Securities 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.

Andrew Walker

What kind of whistleblowing should the Dodd-Frank Act protect? In Asadi v. G.E. Energy (USA), L.L.C., the Fifth Circuit held that Dodd-Frank’s antiretaliation provisions extend only to whistleblowers who report information externally, an interpretation of the statute that leaves “internal whistleblowers” unprotected. At first glance, such a ruling, by minimizing protection for whistleblowers, appears likely to result in negative consequences. This Note argues, however, that the Fifth Circuit put forward a rule that not only rests upon a legitimate interpretation of the Dodd-Frank Act but that also may have positive real world consequences. Such consequences, this Note argues, include better channeling of information to the SEC, incentivizing a stronger “tone at the top” within corporations, and minimizing opportunities for corporations to mask wrongdoing.

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.

Robert B. Ahdieh

The analysis herein arises from the collision course between the sweeping reforms mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and a single sentence of the U.S. Code, adopted nearly fifteen years earlier and largely forgotten ever since. Few were likely thinking of Section 106 of the National Securities Market Improvement Act when the Dodd-Frank Act was enacted on July 21, 2010. As applied by the D.C. Circuit less than a year later in Business Roundtable v. SEC, however, that provision’s peculiar requirement of cost-benefit analysis could prove the new legislation’s undoing.

To help navigate this potential impasse, the Article that follows suggests the need to more carefully analyze the function and form of the cost-benefit analysis mandate in Section 106 and develops a generally applicable framework for doing so. Discussions of cost-benefit analysis have traditionally approached it as a fairly singular phenomenon—with broad aspirations of “efficiency” as its purpose and with its application in environmental and risk regulation understood to capture its form. In reality, cost-benefit analysis is both more ad hoc—and more systematically varied—than this account suggests.

The framework proposed herein thus makes an important contribution to our understanding of the complexities and varieties of cost-benefit analysis generally. In the particular case of Section 106, meanwhile, it counsels a distinct function and particular characteristics of form that will better direct its application—both to the myriad regulations mandated by the Dodd-Frank Act and beyond. Properly understood, Section 106 is designed to encourage SEC attention to substantive considerations that might otherwise be neglected, given the Commission’s traditional focus on investor protection. As to form, Section 106 constitutes a true mandate and one properly subject to judicial review. Contrary to the analysis in Business Roundtable, however, that mandate is procedural rather than substantive in nature. By comparison with formal cost-benefit analysis, it is less rigidly quantitative. It does, however, demand careful attention to the distributional impacts of relevant rulemaking. To such particularized ends and in such tailored form, ultimately, cost-benefit analysis has the potential to generate significant insight—both under Section 106 and for financial regulation as a whole.

Marlon A. Layton

In recent years, financial economists have authored an influential series of articles that link strong minority shareholder protection—exemplified by private enforcement of securities regulations—to greater financial market development. Their findings, which suggest that transition economies seeking larger financial markets should reform their legal institutions so as to strengthen private enforcement, have practically become conventional wisdom, and provide support for those who argue that China needs to improve investors’ ability to sue listed companies in order to encourage growth in its financial markets. This Note argues, however, that in China’s current legal and political environment, various obstacles preclude private enforcement from playing a significant role in market regulation. A more viable strategy would be to strengthen public enforcement. It is more likely to be effective in China’s current environment, will improve investor protection, and has been shown to have positive effects on market development.

Lee Harris

Economic theory that suggests underperforming boards of directors should be
fearful of an ouster vote by shareholders underappreciates the complexity of shareholder
voting decisions. Skill at enhancing firm value has less to do with whether
directors win votes and stay at the helm of public companies than previous commentators
have presumed. Instead, like incumbent politicians, managers of some of
the largest U.S. firms tend to stay in charge of firms because they understand—and
take advantage of—the political dynamics of corporate voting. This Article presents
a competing theory of shareholder voting decisions, one that suggests that shareholder
voting in corporate elections is not dissimilar from citizen voting in political
elections. Next, the Article presents the evidence. Using a hand-collected dataset
from recent board elections, the Article compares the explanatory power of a standard
economic variable (long-term stock price returns) and a political variable
(money budgeted for campaigning) on election outcomes. Based on the data, directors’
ability to enhance firm value (as measured by stock price returns) is not significantly
related to whether they win reelection. Rather, the likelihood of being
returned to office appears to be a function of typical election politics—how much
was spent by challengers to persuade shareholder voters. These findings have at
least two implications. First, the theory that shareholder voting may be politicized
helps point the way to how the SEC ought to craft reforms—and, just as important,
how not to craft them. Recent SEC reform efforts have the laudable goals of creating
new conduits for shareholders to participate in firm affairs, increasing
shareholder-nominated candidate success, and disciplining incumbent managers.
The results of this study suggest that these reforms will not achieve the stated goals.
Even with these reforms, the board continues to have an important political advantage,
which likely translates into real votes. As the research here shows, the outcome
of elections depends on persuasion and, not simply, as the SEC contends, on shareholders’
director nominees being presented alongside those of management.
Second, the evidence and theory about shareholder voting presented here has significant
implications for understanding mergers and acquisitions, particularly hostile
acquisitions. The theory is that acquirers have steep incentives to target firms
with poor performance. In most cases, however, such acquisitions depend on winning
a vote from shareholders. Thus, if there is any disciplinary effect created by the
prospect of takeovers, it depends crucially on understanding what motivates shareholder
voting behavior. If voting shareholders respond to political motivations, not
economic ones, then the performance of target board members might not be as
relevant as takeover theorists had previously surmised.