Opinion: Taking a new look at US securities law
In my recently published book Rethinking Securities Law, I examine deficiencies in the existing framework and changes that should be implemented to enhance the securities laws by basing them on sound and consistent principles.
I set forth roughly 125 recommendations – a number conveying the extent to which the current regimen needs drastic repair and remediation. Here I outline a few examples of changes that could and should be made.
One recommendation is that strict liability under the securities laws be eliminated and replaced with a reasonable care standard. No sound public policy exists today for subjecting issuers in Securities Act-registered offerings to the specter of strict liability after relying in good faith on reputable legal counsel and other advisers.
The detrimental impact of strict liability is that often the company’s shareholders are ultimately harmed by damages incurred even though reasonable care was exercised. The same holds true with respect to a registration violation when an exemption from registration is not perfected. In view of the complexities and uncertainties of the securities law exemption process, an affirmative defense of reasonable care should be recognized.
A similar line of analysis applies to the SEC’s practice of levying monetary penalties on publicly held companies. For decades, the commission has levied fines of millions and even billions of dollars against these corporations.
Unless a large percentage of the monetary amounts collected are distributed to victims of the wrongdoing (such as through the fair fund process), these money penalties inflict harm on a subject company’s shareholders. Payment of these amounts to the US Department of the Treasury is bad policy, detrimental to shareholder interests and should be eliminated.
From a disclosure perspective, a gap in the US securities law framework exists: unlike many developed markets, such as the EU, no statutory obligation exists mandating that a publicly held company must disclose all material information. If a material event is not required to be disclosed pursuant to Regulation S-K and the company has not spoken on the matter, then the company may ordinarily refrain from disclosing this important information. Although stock exchange rules require such disclosure, these rules are all too often ignored and not enforced.
Importantly, as court decisions and SEC rules make clear, absent a duty to disclose, there is no affirmative obligation under the federal securities laws for a corporation to disclose material information. And that duty normally is found in the SEC forms and reports (embodying the Regulation S-K disclosure items) or when the company opts to speak on the matter. This practice disserves the efficiency of the securities markets and investor protection.
Pursuant to the efficient market theory, all material information in the public domain impacts market price and provides a reliable indicator of the value of a company’s common stock. Of course, the fault with this rationale is that companies legally withhold material information from the marketplace, thereby impairing the efficient market theory’s validity.
Moreover, investors buying and selling in the securities markets should be entitled to all material information, with one exception: non-disclosure is permissible provided the company can establish that it has a justifiable business reason (such as the undertaking of merger negotiations with a third party) for such non-disclosure. The implementation of this approach would enhance the efficiency of the securities markets and provide investors with valuable information.
The foregoing discussion provides a sampling of the recommendations made in Rethinking Securities Law. Many recommendations proffered fundamentally impact corporate governance, private securities litigation and SEC enforcement. For example, on the corporate governance front, I recommend that with respect to companies whose securities are listed on a national securities exchange:
– The chair of the board of directors must be an independent director
– An employee representative must serve on the board as well as being a member of the corporation’s compensation committee
– The shareholder say-on-pay vote must be elevated from an advisory to a binding vote.
With regard to shareholder litigation, a drastically modified regime is proposed, including, as discussed above, the elimination of strict liability. And lastly, regarding SEC enforcement, the commission must use the resources within its authority, such as the use of the control person provision, to hold culpable individual fiduciaries and insiders responsible for their conduct.
Indeed, perhaps the most far-reaching recommendation is a revision in the composition of the commission to include qualified individuals who have a wider diversity of perspectives, with these individuals coming from organizations whose clients, members or operations are closely connected with the securities laws or the securities markets.
I am hopeful that Rethinking Securities Law will contribute to the growth and enhancement of our securities laws. Much is wrong with the current framework. Expeditious correction should be the route pursued and implemented. The stature of the US securities laws, investor protection and the integrity of our securities markets deserve no less. The time is now for Congress and the SEC to take appropriate corrective action.
Marc Steinberg is Radford Professor of Law at SMU School of Law