Current Issue

  • Volume 66,
  • Number 3 -
  • December 2016

Foreword

James D. Cox
David F. Levi
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Articles

James D. Cox: The Shareholders’ Best Advocate
Randall S. Thomas & Harwell Wells
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This Article explores the historical development of the academic analysis of corporate law over the past forty years through the scholarship of one of its most influential commentators, Professor James D. Cox of the Duke University School of Law. It traces the ways in which corporate law scholarship changed from the 1970s to the present, including the rise of economic theory and empirical work in the study of corporate law. It shows how Professor Cox’s early scholarship shaped and challenged economic orthodoxy, while his later work used empirical analysis to help corporate law become a more dynamic and richer field.

Throughout his career, Professor Cox’s scholarship has focused on the protection of shareholder rights. He has rebuffed contractarians’ attacks on shareholder protections using a variety of economic, psychological, and empirical techniques. Professor Cox’s support for investors has continued in the wake of financial-market crises, corporate scandals, and the challenges of globalization. He provides an outstanding example of how a thoughtful academic can influence theories and market conditions with several decades of valuable insights.

How Understanding the Nature of Corporate Norms Can Prevent Their Destruction by Settlements
James D. Cox
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Scholars have long celebrated the importance of norms in corporate law. Indeed, norms likely guide corporate actors more than the omnipresent threat of shareholder suits. This Article divides corporate norms into two distinct groups: aspirational norms and arbiter norms. Aspirational norms announce socially desirable objectives for corporate managers and encourage certain disclosure practices; arbiter norms identify distinct transactions for closer scrutiny by an independent body, the court. This Article shows that even though aspirational norms and arbiter norms serve different objectives, they share a common characteristic—overbreadth. This feature exists whether the norm is set forth by statute or found in judicial doctrine. Such overbreadth explains some, but by no means all, of the problems accompanying shareholder litigation, including the frequency of suits and inconsequential settlements. This Article also develops the paradoxes that accompany corporate norms.

The inherent overbreadth of both aspirational and arbiter norms can be of great assistance to their protection against inconsequential settlements. Using the recent decision In re Trulia, Inc. Stockholder Litigation, this Article addresses how courts can fulfill their role in the non-adversarial setting of the settlement hearing. When asked to approve a settlement, the court should anchor its scrutiny of the adequacy and reasonableness of a settlement in the norm that is central to the suit. By doing so, the court can more positively contribute to the ongoing development of corporate norms.

Using the False Claims Act to Remedy Tax-Expenditure Fraud
Ian Ayres & Robert McGuire
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The federal False Claims Act (FCA) may be a tool for combating fraudulent claims regarding tax expenditures. The FCA has been used to protect the public fisc by imposing liability upon anyone who makes a false or fraudulent claim relating to an expenditure of federal funds. A substantial share of government spending is implemented through tax credits and deductions granted to individuals and entities for taking particular actions promoted by the tax code—so-called “tax expenditures.” Funds subsidized by such tax expenditures can themselves be the objects of fraud. For example, a taxpayer could be defrauded of retirement funds that the government has indirectly subsidized through tax deductions granted to the defrauded taxpayer. This Article explores how the FCA might be invoked to combat fraud that targets the recipients of tax expenditures, as well as doctrinal counterarguments to such an application. We touch on the potential breadth of the FCA’s reach insofar as it encompasses such claims, as well as the prospect of using other whistleblower mechanisms to achieve similar results.

Adaptive Financial Regulation and RegTech: A Concept Article on Realistic Protection for Victims of Bank Failures
Lawrence G. Baxter
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Frustrated by the seeming inability of regulators and prosecutors to hold bank executives to account for losses inflicted by their companies before, during, and since the financial crisis of 2008, some scholars have suggested that private-attorney-general suits such as class action and shareholder derivative suits might achieve better results. While a few isolated suits might be successful in cases where there is provable fraud, such remedies are no general panacea for preventing large-scale bank-inflicted losses. Large losses are nearly always the result of unforeseeable or suddenly changing economic conditions, poor business judgment, or inadequate regulatory supervision—usually a combination of all three.

Yet regulators face an increasingly complex task in supervising modern financial institutions. This Article explains how the challenge has become so difficult. It argues for preserving regulatory discretion rather than reducing it through formal congressional direction. The Article also asserts that regulators have to develop their own sophisticated methods of automated supervision. Although also not a panacea, the development of “RegTech” solutions will help clear away volumes of work that understaffed and underfunded regulators cannot keep up with. RegTech will not eliminate policy considerations, nor will it render regulatory decisions noncontroversial. Nevertheless, a sophisticated deployment of RegTech should help focus regulatory discretion and public-policy debate on the elements of regulation where choices really matter.

The Role of Blue Sky Laws After NSMIA and the JOBS Act
Rutheford B. Campbell, Jr.
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State securities laws—in particular, state laws requiring that securities offered by issuers be registered with the states—have been an impediment to the efficient movement of capital to its highest and best use. The pernicious effects of these laws—generally referred to as “blue sky laws”—have been felt most acutely by small businesses, a vital component of our national economy.

It has been difficult to remedy this problem. States and state regulators have been tenacious in protecting their registration authority from federal preemption. The Securities and Exchange Commission, on the other hand, has been reluctant to advocate for preemption and unwilling to exercise its delegated power to expand preemption by regulation.

In recent years some progress has been made toward a more efficient regulation of capital formation, principally as a result of some congressional preemption of state registration authority. Nonetheless, state registration provisions continue to impede significantly businesses’—especially small businesses’—efficient access to external capital.

Further gains in efficient regulation of capital formation can be achieved but require actions both by states and the federal government. States must allocate more resources and effort toward vigorous enforcement of their antifraud provisions. At the federal level, Congress must preempt completely state registration authority. This duty of preemption falls to Congress, because the Commission has shown a sustained unwillingness to exercise its broad, delegated power to preempt state registration authority.

The Knowledge Gap in Workplace Retirement Investing and the Role of Professional Advisors
Jill E. Fisch, Tess Wilkinson-Ryan & Kristin Firth
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The dramatic shift from traditional pension plans to participant-directed 401(k) plans has increased the obligation of individual investors to take responsibility for their own retirement planning. With this shift comes increasing evidence that investors are making poor investment decisions.

This Article seeks to uncover the reasons for poor investment decisions. We use a simulated retirement investing task and a new financial literacy index to evaluate the role of financial literacy in retirement investment decisionmaking in a group of nonexpert participants. Our results suggest that individual employees often lack the skills necessary to support the current model of participant-directed investing. We show that less knowledgeable participants allocate too little money to equity, engage in naive diversification, fail to identify dominated funds, and are inattentive to fees. Over the duration of a retirement account, these mistakes can cost investors hundreds of thousands of dollars.

We then explore the capacity of professional advisors to mitigate this problem. Using the same study with a group of professional advisors, we document a predictable but nonetheless dramatic knowledge gap between professionals and ordinary investors. The professional advisors were far more financially literate and made better choices among investment alternatives. Our results highlight the potential value of professional advice in mitigating the effects of financial illiteracy in retirement planning. Our findings suggest that, in weighing the costs of heightened regulation against the value of reducing possible conflicts of interest, regulators need to be sensitive to the knowledge gap.

Regulating Public Offerings of Truly New Securities: First Principles
Merritt B. Fox
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The public offering of truly new securities involves purchases by investors in sufficient number and in small enough blocks that each purchaser’s shares can reasonably be expected to be freely tradable in a secondary market that did not exist before the offering. Increasing the ability of small and medium-sized enterprises (SMEs) to make such offerings has been the subject of much recent discussion.

At the time that a firm initially contemplates such an offering, unusually large information asymmetries exist between its insiders and potential investors. These can lead to severe adverse-selection problems that prevent a substantial portion of worthy offerings from being successfully marketed. A regime relying solely on market-based antidotes to this problem—signaling, underwriter reputation, and accountant certification—and backed only by liability for intentional affirmative misrepresentation will fall well short of being a solution. This shortfall suggests a role for regulation.

This Article goes back to first principles to determine the proper content of such regulation. The relevant questions include: What should issuers be required to disclose at the time of the offering and thereafter? Under what circumstances should various offering participants be liable for damages if, at the time of the offering, there were misstatements or omissions? And should this regime be mandatory or optional? The answers are then used to critically evaluate a number of recent U.S. reforms aimed at increasing SME offerings by lessening regulatory burdens. These include Securities Act Rule 506(c), Regulation A+, and the new crowdfunding rules.

Detecting Good Public Policy Rationales for the American Rule: A Response to the Ill-Conceived Calls for “Loser Pays” Rules
Peter Karsten & Oliver Bateman
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Several critiques have been leveled at the American Rule—that is, the rule that each party to a lawsuit should pay for its attorneys. Some claim that there were no principled justifications offered by the nineteenth-century jurists who authored the opinions marking the rule’s origins. Instead, these jurists only cited their states’ “taxable costs” statutes. Others claim that the American Rule—as well as its close relative, the contingency-fee contract—contributed to a “liability explosion” in that century. This Article offers a comprehensive examination of the origins of, rationales given for, and impact of the American Rule; then it evaluates instances in which the rule has faced legislative, judicial, and academic opposition.

“We Believe”: Omnicare, Legal Risk Disclosure and Corporate Governance
Hillary A. Sale & Donald C. Langevoort
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The Supreme Court’s decision in Omnicare Inc. v. Laborers District Council Construction Industry Pension Fund presents new challenges for boards of directors. The opinion speaks to whether and when an issuer’s statement of belief can be false or misleading other than by proof that the issuer’s genuine opinion was different from what it stated. Statements of opinion imply something about how the belief was formed, and that process implicates the role of directors as fiduciaries.

This Article uses Omnicare as a starting point for exploring and developing the interplay between disclosure, discourse, and fiduciary duties. Using the lens of corporate-discourse theory, this Article explores how the judicial process extracts (or should extract) meaning from ambiguous, often strategically crafted words communicated to vastly complicated financial markets. Questions such as what it means for a corporate entity—a legal fiction incapable of thought—to express a belief, who the “we” is in “we believe our practices are legally compliant,” and what it means to believe, all help to frame the conversation about the role of directors in disciplining the corporate-disclosure process.

Federal securities law cases that raise questions about disclosure related to legal compliance and derivative lawsuits challenging board oversight are common after a big corporate penalty for violations of federal or state law. Regulators are also pushing boards of directors to participate more in legal and disclosure quality control. To the extent that Omnicare was favorable to plaintiffs in allowing some suits to proceed notwithstanding belief or opinion qualifiers, this Article posits that boards need to exercise greater responsibility for disclosures, particularly with respect to legal compliance. In this manner, the securities laws perform in an information-forcing-substance manner, creating a disclosure regime that is backed by due diligence and fiduciary performance. Finally, this Article argues that the Omnicare litigation—and control over discourse about legal risk—belongs in the broader context of board fiduciary responsibility for enterprise risk management generally, and legal compliance in particular.