Team Production and Securities Laws

In the seminal paper that this symposium celebrates, A Team Production Theory of Corporate Law, Margaret Blair and Lynn Stout made two related points. First, that Delaware law does not require shareholder primacy in public corporations. Rather, the broad deference afforded to the decisions of predominantly independent corporate boards of directors is consistent with a contrary theory, that of team production, or, as they call it, “the mediating hierarch” theory. The fundamental role of the board of directors is to mediate between the interests of various stakeholders that contribute to the corporation’s output. As a result, Delaware courts have repeatedly authorized board decisions that further the interests of stakeholders at the expense of shareholders’ short-term interests, so long as directors are pursuing the long-term interests of the corporation. Second, Blair and Stout assert that such an arrangement is more efficient than narrow shareholder primacy. Board decisions are protected by the business judgment rule, which allows and enables the board, without risk of liability, to further the interests of stakeholders because that increases overall social welfare. Blair and Stout’s positive and normative assessments that team production is a better fit with Delaware corporate law, and likely more efficient, are convincing. In my brief contribution, I draw on a closely related area of law—securities regulation—to make two related points. First, unlike corporate law, securities regulation can be described as requiring shareholder primacy, or at least investor primacy. This is important because securities compliance takes up more of directors’ and officers’ time than compliance with corporate law, and thus likely influences and informs their day-to-day decisionmaking to a greater degree than does corporate law. If so, perhaps the persistent dominance of shareholder primacy in corporate governance should not be surprising. Second, investor primacy in securities regulation and enforcement may produce efficient results for most securities activities, but produces suboptimal compliance and enforcement for the most heavily litigated and debated category of securities misconduct: accounting fraud. Empirical evidence on the economic consequences of fraudulent financial reporting suggests that the exclusive focus on shareholders is misplaced

Distortion Other Than Price Distortion

The fraud-on-the-market doctrine adopted in Basic Inc. v. Levinson (“Basic”) allows the plaintiff suing under Rule 10b-5 to satisfy the reliance requirement by showing that the market in which the security was traded was efficient and that she purchased the security at the market price during the period of the misrepresentation. If she succeeds, the plaintiff is entitled to two presumptions: first, that the misrepresentation distorted the price of that security, and second, that she purchased the security in reliance on that misrepresentation. In Halliburton Co. v. Erica P. John Fund, Inc. (“Halliburton II”), the Supreme Court considered a direct attack on Basic’s presumptions, and declined to do away with them. Judging by the volume of academic commentary to date, the most significant contribution of Halliburton II is a more pragmatic definition of market efficiency, which is the underlying mechanism that converts information about securities into their prices. To invoke the presumption of reliance in a fraud-on-the-market suit, plaintiffs no longer need to show that the market for a public company security is hyper-efficient, in that it fully and quickly impounds into stock prices all publicly available information, as some courts have required. Rather, the Court embraced the notion that market efficiency is a “matter of degree.” In this Article, I propose that much of Halliburton II’s second holding—that a defendant can prevent class certification by showing no statistically significant movement in the price of the security at the time of corrective disclosure—does nothing to improve the quality of securities class-action litigation, and could make it worse. Financial misreporting by public companies distorts more than just the price of the firms’ securities, and that distortion other than that affecting the prices of public securities can in some circumstances be more significant and economically wasteful than stock price distortion. This Article develops an analytical matrix that identifies possible combinations of distortions in the stock price and economic dislocation to suggest when fraud-on-the-market litigation is likely to insufficiently deter disclosure fraud. Based on empirical studies, this Article identifies the circumstances in which large economic distortions caused by false disclosures are likely to be particularly large. In light of these observations, the Article suggests that fraud-on-the-market litigation should not be understood primarily as a remedy for victimized shareholders, who can often eliminate the cost of fraud ex ante, but as a quasi qui tam cause of action available to purchasers and sellers of (usually equity) securities to police economically-harmful false disclosures by public companies. Even in cases where buyers and sellers of stock are not the class most significantly harmed by disclosure fraud, they nearly always suffer some identifiable losses, thus avoiding difficult evidentiary questions about standing. When viewed through this lens, many of the objections to securities litigation become moot and its virtues are revealed

Politics in Securities Enforcement

American securities enforcement agencies often face charges that they use their enforcement power to further political goals.\u27 Most recently, Standard & Poor\u27s credit rating agency claimed that the U.S. Department of Justice unfairly singled it out for prosecution for fraudulent credit ratings after it downgraded U.S. sovereign debt. The U.S. Securities and Exchange Commission (SEC or the Commission), too, has been accused of using its enforcement politically: of bringing enforcement actions to improve its political standing, to punish its detractors, or to deflect attention from negative reports about its activities; and of holding back investigations of politically-connected figures

Accountability for Nonenforcement

Changes in enforcement can move in more than one direction: enforcement can increase significantly as the Securities and Exchange Commission saw in the aftermath of the accounting scandals or the Madoff Ponzi scheme, and decrease precipitously, as evidenced at the Consumer Financial Protection Bureau under Acting Director Mick Mulvaney. There is no reason in constitutional or administrative law to treat changes in enforcement policy differently depending on whether enforcement increases or decreases. Policy choices raise similar questions about reviewability and accountability, regardless of whether they increase or decrease enforcement. They also raise symmetrical questions about fair notice and due process and about the separation of powers. We demand that agencies give reasons for changes in rules; reason giving seems appropriate for significant shifts in enforcement, in order to match given reasons with observed enforcement practices, and to subject those reasons to political scrutiny through media coverage and congressional attention, even when judicial review is not available or appropriate

Are the SEC\u27s Administrative Law Judges Biased? An Empirical Investigation

The Dodd-Frank Act significantly expanded the SEC’s enforcement flexibility by authorizing the agency to choose whether to bring an enforcement action in court or in an administrative proceeding. The change has faced strong opposition. Federal courts have enjoined several enforcement actions filed in administrative proceedings for constitutional infirmities, and cases are currently winding their way through the appellate process. But even if any constitutional problems were remedied, controversy would persist. Judges, lawmakers, practitioners, and academics have raised doubts as to whether litigation before administrative law judges (“ALJs”) is fair to defendants. In advancing their arguments, they have relied heavily on a series of reports published in the Wall Street Journal purporting to show that the SEC enjoys a home-court advantage in litigation before ALJs. As documented in this Article, the evidence offered by the Wall Street Journal is deficient and its conclusions unfounded. This Article compiles and analyzes a large dataset of all enforcement actions filed in fiscal years 2007 to 2015. Contrary to the claim advanced by the Wall Street Journal and critics of administrative adjudication, SEC litigation before ALJs remains rare. Although the number of contested actions filed in the administrative forum has increased since Dodd-Frank, this is mostly due to an increase in actions that could have been litigated before ALJs prior to the Dodd-Frank amendment. More significantly, there is no robust correlation between the selected forum and case outcome. Federal district court judges ruled for the SEC and against defendants in 88% of cases, whereas ALJs ruled for the SEC in 90% of cases. This finding does not imply that the type of forum in which the SEC litigates does not matter. Rather, there are significant empirical obstacles to finding any useful results by comparing case outcomes

Negotiating Executive Compensation in Lieu of Regulation

Published in cooperation with the American Bar Association Section of Dispute Resolutio