The Future of Price Distortion in Federal Securities Fraud Litigation

In its recent Halliburton decision, the Supreme Court focused on the role of price distortion in meeting the requirements for class certification in private securities fraud litigation. Accepting the argument that the fraud-on-the-market theory requires fraudulent information to have an effect on stock price, the Court reasoned that defendants should therefore be allowed to introduce evidence of lack of price impact in an effort to defeat class certification. Specifically, the Court suggested that defendants might introduce event studies as direct evidence that could sever the link between the misrepresentation and stock price. This conclusion, however, misapprehends the event study methodology. Specifically, the emphasis on event studies is misguided because the event studies proffered by defendants do not conclusively establish that the fraud did not distort stock price. More broadly, the limitations of existing quantitative methods suggest that they should not be the exclusive way of analyzing price distortion for purposes of class certification. Instead, the importance of price distortion suggests the need for greater consideration of materiality because a finding of materiality is an implicit determination that the information has the capacity to affect stock price

The Qualified Legal Compliance Committee: Using the Attorney Conduct Rules to Restructure the Board of Directors

The Securities and Exchange Commission introduced a new corporate governance structure, the qualified legal compliance committee, as part of the professional standards of conduct for attorneys mandated by the Sarbanes-Oxley Act of 2002. QLCCs are consistent with the Commission\u27s general approach to improving corporate governance through specialized committees of independent directors. This Article suggests, however, that assessing the benefits and costs of creating QLCCs may be more complex than is initially apparent. Importantly, QLCCs are unlikely to be effective in the absence of incentives for active director monitoring. This Article concludes by considering three ways of increasing these incentives

Why do retail investors make costly mistakes? An experiment on mutual fund choice

There is mounting evidence that retail investors make predictable, costly investment mistakes, including underinvestment, naïve diversification, and payment of excessive fund fees. Over the past thirty-five years, however, participant-directed 401(k) plans have largely replaced professionally managed pension plans, requiring unsophisticated retail investors to navigate the financial markets themselves. Policy-makers have struggled with regulatory interventions designed to improve the quality of investment decisions without a clear understanding of the reasons for investor mistakes. Absent such an understanding, it is difficult to design effective regulatory responses. This article offers a first step in understanding the investor decision-making process. We use an internet-based experiment to disentangle possible explanations for inefficient investment decisions. The experiment employs a simplified construct of an employee’s allocation among the options in a retirement plan coupled with technology that enables us to collect data on the specific information that investors choose to view. In addition to collecting general information about the process by which investors choose among mutual fund options, we employ an experimental manipulation to test the effect of an instruction on the importance of mutual fund fees. Pairing this instruction with simplified fee disclosure allows us to distinguish between motivation-limits and cognition-limits as explanations for the widespread findings that investors ignore fees in their investment decisions. Our results offer partial but limited grounds for optimism. On the one hand, within our simplified experimental construct, our subjects allocated more money, on average, to higher-value funds. Furthermore, subjects who received the fees instruction paid closer attention to mutual fund fees and allocated their investments into funds with lower fees. On the other hand, the effects of even a blunt fees instruction were limited, and investors were unable to identify and avoid clearly inferior fund options. In addition, our results suggest that excessive, naïve diversification strategies are driving many investment decisions. Although our findings are preliminary, they suggest valuable avenues for future research and important implications for regulation of retail investing

The Long Road Back: Business Roundtable and the Future of SEC Rulemaking

The Securities and Exchange Commission has suffered a number of recent setbacks in areas ranging from enforcement policy to rulemaking. The DC Circuit’s 2011 Business Roundtable decision is one of the most serious, particularly in light of the heavy rulemaking obligations imposed on the SEC by Dodd-Frank and the JOBS Act. The effectiveness of the SEC in future rulemaking and the ability of its rules to survive legal challenge are currently under scrutiny. This article critically evaluates the Business Roundtable decision in the context of the applicable statutory and structural constraints on SEC rulemaking. Toward that end, the essay questions the extent to which deficiencies in the SEC’s rulemaking process can accurately be ascribed to inadequate economic analysis, arguing instead that existing constraints impede the SEC’s formulation of regulatory policy, and that this failure was at the heart of Rule 14a-11. Bad rules make bad law, and Rule 14a-11 was a bad rule. This essay argues that the flaws in SEC rule-making are quite different, however, than those identified by the DC Circuit. Moreover, in the case of Rule 14a-11, Congress played a critical role by explicitly authorizing the SEC to adopt a proxy access rule. By substituting its own policy judgment for that of Congress, the DC Circuit threatens not just the ability of administrative agencies to formulate regulatory policy, but the ability of Congress to direct agency policymaking

Confronting the Circularity Problem in Private Securities Litigation

Many critics argue that private securities litigation fails effectively either to deter corporate misconduct or to compensate defrauded investors. In particular, commentators reason that damages reflect socially inefficient transfer payments—the so-called circularity problem. Fox and Mitchell address the circularity problem by identifying new reasons why private litigation is an effective deterrent, focusing on the role of disclosure in improving corporate governance. The corporate governance rationale for securities regulation is more powerful than the authors recognize. By collecting and using corporate information in their trading decisions, informed investors play a critical role in enhancing market efficiency. This efficiency, in turn, allows the capital markets to discipline management, producing a governance externality that improves corporate decision-making and benefits non-trading shareholders. As this article shows, this governance externality justifies compensating informed traders for their fraud-based trading losses

Measuring Efficiency in Corporate Law: The Role of Shareholder Primacy

The shareholder primacy norm defines the objective of the corporation as maximization of shareholder wealth. Law and economics scholars have incorporated the shareholder primacy norm into their empirical analyses of regulatory efficiency. An increasingly influential body of scholarship uses empirical methodology to evaluate legal rules that allocate power within the corporation. By embracing the shareholder primacy norm, empirical scholars offer normative assessments about regulatory choices based on the effect of legal rules on measures of shareholder value such as stock price, net profits, and Tobin’s Q. This Article challenges the foundations of using the shareholder primacy norm to judge corporate law. As this Article explains, existing legal doctrine and economic theory provide only limited support for shareholder primacy. Similarly, shareholder primacy cannot be justified as a necessary consequence of existing limits on the enforcement of management fiduciary duties. This Article demonstrates that, rather than defining the corporation’s objectives, the limited scope of a fiduciary duty claim provides a mechanism for institutional specialization in responding to the needs of different corporate stakeholders. Comparative institutional analysis suggests that the courts are uniquely positioned to protect the interests of shareholders in the context of inter-stakeholder conflicts. Implementation of this role through rules that grant shareholders a unique degree of judicial access does not privilege the interests of shareholders in the evaluation of firm value. The presence of other stakeholders, whose interests in the firm may not be reflected in an assessment of shareholder value, offers reasons to question the conclusions of existing empirical research. In addition, the measures of shareholder value typically employed by empirical scholars—particularly short-term stock price—are problematic as indicators of firm value and may reinforce inappropriate managerial decisions. This Article maintains that empirical scholars need to offer better and explicit justifications for their reliance on shareholder wealth and, more importantly, for their argument that shareholder wealth effects should dominate regulatory policy