Federalism and Investor Protection: Constitutional Restraints on Preemption of State Remedies for Securities Fraud

Abstract

The dual regulatory system developed for U.S. securities markets has provided the foundation for market confidence and market success. However, the paradox is that regulation breeds the success that breeds complacency that, in turn, breeds resistance to regulation. This cycle has been fully exploited by corporate issuers and their various high-tech support groups, with the result that their lobbying effort has overwhelmed opponents representing rank and file investors. Among the high-tech lobby’s major objectives, the preemption of private remedies traditionally afforded by state law, has been relentlessly pursued in the form of proposed “uniform standards” legislation that would federalize private causes of action for securities fraud.

This article begins with a brief description and analysis of the Private Securities Litigation Reform Act of 1995 and the National Securities Market Improvement Act of 1996. It then discusses the proposed uniform standards legislation [later enacted as the Securities Litigation Uniform Standards Act of 1998]. After analyzing the normative arguments for and against this legislation, the article turns to what the author perceives to be present and developing constitutional limitations. The author then concludes that despite the weight of normative arguments against preemption of investor remedies, predominant federalism postulates foreclose the proposed intrusion into investors’ tort remedies traditionally afforded by the states under centuries-old common law. Based upon his own “symmetrical analysis” of active and dormant Commerce Clause powers, the author proposes supplementation of the traditional “rational basis” scope of review of commerce power legislation with a “strict scrutiny” review where federal legislation, like the proposed uniform standards legislation, seeks to veto or significantly abrogate regulation in areas of traditional state concern.

Keywords: regulatory system, securities markets, securities, regulation, uniform standards, Private Securities Litigation Reform Act of 1995, National Securities Market Improvement Act of 1996, Securities Litigation Uniform Standards Act of 1998, preemption, investor protection, federalism

JEL Classification: G1, G2, K2, K20, K22