Senate Banking, Housing and Urban Affairs Committee

Subcommittee on Securities



Prepared Testimony of Mr. Keith Paul Bishop
Commissioner
California Department of Corporations

Oversight Hearing on Securities Litigation Abuses
10:00 a.m., July 24, 1997


I. Introduction.

As the California Commissioner of Corporations, I am charged with the oversight of my state's laws regulating the offer and sale of securities and the licensing of broker-dealers, agents and investment advisers. In California, we recognize that efficient capital markets are the keys to business growth and economic prosperity. Under the leadership of Governor Pete Wilson, the Department of Corporations is sponsoring a number of initiatives to eliminate unnecessary burdens on capital formation on California businesses by making California's regulation of securities more consistent with federal standards. States do have a role in securities regulation and enforcement. Consistent with efficient capital markets, this role should complement, not duplicate, federal regulation. I have sponsored and supported legislative efforts in California to enhance consistency in securities regulation and I support similar efforts at the federal level insofar as they recognize and retain the role of state regulation and enforcement. It is not too soon to eliminate unnecessary costs imposed on business growth by the current system of inconsistent pleading, discovery and other procedural standards governing private securities litigation.

II. Historic Allocations of Jurisdiction.

Regulation of securities in this country started with the states. It was not until after the stock market crash of 1929 that Congress enacted the first comprehensive federal securities regulation law, the Securities Act of 1933 (the "1933 Act"). This law primarily governed the initial offerings of securities by issuers. A year later, Congress passed the Securities Exchange Act of 1934 (the "1934 Act") which regulates the secondary trading of securities. Both of these laws imposed (either directly or implicitly) liability for material misstatements and omissions.

The 1933 Act and the 1934 Act take inconsistent approaches with respect to the jurisdiction of federal and state courts. Both acts give the U.S. district courts jurisdiction over civil and criminal matters. State courts have been granted concurrent jurisdiction over private actions under the 1933 Act. The 1933 Act bans removal of state court actions to federal court. Under the 1934 Act, however, the United States district courts have exclusive jurisdiction. The legislative history is far from clear on the purpose of exclusive jurisdiction under the 1934 Act. Presumably, Congress wanted to achieve greater uniformity in the interpretation and application of the 1934 Act. Thus, precedent dating from the 1930's exists for vesting exclusive jurisdiction over certain types of actions in the federal courts.

III. Development of National and Global Securities Markets Since the 1930's.

Dramatic changes have occurred in the nation's securities markets since Congress enacted the original federal securities laws in the 1930's. In the 1970's, for example, advances in communications technologies allowed for the development of a national automated over-the-counter trading system in the form of the NASDAQ. The NASDAQ system in many ways exemplifies the borderless quality of today's national markets because trading is not centralized at any specific geographic location. At the same time, exchange trading has grown in both the number of issuers and trading volume. As a result, most companies that "go public" today find that their securities are being traded on a national and even international basis.

It is important to note that companies cannot control where their securities are traded after an initial public offering. Thus, a company's securities may be offered and sold in the secondary market in jurisdictions in which the issuer is not incorporated and has no physical presence or business activities. As a result, companies with publicly-traded securities can not choose to avoid jurisdictions which present unreasonable litigation costs. Thus, a single state can impose the risks and costs of its peculiar litigation system on all national issuers.

IV. Federal and State Regulatory Responses to Change.

A. The Private Securities Litigation Reform Act of 1995.

In 1995, Congress overrode President Clinton's veto and adopted the Private Securities Litigation Reform Act of 1995 (the "1995 Act"). This legislation grew out of the Congress' desire to curb abusive lawsuits and coercive settlements that had become routine whenever an issuer's stock dropped significantly. Because these lawsuits tended to target high technology companies, California was particularly hurt by these abuses.

By altering the procedural rules governing private, class action litigation under both the 1933 Act and 1934 Act, Congress acted decisively to reduce the number of frivolous lawsuits and to place the control of valid litigation in the hands of shareholders who had significant stakes in the companies being sued.

B. National Securities Markets Improvement Act of 1996.

In 1996, the Congress passed and the President signed the National Securities Markets Improvement Act of 1996 (the "NSMIA"). This legislation reallocated regulatory authority between the federal government and the states with the goal of reducing overlapping regulatory requirements and simplifying the requirements that apply to participants in the U.S. securities markets.

Until this time, the states and the federal government had overlapping jurisdictions. Participants in the markets had to comply with multiple sets of laws. This increased costs, loaded burdens on the formation of capital, retarded economic growth without providing corresponding benefits to either shareholders or the general public.

The NSMIA preempted state authority to impose registration or qualification requirements on "covered securities" - principally securities issued by nationally traded companies. The law left intact state authority to enforce antifraud statutes. Further, the states could continue to impose registration and qualification standards on issuers of non-covered securities.

C. California - SB 1205 and AB 721 - Models for Complementary, Consistent and Competitive State Regulation.

Because I recognized the significant efficiencies associated with complementary and consistent state securities regulation, the Department of Corporations wrote and sponsored legislation to bring California in line with the federal full disclosure standard with respect to the registration of securities. This bill, SB 1205 (McPherson), is currently pending in the California Legislature.

We also recognized the need to acknowledge the preemption effected by the enactment of the NSMIA. Accordingly, the Department of Corporations is sponsoring conforming legislation at the state level, AB 721 (Firestone). This legislation is also pending before the California Legislature.

In conforming California law to the NSMIA, I believe that Congress should reaffirm the continued viability of the Section 3(a)(10) exemption to federal regulation under the 1933 Act. California businesses have had a long history of successfully utilizing this exemption to avoid duplicative regulatory review at the state and federal levels. States have exerted positive competitive pressure for over half a century by offering this alternative to federal regulation.

Both of these bills represent an approach to securities regulation which balances the benefits of local regulation and enforcement with the need for efficient national markets. California has an important role to play in both registering and policing the securities markets. This does not mean, however, that it must impose inconsistent and burdensome requirements on either capital formation or national markets.

V. Need For Further Reform.

A. The Need to Act Now.

I strongly disagree with the position of the United States Securities and Exchange Commission and Mark Griffen, the current president of the North American Securities Administrators Association, Inc., that it is too early to consider and make further changes with respect to the 1995 Act. While I acknowledge that it may be too early to count all of the effects of the 1995 Act, it is not too early to conclude that the securities of many issuers trade in what is quintessentially a national securities market. For these national issuers and their stockholders, the litigation standards should be consistent. Consistent standards is a matter of both common sense and fairness.

Uncertainty and risk create economic costs for companies. Under the present system, an issuer can not choose to avoid jurisdictions that impose unreasonably high private litigation risks. Thus, the issuer's capital formation costs must reflect the risks (costs) of all state private litigation standards. Savvy investors will take into account these costs. For example, a California investor may invest in a California business only to find that the business is forced to litigate a securities claim under another state's laws. California, moreover, can not prevent this situation by changing its own laws.

It cannot be denied that the current system favors forum shopping on the part of potential plaintiffs. It also cannot be denied that the plaintiffs' bar will continue to exert pressure on state legislatures and voters to tilt the playing field in their favor. In California, this was illustrated by the tremendously expensive electoral fight over Proposition 211 which our voters defeated overwhelmingly in 1996. Failure to act to impose uniform standards will necessarily result in further local efforts to undermine the salutary purposes of the 1995 Act. Congress should put an end to this very expensive "race to the bottom" in terms of procedural safeguards.

Inconsistent standards also frustrate the intent of Congress to improve the quality and quantity of forward-looking disclosures. The Securities and Exchange Commission has found that these types of disclosures have not improved following the enactment of the 1995 Act. No matter how safe the federal harbor is, it affords little protection when companies can be sued in state courts under different standards for their forward-looking disclosures.

Over the years, California and other states have strongly defended their authority to regulate securities under our federal system of government. California believes in the federal system and the primary role of the states within that system. However, California does not believe that federal standards are improper when dealing with truly national markets. California businesses, their stockholders and their employees are all hurt by inordinate burdens on national markets. Our businesses must compete in a world market and they will be disadvantaged if they must continue to contend with 51 or more litigation standards.

B. Need to Protect State Enforcement Authority.

As the Commissioner, my Department oversees the issuance of securities, but unlike other state regulators in California, this Department has its own enforcement authority. The Department is able to seek administrative and civil remedies for violations of California law. I believe that this authority is important to protecting California investors. Therefore, I would oppose any attempt to infringe on California's authority to pursue violators of its laws.

In moving to consistent national standards, Congress should support:

VII. Conclusion.

The United States capital markets represent the strength and future of the American economy. It is our duty as state and federal officials to take steps to strengthen and protect these markets. Passage of litigation reform that creates a national standard closes a loophole that currently defeats the purposes of the 1995 Act and the NSMIA. Prompt action by Congress and the President is needed to preserve the competitiveness and integrity of the nation's capital markets.




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