Thursday, June 4, 2020

Gatekeeping in the Dark

Alex Platt has a fascinating new paper arguing that the SEC should consider the potential private litigation consequences of their activities.  He starts with the observation that SEC enforcement and oversight activity undoubtedly influences the private securities class actions often following in the SEC's wake. SEC enforcement can catalyze or inhibit these "piggybacked" private securities class actions in many different ways.  For example, the SEC's enforcement division may catalyze private litigation by revealing facts either through the filing of a complaint or in a settlement agreement. An SEC decision to include an admission of wrongdoing in a settlement agreement would substantially advance private litigation. This process can allow private attorneys to discover, and later plead, facts critical to surviving a motion to dismiss.  The SEC's Division of Corporation Finance now also catalyzes and inhibits private litigation through its comment letter process.  Consider how the SEC communicates its views to issuers.  Oral comments in a phone call leave no record for plaintiffs to cite in some later class action.  In contrast, a disclosed letter laying out the SEC's reasoning may persuade a court that particular facts were material or that a defendant had scienter.  A decision to pick up the phone instead of writing a letter has real consequences.

Yet the SEC does not now account for these collateral consequences stemming from its activities--even though it has to actually know about them.  Platt points out that the SEC now regularly reports to Congress about enforcement but omits its true effects because the score sheet does not include private securities class actions catalyzed by SEC actions.  Adding these into the mix might give the SEC a reason to internalize the impact of its decisions.

As a former defense lawyer, I know that companies sometimes view SEC or state enforcement actions as a single front in a larger war which may be waged in state and federal courts across the country.  Companies might prefer to pay larger settlements to the SEC with carefully negotiated language to deny plaintiffs the factual ammunition they would need to withstand summary judgment or a motion to dismiss.  In this sense, a large SEC settlement might actually reduce a defendant's overall liability.

Oddly, even though we know defense teams think about these issues, there does not seem to be any disclosed process for weighing these impacts at the SEC.  Putting a process in place to consider these impacts would likely result in more effective and judicious enforcement.

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