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Broker-dealers. There are few business activities subject to more regulation and potential litigation coming from several different directions than broker-dealers registered with the SEC. If registered with the SEC, as substantially all broker-dealers are compelled to be, the broker-dealer is also a member of the National Association of Dealers and subject to its regulatory arm. During the SEC’s fiscal year 2001, the Commission initiated 65 enforcement proceedings involving broker-dealers, of which 13 were civil actions and 52 administrative proceedings, involving a total of 132 respondents, representing 13% of all enforcement cases. Thirty-four of these proceedings involved fraud against customers. During 2000, NASD Regulation received 6,584 customer complaints involving its 5,557 member firms, suspended or expelled 15 firms, barred or suspended 669 individuals.[1] During 2000, broker-dealer customers initiated 5558 arbitration proceedings under the NASD arbitration procedures and the NASD appropriately refers to itself as “the largest securities dispute resolution forum in the world.”[2] Through June of 2001, there were 3,358 arbitration filings made with the NASD.[3] During 2000, 5,473 arbitration cases closed, of which 2,570 settled. Arbitration awards during 2,000 aggregated $76 million, of which $21 million were punitive damages and $55 million compensatory damages.[4] The bulk of private securities litigation involving broker-dealers fortunately is handled by arbitration, but the NASD’s Code of Arbitration Procedure does not permit it to arbitrate class actions; hence, broker-dealers may also be defendants in class actions. Insider Trading: Over a period of years, the Commission has put a good deal of emphasis on bringing actions alleging illegal insider trading. The law of insider trading since Texas Gulf Sulphur has developed in large part as a result of enforcement actions initiated by the Commission and legislation adopted in that area at the suggestion of the Commission to strengthen its enforcement powers. During fiscal 2001, the SEC initiated 47 civil actions involving 101 defendants alleging unlawful insider trading and ten administrative proceedings involving insider trading, collectively 12% of the total enforcement cases brought that year. We consider insider trading only as it is related, often indirectly, to financial fraud and primarily in connection with private actions. Securities Offerings: The Commission always has devoted considerable resources to bring enforcement actions against blatant type securities fraud generally involving the sale of unregistered securities as part of Ponzi and other apparent frauds, once exposed. The Commission during fiscal 2001, brought 95 cases in this category, of which 56 were civil actions, 39 administrative proceedings, involving collectively 315 defendants or respondents and 20% of the enforcement cases for the year. Although the Commission often obtains disgorgement orders in this type of case, the stakes are not large enough in most instances to attract the class action lawyers. We consider securities offerings only in the context of private actions asserting Section 11 and 12(a)(2) claims under the Securities Act based on alleged false or misleading statements in connection with offerings registered under the Securities Act. Tender Offers and Takeovers: We do not consider this area, although it features a significant number of private actions. For most purposes, the Delaware Court of Chancery is the National Takeover Court and the law relating to poison pills and other takeover defenses is largely Delaware law. Fascinating, but beyond our scope. Although the center piece of Sarbanes-Oxley, we will consider only to a limited extent the Public Company Accounting Oversight Board (PCAOB), and primarily in the context of enforcement. Although all public company accounting firms will have to register with that board and will be subject to oversight, including disciplinary proceedings, by the Board, it will be some time before it is up and functioning. The Board’s founding members have been named (although the initial Chairman resigned before taking office) and is in the process of getting organized. The Commission no later than April 26, 2003 is to declare the Board organized and capable of carrying out its responsibilities under the Act.[5] Beginning 180 days after the date the Commission declares the Board organized. it will be unlawful for any public accounting firm that is not registered with the PCAOB to “prepare or issue, or to participate in the preparation or issuance of, any audit report with respect to any issuer.”[6] Issuer is a defined term for this purpose and for our immediate purposes we will define it as a public company subject to the reporting requirements of the Exchange Act. The PCAOB held its organization meeting on January 9, 2003 and voted itself salaries that exceed that of the President. Click HERE. Our principal focus will be financial fraud cases and fraud on the market, involving both SEC enforcement actions and private actions, with emphasis on the latter. In the process we will try to relate those provisions of the Sarbanes-Oxley Act that are designed to ameliorate the financial fraud problem. By fraud on the market, we are referring to disclosures made to the market via press releases, conference calls with analysts and institutional investors and the like. In some respects it is the converse of false financial statements as in many instances it involves projections of future financial performance. The SEC and Congress have made projections (forward-looking statements) a protected specie in the belief that future performance is as or more important than past performance. This is the area that for years largely was the terrain of the securities fraud class action bar, which, in the process, earned the enmity of corporate America and Congress and led to the adoption of the Private Securities Litigation Reform Act of 1995. The Commission belatedly recognized that there was a problem in this area. Then Chairman Levitt on September 28, 1998 delivered “a major address on the state of accounting.” In the address he “expressed concern that the quality of financial reporting in corporate America is eroding and he presented an action plan that calls on the entire financial community to remedy the problem.” Sounding like a class action complaint, he attributed it to a “zeal to satisfy consensus earnings estimates and project a smooth earnings path,” Chairman Levitt accused “[t]oo many corporate managers, auditors, and analysts” of participating in a game of creative accounting to meet the analysts’ expectations. Chairman Levitt charged such miscreant activities are undertaken “in order to grow market capitalization and increase the value of stock options.”[7] Richard H. Walker, then Director of the Division of Enforcement, on June 14, 2000 announced “zero tolerance for fraudulent financial reporting.”[8] There is no doubt that the Division of Enforcement was energized and placed a new-found emphasis on fraudulent financial reporting. The result showed in the statistics for cases brought involving financial disclosures during fiscal 2001 (October 1, 2000 to September 30, 2001)—103 enforcement actions consisting of 38 civil actions, 65 administrative proceedings, 183 defendants/respondents. Levitt resigned as Chairman and a member of the Commission on February 1, 2001; Laura Unger became acting Chairperson; Harvey Pitt was appointed by President Bush as Chairman on August 3, 2001. Ms. Unger resigned as of the end of the year (Dec. 31, 2001). In the meantime Richard Walker, Director of the Division of Enforcement and Lynn Turner, Chief Accountant the driving force behind the focus on accountants and financial fraud both left the Commission. We will pick-up on this narrative when we start down the Enron/WorldCom trail that led to the adoption of the Sarbanes-Oxley Act. The Commission under Harvey Pitt became energized and made enforcement a priority and took a number of steps to make the adoption of new legislation unnecessary. We consider those steps and the adoption of Sarbanes-Oxley primarily in the context of SEC enforcement. We are not at that point, but in case you don't read the financial press or listen to cable TV, SEC is at the center of a storm and you should be forewarned. Click HERE. Congress in adopting Sarbanes-Oxley studiously avoided taking any action that would aid the bringing of private litigation except to extent the statute of limitations for private actions alleging violations of the fraud provisions of the Securities Acts. We will discuss this provision and others that may indirectly impact private actions in context. You may want to browse on the home page of one or more of the entrepreneurial class action lawyers Internet sites including Milberg Weiss Bershad Hynes & Lerach LLP [offline]; Wolf Haldenstein Adler Freeman & Herz LLP [offline]; Stull Stull & Brody [offline]; Berger & Montague P.C. [offline]; Cauley Geller Bowman & Coates, LLP [offline];Cohen, Milstein, Hausfield & Toll P.L.L.C. [offline] -- collectively representing, perhaps, 90% of all securities fraud class actions that are filed. We can get a feel for the extent of securities fraud class actions by taking some pages from the Stanford Securities Class Action Clearinghouse. Use the bookmarks in the navigation pane to look at the index of case, those filed in the District of Colorado, and the search form. HERE Then go to Milberg Weiss and note the number of active cases for one law firm, albeit the most prominent securities fraud class action firm. HERE. Firms that specialize in defending such actions are not modest about their talents. Try Brobeck. We can take their approach and view this course as a risk audit course designed to prevent our clients from being defendants in a private action or SEC enforcement action. This course in large part revolves around private actions under the Securities Acts and the Private Securities Litigation Act (PSLRA) and enforcement actions by the Commission and Department of Justice, both as impacted by Sarbanes-Oxley and the aftermath of Enron/Worldcom. Click HERE for Enron Task Force. We cannot understand the PSLRA or SEC enforcement actions without some familiarity with the provisions of the Securities Acts (the Securities Act of 1933 and the Securities Exchange Act of 1934) that are the basis for asserting a claim for damages. Since those provisions when studied in depth form the nucleus of at least two separate courses, we cannot hope to gain an in depth understanding of the substantive law giving rise to civil liabilities in private actions under the Securities Acts. We delve into that substantive law only as an entrée to securities litigation. Not that the substantive law of civil liability is not an important aspect of securities litigation, but we cannot do both in depth in a three-semester hour course. Private securities litigation is unique in many respects, not the least of which is that securities litigators seldom actually try a case. The ability to write a convincing brief and to argue effectively to the court for the most part can be put to better use than the ability to persuade a jury. The Securities Act includes three provisions that expressly create private actions: Section 12(a)(1) creates a private action that can be brought be a purchaser of securities sold in violation of the registration provisions of the Securities Act. Section 12(a)(2) creates a private action that can be brought by a purchaser of securities sold in a public offering by means of false or misleading representations. Section 11 creates a private action that can be brought by one who purchases securities registered under the Securities Act if the registration statement includes false or misleading statements. There are two provisions ancillary to the above. Section 13 sets forth the periods of limitations applicable to the bringing of the above actions. Section 15 imposes liability upon persons who control defendants liable under the above sections. Section 12 historically was Section 12(1) and Section 12(2) until adoption of the Private Securities Litigation Reform Act in December of 1995, and is sometimes referenced in that fashion by the courts and herein; particularly, in a historical context. The PSLRA modified Section 12 in only one limited respect by adding a Section 12(b) relating to causation as part of a Section 12(a)(2) action, but in the process renumbered Section 12(1) as Section 12(a)(1) and what was Section 12(2) as Section 12(a)(2). In terms of private actions brought under the Securities Exchange Act, we do not consider, except in passing, the provisions of that Act expressly providing for a private action. Those provisions include the following; Section
18(a)
permits one who purchases or sells securities in reliance on false or
misleading representations in filings required to be made under the
Exchange Act to assert a private action for damages. This has not proven
to be an effective remedy and is seldom asserted. Section 16(b) permits any shareholder to bring a derivative action if the corporation fails to bring such action to recover on behalf of the corporation any profit realized by insiders as the result of the purchase and sale or sale and purchase within a period of six months of the company’s equity securities. Such actions were relatively common at one time and are still brought on occasion, but are of limited significance in the overall scheme of things. See § 1.13. Section 9(e) permits one who purchases or sells listed securities to bring an action against one who while purchasing or selling such securities makes false or misleading statements concerning same or engages in manipulative practices relating to same that affect the price of the security purchased or sold. Congress intended such actions to be the primary private action with respect to market representations, but it has been supplanted in large part by 10b-5 private actions. Section 20A creates a private action for the benefit of contemporaneous purchasers or sellers against one who purchases or sells a securities while in possession of material non-public information in violation of any provision of the Exchange Act. The Exchange Act includes a number of provisions that make actions in violation of that provision or any regulation adopted there under unlawful, without expressly providing for a private right of action. Section 10(b) of the Exchange Act and Rule 10b-5 adopted there under are in this category. Rule 10b-5, among other things, makes it unlawful in connection with the purchase or sale of a security to make a false or misleading representation of a material fact. Although the scope of an implied private action under Rule 10b-5 has a checkered history and the right to assert such a claim appeared in doubt at one point of time, the existence of an implied private action under Rule 10b-5 today is "beyond peradventure" (Justice Marsahll in Herman & MacLean v. Huddleston, 459 U.S. 375, 386 (1983)). Section 20(a) imposes joint and several liability on persons who control other persons liable under other provisions of the Exchange Act, including Rule 10b-5. On the surface it provides only a good faith defense. Private actions arising under Rule 10b-5 together with the express private actions under the Securities Act provide the core of the substantive law of private actions that we consider in this course. HSB [1] See NASD Regulation statistics published by NASDR available on the Internet at <http://www.nasdr.com/2380.htm>. [2] See Dispute Resolution Statistics maintained by the NASD, available at <http://www.nasdadr.com/statistics.asp>. [3] Id. [4] Id. [5] Pub. L. No. 107-204 § 101(d). [6] Pub. L. No. 107-204 § 102(a). [7] See SEC Press Release 98-95, Chairman Levitt Announces Action Plan to Improve Quality of Corporate Financial Reporting (Sept. 28, 1998). [8] SEC Press Release 2000-80 (June 14, 2000).
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