NASAA President Heath Abshure’s Keynote Address at SIFMA Compliance and Legal Society Annual Meeting

March 19, 2013
Scottsdale, Arizona

Good morning, my name is Heath Abshure.  I am the Arkansas Securities Commissioner, and the President of the North American Securities Administrators Association.   NASAA membership consists of 67 state, provincial, and territorial securities administrators in the 50 states, DC, the U.S. Virgin Islands, Puerto Rico, Canada, and Mexico.  Our primary goal is to advocate and act for the protection of investors, especially those who lack the expertise, experience and resources to protect their own interests.  NASAA’s activities cover a broad spectrum, ranging across regulatory, policy and enforcement issues.    

I want to thank David Prince at Stephens and SIFMA for the invitation to speak to you today.  While NASAA and SIFMA have not always agreed on certain issues, we have worked hard to maintain open lines of communication between our staffs.  We believe this communication is important and we look forward to continuing our dialogue with SIFMA on matters important to investors, regulators, and industry.

Today, I want to talk about NASAA’s legislative agenda for the 113th Congress.  Earlier this month, I held a press conference to announce our legislative priorities.  Our agenda is far-reaching and covers a host of topics from issues related to regulation of investment advisers to increased penalty authority for the SEC.  I will not cover the full agenda in my limited time, but I would encourage you to review the agenda in its entirety on NASAA’s website.

Before I start on our concerns as expressed in the Agenda, I want to emphasize that NASAA understands the important role that broker-dealers play in protecting investors and we want you involved. 

Every securities regulator has an active investor education section that encourages prudent investment. We all understand the necessity of investing to provide for retirement, college education, and the “rainy day.”  However, the typical investor has neither the expertise nor the experience to adequately research a particular investment to determine whether it is suitable, much less analyze his portfolio to determine whether it adequately provides for his needs.  The professional advice of a broker-dealer is absolutely essential to this process.  Certain provisions of the JOBS Act encourage investment between the issuer and the investor without the important role of the broker-dealer as intermediary.  In my opinion, encouraging investors to invest without the benefit of broker-dealer expertise is the equivalent of encouraging people to do their own dental work without the benefit of a dentist. 

Class Action Relief

I would like to start with one issue covered in our agenda; the erosion in investor confidence caused by the lack of civil recovery options for harmed investors.  The virtual elimination of litigation as a dispute resolution option through mandatory arbitration clauses, coupled with increasing procedural and evidentiary burdens, will have profound effects on investors and their confidence in investment products and markets.  Most troubling is that these remedies are decreasing just as the era of crowdfunding and general solicitation in Regulation D, Rule 506 offerings is about to launch.  This presents particular risks to small investors. 

No doubt many of you are familiar with the JOBS Act, a bill that was passed purportedly to make it easier for smaller companies to raise capital.  Last week, Mary Jo White, the nominee for Chairman of the SEC, indicated that JOBS Act rulemaking remains a priority and that the final rules should be adopted soon.  Once that occurs, the number of small investments in small, private companies will greatly increase. 

I want to emphasize that, despite our concerns with crowdfunding and increased use of Rule 506, state securities regulators want to see small businesses get the capital they need to grow.  But, investment follows trust, and the JOBS Act fails to facilitate this investor trust.  It is important that investors understand the risk involved and have the financial ability to absorb attendant losses.  Even where no fraud occurs, small and emerging businesses, by definition, carry extreme risk and are highly illiquid.  It is very difficult for most retail investors to evaluate or price these traits.

Within this risky sector of small business investment, start-up businesses without a track record are extremely speculative and subject to high rates of failure.  If efforts to promote access to investment capital for small businesses are to be successful, investors need to be confident that they are reasonably protected from fraud and undisclosed risk. This means that investors must have access to information about the issuer and, where there is wrongdoing, adequate civil recourse.  This will facilitate investor trust, which is essential to ensure the availability of investment capital. 

By definition, the “crowdfunding” model of capital formation encourages large numbers of investors to make relatively small investments. A single instance of crowdfunding fraud or material undisclosed risks might easily result in damages to a large number of people.  At the same time, the JOBS Act caps both the amount that individuals can invest in crowdfunded securities and the aggregate amount that may be raised in an offering.  The losses in instances of fraud are unlikely to be sufficient to support a private legal action by a single victim. NASAA believes that investors will not trust a marketplace in which they are unable to protect themselves.  Therefore, for crowdfunding to be successful, class action relief must be available to investors who are defrauded in an offering of crowdfunded securities.  

Unfortunately, crowdfunding and the expanded use of Regulation D, Rule 506 is set to launch against a backdrop where investor class action recourse is increasingly limited.  Class action remedies began to be limited in the 1990s, starting with the Private Securities Litigation Reform Act in 1995.  This Act was designed to reduce the number of abusive securities class action matters in federal court by making both substantive and procedural changes.

Within three years of the passage of the Private Securities Litigation Reform Act, the Securities Litigation Uniform Standards Act applied the same reforms to class actions filed in state courts.  It also made the Exchange Act the exclusive remedy for fraud claims involving securities for a majority of cases. 

Then, the Class Action Fairness Act of 2005 further expanded federal jurisdiction over class action lawsuits, therefore contributing to this growing body of law ignoring the rights of the states with regard to class action recourse based on state securities laws and corporate governance laws.

These changes were deemed a necessary response to abusive class actions brought against large publicly traded companies, not small companies. Even at the time of passage, there was no evidence that there was an epidemic of class actions or that there were widespread abuses of private securities class actions.

Our goals are to advocate against further restrictions to class actions, through both legislative means and appellate litigation.  Also, one of NASAA’s legislative priorities is to advocate for amendments to federal law to permit private lawsuits for fraud associated with small offerings.

Arbitration

Alongside these limitations on the use of class actions, arbitration has increasingly become the sole forum available to an aggrieved investor.  Part of investor protection is ensuring civil remedies for investors, and one size does not always fit all when it comes to remedies.  Arbitration doesn’t make sense for a $10,000 investment, much less a $2,000 investment—which is the size contemplated by the crowdfunding provisions in the JOBS Act.  NASAA remains committed to ensuring that arbitration forums and procedures create an even playing field.  But, NASAA also believes that arbitration should not be the sole forum available to aggrieved investors, especially those investing small amounts.  When it comes to addressing disputes that may arise between investors and their broker-dealers, NASAA believes investors should have a choice of arbitration or litigation.  Investors should not be forced into a “take it or leave it” scenario.

Every year thousands of investors file complaints against their stockbrokers, usually through FINRA arbitration because they are bound by pre-dispute arbitration provisions.  Almost every broker-dealer presently includes in their customer agreements a mandatory pre-dispute arbitration provision that forces those investors to submit to FINRA’s arbitration program.  Such clauses have become that much more troubling to NASAA in light of the recent decision in the FINRA enforcement proceeding against Schwab.   This ruling would essentially allow broker-dealers to prohibit participation in class actions against them by their customers.  NASAA’s public statements on this decision reflect our belief that it is wrong on the merits and is bad public policy.  This is especially true given that Section 921 of the Dodd-Frank Act provided the SEC with rulemaking authority to prohibit or impose conditions on the use of mandatory pre-dispute arbitration agreements.  

NASAA will take steps to encourage the SEC to exercise its authority to propose or adopt rules prohibiting or conditioning pre-dispute agreements mandating arbitration.  Aggrieved investors should be able to seek relief in any forum and not be forced into arbitration.  Failure to provide recourse to defrauded investors may have a chilling effect on future investment in these offerings and capital raising efforts generally.  If the SEC is unwilling or unable to take action then we will encourage Congress to pass legislation that would dramatically curb the use of these mandatory provisions. 

Fiduciary Duty

Giving investors appropriate redress for misdeeds is but one way to restore the confidence that they place in their investment professionals.  The other way is to work to align the duty owed to investors with the expectations of those investors.  Most investors cannot distinguish broker-dealers from investment advisers, nor do they understand the different legal standards applicable to either.  The use of titles such as “financial advisor” or “investment counselor” only serve to exacerbate this confusion.  As a result, many investors are unable to make informed decisions as to the best type of financial professional to retain. NASAA has long supported the extension of fiduciary duty to broker-dealers and it remains a key element of our legislative agenda. 

Earlier this month, the SEC released a request for additional information and data in connection with extending a fiduciary duty to broker-dealers.  I believe this is a positive step, but it is only a first step.  NASAA will continue to urge the SEC to exercise its discretion, pursuant to Section 913 of the Dodd-Frank Act, to engage in rulemaking to subject broker-dealers to fiduciary duty.  Retail investors should be provided with the protection that they expect from their investment professionals.  A fiduciary standard for broker-dealers will guarantee that all financial professionals providing investment advice will act in the best interests of their clients.  This will enhance investor confidence in the financial services industry, the products they are being advised to purchase, and the securities markets overall.       

Conclusion

I would like to close by mentioning our efforts to cooperate and reach common ground.  NASAA has been keenly interested in industry efforts to address elder financial abuse and we have, in the past, worked with industry and regulators to publish best practices and other information to help guide firms in dealing with the complex issues surrounding diminished capacity.  We look forward to continuing that dialogue and invite you to engage with us on how we can update that guidance.  Firms will also play a significant role in solving the issues related to crowdfunded securities.  You will likely face some challenges in supervising transactions in these securities and with monitoring what we expect will be a significant increase in offerings made pursuant to Rule 506 once the general solicitation ban is lifted.  These are just a few examples of the types of issues where we are likely to find common ground, and we look forward to working with you on these and many other issues. 

Thank you again for the opportunity to speak to you this morning and please enjoy the rest of the Conference. 

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