[House Hearing, 116 Congress]
[From the U.S. Government Publishing Office]
INSIDER TRADING AND STOCK OPTION
GRANTS: AN EXAMINATION OF CORPORATE
INTEGRITY IN THE COVID-19 PANDEMIC
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON INVESTOR PROTECTION,
ENTREPRENEURSHIP, AND CAPITAL MARKETS
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED SIXTEENTH CONGRESS
SECOND SESSION
__________
SEPTEMBER 17, 2020
__________
Printed for the use of the Committee on Financial Services
Serial No. 116-110
HOUSE COMMITTEE ON FINANCIAL SERVICES
MAXINE WATERS, California, Chairwoman
CAROLYN B. MALONEY, New York PATRICK McHENRY, North Carolina,
NYDIA M. VELAZQUEZ, New York Ranking Member
BRAD SHERMAN, California ANN WAGNER, Missouri
GREGORY W. MEEKS, New York FRANK D. LUCAS, Oklahoma
WM. LACY CLAY, Missouri BILL POSEY, Florida
DAVID SCOTT, Georgia BLAINE LUETKEMEYER, Missouri
AL GREEN, Texas BILL HUIZENGA, Michigan
EMANUEL CLEAVER, Missouri STEVE STIVERS, Ohio
ED PERLMUTTER, Colorado ANDY BARR, Kentucky
JIM A. HIMES, Connecticut SCOTT TIPTON, Colorado
BILL FOSTER, Illinois ROGER WILLIAMS, Texas
JOYCE BEATTY, Ohio FRENCH HILL, Arkansas
DENNY HECK, Washington TOM EMMER, Minnesota
JUAN VARGAS, California LEE M. ZELDIN, New York
JOSH GOTTHEIMER, New Jersey BARRY LOUDERMILK, Georgia
VICENTE GONZALEZ, Texas ALEXANDER X. MOONEY, West Virginia
AL LAWSON, Florida WARREN DAVIDSON, Ohio
MICHAEL SAN NICOLAS, Guam TED BUDD, North Carolina
RASHIDA TLAIB, Michigan DAVID KUSTOFF, Tennessee
KATIE PORTER, California TREY HOLLINGSWORTH, Indiana
CINDY AXNE, Iowa ANTHONY GONZALEZ, Ohio
SEAN CASTEN, Illinois JOHN ROSE, Tennessee
AYANNA PRESSLEY, Massachusetts BRYAN STEIL, Wisconsin
BEN McADAMS, Utah LANCE GOODEN, Texas
ALEXANDRIA OCASIO-CORTEZ, New York DENVER RIGGLEMAN, Virginia
JENNIFER WEXTON, Virginia WILLIAM TIMMONS, South Carolina
STEPHEN F. LYNCH, Massachusetts VAN TAYLOR, Texas
TULSI GABBARD, Hawaii
ALMA ADAMS, North Carolina
MADELEINE DEAN, Pennsylvania
JESUS ``CHUY'' GARCIA, Illinois
SYLVIA GARCIA, Texas
DEAN PHILLIPS, Minnesota
Charla Ouertatani, Staff Director
Subcommittee on Investor Protection, Entrepreneurship,
and Capital Markets
BRAD SHERMAN, California, Chairman
CAROLYN B. MALONEY, New York, BILL HUIZENGA, Michigan, Ranking
DAVID SCOTT, Georgia Member
JIM A. HIMES, Connecticut STEVE STIVERS, Ohio
BILL FOSTER, Illinois ANN WAGNER, Missouri
GREGORY W. MEEKS, New York FRENCH HILL, Arkansas
JUAN VARGAS, California TOM EMMER, Minnesota
JOSH GOTTHEIMER. New Jersey ALEXANDER X. MOONEY, West Virginia
VICENTE GONZALEZ, Texas WARREN DAVIDSON, Ohio
MICHAEL SAN NICOLAS, Guam TREY HOLLINGSWORTH, Indiana, Vice
KATIE PORTER, California Ranking Member
CINDY AXNE, Iowa ANTHONY GONZALEZ, Ohio
SEAN CASTEN, Illinois BRYAN STEIL, Wisconsin
ALEXANDRIA OCASIO-CORTEZ, New York
C O N T E N T S
----------
Page
Hearing held on:
September 17, 2020........................................... 1
Appendix:
September 17, 2020........................................... 35
WITNESSES
Thursday, September 17, 2020
Claypool, Rick, Research Director, Office of the President,
Public Citizen................................................. 5
Fisch, Jill E., Saul A. Fox Distinguished Professor of Business
Law, and Co-Director, Penn Institute for Law & Economics,
University of Pennsylvania Law School.......................... 7
Frenkel, Jacob S., Chair, Government Investigations and
Securities Enforcement Practice, Dickinson Wright.............. 9
Martin, Granville, Senior Vice President and General Counsel,
Society for Corporate Governance............................... 10
APPENDIX
Prepared statements:
Claypool, Rick............................................... 36
Fisch, Jill.................................................. 59
Frenkel, Jacob S............................................. 64
Martin, Granville............................................ 87
Additional Material Submitted for the Record
Sherman, Hon. Brad:
Letter from SEC Chair Clayton, dated September 14, 2020...... 94
Huizenga, Hon. Bill:
Letter from SEC Chair Clayton, dated September 14, 2020...... 94
Reuters article entitled, ``U.S. SEC enforcement activity
hits second-highest level ever in 2019''................... 97
INSIDER TRADING AND STOCK OPTION
GRANTS: AN EXAMINATION OF CORPORATE
INTEGRITY IN THE COVID-19 PANDEMIC
----------
Thursday, September 17, 2020
U.S. House of Representatives,
Subcommittee on Investor Protection,
Entrepreneurship, and Capital Markets,
Committee on Financial Services,
Washington, D.C.
The subcommittee met, pursuant to notice, at 12:31 p.m.,
via Webex, Hon. Brad Sherman [chairman of the subcommittee]
presiding.
Members present: Representatives Sherman, Maloney, Himes,
Foster, Meeks, Vargas, Gottheimer, Porter, Axne, Casten,
Ocasio-Cortez; Huizenga, Wagner, Hill, and Gonzalez of Ohio.
Ex officio present: Representative McHenry.
Chairman Sherman. The Subcommittee on Investor Protection,
Entrepreneurship, and Capital Markets will come to order.
Without objection, the Chair is authorized to declare a
recess of the subcommittee at any time.
Also, without objection, members of the full Financial
Services Committee who are not members of this subcommittee are
authorized to participate in today's hearing.
Members are reminded to keep their video function open at
all times, even when they are not being recognized by the
Chair. Members are also reminded that they are responsible for
muting and unmuting themselves, and to mute themselves after
they are finished speaking.
Consistent with the regulations accompanying H. Res. 965,
the staff will only mute Members and witnesses as appropriate,
when not being recognized by the Chair, in order to avoid
inadvertent background noise. Members are reminded that all
House rules relating to order and decorum apply to this remote
hearing.
Today's hearing is entitled, ``Insider Trading and Stock
Option Grants: An Examination of Corporate Integrity in the
COVID-19 Pandemic.''
We know that we have votes on the Floor, but we will not
have any further delays of this hearing in order to allow
Members to vote. Rather, Members should go vote and return, and
while we all have our part of the alphabet to vote in, I am
sure there can be some accommodation made, so that if it is
your turn to ask questions, you can vote with others not of
your same alphabetic characterization. And when I am voting, I
believe Mr. Meeks has agreed to serve as Chair until my return.
I will now recognize myself for 5 minutes for an opening
statement.
Our capital market system is unique in history. Up until
about 150 years ago, every business enterprise was made up of
people who knew each other, were family members, who had
personal trust, and a business could only be as large as a
group of people could finance and put together, and investment
opportunities were limited to those that you happened to know.
You wouldn't trust your money with some enterprise of
strangers and, of course, you didn't have liquidity since you
could sell your investment pretty much only to somebody else
who knew those who were in the syndicate.
And so at that point, people could rely on personal trust.
Today, investors turn their money over to anonymous insiders,
corporate boards, and executives whom they have never met, and
they know that the insiders have far more information,
attention, and power.
So, they don't have the bonds of personal trust. They rely
on the law to make sure that the insiders are treating the
investment fairly. [Inaudible] turn their money over
[inaudible].
I will continue. We had a little technical problem there.
We now apply that system to the COVID pandemic in which
nearly 200,000 Americans have lost their lives, and in which
many firms affected by this pandemic are having sudden
increases or decreases in their value.
For many pharmaceutical firms, for example, even the
suggestion of involvement in a Federal program can cause shares
to shoot up in value.
Following this sort of announcement, Kodak, Novavax, and
Vaxart each saw their stock prices rise by over 400 percent.
With this trend in mind, the SEC has reminded companies that in
this pandemic, they should not only abide by the law, but
practice, ``good corporate hygiene.''
SEC Chair Clayton has reiterated these views in a recent
letter regarding today's hearing, which will I submit for the
record, and it will be made a part of the record, without
objection.
But admonishments are not laws and regulations.
Admonishments will not deter the truly greedy, and so we have
to design our laws and regulations to govern those who cannot
be governed by mere admonishments.
For example, while taxpayers have invested $3.1 billion in
Federal contracts with Novavax and Moderna to develop vaccines,
since April, executives of these firms have sold over $60
million of their company stock. We need to know that they were
not taking advantage of any inside information, that perhaps
their stock had gone up too high, given the realistic
possibilities.
Of greater concern is suspicious activity involving Kodak
with the announcement of a $765 million government loan that
raised insider trader concerns. In particular, we have a
concern there on stock options and their grant dates when all
equity compensation to insiders needs to be approved by
shareholders.
When shareholders approve a plan which says that stock
options will be granted with a stock option exercise price
equal to fair market value on option grant date, they believe
that executives who get these stock options will live by that.
If, instead, the ``fair market value'' doesn't reflect
material information, insider information that is going to be
announced the next day or the next week, then shareholders have
been duped into approving equity compensation that does not
reflect real fair market value.
I want to thank the insiders at Kodak who have added insult
to injury. First, they granted stock options at what they knew
to be an unfairly low price. Then, they spent a lot of
shareholder money on a corporate law firm to tell them it was
all legal.
That memo tells us we have to change the law, because if
any major firm can say this is legal, it shouldn't be. And so,
we have to deal with the issues of what is called, ``spring-
loading,'' where shareholders approve a compensation plan based
on fair market value.
It has to be fair market value where the market has
knowledge of the material transactions that the insiders know
about.
I look forward to exploring this with our witnesses, I now
recognize the ranking member of the subcommittee, Mr. Huizenga,
for 4 minutes for his opening statement.
Mr. Huizenga. Thank you, Mr. Chairman.
It has famously been said that the definition of insanity
is doing the same thing over and over again, and expecting
different results. So, here we are once again holding a hearing
on an issue on which we have already held a hearing.
Additionally, three of the bills attached to this hearing
have not only had a hearing; they have been passed by the House
of Representatives. So I ask the committee, why are we spending
precious time and resources on bills that have already passed
the House of Representatives 9 months ago? Just because we keep
having hearings on bills that have already passed doesn't mean
that the Senate is going to take them up.
Now, don't get me wrong. Insider trading is not only wrong,
it is illegal, and not only does it hurt the integrity of our
capital markets but it also hurts our Main Street investors as
well as Mr. and Mrs. 401K.
And yes, we also agree that insider trading should be and
must be punished to the fullest extent of the law.
However, this subcommittee should not be used as a name and
shame game for companies for wrongdoing that has been perceived
to have happened. And yes, the facts surrounding one company at
first certainly appear to be suspicious and need to be fully
investigated.
But that is not our job. The Securities and Exchange
Commission is tasked with ensuring market integrity, and under
the Securities Exchange Act of 1934, the SEC already has the
power to bring enforcement actions in instances of insider
trading.
In fact, during Fiscal Year 2019, the Commission brought
862 enforcement actions to hold individual issuers, financial
institutions, and others accountable, sending a clear message
to market participants.
Last year's results speak for themselves: 862 enforcement
actions obtained judgments and orders totaling more than $4.3
billion in disgorgement and penalties, obtained nearly 600 bars
or suspensions against market participants, suspended trading
in the securities of 271 issuers, and returned nearly $1.2
billion to harmed investors.
So instead of playing judge, jury, and executioner in the
court of public opinion, this committee should be focused on
the bipartisan solutions that support job creators of all
sizes, particularly our hard-hit small businesses.
These proposals would strengthen broader access to capital,
reduce regulatory costs and burdens, and improve and expand
access for investors to better put their money to work and
create more investment opportunities for everyday Main Street
investors.
But I am not just going to curse the political darkness. I
am going to try to light a policy candle here, and here is a
partial list of what we should be discussing and working on
today.
H.R. 4860, the Crowdfunding Amendments Act, introduced by
the ranking member. We have my legislation, H.R. 609, the Small
Business Mergers, Acquisitions, Sales, and Brokers
Simplification Act, something we have dealt with now for 4
Congresses in a row.
H.R. 1909, the Helping Angels Lead Our Startups (HALOS)
Act, by Representative Chabot of the Small Business Committee.
H.R. 2899, the Main Street Growth Act, introduced by
Representative Emmer. Representative Loudermilk's H.R. 3987,
the Alleviating Stress Test Burdens to Help Investors Act. H.R.
4076, the Modernizing Disclosures for Investors Act, introduced
by the vice ranking member, Representative Wagner.
Another one of my bills, H.R. 2919, the Improving
Investment Research for Small and Emerging Issuers Act.
Representative Steil has one, H.R. 4918, the Helping Startups
Continue to Grow Act. And H.R. 7834, the Regulation A+
Improvement Act, introduced by the subcommittee vice ranking
member, Representative Hollingsworth.
I could go on and on. But the list is, as you can see,
exhaustive, and we have much more to do. But instead of holding
hearings on legislation that the House has already acted on,
let us move forward on bipartisan solutions that deliver the
results the American people deserve from the Financial Services
Committee.
We know that there are problems. We need to address those
problems. This isn't going to do it, unfortunately.
Chairman Sherman. I would point out that one part of this
hearing is on my bill to deal with spring-loading, which has
not been considered by this committee, let alone the full
House, and which bans a practice that I think we will discover
is both wrongful and, unfortunately, legal.
And so, we do have a strong purpose to have this
subcommittee hearing.
I now recognize the ranking member of the full Financial
Services Committee, the gentleman from North Carolina, Mr.
McHenry, for one minute.
Mr. McHenry. Look, insider trading is wrong. We can all
agree on that. The SEC, I think we can all agree, is doing a
really good job in pursuing bad actors.
As my friend, Bill Huizenga, just said, we should be
spending time on identifying solutions that strengthen our
economy, strengthen our economic recovery, and help our workers
come back safely to the workforce after the virus, after we get
testing and treatment going.
And today, I introduce a bill to do just that, H.R. 8280,
the Gig Worker Equity Compensation Act. Today, an increasing
share of our workforce does not want to be bound by traditional
constraints such as an office or set hours or traditional
employer/employee relationships.
These gig workers are critical in our technology-driven
world. My bill allows gig workers such as rideshare drivers or
food delivery couriers to share in the same economic benefits,
the upside potential of owning the businesses they are helping
to improve.
So today's hearing should be focused on that type of
solution, not just a rear-facing set of issues in an election
year.
Thanks so much.
Chairman Sherman. I will point out that spring-loading is
legal until this committee makes it illegal, and it is just as
wrong as the--
Mr. McHenry. Regular order, Mr. Chairman. If you wish to
debate, the Chair can debate. But you should not opine about
everyone else's opinion. That is not in good form for the
Chair.
Chairman Sherman. You were not recognized, but you did make
your point clear. But when people question whether this is a
legitimate hearing, it is appropriate to spend 10 or 20 seconds
responding.
Today, we welcome the testimony of Mr. Rick Claypool, Dr.
Jill Fisch, Mr. Jacob Frenkel, and Mr. Granville Martin.
First, Mr. Claypool is a research director for the Public
Citizen's president's office, where he focuses on corporate
crime and wrongdoing and the ways in which corporate power
distorts our democracy.
Second, Dr. Fisch is the Saul A. Fox Distinguished
Professor of Business Law, and co-director of the Institute of
Law and Economics at the University of Pennsylvania Law School.
Third, Mr. Frenkel is Chair of the Government
Investigations and Securities Enforcement Practice at Dickinson
Wright. He also previously served as Senior Counsel for the
SEC's Division of Enforcement.
And finally, Mr. Martin is senior vice president and
general counsel for the Society for Corporate Governance, where
he leads the Society's efforts related to corporate governance,
securities laws, and regulations.
Witnesses are reminded that your oral testimony will be
limited to 5 minutes. A chime will go off at the end of your
time, and I would ask you to respect our rules here by wrapping
up your oral testimony. And without objection, your written
statements will be made a part of the record.
I now recognize our first witness, Mr. Claypool.
STATEMENT OF RICK CLAYPOOL, RESEARCH DIRECTOR, OFFICE OF THE
PRESIDENT, PUBLIC CITIZEN
Mr. Claypool. Thank you.
Chairman Sherman, Ranking Member Huizenga, and members of
the subcommittee, on behalf of more than 500,000 members and
supporters of Public Citizen, many of whom are investors and
who, like all Americans, are hopeful for the timely development
of safe and affordable COVID-19 treatments, welcome this probe
into insider trading during the pandemic.
The reported events are concerning. Chair Sherman described
the Kodak concerns well. Additionally, Moderna Therapeutics
announced that all 45 participants in the first phase of its
COVID-19 trial, who received its vaccine, developed some
antibodies.
This is good news, good news that pushed up the company's
stock price 30 percent to an all-time high of $87. Prior to the
announcement, several executives modified existing or adopted
new 10b5-1 plans. In the days following the announcement,
Moderna's CEO, other executives, and funds controlled by the
board sold about $90 million worth of company shares.
Now, remember, it is taxpayer money funding 100 percent of
this work to develop a COVID-19 vaccine, all of it.
A study published by a coalition that Public Citizen helps
lead found that stock market value for the 8 biotech companies
in the S&P 500 grew by $130 billion between January and August,
and executives and insiders from just 3 of these companies--
Moderna, Inovio, and Vaxart--sold at least $370 million in
company stocks, inflated by news of government awards and trial
results.
Meanwhile, NPR is reporting that the number of SEC insider
trading enforcement actions has plummeted to its lowest point
in decades. Public Citizen research has documented declines in
corporate and white-collar crime enforcement at the SEC and
across the Federal Government.
If the agency is following the Trump Administration's
orders to stand down, as numerous government-wide policies such
as a May Executive Order and subsequent August memo direct,
then that alone deserves a hearing.
As to legislation, we look forward to a full House passage
of Representative Cynthia Axne's bill requiring the SEC and the
CFPB to provide monthly reports on consumer and investor
protection activities.
Ideally, the SEC will want to report a significant
enforcement increase against opportunistic insiders.
We applaud the House for approving the Public Citizen-
endorsed insider trading reform bill authored by Representative
Jim Himes, establishing a clear law against illegal trading,
that will serve prosecutors well.
We also applaud passage of the 8-K Trading Gap bill
authored by Representative Carolyn Maloney, and the 10b5-1
trading plan authored by Chairwoman Waters.
One particularly promising deterrent is compensation
deferral mechanisms that requires recipients of Coronavirus
Aid, Relief, and Economic Security (CARES) Act aid to place a
significant percent of senior compensation in a collective
pool.
Should a corporation later be found to misuse CARES Act aid
or aid from a successor law, or engage in any other misconduct
that results in fines, then the pool of senior managers'
deferred pay would be used to fund the funds.
Such a concept already exists in separate bills sponsored
by Representatives Tulsi Gabbard and Katie Porter.
I think it is crucial for Congress to condition the
trillions in Federal aid, purportedly with the intention of
helping workers, so that it is not diverted into the pockets of
pandemic profiteers.
We applaud this committee's contributions to the Health and
Economic Recovery Omnibus Emergency Solutions (HEROES) Act, and
look forward to working with you as you fashion the next
necessary round of recovery and stimulus legislation.
I welcome your questions, and you may draw on Public
Citizen issue experts with written responses where relevant.
[The prepared statement of Mr. Claypool can be found on
page 36 of the appendix.]
Chairman Sherman. The Chair is amazed. This may be the
first time in decades that a witness has concluded in well less
than 5 minutes. The witness did not choose to yield his
remaining time to me and, accordingly, I will now recognize Dr.
Fisch.
STATEMENT OF JILL E. FISCH, SAUL A. FOX DISTINGUISHED PROFESSOR
OF BUSINESS LAW, AND CO-DIRECTOR, PENN INSTITUTE FOR LAW &
ECONOMICS, UNIVERSITY OF PENNSYLVANIA LAW SCHOOL
Ms. Fisch. Chairman Sherman, Ranking Member Huizenga, and
members of the subcommittee, it is an honor to participate in
today's hearing.
Thank you to Chairman Sherman for the kind introduction.
Just a point of clarification, I am just a lowly law professor,
I am not a doctor, but thank you for the promotion.
[laughter]
But I want to take just a few minutes to put the reported
events to which Chairman Sherman and Rick Claypool referred in
a little bit of context.
In the past 6 months, as we all know, the capital markets
have experienced unprecedented levels of volatility and trading
activity.
I know SEC Chairman Jay Clayton has provided this
subcommittee in earlier testimony with data on both the high
levels of trades and the incredible price swings that we have
seen, not just in pharmaceutical companies but across a range
of industries that have been affected by the pandemic, and
these fluctuations, obviously, create the opportunity for
manipulation, for misconduct, and for self-dealing. They have
also drawn considerable media attention.
I have written about securities fraud, SEC enforcement, and
insider trading, and I want to focus in my opening remarks on a
review of the regulatory structure and the challenges that the
market environment imposes on that regulatory structure.
The activities that I understand the subcommittee to be
interested in today involve three distinct sets of legal
issues: disclosure integrity; the use of stock options; and
insider trading.
I will address those issues in turn. I will briefly
conclude by addressing potential areas of regulatory reform.
The first issue is disclosure integrity. Some news stories
that we have heard say that the issuers have made distorted,
inaccurate, or overly optimistic disclosures to drive up their
stock prices, and this can be for various reasons ranging from
enabling insiders to sell and make a lot of money, to
increasing the value of stock options, or facilitating the
issuer's access to the capital markets.
Now, let me be clear. Existing securities regulation
requires disclosures to be accurate. False and misleading
statements, particularly those that are made with an effort to
distort stock prices or create opportunities for personal gain,
constitutes securities fraud. An issuer or a corporate official
that makes false claims, claims about a pharmaceutical product
that is under development or misstates the results of a
clinical trial could face both an SEC enforcement action and
private civil litigation, and false statements that are made
willfully can subject the issuer and individual corporate
officials to criminal liability. This is not a gray area.
The existing market environment, however, creates a
challenging disclosure environment. The scope of the pandemic,
the lockdown, and the effect on the world's economy, are
unprecedented.
Pandemic-related information has the potential to have an
enormous impact on the economy and on stock prices. Everyone is
watching to see what is happening with these companies. And the
SEC itself has encouraged issuers to provide as much
information as possible about pandemic-related risks on
businesses.
But at the same time, we don't actually know what the truth
is. The scientific community, and the public health community
is still evaluating all of this.
So, it is hard for businesses to predict what is going to
happen in the future, what is going to be the effect on their
stock prices, and so forth.
Simply put, issuers are in a challenging environment. They
are pressured to disclose as much information as possible. But
premature disclosure of uncertain information may, in
hindsight, prove inaccurate.
At the same time, stock prices are reacting dramatically.
Chairman Sherman identified the possibility that stock prices
may be too high at the time that executives receive stock
options.
The concept that stock prices reflect fundamental value or
that the fundamental value of these companies is even knowable
at any given point right now is something that is very
challenging from a market regulatory perspective.
Now, let me say--I see, my time is running short, and as a
law professor, I am always long-winded, so I will cut to the
chase and talk further, perhaps, in response to your questions
about stock options and insider trading.
But let me just say a couple of words about potential
regulatory reforms. As I said, the law doesn't prohibit
accurate statements, even if those statements are forward-
looking, even if those statements are not based on hard science
about what a vaccine or what a product is going to do.
The law, however, doesn't permit executives to create
trading opportunities through their public statements, and
here, I think, the potential, if I--Chairman Sherman, if I
could just take a minute to wrap up.
Chairman Sherman. Thirty seconds.
Ms. Fisch. Here, I think the potential rethinking of 10b5-1
plans, which I think the current market has exposed, is
creating a potential regulatory gap, a potential opportunity
for profitable manipulation of disclosures in order for the
potential of self-gain is a really promising area and, I think,
a scenario that legislation and regulation haven't fully
recognized.
And I would be happy to talk about that more in response to
questions.
Thank you.
[The prepared statement of Ms. Fisch can be found on page
59 of the appendix.]
Chairman Sherman. Thank you for your testimony.
I now recognize Mr. Frenkel.
STATEMENT OF JACOB S. FRENKEL, CHAIR, GOVERNMENT INVESTIGATIONS
AND SECURITIES ENFORCEMENT PRACTICE, DICKINSON WRIGHT
Mr. Frenkel. Thank you.
Good afternoon, Chairman Sherman, Ranking Member Huizenga,
and distinguished members of this subcommittee.
Thank you for giving me the opportunity to testify on
critical issues impacting our capital markets. My perspective
comes from 32 years of professional experience in capital
markets enforcement, investigations, governance, and integrity
issues, including my work at the Securities and Exchange
Commission's Division of Enforcement, as a Federal prosecutor
of public corruption and securities violations, and as an
actively practicing defense and governance lawyer for more than
21 years.
I believe that in 2020, unlike 20 or more years ago, pre-
Enron, most corporate boards and management want to get it
right.
Nevertheless, we still see capital markets activity that
gives rise to questions about commitments to compliance and
fundamental common law duties that are the responsibility of
corporate custodians.
This committee has identified insider trading, Rule 10b5-1
plans, stock option grants, spring-loading, and bullet dodging
as issues of heightened interest, warranting consideration of
legislation.
Beyond these undeniable vital areas of concern, I suggest
to the committee, respectfully, that COVID-19 solutions-related
capital markets activities also should invite scrutiny of
several other issues.
They include, first, regulation FD and its inapplicability
to foreign private issuers. We saw the effect of the exemption
2 weeks ago when AstraZeneca's CEO disclosed, on a nonpublic
call arranged by JPMorgan, about its suspension of vaccine
clinical trials as a result of an unexplained illness in a
trial participant.
If AstraZeneca had been a U.S. issuer, then there likely
would have been an obligation for prompt public disclosure of
what appeared to be an unintentional selective disclosure.
Second, is the SEC's 10-day trading suspension authority,
which operates like a court-imposed temporary restraining
order. However, it is not an enforcement action, but operates
as an administrative arrow through the heart of legitimate
small entrepreneurial public companies.
For trading suspensions that issuers contest, the SEC takes
months if not longer to resolve the challenge. Legislation
should dictate a precise and narrow timeframe for making the
decision.
Third, is delegation of authority to authorize formal
orders of investigation at the SEC. For decades, the Commission
alone made the decision. Post-Madoff, the authority was
delegated into the Enforcement Division, what I and others
viewed as the out-of-control practice in the previous SEC
administration.
Although SEC Chairman Clayton has reined in this delegation
of authority, I believe the Congress intended for the
Commissioners to decide whom to investigate and to make the
solemn decision about authorizing subpoena power much like a
Federal Judge reviews and approves search warrant applications.
And fourth, is trade clearance and conflict-of-interest
disclosure policies and whether they should apply to NIH
advisory panels.
The question for consideration is what level of
transparency should exist to enable you on Capitol Hill, and
the public, to assess possible conflicts of interest among
scientific and technical peer review advisors who are not
subject to the Federal Advisory Committee Act.
These are not instead of, but are in addition to, the
important issues already identified by this subcommittee. I
hope that we will be able to discuss each of these issues this
afternoon.
Finally, you have asked that we address the importance of
corporate integrity during the COVID-19 pandemic and the impact
it has on investor protection and overall market integrity. I
believe that is too narrow.
Corporate integrity, a commitment to best practices and
proper governance, including a conscientious discharge of
common law fiduciary duties and a constant focus on investor
protection and market integrity was, is during the pandemic,
and always will be and must be the guiding principles of
corporate boardrooms and C-Suites for U.S. capital markets
participants.
I compliment the committee for highlighting the importance
of and addressing these issues with this hearing. I look
forward to answering your questions this afternoon.
Thank you.
[The prepared statement of Mr. Frenkel can be found on page
64 of the appendix.]
Chairman Sherman. Thank you.
As described earlier, Mr. Meeks will be taking over while I
vote. So, I am hoping to encourage Mr. Meeks to vote in the
next few minutes, since I will be turning the gavel over to him
in about 20 minutes.
Mr. Meeks. Very well. I will run to vote now, and I will be
back.
Chairman Sherman. Good. See you in 15 or 20 minutes.
With that, I now recognize Mr. Martin.
Mr. Martin?
STATEMENT OF GRANVILLE MARTIN, SENIOR VICE PRESIDENT AND
GENERAL COUNSEL, SOCIETY FOR CORPORATE GOVERNANCE
Mr. Martin. I, of course, didn't unmute myself. You would
think I would be used to this by now, 6 months into this. My
apologies.
I am also wearing a tie for the first time in many months.
So, thanks for the opportunity to do that.
Chairman Sherman, Ranking Member Huizenga, and members of
the subcommittee, thanks for the opportunity to testify today.
I am Granville Martin, general counsel for the Society for
Corporate Governance, the Society's professional association of
approximately 3,500 corporate and assistant secretaries serving
approximately 1,000 public companies.
Our members support the work of corporate boards and
executive managements on corporate governance and disclosure
matters.
We traditionally focus on securities and corporate law
issues, and in the last several years have broadened our
perspective to also include environmental and social issues.
Diversity, climate change, and human capital management are
among the key issues which investors have sought greater
disclosure on, and that public companies increasingly provide.
At the outset, let me state clearly that the Society's
public company members support a rigorous framework of insider
trading regulation and enforcement. Ensuring that America's
markets retain a reputation for transparency and fairness is in
the interest of all public companies.
A market where insiders can benefit from material nonpublic
information at the expense of other investors is wrong, and we
support the laws and enforcement necessary to prevent and
punish such conduct.
Most public companies have adopted policies that prevent
illegal insider trading. Common features of such policies
include a prohibition of trading at any time while in
possession of Material Nonpublic Information (MNPI), a
preclearance procedure of transactions, imposition of trading
blackout periods, and limitations on the adoption of 10b5-1
plans.
It is worth noting that the company-imposed blackout
periods restricting executives from selling stock generally
begin several weeks prior to the end of the fiscal quarter, and
last until a day or two after the publication of quarterly
earnings.
As a result, company officers and directors typically will
have four open windows per year, with each window lasting just
a few weeks.
Section 10b of the Securities Exchange Act and the
associated Rule 10b5-1 prohibit stock sales made on the basis
of MNPI that is obtained through a breach of duty of trust that
is owed to the issuer of that security.
Rule 10b5-1 specifies that the sale of a security is made
on the basis of MNPI, when the person making the sale was
``aware'' of that information when the sale was made.
Rule 10b5-1 also provides an affirmative defense to Section
10b insider trading allegations, when such trades are made
pursuant to a preexisting written trading plan that complies
with the rule.
The rule's affirmative defense is only available, however,
if the plan was entered into in good faith.
Rule 10b5-1 does not operate in a vacuum. It does not alter
the elements of a case under Section 10b. Scienter is still
required.
Additionally, transactions pursuant to a 10b5-1 plan must
still comply with the volume limitations of Rule 144 of the
short-swing profit rule 16b.
In addition, executives are subject to the filing of
ownership forms under Section 16a of the Exchange Act,
including Form 4, which must be filed in connection with each
transaction.
The filing of Schedules 13d and 13g are also required where
appropriate.
The Section 10b and Rule 10b5-1 prohibition on insider
trading when aware of MNPI, along with the related disclosure
obligations and established company practices, provide, in our
view, a comprehensive and effective legal framework. We do not
believe that changes are warranted.
Like so many other aspects of our lives, COVID-19 presents
new and abrupt challenges to public companies, including
related to insider trading law compliance.
As companies grappled with the implications of the
pandemic, the SEC issued guidance emphasizing market integrity
and urging companies to provide detailed COVID-related
disclosure.
Based on our review of Society members' disclosures, we
believe public companies have responded robustly to this
guidance. COVID-related disclosure has been widespread and has
covered a wide range of topics.
In addition, many public companies reassessed their insider
trading policy compliance programs, including whether their
internal procedures were able to identify all of the executives
who are now possibly in possession of COVID-related MNPI.
Pre-pandemic, such concerns for supply chain and
operational executives were minimal.
Let me turn to some of the pending legislation. In general,
the Society does not have a position on the appropriateness of
the [inaudible] structure of executive compensation.
Having said that, we have observed that the use of stock
options by startups and other early-stage companies is common
and essential. Boards of directors and their compensation
committees are best-positioned to decide on the appropriateness
of such options grants.
Investors expressed their view on the appropriateness of
compensation through required sale on payloads that incur in
many cases annually. Transparent fairness exists under the
current regulatory framework.
Similarly, we believe the 8-K Trading Gap bill is
unnecessary, given that Section 10b and Rule 10b5 already
prohibit trading by insiders if the undisclosed significant
event is material.
We would note that the bill makes conduct that is already
prohibited further illegal, if that is possible. We believe the
regulation of insider trading is almost done.
We believe the regulation of insider trading has been
subject to some confusion. Having said that, the SEC study
mandated by H.R. 624 could contribute to a common and well-
founded understanding of 10b5-1 plans and whether any changes
are warranted, and we support the enactment of H.R. 624.
Thanks for the invitation for the invitation to testify,
and I would be happy to answer any questions.
[The prepared statement of Mr. Martin can be found on page
87 of the appendix.]
Chairman Sherman. Thank you.
I now recognize myself for 5 minutes for questions. I want
to commend the Chair and the ranking member for authoring
legislation that has already passed the House dealing with
instructing the SEC to focus on insider trading and certain
aspects thereof, and one of the purposes of this hearing is to
join forces with the ranking member and the Chair to make that
statement very clear to the SEC.
It is the hope that these hearings will inspire the Senate
to act on that bipartisan legislation or, just as good, get the
SEC to do what the legislation directs them to do, whether the
statute directs them to do it or not.
Insiders hold material information that is not known to the
general public. We have insider trading rules that deal chiefly
with transactions between the insider and outsiders through the
market.
We have much weaker rules dealing--or no rules dealing with
insider trading and options or stock between the insider and
the corporation itself.
Now, I know that the Minority can be very popular in the
boardrooms of this country by saying that it is illegitimate to
have a hearing of this subcommittee except if the purpose of
that hearing is to make it easier to market stock to the
public, and there is a rule for us making it easier on business
insiders to raise capital.
But it is, certainly, legitimate for this subcommittee to
explore the loopholes that caused insiders to be able to take
advantage of the general public and the general investing
public.
We do have good laws on traditional false statements. The
SEC has done many thousands of enforcement transactions dealing
with traditional insider trading.
But when insiders make use of material undisclosed
information in stock option transactions and other transactions
with the company, according to Kodak's lawyers and, frankly,
including--and even in our discussions with the SEC can,
generally, be legal, although wrongful.
Ms. Fisch, as you know, the day before the Federal
Government announced its plans to provide Kodak a $765 million
loan, the company's CEO was granted 1.75 million stock options.
Now, stock option plans legally need to be approved by
shareholders, and the shareholders approved a plan that said
that the option exercise price for these employee stock options
needs to be set at, ``fair market value.''
But here is where the shareholders may have gotten tricked,
because that is defined as the latest closing price of the
shares, and under normal circumstances, that is fair market
value.
But in this case, Kodak, undisclosed to the market, had
just landed $765 million. Considering Kodak's share price rose
by over 500 percent within hours after these options were
granted, this seems to be a situation where the shareholders
were fooled by the term, ``fair market value,'' which turned
out to be a much lower--a value that didn't reflect the
knowledge.
Would you agree that legislation is appropriate to close
this loophole by prohibiting users who use fair market value to
set employee stock option exercise prices from doing so based
on a market price that doesn't reflect information the company
is about to disclose prior to disclosure?
Ms. Fisch. Thank you, Chairman Sherman.
Stock options, obviously, are a form of executive
compensation, and as compensation, they have a number of
problems. One of the problems that we see right now is there is
a huge amount of volatility in prices. Prices are reacting--as
you yourself observed, prices may be overreacting to
information as well.
So, I think a compensation structure that looks at market
price as an indication of fair value is particularly
problematic in this environment.
That being said, the whole regulatory structure is designed
to put safeguards into place, not just the shareholder vote but
also the role of the compensation committee.
Chairman Sherman. Thank you. My time has expired.
I now recognize the ranking member of the subcommittee, Mr.
Huizenga.
Mr. Huizenga. Thank you, Mr. Chairman. I appreciate the
opportunity, and I would ask unanimous consent to submit a
letter for the record that is from Securities and Exchange
Commission Chairman Clayton. It is addressed to you, and CC'd
to me. I would like to put that into the record.
Chairman Sherman. Without objection, it is so ordered for
the second time, since I had already put it in the record. Now,
it is in there twice. That is good.
Mr. Huizenga. Double. Belt and suspenders.
I appreciate it. And maybe, I will just start with where
Professor Fisch had left off, and in this letter the chairman
is very clear about some of his concerns about the 10b5-1 plans
and, in fact, a couple of the headings on this are: Insider
Trading Policies for Senior Executives and Board Members; Terms
and Administration of Rules; and 10b5-1 Plans.
He does say also in the letter that there is a joint
explanatory statement accompanying the Fiscal Year 2020
Financial Services and General Government (FSGG) Appropriations
Act on the growth share repurchases and are considering this
and other issues relating to Rule 10b5-1 as plans as part of
that report.
Under Issuing and pricing stock options, he very
specifically says that a grant may also be inconsistent with
existing accounting standards because, in short, the trading
price of its stock is not a good indicator of fair market
value, and he then goes on to ask to make sure that senior
executives and board members keep that in mind, but also to
have the Divisions of Corporation Finance and Enforcement look
at it.
So, Professor Fisch, I don't know if you would care to
address that, very briefly, any more than where you had started
to go down that path?
Ms. Fisch. Thank you. I guess what I did want to say is you
are absolutely right and, of course, SEC Chairman Clayton is
absolutely right. Good corporate hygiene, I think, these days
requires a corporation to think seriously about having explicit
written policies in place with respect to its option grants,
with respect to its executive trading in the company stock, and
with respect to 10b5-1 plans. I think those are all important
issues.
But I just want to distinguish between good corporate
hygiene, matters of good corporate governance, and even matters
of a director's fiduciary duties and insider trading, because
they are two different concepts, and lots of companies can be
overpaying their executives right now based on salary or
bonuses that are tied to stock prices without using stock
options.
The problem is the overpayment. The problem is using stock
prices as a metric of value, and the problem is not necessarily
in the option form itself.
Mr. Huizenga. And the chairman says that may be
inconsistent with existing accounting standards. So, is that
something that the Public Company Accounting Oversight Board
(PCAOB) needs to tackle?
Ms. Fisch. That is an interesting question, and the problem
is, I am not sure how you come up in this market environment
with a concept of fair value and how a board or a compensation
committee goes ahead and does that.
Now, Chairman Sherman is right. If the company knows
tomorrow it is going to release material information, the
company is, obviously, going to suspect the stock price is
going to be affected.
But if you look at Kodak's trading price from the time
before the first press reports until today, it is all over the
place, and I don't know at which point of the trading price we
could say with confidence, yes, that reflects fair market
value.
Mr. Huizenga. I think that point has been made. It is more
than just one company. But the SEC, clearly, is very concerned
about it, and the Chairman is.
Quite honestly, when Mr. Claypool was, I would say,
disparaging the SEC Chair, whether it is Mary Jo White or Jay
Clayton, I don't think I have ever heard a SEC Chair even come
close to thinking that insider trading or that enforcement is
somehow not acceptable. So, that just was wrongheaded on that.
Mr. Martin, specifically, companies participating in
government assistance programs through the CARES Act have some
guidance that has been put up, correct? Do you believe it is
clear enough?
Mr. Martin. Yes, I do. I think the company response to the
SEC guidance, both the statements with respect to insider
trading and subsequent statements by the Chairman and Director
Bill Hinman, were well-received.
It was very clear to the corporate community, and what you
saw was a big increase, a needed increase in COVID-related
disclosure, which the Chairman was very focused on, along with
the Director.
We can provide a few statistics about the increase of that
disclosure and, appropriately--and I think Professor Fisch was
alluding to this--companies were really struggling at the
beginning and, to some degree still are, with understanding
what the significance of particular events are to their own
business operations and, indeed, their stock prices have been
extremely volatile.
And so, companies have struggled with that and their
response, significantly, has been to very dramatically increase
the amount of disclosure on COVID.
For example, at the end of March, a National Association of
Corporate Directors (NACD) study found that 50 percent of
Russell 3,000 companies that filled out a Form 10K as of March
30th--
Chairman Sherman. I believe the--
Mr. Martin. --were qualifiers for COVID-19--
Chairman Sherman. --time of the gentleman has expired.
Mr. Martin. Excuse me. I'm sorry. One last point.
Chairman Sherman. Thank you. Mr. Himes, it is your turn.
Have you already voted?
Mr. Himes. No, I have not. But I think I have time. So, I
will use my time now.
Chairman Sherman. Ms. Porter, have you already voted or are
you voting by proxy?
Ms. Porter. I have already voted, sir.
Chairman Sherman. Good. I am going to--since Mr. Meeks has
not returned, and with your permission, I will make you
temporary Chair as I go vote.
Mr. Huizenga. And, Mr. Chairman, I guess I am looking to
see if there is a Republican who is on as well to take the
helm--the challenges of having committee hearings continue
while we are doing extended voting. But I would love to hear
one of my Republican colleagues let me know that they can take
over as ranking member while I go vote..
Chairman Sherman. Okay. I am going to call upon Ms. Porter
to act as our temporary Chair and ask Mr. Himes to proceed for
5 minutes.
Mr. Himes. Great. Thank you, Mr. Chairman, and thanks very
much to our witnesses today. This is an area of intense
interest for me.
My office has devoted a lot of time to crafting what was,
as the ranking member pointed out, bipartisan legislation which
passed the House in May 2019, with H.R. 2534, the Insider
Trading Prohibition Act. I'm very, very interested in that. It
was very steeped in the complexity of defining insider trading.
I do have a question, but since it was a bipartisan bill, I
want to suggest to my Republican friends that this is far from
a waste of time, and it may not be exactly the way you want to
promote business investment but there is, arguably, nothing
quite so important to business investment as confidence in the
capital markets, the confidence on the part of shareholders and
others that they are playing in a fair market, which is why I
have been very, very devoted to crafting a specific statute on
the topic of insider trading.
There is a need for this. My Republican friends know that
only 14 percent of Americans directly own stocks, and so as the
stock market has rocketed in these last couple of years,
directly, a very small percentage of Americans have been able
to participate in that upside.
It is true that roughly half of Americans, of course,
indirectly own some stock through pension plans and retirement
plans.
But we should all be looking to increase the number of
Americans who feel like they have a stake in the equity of
their economy, and critical to that, of course, is making sure
that we can look people in the eye and say, this is a fair and
level playing field.
I don't want to get into the complexities of all that
occurred in Kodak, and I understand they are complicated.
Look, there is nothing wrong with stock prices going up,
necessarily. There is nothing wrong with stock option plans,
necessarily.
What is wrong is when corporate insiders take advantage of
inside information. We spend a lot of time in the bill defining
transactions, the purchase and sales of securities.
The fact that we are talking about spring-loading and
bullet dodging, that pertains to, essentially, a transaction.
But it is an indirect transaction. It is the conveyance of
value, because a stock option is valuable.
And so my question is--I am not quite sure which of my
witnesses, maybe I will start with Mr. Frenkel.
My question is, do you think we can alter insider trading
law, broaden it to be about the conveyance of value, and would
that capture what we are talking about here?
Or do we need an entirely separate statute for value that
is conveyed via option plans and programs as opposed to the
purchase or sale of securities?
[No response.]
Mr. Himes. Mr. Frenkel, you are muted, I think.
Ms. Porter. [presiding]. Mr. Frenkel, you are on mute.
Mr. Frenkel. I'm sorry. Thank you, Congressman Himes, and I
apologize for staying on mute.
I think in the context of the insider trading laws, the
focus has always historically been on the purchase and sale and
the conveyance of information.
To me, as Professor Fisch had indicated, the issues around
spring-loading and bullet dodging are as much a part of
executive compensation as they are the information.
Insiders are always going to have access to information
that is in balance with respect to the rest of the market. But
that really is more an issue of timing and broader disclosure
obligations than insider trading itself.
Mr. Himes. No, I understand that, and I guess the point I
am making--and I understand that we are really talking more
about compensation than a purchase or a sale of a security.
But at the end of the day, what is happening is that a
decision about conveyance of value is being made possibly when
there is an imbalance of information.
So it is not clear to me that there is a radical
categorical difference between an executive who is going to
approve a stock option plan 3 weeks from now, but knowing that
they are about to receive a loan accelerates that decision--
there is not a categorical difference between that and that
executive going out and purchasing the stock.
There are differences of timing, et cetera. But it is,
effectively, the same thing. It is conveying value wrongly
because inside information is bad, right?
Mr. Frenkel. I would agree, and really what--Congressman,
you are correctly identifying the issue as being the use and
application of that information as being subject to imbalance
favoring that corporate executive.
I still believe it is an issue that really should fall
beyond insider trading, because it really does not relate to a
trade itself. It really goes to disclosure issues, in my view.
Mr. Himes. Yes. My time has expired. But I would be
grateful if in this hearing, we got down to, how can we address
legislatively spring-loading and bullet dodging most
appropriately?
But my time has expired, so I will yield back, and I thank
the witnesses.
Ms. Porter. The Chair now recognizes the gentleman from
Ohio, Mr. Gonzalez.
Mr. Gonzalez of Ohio. Thank you, Madam Chairwoman. And
thank you, everybody, for your testimony today.
I want to start with something that Mr. Claypool brought up
that kind of perked my interest, and I am curious for
everybody's take on it.
You highlighted the Moderna situation where, upon getting
good news, the stock price went up significantly. It sold
stock. There's nothing in and of itself wrong with that.
But it does sort of raise a question around specific COVID
support. to me it does, anyway, specific COVID support and any
additional disclosures we might want as a result of that.
I think these are unusual times, and when we have the
Federal Government, basically, funding 100 percent of R&D on a
product that is going to be incredibly important, God willing,
maybe there should be additional scrutiny there.
I guess I would start first with Mr. Martin. Do you have
any thoughts on how we could better inform investors with
respect to these sorts of announcements or any changes you
might make on a temporary basis? Not permanent, but on a
temporary basis, as a result of COVID?
Mr. Martin. I think the existing framework that
necessitates the disclosure of material information to
investors through the filing of an 8-K is the appropriate
mechanism.
To the extent that there is trading around or in advance of
such disclosure, that is already illegal. So it is not
immediately evident to me what an alternative framework can do
beyond what the existing framework does, which is to mandate
the disclosure of material information to investors.
And I am sorry, but I don't have any particularly
intelligent ideas as an alternative to that.
Mr. Gonzalez of Ohio. Yes, that is a fine answer. I just
wanted your perspective on it.
And now, another thing from Mr. Claypool's testimony I
would take issue with, which is around sort of a normative
judgment around repurchasing of stocks, in particular.
There is a quote in here: ``When managers repurchase stock,
they are confessing they have no new promising ideas on which
to invest.''
Mr. Martin, again, what do you think of that statement? I
will just say, as a--I don't want to set you up to be overly
combative, but as somebody who has been an investor for my
entire adult life, when companies I have invested in repurchase
stock, that means that I own more of the company now.
And so, that actually benefits all of the shareholders, is
my personal belief. But I would be curious for your perspective
on that as well.
Mr. Martin. I agree with that. Share repurchases are a
legitimate tool for capital planning for companies. Of course,
companies can raise or lower their dividend as needed and share
repurchases are an entirely legitimate use of shareholder funds
for the benefit of existing shareholders.
I know that there are conflicting feelings about that,
particularly in the wake of some tax legislation a few years
ago.
I just disagree with that perspective and would hope that
Congress will maintain the discretion that companies have to
make those kinds of capital planning decisions and that boards
and senior management are left to make those kinds of
determinations.
Mr. Gonzalez of Ohio. Thank you. I agree with everything
you just said, and I yield back.
Ms. Porter. Thank you. I am now going to turn over the
chairing of this hearing to my colleague, the distinguished
gentleman from New York, Mr. Meeks.
Mr. Meeks. [presiding]. Thank you, Congresswoman Porter.
Thank you for holding it down for us.
I now yield 5 minutes to the gentleman from Illinois, Mr.
Foster, for questions.
Mr. Foster. Thank you. Professor Fisch, I would like to
take you up on your offer to dig a little bit deeper on 10b5-1
plans. Some of the stories that we have seen regarding
pharmaceutical companies developing COVID-related products
apparently involved executives modifying these plans right
before some big announcement, which caused the stock to
skyrocket.
Some of these apparently have resulted in what might
otherwise be considered suspiciously timed trades, but are
given at least a partial safe harbor because they were done
pursuant to 10b5-1 plans.
So, very quickly, could you briefly describe what 10b5-1
plans are and what they are intended to be and accomplish?
Ms. Fisch. Thank you.
Yes, 10b5-1 plans are designed primarily as a tool for
executives to manage their stock trading over the long term. So
today, executives increasingly are being paid in stocks, stock
options, restricted stock.
Obviously, they have liquidity needs, and the idea behind a
10b5-1 plan is typically what this allows you to do is sell
stock on a regular basis, right--they are usually used on the
sales side--and not worry about the fact that before you sell
the stock, you come into possession of material nonpublic
information, and you would thereby be precluded from selling.
Once you put the plan in place, once you commit to sell,
you are insulated from liability even if you have knowledge at
the time the sale actually occurs.
Now, the loophole, Congressman, that you are referring to
is the fact that these plans don't have to be disclosed, and
practice among issuers varies dramatically in the type of
disclosure that they make, or whether they disclose the
existence of these plans at all. So, that is the first problem.
The second problem is that the law allows you to modify or
to terminate your 10b5-1 plan, and it doesn't restrict that
termination to situations in which you don't have material
nonpublic information.
So, let us say I have a 10b5-1 plan. I am planning to sell
my stock this week. I learn good news about my company or it is
going to get a Federal grant or promising drug trials, and I
say, okay, hang on, I am going to terminate my plan, I am not
going to sell.
Obviously, I am making use of inside information, but I
have not traded. I am declining to trade, and as a result, it
is a loophole that is not covered by existing law.
Mr. Foster. Is there a downside in mandatory disclosure of
these, either in real time or at quarterly intervals or some
standardized time?
Ms. Fisch. Frankly, sir, I don't see a downside and, in
fact, there have been a couple of empirical studies that have
looked at issuer disclosure practices and found that the
issuers who disclosed these plans voluntarily also have better
general corporate governance. In other words, disclosure seems
to be a signal of good corporate hygiene, so to speak.
Mr. Foster. And what about requirements that separate the
decision time from the time of the actual purchases, so that
you have to declare months or longer in advance that you are
going to start or stop this program?
Ms. Fisch. That would absolutely be a useful refinement as
well. We haven't yet talked in this hearing about 16b and
short-swing trading liability. That is a provision in the
original Securities Exchange Act of 1934 that is supposed to
limit the ability of executives to benefit from sort of short-
term trading by buying and selling within a short time period.
I think you could apply that same approach to 10b5-1 plans
and say, look, given the intent behind these plans, you should
have to put the plan into place for a period of time and,
ideally, the plan should persist for a period of time so that
there is less likelihood the executives will try to take
advantage of short-term information asymmetries.
Mr. Foster. And do any of the other witnesses have any
comments on this area of potential improvements or fixing
loopholes or other risks?
[No response.]
Mr. Foster. Okay. Deafening silence.
Well, I appreciate all your help. As the son of a law
professor, I just have a lot of sympathy for your life, and
anyway, we will have that discussion offline.
And with that, I yield back.
Chairman Sherman. Thank you very much. I thank the
gentleman for his questions, and commend to him and others the
Waters-McHenry bill designed to focus on the problem he
illustrates.
I want to thank Ms. Porter and Mr. Meeks for acting as
temporary Chair in my absence, and I now recognize Mr. Hill for
5 minutes.
Mr. Hill. Thank you, Mr. Chairman, and what a good
discussion this is. I want to, of course, commend and thank all
of the members who worked on insider trading topics over the
years but, particularly, my friend, Mr. Himes of Connecticut,
who has been such a thoughtful leader on this subject as our
committee has navigated what is a very challenging subject in
order to balance the needs for information in the capital
markets, the flexibility of use, and really identify criminal
behavior.
So thanks, Jim Himes, for your work and for the bipartisan
work that we have done together.
Mr. Martin, I want to talk a little bit about the Society's
survey on the members regarding insider trading preclearance
policies.
You say 90 percent of your members follow a preclearance
policy. Could you highlight what your best practices would
indicate that could have prevented or brought clarity to or
remediated some of the challenges that we have read about in
recent days and that we have talked about over the course of
this hearing?
Mr. Martin. Sure. In general, I think there is a suite of
policies that corporates implement to, as was said at the
outset, that 20 years ago, I think it was Mr. Franklin noted,
that the change in most corporate suites to take insider
trading and avoiding it and regulating it--companies are taking
it very seriously.
So, there is a suite of policies that they instituted to
address that, including compliance training with executives
that requires the executives to acknowledge the existence of
the policies, that they understand what the limitations are
including, obviously, that you can't trade while in possession
of MNPI.
The designation of particular brokerage houses to handle
all transactions in company stock that allows Section 16
executives and others who may have an MNPI to be flagged, and
so those accounts can be monitored.
You mentioned the survey that the Society conducted about 2
years ago which indicated that approximately 90 percent of the
companies surveyed require preclearance of trades by in-house
legal.
I mentioned in my opening remarks that virtually every
company imposes blackout periods in advance of quarterly
earnings. But it is more stringent than just that.
Those windows will be closed in the event that new material
information develops. It could be a leadership change, or it
could be something with respect to a new product. And then, of
course, some companies further regulate the adoption of 10b5-1
plans when they can be adopted and cooling off periods and
things like that.
So, there is a suite of policies that companies have become
much more conversant and frequent users of, because trying to
avoid their executives becoming embroiled in an insider trading
allegation or enforcement action is incredibly time-consuming
and expensive for companies, and the incentives are really
lined up for companies to try to avoid those kinds of outcomes.
Mr. Hill. Yes. My limited experience in this area is also
at a very active company that is growing and doing mergers and
acquisitions and having executive management changes and maybe
having a very periodic 8-K filing process is that the number of
days somebody can actually trade their stock is very limited
per quarter, just fractionally.
Is there a better way? Now that we have seen the expansion
of stock options over the past 30 years, is there a better way
to provide long-term growth-based compensation to executives
other than stock options? Have you all done any studies on
that?
Mr. Martin. I don't think we have done any particular
studies on that. Obviously, the question of how long vesting
periods are is pertinent to your question, and I can speak from
my own personal experience in a limited amount of time, that
those vesting periods for some executives have been pushed out.
Mr. Hill. Thank you. I look forward to following up with
you on that and I appreciate it.
Mr. Chairman, my best regards for our panel. It was an
excellent discussion.
Chairman Sherman. Thank you.
I now recognize my fellow Californian, Mr. Vargas.
Mr. Vargas. Thank you very much, Mr. Chairman, and I
appreciate very much the words of my good friend, French Hill.
I was a little surprised when this hearing started, that I
heard the ranking member and others say, basically, there is
nothing here to see; why don't we just move along?
IT seems to me that there is a lot here to see, at least
from my perspective. I appreciate the effort that the
pharmaceutical companies are putting forward to develop a
COVID-19 vaccine and the treatment supply and, of course, they
should be compensated.
I believe that they should be. But I am also concerned
about the large amounts of money that they are making when the
rest of the country is having such a difficult time.
And I guess I am very concerned about the legal but
wrongful aspects of this. It really does seem to me that while
what Kodak did was lega,l it is certainly wrongful, and I do
not have great confidence in the SEC at the moment. Their
enforcement is way down.
So, I think that we have something here.
Professor Fisch, could you comment on that? Is there
nothing to see here? Should we move along?
Ms. Fisch. No, I commend the subcommittee for raising what
I think are very important topics, and I wouldn't say that you
all should just move along.
But what I think a number of the comments have suggested,
though, is that you are actually focusing on two related but
separate ideas.
One is the conveyance or the wrongful misuse of
information, and the other is sort of the compensation and
whether companies that are facing speculation in their stock
price and also companies that are the subject of government
funding, whether they should be compensating their executives
to the degree that they are.
Stock options and some of the recent stock option
experiences involve a combination of the two, and I think
members of the subcommittee, at least some members, might be
equally upset if these executives were getting huge grants just
in the form of salary.
Now, obviously, there is nothing wrong with a compensation
committee deciding to pay an executive millions of dollars
before the news of a government grant has been publicly
released.
The compensation committee knows about the government
grant. It is not a misuse of nonpublic information. But you
might say, well, gee, it smells bad. This is taxpayer funding.
This isn't something the executives should profit from.
That is a little bit different from the stock trading or the
insider trading concept.
Mr. Vargas. Well, Professor, I think it does smell pretty
bad, to be frank.
Mr. Frenkel, if you could speak a little bit about the
spring-loading and bullet dodging you were talking about
earlier?
Mr. Frenkel. I would agree with all of the comments that
have been made so far with respect to spring-loading and bullet
dodging.
I think the focus has been more on the spring-loading
component, where the bullet dodging piece of it is about a
company temporarily depressing the stock price by releasing
information before a stock option grant date as opposed to
holding back the release of the positive information until
after the option date.
I think one of the courts in Delaware, if I am not
mistaken, a number of years ago referred to spring-loading and,
really, in particular, spring-loading as being a matter of a
corporate disclosure conduct issue involving an unclean heart
but not necessarily in violation of the law.
I think what we are really talking about here is moving the
whole discussion into how to provide some form of disclosure
and regulation around these concerns.
The one thing, respectfully, that I think I should also
address is the issue of SEC enforcement in this area, because
while the SEC's numbers may be down, I would submit, as
somebody who defends these investigations, that the Commission
is very aggressive.
There have been 40 trading suspensions that are
specifically related to issuers in the COVID-19 solutions
space. So, the Commission really has been very vigilant.
On the other hand, as it has been dealing with staff
reductions, that also has impacted its ability to be as broad
in its application of, or choice of cases.
But I think in terms of the gestation of investigations, we
are still seeing a very active division, just sort of a
reprioritization over the last 18 months.
Mr. Vargas. My time is about up. Not to be confrontational
or be difficult, but I would disagree with that, especially
when you see what happened with Kodak.
I don't know how you explain that to the American public.
Thank you. My time has expired.
Chairman Sherman. I now recognize the former Chair of this
subcommittee, the gentlelady from New York, Mrs. Maloney, who
is also the Chair of the House Committee on Oversight and
Reform..
Mrs. Maloney. I thank the gentleman for yielding, and thank
you for this important hearing.
Mr. Frenkel, I would like to address my question to you.
Earlier this year, the House passed my legislation, the 8-K
Trading Gap Act, with overwhelming bipartisan support.
This bill would close the loophole in our current law that
allows corporate executives to trade on information before it
is disclosed to the public.
And right now, when there is a significant corporate event
at a public company, the company has to disclose that
significant event to the public by filing a Form 8-K within 4
days of the event occurring.
Of course, during this 4-day gap, executives at the company
know about the event but their investors don't. My bill would
address this problem by simply prohibiting executives from
trading during this 4-day gap.
Given the recent controversial activities that my
colleague, Congressman Vargas, just mentioned, the companies
like Kodak, Novac, and Moderna, I believe it is important now
more than ever to close this loophole.
Since the start of the pandemic in mid-March, there have
been over 10,000 8-K filings with the SEC.
Mr. Frenkel, would you agree that during this crisis, when
firms have increasingly made important public announcements, it
is especially important that we close this loophole?
Mr. Frenkel. I would agree. I would agree entirely, and I
think your legislation is right on point, and I think it also
goes to a point that Mr. Martin had made before regarding
corporate blackout periods. And certainly, there is abuse.
But, using the example that Mr. Vargas had raised with
respect to Kodak, I also refer to the committee statement from
yesterday.
The fact is, the SEC has not yet begun, let alone
completed, conducting its investigation, and the SEC certainly
can come to entirely different conclusions than the findings of
the internal investigation, because if you look at the report
of the internal investigation, I believe the questions that
were posed were extremely narrow, or at least that were
addressed in the course of the internal investigation.
So yes, back to the guts of your question, I do think that
your proposed legislation around 8-K disclosures is right on
point and, essentially, legislates the blackout period, which
is something that really does impose a level of control that
the market really warrants.
Mrs. Maloney. Also, as Chair of the House Committee on
Oversight and Reform, I launched an investigation with
Chairwoman Waters, and Representatives Engel and Clyburn, into
the Administration's $765 million loan to Kodak.
As part of our investigation, the Oversight Committee
continues to investigate the reasoning behind the U.S.
International Development Finance Corporation decision to
provide the loan, and whether they violated their own policies
and procedures, and whether Kodak shared any material nonpublic
information before the announcement was made public.
Now, this was the International Development Finance
Corporation. They gave it to a domestic corporation--that is a
violation there--and to a company that had no experience, zero,
in vaccines.
Kodak itself has acknowledged that it is under
investigation by the SEC, and this follows the unusual spike in
the trading of its stock just one day prior to the July 28th
announcement, on July 27th.
More than 1.6 million shares of Kodak were traded, more
than 6 times the average daily volume of shares a day during
the previous 30 days.
And while the increase in trading activity is reported as a
result of Kodak inadvertently releasing the news of the loan to
local news outlets--now, why did they do that--where it is
headquartered, Kodak waited until the following day to publicly
disclose the announcement.
Unless its stockholders were paying attention to social
media, Kodak effectively kept millions of shareholders in the
dark from the spike in trading activity.
So, Mr. Frenkel, do you see this as a potential violation
of Regulation Fair Disclosure (FD), which states that when
there is a, ``nonintentional disclosure,'' the issuer must
publicly disclose the information promptly and, if not, can
this sort of trading activity still be harmful to shareholders
and the market?
Mr. Frenkel. The answer, Congresswoman, is yes, there is a
potential for a violation of Regulation FD, which I believe the
SEC would include within the scope of its investigation.
I would also point out that as we look at the price of the
stock--I will be very brief on this--we are also dealing with
issues such as potential stock manipulation but also tipping--
were there other people who traded--and with the people who
potentially were selling--were involved on the put option side.
I believe all of these things are something that the SEC
will look at during the scope of its investigation.
Mrs. Maloney. When do you expect the investigation to be
completed?
Chairman Sherman. I believe the gentlelady's time has
expired. If there could be a one-sentence answer, we will hear
it, and then we will go on to Mr. Meeks.
Mr. Frenkel. I think SEC investigations on allegations such
as this easily could run 9 months to 12 to 15 months.
Chairman Sherman. Thank you.
Mrs. Maloney. I yield back. Thank you, Mr. Chairman.
Chairman Sherman. I now recognize the gentleman from New
York, Mr. Meeks.
Mr. Meeks. Thank you, Mr. Chairman. And thank you for
holding this important hearing.
I have been listening off and on to some of the witnesses
and some of my colleagues' questioning, and I think that what
we have here is, in the middle of this pandemic that just
killed hundreds of thousands of Americans, and I know that it
has devastated the economy and a number of other things, the
question that presents itself to us, though, is credibility,
and when we have a time of everybody questioning things,
especially when you have the President of the United States
questioning the scientists and doctors and when we are going to
have a vaccine and when we are not, whether or not everything
is on the up and up. We also deal with lies as we deal with
these pharmaceutical companies in the search for a vaccine.
And I agree that we need one sooner rather than later, and
I agree that individuals should be compensated for the
appropriate amount of work that they do.
As we know, there is no magic bullet. But a vaccine is an
effective and safe thing that we need, as well as wearing our
masks on a continuous basis as the doctor said in testimony
yesterday.
And so, I applaud all of the doctors, scientists, and
companies working on this crucial project.
So what it is is the importance of a vaccine is why it is
so unfortunate that we have--as I had indicated, the President
just yesterday contradicted his own CDC Director about when a
vaccine would be ready. So, I think we need to be building up
the confidence of the American people.
That brings me to where we are now, because there is also a
role, I think, for the capital markets and corporate governance
to step up because they have to understand the credibility
issue and have an important role to play here also.
I believe that we need leaders of these companies to have
their incentives structured toward producing a safe and
effective vaccine, but we also need laws that can foster some
productive arrangements while protecting the integrity of our
capital markets.
I will start with you, Ms. Fisch. What are some of the ways
you think that we can use corporate governance and combine it
with financial regulations to promote and encourage the
development of a safe and effective vaccine while also
protecting some of the market misbehavior that I hear a lot of
my colleagues talking about?
Ms. Fisch. Congressman, I wish I had an answer for that
question. I think the challenge that we all face is that yes,
in this environment we really want to preserve capital market
incentives.
We want to preserve compensation incentives. If some
company or some executive comes up with a vaccine, the whole
world is going to say yes, this is worth an awful lot of money
to us.
But corporate governance only gets you so far. Right now, I
think sort of the gap between corporate governance and science
is really wide and that is part of the struggle.
A company is taking baby steps and I hear the debate about,
well, companies should be precluded from awarding stock options
until they file an 8-K. A company may not know if this baby
step, the step with respect to testing progress, is going to
pan out.
Am I going to mislead investors if I say we are making
progress? Am I going to mislead investors if I don't talk about
the progress?
So, that is why I talked about this disclosure environment
being very challenging to manage, and I do think it comes down
to good corporate governance practices. But a lot of those
governance practices are internal.
How much is the board riding herd on all of this? How much
is the board paying attention both to what the company is
saying and to what its executives are doing? And so to a
certain degree, that is not about insider trading with
securities. It is not about fraud. But it is about best
practices.
Mr. Meeks. Thank you.
Mr. Martin. Can I just add something there?
Mr. Meeks. Go ahead.
Mr. Martin. I'm sorry, Congressman.
Mr. Meeks. Go ahead. I am out of time, but go ahead.
Mr. Martin. I would just add that a lot of our committees
have been trying to figure out how to--and have revised how
they use their procedures around their disclosure committees.
They add to those disclosure committees to try to add the
right kinds of perspectives, to get at what Ms. Fisch is
saying, how do you assess the materiality or particular
developments that, pre-pandemic, would not have risen to that
level?
Mr. Meeks. Thank you.
Let me ask another quick question. What I am noticing--I
had another one but I won't get to it--is that there has been a
growing trend for companies to go public, not by using the
traditional IPO process but, rather, through a reverse merger
with a special purpose acquisition company (SPAC), and I have
serious concerns about this new trend.
I wanted to know if you see any particular implications for
insider trading or other issues with SPACs. I'm just curious,
you can say yes or no, you have some concerns.
Mr. Frenkel. This is Jacob Frenkel. I could certainly
address that, very briefly.
Mr. Meeks. Please, if the chairman will allow.
Mr. Frenkel. The issue with reverse mergers is not just
SPACs. It is also with reverse mergers with, essentially,
dormant public companies. That is something that is a hot topic
issue for the SEC, and has been for probably 30 years, if not
longer. It is not an insider trading issue. It really is more
of a market structure issue.
Chairman Sherman. Thank you very much. The time of the
gentleman has expired. The next two questioners, I believe, are
both voting, and at the suggestion of staff, we are going to
take a 10-minute recess. We will reconvene in 10 minutes.
Thank you.
[brief recess]
Chairman Sherman. We will reconvene, and I believe Mr.
Gottheimer is next to be recognized for 5 minutes.
Mr. Gottheimer. Thank you, Chairman Sherman, and thank you
to all of our panelists for being here today.
When the pandemic first hit, my district in northern New
Jersey was in the eye of the COVID storm. New Jersey had the
second-highest rate of cases in the country, and the supply of
protective gear was uncertain.
Some health care providers estimated that supplies would
run out in a matter of days. Health providers called on the
Administration to use the Defense Protection Act (DPA) to
leverage America's manufacturing capacity to make sure the
necessary equipment was ready to keep fighting the pandemic.
Using the DPA is crucial in our fight against COVID.
However, I was just as surprised as many of us when the
International Development Finance Corporation (DFC) announced
that they would issue their first DPA loan worth $765 million
to Kodak to produce pharmaceutical components.
The DPA is finally being utilized, but to a company that
has only just recently left bankruptcy, with no proven success
record in pharmaceuticals being entrusted with such a important
task. Frankly, it is a joke.
Still, we know who was not surprised. Kodak's CEO purchased
46,737 shares of the company leading up to the announcement and
received 1.75 million stock options from the Kodak board the
day before the announcement was made.
These stock options may have been worth as much as $50
million just a few days later. I helped lead a letter from this
committee to the SEC urging an investigation surrounding these
transactions and market movement, and I was pleased to hear the
SEC has opened an investigation, that the DFC's inspector
general is investigating the origin of the loan.
Mr. Frenkel, knowing the circumstances around the loan, the
purchasing of the stocks by corporate insiders, the options
granted, the early leak of the announcement, would you say
there is a potential here for unlawful insider trading?
Mr. Frenkel. I think I would go beyond that. I think in
terms of potential violations, there is the potential that the
SEC could find a range of violations including in a disclosure,
in terms of trading, in terms of possibly even individuals
involved in manipulation.
We don't know, and I think the fundamental issue from my
perspective is we have to give deference to the SEC to allow it
to conduct its investigation.
I also think that we have to be mindful of one other thing,
which is that when we talk about the specific securities laws
violations, if we go back to insider trading enforcement in the
1980s and 1990s, those cases primarily were brought by the
Southern District of New York, charging it as wire fraud and
mail fraud.
So, there is also a broad range of Federal criminal
statutes that potentially can apply, even if there may not be a
specific SEC law or regulation that could fall within the scope
of a violation.
In terms of the potential scope of the investigation, I
think it is real. I think that, as I mentioned earlier, if you
look at the questions that were posed in the internal
investigation by outside counsel, they are very narrowly
framed.
I think to the committee's point, there still is plenty for
the SEC to look at, and there is the potential for the
Commission's Enforcement Division to find and recommend
enforcement action. But only time will tell.
Mr. Gottheimer. Thank you, sir. I appreciate that response.
Would you discuss a little more kind of the harm this
causes shareholders and potential harm here to shareholders and
capital markets and the taxpayers?
Mr. Frenkel. The core issue, one, is credibility.
Interestingly, I actually go back to the language of the
Securities Act of 1933.
When you look at the preamble of the 1933 Act, it is full
and fair disclosure of the character of securities sold to
interstate and foreign commerce through the mails and to
prevent frauds in the sale thereof.
I think everything that this committee is doing on a
bipartisan level is very much directed towards, and I support
it fully, enhancing disclosure to ensure that there is a level
of--the ability for the public, for participants, to have
confidence in our markets, and I think that continues to be,
really, the core issues: credibility; transparency; and
confidence.
Mr. Gottheimer. Thank you. Our country is clearly on the
cusp here of many questions that we need to get answers to, and
where I live, we are home to so many life sciences companies
that have decades of experience and success.
Now is not the time, clearly, to place bets, during a
public health crisis, on unproven entities that are unprepared
to help our nation through this pandemic, and I strongly agree
that a corporate insider shouldn't profit from these misguided
allocations of resources.
So, I look forward to our continued oversight. Thank you
very much for being here, sir.
Chairman Sherman. Thank you.
I now recognize the gentleman who brings extensive security
law experience to his service on this subcommittee, Mr. Casten.
[No response.]
Chairman Sherman. Mr. Casten, you are recognized for 5
minutes.
Mr. Casten. I apologize, Mr. Chairman. I didn't recognize
that I had all that extensive securities law experience and
didn't realize you were talking about me.
Thank you so much, Mr. Chairman, and thank you to our
witnesses for being here.
I want to start by making three statements that I think are
just factual and should be fairly nonobjectionable.
First, capital markets are not moral. Capital markets are
not immoral. Capital markets are amoral. They amorally
rationally allocate capital to places where we think there will
be future cash flows.
Second, rushing a vaccine to market too early is massively
dangerous to public health. If it is not tested on populations
who are healthy prior to taking the vaccine, it not only risks
our health from the vaccine but risks future certainty about
the trustworthiness of all vaccines.
And the third statement of fact, Operation Warp Speed has
distributed, I think, about $9 billion to developers of
vaccines, and the President of the United States is openly
touting that there will be a vaccine available by election day.
Those are facts. Given that amorality, a question for you,
Mr. Claypool, is it rational to assume that a company receiving
cash from Operation Warp Speed, when the President of the
United States is saying there will be a vaccine by the
election, is it rational for an amorally rational investor to
assume that that company might have an increase in near-term
cash flows?
Mr. Claypool. I think it is perfectly rational to think
that, as a result of good news, the company's value is going to
go up.
With that said, there is not a place for--in the greater
context of this crisis and seeing the idea that--I guess, one
could also argue that it is rational for an insider to exploit
insider information if they believe they could get away with
it.
Mr. Casten. I am not trying to ask you a ``gotcha''
question. I am glad you agree with the first part. Is it not
also rational to assume that if a company did see a surge in
cash flows from that good news, and a surge in their equity
value, but that the vaccine was subsequently proven to be
dangerous, that that company might face longer-term
liabilities, legal or otherwise, from bringing that to market
too soon?
Okay. So is it then not rational for an informed amoral
insider, looking at that information, to say, it is in my
amoral interest to participate in those markets? Buy now and
cash out quickly before that future liability comes home to
roost?
Mr. Claypool. I could see if there was a logic to that sort
of hedge. It strikes me as, I guess, more cynical than we would
hope the companies that we are relying on to develop vaccines
for all of us will be acting in this crisis.
I think we expect good faith development from those who do
the work. That is their core business purpose.
Mr. Casten. Yet, and I am in no way--I don't mean my
comments in any way to question the morality of the companies.
I am just making a comment about the nature of markets, that
are not immoral. But they are not moral either. They are just
making judgments. And I have concerns about the public health
risks of rushing a vaccine to market.
When we have insiders trading on this information, and
should the chickens come home to roost that we have rushed this
out too soon, what concerns do you have about what that does to
trust in our capital markets?
Mr. Claypool. I think it is very dangerous, and I also
would add that to the concern of spring-loading and those kinds
of issues, it is worth being concerned that good news could be
withheld until after those stock options are issued in a way
that executives are most able to exploit.
Mr. Casten. Thank you. I don't know what we do with this
other than that back in the days when I was a CEO of a company,
one of the--I had a professor in grad school who said the most
dangerous type of leadership is leadership based on knowledge,
because the preservation of power depends on limiting people
around you's access to information.
And I used to find, when I raised money on Wall Street, as
the chairman was praising me for, that Wall Street is a place
where information is power. Sadly, it is actually true of the
current job I have.
But I think we always need to keep our vigilance up in
industries like that where withholding information from other
people is a way to gain power.
Thank you, and I yield back.
Mr. Claypool. I agree.
Chairman Sherman. The gentlelady from New York, Ms. Ocasio-
Cortez, is recognized for 5 minutes.
Ms. Ocasio-Cortez. Thank you, Mr. Chairman, and thank you
for hosting this incredibly important hearing. I had a quick
question. So much of what we are discussing today has to do
with prospects of insider trading, and also tying CEO
compensation to stock, and my question for Mr. Claypool is,
when CEOs and corporate CEOs, pharmaceuticals and otherwise,
are compensated with stock packages and packages where an
enormous amount of money that they are being compensated in is
in stock options, how does that potentially influence decision-
making when it comes to the long-term health of a company or
long-term decisions for pharmaceuticals?
Mr. Claypool. Thank you, Congresswoman.
That is an interesting question, because so often, the
premise of issuing stock options as a way of paying executives
is intended to align the interests of a company with the
interests of shareholders.
And what we are seeing in instances such as we are
observing here, is that this intense short-termism encourages
ways for companies to look for ways to quickly raise the stock
price or to take advantage of volatile circumstances and pursue
a short-term gain.
There have been a variety of reforms that even companies
have self-enacted. Most companies, in the aftermath of the
scandal where companies were backdating their pay to--it was
kind of the opposite where they were kind of--they knew the
price of a stock would go up, so they would sort of shift the
date of the award backwards in time, was that many companies
sort of picked--in fact, I think most companies now pick a
select date to award those stock options.
That was a positive development. However, what studies are
now showing is that companies are trying to find ways to, say,
time bad news for before before the announcements or saving the
good news for after the set date they know the stock options
are made.
Now, every individual instance of this may have a very
plausible explanation for why they announced the news they did,
when they did, and the timing of the options.
But the reasons that I have just shown, 1,200 companies
that have this sort of V-shaped pattern in how they are paid,
and the pattern is even greater for companies who pay above
average amounts of stock options and for companies that are
hard to value because, like these pharmaceutical companies
whose--their real destinies are based on just the success or
failure of, often, a single drug being developed is a
circumstance that invites shenanigans, and I am happy that the
committee is looking into that, and hopefully will find ways to
thwart it.
Ms. Ocasio-Cortez. Absolutely.
Ms. Fisch. Congresswoman, could I just weigh in on that?
Ms. Ocasio-Cortez. Yes, absolutely.
Ms. Fisch. I'm sorry to interrupt. You identified concerns
about short-termism in trading opportunities. But I think the
academic literature reveals a bigger problem with option-based
compensation, which is that it makes operational decisions too
risky, and I think that relates to Congressman Casten's concern
about scientific development and particularly vaccines.
If you have stock options, that is a really high-powered
incentive to take risks so that your stock price balloons, and
I think in this environment, that is an extra caution that we
really have to worry about.
Ms. Ocasio-Cortez. Absolutely. So, would you say it is fair
to say that having these kinds of stock options could
incentivize riskier behavior when it comes to an industry like
pharmaceuticals, that could carry an elevated risk with it?
Ms. Fisch. Absolutely, and I think where we see particular
concern is in some of these companies that historically have
not been profitable, where their stock price is very low to
begin with and, therefore, the potential downside is very
limited but the potential upside is enormous.
Ms. Ocasio-Cortez. Thank you. Thank you very much.
And I have one last question for Mr. Frenkel. You have been
a prosecutor, and insider trading, and, perhaps, activities
that mirror or appear like insider trading, are not exclusive
to the private sector.
We have seen some questionable activity right here in
Congress, and I am really interested in your thoughts on the
2012 Stock Act, how it may fall short, and what are some of the
concerns that you think there are with respect to Congress and
Members of Congress engaging in behavior that could be seen as
or interpreted as insider trading?
Chairman Sherman. I will ask you to answer in just a couple
of seconds, because the time of the gentlelady has expired.
Mr. Frenkel. Thank you, Mr. Sherman.
I think the easiest way to answer that question succinctly
is that we look to the SEC and the Department of Justice,
through bringing their cases, to have a deterrent effect on
certain behavior.
So, absent there being such cases, there is always going to
be a perception that the law may not be sufficiently effective.
I think at this point, we have to defer to the investigations
and see if they result in enforcement actions that, in turn,
will send a message about the level of commitment to
enforcement of such laws.
Chairman Sherman. Thank you. Thank you very much.
I see no other members who have not been recognized. I am
informed that all members of the subcommittee who wish to
participate have been able to ask questions.
Mr. Huizenga. Mr. Chairman, I am trying to get your
attention so that I can submit an article for the record.
Chairman Sherman. The gentleman is recognized.
Mr. Huizenga. Thank you, and it actually fits perfectly
with what my colleague from New York was talking about, as well
as Mr. Frenkel and others.
This is a November 2019 Reuter's article. The headline is,
``U.S. SEC enforcement activity hits second-highest level ever
in 2019,'' and the article goes on to explain what the SEC has
been doing on enforcement.
So, I would like to submit that for the record.
Chairman Sherman. Without objection, it is so ordered.
Mr. Huizenga. Thank you.
Chairman Sherman. Again, seeing no Members who have not
been recognized, I would like to thank our witnesses for their
testimony. I think today, we have learned that, especially
during an outbreak of COVID, we need to make sure that insiders
don't deal unfairly with the investing public and don't profit
from not-yet-disclosed material information.
I look forward to working with my colleagues to achieve
those objectives and, hopefully, the SEC will not only continue
the enforcement efforts that Mr. Huizenga pointed out, but will
look at some of the issues brought up in this hearing in the
areas that are perhaps wrongful but legal.
The Chair notes that some Members may have additional
questions for this panel, which they may wish to submit in
writing. Without objection, the hearing record will remain open
for 5 legislative days for Members to submit written questions
to these witnesses and to place their responses in the record.
Also, without objection, Members will have 5 legislative days
to submit extraneous materials to the Chair for inclusion in
the record.
This hearing is now adjourned. Thank you.
[Whereupon, at 2:29 p.m., the hearing was adjourned.]
A P P E N D I X
September 17, 2020
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