15 January 2008

Paradigmatic Market Failure

As The Perfesser notes — and made very clear, without once descending into ideological preconception, a decade and a half ago in Securities Regulation — the Supreme Court does not have a very encouraging history on dealing with securities cases. And that's true regardless of one's ideological preconceptions; even when it reaches the "right" result, it often does so with indefensibly sloppy reasoning, as in Stoneridge (decided today {PDF}).

Much as I'd like to allow individual plaintiffs to sue under a "scheme liability" theory, as a practical matter I cannot agree that such theories are appropriate for private parties. This, however, is based on a different kind of "institutional incompetence": The general incompetence of the private bar — specifically including the securities bar — at performing a proper prefiling investigation, coupled with various unintended consequences of the rules of evidence. In the end, I suspect that this is another reason that the legal academe and the practicing bar don't get along. Clean theory in the classroom simply does not translate very well to the messiness of fact-bound practice, and vice versa; throw in some procedural issues (and, with all due respect, most "substantive law" professors have at best an incomplete and inelegant appreciation of the nuances of procedure) and they're not even speaking the same language, let alone separated by a common one.

What Stoneridge really does, though, is demonstrate two other market failures... both of which are entirely preventable.

  • The first, and most obvious, of these market failures is in the market for preventing sham transactions. The Court has held that this is not, under the law as written, properly a matter for the market (private enforcement) at all: It is instead a matter for the SEC. I'll wait while you finish snickering.

    The problem here is that we're now at one extreme of the pendulum's trajectory. Since the so-called "Reagan Revolution" (which, in both securities law and antitrust law, actually began under Ford, but that's a long story indeed) began in reaction to some acknowledged government overenthusiasm in propounding dubious theories of enforcement.1 In practice, though, what the Court has done with Stoneridge is made it all but impossible to actually get punished for deception in the securities market unless one is under a formal duty of disclosure; one need only be smart enough not to do the securities-market equivalent of taking an injection of nandrolone the morning before one's known testing date.

  • The other market failure is embedded in the Court's statement on what § 10(b) (and corresponding SEC Rule 10b-5) means. As Justice Stevens notes in dissent (in language much clearer on this point than Justice Kennedy adopts in his majority opinion),

    Finally, the Court relies on the course of action Congress adopted after our decision in Central Bank to argue that siding with petitioner on reliance would run contrary to congressional intent. Senate hearings on Central Bank were held within one month of our decision. Less than one year later, Senators Dodd and Domenici introduced S. 240, which became the Private Securities Litigation Reform Act of 1995 (PSLRA). Congress stopped short of undoing Central Bank entirely, instead adopting a compromise which restored the authority of the SEC to enforce aiding and abetting liability. A private right of action based on aiding and abetting violations of § 10(b) was not, however, included in the PSLRA, despite support from Senator Dodd and members of the Senate Subcommittee on Securities. This compromise surely provides no support for extending Central Bank in order to immunize an undefined class of actual violators of 10(b) from liability in private litigation. Indeed, as Members of Congress — including those who rejected restoring a private cause of action against aiders and abettors — made clear, private litigation under § 10(b) continues to play a vital role in protecting the integrity of our securities markets. That Congress chose not to restore the aiding and abetting liability removed by Central Bank does not mean that Congress wanted to exempt from liability the broader range of conduct that today's opinion excludes.

    Stoneridge, slip op. at 25–27 (footnotes and internal citations omitted).

    The market failure in question here is the market for clear, well-considered statutes. The PSLRA contains more than a few internal contradictions and lacunae that were predictable at the time of its passage (and, indeed, predicted in both hearing testimony and floor debate). Make no mistake: In this day of Buckley and its progeny, and of the superlobbyist, it is indeed a "market."

Applying these principles to current issues in intellectual property law and in publishing practice is left as an exercise for the student.

  1. Admittedly, some of that overenthusiasm resulted from personal, partisan, and/or ideological vendettas. And also admittedly, some of the people who might have worked for the SEC during the height of its powers are now in the securities bar, making a lot more money. In short, they've filled the abuse-of-power vacuum quite nicely.