221 The Attorney As Gatekeeper: An Agenda for the SEC (Coffee, John C. Jr.)
April 2003
Section 307 of the Sarbanes-Oxley Act authorizes the SEC to prescribe "minimum standards of professional conduct" for attorneys "appearing or practicing" before it. This brief statutory provision frames a much larger question: What is the role of the corporate attorney in securities transactions in the public markets? Is the attorney's role that of (a) an advocate, (b) a transaction cost engineer, or, more broadly, (c) a gatekeeper - - that is, a reputational intermediary with some responsibility to monitor the accuracy of corporate disclosures? The bar has long divided over this question, with the bar associations resisting any such obligation. Yet, Section 307 now "federalizes" this issue.
Skeptics of a gatekeeper role for attorneys have long argued that (a) such a role conflicts with the traditional obligations of loyalty that the attorney owe their clients; and (b) imposing gatekeeping obligations on attorneys will chill attorney/client communications and thereby reduce law compliance. Thus, they have resisted a pending SEC proposal that would require an attorney to make a "noisy withdrawal" when the attorney is unable to stop or prevent certain ongoing material violations of law by the corporate client. This comment examines these arguments that attorneys make inferior gatekeepers and replies that (i) securities attorneys can and do perform a "gatekeeping" function; (ii) the differences between attorneys and auditors are less fundamental than bar associations maintain; (iii) in some respects, it is easier to impose gatekeeper obligations on attorneys than on auditors; and (iv) imposing such obligations on attorney should neither chill socially desirable client communications nor reduce the attorney's influence over the client (and probably will increase that leverage). Finally, this comments examines specific standards and obligations that the SEC might adopt to recognize the securities attorney's role as a gatekeeper. Going beyond the narrow "noisy withdrawal" issue, it proposes both limited certification and independence standards.
222 Law Enforcement Under Incomplete Law: Theory and Evidence from Financial Market Regulation (Xu, Chenggang & Katharina Pistor)
This paper studies the design of lawmaking and law enforcement institutions based on the premise that law is inherently incomplete. Under incomplete law, law enforcement by courts may suffer from deterrence failure. As a potential remedy a regulatory regime is introduced. The major functional difference between courts and regulators is that courts enforce law reactively, that is only once others have initiated law enforcement procedures, while regulators enforce law proactively, i.e. on their own initiative. We study optimal regime selection between a court and a regulatory regime and present evidence from the history of financial market regulation.
223 A Taxing Blog: The Uneasy Case for Blogging Taxation (Fleischer, Victor & Jeffrey Kahn)
This mercifully short article discusses the growing importance of web logs (called "blogs") and describes "A Taxing Blog," the tax policy blog recently created by Victor Fleischer and Jeffrey Kahn. Recent blog topics include corporate inversions, the Vice President's tax return, the Bush administration's dividend exclusion proposal, and other things that tax nerds might find interesting.
224 The Enabling Role of Democratic Constitutionalism: Fixed Rules and Some Implications for Contested Presidential Elections (Issacharoff, Samuel)
April 2003 Texas Law Review, June 2003
This article explores the preconditions for the transfer of power within democratic regimes. Invariably, constitutional discussion of the necessary preconditions for a successful, peaceful transition to power focuses primarily on rights guarantees to the defeated minority. The minority must be assured of the ability to proclaim its views in the future, the ability to assemble and to organize itself, the ability to be secure in their person and property—in short, much of the formation of rights associated with democratic liberties. But just as surely as the rights domain is necessary for a rudimentary formulation of democratic legitimacy, it is also incomplete. Just as central are the structural protections, which include the obligation to stand for election anew at some fixed or relatively fixed interval, the limitations on the powers of office, and the accountability of the governors to the structures of office, as exemplified in this country by the divisions of powers among coordinate branches of power. This article focuses on the structural components of constitutionalism as a necessary constraint on democratic politics. This precommitment necessarily thwarts or limits deliberative choices after constitutional enactment, yet serves as a precondition for the functioning of democratic politics. The article focuses on the work of political theorists Jon Elster and Stephen Holmes to argue that current constitutional scholarship underestimates the importance of constitutional obduracy. The article concludes with a reexamination of the Florida electoral crisis of 2000 from the vantagepoint of the entrenchment of ex ante constitutional procedures.
225 Regulation for Conservatives: Behavioral Economics and the Case for 'Asymmetric Paternalism' (Camerer, Colin, Samuel Issacharoff, George Loewenstein, Ted O'Donoghue and Matthew Rabin)
April 2003 University of Pennsylvania Law Review, June 2003
This paper examines the regulatory implications of behavioral economic insights. The central effect of behavioral economics in the legal literature to date has been to challenge the premise of formal economic theory that individuals understand their preferences and work to maximize these preferences. Behavioral economics has gathered increased attention in the economic analysis of law because of its demonstration that individual decisionmaking is prone to numerous biases and heuristics, and that as a result individuals may not act to realize their best interests. Part of the enthusiasm for behavioral economics in the legal literature has come from the apparent compatibility of the behavioral insights with proposals for paternalistic regulation. By pointing out some of the ways that human behavior falls short of perfect rationality, behavioral economics can potentially expand the scope of beneficial paternalistic policies that constrain individual choice. However, such policies should be implemented cautiously, given differences in opinion about what behaviors are irrational and concerns about costs imposed on people who are rational. In response to these concerns, we propose a principle for developing and evaluating regulatory policies that we term "asymmetric paternalism." Asymmetrically paternalistic regulations benefit those who would otherwise make poor decisions, but impose little or no costs on those who behave optimally. As such, they challenges both opponents and supporters of regulation by setting forth a disciplined set of criteria by which to judge the costs and benefits of regulatory proposals. The article explores the application of this principle to several specific sources of flawed decision making identified by behavioral economics in such diverse areas as retirement savings, consumer protection, and family law, and suggests examples of already existing regulations in these fields that seem to embody the principle of asymmetric paternalism.
226 Punitive Damages As Societal Damages (Sharkey, Catherine M.)
Yale Law Journal, Vol. 113, 2003.
Jury awards of "classwide" punitive damages provide windfalls to individual plaintiffs, particularly in products liability, fraud, civil rights, and employment discrimination cases.This suggests a new angle from which to approach the ongoing punitive damages debate.Under current law, classwide assessment of widespread public harms has proceeded under the rubric of retributive punishment and deterrence—the traditional justifications for punitive damages—bypassing class action procedural requirements and unjustly enriching the plaintiff.In the wake of the Supreme Court's admonition in State Farm that such a practice can violate due process by exposing defendants to the risk of "multiple punitive damages awards for the same conduct," the Article proposes explicit recognition of a distinct category of compensatory societal damages for redress of third-party and societal harms.Up until now, this category has been quietly subsumed within punitive damages.But damages for specific harms to third parties and more diffuse harms to society are actually compensatory (as opposed to punitive) in nature, and should, once assessed, be distributed by legislatures, courts, and juries accordingly.Drawing upon heretofore unconnected trends in punitive damages and class action tort cases, and state-level legislative and judicial innovations with "split-recovery" schemes for distributing punitive awards, the Article explores various mechanisms for transforming punitive damages into societal damages, including the formation of an "ex post class action" at the remedial stage and the punitive-damages-only class at the liability stage.The theory of compensatory societal damages—whether or not embraced by legislatures and courts—reveals more clearly the tradeoffs in transforming the doctrine of punitive damages to achieve the compensatory and deterrence goals of the tort system.
This case study, intended as a teaching exercise, highlights the problems of contracting in a world of great uncertainty. Streetwatch is a startup company seeking financing, and the CEO has received two offers for investment, each with its own advantages and disadvantages. The case highlights the problem of asymmetric information as well as some possible responses, including monitoring, the structure of executive compensation, and staged financing and the “option to abandon.”
The case also includes a negotiation and drafting “skills” exercise.
228 Controlling Controlling Shareholders (Gilson, Ronald J. and Jeffrey N. Gordon)
June, 2003
The rules governing controlling shareholders sit at the intersection of the two facets of the agency problem at the core of public corporations law. The first is the familiar principal-agency problem that arises from the separation of ownership and control. With only this facet in mind, a large shareholder may better police management than the standard panoply of market-oriented techniques. The second is the agency problem that arises between controlling and non-controlling shareholders, which produces the potential for private benefits of control. There is, however, a point of tangency between these facets. Because there are costs associated with holding a concentrated position and with exercising the monitoring function, some private benefits of control may be necessary to induce a party to play that role. Thus, from the point of view of public shareholders, the two facets of the agency problem present a tradeoff. The presence of a controlling shareholder reduces the managerial agency problem, but at the cost of the private benefits agency problem. Non-controlling shareholders will prefer the presence of a controlling shareholder so long as the benefits from reduction in managerial agency costs are greater than the costs of private benefits of control.
The terms of this tradeoff are determined by the origami of judicial doctrines that describe the fiduciary obligations of a controlling shareholder. In this article, we examine the doctrinal limits on the private benefits of control from a particular orientation. A controlling shareholder may extract private benefits of control in one of three ways: by taking a disproportionate amount of the corporation's ongoing earnings; by freezing out the minority; or by selling control. Our thesis is that the limits on these three methods of extraction must be symmetrical because they are in substantial respects substitutes. We then consider a series of recent Delaware Chancery Court decisions that we argue point in inconsistent directions: on the one hand reducing the extent to which a controlling shareholder can extract private benefits through selling control, and on the other increasing the extent to which private benefits can be extracted through freezing out non-controlling shareholders. While judicial doctrine is too coarse a tool to specify the perfect level of private benefits, we believe these cases get it backwards - the potential for efficiency gains are greater from sale of control than from freeze outs, so that a shift that favors freeze outs as opposed to sales of control is a move in the wrong direction. In particular we argue that the Delaware law of freeze outs can be best reunified by giving "business judgment rule" protection to a transaction that is approved by a genuinely independent special committee that has the power to "say no" to a freeze out merger, while also preserving what amounts to a class-based appraisal remedy for transactions that proceed by freeze out tender offer without a special committee approval.
229 Columbia Venture Partners - MedTech Inc. (Fleischer, Victor & Geoffrey W. Smith
June 2003
This case study is a teaching exercise that was first used in the "Deals Workshop" seminar at Columbia Law School in April 2003. The case involves a potential investment by Columbia Venture Partners, a venture capital fund, in MedTech Inc., an emerging developer of medical devices for the cardiovascular market. The case offers an opportunity to examine the relative importance of various terms in typical venture capital contracts, such as valuation, liquidation preference, conversion rights, board representation, tag-along and drag-along rights, and vesting. The case also illustrates the use of negotiation tactics, including the use of "market" or industry standards, efficient risk allocation, and how to bring other objective criteria into the discussion.
The case includes a teacher's manual followed by a background memo and term sheet intended for distribution to the students.
230 Trade, Law and Product Complexity (Daniel Berkowitz, Johannes Moenius & Katharina Pistor)
February 2003
How does the quality of national institutions that enforce rule of law influence international trade? Anderson and Marcouiller (2001) argue that bad institutions located in the importer's country deter international trade because they enable economic predators to steal and extort at the exporter's country enhance international trade and, in particular, trade in complex products whose characteristics are difficult to fully specify in a contract. We build a model in which both exporter and importer institutions impact both international and domestic transaction costs of trade, domestic transaction costs affect complex and simple products differently, thereby changing comparative advantage. We find strong evidence for the model's predictions: most notably, the quality of importer institutions is most important for simple markets.
