-state coordination, NASAA entered into important 

information sharing MOUs with federal re~o;ulators. In 2017, the SEC and NASAA signed an 

MOU to facilitate sharing information about intrastate crowdfunding offerings and regional 

securities offerings. This should help small businesses raise needed capital. More recently, in 

May 2018, NASAA signed an MOU with the CFTC to foster a closer working relationship 

between the CFTC and state securities agencies. 9 This MOU will facilitate information sharing 

about violations of the Commodity Exchange Act. In recent Congressional testimony, CFTC 

Chairman Christopher Giancarlo described the MOU as "marking a milestone in the area of U.S. 

federal and state financial fraud detection and prosecution." 10 

Securities Enforcement Coordination: State to State 

NASAA serves as a forum to facilitate collaboration among its members in 

multijurisdictional enforcement matters. State regulators who are members ofNASAA's 

Enforcement Section routinely assist in coordinating these cases by sharing infonnation and 

leveraging state resources in the most efficient way. 11 Each year the section compiles data from 

See: Eric Zitzewitz, An Eliot £)feet? Prosecutorial Discretion in Mutual Fund Settlement Negotiations, 2003-7, 

accessible at http:/ /papers.ssm.com/sol3/papcrs.cfin?abstract id-1 091035. 

See: Press Release, North American Securities Administrators Association, CFTC, NASAA Sign Agreement for 

Greater Information Sharing Between Federal Commodities and State Securities Regulators (May 21, 2018), 

accessible at http://www .nasaa.org/4 5123/cftc-nasaa-sign-agreement-for-greater-information-sharing-betweenfederal-commodities-and-state-securities-regulators/. 

10 See: Testimony ofCFTC Chairman J. Christopher Giancarlo Before the Senate Committee on Appropriations 

Subcommittee on Financial Services and Government Affairs, p.9. (Jun. 5, 2018), accessible at 

II 

https://www .aooropriations.senate.gov/imo/media/doc/060518%20-

%20CFTC%20Giancarlo%20Testimony.pdf. 

'fbere are numerous examples of collaboration among state securities regulators in multijurisdictional 

enforcement matters. See: e.g., Press Release, North American Securities Administrators Association, State 

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participating NASAA jurisdictions and publishes this information in an annual enforcement 

report. 

III. NASAA's Perspective on H.R. 5037 and H.R. 2128 

The Committee has requested NASAA's views on the two bills pending before the 

Committee, H.R. 5037 and H.R. 2128. I will discuss each in turn. 

H.R. 5037: "The Securities Fraud Act of 2018" 

If enacted, H.R. 5037 will harm the investors that state regulators are charged with 

protecting by preempting state securities regulators' civil enforcement authority and by impeding 

-if not outright preempting-- state criminal securities fraud prosecutions. The bill should be 

understood as nothing less than an attempt to tie the hands of state regulators, the "cops on the 

beat" closest to Main Street investors, in favor oflargc companies engaged in or suspected of 

securities fraud. H.R. 503 7 represents a dramatic encroachment by the federal government on 

state police powers and is bad for investors and bad for our capital markets. 

As a threshold matter, the putative findings in Section 2 of the bill are inaccurate. State 

securities regulatory authority was entirely unrestricted for most of the 20'h century, until passage 

of the National Securities Market Improvement Act of 1996. 12 In 1996 Congress realigned state 

and federal regulatory authority over the offer and sale of nationally traded securities and of the 

broker-dealer and investment advisory industries. What Congress did not do was preempt any 

aspect of state antifraud authority. In fact, Congress deliberately left this authority fully intact. 13 

In a colloquy on the floor of the House, Representatives Moran and Bliley discussed this precise 

point: 

Congressman Moran: "Mr. Speaker, ... our State Corporation 

Commission in Virginia ... [is afraid] they will not 

have sufficient enforcement authority [after 

NSMIA] .... " 

Securities Regulators Flle Action Against Morgan Keegan (Apr. 7, 201 0), accessible at 

http://www .asc.statc.al.us!News/20 I 0%20News/4-7 -I 0%20Morgan%20Keegan%20show%20cause. pdf; Press 

Release, North American Securities Administrators Association, State Securities Regulators Announce $26 

Million Settlement with LPL Financial LLC Involving Sales of Unregistered, Non-Exempt Securities (May 2, 

20 18), accessible at http://www.nasaa.org/44990/state-securitics-regulators-announce-26-million-settlementwith-lpl-financial-llc-involving-salcs-of-unregistered-non-excmpt-securitiesl; Press Release, North American 

Securities Administrators Association, State Securities Regulators Announce Settlement with Bankers Life and 

Casualty Company (Apr. 4, 2012), accessible at htt:p://www.nasaa.org/11996/state-securities-regulatorsannouncc-settlement-with-bankers-life-and-casualty-company/. See also: e.g, In the Matter of Prudential 

Securities Inc., 51 SEC 726 (1993); SEC v. Prudential Securities Inc., No. 93-2164 (EGS) (D.D.C. Jan. 21, 

1993); and SEC v. Prudential Securities Inc., 171 F.R.D. 1, 2 (D.D.C. 1997), aff"d, 136 F.3d 153 (D.C. Cir. 

1998). 

'

2 Pub. Law 104-290, 110 Stat 3416 (1996). 

13 "The Managers have preserved the authority of the states to protect investors through application of state 

antifraud laws." See: H.R. Rep. No. 104-864, 1996 WL 559878 (1996). 

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Congressman Bliley: 

Congressman Moran: 

Congressman Bliley: 

"Mr. Speaker, reclaiming my time, they have all of 

that enforcement authority and they retain their 

fees." 

"They retain their fees and enforcement authority." 

'That is correct." 14 

This was not the first time Congress did so. In 1995, when Congress was considering the 

Securities Litigation Unifonn Standards Act of 1998, it included a statutory preservation of state 

antifraud authority. 15 Another example of Congress's recognition of the importance of state 

antifraud authority came in the form of the rejection in 2003 of an amendment to the Securities 

Fraud Deterrence and Investor Restitution Act that would have placed limits on state antifraud 

authority. 16 The state-federal balance struck by Congress in the regulation and enforcement of 

securities laws has been debated and settled. The attempt to upend this balance in H.R. 5037 in 

favor of firms and individuals suspected of securities fraud should be rejected yet again. 

Furthermore, H.R. 5037 is premised on the specious assertion that state securities 

enforcement is detrimental to the public interest and somehow disincentivizes capital raising. 

Such a premise is unsupported by either logic or fact. 17 As the U.S. Treasury Department 

recently reported, America's capital markets are ""the largest, deepest, and most vibrant in the 

world," and U.S. businesses "successfully derive a larger portion of business financing from 

[America's l capital markets, rather than the banking system, than most other advanced 

economies." 18 The Financial Services Committee has, for the past five-and-a-half years, 

conducted rigorous oversight of the U.S. capital markets holding at least twenty hearings with 

dozens of witnesses and as a result passed numerous measures designed to facilitate capital 

formation. All of these hills have left untouched state antifraud authority in recognition of the 

14 

15 

16 

142 Cong. Rec. I-16436-05, 1996 WL332161 (1996). 

15 U.S.C. §77p(e). 

See: Cheryl Nichols, HR. 2179, The Securities Fraud Deterrence and Investor Restitution Act of 2004: A 

Testament to Selective Federal Preemption, 31 Suffolk Transnat'l L. Rev. 533 (2008). 

17 A recent analysis, by EY, of trends in the U.S. capital markets identified the following four factors as the basis 

for a challenging !PO climate: ( 1.) economic or geopolitical uncertainty; (2.) market declines; (3.) a risk averse 

investor mindset; and (4.) poor recent !PO performance. Notably absent from this list of factors is state 

enforcement activity. See: EY, Looking Behind the Declining Number of Public Companies- An Analysis of 

Trends in US Capital Markets (May 20 17), available at https:i/www.ey.com/Publication/vwLUAssets/ananalysis-of-trends-in-the-us-capital-markets/$FILE/ev-an-analysis-of-trends-in-the-us-capital-markets.pd£ 

Furthermore, an exhaustive list of recommendations by the U.S. Department of the Treasury to bolster the 

capital markets does not include a recommendation to weaken state enforcement authority. See: U.S. 

Department of the Treasury, A Financial System That Creates Economic Opportunities- Capital Markets (Oct. 

2, 2017), available at http://www.treasurv.gov/press-center/prcss-rclcascs/Documents/A-Financiai-SvstemCapital-Markets-FlNAL-FlNAL.pd£ Finally, a recent report by a coalition of organizations including the U.S. 

Chamber of Congress Center for Capital Markets Competitiveness explored a number of recommendations to 

address the decline in the number of public companies, none of which advocate for the preemption of state 

enforcement authority. See: U.S. Chamber of Commerce, Expanding the On-Ramp: Recommendations to Help 

More Companies Go and Stay Public (Apr. 26, 2018), accessible at 

https://www.uschamher.com/sitesldefault/files/ipo report expanding the on-ramp.pdf 

" Ibid. 

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important role this authority plays in maintaining confidence in U.S. markets. 19 In short, the 

evidence simply does not support the assertion that state enforcement is detrimental to capital 

formation. 

More tangibly, though, H.R. 5037 is problematic because of the negative impact it would 

have on the ability of states to protect investors and punish those who commit securities fraud. 

Analysis ofH.R. 5037 

First, H.R. 5037 would preempt state civil antifraud authority for certain violations of 

state securities laws, putting Main Street investors at risk. 

H.R. 503 7 would amend the Securities Exchange Act by adding new state law 

preemption provisions whereby states would be prohibited from pursuing certain civil securities 

fraud cases. The relevant provisions are drafted in such a way that they are ambiguous as to 

scope. At a minimum, states would be prohibited from pursuing civil fraud cases against the 

issuers of publicly traded securities. However, the preemption provisions are drafted such that a 

defendant could argue and a court could find that states are preempted from pursuing civil fraud 

violations in connection with any transaction involving publicly traded securities. Under such an 

interpretation, for example, the bill would preempt state enforcement actions against a brokerdealer and/or its associated pcrson(s) for defrauding customers so long as the fraud involved a 

covered security. I have had enough experience trying securities fraud cases that I know 

defendants will make the argument that the ambiguous preemption provisions should be 

construed broadly in order to shield their violative conduct from state enforcement action. 

Second, H.R. 5037 would hamper or prevent state prosecutions of criminal securities 

fraud. 

Section 3(a) ofH.R. 5037 would amend the Securities Exchange Act to add new Section 

21G(c)(2), which would require that state criminal securities fraud prosecutions "comply in all 

respects" with federal legal requirements. This provision is also inherently ambiguous and 

poorly drafted and as a result has the potential to be extremely problematic for all state criminal 

authorities. 20 Depending on how the provision is interpreted by the courts, it could hamper- if 

not outright preempt state criminal securities fraud prosecutions. (For example, I am aware of 

no state judge or judiciary panel in Alabama that will agree to suspend all state criminal laws and 

procedures in favor of federal requirements.) 

H.R. 5037 does not provide any direction or clarification regarding how states could 

satisfy the requirements of Section 21G(c)(2) or what it means to "comply in all respects" with 

19 In addition to various hearings held pursuant to its mandate to oversee the Securities and Exchange 

Commission, the House Financial Services Committee and its Subcommittee on Capital Markets have held at 

least twenty hearings intended to examine capital formation in the U.S. equity markets under Chairman 

Hensarling. This includes at least eight hearings in the I !3th Congress, seven in the I 14th Congress, and six in 

the current !15th Congress, to date. 

20 The adverse effect of this provision would apply to district, county and all other non-federal prosecutions. 

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federal Jaw. 21 Defendants in state criminal prosecutions would of course vigorously advocate for 

the broadest possible reading of this language. Thus, for practical purposes, Section 2JG(c)(2) 

will be preemptive in its effect to the extent that no state judge or judiciary panel will agree to 

suspend all state criminal Jaw and procedure. In essence, Section 21G(c)(2) functions as a 

directive to state prosecutors and courts that state criminal cases must be referred to federal 

prosecutors, to be tried in federal courts. 

At a minimum, by forcing state regulators, state courts, and state prosecutors to comply 

with federal legal requirements applicable to securities fraud cases, Section 3(a) would have a 

chilling effect on the willingness and ability of states to bring criminal securities fraud 

prosecutions if not halt all such actions altogether. 

I imagine that the fraudsters, including the ones my office has prosecuted, would be 

pleased with such a result. 

Third, H.R. 5037 will deprive defrauded investors of a choice in forum in seeking 

recourse for their claims. 

Section 3(a) ofH.R. 5037 would amend the Securities Exchange Act by adding Section 

21G(b), which states that all civil (i.e., private) securities fraud claims involving covered 

securities shall proceed in federal district courts under federal law. There are no exceptions. 

This would prevent all private litigants from seeking relief in state court for securities fraud 

claims arising in connection with covered securities (to the extent such claims are not already 

foreclosed by the Private Securities Litigation Reform Act of 1995 ("PSLRA") and the Securities 

Litigation Uniform Standards Act of 1998 ("SLUSA")). Under the bill, defrauded investors 

pursuing private securities fraud claims outside of the class action context would no longer have 

a choice of forum in which to pursue their claims. Section 3( a) thus represents a direct threat to 

state pension funds that would require them to litigate in federal courts, and other investors who 

seek to "opt-out" of shareholder class action litigation and instead advocate on their own behalf 

in pursuing claims against an issuer. 

Views Regarding H.R. 5037 

Based on the significant harm H.R. 5037 poses for investors NASAA opposes this 

legislation in the strongest possible terms. Enacting policies that would make it more difficult, 

and in some cases impossible, for state regulators- the regulators closest to Main Street 

investors to hold accountable the most powerful companies on Wall Street serves no valid 

interest. State antifraud provisions serve as a deterrent to improper conduct by companies and 

the potential consequences of violating these laws serves as an incentive to these companies to 

provide investors with complete and accurate information. 22 Moreover, while state regulators are 

judicious in exercising their enforcement authority against publicly traded companies, states' 

authority to pursue enforcement activity against issuers of securities, and to do so independently 

21 For example, it is an open question under H.R. 5037 whether litigation in state courts would have to apply 

federal rules of civil or criminal procedure and federal rules of evidence. 

22 State antifraud provisions can both raise the amount of any potential penalty and, even more importantly, raise 

the probability of detection and prosecution of those companies that commit securities fraud. 

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when appropriate, is a major deterrent to fraud and one of many reasons investors have 

confidence in America's capital markets. 23 

Beyond the ovcrarching backwardness of the policies prescribed by H.R. 5037, the 

enactment of which would be inadvisable at any juncture, NASAA questions the basis for 

Congress's interest in curtailing state enforcement authorities at the present time. Indeed, given 

the recent and marked decline in enforcement actions by the SEC against public companies, this 

would appear to be the most inopportune time for Congress to tic the hands of states in policing 

fraud by publicly traded companies. 24 The proposed legislation would also shift policies in a 

direction diametrically opposed to those encouraged by the current Administration, which favors 

states' rights, and encourages the exercise of state authority with regard to enforcement 

activity. 25 

In sum, H.R. 5037 is a misguided and dangerous bill. It is premised on a flawed 

understanding of the importance of state securities enforcement functions in protecting "mom 

and pop" investors and deterring fraudulent conduct in our securities markets. In every instance, 

the bill places the interests ofbig companies above those of the hardworking Americans who 

look to our capital markets to help build a secure retirement. For all the foregoing reasons, 

NASAA opposes the bill, and strongly encourages the Committee to reject it. 

H.R. 2128: "The Due Process Restoration Act of2018" 

The Due Process Restoration Act seeks to benefit respondents in SEC enforcement 

actions by providing them with a broad right of removal to federal district courts. The bill also 

would raise the burden of proof in SEC administrative proceedings from preponderance of the 

evidence to clear and convincing evidence. While we understand that there arc due process 

concerns evidently underlying the bill, the bill would have deleterious downstream consequences 

for the public interest and, ultimately, for respondents in SEC enforcement actions. The bill 

would likely cause most SEC enforcement actions to proceed in federal district courts, burdening 

the courts and limiting the opportunities for administrative resolution of SEC actions. 

23 

24 

According to legal research on the role of enforcement in promoting market integrity, a "growing body of 

academic research has found that tbrcign corporations that do cross-list on a U.S. exchange seem to reap 

extraordinary benefits," including "a valuation premium compared to otherwise similar firms that do not crosslist in the United States, which at least one study has found to average 37% for foreign firms cross-listing on a 

major U.S. exchange." See: John C. Coffee, Jr., Law and the Market: The Impact of Enforcement, 156 U. Pa. L. 

Rev. 229, 235 (2007). 

According to an analysis published by New York University's Pollack Center, new SEC enforcement actions 

against public companies decreased by 33% from FY 2016 to FY 2017. Likewise, SEC settlements declined by 

more than 80% over 2017, from $1 billion in the first half ofFY 2017 to $196 million in the second half, and 

penalties during the second half ofFY 2017 accounted for only 16% of total settlements tor the fiscal year- the 

lowest percentage and dollar amount for any half year since FY 20 I 0. See: Cornerstone Research, SEC 

Enforcement Activity: Public Companies and Subsidiaries- Fiscal Year 2017 Update (2017), available at 

http://www.comerstone.com/Publications/Reports/SEC-Enforcement-Activity-2017-Updatc. 

25 See: Office ofManagement and Budget Director and Consumer Financial Protection Bureau Acting Director 

Mick Mulvaney remarks to the National Association of Attorneys General winter meeting, "We're going to be 

looking to the state regulators and the states' attorneys general for a lot more leadership when it comes to 

enforcement" (Feb. 20, 2018), available at https://www.c-span.org/vidco/?441853-4/consumer-financialprotection-bureau-acting-director-mick-mulvaney. 

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Analysis ofH.R 2128 

Sections 40(a) and 40(b) ofthe bill would give respondents in SEC administrative 

enforcement actions where penalties could be imposed the right to remove the action to federal 

district court. More importantly, Section 40(c) would raise the burden of proof in administrative 

proceedings from a "preponderance of the evidence standard" to a "clear and convincing 

standard." This would incentivize respondents not to remove the action to federal court- and 

also disincline the SEC to ever bring enforcement actions administratively in the first place. 

Views Regarding H.R. 2128 

NASAA sees no good reason for Congress to enact the changes contemplated by H.R. 

2128 -and several reasons why these changes would disrupt our securities markets and the 

efficient functioning of the federal judiciary. 

First, the SEC has broa.d statutory authority to seek penalties administratively. 26 Given 

this, the removal power conferred by H.R. 2128 would allow respondents all respondents, 

including SEC-registered broker-dealers, investment advisers and their respective registered and 

associated persons- to remove nearly all SEC administrative actions to federal court. 

Administrative proceedings generally proceed faster than federal court cases and affording 

respondents a right of removal would invariably slow the SEC enforcement process, delaying 

justice. It would also add to the cascload of our already overburdened federal judiciary. 

Further, the downsides of Sections 40( a) and 40(b) pale in comparison to the potential 

negative consequences of Section 40(c). Section 40(c) represents a potential death knell for SEC 

administrative practice. By raising the standard of proof in SEC administrative proceedings to 

clear and convincing evidence, the bill would disincline the SEC from bringing any cases 

administratively. This would slow justice and clog the courts and, when taken with the other 

sections of the bill, give respondents an opportunity for regulatory arbitrage. If the SEC brought 

an action administratively, the respondent could choose to proceed in that forum or remove the 

case to federal district court (and proceed under a lesser preponderance of the evidence burden of 

proof). H.R. 2128 thus represents a significant change in SEC enforcement jurisprudence and 

likely would substantially increase the number of SEC enforcement cases filed in federal court. 

NASAA urges the Committee to reject this legislation. 

IV. NASAA's Views on Certain Federal Securities Enforcement Matters 

SEC Regulation D, Rule 506 and the Private Placement Market 

Private securities once comprised just a fraction of the overall marketplace, but today 

they serve as a major source of investment capital for certain businesses, exceeding public 

26 See: e.g., Section 21 B of the Securities Exchange Act of 1934. 

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markets.27 Unfortunately, these markets are inherently inefficient and risky. Because private 

placement offerings are exempt from registration at both the state and federal levels, no state or 

federal regulator reviews these offerings before they are sold to investors.28 It should not be 

surprising that these offerings routinely rank among the most common products or schemes 

leading to enforcement actions in surveys of state securities regulators. 29 

Securities sold in compliance with Ret,>ulation D, Rule 506 are "covered securities," 

which results in preemption of state-level registration requirements. However, the states retain 

antifraud jurisdiction and, for all practical purposes, are responsible for policing this market, only 

after the losses have been inflicted on America's Main Street investors. As the regulators closest 

to hardworking Americans, state securities regulators frequently receive complaints from those 

who are victimized in offerings conducted under Rule 506, and private placements are 

commonly listed on NASAA's annual list of top investor traps. As a result, the states have a 

very large stake in the SEC's rulemaking in this area, as well as in any legislative changes that 

would affect the private securities market. 

NASAA is not wholly opposed to efforts to modernize the accredited investor standard, 

including in a manner that would increase the size of this marketplace. However, if Congress or 

the SEC wish to grow these markets, that should occur only in tandem with refonns that provide 

regulators with the tools necessary to address fraud and misconduct and improve transparency in 

this growing segment of the U.S. markets. NASAA believes that modest changes can be made to 

Rule 506 and Form D that will enhance the ability of the Commission and NASAA members to 

protect investors while minimizing the burdens to the small businesses who utilize the rule to 

raise capitaJ.l0 We have also offered suggestions to the SEC and Congress as to how to revise 

the current accredited investor definition such that it more accurate! y measures investor 

sophistication and at the same time improves regulatory oversight of this important segment of 

our marketsY In the absence of such concrete improvements in the oversight of these offerings, 

27 See: SEC Division of Economic and Risk Analysis, Access to Capital and Market Liquidity (Aug. 8, 2017), 

available at https://www.sec.gov/files/access-to-capital-and-market-liquidity-study-dera-2017 .pdf. See also: 

28 

Scott W. Bauguess, Deputy Director, SEC Division of Economic Risk and Analysis, Private Securities 

Offerings post-JOBS Act. Presentation to Accounting Standards Executive Committee (Feb. 25, 2016), available 

at https://www.sec.gov/info/smallbus/acsec/private-securities-offerings-post-jobs-act-bauguess-022516.pdf. 

As described in SEC Inspector General Report No. 459, "Regulation D Exemption Process"' (March 31, 2009), 

the Commission conducts no substantive review of Form D filings to determine whether an issuer actually 

complies with Rule 506. Accessible at http://www.sec-oig.gov/Reports/Auditslnspections/2009/459.pdf. 

29 See: NASAA Enforcement Report- 2015 Report on 2014 Data, p.7 (Sep. 2015), available at 

http:/ /nasaa.cdn.s3 .amazonaws.com/wp-content/up loads/20 I 1/08/20 15-Enforcement-Report -on-20 14-

Data FINAL.pdf. 

30 NASAA has repeatedly expressed support for amendments the SEC proposed in July 2013 that would make 

modest changes to Rule 506 and Form D that will significantly enhance the ability of the SEC and NASAA 

members to protect investors while minimizing the burdens to the small businesses who utilize the rule to raise 

capital. See: http://www.nasaa.org/wpeontent/uploads/20 11/07 /NASAA-Comment-Letter-re-Fonn-D.pdf. 

3l The current income and net worth standards were established by the SEC in 1982 and have not been adjusted to 

reflect the impact of inflation. Had the thresholds been adjusted for inflation when they were put in place by the 

SEC in 1982, the income threshold today would be approximately $500,000 and the net worth threshold would 

be approximately $2.5 million. However, if Congress wishes to maintain the current income and net worth 

standards, other investor protection tools, such as investment limits, could be put into place to account for the 

effects of not adjusting the standards for 35 years. 

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NASAA remains opposed to legislation that would further expand the size of the marketplace for 

private securities by increasing the number of persons who quality as "accredited investors." 

Finally, as the Subcommittee is undoubtedly aware, the unprecedented expansion of the 

private placement market in recent years is a primary driver of the decline in initial public 

offerings ("IPOs") during the same period. There are a variety of factors contributing to the 

decline in IPOs. Some examples would include expanded use of Regulation D, Rule 506, 

business development companies, venture capital and private equity funds, and the federal 

crowd funding laws. The simple fact is that it is easier now to raise capital through private 

securities offerings than at any other time in our history. 32 Given Congress's ongoing, bipartisan 

interest in taking steps to increase the number of IPOs -efforts which have recently been the 

focus of hearings by the Subconunittee- Congress should be very cautious about taking any 

steps that would further expand the private markets at the expense of public markets. 

SEC Penalty Authority 

When it comes to protecting investors from bad actors, aggressive enforcement actions 

that penalize violators, disgorge ill-gotten gains, and provide damages and restitution for 

aggrieved investors, are the best deterrent and the only proven remedy. In order for enforcement 

to be effective as a deterrent, the costs to violators must be meaningful as a punishment. 

Hearings in the wake of the financial crisis established that the present statutory limit on the 

SEC's authority to pursue civil penalties significantly ties the hands of the SEC in performing its 

enforcement duties. 33 

Federal securities laws currently limit the amount of civil penalties that the SEC can 

impose on an institution or individual. Specifically, under existing law, the SEC can only 

penalize individual violators a maximum of$150,000 per offense, and institutions $725,000 per 

offcnse. 34 

32 

33 

34 

As Healthy Markets Association Executive Director, Tyler Gellasch, noted in his testimony to this 

Subcommittee last month, "It's not a great mystery why in the last few years the trend has developed whereby 

there are more private offerings in the U.S. today than public ones. In the past, the law and SEC rules simply 

didn't penn it all these private offerings. Over the past two decades, however, Congress and the SEC have spent 

years constructing ad hoc exemptions and exceptions designed to allow firms, their executives, and their early 

investors to sell securities without incurring the costs or burdens typically associated with public offerings. 

While some of these exemptions and exceptions may have been well-intended, the undeniable result has been 

that they have grown so dramatically that they have undermined the public markets." See: Testimony of Tyler 

Gellasch before the House Financial Services Committee, Subcommittee on Capital Markets, Securities and 

Investment (May 23, 20 18), accessible at https://financialservices.house.gov/uploadedfiles/hhrg-115-bal6-

wstate-tgellasch-20180523 .pdf. 

See: Senate Committee on Banking, Subcommittee on Securities, Insurance and Investment. Hearing entitled 

"Strengthening the S.E.C.'s Vital Enforcement Responsibilities." May 7, 2009. 

In some cases, the SEC may calculate penalties to equal the gross amount of ill-gotten gain, but only if the 

matter goes to federal court, not when the SEC handles a case administratively. 

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NASAA supports legislation that has been proposed in Congress that would increase the 

per violation cap applicable to the most serious securities laws violations. 35 NASAA also 

supports proposals to provide the SEC with the discretion to increase the amount of the penalty 

in cases where the size of the penalty is tied to the amount of money gained by the bad action. 36 

SEC Enforcement Resources 

The SEC's Division of Enforcement polices approximately 8,000 public companies and 

more than 26,000 registered market participants. While highly skilled and dedicated to their 

mission, the fact remains that the SEC Enforcement Staff of approximately I ,400 is less than 4 

percent of the number of companies the SEC oversees, and easily less than 0.1 percent of the 

employees of those companies. As Ranking Member Maloney noted at a recent hearing of the 

Subcommittee on Capital Markets, Securities, and Investment, "given this huge disparity, there's 

simply no way that the enforcement division can catch and punish every single violation of the 

securities laws. "37 

Earlier this year the SEC announced a $1.658 billion budget request for fiscal year 2019 

to support its "core mission" and expand "oversight and enforcement in emerging areas such as 

financial innovation, market structure and cybersecurity." Of note, this would reflect a modest 

increase in funding and allow the SEC to lift a hiring freeze that has been in place for several 

years. 38 NASAA strongly urges Congress to fully fund the SEC's fiscal year 2019 budget 

request. 

SEC Disgorgement Authority (Kokesh v. SEC) 

The American people need Congress to enact legislation granting the SEC statutory 

authority to bring federal court claims for disgorgement and restitution. The SEC has authority 

to seek disgorgement through its own administrative courts. 39 But the SEC lacks explicit 

authority to do so in federal court. Traditionally this has not been a problem, and the SEC has 

for decades relied on federal courts' own inherent equitable powers to obtain disgorgement from 

wrongdoers40 The SEC often returns these monies to harmed investors. But the necessity for 

Congress to enshrine the SEC's disgorgement and restitution authority in federal law has been 

brought to the fore by the Supreme Court's decision last year in Kokesh v. SEC. 41 

35 For example, S. 779 - TI1e Stronger Enforcement of Civil Penalties Act of 2017, (Similar provisions are also 

included in H.R. 10, the Fiuancial CHOICE Act of2017.) 

36 !bid, 

37 See: U.S. House Financial Services Committee, Subcommittee on Capital Markets, Securities and Investments. 

Hearing entitled "Oversight of the SEC's Division of Enforcement." (May 16, 20 18). 

38 See: Testimony by Chairman Jay Clayton Before the Senate Committee on Appropriations Subcommittee on 

Financial Services and Government Affairs. (Jun. 5, 20 18). Accessible at 

https://www.sec.gov/news/testimony/testimony-financial-services-and-gcneral-govemment-subcommittcesenate-committee. 

39 See: Section 21C(e) of the Securities Exchange Act, 15 U.S. C.§ 78u-3(e). 

40 See: SEC v. Texas Gulf Sulphur, 312 F. Supp. 77, 91 (S.D.N.Y. 1970), aff'd inpart446 F.2d 1301 (2d Cir. 

1971). 

41 Kokesh v. SEC, 137 S. Ct. 1635 (2017). 

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In Kokesh, the Supreme Court reversed decades of established jurisprudence by holding 

that SEC disgorgement is a "penalty" subject to the five-year statute oflimitations in 28 U .S.C. § 

2462. The Court furthermore in a footnote questioned the SEC's ability even to obtain 

disgorgement in federal court42 Kokesh followed on the heels of another problematic Supreme 

Court decision, Gabelli v. SEC. 43 In Gabelli, the Court held the SEC cannot benefit from the socalled "discovery rule" to toll the beginning of the statute oflimitations period when it seeks 

penalties. The Supreme Court no doubt thought it was doing what federal law commanded when 

it issued the Kokesh and Gabelli decisions. But these two decisions have only negative 

implications for the American people. 

Kokesh and Gabelli will severely limit the SEC's ability to recover from wrongdoers in 

the future. Fraudsters will use these decisions to avoid returning ill-gotten gains to banned 

investors. Imagine the American people's outrage if a future Ponzi schemer is able to retain the 

proceeds from his fraud simply because he evaded detection long enough. (The American 

people are fortunate that Kokesh and Gabelli were not the law of the land when the Bernie 

Madoff and Allen Stanford schemes finally came to light.) 

The SEC is stuck with Kokesh and Gabelli and the agency is adjusting its enforcement 

activities in response. But the American public should not have to be stuck with these bad 

decisions. Congress can- and should- legislatively oven-ide these rulings by revising the 

federal securities laws to make clear that the SEC has authority to seek disgorgement and 

restitution in federal court and that no statute oflimitations applies to these remedies. In 

Alabama, we took such a step in 2014 when we revised our state laws to provide prosecutors in 

Alabama (such as myself) the ability to pursue felony securities fraud or theft by deception 

charges for five years from our discovery of the fraud. 44 

V. CONCLUSION 

I will close my testimony by reiterating my opposition to H.R. 5037. In more than 24 

years as a securities regulator, I don't believe that I've ever seen a legislative proposal that so 

alarms me, offends me, and won-ies me. Should Congress pass this bill, my office's efforts, as 

well as those of my colleagues, to protect investors from serious violations of the securities laws 

would be eviscerated. Real investors in your districts you can call them "Mom and Pop" 

investors, call them "Mr. and Mrs. 401K"- but real investors, and real people, will suffer as a 

result of this misguided and in-esponsible legislation. 

Thank you, Mr. Chairman and Ranking Member Maloney, for the opportunity to appear 

before the subcommittee today. I will be pleased to answer any questions you may have. 

42 !d. n.3. 

43 Gabelli v. SEC, 133 S. Ct. 1216 (2013). 

44 See: Press Release, Alabama Securities Commission, Alabama Statute of Limitations Bill Signed by Governor 

Bentley (Apr. 9, 2014), http://asc.alabama.gov/News/2014%20News/4-9-

14%20HB325%20Signed%20and%20now%20law%20FNL.pdf. 

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Statement of the U.S. Chamber of Commerce 

ON: Ensuring Effectiveness, Fairness, and Transparency 

in Securities Law Enforcement 

TO: House Committee on Financial Services, 

Subcommittee on Capital Markets, Securities and 

Investment 

BY: Thomas Quaadman, Executive Vice President, Center 

for Capital Markets Competitiveness, U.S. Chamber of 

Commerce 

DATE: June 13, 2018 

1615 H Street NW I Washington, DC I 20062 

The Chamber's mission is to advance human progress through an economic, 

political and social system based on individual freedom, 

incentive, initiative, opportunity and responsiblllty. 
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The U.S. Chamber of Commerce is the world's largest business federation, 

representing the interests of more than three million businesses of all sizes, sectors, 

and regions, as well as state and local chambers and industry associations. The 

Chamber is dedicated to promoting, protecting, and defending America's free 

enterprise system. 

More than 96% of Chamber member companies have fewer than 100 

employees, and many of the nation's largest companies arc also active members. We 

are therefore cognizant not only of the challenges facing smaller businesses, but also 

those facing the business community at large. 

Besides representing a cross~section of the American business community with 

respect to the number of employees, major classifications of American business--e.g., 

manufacturing, retailing, services, constmction, wholesalers, and finance-are 

represented. The Chamber has membership in all 50 states. 

The Chamber's international reach is substantial as welL We believe that global 

interdependence provides opportunities, not threats. In addition to the American 

Chambers of Commerce abroad, an increasing number of our members cns>agc in the 

export and import of both goods and services and have ongoing investment activities. 

The Chamber favors strengthened international competitiveness and opposes artificial 

U.S. and foreign barriers to international business. 
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Chairman Huizenga, Ranking ,',!ember :\!aloney, and members of the 

Subcommittee on Capital Markets, Securities, and Investment: my name is Tom 

Quaadman, executive vice president of d1e Center for Capital l'vfarkets 

Competitiveness ("CCl'v1C'') at the U.S. Chamber of Cormnerce ("Chamber"). 

The Chamber views a strong and fair Securities and Exchange Commission 

("SEC'') as a critical and essential clement needed for efficient capital markets. Having 

a strong securities regulator is necessary for investors and businesses to have the 

certainty needed to transfer capital for its best use with an expectation of return. This 

allows market participants to engage in reasonable risk taking on a fair playing 

field. A rigorous enforcement regime ensures efficient markets by rooting out 

fraudsters and other bad actors, but if not properly calibrated, it will also serve to 

discourage legitimate businesses that may be seeking growth capital. This is an 

especially acute issue in light of the declining number of public companies-in the 

past twenty years, the number of U.S. public companies has been cut in half. 

The Chamber has become increasingly focused on ensuring that the SEC 

remains the premier securities regulator and is well-positioned for the challenges of a 

twenty-first century economy. As members of this Subcommittee know, capital 

markets have fundamentally changed since the SEC was created during the Great 

Depression of the 1930s. Additionally, managerial challenges wid1in the agency have 

at times created obstacles that have prevented the SEC from acquiring the appropriate 

expertise and deploying its resources for the best usc, undercutting its ability to evolve 

with changing markets and oversee them. Of particular importance to today's hearing, 

changes in enforcement practices have created fundamental issues of due process and 

fairness that arc at the heart of any legal proceeding under our constitutional form of 

government. Relatedly, it has sometimes been difficult for the SEC to focus on all of 

the elements of its tripartite mission-promoting investor protection, facilitating 

capital fonnation, and maintaining fair, orderly, and efficient markets. We believe SEC 

Chainnan Jay Clayton is aware of these issues and we commend him for his efforts to 

overcome them. 

Over the years, the Chamber has identified shortcomings in our financial 

regulatory structure that make it harder for businesses to acquire the capital needed to 

grow and prosper. As far hack as 2007, the Chamber released a report, the Report and 

RemtlllllCndation.> o(tbe ComJJ!is.rion 011 the Reg;dation of U.S. Capital Mar!at.r in tbe 21.rt 

Cen!Nry, and a report in 2011, the U.S. Ca,IJital Markets ComiJetitiliemss, tbe Ul(fini.rbed 

Aowda, to identify problems and the shortfalls of our fmancial regulatory system and 

the difficulty this puts on the United States to compete in a global economy. 
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The Chamber has also offered solutions. For example, in 2009, we issued a 

report, UYatlJining the Fi(ficim9' and Efftctivem.u o{tbe U.S. Semritie.r and EYd)(mae 

CoJ7Jmission, and in 2011, tbc U.S. Seamtie.r and Bxchange Commission: a Roadmapfor 

'fiunsfomtational Re/om;, that contained 51 recommendations for managerial reforms 

and regulatory enhancements to help the SEC acquire the knowledge and expertise 

needed to better understand and oversee the markets and products it regulates. 

Of particular relevance to today's hearing, in July 2015 the Chamber issued a 

report, Examininp U.S. Semrities and Excban~e Commi.r.rion Enforcement: Recommendations on 

Cmmlf Prore.r.re.r and Practi<n ("Chamber SEC enforcement report''), which made 28 

specific recommendations to improve SEC enforcement and due process. 

The Chamber's 2015 SEC enforcement report reviewed the practices of the 

SEC Enforcement Division, changes in strategy and practice by the SEC, the evolving 

usc of administrative proceedings, and the adec1uacy of rules of practice. This paper 

was the culmination of almost two years of effort that included a survey of more than 

75 companies to identify areas where there was a perceived ambiguity or lack of clarity 

in the process. \'Vc conducted extensive interviews 'vith a "'~de range of more than 30 

former SEC officials, legal experts, and corporate counsels to develop specific 

recommendations. We included the ideas that have broad support from those who 

generously participated in tbis process. 

The Chamber's 2015 enforcement report recommended a wide variety of 

structural and procedural changes to the SEC's enforcement process. i\t a high level, 

our recommendations focused on: 

• Providing a stmcture for the choice of fonun decision that incorporates due 

process protection; 

• Strengthening the "Wells Process" so that defendants in SEC investigations 

have a more robust ability to marshal a defense before the SEC commences 

litigation; 

• Clarify~ng the SEC policy on admissions of liability in settled cases; 

• Reducing duplication in regulatory enforcement; 

• Rationalizing the "broken windows" enforcement policy and the need for 

alternative methods of resolving matters; 

• Improving oversight by the SEC commissioners over the SEC enforcement 

staff; and 

• Streamlining and improving the efficiency of the SEC investigation process, 

including with respect to document requests, production, and preservation. 

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To describe a few of these recommendations in greater det,ul, oversight of the 

SEC Enforcement program by the five presidentially-appointed commissioners 

remains an area that we believe is critical. Macro-level Commission oversight of the 

overall enforcement program, in terms of priorities and areas of emphasis, allocation 

of resources, and periodic assessment of effectiveness has traditionally been extremely 

limited. Given tbe importance of the SEC's enforcement program, a macro-level 

oversight process is required. l'irst, there must be systematic collection of quantitative 

and qualitative information on the program operations. Second, there must be a 

regular periodic process for presenting this information to the Commission in a 

manner that provides them \N~th a meaningful, not a pro forma, opportunity to 

provide input and direction. 

To this end, we recommended that the Division of Enforcement should submit 

a quarterly management report to the five commissioners containing productivity and 

efficiency metrics developed by the agency's Division of Economic and Risk Analysis. 

The commissioners should receive quarterly oversight briefint,,; on the enforcement 

program, with an emphasis on "national priority" investigations, investigations raising 

novel or complex legal questions, oldest active investigations, post-mortem analysis of 

litigated cases decided not in favor of the SEC, and new or emerging areas warranting 

investigation. \Ve also recommended that the SEC improve transparency of its 

enforcement regime to place the public and regulated entities on notice as to emerging 

regulatory issues and enforcement priorities. For example, we recommended that the 

SEC should publish annually a report on its enforcement program, provide a public 

comment period on relevant issues, and conduct an annual public roundtable to 

discuss the repon and the operations of its enforcement program. 

\Ve also offered several recommendations in the 2015 report to improve the 

efficiency and effectiveness of the SEC investigation process. The agency's 

investigation process is the largest program at the SEC. It is also the most opaque. 

The Commission provides very limited information on the process, except when a 

formal enforcement action is filed. The process is often long and costly, both to the 

SEC and to persons and entities that are the subjects of the investigation. Because the 

great majority of SEC investigations are closed without any action taken, these 

substantial costs arc incurred by significant numbers of persons and entities that are 

never charged with committing violations. For public companies that arc unable to 

raise capital because of the uncertainties associated with an open SEC investigation or 

that suffer large share-price decreases upon the announcement of an investigation, the 

consequences can be significant. By improving the efficiency of the investigation 

process, the Sl (C would make more effective usc of its limited resources and, at the 

same time, reduce the substantial costs incurred by persons and entities tl1at are 

subjected to the process. There, our recommendations focused on the importance of 
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better internal management of the process and on ways to streamline the document 

production process. 

In the 2015 report, we also advocated for improving the efficiency of the 

investigative process. Improving management of the investigative process requires 

greater internal controls over the duration of investigations, the mctrics that arc used 

to evaluate and incentivize the staff, the problems resulting from staff turnover, and 

the case closing process. Additionally, the report recommended a review and changes 

in the rules of practice to make due process enhancements, creating a right of removal 

to district court under appropriate circumstances and strengthening the \'I/ ells process 

by which defendants mount a defense to the staff and commissioners before the 

commissioners vote to comtnencc litigation. 

Reducing duplication in regulatory enforcement was another theme of the 

Chamber's 2015 enforcement report. As we noted in the report, regulation of the 

financial markets in the United States has historically involved multiple entities, 

including multiple agencies at the federal level (the SEC, U.S. Commodity Futures 

Trading Commission, and the Department of Justice), multiple self-regulatory 

organizations (SRO), and at the state level, a state securities regulator and a state 

attorney generaL For businesses engaged across the financial sector, prudential 

supervision can mean multiple examinations by more than one SEC rq.,>ional office in 

addition to a designated SRO, and the multiple federal banking regulators. 

Globalization of the securities markets has added one more layer of foreign regulation 

for multinational companies. 

\'1/hen companies respond to allegations of improper activities, management's 

focus is necessarily diverted from the day-to-day running of its business. That is a 

consequence of doing business in a regulated society. But, we believe there should be 

some understanding on governn1ent's part that, in the current era, finns are frequently 

subject to multiple domestic and foreign regulators. Responding to multiple regulators 

with respect to the same conduct or transaction is not, and should not be allowed to 

become, a regular attribute of doing business. It is counterproductive-and damaging 

to shareholders-to subject firms and individuals serially to multiple SEC inquiries or 

multiple regulators and self-regulators for the same alleged misconduct. 

Regulatory duplication occurs on three different levels--duplicative or 

overlapping investigations and exams by different offices of the SEC; duplicative or 

overlapping efforts 'W-ithin the United States at the federal and state levels; and most 

recently, duplicative or overlapping efforts internationally. Of course, there is a limit 

to what the SEC can accomplish with regard to duplication at the federal level, the 

federal and state levels, or the international level, given the sovereignty or 

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independence of other enforcement authorities that can pursue the same (or similar) 

conduct that the SEC can pursue. There arc limits to the agency's ability to cabin all 

duplicative proceedings. 

However, in preparing the 2015 report, it became dear the scope of the 

problem appears to be increasing. For example, during the preparation of our 2015 

enforcement report, we learned from multiple interviewees of firms that were 

regulated by the Sl •:C, FINRA, the Office of the Comptroller of the Currency, the 

Federal Reserve Board, and the Consumer Financial Protection Bureau, that they 

frequendy experienced upward of 60 regulatory examinations each year. \'(! e have also 

observed a growing trend of state enforcement agencies bringing state charges that arc 

substantially the same as those brought against the same defendant by their federal 

enforcement counterparts. 

To remedy this situation, the 2015 report recommended the SEC take steps to 

eliminate duplicative and overlapping enforcement responses within the Commission 

and by multiple enforcement authorities against the same individuals or entities for 

effectively the same misconduct l n this respect, we believe the SEC should take a 

leadership role among regulatory bodies at the federal, stilte, and international levels to 

reduce or eliminate duplicative and overlapping investigations and enforcement 

actions for the same conduct. 

To this end, the 2015 Chamber enforcement report recommends that, within 

the United States, the SEC should: 

• Consider greater use of memoranda of understanding with one or more other 

enforcement authorities to avoid "duplication of efforts, unnecessary burdens 

on businesses, and ensuring consistent enforcement" of sccuritics-telatcd 

requircrncnts; 

• Seek to proceed jointly with other enforcement authorities at the early stages of 

an investigation; 

• Coordinate non-cause examinations with other regulatory agencies and selfregulatory organizations; 

• Before commencing an enforcement action, contact other agencies to try to file 

a single action reflecting the common interest of multiple regulators; 

• Consider standing down, or utilizing a deferred prosecution agreement, where 

effective action already has been taken (or commenced) by another 

enforcement authority; 

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• Develop mutual coordination agreements with domestic enforcement 

authorities, and jointly pledge to eliminate, where appropriate, duplicative 

enforcement actions; and 

• Pursue special efforts to eliminate or diminish the extensive duplication of 

efforts that occurs on the part of state and local enforcement authorities. 

As we noted in the 2015 report, it would be a mistake to misinterpret any of these 

recommendations as calling for changes that would either weaken enforcement or 

erect any process barriers that would impede vigorous action by the SEC. This 2015 

report proposed changes that would both further maintain a tough-as-nails efforts to 

punish and deter fraud while ensuring that honest market participants benefit from a 

clear and predictable process. The Chamber firmly believes that investors, market 

participants, and the SEC all benefit from this approach. 

We are encouraged that the SEC has been moving forward on some of the 

Chamber's recommendations. The SEC continues to integrate trial lawyers into the 

investigative process at an early stage. Similarly, the SEC has also adopted incremental 

changes to its rules of practice for administrative proceedings. This responds to a 

specific rcconunendation in our 2015 report. And the SEC appears to have begun 

focusing on programmatically more important cases in lieu of pursuing so-called 

"broken windows," a strategy that has previously strained agency resources and sent a 

mixed message to the markets. 

To his credit, Chairman Clayton has also begun to put his own mark on 

enforcement priorities at the SEC. \'\/e applaud his efforts to focns on "Mr. and l\frs. 

401 (k)" by launching a Retail Strategy Task Force. r\s Chairman Clayton has noted, 

retail investors are more vulnerable to fraud schemes than institutional or other 

sophisticated investors. i\nd we commend the agency's efforts to focus on 

cybersecurity. Indeed, the Enforcement Division's new Cyber Unit has already taken 

important strides to combat cybcr-fraud in our capital markets. 

Our discussion regarding relevant legislation being considered at today's 

hearing is discussed in further detail below. 

H.R. 5037, the Securities Fraud Act of2018 

As noted above, reducing duplicative enforcement was a major theme of the 

Examining U.S. Securities and Exchange Commission Enforcement: 

Recommendations on Current Processes and Practices. Responding to multiple 

regulators with respect to the same conduct or transaction is not., and should not be 

allowed to become, a regular attribute of doing business. lt is counterproductive-and 

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damaging to shareholders-to subject firms and individuals serially to multiple SEC 

inquiries, self-regulatory organizations, or multiple state regulators or attorneys 

general, for the same alleged misconduct. 

But a more pernicious problem exists within the scope of securities 

enforcement, and that is state authorities acting as de facto national regulators for 

companies who list their shares on a national securities exchange. lt is worth 

remembering that the SEC itself was created to establish a system of 1tatio11al securities 

regulation and enforcement for entities engaged in interstate commerce. States 

should not be able to substitute their powers for those that are rightfully reserved for 

a federal regulator. State attorneys general in particular certainly have a right to 

protect their residents from all types of criminal conduct, frauds, and scams but that 

docs not mean that a single state elected official should be allowed to impact aU 

aspects of a national economy. 

Emblematic of this problem is New York State's Martin .-\ct, a law enacted in 

1921 to facilitate the prosecution of "bucket shops" and other scams directed at small 

investors. For 80 years, the law was used responsibly by New York attorneys general 

to protect residents from stock scams or other frauds. 

However, in the last decade, the J'Vlartin Act was weaponized by New York 

attorneys general. This was largely due to the fact that the Martin Act does not 

require the attorney general to prove fraudulent intent, and does not even re<Juire 

prosecutors to show that anyone has been injured or that any securities transaction 

actually took place. 

Because New York is home to thousands of U.S.-listcd public companies, the 

Martin Act effectively anoints the state attorney general a national regulator for these 

businesses engaged in interstate commerce. In the Constitution, the Federal 

Government has sole domain over issues involved in interstate commerce. The 

Martin Act harms certainty by allowing one state to set policies that compete with the 

SEC 

Introduction of the Securities Fraud Act of 2018 is an important step towards 

rebalancing securities enforcement as it relates to nationally listed public companies. 

The legislation clarifies and reaffirms federal law's supremacy and Congress's 

authority over interstate commerce (including our national securities markets). It 

limits the authority of state officials to establish national regulations, while ensuring 

that they can continue to protect the residents of their state. This bill would preserve 

the ability of the New York Attorney General to bring cases under the Martin Act. 

However, civil cases would be required to be heard in federal court and the intent to 

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defraud proved. These requirements are wholly consistent with the history of the 

federal securities laws, and would also help prosecutors prioritize important 

enforcement cases against bad actors. We believe that efforts in this area should not 

harm the ability of state securities administrators to prosecute crimes such as boiler 

rooms or pump and dump schemes. 

The Chamber appreciates Rep. MacArthur's work on this important legislation, 

and we look forward to working with all members of the Financial Services 

Committee as it advances through the legislative process. 

H.R. 2128, the Due Process Restoration Act of2017 

The Chamber supports the Due Process Restoration 1\ct of 2017, with a 

suggested amendment described in more detail below. Tlus legislation would provide 

respondents in SEC administrative proceedings the right to have their case removed 

to federal district court if the SEC is seeking both a cease and desist order and a 

monetary penalty. 

As noted above, a major concern identified during the development of the 

Examining U.S. Securities and Exchange Commission Enforcement: 

Recommendations on Current Processes and Practices was the increased and widespread nse of administrative proceedings for enforcement cases. Since enactment of 

the 2010 Dodd-Frank \'Vall Street Reform and Consumer Protection Act- which 

expanded the SEC's authority to usc administrative proceedings -we began to sec 

such proceedings used as the primary means of the SEC prosecuting enforcement 

cases under its non-criminal powers. This has created an imbalance within the system 

that endangers the rights of defendants and undermines the use of appropriate 

enforcement tools, while raising important questions regarding the separation of 

powers between the executive and judicial branches of government. 

In 2016, the SEC adopted a series of amendments to its rules of practice that 

were intended to address many of the concerns raised over the agency's increased use 

of administrative forums. 1 \'>;'hile these amendments were a small step in the right 

direction, the protections afforded defendants in administrative proceedings still fall 

well short of those provided in an Article I !I court, and the due process standards 

provided by the Federal Rules of Evidence and the Federal Rules of Civil Procedurc 2 

For example, the number of depositions allowed to be taken by respondents in 

'https://www.sec.gov/rules/final/2016/34-78319.pdf 2 See e.g. U.S. Chamber comment letter on proposed amendments to rules of practice, available at: 

https:/ /www .sec.gov/comments/s7 -18-15/s71815-12.pdf 

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administrative proceedings and the amount of time respondents has to build a defense 

still pale in comparison to what is provided for in federal district court. 

\Ve believe that the Due Process Restoration Act of2015 is an important step 

forward in restoring the balance between the appropriate uses of administrative 

proceedings and preserving the due process rights of defendants. This bill, if passed, 

would allow defendants, within parameters, to have the option to take a case to 

district court. We believe this bill would allow for the SEC to usc administrative 

proceedings as they have been used historically, while allowing defendants all available 

options. If the SEC rules of practice arc amended to allow for a fair process of 

discovery, administrative proceedings would be a fair and level playing field. The right 

of removal would not, in our opinion, burden court dockets. 

Nevertheless there is one amendment we would suggest: making to H.R. 2128 

as it moves through the legislative process. The legislation changes the burden of 

proof that the SEC mnst use in an administrative proceeding to a "clear and 

convincing" standard. We believe the burden of proof should be the same in an 

administrative proceeding or a district court case. While we understand the thought 

behind the usc of a clear and convincing standard, this can have unforeseen 

consequences that may not help defendants or appropriate enforcement activities. 

The Chamber believes that the passage of the Due Process Restoration Act of 

2017, with our su7,gested amendment, as well as further changes to the SEC's rules of 

practice, would allow for both fair due process and strong enforcement policies. 

We ask that the Subcommittee and House consider both of these bills 

expeditiously in order to provide ,\mcrican businesses \\~th greater enforcement 

certainty that encourages them to compete, thrive, and create jobs. 

I am happy to take any questions that you may have at this time. 

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HEARING BEFORE THE SUBCOMMITTEE ON CAPITAL MARKETS, SECURITIES, AND 

INVESTMENT 

OF THE COMMITTEE ON FINANCIAL SERVICES 

OF THE HOUSE OF REPRESENTATIVES 

Ensuring Effectiveness, Fairness, and Transparency in Securities Law Enforcement 

Testimony of Andrew N. Vollmer 

June 13, 2018 
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Chairman Huizenga, Ranking Member Maloney, and Members of the Subcommittee: 

I am pleased to have an opportunity to comment on several timely and 

important issues about the approach of the Securities and Exchange Commission to 

enforcing the federal securities laws. I will address (1) general problems with SEC 

enforcement, (2) disgorgement, limitations periods, and the length of investigations, 

(3) the role of administrative proceedings in enforcement of the federal securities 

laws, and (4) the role of civil enforcement of securities laws by states. 

I have extensive experience with the SEC enforcement process and have 

written about various aspects of it. A summary of my background and a list of 

enforcement articles are at the end of these written remarks. The views I express in 

this written statement and in my oral testimony are solely my own and are not on 

behalf of and do not necessarily reflect the views of any other person. For 

convenience, I will refer to a person involved in an SEC investigation or charged 

with a violation of the securities laws as a defendant. 

Enforcement of the federal securities laws should be vigorous but fair. Fair 

treatment of defendants increases accuracy of results, promotes the legitimacy and 

acceptability of the enforcement process, fosters respect for the law, and therefore 

advances the statutory goals of encouraging capital formation while protecting 

investors and markets. The SEC enforcement process should be based on the rule of 

law and should provide each defendant with adequate advance notice of specific and 

identifiable standards of conduct, a meaningful opportunity to prepare and present 

a defense, and an ability to bring cases that lack merit to a rapid close. Fairness to 

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defendants should be one of the highest values protected by the process used to 

enforce the federal securities laws. 

General 

In an article a few years ago, I suggested several ways to improve the SEC 

enforcement process. Four Ways To Improve SEC Enforcement, 43 Sec. Reg. L.J. 333 

(2015). The article said that the SEC could extend more fairness and consideration 

to defendants without any damage to tough enforcement by: 

• using established and accepted legal theories and not basing claims on new, 

untested liability theories, 

• creating an objective and balanced investigative record that considers both 

potential wrongdoing and innocent explanations, 

• applying rigorous, neutral standards before opening investigations and 

initiating cases. The Commissioners should not authorize a proceeding 

unless they believe a reasonable person would conclude that the SEC is more 

likely than not to prevail on the facts and the law and believe that a 

proceeding would serve broad and legitimate enforcement goals, and 

• substantially shortening investigations. Each member of the staff should 

make an effort to limit the number of documents requested and the number 

of individuals called for testimony. 

Many of these areas can be addressed internally at the Commission with 

better procedures, controls, and management and do not require action by 

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Congress. The Commissioners and staff at the SEC periodically pay attention to 

ways to improve the internal systems, but the problems addressed in the article 

largely remain relevant today. 

Disgorgement, limitations periods, and the length of investigations 

One of my concerns about the SEC enforcement process is with the length of 

investigations. This is an area in which attention from Congress could be helpful. 

In my experience, the length of SEC investigations is strongly correlated to 

the five-year limitations period for fines, penalties, and forfeitures in 28 U.S.C. § 

2462. The Supreme Court decisions in Gabelli v. SEC, 568 U.S. 442 (2013), and 

Kokesh v. SEC, 137 S. Ct. 1635 (2017), addressed the application of section 2462 to 

SEC enforcement cases. The Commission and the staff have an incentive to complete 

investigations in time to commence enforcement proceedings before the five-year 

statute of limitations for monetary penalties and disgorgement expires. 

Too frequently, however, the Commission does not complete an investigation 

within five years and initiates an enforcement action based on alleged misconduct 

many years old. The staff of the Division of Enforcement often avoids the effect of 

the limitations period by entering into one or more tolling agreements. In a tolling 

agreement, the person being investigated agrees with the staff to suspend the 

running of time for purposes of calculating any limitations period. See SEC Division 

of Enforcement, Enforcement Manual 3.1.2 (November 28, 2017). 

Long investigations and the use of tolling agreements signal a need for 

stricter application oflimitations periods. "Statutes of limitation are vital to the 

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welfare of society and are favored in the law. They are found and approved in all 

systems of enlightened jurisprudence. They promote repose by giving security and 

stability to human affairs." Wood v. Carpenter, 101 U.S. 135, 139 (1879). Important 

public policies lie at their foundation: "repose, elimination of stale claims, and 

certainty about a plaintiffs opportunity for recovery and a defendant's potential 

liabilities." Rotella v. Wood, 528 U.S. 549, 555 (2000). "A federal cause of action 

"brought at any distance of time" would be "utterly repugnant to the genius of our 

laws." Adams v. Woods, 2 Cranch 336, 342 (1805). As time goes by, evidence 

becomes less reliable, and the results of investigations and litigation become less 

accurate. "Just determinations of fact cannot be made when, because of the passage 

of time, the memories of witnesses have faded or evidence is lost. In compelling 

circumstances, even wrongdoers are entitled to assume that their sins may be 

forgotten." Wilson v. Garcia, 4 71 U.S. 261, 271 (1985). 

Long investigations cause other social harms. They create uncertainty, which 

can lead businesses to fail or postpone research and investment in potentially 

beneficial goods and services. Individuals suffer. They can be fired or put on 

administrative leave during investigations even when no misconduct occurred. The 

existence of an investigation can become public, injuring reputations and causing 

investors to withdraw money and customers to abandon a company. The longer an 

investigation, the worse these problems are. 

For these reasons, Congress should be reluctant to lengthen limitations 

periods for SEC cases. It should lengthen the limitations period for the SEC only if it 

receives convincing data that a substantial problem with the current five-year 

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period exists and that five years is not sufficient for an effective enforcement 

program. Has the SEC been unable to obtain adequate relief in a large number of 

cases because of the limitations period? Even if some such cases exist, does that 

justify extending the limitations period for all SEC cases? A longer limitations 

period is likely to lead to longer and longer investigations. A ten-year period seems 

inordinately long given the catalogue of ills from lengthy investigations and 

litigation based on old conduct. 

If Congress is convinced that the five-year period prevents obtaining effective 

relief in a sufficient number of cases, the better approach would be to define specific 

exceptions from the five-year period. Exceptions should be few. The SEC should be 

obliged to prove that a case involved serious and widespread misconduct and that 

the SEC could not reasonably have commenced an action within a five-year period 

for an alleged violation occurring more than five years ago. 

Congress also should address additional matters if it is inclined to reconsider 

the limitations period for SEC cases. First, a limitations period should apply to the 

power of the SEC to commence an enforcement case and should not apply to any 

particular form of relief. The statute of limitations should not be tied to fines, 

disgorgement, injunctions, or other relief. That is how section 2462 operates now, 

but that statute presents a variety of interpretive difficulties and is not the best 

approach. The expiration of a limitations period should stop the SEC from suing. 

Second, a limitations period should apply to SEC enforcement cases brought 

in district court or as administrative proceedings. The litany of social harms from 

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long investigations and ancient misconduct exists no matter what forum the SEC 

uses. 

Third, a limitations period should not be connected to compensation for 

investor losses. The Kokesh opinion did that for purposes of analyzing the language 

in section 2462, but Congress has no reason to connect the two. It has authority to 

set a limitations period of reasonable length and reasonable terms without linking 

the period to the return of funds to harmed investors. 

Congress has never given the SEC power to calculate a monetary recovery 

based on investor loss or damage. Congress has given the SEC many different forms 

of relief, but they have all related to prevention and deterrence, such as injunctions, 

civil penalties, and revocation of a person's registration as a broker-dealer or 

investment adviser. Private actions recover loss, but private actions provide a 

defendant with a variety of procedural protections not available in SEC enforcement 

cases. Those protections include the plaintiffs need to prove reliance, loss, and loss 

causation and to meet higher pleading standards. Granting the SEC the power to sue 

for compensation for investor damage would be a sharp break from precedent with 

unpredictable consequences. 

Fourth, a new statute of limitations should restrict and control tolling 

agreements. The staff currently uses them to prolong the five-year limitations 

period. Congress might not want to prohibit all tolling agreements, but they should 

be rare. 

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The role of SEC administrative proceedings in enforcement of the federal 

securities laws 

SEC administrative enforcement proceedings have been the subject of 

serious criticism and complaint for decades. Congress should take action to address 

the concerns and has several different approaches it could take. 

The basic problem with SEC administrative proceedings (APs) is that they 

are either inherently unfair to defendants or appear to be unfair. Defendants caught 

up in the process emerge with a sense that they did not receive the same evenhanded and impartial consideration from an AP that they would have received in 

district court. The first level of adjudication is before an administrative law judge 

(ALJ) who has or appears to have reasons to favor the SEC. The second level of 

adjudication is before the Commission itself, which is the same body that voted to 

charge the defendant. A defendant could be forgiven for questioning whether the 

body- sometimes the very same Commissioners-- that sued him is entirely openminded on the ultimate question of whether he committed the violation. 

In addition, the procedures used at the ALJ level hamper a defendant's ability 

to prepare and present a full defense. The SEC staff spends years investigating 

potential violations. They have subpoena power and often amass an enormous 

investigative record. Only part of that record is available to a defendant before the 

SEC sues. After the SEC sues, APs are on a short time schedule. That short schedule 

can have advantages over district court litigation but generally favors the SEC 

because the staff is already more familiar with the facts and evidence than the 

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defendant. The SEC must disclose most (but not all) of the record to the defendant, 

but the shortness of time seriously impairs considered review of the record, 

especially in large or complicated matters. 

A defendant's ability to obtain information during an AP is severely 

restricted. A defendant must request a subpoena for depositions or documents and 

is not assured of obtaining it. When several persons are defendants in a single case, 

they may notice no more than five depositions and must move for additional 

depositions. SEC rules do not offer all forms of discovery available pursuant to the 

Federal Rules of Civil Procedure. 

Restrictions on a defendant's ability to obtain information is consequential 

because the investigative record reflects the efforts of the SEC staff to obtain 

information to charge and support a violation. The staff has little incentive to 

develop facts that could support exoneration. The result is that the investigative 

record in many cases is incomplete from the defendant's point of view, and a 

defendant is not provided the time or tools to prepare an adequate defense. 

The SEC rules of practice also do not provide a defendant with an early 

mechanism to test the legal validity of a claim. In district court, the motion to 

dismiss is a common first step. 

A jury is not available in an SEC AP. Some would argue that the unavailability 

of a jury is a disadvantage of APs. 

Empirical research has only a limited ability to sort through a comparison of 

the fairness of APs and district court cases. The results in district court cases cannot 

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just be compared to the results of APs because the allocation of enforcement cases 

between court and APsis not random. The SEC staff and the Commissioners decide 

on the allocation. They are human and make decisions for many different reasons. 

They could be sending easier or more difficult cases to APs, or the likelihood of 

success in the two categories of cases could be the same. An amicus brief in the 

Supreme Court in Lucia v. SEC filed by Professors Velikonja and Grundfest discuss 

the research issues (page 6). 

If Congress concludes that reasonable questions about the impartiality and 

legitimacy of APs exist, it could take one of several different actions. Congress could 

give serious consideration to abolishing SEC APs and could collect more information 

on whether the benefits of retaining APs outweigh their costs, particularly the cost 

of the actual or perceived unfairness. The general assumption is that APs are faster 

and more expert than district court proceedings, but those assumptions could be 

tested. Are ALJs and Commissioners actually more expert and more accurate than 

district courts on the issues raised by standard enforcement cases involving a fraud, 

misstatement, or the mistreatment of a customer by a broker-dealer or investment 

adviser? Do the short periods of time for proceedings before ALJs actually serve the 

interests of justice and fairness to defendants in a case of factual complexity? A 

further question is whether elimination of APs would impose an unacceptable 

burden on district courts. 

A second approach would be to make APs as fair to defendants as district 

court cases. Whether that could be accomplished is not clear. The SEC Rules of 

Practice would need to be overhauled to give defendants an adequate opportunity 

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to obtain information and to prepare and present a complete defense. Congress 

could require SEC APs to use the Federal Rules of Civil Procedure and the Federal 

Rules of Evidence after having a group of experts modify the Rules specifically for 

use before ALJs. The Federal Rules are highly regarded, treat all parties equally, and 

have held up well over time. ALJs would need to be independent from the 

Commission, but constitutional problems with appointment and removal would 

need to be resolved. More thought should be given to the triple role of SEC 

Commissioners. They adopt substantive rules of conduct, initiate enforcement 

cases, and then make final determinations of violations when reviewing ALJ 

decisions. Concentrating that much power and discretion in the same small group of 

individuals cannot be healthy or appropriate in our system of government. I 

discussed the due process issues from the combination of charging and adjudicating 

functions in a recent paper: Accusers as Adjudicators in Agency Enforcement 

Proceedings, http:/ jssrn.comjabstract=3171674 and forthcoming in 52 U. Mich. J.L. 

Reform. 

A third approach would be to give defendants in APs the right to move the 

case to district court. This is the removal concept. The idea has several variations, 

including the one in H.R. 2128, which gives a defendant in an AP an absolute right to 

require the SEC to proceed in court but only if the AP seeks a cease-and-desist order 

and a penalty. Other variations create complicated removal procedures that rely on 

vague and subjective standards to be applied by the district court. The more 

complicated versions could add cost, delay, and uncertainty to the enforcement 

process. 

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My preference is to let the SEC make the initial forum selection, as it does 

now, but then give a defendant in any type of AP a right to transfer the case to 

district court. The right would be unqualified and unreviewable. The approval of 

the district court would not be needed. This approach would be simple and fast and 

would allow each defendant to consider the specifics of the particular case and 

decide whether an AP or a district court would produce a more accurate and fairer 

result. Under this approach, the number of cases each year that would be entitled to 

use a removal right would not be too large and should not burden the federal courts. 

The right would matter only when a defendant intended to contest the SEC charges 

and would not be used when a defendant settled at the time of initiation or very 

soon after initiation. 

Some have proposed requiring the use of APs for certain types of cases. In 

these proposals, a defendant could not remove certain cases or the SEC could have a 

district court remand certain cases back to the SEC for continuation as an AP. My 

concern with these proposals is that APs do not necessarily offer a clear 

comparative advantage for any particular category of case. ALJs are not necessarily 

more expert than federal court judges in all areas of the federal securities laws, and 

the time limit for APs are not necessarily a benefit for a defendant who needs time 

to prepare a defense. Statutory language attempting to define a category of cases 

more suitable to be litigated as APsis likely to be over and under inclusive and 

inflexible. 

The role for civil enforcement of securities laws by states 

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The final topic concerns the extent to which federal law should pre-empt civil 

enforcement of securities laws by states. Currently, federal law has a complicated 

arrangement with state law in the securities area, but federal law generally 

preserves the power of state securities authorities to investigate and bring 

enforcement actions (section 18(c)(l) of the Securities Act and section 28(f)( 4) of 

the Exchange Act). 

State enforcement of securities laws can be valuable, especially when a 

problem is limited to one or a small number of states and involves local activities, 

such as the actions of a few local securities sellers or employees of a broker-dealer 

or investment adviser. Many times, however, state enforcement targets a perceived 

problem that exists nationwide and might be the subject of an SEC or FINRA 

investigation. In those cases, state enforcement can lead to novel theories of liability 

and standards of conduct or to piling on to the efforts of other regulators. 

H.R. 5037 is on the right track. It properly concentrates on the need for 

national uniformity of legal standards and the need to reduce and minimize the 

costly overlap and duplication of the federal and state systems of regulating the 

securities area. The bill is limited to securities fraud, broadly defined, and to 

securities listed on major national stock exchanges. That would be an important 

first step, but the principles underlying the bill usefully could be extended to all 

regulatory obligations in addition to the anti-fraud provisions and to all securities 

transactions other than those having a distinctly local nature. 

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Background 

I am Professor of Law, General Faculty, and Director of the John W. Glynn, Jr. 

Law & Business Program at the University of Virginia School of Law. I teach 

Securities Regulation, Advanced Topics in Securities Regulation, and Securities 

Litigation and Enforcement. I was Deputy General Counsel of the Securities and 

Exchange Commission from mid-2006 to March 2009 and was a partner in the 

securities litigation and enforcement practice of Wilmer Cutler Pickering Hale and 

Dorr LLP before and after my time at the SEC. While at the Commission, one of my 

main areas of responsibility was to advise the Commissioners and the Division of 

Enforcement on legal aspects of contemplated enforcement proceedings. While in 

private law practice, I represented many individuals and companies that were in 

SEC investigations and private securities litigation or that discovered potential 

misconduct before an investigation or private litigation began. 

I have written on various aspects of the SEC enforcement process: 

Accusers as Adjudicators in Agency Enforcement Proceedings, 

http:/ fssrn.comfabstract=3171674 and forthcoming in 52 U. Mich. J.L. Reform. 

A Rule of Construction for the Personal Benefit Requirement in Tipping Cases, 11 

N.Y.U. J.L. & Lib. 331 (2017). 

SEC Revanchism and the Expansion of Primary Liability Under Section 17( a) and 

Rule lOb-S, 10 Va. L. & Bus. Rev. 273 (2016). 

Computer Hacking and Securities Fraud, 47 Sec. Reg. & L. Rep. (Bloomberg BNA) 

1985 (October 19, 2015). 

Four Ways To Improve SEC Enforcement, 43 Sec. Reg. L.J. 333 (2015). 

Need for Narrower Subpoenas in SEC Investigations, New York Law Journal 4 

(October9, 2014). 

A Chance to Rein in Securities Class Actions, Wall Street Journal A17 (March 4, 

2014). 

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Should Class Actions To Enforce Rule lOb-S Be Expanded or Curtailed?, 44 Sec. Reg. 

& L. Rep. (Bloomberg BNA) 325 (2012). 

How hedge fund advisers can reduce insider trading risk, 3 Journal of Securities 

Law, Regulation & Compliance 106 (2010). 

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COMMUNITY BANCORP OF SANTA MARIA 

2739 Santa Maria Way, Santa Maria, California 93455 

May18, 2018 

The Honorable Jeb Hensarling, Chairman 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Maxine Waters, Ranking Member 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Bill Huizenga, Chairman 

(805) 922- 2900 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Carolyn Maloney, Ranking Member 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

Re: Main Street Growth Act 

Dear Chairman Hensarling, Ranking Member Waters, Chairman Huizenga and Ranking 

Member Maloney, 

I am the President and Chief Executive Officer of Community Bancorp of Santa Maria (OTCQX: 

CYSM), a community bank located in Santa Maria, California that is publicly-traded on OTC 

Markets Group's OTCQX Best Market. 

I am writing to share Community Bancorp of Santa Maria's experience as a small, public 

company and describe why we do not support the "Main Street Growth Act." 

The Main Street Growth Act would allow the creation of "Venture Exchanges" that are intended 

to have trading and listing rules tailored for smaller companies like ours. However, these 

regulatory privileges would not be available to non-exchange markets such as OTCQX. 1 

1 OTC Markets Group Inc. operates the OTCQX Best and OTCQB Venture markets, where over 1,200 

companies meeting financial standards and providing current disclosure to investors, including many 

innovative and entrepreneurial 'venture' companies, trade via an SEC registered alternative trading 

system ("ATS"). 
156 

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Community Bancorp of Santa Maria joined the OTCQX market on January 1, 2016. Under the 

OTCQX Rules, Community Bancorp of Santa Maria is required to meet high financial standards 

(OTCQX does not accept Penny Stocks or Shell Companies) and provide current disclosure to 

investors (including PCAOB audited annual financials). Since joining OTCQX we have 

experienced improvement in the liquidity of our shares, and recognized a 75% increase in the 

market value of our stock. 

There are many reasons why the OTCQX market works well for small, growing companies like 

ours: 

Lower Cost & Complexity: OTCQX costs less, and our compliance obligations, while 

challenging, are less burdensome than listing on an exchange, giving us more time and 

money to spend growing our business. 

Small Company Liquidity: OTC Markets Group's ATS dealer model supports the 

liquidity needs of smaller, less-actively traded securities. Unlike large, exchange-listed 

companies, we do not have large amounts of natural liquidity and high trading volumes. 

Rather, our liquidity needs are focused on making sure our shareholders have the ability 

to buy and sell on an as-needed basis. 

Investor Engagement & Capital Formation: Through OTC Markets' disclosure 

services, we are able to easily communicate with our shareholders, publish financial 

reports and share company updates to broaden our visibility in the marketplace. The 

OTCQX market is also exempt from Blue Sky secondary trading regulations in 30 states, 

which allows broker dealers to reach a wider audience of potential investors, raise 

capital and grow our shareholder base. 

The OTCQX market has helped Community Bancorp of Santa Maria grow and mature by 

providing all of the benefits of a public market- scaled to fit the needs of small companies. 

The Main Street Growth Act does not work for companies like us because it focuses solely on 

national securities exchanges and excludes other models, such as OTCQX where we have 

established a thriving secondary market. The Main Street Growth Act instead would restrict 

trading to one, single exchange. 

While we welcome legislation aimed at supporting small public companies and the venture 

markets that serve them, the Main Street Growth Act does not achieve these goals. We urge 

the Committee to consider the value of alternative secondary market models, such as ATSs, 

because companies should be able to choose the venue that best suits their needs. A "Venture 

Company" should be afforded the same regulatory treatment, regardless of whether it trades on 

an exchange or an ATS market like OTCQX. 

We remain hopeful that Congress, the SEC, and market participants can work together to 

provide venture companies with all of the tools necessary to foster their growth and 

development. Please let me know if we can provide any additional information or insight in 

furtherance of that shared goal. 

Sincerely, 

Janet Silveria 

President 

Chief Executive Officer 

2 
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May 22, 2018 

The Honorable Jeb Hensarling, Chairman 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Maxine Waters, Ranking Member 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Bill Huizenga, Chairman 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Carolyn Maloney, Ranking Member 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

Re: Main Street Growth Act 

Dear Chairman Hensarling, Ranking Member Waters, Chairman Huizenga and Ranking Member 

Maloney, 

I am the President of The Freedom bank of Virginia (OTCQX: FDVA), a community bank located in 

Fairfax, Virginia that is publicly-traded on OTC Markets Group's OTCQX Best Market. 

I am writing to share Freedom Bank's experience as a small, public company and describe why we 

do not support the "Main Street Growth Act." 

The Main Street Growth Act would allow the creation of "Venture Exchanges" that are intended to 

have trading and listing rules tailored for smaller companies like ours. However, these regulatory 

privileges would not be available to non-exchange markets such as OTCQX. 1 

Freedom Bank joined the OTCQX market in March 2015. Under the OTCQX Rules, Freedom 

Bank is required to meet high financial standards (OTCQX does not accept Penny Stocks or Shell 

Companies) and provide current disclosure to investors (including PCAOB audited annual 

financials). Since joining the OTXQX, we have seen our market capitalization increase from $45 

1 OTC Markets Group Inc. operates the OTCQX Best and OTCQB Venture markets, where over 1,200 companies 

meeting financial standards and providing current disclosure to many innovative and entrepreneurial 

'venture' trade via an SEC 

502 Maple Avenue West 

Vienna, Virginia 22180 

703.667.4170 

I I 700 Plaza America Drive 

Reston, Virginia 20 190 

703.663.2300 

freedombankva.com 

I 0555 Main Street 

Fairfax, Virginia 22030 

703.242.5300 
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million to $85 million. partially due to a successful stock offering we were able to undertake as a 

OTCQX bank. Our daily trading volume has increased from 1,000 shares daily to up 5,000 shares 

daily on average. 

There are many reasons why the OTCQX market works well for small, growing companies like 

ours: 

• Lower Cost & Complexity: OTCQX costs less, and our compliance obligations. while 

challenging. are less burdensome than listing on an exchange, giving us more time and 

money to spend growing our business. 

• Small Company Liquidity: OTC Markets Group's ATS dealer model supports the liquidity 

needs of smaller. less-actively traded securities. Unlike large, exchange-listed companies, 

we do not have large amounts of natural liquidity and high trading volumes. Rather. our 

liquidity needs are focused on making sure our shareholders have the ability to buy and sell 

on an as-needed basis. 

• Investor Engagement & Capital Formation: Through OTC Markets' disclosure services, 

we are able to easily communicate with our shareholders, publish financial reports and 

share company updates to broaden our visibility in the marketplace. The OTCQX market is 

also exempt from Blue Sky secondary trading regulations in 30 states. which allows broker 

dealers to reach a wider audience of potential investors. raise capital and grow our 

shareholder base. 

The OTCQX market has helped Freedom Bank grow and mature by providing all of the benefits of 

a public market- scaled to fit the needs of small companies. 

The Main Street Growth Act does not work for companies like us because it focuses solely on 

national securities exchanges and excludes other models, such as OTCQX where we have 

established a thriving secondary market. The Main Street Growth Act instead would restrict trading 

to one, single exchange. 

While we welcome legislation aimed at supporting small public companies and the venture markets 

that serve them, the Main Street Growth Act does not achieve these goals. We urge the 

Committee to consider the value of alternative secondary market models, such as A TSs, because 

companies should be able to choose the venue that best suits their needs. A "Venture Company" 

should be afforded the same regulatory treatment, regardless of whether it trades on an exchange 

or an A TS market like OTCQX. 

We remain hopeful that Congress. the SEC and market participants can work together to provide 

venture companies with all of the tools necessary to foster their growth and development. Please 

let me know if we can provide any additional information or insight in furtherance of that shared 

goal. 

Si~ ~- L)r;JJnjJf 

Craig S. Underhill 

President & CEO 

The Freedom Bank of Virginia 

502 Maple Avenue West 

Vienna, Virginia 22180 

703.667.4170 

I 1700 Plaza America Drive 

Reston, Virginia 20 190 

703.663.2300 

2 

freedombankva.com 

I 0555 Main Street 

Fairfax, Virginia 22030 

703.242.5300 
159 

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May 21,2018 

The Honorable Jeb Hensarling, Chairman 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Maxine Waters, Ranking Member 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Bill Huizenga, Chairman 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Carolyn Maloney, Ranking Member 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

Re: Main Street Growth Act 

Dear Chairman Hensarling, Ranking Member Waters, Chairman Huizenga and Ranking 

Member Maloney, 

I am the Executive Vice President & Chief Financial Officer of First Resource Bank (OTCQX: 

FRSB), a community bank providing loan and deposit services to businesses and consumers 

located in Exton, Pennsylvania that is publicly-traded on OTC Markets Group's OTCQX Best 

Market. 

I am writing to share First Resource Bank's experience as a small, public company and describe 

why we do not support the "Main Street Growth Act." 

The Main Street Growth Act would allow the creation of "Venture Exchanges" that are intended 

to have trading and listing rules tailored for smaller companies like ours. However, these 

regulatory privileges would not be available to non-exchange markets such as OTCQX. 1 

1 OTC Markets Group Inc. operates the OTCQX Best and OTCQB Venture markets, where over 1,200 

companies meeting financial standards and providing current disclosure to investors, including many 

innovative and entrepreneurial 'venture' companies, trade via an SEC registered alternative trading 

system ('ATS"). 

FirstResourceBank.com 
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First Resource Bank joined the OTCQX market in November 2014. Under the OTCQX Rules, 

First Resource Bank is required to meet high financial standards (OTCQX does not accept 

Penny Stocks or Shell Companies) and provide current disclosure to investors (including 

PCAOB audited annual financials). Since joining OTCQX First Resource Bank has grown 51% 

from $175 million in assets at October 31, 2014 to over $265 million today, with over $275 

million in new loans generated in our local market during that timeframe. In addition to the jobs 

created and supported by this significant loan growth, we have grown our own staff from 25 

employees in October 2014 to 43 employees today, with plans to hire 16 more over the next 

three years. Our growth was supported by capital growth of $5.8 million since joining OTCQX 

and our market capitalization has increased from $10.6 million in October 2014 to approximately 

$30 million today. Our growth has allowed us to achieve not only record profitability for our 

shareholders, but it has also allowed us to donate over $575,000 to schools and charitable 

organizations in our local market of Chester County, Pennsylvania since we joined OTCQX. 

Since opening First Resource Bank in 2005, we have donated well over $1 million to local 

schools and charities. 

There are many reasons why the OTCQX market works well for small, growing companies like 

ours: 

Lower Cost & Complexity: OTCQX costs less, and our compliance obligations, while 

challenging, are less burdensome than listing on an exchange, giving us more time and 

money to spend growing our business. 

Small Company Liquidity: OTC Markets Group's ATS dealer model supports the 

liquidity needs of smaller, less-actively traded securities. Unlike large, exchange-listed 

companies, we do not have large amounts of natural liquidity and high trading volumes. 

Rather, our liquidity needs are focused on making sure our shareholders have the ability 

to buy and sell on an as-needed basis. 

Investor Engagement & Capital Formation: Through OTC Markets' disclosure 

services, we are able to easily communicate with our shareholders, publish financial 

reports and share company updates to broaden our visibility in the marketplace. The 

OTCQX market is also exempt from Blue Sky secondary trading regulations in 30 states, 

which allows broker dealers to reach a wider audience of potential investors, raise 

capital and grow our shareholder base. 

The OTCQX market has helped First Resource Bank grow and mature by providing all of the 

benefits of a public market- scaled to fit the needs of small companies. 

The Main Street Growth Act does not work for companies like us because it focuses solely on 

national securities exchanges and excludes other models, such as OTCQX where we have 

established a thriving secondary market. The Main Street Growth Act instead would restrict 

trading to one, single exchange. 

While we welcome legislation aimed at supporting small public companies and the venture 

markets that serve them, the Main Street Growth Act does not achieve these goals. We urge 

the Committee to consider the value of alternative secondary market models, such as ATSs, 

because companies should be able to choose the venue that best suits their needs. A "Venture 

Company" should be afforded the same regulatory treatment, regardless of whether it trades on 

an exchange or an A TS market like OTCQX. 

2 
161 

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We remain hopeful that Congress, the SEC and market participants can work together to 

provide venture companies with all of the tools necessary to foster their growth and 

development. Please let me know if we can provide any additional information or insight in 

furtherance of that shared goal. 

Sincerely, 'I< WV\Lv'- ( · K~VLJHt. Lauren C. Ranalli 

EVP& CFO 

First Resource Bank 

3 
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May 21, 2018 

The Honorable BiU Huizenga, Chairman 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

Re: Main Street Growth Act 

Dear Bill, 

As you may be aware I am the CEO of Grand Rapids based Maritage Hospitality Group 

(OTCQX:MHGU), a restaurant company employing 10,000 people, that is publicly-traded on 

OTC Markets Group's OTCQX Best Market. 

I am writing to share Maritage's experience as a small, public company and describe why we do 

not support the "Main Street Growth Act." 

The Main Street Growth Act would allow the creation of "Venture Exchanges" that are intended 

to have trading and listing rules tailored for smaller companies like ours. However, these 

regulatory privileges would not be available to non-exchange markets such as OTCQX. 1 

Maritage joined the OTCQX market in 2007. Under the OTCQX Rules, Maritage is required to 

meet high financial standards, (OTCQX does not accept Penny Stocks or Shell Companies) and 

provide current disclosure to investors (including PCAOB audited annual financials and sworn 

certifications). Over the past 11 years, we have seen our market capitalization increase 270% 

to $112 million and expanded our business into 16 states with 10,000 employees. 

There are many reasons why the OTCQX market works well for small, growing companies like 

ours: 

• Lower Cost & Complexity: OTCQX costs less, and our compliance obligations, while 

challenging, are less burdensome than listing on an exchange, giving us more time and 

money to spend growing our business. 

• Small Company Liquidity: OTC Markets Group's ATS dealer model supports the 

liquidity needs of smaller, less-actively traded securities. Unlike large, exchange-listed 

companies, we do not have large amounts of natural liquidity and high trading volumes. 

1 OTC Markets Group Inc. operates the OTCQX Best and OTCQB Venture markets. where over 1,200 

companies meeting financial standards and providing current disclosure to investors, including many 

innovative and entrepreneurial 'venture' companies, trade via an SEC registered alternative trading 

system ("ATS"). 
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Rather, our liquidity needs are focused on making sure our shareholders have the ability 

to buy and sell on an as-needed basis. 

• Investor Engagement & Capital Formation: Through OTC Markets' disclosure 

services, we are able to easily communicate with our shareholders, publish financial 

reports and share company updates to broaden our visibility in the marketplace. The 

OTCQX market is also exempt from Blue Sky secondary trading regulations in 30 states, 

which allows broker dealers to reach a wider audience of potential investors. raise 

capital and grow our shareholder base. 

The OTCQX market has helped Meritage grow and mature by providing all of the benefits of a 

public market- scaled to fit the needs of small companies. 

The Main Street Growth Act does not work for companies like us because it focuses solely on 

national securities exchanges and excludes other models, such as OTCQX where we have 

established a thriving secondary market. The Main Street Growth Act instead would restrict 

trading to one, single exchange. 

While we welcome legislation aimed at supporting small public companies and the venture 

markets that serve them, the Main Street Growth Act does not achieve these goals. We urge 

the Committee to consider the value of alternative secondary market models, such as ATSs, 

because companies should be able to choose the venue that best suits their needs. A "Venture 

Company" should be afforded the same regulatory treatment, regardless of whether it trades on 

an exchange or an ATS market like OTCQX. 

We remain hopeful that Congress, the SEC and market participants can work together to 

provide venture companies with all of the tools necessary to foster their growth and 

development. Please let me know if we can provide any additional information or insight in 

furtherance of that shared goal. 

Sincerely, 

;d;f;/ 

Rnbat ~ ~~. ,, 

CEO 

Meritage Hospitality Group tnc. 

45 Ottawa Ave 

G'h Floor 

Grand Rapids, M149503 

2 
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May 21,2018 

The Honorable Jeb Hensarling, Chairman 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Maxine Waters, Ranking Member 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Bill Huizenga, Chairman 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Carolyn Maloney, Ranking Member 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

Re: Main Street Growth Act 

Dear Chairman Hensarling, Ranking Member Waters, Chairman Huizenga and Ranking 

Member Maloney, 

I am the President and CEO of Mission Valley Bank (OTCQX: [MVL Y]), a $326 million 

community focused small business bank located in the San Fernando Valley, California that is 

publicly-traded on OTC Markets Group's OTCQX Best Market. The exposure the OTCQX has 

afforded MVL Y has allowed for greater liquidity in our stock and enhanced market value. 

I am writing to share Mission Valley Bank's experience as a small, public company and describe 

why we do not support the "Main Street Growth Act." 

The Main Street Growth Act would allow the creation of "Venture Exchanges" that are intended 

to have trading and listing rules tailored for smaller companies like ours. However, these 

regulatory privileges would not be available to non-exchange markets such as OTCQX.1 

Mission Valley Bank joined the OTCQX market in 2014. Under the OTCQX Rules, Mission 

Valley Bank is required to meet high financial standards (OTCQX does not accept Penny Stocks 

1 OTC Markets Group Inc. operates the OTCQX Best and OTCQB Venture markets, where over 1,200 

companies meeting financial standards and providing current disclosure to investors, including many 

innovative and entrepreneurial 'venture' companies, trade via an SEC registered alternative trading 

system ("A TS"). 
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or Shell Companies) and provide current disclosure to investors (including PCAOB audited 

annual financials). We have seen our market cap grow over the past 4 years from $16.8 

million to $49.4 million. 

There are many reasons why the OTCQX market works well for small, growing companies like 

ours: 

• Lower Cost & Complexity: OTCQX costs less, and our compliance obligations, while 

challenging, are less burdensome than listing on an exchange, giving us more time and 

money to spend growing our business. 

• Small Company Liquidity: OTC Markets Group's ATS dealer model supports the 

liquidity needs of smaller, less-actively traded securities. Unlike large, exchange-listed 

companies, we do not have large amounts of natural liquidity and high trading volumes. 

Rather, our liquidity needs are focused on making sure our shareholders have the ability 

to buy and sell on an as-needed basis. 

Investor Engagement & Capital Formation: Through OTC Markets' disclosure 

services, we are able to easily communicate with our shareholders, publish financial 

reports and share company updates to broaden our visibility in the marketplace. The 

OTCQX market is also exempt from Blue Sky secondary trading regulations in 30 states, 

which allows broker dealers to reach a wider audience of potential investors, raise 

capital and grow our shareholder base. 

The OTCQX market has helped Mission Valley Bank grow and mature by providing all of the 

benefits of a public market- scaled to fit the rieeds of small companies. 

The Main Street Growth Act does not work for companies like us because it focuses solely on 

national securities exchanges and excludes other models, such as OTCQX where we have 

established a thriving secondary market The Main Street Growth Act instead would restrict 

trading to one, single exchange. 

While we welcome legislation aimed at supporting small public companies and the venture 

markets that serve them, the Main Street Growth Act does not achieve these goals. We urge 

the Committee to consider the value of alternative secondary market models, such as ATSs, 

because companies should be able to choose the venue that best suits their needs. A "Venture 

Company" should be afforded the same regulatory treatment, regardless of whether it trades on 

an exchange or an ATS market like OTCQX. 

We remain hopeful that Congress, the SEC and market participants can work together to 

provide venture companies with all of the tools necessary to foster their growth and 

development Please let me know if we can provide any additional information or insight in 

furtherance of that shared goal. 

Sincerely, 

~ President & CEO 

Mission Valley Bank 

2 
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Unleashing 

our~Ms great ideas in pet care: 

May 21,2018 

Re: Main Street Growth Act 

Dear Chairman Hensarling, Ranking Member Waters, Chairman Huizenga and Ranking 

Member Maloney, 

I am the Chairman/CEO of OurPet's Company (OTCQX: OPCO), a leading company in the 

rapidly growing pet market, located in Cleveland, OH that is publicly-traded on OTC Markets 

Group's OTCQX Best Market. 

I am writing to share OPCO's experience as a small, public company and describe why we do 

not support the "Main Street Growth Act." 

The Main Street Growth Act would allow the creation of "Venture Exchanges" that are intended 

to have trading and listing rules tailored for smaller companies !ike ours. However. these 

regulatory privileges would not be available to non-exchange markets such as OTCQX.' 

OPCO joined the OTCQX market in 2015. Under the OTCQX Rules, OPCO is required to meet 

high financial standards (OTCQX does not accept Penny Stocks or Shell Companies) and 

provide current disclosure to investors (including PCAOB audited annual financials). Our 

experience since joining OTCQX has been very positive in terms of stock price appreciation, 

revenue and employee growth and credibility. 

There are many reasons why the OTCQX market works well for small, growing companies like 

ours: 

Lower Cost & Complexity: OTCQX costs less, and our compliance obligations, while 

challenging, are less burdensome than listing on an exchange, giving us more time and 

money to spend growing our business. 

• Small Company Liquidity: OTC Markets Group's ATS dealer model supports the 

liquidity needs of smaller, less-actively traded securities. Unlike large, exchange-listed 

companies, we do not have large amounts of natural liquidity and high trading volumes. 

Rather, our liquidity needs are focused on making sure our shareholders have the ability 

to buy and sell on an as-needed basis. 

• Investor Engagement & Capital Formation: Through OTC Markets' disclosure 

services, we are able to easily communicate with our shareholders, publish financial 

reports and share company updates to broaden our visibility in the marketplace. The 

OTCQX market is also exempt from Blue Sky secondary trading regulations in 30 states, 

which allows broker dealers to reach a wider audience of potential investors, raise 

capital and grow our shareholder base. 

1 OTC Markets Group Inc. operates the OTCOX Best and OTCQB Venture markets, where over 1,200 

companies meeting financial standards and providing current disclosure to investors, including many 

tnnovative and entrepreneurial 'venture' companies, trade via an SEC registered alternative trading 

system ("ATS"). 

1300 East Street, Fanport Harbor, OH 44077 •1-800-565-2695 • 440-354-6500 • fa< 440-354-9129 • www.ourpets com 
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Unleashing 

our~Ms great ideas ln pet care: 

The OTCQX market has helped grow and mature by providing all of the benefits of a public 

market -scaled to fit the needs of small companies. 

The Main Street Growth Act does not work for companies like us because it focuses solely on 

national securities exchanges and excludes other models, such as OTCOX where we have 

established a thriving secondary market. The Main Street Growth Act instead would restrict 

trading to one, single exchange. 

While we welcome legislation aimed at supporting small public companies and the venture 

markets that serve them, the Main Street Growth Act does not achieve these goats. We urge 

the Committee to consider the value of alternative secondary market models, such as ATSs, 

because companies should be able to choose the venue that best suits their needs. A 'Venture 

Company" should be afforded the same regulatory treatment, regardless of whether it trades on 

an exchange or an ATS market like OTCQX. 

We remain hopeful that Congress, the SEC and market participants can work together to 

provide venture companies with all the tools necessary to foster their growth and development 

Please let me know if we can provide any additional information or insight in furtherance of that 

shared goal. 

Chairman/CEO 

OurPefs Company (OTCOX: OPCO) 

1300 East Street, Farrport Harbor, OH 44077 • 1·800·565·2695 • 440·354-6500 • fal 440-354-9129 • wwv..ourp€ts com 
168 

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May 22, 2018 

The Honorable Jeb Hensarling, Chairman 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Maxine Waters, Ranking Member 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Bill Huizenga, Chairman 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Carolyn Maloney, Ranking Member 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

Re: Main Street Growth Act (H.R. 5877) 

Dear Chairman Hensarling, Ranking Member Waters, Chairman Huizenga and Ranking 

Member Maloney, 

OTC Markets Group Inc. operates the OTCQX Best and OTCQB Venture markets with 

over 1 ,200 companies meeting financial standards and providing current disclosure to 

investors, including many innovative and entrepreneurial 'venture' companies, trading 

via our SEC registered alternative trading system ("ATS"). 1 In advance of the House 

Financial Services Committee's Subcommittee on Capital Markets, Securities, and 

Investment hearing on Legislative Proposals to Help Fuel Capital and Growth on Main 

Street, we want to share our concerns about the Main Street Growth Act {H.R. 5877) 

and the approach it takes towards regulating the U.S. venture markets. 

We thank the Committee, Committee staff and Congressman Emmer for eliciting our 

feedback and communicating with us as they worked on the Main Street Growth Act. 

While we are disappointed with the bill as currently drafted, we appreciate the 

opportunity to be heard and look forward to working with the Committee on the 

important issues of small company trading and capital raising going forward. 

1 The U.S. based companies on these markets have an aggregate market capitalization of over $17 billion and 

employ over 45,000 people. 
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The Main Street Growth Act would allow the creation of "Venture Exchanges" that are 

intended to have trading and listing rules tailored for smaller companies and regulatory 

privileges that are unavailable to non-exchange markets. The bill focuses soley on 

national securities exchanges and excludes ATSs like ours and other innovative market 

models. We oppose the bill's mandate of a single business model for the trading of all 

venture securities. Prescribing an exchange-only solution for venture-stage companies 

stifles the type of innovative, tailored market structure that has seen more than 300 

companies graduate from our markets to the NYSE or Nasdaq exchanges over the past 

5 years. Many small companies on our OTCQX market do not seek to graduate, and 

have established thriving secondary markets on our ATS platform without the cost and 

complexity of listing on an exchange. 2 

OTC Markets Group and the ATS Model 

Successes on our markets are attributable in part to the structure of our ATS as a 

dealer market, allowing competing broker-dealers to directly interact with one another, 

as opposed to an auction (exchange model) market where broker-dealers interact only 

with the exchange as the centralized trading facility. Dealer markets have been shown 

to work better for smaller company trading, and all market participants should be 

permitted to choose the type of trading venue that best suits their needs. 

Companies should be free to choose their listing or designation based on value 

and cost, broker-dealers should be free to seek best execution from the market or 

broker-dealer of their choice, and investors should benefit from competition 

between multiple market options for buying and selling company stock. 

In an attempt to consolidate liquidity, H.R. 5877 would not permit Venture Exchanges to 

offer Unlisted Trading Privileges (UTP) to the securities traded there. Unlisted Trading 

Privileges allow securities to trade across multiple venues and were adopted, in large 

part, to facilitate competition between markets and deter monopolistic practices by the 

exchanges. Removing these privileges incentivizes anti-competitive behavior and far 

outweighs the potential benefits of consolidated liquidity. Forcing these participants to 

use a venue type prescribed by regulators is not in the best interest of any market, 

particularly one intended to support smaller companies and their investors. 

For example, our markets cost significantly less than exchange listings, and offer 

streamlined compliance processes while requiring that companies meet high financial 

standards and produce audited financial statements among other ongoing, current 

public disclosure. 3 We work closely with state regulators, and thus far 30 states have 

recognized our OTCQX market as exempt from state "Blue Sky" restrictions on 

2 Nine OTCQX companies submitted letters to the Committee expressing their concern over the Main Street Growth 

Act. 

3 All OTCQX and OTCQB cornpany disclosure is made publicly available for free on the OTC Markets Group website 

at www.otcmarkets.com. The website also features transparent real-time pricing information for these companies, 

including the inside bid and offer as well as the full depth-of-book market data for each OTCQX and OTCQB security. 
170 

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secondary trading. That allows broker-dealers to reach a wide audience of potential 

investors, which improves liquidity and capital raising opportunities. 

Liquidity and Competition 

High-speed exchange matching engines can capture the substantial existing liquidity in 

the largest public companies, but they cannot create liquidity for smaller companies. 

Only market makers using dealer-based markets like our ATS can provide additional 

liquidly as a service, which is an important reason why OTCQX and OTCQB have been 

successful for smaller company securities without large amounts of natural liquidity. 

Academic research also indicates that the competing broker-dealer model used by OTC 

Markets Group compares favorably to other successful smaller company trading 

markets. 4 

Market makers today can compete with the exchange markets for online broker orders 

based on quality of executions, costs and providing greater liquidity than is displayed on 

the exchanges. This structure requires a competive, low-cost trading ecosystem that 

ATSs like ours can provide while exchanges cannot. We should seek to foster forwardthinking markets structure models, rather than restricting trading to a single, exchange 

license only model. 

Conclusion 

For the reasons outlined above, OTC Markets Group does not support the Main Street 

Growth Act in its current form. Our OTCQX and OTCQB markets provide secondary 

trading platforms for the companies that drive the Main Street economy. We have a 

history of providing a long-term home for these companies and their investors, and 

acting as a launching pad for the 60+ companies a year that grow with us and ultimately 

graduate from our markets to a national securities exchange listing. 

We remain hopeful that Congress, the SEC and market participants can work together 

to provide smaller, venture companies with all of the tools necessary to foster their 

growth and development. Please let me know if we can provide any additional 

information or insight in furtherance of that shared goal. 

Sincerely, 

Daniel Zinn 

General Counsel 

OTC Markets Group Inc. 

4 The study, attached as Exhibit A, is titled: The rise and fall of the Amex Emerging Company Marketplace, Journal of 

Financial Economics 52 (1999), 257-289. 

OTC Markets Group !riC. 

304 Hudsor1 Street, 3rd Roor 

New York, NY 10013 
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EXHIBIT A 

NH 

C-~ 

m 

w_~ ELSEVIER Journal of Financial Economics 52 (1999) 257-289 

JOURNAL OF 

Fmancial 

ECONOMICS 

The rise and fall of the Amex Emerging 

Company Marketplace* 

Reena Aggarwala,b,*, James J. Angelb 

'Georgetown University School of Business, Georgetown University, Washington, DC 20057, USA 

bUS. Securities and Exchange Commission, Washington, DC, USA 

Received 12 September 1995; received in revised form 27 April 1998; accepted I January 1999 

Abstract 

In 1992, the Amex launched the Emerging Company Marketplace (ECM) to trade the 

stocks of small but growing companies. Bid-ask spreads decreased dramatically for 

listing firms, and news coverage increased. Executives of listing firms were quite satisfied. 

Yet few firms chose to list on the ECM, and it closed in .1995. What went wrong? Most 

Am ex stakeholders had little to gain from the success of the ECM, and a series of scandals 

damaged the reputation of the exchange. Similar small-firm markets have also failed, 

largely because successful firms quickly depart for traditional markets, leaving only 

unsuccessful firms behind. © 1999 Elsevier Science S.A. All rights reserved. 

JEL classification: GlO; G15 

Keywords: Amex; Nasdaq; Listings; Stock market failure; Market structure 

*Corresponding author. Tel.: 202-687-3784: fax: 202-687-4031. 

E-mail address: aggarwal@gunet.georgetown.edu (R. Aggarwal) 

''We wish to thank the Amex, the NASD, and the Vancouver Stock Exchange for providing data 

used in this study, along with the many senior oilicials ofECM-listed companies and Amex members 

who generously shared their insights with us. We also wish to thank the referee for very helpful 

comments. We also thank seminar participants at the SEC, Georgetown University, and Financial 

Management Annual Meetings for comments. Excellent research assistance was provided by Amin 

Haque. We acknowledge funding support from Georgetown University School of Business and the 

Georgetown University Center for Business-Government Relations. The Securities and Exchange 

Commission disclaims responsibility for any private publication or statement of any SEC employee 

of commissioner. This article expresses the author's views and does not necessarily reflect those of 

the Commission, the commissioners, or other members of the staff. 

0304-405X/99i$- see front matter 1999 Elsevier Science S.A. All rights reserved. 

PH: S0304-405X(99)000 10-0 
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258 R. Aggarwal, JJ Angel/ Journal of Financial Economics 52 (1999) 257-289 

1. Introduction 

On March 18, 1992, the American Stock Exchange (Amex) launched the 

Emerging Company Marketplace (ECM) with great fanfare. The ECM was 

designed to trade the stocks of small but growing firms until they grew large 

enough to qualify for a regular Amex listing. Bid-ask spreads fell substantially 

for the firms that listed on the ECM, and media coverage of the ECM firms 

increased. However, relatively few companies followed the initial 22 firms, and 

the Amex closed the market on May 11, 1995. 

What went wrong? How could a market produce a substantial reduction in 

transaction costs, yet fail to succeed? The ECM is one of many failed attempts to 

launch public equity markets for small stocks in the US and Europe. Why do 

such markets have so much trouble? This paper analyzes several factors that 

possibly contributed to the demise of the ECM and that shed light on the factors 

affecting the development of equity markets for smaller firms. 

The governance structure of the Amex is one such factor. Like most traditional exchanges, the Amex is organized as a membership organization rather 

than a private firm. This cooperative structure means that most Amex stakeholders had little to gain if the ECM succeeded. In fact, some members of the 

Amex board represented firms that also owned Nasdaq market makers who 

were in direct competition with the Amex. 

So-called 'junior' markets like the ECM also suffer from an adverse selection problem. The successful firms graduate to a listing on the senior market, 

leaving behind the unsuccessful ones. The junior market thus develops a reputation as a place for unsuccessful firms. As part of the Amex, the ECM had 

no incentive to keep firms from graduating to a regular Amex listing. This 

problem was made worse for the ECM because poor screening of firms led to 

some embarrassing scandals that hurt the ability of the ECM to attract new 

listings. 

The market mechanism chosen for the ECM, which was the same as the 

regular Amex auction market, is another possible problem. Although auction 

markets like the Amex generally have lower bid-ask spreads than dealer 

markets such as Nasdaq, the wider bid-ask spreads of a dealer market can 

possibly motivate broker-dealers to promote a stock, increasing liquidity by 

widening the pool of potential shareholders. However, the ECM-listed firms 

enjoyed both a decrease in bid-ask spreads and an increase in their media 

visibility, implying that the market mechanism alone did not lead to the 

failure. 

The experience of the ECM provides a natural opportunity to investigate 

these questions and to take a closer look at the competition between markets for 

listings. The next section presents the history of the ECM. Section 3 examines in 

more detail the hypotheses regarding the failure of the ECM, and presents the 

empirical results. Section 4 documents the failures of other markets in the US 
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R. Aggarwal. J.J. Angel( Journal of Financial Economics 52 (1999) 257~289 259 

and elsewhere that have attempted to trade very small company stocks. Section 5 concludes and summarizes. 

2. The Amex emerging company marketplace 

By 1992, the Amex was in a difficult competitive position. Traditionally, new 

firms first traded on the over-the-counter (OTC) market, then moved to the 

Amex as they grew larger, and eventually attaining a listing on the NYSE. 

However, the evolution of the OTC market into the Nasdaq market, with 

substantially improved quotation and trade dissemination compared to the old 

OTC market, significantly reduced the relative benefits of an Amex listing. The 

Amex lost significant market share in its core equity business. As a fraction of 

the total share volume on the traditional exchanges (NYSE, Amex, and the 

regionals), Amex market share fell from a peak of29.6% in 1968 to 6.1% in 1991. 

The number of issuing firms fell from a level of 1215 in 1975 to 860 by the end of 

1991. (These facts are derived from the 1992 fact books published by the Amex, 

NASD, and the NYSE.) 

The Amex had tried a number of ways to increase its business in the 1970s and 

1980s, including a successful entry into the options business, a failed entry into 

futures trading and an unsuccessful effort to trade NYSE-Iisted stocks. Bruchey 

(1991) provides more details about this and the Amex's entries into options 

and futures trading. The Amex also scored a series of successes by listing 

innovative derivative securities that the NYSE would not. Thus, it was in 

character with the history of the Am ex that it would contemplate starting a new 

market in 1992. 

Following the resignation of Amex Chairman Arthur Levitt, Jr. in 1989, the 

Amex chose former congressman James Jones as its chairman. Although he 

had been a public member of the Amex's board since 1987, Jones had no 

work experience in financial services. Jones, when first asked about the job, 

remarked, 'I don't really know enough about the industry (Investment Dealers' 

Digest, Nov. 18, 1991, p. 12)'. In addition to launching the ECM, Jones explored 

plans for a number of potential new ventures, including after-hours trading, 

a satellite trading floor in Hawaii, and a merger with the Philadelphia Stock 

Exchange. 

The ECM was similar in concept to many of the junior or 'incubator' markets 

that had been started by the major stock exchanges in Europe to provide an 

exchange market for firms too small for the senior market. The Amex also 

intended to compete with Nasdaq for the listings of stocks that were too small to 

qualify for the regular Amex. By listing such companies early in their development, the Amex hoped to retain them as they grew bigger. 

The Am ex had three potential competitive advantages in this market segment. 

First, its auction market usually produced narrower bid-ask spreads than did 
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260 R. Aggarwal, J.J. Angel/ Journal of Financial Economics 52 (1999) 257-289 

Nasdaq's dealer market. The lower transaction costs were expected to attract 

firms and investors. Second, at that time there was no last-trade reporting for 

Nasdaq stocks that were not part of the Nasdaq National Market, so investors 

had substantially less information about prices and volumes for such stocks. 

Since the Amex reported trade prices and volumes almost immediately over the 

consolidated tape, this improved information should also have attracted both 

listing companies and investors. Third, because of its traditional listing standards, the Amex had a reputation for listing firms of higher quality than many of 

those found in the Pink Sheets or the Nasdaq stocks outside the Nasdaq 

National Market. 

The Amex adopted listing requirement for the ECM that were much less 

stringent than for a regular Amex listing. These are illustrated in Table 1. 

Not only were ECM requirements smaller in terms of stockholders' equity 

than were regular Amex requirements, ECM firms did not have to show 

positive earnings. Furthermore, there was no requirement for outside directors or audit committees. Concerns about the quality of the ECM firms 

were raised by the SEC and others even before the market started. Mary 

Schapiro, then SEC Commissioner, observed that 'Investors should understand that these companies are subject to much lower standards than companies traditionally associated with the American Exchange' (The New York 

Times, March 5, 1992, p. 01). The Amex sought to allay these concerns by 

promising to screen the companies very carefully. In addition, the Amex priced 

the listing fees for the ECM just slightly lower than Nasdaq's listing fees, as seen 

in Table 2. 

2.1. The ECM companies 

The ECM began trading on March 18, 1992 with 22 companies. The original 

ECM companies were relatively small, having a median market capitalization of 

$18 million and a median market price of $3.00 per share. Many of them were 

high-tech firms. The companies were reportedly picked by a 'blue ribbon' 

committee of Amex members and money managers. Most of the original 

companies had previously traded on what is now known as the Nasdaq Small 

Cap market, a lower tier of Nasdaq than the Nasdaq National Market. Six of 

the firms had previously traded on the Pink Sheets, meaning that they were even 

smaller and there was less trading activity in them. Pink Sheets' quotations are 

not firm; rather, they are primarily indications of interest, not commitments by 

dealers to trade at a given price. One of the stocks (Intertel Communications) 

had previously traded on the Vancouver Stock Exchange, an automated exchange known primarily for trading speculative mining stocks. Table 3 provides 

summary statistics about the firms that listed on the ECM and where their 

stocks traded prior to listing on the ECM. Table 10 of Appendix A contains 

more details about the firms. 

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Table 1 

Amex, Nasdaq, and NYSE initial and continuing fees 

The Amex, NYSE, and NASD charge listing firms a fee for initial listing in addition to an annual maintenace fee. The fees are usually based on the num

of shares outstanding. This table demonstrates the listing and maintainence fees for selected firm sizes when the Amex ECM was launched in 1992

Share Original listing fees Annual maintenance fees 

outstanding 

(millions) Nasdaq Nasdaq national Am ex Am ex NYSE Nasdaq Am ex NYSE 

market ECM 

1 $6000 $10,000 $5000 $10,000 $51,550 $5250 $5500 $15,7

5 $10,000 $30,000 $5000 $25,000 $84,600 $7250 $7500 $15,7

10 $10,000 $42,500 $5000 $37,500 $102,100 $9750 $10,000 $15,7

25 $10,000 $50,000 $5000 $52,500 $154,600 $13,250 $13,000 $31,4

50 $10,000 $50,000 $5000 $77,500 $242,100 $20,000 $13,500 $41,8

100 $10,000 $50,000 $5000 $127,500 $417,400 $20,000 $13,500 $82,0

200 $10,000 $50,000 $5000 $227,500 $767,100 $20,000 $13,500 $162,5

Maximum $10,000 $50,000 $5000 $227,500 + $1,467,100 + $20,000 $13,500 $500,0

$0.00 h shares $0.0009• shares 

over 100 millions over 300 millions 

Source: Amcx listing fee data published in 1993. 

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Table 2 

Amex, NYSE, and Nasdaq comparative listing requirements in 1992 

This table contains representative initial listing standards for the Nasdaq, Amex, and NYSE at the time of the inauguration of the Amex ECM in 19

obtained from the individual markets. All markets also have lower standards for continued inclusion on their lists. Some alternative standards exi

Nasdaq Nasdaq 

national 

market 

system 

Total assets $4 million 

Stockholder's equity $2 million 

Net tangible assets ·~ $4 million 

Net income $400,000" 

Pretax income - $750,000" 

Public float (shares) 100,000 500,000 

Market value of $1 million $3 million 

public float 

Market value 

Market makers 2 2 

Minimum price $3 $5 

Public Shareholders 300 400-SOOb 

•rn last fiscal year or two of last three fiscal years. 

Amex ECM 

(Companies presently 

not trading on Nasdaq) 

$4 million 

$2 million 

250,000 

$2.5 million 

$1 

300 

bBased on number of shares publicly held and average daily trading volume. 

(Companies presently 

trading on Nasdaq) 

$2 million 

$1 million 

250,000 

$2.5 million 

$1 

300 

Amex 

$4 million 

$750,000" 

500,000 

$3.0 million 

$3 

400-SOOb 

NYSE 

$18 million 

$2.5 million

1,100,000 

$18 million 

2000d 

c In addition, the firm is required to have $2.0 million in pretax income for each of the preceding two years or a total of $6.5 million for the sum of the l

three years with $4.5 million in the preceding fiscal year. All three years must be profitable. The alternative is an aggregate of $6.5 million in pretax inco

for the last three years and a minimum of $4.5 million in the preceding year, with all three years profitable. 

rlRound lot holders. Alternatively, a firm can have 2200 total shareholders together with average monthly trading volume of 100,000 shares. 
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Table 3 

Summary statistics on ECM firms 

Panel A contains summary statistics for the 65 firms that listed on the Amex ECM between March 

18, I 992 and May 11, 1995. The number of market makers in each stock before lisitng was obtained 

from the NASD, Amex, or the Pink Sheets. Panel B contains information on the source of listings for 

the ECM. The original firms arc the firms that listed on the ECM when it commenced operations on 

March 18, 1992, and the additional firms are those firms that listed later. 

Panel A: Summary statistics on the listed firms 

Market Stock price Number of 

capitalization pre-ECl\.1 

(millions) market makers 

Mean $28.8 $4.34 9.61 

Median $15.1 $3.38 8.00 

Standard deviation $38.8 $3.17 6.57 

Minimum $3.0 $0.69 1 

Maximum $253.7 $15.19 30 

Numbers of firms 65 65 46 

Panel B: Sources of ECM listings 

Prior market Original Additional Total firms 

firms firms 

Nasdaq not national market 15 (68.2%) 11 (25.6%) 26 (40.0%) 

Pink sheets/Nasdaq Bulletin Board 6 (27.3%) 15 (34.9%) 21 (32.3%) 

No previous market 0(0.0%) 5 (11.6%) 5 (7.7%) 

Vancouver stock exchange I (4.5%) 3 (7.0%) 4 {6.2%) 

Initial public offering 0(0.0%) 3 (7.0%) 3(4.6%) 

Spinoff 0(0.0%) 3 (7.0%) 3 (4.6%) 

London stock exchange 0(0.0%) I (2.3%) 1 (1.5%) 

Pacific stock exchange 0(0.0%) I (2.3%) 1 (1.5%) 

Toronto stock exchange 0(0.0%) 1 (2.3%) 1 (1.5%) 

Total 22 (100%) 43 (100%) 65 (100%) 

As time progressed, the ECM listed smaller firms and firms that had been 

delisted from Nasdaq. Few of the additional listings came from the Nasdaq 

Small Cap market. Most came from the Pink Sheets or elsewhere. Five of the 

firms were private firms that had no public market for their stocks, not even in 

the Pink Sheets. 

The Amex used the same market mechanism for the ECM stocks as for the 

regular Amex stocks. Eleven different specialist firms handled the trading in 

the original ECM stocks along with their regular stocks at various posts on the 

Amex trading floor. Although in general the ECM stocks traded like regular 
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264 R. Aggarwal, J.J. Angel/ Journal of Financial Economics 52 (1999) 257-289 

Amex stocks, there were a few differences. The ticker symbols for ECM stocks 

carried the suffix 'EC', which made it difficult for some brokers to access 

information about the firms on their computer systems. Furthermore, 

ECM-Iisted stocks were not automatically marginable like regular Amex-listed 

stocks. 

Another difference between the regular Amex and the ECM was that, unlike 

regular Amex-listed firms, ECM firms were not automatically exempt from the 

SEC's penny stock disclosure rules. SEC Rules 15gl-15g6, which generally 

require that brokers selling unlisted stocks with a price less than $5.00 per share 

must provide additional written disclosures to customers about the risks of such 

stocks. This meant that brokerage firms would incur additional compliance 

costs and paperwork in determining which ECM firms were covered by the 

penny stock disclosure rules, making it less likely that the firms would want to 

bother promoting ECM-Iisted firms. Seguin and Smoller (1997) address the 

trading and risks involved in penny stocks. 

2.2. Scandals and embarrassments 

Almost immediately after the ECM started, questions arose about the care 

with which the Amex had screened the ECM firms. Business Week (April 13, 

1992, p. 78) and The Wall Street Journal (July 2, 1992, p. A1) reported that the 

controlling shareholder of one ECM-listed firm, PNF, a maker of flame 

retardants, had previously been barred for life by the Amex and was a convicted 

arsonist. Other scandals also beset the market. In May 1993, the SEC temporarily suspended trading in Digitran, the first ECM firm to graduate to the 

regular Amex, in May 1993 pending an investigation of the firm's accounting 

methods. Later, Business Week (Sept. 12, 1994, p. 80) reported that the CEO of 

Printron had been sued twice by the SEC for securities violations - once as 

a man and once as a woman - and had not revealed this information to the 

Amex. 

Perhaps even more embarrassing than the scandals, two of the original ECM 

firms, North Coast Energy and Ocean Optique, voluntarily returned to trading 

on Nasdaq. Ken Gordon, the CFO of Ocean Optiquc, stated, 'We were almost 

illiquid on the Amex, and would sometimes go an entire week without trading' 

(Securities Week, Nov. 23, 1992, p. 4). 

This U.S. General Accounting Office delivered more bad news in 1994, finding 'weaknesses in Amex's practices of assessing companies' qualifications 

for Marketplace listings' (Report # GAO/GGD 94-72). Specifically, the 

Amcx had not screened the early firms thoroughly, although it later improved its screening process. The report also found that the Amex's reliance 

on qualitative listing factors, such as the companies' prospects, was 

potentially misleading to investors who were expecting tougher listing 

standards. 
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2.3. Closure 

Throughout the life of the ECM, new listings replaced some of the firms that 

left, so the total number ofECM listings stayed relatively stable. Nonetheless, by 

the end of 1992, there were only 28 companies on the ECM, far below the 50 that 

Amex officials had envisioned. The number fell to 22 by the end of 1993. Some 

smaller firms joined the ECM in 1994, bringing the number of listings to 35 and 

the median market capitalization from its original $18.4 million down to $6.8 

million. Several of the later listings on the ECM were 'fallen angels', companies 

that had been delisted from Nasdaq and then traded in the Pink Sheets. In 

August 1993, Jones, who had personally championed the ECM, resigned as 

chairman of the Amex to become the US ambassador to Mexico. He was 

replaced in 1994 by Richard Syron, who had been president of the Federal 

Reserve Bank of Boston. Syron stopped actively marketing the ECM pending 

a review, and the Amex announced the closure of the market on May 11, 1995. 

After the closure, the remaining ECM firms were permitted to continue trading 

on the ECM. Many of them moved up to the regular Amex list as soon as they 

met the listing standards, although as of this writing several of them are still 

trading as ECM stocks. 

During its life, the ECM listed a total of 65 firms. Table 4 contains information about the status of the firms after the ECM closed. As of June 1997, 29 of 

those 65 firms had graduated to a primary Amex listing, and 15 were still on the 

ECM. Eight of the firms had voluntarily switched to Nasdaq, and 11 were 

delisted by the Amex for failing to meet listing requirements. One stock was 

listed in Toronto and one other on the NYSE. 

Table 4 

Primary listing status of ECM-listcd firms, May 1995 and June 1997 

This table presents the primary listing status of the 65 firms that listed on the ECM as of the May 

1995 announcement of the closure of the market and also as of June 1997. 'Delisted' refers to firms 

that were removed from the Amex for failure to meet Amex listing requirements or whose trading 

was suspended by the Amex. Nasdaq refers to firms that switched voluntarily to Nasdaq. 

Primary listing of firm Status as of May 1995 Status as of June 1997 

number of firms number of firms 

Amex ECM 32 (49.2%) 15 (23.1%) 

Amex (regular) 19 (29.2%) 29 (44.6%) 

De listed 7 (10.8%) 11 (16.9%) 

Nasdaq 5 (7.7%) 8 (12.3%) 

NYSE 1 (1.5%) I (1.5%) 

Toronto 1 (1.5%) 1 (1.5%) 

Total 65 (100%) 65 (100%) 
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266 R. Aggarwal. J.J. Angel/ Journal of Financial Economics 52 (1999) 257-289 

3. Hypotheses regarding the failure of the ECM 

3.1. Governance structure of the Amex and the ECM 

The governance structure of the Amex might have contributed to the failure of 

the ECM because important Amex constituencies had little to gain from the 

ECM. Like most traditional stock exchanges, the Amex is organized as a notfor-profit membership organization. As Hart and Moore (1995) eloquently point 

out, this cooperative organization can lead to serious inefficiencies. Whereas an 

investor-owned firm has the clear objective of maximizing shareholder value, the 

members of a cooperative have divergent interests. Members buy seats on the 

Amex in order to make money by executing trades for themselves or for their 

customers on the Am ex. The members are more concerned with earnings from 

their trading operations than they are with maximizing the value of an Amex 

membership. 

It is interesting to note that none of the successful entrants into the U.S. equity 

market in recent years have been organized as cooperatives. Electronic trading 

networks such as POSIT and Instinct are for-profit ventures. Furthermore, 

several exchanges, including Amsterdam, Australia, Milan, and Stockholm, 

have converted or are in the process of converting from cooperative ownership 

to limited liability companies. 

Euroquote, an earlier attempt to start a pan-European trading system, highlights some of the problems cooperative organizations face when attempting to 

launch new ventures (see Clarkson, 1990; Financial Times, Mar 13, 1991, 

p. 34 and Sept. 24, 1991, p. 25). The Federation of European Stock Exchanges 

sought to make it possible for its member stock exchanges to share prices and 

quotations. In its first phase, Euroquote would have provided only price 

information, but the long-term goal was to become an integrated European 

trading mechanism. Euroquote would have allowed the member markets to 

compete with one another in a manner similar to the competition between 

market makers on Nasdaq. However, the system was scuttled prior to launching 

because several member exchanges felt their individual interests were threatened 

by it. 

Apparently few, if any, Amex stakeholders had a stake in the ECM. As the 

CEO of one ECM-listed firm (who requested anonymity) bluntly put it, 'There 

was no constituency inside the exchange [for the ECM]'. Clearly, the Amex 

officials who had championed the ECM, such as its chairman, James Jones, had 

a reputational stake in its success. However, the other constituencies had little to 

gain from the ECM. Some of the existing Amex-listed companies were concerned that the new segment with its lower listing standards would damage the 

reputation of Amex-listed firms (Investment Dealer's Digest, Nov. 18, 1991, 

p. 12). Even if the ECM had succeeded, it would not have benefited the options 

traders, because the Amex trades options mostly on non-Amex stocks. 
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Although the Amex specialists would have benefited had the ECM resulted in 

more high-volume regular Amex listings, conversations with some Amex 

specialists indicate that they were not too interested in the ECM firms themselves. The low potential trading volumes of the tiny ECM firms meant that they 

had little immediate profit potential (Hasbrouck and Sofianos (1993) report that 

NYSE specialists earn substantially lower profits per trade on less frequently 

traded stocks). Because the specialists were already trading the regular Amex 

stocks, they did not give the ECM firms much attention. However, some 

specialists strongly supported the ECM because they viewed it as providing the 

listings of the future. 

The retail brokerage firms that route orders to the Amex should not have 

been particularly concerned over whether a stock traded on the ECM, the 

regular Amex, or the NYSE. They would have earned the same commission 

regardless of where a trade executed. However, Amex member firms that also 

owned Nasdaq broker-dealers stood to gain from the failure of the ECM, 

because their affiliated market makers could earn more money from Nasdaq's 

traditionally wider bid-ask spreads. 

The composition of the Amex's 25-member Board of Governors in 1992 

reflects the diverse interests of the membership. The Amex, like the NYSE 

and the NASD, is required to have public board members. There were 12 

board members who represented the public, including former Federal Reserve 

Chairman Paul Volcker and Princeton University Professor Burton Malkiel. 

Several of these public board members were affiliated with the larger Amexlisted firms. The remainder of the board positions were split between 

specialist firms, floor brokers, and brokerage firms. Six of the Amex governors 

represented firms that were also affiliated with Nasdaq market makers, including Merrill Lynch, Smith Barney, Prudential, and Nomura. Thus, the 

potential supporters of the ECM among the floor traders and specialists were in 

a minority on the board and unable to save the ECM when the board was 

deciding its fate. 

One example of how this cooperative governance hurt the ECM was in the 

screening of ECM firms. Some of the poor quality firms that hurt the ECM's 

reputation were introduced by members of the exchange, and thus received less 

than appropriate scrutiny. Another example is the response of the Amex to the 

concerns of the larger listed firms, represented by 'public' members of the board, 

that the ECM would hurt the reputation of the larger firms. Thus, the Amex 

took several steps to differentiate the ECM firms from the regular Amex-listed 

firms, such as adding the problematic 'EC' suffix to the ticker symbol of ECM 

firms. 

In addition, because the Amex had designed the ECM to generate more 

listings for the regular Amex, there was no incentive for the ECM to discourage 

firms from moving up to the main list. Indeed, conversations with executives of 

ECM-Iisted firms indicate that the Amex encouraged the firms to move to the 
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268 R. Aggarwal, J.J. Angel /.foumal of Financial Economics 52 (1999) 257-289 

main list as soon as they qualified. An independent market like Nasdaq competes aggressively to keep its listed firms from moving to another market. This 

accentuated the adverse selection problem described below. 

3.2. Adverse selection 

The ECM, like other junior markets, suffered from an adverse selection 

problem. By definition, such markets target firms that are too small for the 

senior market. Some of the firms do well and graduate to the senior market. The 

firms that do not do well remain behind in the junior market. Thus, the junior 

market must constantly list new firms or face a drop in listings. For example, of 

the 28 firms on the ECM at the end of 1992, 16 (57.1 %) were gone by the end of 

1993. 

If anything such as an economic recession, a market downturn, or a scandal 

disrupts the flow of new listings, the junior market will comprise only the less 

successful firms, damaging its reputation. The declining number of listings and 

an unsuccessful reputation further deters new firms from listing in the junior 

market, setting up a vicious circle of decline. The poor screening by the Amex 

made this problem even worse. The scandals created a reputation for the ECM 

as a collection of poorly screened firms, further deterring other firms from 

considering a listing. 

3.2.1. Stock market performance of ECM.firms 

The adverse selection hypothesis implies that successful firms would quickly 

move on to the regular Amex and that the less successful firms would spend 

more time on the ECM. This was indeed the case. To investigate this, we 

examine the stock market performance of the ECM firms during the time they 

were listed on the ECM. Overall, many of the ECM-listed stocks performed 

poorly, as indicated by the 11 delistings out of the 65 stocks. To examine 

aggregate performance of the ECM stocks, we calculate returns on a valueweighted portfolio of firms that listed on the ECM during the time period that 

they were on the ECM. We compare the performance of this ECM portfolio 

with the Nasdaq Composite Index and with a control portfolio made up of 65 

size- and industry-matched firms. We use a group of control firms as a benchmark in light of Barber and Lyon's (1997) finding that control firms generally 

provide less biased estimates of long-term abnormal returns. (Results for a variety of different benchmarks were quite similar and are omitted for brevity.) The 

control firms are selected from the Center for Research in Security Prices 

database by matching each ECM firm with the Nasdaq-listed firm in the same 

two-digit SIC code that was closest in market capitalization to the ECM firm. 

A firm is included in the control firm portfolio only during the time its matching 

ECM firm is in the ECM. For comparison, we set each portfolio only during the 

time its matching ECM firm is in the ECM. For comparison, we set each 
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tro.---------------------------------------------, 

140 --Omnlativcretums Nasdaq ---------------! 

__ Omnlative returns controls 

120 

40+-------------------------------------------~ 

0 

<'I <'I <'I N N ...., ...., ..., ..., ...., ...., .... .... ..,. .... .... ... "' "' ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ .... .... .... .... .... .... .... ,_ .... .... .... ,_ .... .... .... .... ..... ..... 

;::: a; ~ ~ ~ ~ 

~ 0; ~ ~ ;:;; ;;; ;::: a; ~ ~ ~ 

"' "' ...., "' ..... 

Date 

Fig. L This figures presents a time series of a value-weighted index of the cumulative buy-and-hold 

returns of the 65 stocks that were members of the Amex ECM during their tenure on the ECM 

compared with the cumulative buy-and-hold returns for the Nasdaq Composite Index and with 

a value-weighted index of 65 size- and industry-matched controls. The index values for March 17, 

1992 are set to 100. 

portfolio to a starting value of I 00 as of the close of the first day of trading on the 

ECM (March 17, 1992). Fig. 1 shows that the returns on the ECM portfolio fall 

by about 40% during the life of the ECM, while the returns on the control 

portfolio fall about 20% and the Nasdaq Composite Index increases almost 

40%. Of the 65 ECM firms, 39 decline in value during their tenure on the ECM, 

25 increase in value, and one is unchanged. 

In Table 5, we compare the cumulative buy-and-hold returns of the individual 

firms during the periods that they were listed on the ECM with the returns on 

the two different benchmark portfolios, the Nasdaq Composite Index and the 

control firms benchmark. In the spirit of Barber and Lyon (1997), we examine 

the buy-and-hold-abnormal return (BHAR1r) for stock i over the period r for 

which it was listed on the ECM, which we compute as follows: 

BHAR1t = f1 [1 + Rit] f1 [1 + E(Ru)J 1, (1) 

I 1 I 1 
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270 R. Aggan.ml, JJ Angel j Journal of Financial Economics 52 (1999) 257-289 

Table 5 

Stock market performance of ECM listed firms 

This table presents the stock market performance of the 65 firms that listed on the Amcx ECM from 

the time that the firms listed on the ECM until the earlier of the time that the firms left the ECM or 

the ECM closed in May 1995. Performance is presented for the cumulative buy-and-hold return, and 

also for cumulative buy-and-hold abnormal returns relative to the size- and industry-matched 

control firms described in the text, as well as for market model adjusted returns using the Nasdaq 

Composite Index as a benchmark. The p-value is for the hypothesis that the probability of a negative 

return is greater than the null hypothesis of a 50% probability. 

Time listed on ECM 

Less than 200-300 More than 

200 days days 300 days 

Number of firms 16 23 26 

Mean 21.5% 10.0% 23.9% 

(t-stat) (1.24) (0.52) 1.80) 

Median 12.8% 10.6% 38.1% 

%negative 31.3% 60.9% 76.9% 

(p-value) (0.993) (0.149) (0.003) 

Cumulative buy-and-hold abnormal return (Control firms benchmark) 

Mean 22.5% 2.6% 19.5% 

(t-stat) (1.15) (0.!6) ( - 1.44) 

Median 11.0% .. 14.2% -39.5% 

%negative 37.5% 65.2% 76.9% 

(p-value) (0.934) (0.072) (0.003) 

Cumulative buy-and-hold abnormal return (Nasdaq Composite Index benchmark) 

Mean 20.4% 6.0% 27.0% 

(t-stat) (1.07) (0.34) (- 2.19) 

Median 10.0% -14.2% -35.4% 

%negative 31.3% 60.9% 80.8% 

(p-value) (0.934) (0.149) (0.001) 

Overall 

65 

0.7% 

0.08) 

16.8% 

60.0% 

(0.053) 

1.4% 

(- 0.15) 

-19.3% 

63.1% 

(0.018) 

3.6% 

( -039) 

-21.1% 

61.5% 

(0.031) 

where Ri, is the return for stock i during period t and E(Ri,) it given by the 

benchmark return. The mean BHAR is not significantly different from zero for 

both benchmarks. However, the median firm's BHAR is significantly negative 

for both benchmarks; the median ECM firm suffers a decline of 19.3% compared with the control firms. 

Furthermore, the adverse selection effect is apparent in Table 5, which also 

displays the results by length of tenure on the ECM. Firms that remain on the 

ECM for under 200 days perform better than the control firm portfolio, with 
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a mean and median BHAR of22.5% and 11.0%, respectively. The mean returns 

are not significant. Only 37.5% of these firms have negative cumulative abnormal buy-and-hold-returns relative to the control firms benchmark. The firms 

that stay on the ECM longer than 300 days suffer a median BHAR of 39.5%, 

and 76.9% of them have negative BHARs. Once again, the mean returns were 

generally insignificant. 1 

This poor stock price performance is indicative of the low quality of the ECM 

firms and of the adverse selection problem faced by the ECM, in which the good 

firms graduate as soon as they can, leaving only the weaker firms behind. The 

ECM itself it not responsible for the price performance of the firms; such firms 

would have suffered price drops on whatever market they traded. 

Although many of the ECM-listed stocks perform poorly, a few do quite well. 

Spectrum Signal Processing, Media Logic, and Colonial Data Technologies all 

tripled in value while they were listed on the ECM. Yet two of these winners, 

Colonial Data Technologies and Spectrum Signal Processing, voluntarily 

switched to Nasdaq, further damaging the image of the ECM. 

3.3. Market mechanism 

The auction market mechanism of the ECM is another possible factor in its 

failure, because small firms in the United States have traditionally chosen to be 

traded in a dealer market. For example, the majority of the small firms that meet 

the listing requirements of the Amex and the regional exchanges have to choose 

a dealer market. For example, as of July 1997, 1328 firms with a market 

capitalization of less than $100 million in the Compustat PC-Plus database 

meet the Amex listing requirements for stockholders' equity, pretax income, 

shares outstanding, market capitalization, and price. Of these firms, 1066 

(80.3%) are listed on Nasdaq, 77 (5.8%) on the NYSE, and 185 (13.9%) are listed 

on the Amex. This preference for dealer markets potentially did not help attract 

listings to the ECM, because the Amex used the same auction market mechanism for the ECM as it did for its main stocks. 

An auction market like the Amex generally produces narrower bid-ask 

spreads than dealer markets by consolidating trading activity in one location 

1 One potential problem that could bias these tests would be a high degree of correlation (e.g., an 

'ECM factor') among the ECM stocks. To check for this, we calculate the Pearson correlation 

coefficient among all possible pairs of ECM stock returns during the time they were listed on the 

ECM, as well as the correlations among all possible pairs of controls. The mean correlation 

among the ECM stocks is only 0.008 with a median of 0.003, compared with a mean correlation 

among the pairs of controls of 0.004 with a median of 0.005. The lOth and 90th percentiles for the 

ECM firms are -0.10 and 0.12, and the lOth and 90th percentiles for the controls are 0.10 and 

0.1 1. We thus do not think that there is a serious correlation bias affecting the stock returns of the 

ECM firms. 
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under the oversight of a single specialist who also acts as a dealer. 2 The wider 

Nasdaq bid-ask spreads have led to much criticism of Nasdaq, including 

allegations of oligopolistic behavior and price fixing (Forbes, Aug. 16, 1993, 

pp. 74-79; Christie and Schultz, 1994).3 But differences in spreads are not 

necessarily evidence that one type of market mechanism is inherently better than 

another. In addition to the bid-ask spread, there is also the issue of 'sponsorship', or the marketing efforts of some broker-dealers on behalf of the stocks 

they cover. Many Nasdaq market makers publish security research about the 

stocks in which they make markets. This increases the information available to 

investors. Furthermore, Nasdaq broker-dealer firms have a double incentive to 

promote trading activity in the stocks in which they make markets, because they 

earn both commission revenue and dealer trading profits on orders that they 

generate. Some broker-dealers pass this incentive on to their registered representatives by allowing them to keep a higher fraction of the gross commissions 

on such stocks (Morgenson, 1993). In contrast, Amex Rule 190 prohibits its 

specialists from promoting their stocks. 

It is not clear a priori which type of market mechanism should provide the 

lowest cost of capital for a firm. Recent theoretical work by Lipson (1997) and 

Aggarwal and Angel (1998) supports the notion that the smallest firms would 

prefer a dealer market and the larger firms an auction market. A dealer market 

generally has higher bid-ask spreads, which would be expected to increase the 

cost of capital in the spirit of Amihud and Mendelson (1986). Yet the higher 

spreads give dealers more incentive to make a market in a given stock. Multiple 

dealers may devote more capital to the market-making process than a monopolist specialist, which should help make the stock more liquid.4 Furthermore, the 

higher spreads give dealers more incentive to provide security research and 

inform investors about a stock. This effect increases the number of investors who 

'know about' the stock in the sense of Merton ( 1987), which leads to a lower cost 

of capital. Thus, a small firm might rationally choose a higher-transaction-cost 

2 Numerous studies investigate differences between dealer and auction markets. See Ule (1937), 

Van Horne (1970), Ying eta!. (1977), Sanger and McConnell (1986), McConnell and Sanger (1987), 

Christie and Huang (1993), Kadlec and McConnell (1994), Dharan and Ikenberry (1995), Huang and 

Stoll (1996), and Clyde et al. (1998) for a sample of the work on dilfert:nces across exchanges. 

3 For more on the alleged Nasdaq collulsion, see Barclay (1997), Bessembinder (1997), Dcmsetz 

(1997), Harris and Schultz (1997), LaPlante and Muscarella (1997), and Kandel and Marx (1997). 

4 However, to the extent that net capital requirements have any relation to the capital employed, 

an exchange can require its specialists to maintain higher capital levels, although it cannot compel 

them to use the additional capital to take larger positions. For example, NYSE Rule 104.20 requires 

a specialist to be able to assume a position of 150 round lots of a given stock, and to maintain 

sufficient net capital equal to 25% of this position requirement. Thus, a $30 stock adds $112,500 to 

the NYSE specialist's net capital requirement. Under SEC Rule 15c3-1, each stock over $5 adds only 

$2,500 to a Nasdaq market maker's net capital requirements, up to a total requirement $1,000,000. 
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market if that market provides additional marketing services for its stock. This 

is similar to a manufacturer who chooses a high-cost boutique as a channel of 

distribution because it provides marketing support that a low-cost mass merchandiser might too. 

Even though some small firms might prefer a dealer market, it does not follow 

that this is the preference for all small firms. Whether the potential for increased 

investor interest provided by a dealer market is offset by its higher transaction 

costs is likely to differ from company to company. For some firms, the added 

marketing from Nasdaq broker-dealers might not be worth the higher transaction costs. Other firms might believe that the reputation effect of an Am ex listing 

would increase the pool of potential investors more than would the marketing 

efforts of Nasdaq broker-dealers. Thus, it is likely that some small firms would 

be interested in an auction market. Indeed, choosing a different market mechanism from Nasdaq could have been a viable way to differentiate the ECM 

product and reach a niche of small firms that did not necessarily prefer a dealer 

market. 

The hypothesis that the market mechanism contributed to the failure of the 

ECM contains several empirical implications. As discussed above, there are two 

dimensions of market quality that affect the decision regarding where to list. 

One dimension is that of transaction costs, which we measure with the bid-ask 

spread. 5 The ECM resulted in significant reductions in bid-ask spreads. The 

other dimension is the number of investors familiar with the firm, which we 

measure indirectly by looking at total trading volume and media visibility. 

Results on average daily trading volume are mixed, but showed a trend toward 

an increase in trading volume. Media visibility generally increases for the 

ECM-listed firms compared with a set of size- and industry-matched controls. 

Thus, the ECM seems to improve market quality on both dimensions, casting 

doubt on the hypothesis that the market mechanism alone caused the failure. 

The following subsections present these empirical results. 

3.3.1. EJject of ECM listing on bid-ask spreads 

We obtain data on price, volume, and bid-ask spreads from the Amex, the 

NASD, the Vancouver Stock Exchange, Dow Jones News Retrieval, and the 

Pink Sheets for 1992 published by the National Quotation Bureau. Bid-ask 

spread and volume data are not available for firms that were not publicly traded 

before they joined the ECM (such as initial public offerings and spinoffs). 

Volume data also are generally not available for firms that traded in the Pink 

Sheets. Consistent with the findings of Christie and Huang (1993) and Huang 

and Stoll (1996), our sample shows a significant drop in the average bid-ask 

5 See Ule (1937), Van Horne (1970), Ying eta!. (1977), Sanger and McConnell (1986), and 

McConnell and Sanger (1987) for a sample of the work on exchange listings. 
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Table 6 

Effect of ECM listing on bid-ask spreads 

This table presents the effect ofECM listing on the quoted closing bid-ask spreads for a sample of 49 

ECM firms for which bid-ask spread data are available both before and after listing. Bid-ask 

spreads before listing are calculated for those firms that were traded on the Nasdaq Small Cap for 

the month prior to listing. For stocks that traded in the Pink Sheets, the week prior to the ECM 

listing date is used. Bid-ask spreads after listing are calculated for the month following the listing 

date. Data are obtained from the NASD, Amex, Vancouver Stock Exchange, and the Pink Sheets. 

Median 

Mean 

Standard error of the mean 

Minimum 

Maximum 

Number of increases 

Number of decreases 

Number unchanged 

t-statistic of mean difference 

Sign test p-value 

Wilcoxon signed rank test 

p-value 

ECM firms 

Dollar bid-ask spreads 

Before After Difference 

listing listing 

0.375 0.160 -0.210 

0.411 0.168 - 0.244 

0.039 0.008 O.o35 

0.034 0.082 - 1.068 

1.30 0.344 0.078 

5 

44 

0 

-6.90 

0.000 

0.000 

Percentage bid-ask spreads 

Before After Difference 

listing listing 

14.1% 4.9% -7.9% 

15.2% 6.2% -8.9% 

1.5% 0.8% 1.3% 

1.9'Yo 1.6% -49.7% 

54.6% 32.0% 4.5% 

5 

43 

0 

-6.63 

0.000 

0.000 

spread for the 49 ECM firms for which before and after bid-ask spread data are 

available. As seen in Table 6, the percentage bid-ask spread falls for 43 of the 49 

firms, from an average of 15.2% before listing to 6.2% after listing, a decline 

of 59%. 

Intertel Communications, which had previously traded on the Vancouver 

Stock Exchange, saw its spread rise from 1.9% to 3.9%. Part of this increase 

might be attributable to the tick size used in Vancouver, where the minimum 

price variation is one Canadian cent. On the Amex, the minimum tick size for 

a stock in this price range is 1/16, or $0.0625. The five other firms whose spreads 

increase generally have a larger number of market makers prior to listing than 

do the other ECM firms. The mean number of market makers for this group is 

18.8 with a median of 18, compared with a mean of 8.5 and a median of eight for 

the other ECM firms. 

3.3.2. Effect of ECM listing on average daily trading volume 

Another natural measure of liquidity, average daily trading volume, shows 

mixed results. Table 7 shows the results on average daily trading volume for the 
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R. Aggarwal, J.J. Angel/ Journal of Financial Economics 52 (1999) 257-289 275 

Table 7 

Effect of ECM listing on average daily trading volume 

This table presents information on the trading volume for the 35 firms that listed on the Amex ECM 

for which before and after trading volume are available. Trading volume data prior to listing are 

unavailable for firms that were IPOs, spinoffs, had no public market, or were traded on the Pink 

Sheets. Statistics are also presented for 35 Nasdaq control firms that were matched to teh ECM firms 

by two-digit SIC code and market capitalization at time of listing. Data are from the Amex, 

Bloomberg, FactSet Research Systems, and the NASD. 

Median 

Mean 

(Standard deviation) 

Median 

Mean 

(Standar deviation) 

Median percentage increase 

Number of firms with 

higher volume 

Number of firms with lower 

volume 

Difference in mean before 

and after listing (t-statistic) 

Sign test (Median 

percentage increase > 0) 

p-value 

Wilcoxon signed-rank 

test (Median percentage 

increase > 0) p-valuc 

ECM firms 

Benchmark 

Prior year Year to date 

Industry-and size-matched 

controls 

Benchmark 

Prior year Year to date 

Average daily volume before listing date 

4577 

15,873 

(22,686) 

10,894 

22,829 

(27,768) 

14,737 

44,362 

(82,659) 

Average daily volume after listing date 

7411 

14,465 

(18,030) 

101.64% -22.14% -9.26% 

21 14 13 

14 21 22 

1372 8364 6658 

(- 0.36) (- 2.00) ( -1.26) 

0.1553 - 0.9123 0.9552 

0.003 0.810 0.725 

14,678 

56.726 

(135,327) 

11,838 

(37,704 

(73,440) 

-23.91% 

2 

33 

63,384 

(- 2.56) 

1.00 

0.948 

35 ECM firms for which before and after volume data are available, along with 

the results for their controls. We compare the average daily volume for the firms 

during their life on the ECM with their average daily volume in the calendar 

year prior to listing and the year-to-date volume prior to listing. Compared 

with the full calender year prior to listing, average daily volume after listing on 

the ECM increases for 21 firms and decreases for 14 fitms. Median average 

daily trading volume increases significantly from 4577 to 7411 shares per day 
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276 R. Aggarwal, J.J. Angel I Journal of Financial Economics 52 (1999) 257-289 

although the mean decreases insignificantly. The median firm's volume increases 

by 101.6%. 

However, if we use the year-to-date period just prior to listing as the benchmark, then volume increases for only 14 firms and declines for 21 firms, and the 

median falls from 10,894 to 7411 shares per day. Volume for the median firm 

decreases by 22.1 %. Table 7 shows that the average daily trading volume 

generally declines for the control firms for both benchmarks. Caution should be 

used in interpreting these trading volume numbers because the double counting 

of trades by Nasdaq creates an upward bias in reported Nasdaq volume 

compared with the Amex. 6 

3.3.3. Effect of ECM listing on media coverage 

Because exchange membership can provide additional visibility for a firm, it 

can lead to more media coverage. This media coverage can in turn increase the 

pool of investors who 'know about' a firm in the sense of Merton (1987), and 

thus increase its liquidity. To investigate this, we examine the number of media 

reports, including news wires and newspaper stories, disseminated about these 

firms. We collect media reports on the firms for one year before and after their 

ECM listing date from the ALLNWS file on LexisjNexis to determine whether 

ECM listing is followed by an increase in media coverage. We exclude stories 

about the ECM listing itself, duplicate records, and PR wires that are issued by 

the firm. If ECM listing increases the visibility of the firms, then we would expect 

an increase in news stories. On the other hand, with less of a dealer network to 

promote the stock, we would expect a decrease in news stories. Because the 

changes in visibility could be gradual, we examine three-month, six-month, 

nine-month, and one year windows around the listing date. We also examine 

changes in news coverage for the industry and size-matched Nasdaq-traded 

control firms as described above. 

Table 8 shows that the number of news stories increases slightly but insignificantly when comparing the three months prior to listing with the three months 

after. The same is true in comparing the six months before with the six months 

after listing. However, news coverage is significantly higher in the nine-month 

and one-year windows. For the 12 months before and after ECM listing, the 

6 On a quote-driven market such as the Amex, a large number of transactions are directly between 

the buyer and the seller; such trades and their attendant volume will be reported only once. The 

Am ex reports in its 1992 Fact Book that in 1991 its specialists participated in only 11.2% of the total 

transactions in the market. In a dealer market such as Nasdaq, the dealers act as intermediaries, and 

can buy shares from a dealer, who later sells the shares to the natural counterparty. Such a trade 

would be reported as two trades on Nasdaq; if the buyer had purchased directly from the natural 

couterparty on the Amex, only one trade would have been reported. Amex volume is, however, 

increased for trades in which the specialist participates. See Gould and Kleidon (1994) for an analysis 

of Nasdaq trading volume. 

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Table 8 

Media coverage before and after ECM listing 

This table presents the number of news stories in the ALLNWS file on Nexis/Lexis measured relative to each firm's listing date for the 65 firms that lis

on the Amex ECM. News stories that were about the ECM itself and PR news wires issued by the firm itself arc not included. Statistics are also presen

for 65 Nasdaq control firms that were matched to the ECM firms by two-digit SIC code and market capitalization at time of listing. 

65 ECM firms 65 industry and size-matched controls 

0-3 0-6 0-9 0-12 0-3 0-6 0-9 0-12 

months months months months months months months mont

Before listing date 

Median number of stories 5 8 11 15 9 18 23 32 

Mean number of stories 7.5 13.3 16.8 20.2 11.3 22.0 30.7 40.0 

After listing date 

Median number of stories 6 13 21 28 6 12 19 24 

Mean number of stories 7.3 14.3 23.3 31.8 10.8 21.5 33.0 43.2 

Number of firms with higher number of stories 34 41 44 51 19 29 26 28 

Number of firms with same number of stories 5 1 2 1 8 3 8 2 

Number of firms with fewer stories 26 23 19 13 38 33 31 35 

Difference in mean before and after listing (t-statistic) -0.26 1.08 6.49 11.55 -0.51 -0.49 2.23 3.18 

(- 0.21) (0.59) (3.31) (4.84) ( 0.46) ( 0.29) (1.02) (1.26) 

Sign test (Median difference > 0) p-value 0.1831 0.0168 0.0012 0.0000 0.9960 0.7373 0.7866 0.84

Wilcoxon signed rank test (Median difference > 0) 0.087 0.047 0.000 0.000 0.984 0.906 0.426 0.375 

p-value 
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278 R. Aggarwal, J.J. Angel/ Journal of Financial Economics 52 (1999) 257-289 

median number of stories about the ECM-listed firms increased from 15 to 28; 

51 of the 65 firms have increases in the number of stories. In contrast, the control 

firms do not see significant increases in news coverage, and in fact the majority 

(35) of the controls actually have fewer news stories in the year after listing. Thus, 

listing on the ECM is associated with an increase in media coverage for the 

ECM-listed firms. 

3.4. Opinions of senior management of ECM-listed firms 

We also undertook field research to learn more about the ECM from the 

perspective of the ECM-Iisted firms themselves. We interviewed senior 

officials from ECM-listed firms who were personally involved with or highly 

knowledgeable about the original decision to list on the ECM, most of whom 

were CEOs or CFOs. Because of personnel turnover and the disappearance 

of some ECM firms, we were unable to locate such ofiicials at all the ECM 

firms. Table 9 provides summary information about the interviews with 37 of the 

65 firms. 

In general, the officials indicate that they were satisfied with their experiences 

on the Amex, and most (88.6%) of them would have made the same decision if 

they had it to do it over again. This is strong evidence against the notion that the 

Amex alienated its listed companies. Indeed, many of the officials report that 

their firms had unsatisfactory experiences with Nasdaq before they listed on the 

Amex ECM. 

One very important finding from the survey is that the majority (71.4%) state 

that they would have sought an Amex listing anyway once they qualified, even if 

the Amex had not started the ECM. This response indicates that the ECM was 

attracting few firms to the Amex that would not have eventually chosen the 

Amex anyway. Indeed, several of the firms joined the ECM after the Amex 

stopped actively marketing it because those firms wanted to be on the Amex. 

Thus, the ECM was reductant in that it did not attract many listings beyond the 

firms that would eventually have come to the Amex anyway. 

During the interviews, the officials freely volunteered many insights into why 

they listed on the Am ex and on the strengths and weaknesses of the ECM. They 

mentioned repeatedly that lower spreads and more visibility on the ECM were 

important reasons for listing. Some firms were very pleased with the various 

investor relations programs offered by the Amex to introduce them to potential 

investors. For some a contributing factor was to have a listing in the newspaper 

every day, because many newspapers do not carry quotes for Nasdaq Small Cap 

stocks. One CEO felt that an Amex listing had more visibility to Europeans than 

a Nasdaq Small Cap listing, and this visibility was important for raising 

additional financing. 

Many of the officials express a strong belief in the auction market. They think 

that the auction market is the 'right' way to conduct a stock market. Several 
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Table 9 

Opinions of senior management of ECM-listed firms 

This table summarizes the results of personal interviews with senior officials of 37 ECM-listed firms 

regarding their experiences with the ECM. We attempted to interview officials who were personally 

involved with, or highly knowledgeable about, the decision to list on the ECM. During the 

interviews, the officials were asked the questions listed here. The officials also provided additional 

unstructured comments and insights discussed elsewhere in the paper. 

Title Number of firms responding 

Chairman, President, EOC, COO 

CFO 

Investor Relations 

Corporate Secretary or EVP 

Total 

Firm listing status as of June 1997 

Amcx (regular) 

ECM 

Delis ted 

Nasdaq 

NYSE 

Total 

11 (29.7%) 

21 (56.8%) 

2 (5.4%) 

3 (8.1 %) 

37 (100%) 

19 (51.4%) 

13 (35.1 %) 

3 (8.1%) 

1 (2.7%) 

I (2.7%) 

37 (100%) 

"Were you personally involved with the listing decision?" 

Yes No Total 

30 (8 L 1 %) 7 (18.9%) 37 (100%) 

"Did you think that the ECM would provide more visibility for the firm than Nasdaq?" 

Yes No Not sure Total 

21 (67.7%) 7 (22.6%) 3 (9.7%) 31 (100%) 

"If the Amex did not have the ECM, did you think that the firm would have eventually listed anyway 

on the AmexT' 

Yes 

25 (71.4%) 

No 

3 (8.6%) 

Not sure 

7 (20.0%) 

"If you had it to do over again, do you think you would make the same decision?" 

Yes No Not sure 

31 (88.6%) 2 (5.7%) 2 (5.7%) 

"Were you satisfied with the experience of your stock on the AmexT 

Yes No Not sure 

32 (88.9%) 3 (8.3%) l (2.8%) 

Total 

35 (100%) 

Total 

35 (100%) 

Total 

36 (100%) 

firms heard presentations from both the Nasdaq and the Amex and liked the 

Amex presentation better. They found that 'Amex did a better job at selling'. 

Other executives believe that the Amex provides better protection against short 

sellers because at that time there was no uptick rule on Nasdaq. This is 
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280 R. Aggarwal, J.J. Angel/ Journal of Financial Economics 52 (1999) 257-289 

consistent with the notion that the Amex is attractive to firms that prefer an 

auction market but are too small for the NYSE. 

Some firms felt that they had 'no choice' but to list on the ECM. They had 

been delisted from the Nasdaq National Market due to financial difficulties, yet 

they wanted a national marketplace for their stock. Because they were too small 

to qualify for a regular Amex listing, the ECM was the only national marketplace open to them other than the Pink Sheets. 

However, not all of the executives were totally satisfied. As one official 

put it, ' ... the ECM was a good idea that was poorly executed. The two 

main problems with the execution were the poor screening and that it was 

oversold as a market'. One executive felt that 'Amex specialists move the 

stock price too far sometimes on small volume' but was overall very satisfied 

with the ECM. 

Some of the firms that were no longer on the Amex report that they were 

unhappy with the loss of support from retail brokers when they moved to the 

Amex. One CEO states that he was 'dumfounded' by the reaction of the retail 

brokerage firms: 'As soon as we did that [switched to the ECM], we lost the 

interest of a lot of retail brokers. They all felt they needed the extra spread to 

make some money on the stock. They lost interest in us because they couldn't 

make the hidden commission'. Another official indicates that his firm switched 

back to Nasdaq for three reasons: they wanted more research coverage, the 

firm's peer companies were on Nasdaq, and there was a 'negative prestige' about 

Amex. 

4. Other markets for small company stocks 

The failure of the Am ex ECM is not surprising when viewed in the historical 

context of the failures of other stock markets for very small companies. This 

section discusses attempts in the US and elsewhere to start public equity 

markets for small stocks. 

4.1. The U.S. experience 

In the 19th century there were literally dozens of stock exchanges in the U.S. 

Virtually every major city had a stock exchange of one kind or another. These 

local exchanges executed orders for local residents in national stocks, and also 

provided a secondary market for the stocks of local companies. As communications improved, the secondary market for large companies gradually consolidated at the NYSE. This left smaller companies that did not meet the listing 

requirements of the NYSE or the Amex with a choice between the OTC market 

or the regional exchanges, most of which operated specialist auction markets 

similar to the NYSE. Walter (1957) notes that, by the 1950s most small 
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R. Aggarwal, J.J Angel/ Journal of Financial Economics 52 (1999) 257-289 281 

companies that met the listing standards of the regional exchanges chose to be 

traded in the OTC market. Most of the local exchanges died. 

The surviving regionals continue to list small stocks that do not meet Amex or 

NYSE listing requirements. However, most of their trading volume is in NYSEand Amex-listed stocks. According to the Securities and Exchange Commission 

(1994), the surviving regionals now do 97% of their business in NYSE and Amex 

listed stocks, rather than in their exclusive listings. 

In 1962 the New York Mercantile Exchange launched the National Stock 

Exchange in an attempt to diversify by trading equities as well as commodities. 

SEC Release No. 11744 (File No. 10-53) provides some details on the National 

Stock Exchange. Many of the stocks previously traded on the National Stock 

Exchange moved to the Boston Stock Exchange, where a few of them are still 

listed. The National Stock Exchange, like the ECM, was an attempt to provide 

an exchange market for stocks too small for the Amex. At that time, such tiny 

stocks could trade only on the pre-Nasdaq over-the-counter market. However, 

the National Stock Exchange suffered almost exactly the same fate as later befell 

the ECM. Few stocks listed on the National, and it had a hard time gaining 

visibility. Newspapers would not publish its stock quotes, so it had to buy 

advertisements in The Wall Street Journal to disseminate its prices. The National 

also suffered from reputation effects. Its president was a former Amex president 

who had been forced to resign amidst a scandal at the Amex. After languishing 

for several years, the National finally ceased trading in 1968, ironically in the 

middle of one of the biggest bull markets in U.S. history. 

4.2. The European experience 

The European experience demonstrates that problems with small stock markets are not limited to auction markets. During the 1980s, virtually every stock 

market in Europe established a special section for companies that were too 

small to meet the normal listing requirements. These junior, or 'incubator', 

markets used a variety of market mechanisms, usually ones similar to their 

parent markets. For example, London's Unlisted Securities Market was designed as a continuous dealer market, and Amsterdam's Official Parallel Market 

as an auction market with a specialists-like hoekman. Other markets used 

mechanisms for their small market segments that differed from those used in 

their primary markets: Milan's Mercato Ristretto and Paris' March€: Hors Cote 

used daily call auctions. 

Many of these markets appeared to prosper for a short time, but ultimately 

they all suffered from severe illiquidity and attracted few companies or investors, 

as chronicled by Rasch (1994) and Bannock (1994). Amsterdam's Official Parallel Market, which used an auction mechanism similar to the Amex, closed in 

1993. London closed its Unlisted Securities Market, which was a dealer market, 

in 1996. 
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Bannock (1994} notes that all of the second-tier European markets for small 

stocks were started by the major European exchanges, similar to the Amex 

ECM. The adverse selection problem has also been a serious problem with the 

European junior markets. Because most of the business on the major exchanges 

comes from trading larger stocks, the small company tiers are seen as inferior 

cousins of the main market. Companies move up to the main tier as soon as they 

qualify, just as with the ECM. 

4.3. Successful small capitalization stock markets 

In contrast to the dismal record of failure for many small capitalization stock 

markets, there have been some that have survived. In the U.S., Nasdaq now 

reports a higher trading volume than that of the NYSE, and over 900 Nasdaqlisted firms that could list on the NYSE choose not to. This number was 

estimated by using Compustat PC-Plus to search for Nasdaq-listed companies 

that meet NYSE listing requirements for net tangible assets, pretax income, and 

number of shares outstanding}. Japan has created Jasdaq, a Nasdaq-like market 

that now lists almost twice as many stocks as the second section of the Tokyo 

Stock Exchange. These markets have three things in common. First, both 

markets grew out of pre existing over-the-counter markets. They were not just 

mechanisms created in the search for listings. Second, both are dealer markets. 

Finally, both are separate entities from the other national exchanges. By being 

independent, they can specialize in doing the best possible job of serving their 

target clientele, which might otherwise be overlooked in a market for large 

companies. They also have a strong financial incentive to compete to retain 

listings and prevent their successful firms from switching to the other markets. 

Thus, many of the more successful firms remain in these markets for significant 

periods of time, bolstering the markets' reputation. 

4.4. Other new initiatives for small capitalization stock markets 

Other attempts arc also underway to create special markets for smaller stocks. 

London's Alternative Investment Market (AIM} has attracted over 260 stocks 

with a market capitalization over six billion pounds since its inception in 1995. 

The AIM operates a hybrid market that contains elements of both an auction 

and a dealer market. The AIM system allows for the electronic matching of 

orders in addition to displaying competing quotes. 

European stock exchanges have launched new markets for smaller stocks in 

Germany (Neuer Markt, 1997}, France (Le Nouveau Marche, 1996}, Brussels 

(Le Nouveau March€:, 1997), and Amsterdam (NMAX, 1997). These markets 

generally combine features of both auction and dealer markets. They are also 

linking up in a project called Euro-NM, which will allow members of each 

exchange to trade the small stocks listed on the other exchanges. This linkage is 
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R. Aggarwal, J.J. Angel/ Journal of Financial Economics 52 (1999) 257-289 283 

a direct response to the 1996 launch of Nasdaq, a Nasdaq-like system that is 

independent of the national exchanges. It is still too early to tell how these 

markets will do in the long term. As of October 1997, there were only 15 stocks 

on Easdaq, 30 on France's Nouveau Marche, and ten on Neuer Markt. 

5. Summary and conclusions 

The Amex Emerging Company Marketplace appeared to start successfully. 

Bid-ask spreads fell for most of the listed firms. Volume results were mixed, with 

reported trading volume rising substantially for some stocks but falling for 

others. The visibility of most of the ECM firms increased, as evidenced by more 

media coverage in the year after listing on the ECM. Interviews with oflicials of 

ECM-listed firms indicate that they were satisfied with the trading of their 

stocks on the ECM and with the services provided by Amex. 

Nevertheless, the ECM failed. Several factors contributed to this failure. The 

organizational structure of the Amex as a membership organization meant that 

most Amex stakeholders had little to gain from the success of the ECM. Firms 

affiliated with Nasdaq market makers held almost one-fourth of the Amex 

board seats, and these firms could have had a vested interest in seeing the 

venture faiL 

The ECM also suffered from the same adverse selection problem that has 

affected other junior markets. The successful firms graduated to the main Amex 

as soon as they could, leaving the unsuccessful firms on the ECM. Scandals 

affecting three of the original stocks damaged the ECM's reputation for 

monitoring the quality of its listings, one of its initial selling points. Indeed, the 

poor quality of the firms earned the ECM the nickname 'the submerging 

company marketplace'. This poor reputation contributed to the reluctance of 

other firms to list on the ECM, leading to a vicious circle of decline. 

Because the ECM was owned by the Amex, there was no incentive for the 

ECM to try to prevent its listings from moving onto the Amex, which exacerbated the adverse selection problem. One thing that the Amex could have done 

differently would have been to encourage the successful ECM firms to stay on 

the ECM longer in order to build up the reputation of the ECM market. It could 

also have structured the ECM as a separate entity that would have had an 

incentive to try to retain its listings. 

Even though many small firms traditionally choose a dealer market, the 

auction market mechanism of the ECM could have been a viable way to 

differentiate the ECM from Nasdaq. Indeed, interviews with senior officials of 

ECM-listed firms indicate that the ECM attracted firms that wanted an auction 

market. Perhaps modifications to its auction market similar to the new hybrid 

markets such as the AIM and Euro-NM would have broadened the appeal of 

the market. 
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284 R. Aggarwal, J.J. Angel J Journal of Financial Economics 52 (1999) 257-289 

Ultimately, the ECM was closed because it was redundant. It did not attract 

firms beyond those that would eventually have sought an Amex listing anyway, 

and thus it was not worth the direct and reputational costs of operation. This 

redundancy is what one would expect if firms are well informed and choose their 

listing rationally. 

For the designers and regulators of financial markets, especially in countries 

that are developing new markets, the lessons are clear. Exchanges must properly 

screen firms to prevent scandals from destroying confidence in the market. This 

is especially important for a new market with a small number of stocks. Markets 

should seriously consider the limited liability form of ownership instead of the 

traditional membership organization. Policy makers seeking to establish and 

promote capital markets in their countries should nurture competition among 

markets for listings. A firm in the process of deciding its listing policy should 

consider, in addition to transaction costs, how a market mechanism affects the 

visibility of its stock. 

One interesting issue for further research is to explore the reason that Nasdaq 

has managed to avoid the adverse selection problem common to junior markets 

and to retain the listings of many large companies that qualify for listing on the 

Amex and the NYSE. 

Appendix A 

Amex Emerging Company Marketplace Companies (see Table 10). 

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Table 10 This table lists the companies that listed on the Amex Emerging Company Marketplace (ECM). Data are obtained from the Amex, the Natio

Association of Securities Dealers, and Lexis Nexis. Original firms are those that listed when the market commenced operations on March 18, 19

Additional firms are those that listed later. The prior market indicates where the stock traded prior to its listing on the ECM. SC indicates Nasdaq-trad

firms that were not part of the Nasdaq National Market System. Market makers before ECM refers to the number ofNasdaq dealers providing quote

the stock. NA =Not Available or Not Applicable. 

Original tlrms Listing ECM Prior Market Market makers Status 

date ticker market capitalization before ECM May 19

(millions) 

Advanced Photonix 3/18/92 API sc $10.2 6 Amex Alta Energy 3/18/92 ALE sc $17.7 9 Am ex American Pacitlc mint 3/18/92 DLS sc $16.9 4 ECM Audre Recognition Systems 3/18/92 ARS sc $253.7 26 Am ex 

Cancer Treatment Holdings 3/18/92 CHI sc $12.5 12 ECM Colonial Data Technologies 3/18/92 CDT sc $22.1 5 Am ex 

Digitran Systems 3/18/92 DGT Pink Sheets $218 11 Am ex 

Epigen 3/18/92 EPN sc $114 10 Deliste

Intertel Communications 3/18/92 ITR Vancouver $77.3 NA Am ex 

Ion Laser Technology 3/18/92 ILT sc $8.7 16 Am ex 

Media Logic 

3/18/92 TST sc $11.9 10 Amex 

Medphone 

3/18/92 MPO sc $16.3 26 Delis te

North Coast Energy 

3/18/92 NCE sc $13.7 6 Nasdaq 

Ocean Optique Distributors 3/18/92 OPQ sc $8.3 1 Nasdaq 

PNF Industries 3/18/92 PNI Pink Sheets $28.3 1 Delis te

Printron 3/18/92 PNT Pink Sheets $51J 10 De liste

Professional Dental Technology 3/18/92 PRO Pink Sheets $52.5 8 ECM Randers Group 

3/18/92 RGI sc $21.0 13 ECM 

Three-Five Systems 3/18/92 TFS sc $5.0 4 NYSE 

Top Source 3/18/92 TPS sc $70.2 30 Am ex To pox 3/18/92 TPO Pink Sheets $106.9 6 De liste

Unique Mobility 3/18/92 UQM Pink Sheets $18.4 8 Am ex 

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Table 10. Continued. 

Additional firms Listing ECM Prior Market Number of Status 

date ticker market capitalization market makers May 1

(millions) 

ACOI Inc 8/4/92 ccs sc 10.1 15 ECM 

Air Methods Corporation 6/2/92 ARF sc 15.1 15 Nasdaq 

Aviva Petroleum 11/14/94 AVV London 149.5 NA ECM 

Banker's Note, Inc. 3/31/94 TBN sc 3.6 5 ECM 

Bema Gold Corporation 3/4/94 BGO Toronto 68.7 NA ECM 

Besicorp Group Inc. 11/22/93 BGI Pink Sheets 21.6 8 ECM 

CEC Resources 

4/24/95 CGS Spinoff 6.6 NA ECM 

Chad Therapeutics, Inc. 8/4/93 CTU Pink Sheets 37.8 9 Am ex 

Chesapeake Biological Laboratories, Inc. 2/10/94 PHD Pink Sheers 13.4 6 ECM 

Columbus Energy Crop. 7/30/92 EGY Pacific 15.1 NA Am ex 

Cornerstone Bank 

3/20/95 CBN No market 8.8 NA ECM 

Creative Comp. Appl., Inc. 8/23/94 CAP sc 3.6 13 ECM 

Crown Laboratories, Inc. 3(30(94 CLL Pink Sheets 49.7 1 ECM 

Encore Marketing International Inc. 4(29(93 EM! No market 9.0 NA ECM 

Environmental Diagnostics 9/16/92 ED! Pink Sheets 35.4 12 Am ex 

ETS International, Inc. 7(23(92 ETS Vancouver 24.6 NA ECM 

First West Virginia Bancorp 3/8/95 FWV Pink Sheets 11.4 NA ECM 

Grove Real Estate Asset Trust 6/16/94 GRE IPO 5.6 NA ECM 

Inno Vet, Inc 7/15/93 IVT sc 24.2 13 Delis te

Intelligent Controls 2/15/95 ITC No market 12.3 NA ECM 

Interline Resources Corp. 

7/12/94 IRC sc 68.2 18 ECM 

Inti. Remote Imaging Systems, Inc. 6/23/92 IRI sc 9.2 20 Am ex 

Leather Factory, Inc. (The) 9(27 /93 TLF Pink Sheets 67.5 2 Am ex 

Luxtec Corporation 4/20/94 LXU sc 3.0 8 ECM 

Magnum Pertroleum, Inc. 11/15/93 MPM Pink Sheets 12.2 6 ECM 

Measurement Specialities, Inc. 4/23/93 MSS Pink Sheets 15.2 11 ECM 

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MidSouth Bancorp, Inc. 4/19/93 MSL No market 6.8 NA Am ex 

Northern Instrument Corp 3/27/92 NIZ Pink Sheets 12.3 6 Am ex 

NuMED Home Health Care 5/2/94 NHH Pink Sheets 10.9 2 Nasdaq 

OMN1 Multimedia Group Inc 4/20/95 OMG IPO 7.3 NA ECM 

PC Quote, Inc. 4/23/92 PQT sc 6.0 6 ECM 

Pyrocap International Corporation 1/10/94 PYR Pink Sheets 21.2 4 ECM 

Reliv International, Inc. 3/8/93 RLV No market 59.9 NA Amex 

RF Power Products, Inc. 4/29/94 RFP Spinoff 20.5 NA ECM 

Saba Petroleum Company 9/15/93 SAP Pink Sheets 11.0 8 ECM 

Scott Instruments Corp. 7/16/92 SIC sc 8.1 12 Nasdaq 

Sheffield Exploration Co., Inc. 12/14/93 SHE Pink Sheets 25.8 2 ECM 

Soligen Technologies, Inc. 3/10/94 SGT Vancouver 39.1 NA ECM 

SouthFirst Bancshares 2/14/95 SZB IPO 8.9 NA ECM 

Spectrum Signal Processing Inc. 7/29/92 SNL Vancouver 13.4 NA Toront

Statordyne Corporation 6/25/93 STY Spinoff 30.8 NA Delis te

Surety Capital Corporation 2/23/94 SRY sc 14.5 12 Amex 

WIZ Technology, Inc. 2/2/94 WIZ Pink Sheets 17.4 6 ECM 
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288 R. Aggarwal, J.J. Angel/ Journal of Financial Economics 52 (1999) 257-289 

References 

Aggarwal, R., Angel, J., 1998. Optimal listing policy: why Microsoft and Intel do not list on the 

NYSE. Unpublished working paper. Georgetown University, Washington, DC. 

Amihud, Y., Mendelson, H., 1986. Asset pricing and the bid-ask spread. Journal of Financial 

Economics 17, 223-249. 

Bannock, G., 1994. European second-tier markets for NTBFs: a study carried out for the European 

Commission. Graham Bannock & Partners Ltd., London. 

Barber, B., Lyon, J., 1997. Detecting long-run abnormal stock returns: the empirical power and 

specification of test statistics. Journal of Financial Economics 43, 341-372. 

Barclay, M., 1997. Bid-ask spreads and the avoidance of odd-eighth quotes on Nasdaq: an 

examination of exchange listings. Journal of Financial Economics 45, 35-60. 

Bessembinder, H., 1997. The degree of price resolution and equity trading costs. Journal of Financial 

Economics 45, 9-34. 

Bruchey, S., 1991. Modernization of the American Stock Exchange: 1971-1989. Garland Publishing, 

New York. 

Christie, W., Huang, R., 1993. Market structures and liquidity: a transactions data study of exchange 

listing. Journal of Financial Intermediation 3, 300-326. 

Christie, W., Schultz, P., 1994. Why do Nasdaq market makers avoid odd-eighth quotes? Journal of 

Finance 49, 1813-1840. 

Clarkson, G., 1990. EC plan for European stock market threatened by disunity. Reuter Library 

Report, December 19. 

Clyde, P., Schultz, P., Zaman, M., 1998. Trading costs and exchange delistings: the case of firms that 

voluntarily switch from the American Stock Exchange to the Nasdaq. Journal of Finance 52, 

2103-2112. 

Demsetz, H., 1997. Limit orders and the alleged Nasdaq collusion. Journal of Financial Economics 

45, 91-96. 

Dharan, B., Ikenberry, D., 1995. The long run negative drift of post-listing stock returns. Journal of 

Finance 50, 1547-1574. 

Gould, J., Kleidon, A., 1994. Market maker activity on Nasdaq: implications for trading volume. 

Stanford Journal of Law, Business and Finance 1, 11-28. 

Harris, J., Schultz, P., 1997. The importance of firm quotes and rapid executions: evidence from the 

January 1994 SOES rules changes. Journal of Financial Economics 45, 135-166. 

Hart, 0., Moore, J., 1995. The governance of exchanges: members' co-operatives versus outside ownership. Discussion paper 229, Financial Markets Group, London School of 

Economics. 

Hasbrouck, J., Sofianos, G., 1993. The trades of market makers: an empirical analysis of NYSE 

specialists. Journal of Finance 48, 1565-1594. 

Huang, R., Stoll, H., 1996. Dealer versus auction markets: a paired comparison of execution costs on 

Nasdaq and NYSE. Journal of Financial Economics 41, 313-358. 

Kadlec, G., McConnell, J., 1994. The effect of market segmentation and illiquidity on asset prices: 

evidence from exchange listings. Journal of Finance 49, 611-636. 

Kandel, E., Marx, L., 1997. Nasdaq market structure and spread patterns. Journal of Financial 

Economics 45, 61-90. 

LaPlante, M., Muscarella, C., 1997. Do institutions receive comparable execution in the NYSE and 

Nasdaq markets? A transaction study of block trades. Journal of Financial Economics 45, 

97-134. 

Lipson, M., 1997. Market transparency and optimal listing choices. Unpublished working paper, 

University of Georgia, Athens. 

McConnell, J., Sanger, G., 1987. The puzzle in post-listing common stock returns. Journal of 

Finance 42, 119-140. 
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R. Agganval. J.J. Angel/Journal of Financial Economics 52 (1999) 257-289 289 

Merton, R., 1987. A simple model of captial market equilibrium with complete information. Journal 

of Finance 42, 483-510. 

Rasch, S., 1994. Special stock market segments for small company shares in Europe - what went 

wrong? ZEW-Discussion Paper No. 94-13. Centre for European Economic Research. 

Sanger, G., McConnell, J., 1986. Stock exchange listings, firm value, and security market efficiency: 

the impact of Nasdaq. Journal of Financial and Quantitative Analysis 21, 1-25. 

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an examination of current equity market developments. US Government Printing Office, 

Washington, DC. 

Seguin, P., Smoller, M., 1997. Share price and mortality: an empirical examination of newly listed 

Nasdaq stocks. Journal of Financial Economics 45, 333-363. 

Ule, M., 1937. Price movements of newly listed stock. Journal of Business 10, 346-369. 

Van Horne, J., 1970. New listings and their price behavior. Journal of Finance 25, 783-794. 

Walter, J., 1957. The role of regional security exchanges. University of California Press, Berkeley. 

Ying, L, Lewellen, W., Schlarbaum, G., Lease, R., 1977. Stock exchange listings and securities 

returns. Journal of Financial and Quantative Analysis 12, 415-432. 
204 

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May 22,2018 

The Honorable Jeb Hensarling, Chairman 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Maxine Waters, Ranking Member 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Bill Huizenga, Chairman 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Carolyn Maloney, Ranking Member 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

Re: Main Street Growth Act 

Dear Chairman Hensarling, Ranking Member Waters, Chairman Huizenga and Ranking 

Member Maloney, 

I am the CFO of Repro Med Systems, Inc. (OTCQX: REPR), a medical device manufacturer 

located in Chester, New York that is publicly-traded on OTC Markets Group's OTCQX Best 

Market. 

24CarpenterRoad·Chester, NY10918· USA I 800·624· 9600 toll free ls45 ·469·2042 local 1845•469·5518 fax I rmsmedicalproducts.com 
205 

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I am writing to share Repro Med System's experience as a small, public company and describe 

why we do not support the "Main Street Growth Act." 

The Main Street Growth Act would allow the creation of "Venture Exchanges" that are intended 

to have trading and listing rules tailored for smaller companies like ours. However, these 

regulatory privileges would not be available to non-exchange markets such as OTCQX. 1 

Repro Med Systems joined the OTCQX market in September 2015. Under the OTCQX Rules, 

Repro Med Systems is required to meet high financial standards (OTCQX does not accept 

Penny Stocks or Shell Companies) and provide current disclosure to investors (including 

PCAOB audijed annual financials). "We have seen our market cap grow over the past 2.5 years 

from $14.4 million to $52.1 million." "We have grown to 75 employees with sales expanding 

globally." 

There are many reasons why the OTCQX market works well for small, growing companies like 

ours: 

Lower Cost & Complexity: OTCQX costs less, and our compliance obligations, while 

challenging, are less burdensome than listing on an exchange, giving us more time and 

money to spend growing our business. 

Small Company Liquidity: OTC Markets Group's ATS dealer model supports the 

liquidity needs of smaller, less-actively traded securities. Unlike large, exchange-listed 

companies, we do not have large amounts of natural liquidity and high trading volumes. 

Rather, our liquidity needs are focused on making sure our shareholders have the ability 

to buy and sell on an as-needed basis. 

Investor Engagement & Capital Formation: Through OTC Markets' disclosure 

services, we are able to easily communicate with our shareholders, publish financial 

reports and share company updates to broaden our visibility in the marketplace. The 

OTCQX market is also exempt from Blue Sky secondary trading regulations in 30 states, 

which allows broker dealers to reach a wider audience of potential investors, raise 

capital and grow our shareholder base. 

The OTCQX market has helped Repro Med Systems grow and mature by providing all of the 

benefits of a public market- scaled to ftt the needs of small companies. 

The Main Street Growth Act does not work for companies like us because it focuses solely on 

national securities exchanges and excludes other models, such as OTCQX where we have 

established a thriving secondary market. The Main Street Growth Act instead would restrict 

trading to one, single exchange. 

While we welcome legislation aimed at supporting small public companies and the venture 

markets that serve them, the Main Street Growth Act does not achieve these goals. We urge 

the Committee to consider the value of alternative secondary market models, such as A TSs, 

because companies should be able to choose the venue that best suits their needs. A "Venture 

Company" should be afforded the same regulatory treatment, regardless of whether it trades on 

an exchange or an ATS market like OTCQX. 

1 OTC Markets Group Inc. operates the OTCQX Best and OTCQB Venture markets, where over 1,200 

companies meeting financial standards and providing current disclosure to investors, including many 

innovative and entrepreneurial 'venture' companies, trade via an SEC registered alternative trading 

system ("ATS"). 

2 
206 

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We remain hopeful that Congress, the SEC and market participants can work together to 

provide venture companies with all of the tools necessary to foster their growth and 

development Please let me know if we can provide any additional information or insight in 

furtherance of that shared goal. 

~((utt ~lll. j)~ishe~WI Chief Financial Officer 

Repro Med Systems, Inc. 

3 
207 

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~~~t\\ '~' '· Commo,,.-1-Av-e-nu-e-,-C-h-ic-ago, Illinois 60617 -r-··~~~~e: 773-768-4800 

""' jfinancta:I, 1hu. 

May 21,2018 

The Honorable Jeb Hensarling, Chairman 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Maxine Waters, Ranking Member 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Bill Huizenga, Chairman 

Subcommittee on Capit<~l Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Carolyn Maloney, Ranking Member 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

Re: Main Street Growth Act 

Dear Chairman Hensarling, Ranking Member Waters, Chairman Huizenga and Ranking 

Member Maloney, 

I am the President and CEO of Royal Financial, Inc. (OTCQX: RYFL), a Holding Company for a 

$430 million bank located in Chicago, IL that is publicly-traded on OTC Markets Group's 

OTCQX Best Market. 

I am writing to share Royal Financials experience as a small, public company and describe why 

we do not support the "Main Street Growth Act." 

www.royal-bank.us 
208 

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The Main Street Growth Act would allow the creation of "Venture Exchanges" that are intended 

to have trading and listing rules tailored for smaller companies like ours. However, these 

regulatory privileges would not be available to non-exchange markets such as OTCQX.1 

Royal Financial joined the OTCQX market in 2015. Under the OTCQX Rules, Royal Financial is 

required to meet high financial standards (OTCQX does not accept Penny Stocks or Shell 

Companies) and provide current disclosure to investors (including PCAOB audited annual 

financials). 

It is important to say we have enjoyed great transparency of our publicly traded stock and have 

seen large increases in our market cap because of the rigidity of OTC QX Best Markets and the 

integrity behind and the support of the system. We have gone from a two bank branch serving 

Chicagoland to nine full banking centers and two loan production offices, supporting the 

economy in the Midwest. 

There are many reasons why the OTCQX market works well for small, growing companies like 

ours: 

Lower Cost & Complexity: OTCQX costs less, and our compliance obligations, while 

challenging, are less burdensome than listing on an exchange, giving us more time and 

money to spend growing our business. 

Small Company Liquidity: OTC Markets Group's ATS dealer model supports the 

liquidity needs of smaller, less-actively traded securities. Unlike large, exchange-listed 

companies, we do not have large amounts of natural liquidity and high trading volumes. 

Rather, our liquidity needs are focused on making sure our shareholders have the ability 

to buy and sell on an as-needed basis. 

Investor Engagement & Capital Formation: Through OTC Markets' disclosure 

services, we are able to easily communicate with our shareholders, publish financial 

reports and share company updates to broaden our visibility in the marketplace. The 

OTCQX market is also exempt from Blue Sky secondary trading regulations in 30 states, 

which allows broker dealers to reach a wider audience of potential investors, raise 

capital and grow our shareholder base. 

The OTCQX market has helped Royal Financial grow and mature by providing all of the benefits 

of a public market- scaled to fit the needs of small companies. 

The Main Street Growth Act does not work for companies like us because it focuses solely on 

national securities exchanges and excludes other models, such as OTCQX where we have 

established a thriving secondary market. The Main Street Growth Act instead would restrict 

trading to one, single exchange. 

While we welcome legislation aimed at supporting small public companies and the venture 

markets that serve them, the Main Street Growth Act does not achieve these goals. We urge 

the Committee to consider the value of alternative secondary market models, such as ATSs, 

because companies should be able to choose the venue that best suits their needs. A "Venture 

1 OTC Markets Group Inc. operates the OTCQX Best and OTCQB Venture markets, where over 1,200 

companies meeting financial standards and providing current disclosure to investors, including many 

innovative and entrepreneurial 'venture' companies, trade via an SEC registered alternative trading 

system ("ATS"). 

2 
209 

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Company" should be afforded the same regulatory treatment, regardless of whether it trades on 

an exchange or an A TS market like OTCQX. 

We remain hopeful that Congress, the SEC and market participants can work together to 

provide venture companies with all of the tools necessary to foster their growth and 

development. Please let me know if we can provide any additional information or insight in 

furtherance of that shared goal. 

Sincerely, 

Le~h;;rd Szwajko;ski 

!Royal Financial, Inc. 

President and CEO 

3 
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May21, 2018 

The Honorable Jeb Hensarling, Chairman 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Maxine Waters, Ranking Member 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Bill Huizenga, Chairman 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Carolyn Maloney, Ranking Member 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

Re: Main Street Growth Act 

Dear Chairman Hensarling, Ranking Member Waters, Chairman Huizenga and Ranking 

Member Maloney, 

I am the CEO of The Singing Machine Company, Inc. (OTCQX: SMDM), the world-wide leader 

in consumer karaoke products, located in Fort Lauderdale, FL that is publicly-traded on OTC 

Markets Group's OTCQX Best Market. 

I am writing to share my experience operating as a small, public company and describe why we 

do not support the "Main Street Growth Act." 

The Main Street Growth Act would allow the creation of ''Venture Exchanges" that are intended 

to have trading and listing rules tailored for smaller companies like ours. However, these 

regulatory privileges would not be available to non-exchange markets such as OTCQX.1 

Singing Machine joined the OTCQX market in 2016. Under the OTCQX Rules, Singing 

Machine is required to meet high financial standards (OTCQX does not accept Penny Stocks or 

1 OTC Markets Group Inc. operates the OTCQX Best and OTCQB Venture markets, where over 1 ,200 

companies meeting financial standards and providing current disclosure to investors, including many 

innovative and entrepreneurial 'venture' companies, trade via an SEC registered alternative trading 

system ("ATS"). 
211 

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Shell Companies) and provide current disclosure to investors (including PCAOB audited annual 

financials). Since joining OTCQX, we have experienced increased visibility as a public 

company and have grown to 40 employees with two offices throughout the country. 

There are many reasons why the OTCQX market works well for small, growing companies like 

~ours: 

Lower Cost & Complexity: OTCQX costs less, and our compliance obligations, while 

challenging, are less burdensome than listing on an exchange, giving us more time and 

money to spend growing our business. 

• Small Company Liquidity: OTC Markets Group's ATS dealer model supports the 

liquidity needs of smaller, less-actively traded securities. Unlike large, exchange-listed 

companies, we do not have large amounts of natural liquidity and high trading volumes. 

Rather, our liquidity needs are focused on making sure our shareholders have the ability 

to buy and sell on an as-needed basis. 

• Investor Engagement & Capital Formation: Through OTC Markets' disclosure 

services, we are able to easily communicate with our shareholders, publish financial 

reports and share company updates to broaden our visibility in the marketplace. The 

OTCQX market is also exempt from Blue Sky secondary trading regulations in 30 states, 

which allows broker dealers to reach a wider audience of potential investors, raise 

capital and grow our shareholder base. 

The OTCQX market has helped Singing Machine grow and mature by providing all of the 

benefits of a public market- scaled to frt the needs of small companies. 

The Main Street Growth Act does not work for companies like us because it focuses solely on 

national securities exchanges and excludes other models, such as OTCQX where we have 

established a thriving secondary market. The Main Street Growth Act instead would restrict 

trading to one, single exchange. 

While we welcome legislation aimed at supporting small public companies and the venture 

markets that serve them, the Main Street Growth Act does not achieve these goals. We urge 

the Committee to consider the value of alternative secondary market models, such as ATSs, 

because companies should be able to choose the venue that best suits their needs. A "Venture 

Company" should be afforded the same regulatory treatment, regardless of whether it trades on 

an exchange or an A TS market like OTCQX. 

We remain hopeful that Congress, the SEC and market participants can work together to 

provide venture companies with all of the tools necessary to foster their growth and 

development. Please let me know if we can provide any additional information or insight in 

furtherance of that shared goal. 

~ ~~n CEO 

The Singing Machine Company, Inc. 

2 
212 

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May 18,2018 

The Honorable Jeb Hensarling, Chairman 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Maxine Waters, Ranking Member 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Bill Huizenga, Chainman 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial Services 

U.S. House of Representatives 

Washington, D.C. 20515 

The Honorable Carolyn Maloney, Ranking Member 

Subcommittee on Capital Markets and Government Sponsored Enterprises 

Committee on Financial SerVices 

U.S. House of Representatives 

Washington, D.C. 20515 

"Re: Main Street Growth Act 

Dear Chairman Hensarling, Ranking Member Waters, Chainman Huizenga and Ranking 

Member Maloney, 

I am the Chief Financial Officer of Tix Corporation (OTCQX: TIXC), a leading provider of 

discount ticketing services that currently operates nine discount ticket stores in Las Vegas under 

its Tix4Tonight marquee and two online properties www.tix4tonight.com and www.tix4.com. Tix 

Corporation offers up to a 50 percent discount for showS, concerts, attractions, and tours, as 

well as discount dining and shopping offers. Tix Corporation is publicly-traded on OTC Markets 

Group's OTCQX Best Market. 

I am writing to share Tix Corporation's experience as a small, public company and 

describe why we do not support the "Main Street Growth Act." 
213 

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The Main Street Growth Act would allow the creation of "Venture Exchanges" that are 

intended to have trading and listing rules tailored for smaller companies like ours. However, 

these regulatory privileges would_ not be available to rion-exchimge markets such as OTCQX.1 

Tix Corporation joined the OTCQX market in November 2010. Under the OTCQX Rules, 

Tix Corporation is 'required to meet high financial standards (OTCQX does not accept Penny 

Stocks or Shell Companies) and provide current disclosure to investors. (including · PCAOB 

audited annual financials). Since joining the OTCQX, Tix Corporation~s investor base has 

increased significantly, saved money on regulatory efficiencies, increased the number of 

locations, and increased employee headcount. 

There are many reasons why the OTCQX market works well for small, growing 

companies like ours: · 

• lower Cost & Complexity: · OTCQX costs.less, and our compliance obligations, while 

challenging; are less burdensome than listing on an exchange, giving us more time and 

money to spend groWing our business: 

Small Company Liquidity: OTC Markets Group's A TS dealer model supports the 

liquidity needs of smaller, less-actively traded securities. Unlike large, exchange-listed 

companies, .we do not have large amounts of naturaUiquidity and high trading volumes. 

Rather,· our liquidity needs are focused on making. sure our shareholders have the ability 

to buy and sell on an as-needed basis. · 

Investor Engagement · & Capital Formation: Through OTC Markets' disclosure 

services, we . are able to easily communicate with our shareholders, publish financial 

reports and.sharecompany updates to broaden our visibility in the marketplace. The 

OTCQX market is also exempt from Blue Sky secondary trading regulations in 30 states, 

which allows broker dealers to reach a wider audience. of potential investors, raise 

capital and grow our shareholder base. 

The OTCQX market has helped Tix Corporation grow and mature by providing all of the 

benefits of a public market.-:- scaled to frt the needs of small companies. 

The Main Street Growth Act does not work for companies like us because it focuses 

solely on national securities exchanges and excludes other models, such as OTCQX where we 

have established ·a thriving secondary mafket. The. Main Street Growth Act instead would 

restricttrading to one, single exchange. · 

While we welcome legislation aimed at supporting small public companies and the 

venture markets that serve them, the Main Street Growth Act _does not achieve these goals. We 

urge the Committee to consider the·value of alternative secondary· market models, such as 

ATSs, because companies should be able to choose. the venue that best suits their needs. A 

"Venture Company" should b!nlfforded,the same regulatory.treatment, regardless of whether it 

trades on an exchange or an A TS market like OTCQX. · · 

1 OTC Markets Group Inc. operates the OTCQX Best and OTCQB Venture markets, where over 1,200 

companies meeting financial standards and providing current disclosure to investors, including m11ny 

innovative and entrepreneurial 'venture' ccmpanies, trade via an SEC registered alternative trading 

system ("ATS"). 

2 
214 

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We remain hopeful that Congress, the SEC and market participants can work together to 

provide venture companies with all of the tools necessary to foster their growth and 

development. Please let me know if we can provide any additional information or insight in 

furtherance of that shared goal. 

Sin~ly, _---·····--·-

~ Chief Financial Officer 

Tix Corporation 

3 
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Stephen F. Lynch 

Questions for the Record 

Capital Markets Subcommittee hearing entitled, "Ensuring Effectiveness, Fairness, and 

Transparency in Securities Law Enforcement" at 2 p.m. on June 13, 2018 

Questions for the Dem Witness: Mr. Joseph Borg, Director, Alabama Securities Commission, 

President, North American Securities Administrators Association ("NASAA"): 

l. To me, H.R. 5037 is the narrowest kind of special interest legislation. An Aprill5, 2018 article 

in the New York Times. Wall Street Titan Takes Aim at Law that Tripped Him Up, makes it clear 

that H.R. 5037 was filed at the request offonner AIG CEO and Chairman Hank Greenberg. In 

the article, Mr. Greenberg states that he is "at war," and that H.R. 5037 is a direct response to 

securities fraud cases brought by the New York attorney general against him and against AIG. 

AIG is the last company we should be helping. I clearly remember how, in the aftermath of the 

2008 financial crisis, AIG received a massive taxpayer funded bailout to keep it from going 

bankrupt. According to the Congressional Research Service report, Government Assistance for 

AIG: Summary and Cost, "at the maximum, the Federal Reserve and the Treasury committed 

approximately $182.3 billion in specific extraordinary assistance for AIG and another $15.2 

billion through a more widely available lending facility. The amount actually disbursed to assist 

AIG reached a maximum of$141.8 billion in April2009." 

a. Under the language ofH.R. 5037, would a state be barred from taking civil enforcement 

action against a company listed on a national exchange if that company generates false 

financial reports and claims fictitiously high earnings? 

Response: 

You're exactly correct, Congressman. 

If the bill was to become law, my office, my colleagues in Massachusetts, and my colleagues in 

every other state, would be prohibited by federal law from taking on the types of cases 

highlighted in your question and perhaps many more. Investors who have lost money in these 

cases due to fraud will instead have to solely depend on the federal government to pursue the 

wrongdoers. 

At a minimum, under the bill, states would be prohibited from pursuing civil fraud cases against 

the issuers of publicly traded securities. However, the preemption provisions are drafted such 

that a defendant could argue, and a court could find that states are preempted from pursuing civil 

fraud violations in connection with any transaction involving publicly traded securities. Thus, 

the scope of preemption enacted by H.R. 5037 would unquestionably extend to civil cases such 

as those you identify- frauds such as filing false financial reports, false earnings reports - but 

could be applied by courts much more broadly. And defendants would certainly push courts 

towards the broadest possible interpretation, especially given the language of the very first line 

as introduced ... "to provide for exclusive Federal jurisdiction over securities fraud actions, and 

for other purposes." 

IfH.R. 5037 were to become law, more work would fall to the federal government, specifically, 

the SEC and the federal courts. That's bad news for the SEC as the agency is currently 
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underfunded and its bad news for a federal court system that has a backlog of cases that is going 

to get worse under this bill. Further, as I described in my written testimony, the bill includes 

provisions that affect state criminal enforcement authority. These criminal provisions would, at 

a minimum, have a chilling effect on the ability of state authorities to pursue criminal cases in 

connection with these same types of frauds. 

Taken collectively, the overarching effect of the bill's preemption and other requirements would 

be to eliminate an important deterrent against securities fraud at the direct expense of Alabama 

investors and investors in Massachusetts and every oilier state- and strike a blow to the 

integrity of the U.S. securities markets. And it would leave your constituents with nowhere to 

tum should federal investigators be unable to pursue a case. 

2. Under H.R. 5037, states would be prohibited from bringing actions against an issuer. However, 

the bill does not define "issuer" anywhere. Massachusetts has brought cases against issuers who 

are located within the state and selling securities into the state. One example is the case against 

Woodbridge Mortgage Investment Funds, where the fund offered and sold unregistered securities 

in the form of interests in commereialloans ostensibly secured by real property. Another 

example is the case against Lending Club, where individual lenders could pool their money with 

other individual lenders to make a larger loan evidenced by a payment note that were securities 

and were not registered or exempt from registration. In these cases, issuers were selling 

unregistered securities to Massachusetts residents. 

a. Docs the language ofH.R. 503 7 reduce any existing uncertainty or lack of clarity relating 

to state and federal securities enforcement, or docs it increase those results? 

b. Under lhis bill, would Massachusetts still be able to bring these sorts of cases where 

issuers are accused of selling unregistered securities to Massachusetts residents? 

Response: 

Congressman, one of the most striking features of H.R. 5037 is its lack of clarity- both in regard 

to what it seeks. to achieve, what it would actually achieve, and how or why the envisioned 

policy changes would be necessary or appropriate. H.R. 5037 would, if enacted, be a source of 

considerable litigation in federal and state courts as defendants and regulators battle over what 

the bill means. I thus cannot ultimately answer either of these two questions with precision. 

At a minimum, under H.R. 5037 states would be prohibited from pursuing civil fraud cases 

against the issuers of publicly traded securities. However, the preemption provisions are drafted 

such that a defendant could argue, and a court could find, that states are preempted from 

pursuing civil fraud violations in connection with any transaction involving publicly traded 

securities. 1 Under such an interpretation, for example, the bill would preempt state enforcement 

actions against a broker-dealer, or any other entity, so long as the fraud was limited to, or 

involved, or connected to "covered securities" under the bill2 The bill does not define relevant 

Please note the term, ''or transactions of a covered security" appears in several places throughout the bBl. 

Any "transaction" in a listed company or a company involved in interstate commerce would) in essence, cover the entire 

market- including such smaller actions as broker churning accounts, selling unsuitable product.-;, in addition to general 

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terms, including its use of the word "issuer." Furthermore, the bill would require state criminal 

securities fraud prosecutions to "comply in all respects" with federal legal requirements. The 

scope of this obligation is never made clear. Does this, for example, require state courts to apply 

federal rules of evidence or criminal procedure7 I am confident in stating that in my home state 

many state courts would dismiss and suggest the case be brought in Federal Court (and therefore 

prosecuted by federal prosecutors). The likelihood of a federal prosecutor bringing cases on 

behalf of "mom & pop" investors is slim, at best. 

H.R. 5037's many inherent ambiguities would impel defendants to test its boundaries and it is 

impossible to predict with any confidence what courts would do with it. lam certain of one 

thing about the bill, though. IfH.R. 5037 becomes law, it will be a source of significant 

litigation in federal courts, as regulators and defendants battle over its scope and meaning. TI1is 

needless litigation will drain regulators' already limited enforcement resources. 

I would also note that the proffered rationale for the bill is specious. TI1e claims that underlie the 

bill simply do not add up. 

As I discuss extensively in my written testimony, H.R. 5037 is premised on a completely 

unsupported assertion that state securities enforcement is detrimental to the public interest and 

somehow disincentivizes capital raising. 3 4 This is wholly unsupported by fact or logic. Reports 

just issued in July (after H.R. 5037 was filed) show significant increases in the number of 

companies now conducting IPOs. The Wall Street Journal recently reported (July 2, 2018) that 

more than 120 companies have conducted IPOs in U.S. markets in the first halfof2018, the 

highest volume in four years. This trend demonstrates that the !PO market can thrive without the 

need to pass laws that handcuff regulators and expose investors to greater harm. 

For your benefit and the benefit of the Committee, l have enclosed a copy of the relevant Wall 

Street Journal article. 

3. Past bills that would have preempted state regulatory authority have specifically left state 

enforcement authority intact. This has been based on a widespread view that the states have acted 

quickly and effectively to shut down a variety of large-scale and small-scale 

frauds. Massachusetts, for example, has brought a number of cases where they moved quickly 

and were followed by larger federal actions. The 2003 analyst cases, for example, involved sell 

side research analysts who had material conflicts of interest that led to fraudulent activity. This 

activity included payments made to analysts based upon continued favorable stock coverage, 

making research recommendations solely to win or maintain investment banking relationships, 

and making research recommendations without a reasonable basis to do so. Some cases would 

fraud, microcap, insider trading, market manipulation and other rip~offs for which the state may be the only regulator 

who would handle. 

See: The Securities Fraud Act of2018, H.R. 5037, !15th Cong. § 2 (2017) (The lack of a uniform standard for puhlic 

companies is a contributing factor to the declining interest in the United States public market, hanning the United States 

economy and reducing investment opportunities/or the US. public.). The preemption would apply to .... securities 

transactions .... in cmmcction with a covered security or transactions of a covered security (emphasis added). 

Currently, 41 of 50 states have adopted a version of the Uniform Securities Act. Accordingly, there docs not exist as 

much disparity as premised by H.R. 5037. 

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appear to be precluded by the prohibition from bringing cases that involve a covered security and 

other cases would appear to be precluded by the prohibition against bringing actions against an 

issuer. 

a. In light of this, could you address the consequences that would flow from the preemption 

of state enforcement authority that is outlined H.R. 5037? 

Response: 

Congressman, I think it is important to note that Congress has never passed legislation to restrict 

the ability of states to take enforcement action to punish and deter securities fraud. This bill is a 

clear encroachment by the federal government on the authority of states to protect their citizens 

and only benefits those companies and individuals suspected of committing fraud. 

States play a critical role in keeping bad actors out of our markets by enforcing securities laws 

and our work has a long history of bipartisan support. Policy makers have long understood that 

federal agencies simply do not have the resources to police misconduct in the capital markets. 

Working with the SEC and other regulators, state securities regulators help to keep the bad guys 

from ripping off your constituents. 5 

ln my office alone, hundreds of millions of dollars have been returned to hard-working 

Alabamians and many fraudsters have been barred from the securities industry or even jailed for 

committing securities fraud. My colleague in Massachusetts, Secretary of the Commonwealth 

William Galvin, and his team of securities regulators are also fierce advocates for investors in 

that state. My office in Alabama worked alongside many States, including Massachusetts, in the 

Analyst cases, the mutual fund timing cases, the subprirne cases, and others. 

As for the consequences ofH.R. 5037, for all of the reasons I've explained, I believe the bill 

represents a serious threat to investor protection. It would needlessly tic the hands of state 

regulators in a way that would expose everyday investors on Main Street to more financial fraud 

and abuse and leave your constituents without recourse should the federal authorities decline or 

be unable to pursue any case. The bill is bad tor our investors, bad for our markets and bad for 

our small businesses. I hope that you and the rest of the members of Congress will see this 

legislation for what it is- an attempt by those suspected of wrongdoing to make it easier to get 

away with their misconduct 

The combination of state and federal antifraud enforcement authority, along with that of the Financial Industry 

Regulatory Authority ("FINRA"), ensures that U.S. capital markets remain the deepest and most liquid in the world. 

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