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CALIFORNIA CORPORATE & SECURITIES LAW

Unilateral Disarmament, The Prisoners’ Dilemma And SEC Staff Comment Letters

In an arms race, each suffers the worst result if it disarms and the other side remains armed.  However, if both sides are armed, they are not as well off as when both sides are disarmed.  This is, of course, the classic “Prisoners’ Dilemma” game (see table below).

Much the same logic applies to the SEC’s insistence that issuers include the “Tandy Letter” language when responding to staff comments.  This language forces unilateral disarmament by requiring issuers to state that they may not assert staff comments in any proceeding initiated by any person under the U.S. federal securities laws.  See Is Forced Speech In Responding To Staff Comment Letters Inaccurate Speech?  Disarmament is unilateral because class action plaintiffs’ attorneys are not required to disavow the use of comment letters in litigation.  Indeed, one doesn’t have to search very far to find examples of the plaintiffs’ bar use of SEC comment letters:

Pa. Pub. Sch. Employees’ Ret. Sys. v. Bank of Am. Corp., 939 F. Supp. 2d 445 (S.D.N.Y. 2013) (“Specifically, Plaintiff argues that an SEC comment letter indicates that Cotty and Noski were knowingly responsible for the weakness in internal controls.”)

In re Bear Stearns Cos., Inc. Sec., Derivative, & ERISA Litig., 763 F. Supp. 2d 423, 522 (S.D.N.Y. 2011) (Complaint alleging that SEC comment letter stated that “material information”  was not disclosed in 2006 10-K, including a comprehensive analysis of Bear Stearns ‘ exposure to subprime loans).

As far as I know, the SEC has not presented a legal basis for requiring issuers to disavow the defensive use of staff comment letters when there is no such restraint imposed on the plaintiffs’ bar.

 

Issuers

 

Disarm

Arm

Disarm

2,2

0,3

Plaintiffs

Arm

3,0

1,1

The above table illustrates the classic Prisoners’ Dilemma game.  The payoff values are arbitrary and for the sake of illustration.  A plaintiff’s dominant strategy is to “arm” (i.e., use SEC comments).  If the plaintiff uses SEC comments and the issuer does not, it will be better off (a payoff of 3 versus 2).  The plaintiff is also better off using SEC comments even if the issuer also uses comments (a payoff of 1 versus 0).  It seems to me that the effect of the “Tandy Letter” is to force an outcome in which the plaintiff is armed and the issuer disarmed.

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