The SEC and “Piggyback” Securities Litigation

Leading securities regulation scholars have repeatedly called for legislatively expanding the Securities and Exchange Commission’s (SEC) control over private securities litigation.[1] These proposals grow out of profound doubts about the private securities class action regime and frustration with the decentralized multi-enforcer approach to securities enforcement. But these centralization proposals have failed to gain traction.

In a new paper, I map out a different way to harness the SEC’s power to improve the private securities litigation regime.  Rather than expand SEC authority, I argue that the SEC can and should make better use of its existing authority in this domain.

SEC enforcement activities can generate significant downstream consequences for private litigation against the same target for the same alleged wrongdoing. Securities class actions are more likely to survive a motion to dismiss and result in larger settlements when they are accompanied by parallel SEC enforcement actions. The SEC makes various decisions over the course of an investigation and enforcement action that can catalyze such “piggyback” litigation. For instance, since private claims under Rule 10b-5 require proof of scienter, the SEC’s choice to pursue or settle charges based on scienter, rather than negligence, will provide relatively more support for private litigation, as will a choice to include especially incriminating or salacious facts in an agency complaint or settlement.  Requiring a defendant company to admit to liability or to specific actions may also help private plaintiffs survive motions to dismiss.  And, of course, simply initiating an investigation or enforcement action may provide a valuable signal to plaintiffs that there is an actionable misconduct.

This piggyback effect also extends beyond the SEC’s Enforcement Division.  The comment letters sent by the SEC’s Division of Corporation Finance to flag companies’ deficiencies with their periodic disclosures have also become an important resource for private plaintiffs, who have been using these documents to help establish various elements of their claims, including materiality, scienter, loss causation, and more.

But, despite the significant downstream effects that SEC enforcement activities can have on parallel private litigation, the SEC’s leaders have repeatedly denied that the agency accounts in any way for this piggyback effect. In 2012, then-Enforcement Director Robert Khuzami was asked by a congressman whether “the fact that an investor cannot bring an additional action change[d] the decision-making process for determining whether it is appropriate or not to settle with the defendant?”  Khuzami answered: “No. In general, we are going to follow the same guidelines.”  Similarly, in 2013, an assistant director of the SEC office in charge of distributing settlement proceeds to injured investors confirmed that the SEC does not consider the existence of parallel private litigation when it investigates and settles enforcement actions.[2]

Agency policies and guidance further confirm that the SEC does not systematically account for the piggyback effect.  For instance, the SEC Enforcement Manual lays out numerous considerations for enforcement attorneys to evaluate at various stages of the investigation and enforcement process – including the “egregiousness” of the misconduct, the opportunity to send a strong “message of deterrence,” and overlapping jurisdiction with federal, state, and international authorities. But the manual conspicuously omits any reference to private litigation.  Similarly, the SEC policy on admissions in settlements calls for consideration of numerous factors but omits any reference to parallel private litigation.

It is true that an enforcement target facing the prospect of piggyback litigation may be expected to factor that risk into its settlement negotiations with the SEC.  But this does not mean that the agency will properly evaluate and internalize the social value of the parallel private litigation. Imagine a scenario in which the optimal sanction is $100, and the SEC has a choice between two alternative settlements:

Settlement A: SEC extracts a penalty of $80. No private litigation is catalyzed.

Settlement B: SEC extracts a penalty of $50. As a result of SEC’s actions, private litigation is catalyzed resulting in private settlement of another $40.

The target will prefer Settlement A, since it will prefer to pay $80 rather than $100.  If the SEC fails to account for the piggyback effect, it may also prefer Settlement A.  But the correct choice here is Settlement B, which gets closer to the optimal sanction of $100.

The SEC’s failure to integrate the piggyback effect into its enforcement policies and priorities may be politically expedient, allowing the agency to escape blowback from powerful forces on either side of the securities class action debate.  But it is bad policy.  The agency may be catalyzing too much wasteful private litigation or too little socially valuable private litigation.  Its failure to systematically and transparently account for the piggyback effect ensures that the effect will either fall in a random, haphazard manner or (more likely) will be skewed by unseen forces.

When the agency decides whether or when to file a case, what facts to include in a complaint or settlement, and whether to seek an admission of facts or even liability from the target, it should consider what impact its choice will have on potential or ongoing private securities litigation against the same target for the same underlying misconduct.  A good place to start implementing this proposal would be in the annual reports that agencies file with Congress reporting their enforcement performance.  Every year, the SEC provides Congress a set of statistics and anecdotes tracking the impacts of its enforcement program.  But these reports are devoid of any mention of the substantial piggybacking effects that the agency’s activities generate and, accordingly, they present a woefully incomplete and misleading portrait of the agency’s true enforcement footprint.  If the agency began systematically tracking and including these impacts in its reports to Congress, that could kickstart a productive cycle of accountability, as stakeholders and congressional overseers react to the agency’s piggybacking policies as revealed through their impacts.

ENDNOTES

[1] Amanda Rose, Reforming Securities Litigation Reform: Restructuring the Relationship Between Public and Private Enforcement of Rule 10b-5, 108 Colum. L. Rev. 1301, 1357 (2008); Jennifer Arlen, Public Versus Private Enforcement of Securities Fraud 44–47 (2007), available at https://weblaw.usc.edu/assets/docs/Arlen.pdf; Alicia Davis Evans, The Investor Compensation Fund, 33 J. Corp. L. 223, 241–47 (2007); Jill E. Fisch, Class Action Reform, Qui Tam, and the Role of the Plaintiff, 60 L. & Contemp. Probs. 167, 200 (1997); Janet Cooper Alexander, Rethinking Damages in Securities Class Actions, 48 Stan. L. Rev. 1487, 1514–17 (1996).

[2] Urska Velikonja, Public Compensation for Private Harm: Evidence from the SEC’s Fair Fund Distributions, 67 Stan. L. Rev. 331, 388 (2015) (citing Telephone Interview with Nichola Timmons, Assistant Dir., Office of Distributions, SEC (Dec. 24, 2013)).

This post comes to us from Alexander I. Platt, Climenko Fellow at Harvard Law School and incoming associate professor of law at the University of Kansas School of Law (starting Fall 2020). It is based on his recent article, “‘Gatekeeping’ in the Dark: SEC Control Over Private Securities Litigation Revisited” available here.

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