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House Financial Services Subcommittee Hearing on Legislative Proposals

House Financial Services Subcommittee on Investor Protection, Entrepreneurship

and Capital Markets

“Putting Investors First: Reviewing Proposals to Hold Executives Accountable”

Wednesday, April 3, 2019

Key Topics & Takeaways

  • Arbitration: Rep. French Hill (R-Ark.) explained that arbitration is a way to “speed up” the process and that FINRA arbitration often ends in compensation for consumers. Quaadman agreed, adding that arbitration leads to “speedy rewards,” lowers costs, and that there is a significant number of FINRA arbitration cases that are settled before going through the arbitration process.
  • Executive Compensation: Rep. Cindy Axne (D-Iowa) asked why the process to finale executive compensation rules has taken so long, to which Coffee replied that the SEC has “gone very slowly” the last couple of years, adding that more weight needs to be placed on claw back rights. Gregg and Lubin agreed that transparency is needed so shareholders know the link between performance and payment. Quaadman argued that the 2015 SEC proposal is not a workable proposition and needs to instead be principles-based.

Witness

Legislation

Opening Statements

Rep. Carolyn Maloney (D-N.Y.), Chairwoman, House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets

In her opening statement, Maloney highlighted the importance of the draft legislation being discussed in the hearing. She noted that the 8-K Trading Gap Act of 2018 would prevent individuals from intentionally acting on insider information prior to public release. She also stressed the need for a statutory definition of insider trading through the Insider Trading Prohibition Act. She also expressed her support for draft legislation that prevents arbitration clauses, the Investor Choice Act.

Rep. Bill Huizenga (R-Mich.) Ranking Member, House Financial Services Subcommittee on Investor Protection, Entrepreneurship and Capital Markets

In his opening statement, Huizenga emphasized the need to develop a competitive and modern capital marketplace. He shared his concerns about the drop in initial public offerings (IPOs), the increase in private investment and the decline of new business. He expressed his opposition to all of the proposals being considered as he feared they would hinder access to the capital markets for main street investors.

Testimony

John Coffee, Adolf A. Berle Professor of Law, Director of the Center on Corporate Governance at Columbia Law School

In his testimony, Coffee voiced his support for the Insider Trading Prohibition Act. He presented the benefits it would have on the court systems and how its expansion of the definition of insider trading to more than the Securities and Exchange Commission (SEC) Rule 10b would better protect the capital markets from theft. He noted Congress’s responsibility to eliminate the common law practices in the courts that are not enforcing a fair and standard rule of law, and expressed an interest in the elimination of the personal benefit rule, in which insider trading is only recognized when a clear exchange is performed in return for information.

Melanie Lubin, Maryland Securities Commissioner, on behalf of the North American Securities Administrators Association, Inc. (NASAA)

In her testimony, Lubin expressed her support for the Investor Choice Act of 2019 due to its elimination of forced arbitration in customer account agreements, as well as its elimination of corporate issuer disputes settled through arbitration. In addition, she highlighted her support for the 8-K Trading Gap Act of 2019 and shared the need for a statutory definition of insider trading. With regards to potential rule changes for whistleblowers, she voiced her support of the protection of whistleblowers who report within a corporation from retaliation.

Remington A. Gregg, Counsel for Civil Justice and Consumer Rights, Public Citizen

In his testimony, Gregg accused the arbitration system of being a “secretive privatized system of justice” that deprives consumers of their day in court. He claimed that corporations win over 90 percent of the time when using arbitration and that the Investor Choice Act is needed to protect everyday investors from corporate bad actors “getting off the hook.” Gregg stated that over 80 percent of people oppose “forced arbitration,” stressing the need for Congress to protect them through this draft legislation.

Tom Quaadman, Executive Vice President, U.S. Chamber Center for Capital Markets Competitiveness, Chamber of Commerce of the United States of America

In his testimony, Quaadman said that there are half the number of public companies than there were in 1996 and that the Hong Kong stock exchange “outpaces any U.S. stock exchange” regarding initial public offerings (IPOs). He noted that while he appreciates the intent of the bills being discussed, he also has concerns. Quaadman stated that while insider trading does not benefit investors or businesses, he has concerns that the “potential dual approach for prosecutors to bring insider trading cases does not seem to lend itself to” the goal of making insider trading standards clearer. He continued that he does not support the Investor Choice Act because it “would deprive consumers and investors of a valuable tool for resolving disputes and being compensated for harm done to them, and imposes new mandates upon businesses that further expands the federal government’s role in corporate governance.” Quaadman explained that the draft legislation requiring the Securities and Exchange Commission (SEC) to finalize the Dodd-Frank claw back rulemaking within 60 days of the bill’s enactment is “overly complex and prescriptive and may cancel out any potential benefits that may otherwise derive from the implementation of a balanced system, while being overly burdensome for smaller reporting companies.”

Question & Answer

Arbitration

Maloney stated that arbitration clauses are common in brokerage agreements and that some people want to include arbitration clauses directly into company bylaws, preventing shareholders of public companies from bringing class action lawsuits against public companies. Gregg noted that there are several examples of class action lawsuits that have been successful for shareholders and that typically investors can recoup “significantly more” when they do not go through arbitration.

Rep. French Hill (R-Ark.) explained that arbitration is a way to “speed up” the process and that FINRA arbitration often ends in compensation for consumers. Quaadman agreed, adding that arbitration leads to “speedy rewards,” lowers costs, and that there is a significant number of FINRA arbitration cases that are settled before going through the arbitration process.

Rep. Michael San Nicolas (D-Guam) questioned how many frivolous lawsuits could have been avoided if arbitration were in place, noting that arbitration “may not be a bad thing all together” but that it “may just need to be more tilted in balance” for the consumers.

Rep. Sean Casten (D-Ill.) asked if there are conditions where it is appropriate to turn to arbitration, and whether it is important to preserve the choice to enter into arbitration. Gregg responded that if people want to enter into arbitration “that’s fine,” but currently people are forced into a system they know nothing about, and do not know they are agreeing to it until there is a problem, saying transparency is important.

Rep. Bill Foster (D-Ill.) asked why it is important for shareholders to be able to join class action lawsuits. Gregg replied that many people do not understand the process and need help from experts and forensic accountants. Foster asked why it is important for investors to have the right to bring private enforcement action, to which Lubin replied that “regulators can’t be everywhere” and it “takes a village.” Lubin added that often regulatory action does not include restitution, nor at the same scale of what can be recovered in private action.

Executive Compensation

Rep. Cindy Axne (D-Iowa) asked why the process to finalize executive compensation rules has taken so long, to which Coffee replied that the SEC has “gone very slowly” the last couple of years, adding that more weight needs to be placed on claw back rights. Gregg and Lubin agreed that transparency is needed so shareholders know the link between performance and payment. Quaadman argued that the 2015 SEC proposal is not a workable proposition and needs to instead be principles-based.

8-K Trading Gap

Maloney discussed the 8-K Trading Gap Act and some of the reasons why it may take a company four days to file their 8-K, noting that there is no reason why company executives should be able to make trades during this four-day period. Lubin agreed, adding that there is also a debate that the filing time should be shorter, such as two days.

IPOs

In response to questions from Huizenga and Hill on why companies are not going public, Quaadman gave the example of research, as research rules are being written in Europe by way of Markets in Financial Instruments Directive (MiFID) II that will have to be rewritten in 2020. He continued that there are no longer regional IPOs due to disclosure costs and shareholder proposal pressures. Quaadman added that Regulation National Market System (NMS) has also impacted the ability of companies to go public, as well as issues with the Volcker Rule preventing companies from going into the debt and equity markets. Casten asked if the decline in public company listings is due to regulatory burden, to which Lubin replied that while there has been a decrease in IPOs there has been an increase in all other mechanisms a company goes through before going public, which has served investors well.

Insider Trading

Rep. David Scott (D-Ga.) asked how the Newman court case affects the SEC’s ability to effectively police and deter insider trading. Coffee explained that the decision meant prosecutors had to prove there was a known reciprocal benefit, which is an “impossible” burden to put on the prosecution, adding the Himes legislation would solve this problem. Lubin said the bill would help prosecutors bring cases as well as help people trying to correctly comply with the law know what the parameters are. Quaadman noted that while there are concerns with the bill, he agrees with the intent to prohibit insider trading.

Himes asked what changes were necessary to the bill, to which Quaadman explained that there are issues that need to be addressed on the issue of mens rea, as well as possible unintended impacts on 10b-5 plans. Coffee noted the bill does not stand by itself, and while it sets a standard for civil liability for insider trading, there needs to be willful action for it to be criminally prosecuted.

JOBS Act

Rep. Ann Wagner (R-Mo.) asked Quaadman to discuss the JOBS Act of 2012 and how it has helped companies. Quaadman explained that many provisions, including the roadshow, testing the waters, and onramp provisions have greatly helped companies, adding that new provisions considered in the 115th Congress as “JOBS 3.0” would also help, calling them small incremental steps to reverse current trends. Asked about concerns faced by startups today, Quaadman said the biggest issues are proxy advisory firms “running rampant,” disclosure costs, obsolete disclosures, pay versus performance provisions, and auditing issues from the Public Company Accounting Oversight Board (PCAOB). Quaadman said the bills under consideration today would add “significant” requirements and regulatory compliance costs, and could deter companies from going public.

Rep. Warren Davidson (R-Ohio) discussed the accredited investor definition, to which Quaadman replied that last year’s JOBS Act 3.0 modified some of the definitions of accredited investor rules, allowing for certain levels of education, experience and expertise to count rather than solely based on wealth.

For more information on this hearing, please click here.