Thank you, Mr. Chairman. My name is Harry Smith. I am the mayor of the City of Greenwood, Mississippi, and a member of the Board of Directors of the National League of Cities. I am grateful for your invitation to be here this morning and I appreciate the opportunity to discuss the rights and protections of municipalities with regard to securities fraud.
The National League of Cities, which I am representing this morning, is composed of elected Republican, Democratic and Independent leaders of cities of all sizes. It is the largest and oldest organization representing the nation=s cities and towns. I am here today to express strong opposition to S. 1260.
Greenwood is in many ways typical of smaller cities and towns across America in which government is a community effort involving citizens from all walks of life. All told, there are some 35,935 thousand cities and towns in the United States. While some cities have comparatively large budgets and staff, most communities have small populations, few professional staff, and small budgets. 97 percent of the cities and towns in America have populations of less than 25,000; 91 percent have populations of less than 10,000; and 52 percent have populations of less than 1,000. Virtually without exception, cities and towns with populations under 10,000 persons have no full-time professional legal staff or staff with expertise in the nation=s financial markets. As a result, we must rely disproportionately compared to most other investors on outside professionals.
Let me cite one example to illustrate the potential magnitude of the problem. In Mississippi, our securities laws contain a comprehensive anti-fraud structure, including provisions with regard to aiding and abetting - features important to municipalities. We also have a longer statute of limitations provision than current federal law. In August, we learned that at least 22 cities and 12 counties might have been misled with regard to a series of investments. This is a serious issue with consequences for those cities, their employees, and their taxpayers. This appears to be a question of what reliance was made on those professionals who advocated the sale of these securities. It would be equally serious, if there has, in fact, been misrepresentation by underwriters or others to these municipalities, if they were in any way precluded from both seeking justice in the confines of Mississippi's judicial system and if they were unable - through that system - to send a clear message that any kind of aiding or abetting will be dealt with harshly through our traditional remedies.
In Mississippi, the securities fraud statute mirrors that of the SEC=s section 10(b)(5). It has been interpreted by the Mississippi courts as giving private rights of action to investors. However, unlike the relatively short time period alloted in federal courts for the filing of claims related to fraud, our state courts provide a two year statute of limitations from the discovery of a fraud for the filing of a claim. If these cases had to be removed to federal court and tried under the federal law, Mississippi=s ability to protect its investors, including its small governments, would be eliminated. In addition, we have other securities lawsuits that are actually brought under common law fraud claims. These, too, would be eliminated. Surely Mississippi should be able to choose how best to protect its investors.
The most potent protection investors have is the private right of action. To remove that protection could have grave consequences. We oppose taking such a risk; we oppose preemption of traditional state and local rights created to protect our citizens and taxpayers. This bill is inconsistent with Congress= renewed commitment to the preservation of Federalism, and reduces protections for our retirees, employees, and taxpayers.
State and local governments participate in the securities markets both as investors of pension funds and temporary cash balances and as issuers of municipal debt. We are both potential plaintiffs and potential defendants. We, therefore, have a vital interest in a fair litigation system, because we need to preserve well-established investor rights as well as protect themselves from unwarranted and expensive litigation. We, like you, want to ensure that taxpayer funds are protected.
States protect their public funds through the enactment of state investment statutes and state securities laws that are designed to respond to specific identifiable state needs. In addition to the enactment and enforcement of securities regulation, investor protection includes an assurance of meaningful access to the judicial system to provide victims of securities fraud with effective remedies against those who violate securities laws or common law fiduciary responsibilities.
The stock market soared to record levels over the past year, so opportunities for profit abound, not only for investors, but also for those seeking to take advantage of investors. Investments in stock were once thought to be the domain of only the wealthy and institutional investors. Today, according to the NASDAQ stock exchange, 43 percent of American adults own stock. One in three households own stock today, as reported by the North American Securities Administrators Association, compared with one in 17 households in 1980. Many working people who finance their retirement with their own savings and investments have shifted these investments to the stock market from more traditional (and often insured) vehicles.
During the 104th Congress, two major securities bills were passed. The first was the Private Securities Litigation Reform Act of 1995 (PSLRA). Opponents of the PSLRA, including the National League of Cities and other state and local government organizations, consumer and senior citizen groups, labor unions, and others, supported a reduction in "frivolous" lawsuits. However, we were concerned that the new law would be harmful to meritorious cases as well. We believed then, and continue to believe, that the PSLRA did not strike an appropriate balance between the rights of investors and the stated objective of reducing frivolous lawsuits. The PSLRA limits the ability of investors, including state and local governments, to pursue securities claims against wrongdoers in federal courts. It sets formidable hurdles for defrauded investors with respect to pleadings, imposes restrictions on discovery, and contains other harsh provisions. The PSLRA also failed to include more reasonable statutes of limitations and to provide liability for those aiding and abetting fraud -- provisions available in many states and recommended by the SEC. As a result of these and other deficiencies, the bill was vetoed by President Clinton. Because of the time necessary for cases filed since enactment of the PSLRA to work their way through the legal system, we do not yet know how the courts will interpret significant portions of this new law. It is conceivable that there may be few if any federal remedies left.
The second major piece of securities legislation enacted by the 104th Congress was the National Securities Markets Improvement Act of 1996 (NSMIA). This legislation divided the responsibilities for oversight of broker-dealers and investment advisers between the federal and state governments, and entirely removed regulatory responsibility for mutual funds from state purview.
Because of these new statutes and how they may eventually be interpreted, state private rights of action may remain in many cases the only method of obtaining recovery for defrauded investors by permitting liability for aiding and abetting wrongdoing, joint and several liability, and reasonable statutes of limitations for the filing of claims. It is also important to note that many causes of action do not depend on an alleged violation of state or federal securities law, but on state contractual or common law fiduciary violations long recognized as state prerogatives. It is the position of NLC and other state and local government organizations that, in light of the passage of two major securities statutes in the last Congress, neither of which has been definitively interpreted by the courts, enactment of further major alterations to our securities laws is unwarranted and unwise.
Despite the recent enactment of these two major securities laws and the increasing threat to investors both large and small, public and private, proponents of the PSLRA are seeking to extend its restrictive prohibitions to the states by preempting state private rights of action through the promotion of so-called uniform standards, thereby making it more difficult for investors defrauded in securities transactions to recover damages. Each of the two bills introduced in the House (H.R. 1653 and H.R. 1689) and the Senate version of uniform standards legislation (S. 1260) would, to varying degrees, preempt state private rights of action, either individually or through class actions.
The most significant impact of such legislation would be to (1) take away from states the ability to make their own decisions regarding how to carry out their legitimate state powers under the Constitution, and (2) reduce the ability of both individual and institutional investors to recover damages resulting from securities fraud.
Federalism. There is a deep and growing concern among the leadership of state and local governments about federal preemption of historic and essential state and local responsibilities and authority. Federal preemption has the potential to interfere with some of the most fundamental duties of state and local governments.
Traditionally, the enforcement of securities laws has been one of a number of areas in which federal and state governments have shared responsibilities. States enacted protections against financial schemes in the early 1900s. Congress passed federal securities laws in 1933 and 1934 both to complement state laws and to stop abuses that had caused the 1929 stock market crash. This system of "dual sovereignty," recognized by the Supreme Court in Gregory v. Ashcroft, 501 U.S. 452 (1991) and most recently reaffirmed in Printz v. United States, 117 S. Ct. 2365 (June 27, 1997), a decision involving the Brady Act, was clearly envisioned by the framers of the Constitution and has worked well. It has ensured protection for all investors at both the federal and state levels.
This position is also recognized by President Clinton as one of his guiding principles in his consideration of proposed changes to the securities laws. In a letter to Senator Christopher Dodd written just prior to this Subcommittee=s hearing last July, the President underscored his concern for "a thorough respect for the different roles of federal and state legal systems and courts, and of enforcement agencies and private litigants."
In fact, even when the last Congress made sweeping changes to the investor protection laws through the PSLRA and the NSMIA, it wisely left to each state the decision of how best to protect its own citizens under state anti-fraud laws. Many in the current Congress, however, while on the record as favoring "devolution" of responsibilities to the states, would nevertheless infringe on state sovereignty by mandating what types of cases states may allow in their own courts and how their residents and taxpayers will be protected from securities fraud. This represents a drastic departure from the concept of federalism.
The securities litigation preemption legislation now under consideration would dismiss the states' own legislative judgments in an area where states are frequently the leaders. Even where states have identified specific or potential problems associated with securities transactions affecting their citizens, they would be precluded from taking certain steps to deal with these problems. Congress would instead substitute its own determinations for those of every state and local official who is in the forefront in dealing with defrauded individuals or who may themselves have been defrauded as managers of public investments funded by their taxpayers. No variation would be allowed among states; all would operate under an identical and flawed national standard. The Supreme Court expressed its disapproval of such an approach when it clearly stated in New York v. United States, 505 U.S. 144 (1992),
Far-Reaching Effects. Supporters of preemption legislation have also ignored the effect that it would have on the investments of individuals, churches, schools, and charities, as well as of state and local governments, and particularly the almost $1.8 trillion in public pension fund investments. Each of the bills currently under consideration would impose litigation restrictions with regard to covered securities -- that is, nationally traded stocks. Thus, these particular proposals are especially important to public pension funds which, unlike most general governments, are permitted to invest directly in stocks. In a survey conducted by the Public Pension Coordinating Council in 1995, which is the most detailed single source of data on state and local government retirement systems available, the respondent systems indicated that they invest approximately 38.1 percent of their assets in domestic stocks. Thus, about $690 billion in pension funds belonging to state and local government employees is at risk under this legislation.
But it is not only a jurisdiction=s pension funds that are endangered. If a defrauded public pension fund with a defined benefit plan is unable to recover its losses, the general government is legally obligated to make up for those losses. The consequences of such losses will inevitably be felt by all taxpayers. The inability of a public pension fund or a state or local government to pursue legitimate claims and recover damages could lead to higher taxes, the loss of jobs, the inability to provide needed governmental services, severe damage to credit ratings, and a consequent higher cost of borrowing money to fund capital and operating expenses. Particularly hard-hit would be smaller governments, which are often participants in investment pools or state retirement systems.
If we are defrauded, we must join a class action to pursue our claims, because we are unable to afford the expense and burden of individual litigation. Our governments may already be precluded from recovery in federal court; with the passage of proposed preemption legislation and its limitations on class actions, we could find it impossible to seek relief in state court as well. The failure of state and local governments to recover damages can result in our mutual constituents -- our taxpayers and citizens -- being penalized for the wrongdoing of others.
Finally, for defrauded individuals who invest their savings directly in the stock market and whose avenues for recovery have been significantly foreclosed by the PSLRA, the new limitations on their participation in a class action in state court may be a devastating impediment. Surely this is not what the drafters or supporters of preemption legislation intend in their pursuit of the limitation of liability for wrongdoers.
Proponents of preemption legislation contend that it is needed because the PSLRA is somehow being evaded by plaintiffs who are filing class actions in state courts due to the difficulty of bringing suit in federal court. However, new figures on class actions filed during the first five months of 1997 contradict previous figures repeatedly cited as evidence of this migration and undermine the primary argument for preemption of state private rights of action. The new figures, published by the National Economics Research Associates, Inc. (NERA), show that state class actions are not only down from 1996 levels (following enactment of the PSLRA), but are below the number filed in each of the two years preceding the PSLRA's passage. Between January and April 1997, there were only 19 securities class actions filed in state courts, compared with 28 in 1994 and 23 in 1995 during the same period.
The NERA report states that the trend represented by 1996 figures was found to be "transient." Yet last year's few filings -- a minuscule portion of the roughly 15 million civil cases filed in state courts each year -- are offered as the main justification for another attempt at major securities law reform. The lack of quantitative evidence supporting this position raises the concern that there may be some other motivation underlying the proponents= efforts in this area. We fear that this may be an attempt to further widen the shield from liability that was originally created by the PSLRA.
We are well aware that while the size and sophistication of the global securities markets are accelerating, the same is not true of the Securities and Exchange Commission (SEC). The ability of the SEC to protect municipalities and their pension funds is subject to the agency=s capacity and to federal law. As the agency=s resources have been reduced relative to the growth in the world=s markets, and as federal legislation has reduced its authority, the importance of an alternate avenue of legal redress to prevent abuse becomes even more important.
The bill before this committee goes beyond problem areas identified by the SEC, such as institutional investors not taking advantage of lead plaintiff provision and companies not providing more forward-looking information. Clearly the PSLRA is still in its infancy, with many provisions not yet interpreted by courts. As SEC Chairman Arthur Levitt has testified, there is not enough experience with it for the SEC to measure its success or effectiveness.
78 percent of cases (43 out of 55) involving security class action complaints have been brought in California. All except 7 percent have been suits against companies in states where they are either incorporated or have their principal place of business. I would submit, if that is a problem for California and its legal protection system, then the solution is in Sacramento, not in Washington, D.C. Chairman Levitt stated that he was unwilling to testify that all federal statutes are better than all state statutes; rather, he told your colleagues in the House he would like to see cases work through the courts before taking action regarding state cases. The Chairman was reluctant to say that either state or federal law should prevail, but rather said that we should eliminate redundancy, something state regulators are already moving toward.
Mr. Chairman, NLC urges Congress to be wary of legislation that would preempt states in the exercise of a traditional and necessary state function. There is no final judicial interpretation regarding any of the key provisions of the PSLRA. As we have testified, recent figures explode the myth that class action suits are flooding state courts. Tampering with state anti-fraud authority would place at risk the retirement savings and investments of millions of Americans. Now is the time to strengthen, not weaken, state and federal remedies against securities fraud.
More fundamentally, Congress should respect the principles of federalism and the Constitutional prerogatives reserved to the states by not interfering with the ability of states to protect their public coffers and their citizens through their own securities laws. We urge Congress to adopt the cautious approach taken by the SEC in the conclusion to its April 1997 "Report to the President and the Congress on the First Year of Practice Under the Private Securities Litigation Reform Act of 1995," as well as in Chairman Levitt=s testimony in the House last week. The SEC's position that it is premature to make additional changes when the full effects of the PSLRA are yet to be determined is the most prudent course.
We appreciate your interest in this matter which is of particular importance to state and local
governments and their citizens. On behalf of NLC, thank you again for the opportunity to testify
before the Subcommittee today.
--similar to one House bill -- mandates that class actions for securities fraud claims must be brought in fed court and therefore operate under (probably) more restrictive fed law
-- supposedly doesn=t affect individual suits filed in state courts, but this bill says a class action
is: any single lawsuit, or any group of lawsuits filed in or pending in the same court alleging
common questions of law or fact, and defines a class as (1) damages sought on behalf of more
than 25 persons (so that would mean more than 25 individual suits arising from same claim), (2)
one or more named parties seeking to recover damages on behalf of themselves and other
unnamed parties; OR (3) one or more parties seeking to recover did not personally authorize the
filing of the suit.
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