(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

Bill to Amend "Fair Fund" Provisions of Sarbanes-Oxley Moves Forward

A bill that would amend the Sarbanes-Oxley Act in an effort to increase the SEC's ability to return funds to injured investors was reported out of the House Capital Markets Subcommittee. The measure has the support of the SEC, as well as Michael Oxley, chairman of the full Financial Services Committee and subcommittee chairman Richard Baker. The Securities Fraud Deterrence and Investor Restitution Act, H.R.2179, would amend the "fair fund" provisions of the Sarbanes-Oxley Act to return money to harmed investors and make them whole to the greatest extent possible. The bill has drawn fire from state securities regulators, however, because they fear that it could have the unintended effect of reducing the success that they have had in bringing enforcement actions against violators of securities laws.

The "fair fund" section of the Sarbanes-Oxley Act authorizes the SEC to add penalty monies collected in its enforcement cases to disgorgement amounts to create funds for the benefit of victims of a securities law violation if the penalty is collected from the same defendant that has been ordered to pay disgorgement. The bill would amend the fair fund section to allow any civil penalty monies obtained in an SEC action to be distributed to victims.

The bill would also add two new sections to the fair fund statute. The first provides that, when a state establishes broker-dealer regulations that differ from or are in addition to the federal securities law requirements as part of an agreement or judgment requiring the firm to pay civil penalties or disgorgement, the amount of penalty or disgorgement must be remitted to the SEC for distribution in accordance with the fair fund provisions. The second change provides that undistributed portions of disgorgement funds established under Sarbanes-Oxley may be used for investor education.

An amendment offered by Rep. Baker was approved by the subcommittee in two parts. The first, which was approved 24-18, reinforces the SEC's authority to set federal securities laws by extending to agreements and settlements certain guidelines recognized in law for state legislators. The second part of the amendment, which was approved by voice vote, allows states to voluntarily contribute any funds recovered from securities violators to an SEC fund designated to return money to the investors who lost it.

Another amendment, offered by Rep. Brad Sherman, and approved by voice vote, would require the SEC to annually review the financial statements of the top 250 companies registered with the Commission. Two similar amendments, both approved by voice vote, express Congress' opinion that the investor education fund established in the 2003 global research analyst settlement should award two separate $5 million grants to focus on improving financial literacy for low-income and minority individuals and for elementary and secondary school students.

In a letter to Chairman Baker, the president of the North American Securities Administrators Association, Inc., Christine A. Bruenn, contended that the legislation would undermine the efforts of state securities regulators by directing the states to remit to the SEC civil penalty and disgorgement monies ordered in a state enforcement action if the action also includes a conduct remedy, such as enhanced supervision of a broker-dealer, that goes beyond federal law. Similarly, New York Attorney General Eliot Spitzer asserted that the Baker amendment would preclude the states from entering into any voluntary agreements with investment banking firms that include any structural reforms to protect individual investors.

In other provisions, H.R.2179 would increase the civil fine provisions, from the current range of $6,500 to $600,000, to a new range of $10,000 to $2 million, per violation. Separately, the bill would authorize the SEC to make nationwide service of trial subpoenas available in the Commission's civil actions filed in federal district court. H.R.2179 also would give the SEC the ability to impose civil money penalties during administrative proceedings while maintaining the right to appeal the administrative decisions in federal court. This power would expand the SEC's current ability to obtain civil money penalties, which can now be done via an administrative proceeding if the party is directly regulated by the SEC, such as a broker-dealer, or through the federal courts if the party is not directly regulated.

Recently, SEC Enforcement Division Director Stephen M. Cutler told the subcommittee that the measure would greatly assist the Commission in preventing, detecting and prosecuting violations and providing recompense to injured investors. Similarly, the bill received strong support from NASD Vice Chairman Mary L. Schapiro, who noted that the changes to the fair fund provisions are important for maximizing recovery to investors.

The bill would give the SEC added ability to access financial records. Currently, account holders receive notification if the SEC seeks their records, unless the Commission has a court order. The federal bank regulators, however, can access records without a court order and without the knowledge of the account holder, and the SEC would gain this same ability under the bill. Under the bill, private parties could voluntarily share information with Commission staff, without violating attorney-client privilege. The bill's sponsors argue that there may be cases, such as when a company hires an outside lawyer to conduct an internal investigation regarding possible lawbreaking, in which the company may wish that this information be shared with the SEC.

There is a risk, however, that a third party involved in private litigation could gain this information by arguing that supplying it to the SEC waived privilege. While the bill does not require the protected or privileged information be supplied to the SEC, it creates the option. The bill also allows more leeway when the Department of Justice wishes to share grand jury information with the SEC. This sharing is currently constrained by Federal Rule of Criminal Procedure 6(e), which has only limited exceptions, and the SEC must demonstrate a "particularized need" for information that is "preliminarily to or in connection with a judicial proceeding." These restrictions have required the SEC to set up separate investigations to duplicate what the Justice Department has found and has burdened private parties with supplying the same information twice.

H.R.2179 would allow the Justice Department to seek court authorization to release to the SEC information within the ambit of SEC jurisdiction in cases where there may have been violations of the federal securities laws. The standard for court approval is lessened from the current "particularized need" to "substantial need in the public interest."

The bill expressly authorizes the SEC to retain private legal counsel to collect debts owed as a result of Commission judgments or orders. Under this provision, private attorneys hired by the Commission would conduct litigation tailored to the collection of disgorgement, including filing contempt proceedings and using state law procedures required to execute on disgorgement judgments. According to Mr. Cutler, the provision would conserve staff resources for major investigatory functions while potentially increasing amounts available to recompense injured investors. Further, local attorneys with expertise in the complexities of state collection laws should provide quicker and more efficient returns.