Insider Trading in a Globalizing Market: Who Should Regulate What?

As the market for securities becomes increasingly global, the question of whose rules should apply to any particular transaction will arise with increasing frequency. The issue is examined

Lessons from Fiascos in Russian Corporate Governance

"Bad corporate governance" is often invoked to explain poor enterprise performance, but the catch phrase is never precisely defined - neither its consequences for the real economy, nor its causes in particular countries has been adequately explained. This paper uses Russian enterprise examples to address these open questions in corporate governance theory. We define corporate governance by looking to the economic functions of the firm rather than to any particular set of national corporate laws. Firms exhibit good corporate governance when their managers maximize residuals and, in the case of investor-owned firms, make pro rata distributions to shareholders. First, using this definition, we develop a typology that shows the channels through which bad corporate governance can inflict damage on the real economy. The topology helps identify vulnerabilities to corporate governance problems that may appear in any country and it suggests a new way to tailor policy responses. Second, we explain the causes of poor corporate performance in Russia by looking to the particular conditions prevailing at privatization - untenable initial firm boundaries and insider allocation of firm shares - and the bargaining dynamics that followed. The focus on initial conditions helps expand a comparative corporate governance literature built on United States, Western European, and Japanese models. Lessons from Russian fiascos counsel caution as to "stakeholder" proposals - including labor or local communities in formal corporate governance - and generate testable hypotheses regarding potential losses from the multiple large block share ownerships typical of many U.S. firms, especially close corporations.

Required Disclosure and Corporate Governance

This article demonstrates that required disclosure can play an important role in corporate governance. It assists shareholders in effectively exercising their voting franchise and enforcing management's fiduciary duties. It also affects positively four of the economy's key mechanisms for controlling corporate management: the market for corporate control, share price-based managerial compensation, the cost of capital, and monitoring by external sources of finance. In so doing, it improves the selection of proposed new investment projects in the economy and the operation of existing facilities. Finally, it may improve managerial performance simply by forcing managers to become more aware of reality

After \u3cem\u3eDura\u3c/em\u3e: Causation in Fraud-on-the-Market Actions

On April 19, 2005, the Supreme Court announced its unanimous opinion in Dura Pharmaceuticals, Inc. v. Broudo, concerning what a plaintiff must show to establish causation in a Rule lob-5 fraud-on-the-market suit for damages. The opinion had been awaited with considerable anticipation, being described at the time of oral argument in the Financial Times, for example, as the most important securities case in a decade. After the opinion was handed down, a representative of the plaintiffs\u27 bar lauded it as a unanimous ruling protecting investors\u27 ability to sue. A representative of the defendants\u27 bar equally enthusiastically hailed it as a significant victory for public companies and others named as defendants in securities fraud cases. This Article seeks to ascertain the opinion\u27s real significance and to provide a framework for resolving the issues that remain open to be decided by future courts. In the tradition of Bob Clark\u27s treatment of Rule lOb-5 issuer misstatement cases, this framework recognizes that these issues involve difficult tradeoffs that defy perfect solutions. The Supreme Court\u27s grant of certiorari in Broudo v. Dura Pharmaceuticals came against the backdrop of years of highly confusing lower court decisions concerning what a plaintiff needs to show to establish causation in a fraud-on-the-market suit. This confusion had arisen, I will argue, because the lower courts had tried to analyze causation in fraud-on-the-market cases using the twin concepts of transaction causation and loss causation. These concepts had been originally developed in connection with causation determinations in cases based on traditional reliance. Traditional reliance-based cases, unlike fraud-on-the-market cases, involve the plaintiff establishing that defendant\u27s misstatement induced the plaintiff to enter into what has turned out to be a losing transaction. In such cases, transaction causation was satisfied by the very showing of traditional reliance, i.e., that the plaintiff would not have purchased but for the misstatement. Loss causation in these cases involved, in turn, an additional showing that the purchased security declined in value from what was paid (or was sold at a loss) and that the decline or loss was in some way reasonably related to the falsity of the statement that induced the purchase. The function of the loss causation requirement, like the function of proximate cause in actions for negligence, was to prevent the wrongdoer from being responsible for all the consequences for which his action was a but for cause, i.e., all the losses, however unrelated to the misstatement, that the plaintiff might suffer over time as a result of purchasing this security

The Role of the Market Model in Corporate Law Analysis: A Comment on Weiss and White

In a recent article, Elliott Weiss and Lawrence J. White sought to establish that seven decisions of the Delaware courts concerning corporation law had little value in predicting the future conduct of courts and corporations under the Delaware Corporations Law. Weiss and White relied, in part, on a statistical analysis of changes in the prices of publicly traded shares in Delaware corporations to show that the seven studied decisions had no statistically significant market impact. In this Comment, Professor Fox takes issue with the explanation Weiss and White give for their data. Although the absence of an observed market impact might demonstrate the insignificance of the judicial decisions, Fox argues, it more likely demonstrates the limited capacity of market studies to reveal changes in the actual value of shares of stock resulting from such decisions. In Part I, Fox states and defends his assumption that judicial decisions do have predictive value regarding the future conduct of courts and corporate actors. In Part II, he examines the justifications offered for the conclusion that market study techniques provide reliable evidence that the seven decisions Weiss and White studied had no impact on share value. In Part III, he argues that the market model is not well equipped to discern the significance of events like judicial decisions. Finally, in Part IV, Professor Fox examines the significance of the results of the Weiss and White study for the current debate among corporate scholars concerning the contractual model of corporate law

Insider Trading Deterrence Versus Managerial Incentives: A Unified Theory of Section 16(b)

Part I of this article assesses the social costs of a crude rule of thumb. Because section 16(b) applies to a given class of paired transactions, it deters both transactions based on inside information and transactions not so based. Each time section 16(b) is stretched to include a class of paired transactions, it deters some additional innocent transactions. This side effect will take the form of officers\u27 and directors\u27 purchasing fewer shares in their own companies and refusing to accept as large a portion of their compensation in a form based on share price. There are strong theoretical and empirical reasons to believe that managerial share ownership and share-price based compensation are important to the proper functioning of our economy because of the significant incentives they provide for aligning the otherwise divergent interests of management and \u27shareholders. The weakening of these incentives is a social cost of including a given class of paired transactions within the reach of section 16(b ). Part II develops a theory of how a penalty on short-swing trades works in the case of transactions clearly covered by the statute ordinary cash purchases and sales of securities. It utilizes portfolio theory - the mainstay of modem financial economics - to predict the effect of a short-swing penalty on the respective behaviors of insiders who are and who are not trading on inside information. The fact that transactions occur within six months of each other increases the likelihood that one of them is based on inside information - an increase that is significant over a wide range of plausible values for the relevant parameters. Imposing a penalty on short-swing transactions discourages trades based on inside information by forcing those who would engage in them to remain dediversified for six months and hence to be at greater financial risk than they would be without the statute. This theory of section 16(b )\u27s operation, it will be shown, suggests that purchase and sale should be defined in terms of when the increase in portfolio risk is assumed and when it ends. This theory suggests that the statute should only be concerned with the possibility of abuse at the time of the first transaction. Part III employs the lessons of Parts I and II to solve the actual problems faced by the SEC and the courts in applying section 16(b) to cases other than pairs of ordinary cash-for-security transactions clearly covered by the statute. It begins by proposing an overall principle of statutory reach derived from the statute\u27s internal logic, from other evidence of congressional intent, ~md from a concern for economic efficiency: a given class of paired transactions should be included within the coverage of section 16(b) only if the potential officer-and-director transactions belonging to the class, because they are separated by less than six months, contain a larger portion of transactions motivated by inside information than do potential officer-and-director transactions generally. Guided by the theory developed in Part II, this overall principle of statutory reach is then applied to a number of hypothetical examples. This approach is compared with the approaches used by the courts and the SEC dealing with the same issues. As will be seen, the approach based on the theory developed in Part II suggests simple, clear, supportable solutions to a number of problems with which the courts and the SEC have struggled for decades

Gatekeeper Failures: Why Important, What to Do

The United States was hit by a wave of corporate scandals that crested between late 2001 and the end of 2002. Some were traditional scandals involving insiders looting company assets - the most prominent being Tyco, HealthSouth, and Adelphia. But most were what might be called financial scandals : attempts by an issuer to maximize the market price of its securities by creating misimpressions as to what its future cash flows were likely to be. Enron and WorldCom were the most spectacular examples of these financial scandals. In scores of additional cases, the companies involved and their executives were sued by the Securities and Exchange Commission ( SEC ), and, in a number, executives were criminall prosecuted (p. 15). Hundreds of issuers were forced to restate their financial statements (p. 15). Why did this rash of financial scandals occur and what lessons for reform can be learned from the explanation? These are the questions addressed by Professor John Coffee in Gatekeepers: The Professions and Corporate Governance

Thinking to be Paid v. Being Paid to Think

How much deference should be given to the views of those who back them up with cash, and how much to the regulators and academics who are paid to think? This essay is based on a speech delivered to The Journal of Corporation Law annual banquet in Iowa City on March 4, 1994. In the first chapter of The Economic Structure of Corporate Law, Frank Easterbrook and Daniel Fischel make an arresting statement: ... [P]eople who are backing their beliefs with cash are correct; they have every reason to avoid mistakes, while critics (be they academics or regulators) are rewarded for novel rather than accurate beliefs. Market professionals who estimate these things wrongly suffer directly; academics and regulators who estimate wrongly do not pay a similar penalty. Persons who wager with their own money may be wrong, but they are less likely to be wrong than are academics and regulators, who are wagering with other peoples\u27 money. In other words, society should trust decisions to people who put their money where their mouths are. When I first read this passage, I was a bit perturbed. Now that Easterbrook and Fischel had published the book that pulled together their many important contributions to corporate law, it looked like they wanted to put the rest of academia out of business. More dispassionate reflection, however, reveals that there is something to what they have to say

Civil Liability and Mandatory Disclosure

This Article explores the efficient design of civil liability for mandatory securities disclosure violations by established issuers. An issuer not publicly offering securities at the time of a violation should have no liability. Its annual filings should be signed by an external certifier – an investment bank or other well-capitalized entity with financial expertise. If the filing contains a material misstatement and the certifier fails to do due diligence, the certifier should face measured liability. Officers and directors should face similar liability, capped relative to their compensation but with no indemnification or insurance allowed. Damages should be payable to the issuer, not traders in its shares, because the true social harm from issuer misstatements is poor corporate governance and reduced liquidity. A trader is as likely to be a gainer by selling, as a loser by buying, at the misstatement-inflated price. An issuer publicly offering securities at the time of a violation should be liable to purchasers for the resulting inflation in price. Such liability is an antidote to what otherwise would be an extra incentive not to comply. This design would increase incentives for U.S. issuers to comply with periodic disclosure rules. At the same time, litigation-expensive fraud-on-themarket class actions would be eliminated. So would underwriter liability for lack of due diligence, a sharply diminishing spur for disclosure given the speed of modern offerings. For countries considering implementation of securities disclosure civil liability systems for the first time, this design helps them get it right from the start

The Securities Globalization Disclosure Debate

A global market is developing for the shares of an increasing portion of the world’s 41,000 publicly-traded issuers. This trend has given rise to an active debate concerning what United States policy should be toward regulation of their disclosure practices. This Article is a comment on this debate through the eyes of an active participan