Commercial Law

Dan Awrey

These are not your parents’ financial markets. A generation ago, the image of Wall Street was one of floor traders and stockbrokers, of opening bells and ticker symbols, of titans of industry and barbarians at the gate. These images reflected the prevailing view in which stock markets stood at the center of the financial universe. The high point of this equity-centric view coincided with the development of a significant body of empirical literature examining the efficient market hypothesis (EMH): the prediction that prices within an efficient stock market will fully incorporate all available information. Over time, this equity-centric view became conflated with these empirical findings, transforming the EMH in the eyes of many observers from a testable prediction about how rapidly new information is incorporated into stock prices into a more general—and generally unexamined—statement about the efficiency of financial markets.

In their seminal 1984 article The Mechanisms of Market Efficiency, Ron Gilson and Reinier Kraakman advanced a causal framework for understanding how new information becomes incorporated into stock prices. Gilson and Kraakman’s framework provided an institutional explanation for the empirical findings supporting the EMH. It has also played an influential role in public policy debates surrounding securities fraud litigation, mandatory disclosure requirements, and insider trading restrictions. Yet despite its enduring influence, there have been few serious attempts to extend Gilson and Kraakman’s framework beyond the relatively narrow confines in which it was originally developed: the highly regulated, order-driven, and extremely liquid markets for publicly traded stocks.

This Article examines the mechanisms of derivatives market efficiency. These mechanisms respond to information and other problems not generally encountered within conventional stock markets. These problems reflect important differences in the nature of derivatives contracts, the structure of the markets in which they trade, and the sources of market liquidity. Predictably, these problems have led to the emergence of very different mechanisms of market efficiency. This Article describes these problems and evaluates the likely effectiveness of the mechanisms of derivatives market efficiency. It then explores the implications of this evaluation in terms of the current policy debates around derivatives trade reporting and disclosure, the macroprudential surveillance of derivatives markets, the push toward mandatory central clearing of derivatives, the prudential regulation of derivatives dealers, and the optimal balance between public and private ordering.

Jack L. Millman

Jurisdictions have been liberalizing rules surrounding third-party litigation funding or the buying and selling of legal claims since the early twentieth century. Scholars have generally supported liberalization, seeing it as a way to expand access to courts and allow for the more efficient allocation of risk. Opponents have warned about a surge in frivolous litigation and strategic behavior by funders. But both sides have ignored how interrelated the rules governing third-party investment in litigation and the alienability of legal claims are, and how they interact to affect a legal claims market. The focus on reform should be to adjust these rules to create the optimal legal claims market. Instead, reform has increasingly focused on liberalizing third-party investment while keeping rules around alienability the same, or even barring investors from exercising control over the suit. This risks creating new problems without effectively solving many of the issues reform is meant to solve. This incremental approach comes with real costs, and may actually prevent a well-developed legal claims market from developing.

Alex B. Lipton

Consumer products increasingly record the content of user communications without regard to whether the recorded individual is the primary user—the purchaser of the product—or the secondary user—an individual who uses the product but is not the purchaser. The distinction between primary and secondary users proves significant when considering the enforceability of the product’s privacy policy, which purports to establish user consent to the collection of communications content but is only agreed to by the primary user, and protections available under federal and state statutes, many of which prohibit the recording of communications content without consent, and may thus benefit secondary users. This Note analyzes several privacy policies accompanying communications-capturing technologies as well as state eavesdropping laws and the Electronic Communications Privacy Act to demonstrate that the current consumer privacy regime does not adequately protect secondary users of communications-capturing technologies.

In designing protections for secondary users, this Note argues against requiring companies to provide front-end protection through notice of their privacy policies. Instead, this Note proposes a framework for incentivizing communications-capturing technology producers to distinguish between primary and secondary user data use on the back end.

David H. Webber

The recent financial crisis has jeopardized the retirement savings of twenty-seven million Americans who depend on public pension funds, leading to cuts in benefits, increased employee contributions, job losses, and the rollback of legal rights like collective bargaining. This Article examines ways in which public pension funds invest against the economic interests of their own participants and beneficiaries, and the legal implications of these investments. In particular, the Article focuses on the use of public pensions to fund privatization of public employee jobs. Under the ascendant—and flawed—interpretation of the fiduciary duty of loyalty, public pension trustees owe their allegiance to the fund itself, rather than to the fund’s participants and beneficiaries, notwithstanding the fact that the duty of loyalty commands trustees to invest “solely in the interest of the participants and beneficiaries” according to ERISA and similar state pension codes. I argue that this “fund-first” view distorts the duty of loyalty and turns the role of trustee on its head, leading to investments that undermine, rather than enhance, the economic interests of public employees. I turn to ERISA, trust law, agency law, and corporate law to argue that public pension trustees should consider the impact of the funds’ investments on the jobs and job security of the funds’ participants and beneficiaries, where relevant. I also adduce evidence that these controversial investments are widespread. I propose that public pension funds be governed by a “member-first” view of fiduciary duty focused on the economic interests of public employees in their retirement funds, which go beyond maximizing return to the funds. I argue that this view is more faithful to the original purpose of the duty of loyalty than is the fund-first view. I suggest ways to implement the member-first view, discuss potential extensions beyond the jobs impact of investments, and assess the proposed reform’s practical effects.

Daniel Michaeli

A federal law known as the Jones Act imposes citizen ownership and control requirements on owners and operators of ships that transport goods between U.S. ports. Scholars have consistently presumed that these requirements are enforceable. This Note demonstrates, however, that limiting foreign ownership in companies with widely dispersed shareholders has become legally and practically infeasible in modern U.S. securities markets. It sheds light for the first time on the Seg-100 program of the Depository Trust Company, which aims to resolve this problem but would ultimately, even with substantial changes, be unable to discern the citizenship of entities that are not natural persons—a vast majority of shareholders. After considering the Jones Act’s ownership and control restrictions in the context of U.S. national security and economic interests, the Note finds that both practical considerations and U.S. interests support elimination of the citizen ownership and control requirements. Recognizing that Congress may be unwilling to invite unrestricted foreign investment in coastwise shipping, it also proposes more limited reforms to foreign ownership limitations and administrative actions that could reduce, but not eliminate, unnecessary costs of the current system.

Arin H. Smith

In 2010, the economy was reeling from an economic recession that particularly affected low-income consumers. One law, known as the Durbin Amendment, sought to protect consumers by regulating the fees that financial institutions charge merchants each time a customer uses a debit card. This Note examines the amendment’s effects, arguing that it has ultimately raised the costs of banking for low-income consumers. Due to complex banking disclosures and the structure of the regulations, these increased costs have not been offset by increased transparency or lower retail prices. This Note recommends specific changes to the Durbin Amendment that will better support its stated goals. However, because these changes cannot entirely mitigate the negative effects, this Note recommends that Congress also pass legislation to improve access to banking for low-income consumers.

Joseph A. Tillman

The history of the U.S. financial markets is peppered with economic crises. A few scholars have argued that in the wake of these events, the combination of widespread media attention and a flurry of congressional action has led to the hurried creation of sweeping remedial legislation. Indeed, these scholars maintain that in seeking to put out the flames of panic and financial instability, such regulations have often been mismatched to the problems they intended to address. My Note enters the fore and argues that the Volcker Rule and the amendments to the Investment Advisers Act of 1940, promulgated in response to the Financial Crisis of 2008 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, are examples of financial market regulation that go beyond the concerns that led to their enactment. Specifically, this Note explores these regulations as they apply to private equity (PE) funds and contends that they each bring the PE industry within the purview of regulatory scrutiny in a way that may have negative implications for our economic recovery. While the need to be forward-looking remains present in any legislative scheme, this Note takes the position that we are currently facing uncertain economic times that require a response more closely tied to the conduct that led to the Crisis.

Misty L. Archambault

Forestry certification seeks to lessen the environmental impacts of private forestry management practices by providing information to consumers. Certified producers attach a uniform label to their wood products to assure buyers that the products were produced in a sustainable manner. In the United States, forestry certification has existed for more than a decade, yet industry participation in such programs remains low. This Note argues that low industry participation results from a lack of consumer demand for certified forestry products and the failure of certification stakeholders to address this lack of demand. While there are many obstacles to increasing consumer demand, this Note suggests that brand management concepts taken from the field of marketing can help tackle these challenges and, in turn, help increase market acceptance of forestry certification in the United States.

Joanna Warren

In its en banc decision in LePage's Inc. v. 3M, the Third Circuit held that a 3M loyalty rebate program, which provided above-cost price discounts to customers who purchased multiple 3M product lines, violated section 2 of the Sherman Act. Prior to this decision, many practitioners and scholars understood the antitrust case law to hold that a strategic pricing scheme would not violate section 2 so long as the discounted prices remained above cost. The Third Circuit found that this test applies only to predatory pricing cases, and ruled that claims alleging exclusionary conduct other than predatory pricing—as it characterized 3M's loyalty rebate program—are cognizable under section 2 even without a showing of below-cost pricing. The Supreme Court recently denied certiorari in LePage's, leaving the issue in the hands of the lower courts. In this Comment, Joanna Warren criticizes the Third Circuit's decision as lacking sufficient economic analysis of the rebate scheme and providing unclear guidance for addressing future claims. She argues for the adoption of a test that would recognize above-cost pricing as generally legitimate while invalidating schemes that threaten to eliminate equally efficient competitors from the marketplace.

Einer Elhauge

The canonical law and economics view holds that corporate managers do and should have a duty to profit-maximize because such conduct is socially efficient given that general legal sanctions do or can redress any harm that corporate or noncorporate businesses inflict on others. Professor Elhauge argues that this canonical view is mistaken both descriptively and normatively. In fact, the law gives corporate managers considerable implicit and explicit discretion to sacrifice profits in the public interest. They would have such discretion even if the law pursued the normative goal of corporate profit-maximization because minimizing total agency costs requires giving managers a business judgment rule deference that necessarily confers such profit sacrificing discretion. Nor is corporate profit-maximization a socially efficient goal because even optimal legal sanctions are necessarily imperfect and require supplementation by social and moral sanctions to fully optimize conduct. Accordingly, pure profit-maximization would worsen corporate conduct by overriding these social and moral sanctions. In addition to being socially inefficient, pure profit-maximization would harm shareholder welfare whenever shareholders value the incremental profits less than avoiding social and moral sanctions. For companies with a controlling shareholder, that shareholder is exposed to social and moral sanctions and has incentives to act on them, and thus controlling shareholders are well-placed to decide when to sacrifice corporate profits in the public interest. In contrast, the structure of large publicly-held corporations insulates dispersed shareholders from social and moral sanctions and creates collective action obstacles to acting on any social or moral impulses they do feel. Thus, in public corporations, optimizing corporate conduct requires giving managers some operational discretion to sacrifice profits in the public interest even without shareholder approval because, unlike shareholders, managers are sufficiently exposed to social and moral sanctions. Managerial incentives toward excessive generosity are constrained by various market forces, which generally mean that any managerial decision to sacrifice profits in the public interest substitutes for more self-interested profit sacrificing exercises of agency slack. Managerial discretion to sacrifice profits is further constrained by legal limits on the amount of profit sacrificing, which become much tighter when market constraints are inoperable because of last-period problems. Managers should have donative discretion because courts cannot distinguish profit-enhancing donations from profit sacrificing ones, because shareholders are insulated from the social and moral processes that desirably generate the special donative impulses that arise from running business operations, and because otherwise managers would often inefficiently substitute more costly operational profit sacrificing decisions to avoid social and moral sanctions. This explains the legal requirement that corporate donations have a nexus to corporate operations. Antitakeover laws can partly be explained as necessary to preserve sufficient managerial discretion to consider social and moral norms.

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