Clayton Christensen comes to Wall Street

Chris Brummer, Disruptive Innovation and Securities Regulation, 84 Fordham L. Rev. -- (forthcoming, 2015), available at SSRN.

In the early 2000s, I spent some time as a fly on the wall of the floor of the New York Stock Exchange. I talked to specialists—those whose job it was to personally manage trading and make a market for particular high volume stocks—including one who had just earned a coveted specialist’s “seat” (price: $3 million). Once upon a time, a seat was practically a license to make money. As market-makers, specialists bought low and sold high on their own accounts. The NYSE specialists I spoke to talked about decimalization, new at the time—the fact that securities were now quoted in pennies instead of in eighths or sixteenths of a dollar. They agreed that it had cut into their profitability. They were already using an electronic system to pair off small customer orders, and they agreed that it actually handled more order volume than they did. None of them seemed to have given much thought to electronic trading, alternative trading platforms, or the derivatives market. Certainly none of them seemed to think these were existential issues that would undermine their 130-year-old business model.

Securities markets are utterly transformed today. Specialists, as they were then, are gone. Electronic trading networks reign, as does algorithmic trading. The NYSE handles less than 20% of US stock trades (it was 80% just a decade ago). Chris Brummer’s new article, Disruptive Innovation and Securities Regulation, is a gorgeous account of how this happened, how law intersected with innovation, and what the implications might be.

We know already that derivatives and financial engineering have profoundly challenged the assumptions underlying corporate law: think of Bernie Black and Henry Hu’s work on empty voting,1 Ron Gilson’s and Chuck Whitehead’s work on risk-slicing beyond the corporate share,2 or Tamar Frankel’s ruminations on how profoundly new technology affects Adolf Berle’s classic analysis of the separation between ownership and control.3 Bill Bratton and Adam Levitin have pointed out how innovations like the synthetic CDO involving a special purpose entity have redrawn the conceptual boundaries of a firm, and done through contract what formerly would have been done through equity ownership.4 For a broader audience, Michael Lewis’s influential book Flash Boys gave many a sense of the complex ecosystem in which high frequency traders operate (along with a sense of outrage about the disadvantage at which retail investors and even their pension and mutual funds are put in those ecosystems).

Chris Brummer’s important contribution here is at least four-fold: first, he illuminates the historical dance, from the New Deal era onward, between securities regulation and financial sector innovation. The history he provides is engaging and precise, and he consolidates in one place information about how particular regulatory moves, like the SEC’s Rule 144A (in 1994) or Regulation NMS (in 2007), unexpectedly rearranged markets and altered the business models of the very intermediaries—exchanges, broker-dealers and the like—they were intending to regulate. Among other unexpected relationships, he points out how greater clarity around the standards for private placements produced greater innovation around private placements. The relationship between clarity or standardization, and innovation, is an important one that does not always make it into conversations about finance or the financial crisis.

Second, Brummer identifies the ways in which new technology (particularly automated financial services and private capital markets, including dark pools and crowd-funding) has disrupted regulatory practice. For example, the SEC promulgated Regulation NMS in order to deal with the market fragmentation problem that electronic trading networks had created. It promulgated Rule 144A to help investors gain access to young, innovative, capital-intensive firms. The combined result, though, was to spur high frequency trading and to move trading off public markets, to the detriment of price discovery and fair treatment for retail investors (not to mention the specialists I once spoke to).

The other thing that comes out is how vast and tricky remains the challenge of consumer protection in this space. Consumer protection regulators like the SEC, and the law-based nature of their expertise, did not come out well during the financial crisis. In the wake of the crisis, policy-making momentum and credibility has shifted toward prudential regulation, and more technical financial expertise. Among the contributions in Brummer’s article is a reminder that someone needs to be thinking hard about consumer protection, and priorities such as creating an equal playing field for “real economy” and retail players, in the midst of all this disruptive innovation.

Brummer’s most significant contribution, though, is to pursue a conversation about how we might respond to the challenges that innovation presents for regulation. Back in 2009, Mitu Gulati and Bob Scott asked why law firms don’t have R&D departments.5 This is a good question (and they provide a fascinating answer) but the question goes beyond just firms. The reality is that law is not terribly good at tracking, let alone engaging in, innovation. This is true even for securities regulation, the area of law perhaps most directly concerned with allocating capital to its best (which often means its most innovative) uses. Brummer’s article has done us a real service by setting out a thorough, insightful description of how far reality has strayed from the static, institution-oriented market structure that New Deal-era regulation assumes. His helpful proposals are to expand the regulatory perimeter, to consider the benefits and limits of objectives-based regulation, and to consider “adaptive financial regulation.” We could perhaps even go further, to consider the ways in which financial regulation needs to be reframed to allow us to think about innovation as a first order regulatory challenge. How might our perspective change, if we started from the point to which Brummer brings us: from a sense of the historical dance between regulation and innovation, and a recognition of the ways in which regulation itself must anticipate and respond to the disruptive and undermining effects of private sector innovation?

  1. Henry Hu and Bernie Black, Empty Voting and Hidden (Morphable) OwnershipBusiness Lawyer, 2006 at 1011. []
  2. Ronald J. Gilson and Charles K. Whitehead, Deconstructing Equity: Public Ownership, Agency Costs, and Complete Capital Markets, 108 Colum. L. Rev. 231 (2008). []
  3. Tamar Frankel, The New Financial Assets: Separating Ownership from Control, 33 Seattle U. L. Rev. 931 (2010). []
  4. William W. Bratton and Adam J. Levitin, A Transactional Genealogy of Scandal: From Michael Milken to Enron to Goldman Sachs, 86 S. Cal. L. Rev. 783 (2013). []
  5. Mit Gulati and Robert E Scott, The Three and a Half Minute Transaction: Boilerplate and the Limits of Contract Design, 40 Hofstra L. Rev. 1 (2012). []
Cite as: Cristie Ford, Clayton Christensen comes to Wall Street, JOTWELL (September 21, 2015) (reviewing Chris Brummer, Disruptive Innovation and Securities Regulation, 84 Fordham L. Rev. -- (forthcoming, 2015), available at SSRN),

Private Ordering in Corporate Litigation

Verity Winship, Shareholder Litigation by Contract, __  B.U. L. Rev. (forthcoming, 2015, available at SSRN.

The debate over litigation bylaws has been percolating in Delaware for several years, but it shifted into high gear last year, when the Delaware Supreme Court held unexpectedly that a fee-shifting bylaw was “facially valid.” ATP Tour, Inc. v. Deutscher Tennis Bund, 91 A.3d 554, 558 (Del. 2014). This decision prompted discussion of a corporate litigation crisis, which seems to have abated with action this summer by the Delaware General Assembly, passing legislation prohibiting fee-shifting bylaws and charter provisions for Delaware stock corporations. This legislation also addresses forum selection clauses, authorizing bylaws, or charter provisions designating Delaware as the exclusive forum for claims relating to “internal affairs” and prohibiting provisions designating courts outside of Delaware as the exclusive forum for such claims. Although the immediate threat of crisis has been abated, important issues remain regarding bylaw- and charter-provision-regulating corporate litigation. In Shareholder Litigation by Contract Verity Winship offers a useful framework for thinking about these issues.

Winship begins with a sensible premise: “procedural law should not be used to waive mandatory provisions of substantive law.” (P. 6.) Of course, she recognizes that the number of mandatory provisions in state corporate law is few, but she includes among those provisions “the core duty of loyalty claim within the umbrella of state-law fiduciary suits.” (P. 45.) This is a controversial claim, but one that seems to be shared by the Delaware General Assembly, as the implicit motivation for prohibiting fee-shifting is the desire to preserve fiduciary duty litigation.

It is probably worth noting that the legislation prohibiting fee-shifting was not drafted by members of the Delaware General Assembly, but rather by the Council of the Corporation Law Section of the Delaware State Bar Association, an organization comprising top Delaware corporate lawyers, who have a strong pecuniary interest in a vibrant litigation environment. That said, anyone who believes that fiduciary duty litigation is an important part of the corporate governance system should also endorse Winship’s aspiration to “prevent procedural provisions from being used to kill shareholder litigation altogether” and to “also avoid throwing the baby out with the bathwater.” (P. 6.)

Winship’s approach depends on a contracting framework, which also is not uncontroversial, even though the ATP used this framework in approving the fee-shifting bylaw in that case. The Court in that case reasoned:

Delaware follows the American Rule, under which parties to litigation generally must pay their own attorneys’ fees and costs. But it is settled that contracting parties may agree to modify the American Rule and obligate the losing party to pay the prevailing party’s fees. Because corporate bylaws are “contracts among a corporation’s shareholders,” a fee-shifting provision contained in a nonstock corporation’s validly-enacted bylaw would fall within the contractual exception to the American Rule. Therefore, a fee-shifting bylaw would not be prohibited under Delaware common law. (Pp. 9-10.)

In Private Ordering with Shareholder Bylaws, my co-authors and I suggested that shareholders in public corporations perform not only the conventional functions of selling, voting, and suing, but they also engage in contracting through bylaw amendments. One limitation on our proposal is embedded in the term “shareholder bylaws.” The fee-shifting bylaw in ATP was a “director bylaw,” which seems unlike “contracts among a corporation’s shareholders.” We criticized the Delaware Supreme Court’s opinion in CA, Inc. v. AFSCME Employees Pension Plan, 953 A.2d 227, 238 (Del. 2008) for placing too much bylaw power in the corporate directors, and ATP suffers from this same shortcoming.

Critics of our contracting view note that bylaws are not really contracts, but are simply interpreted by the Delaware courts according to contract interpretation principles. You can see Kurt Heyman, a distinguished Delaware practitioner, making this argument in a recent panel discussion at Fordham Law School. This, of course, is merely a formal objection, which we assume that everyone who endorses the contracting framework recognizes. (Winship dedicates an entire section of her article to examining various caveats to treating bylaws and charters as contracts.) The issue is deciding the extent to which shareholders ought to be allowed to engage in private ordering. Or, in Winship’s words, “Should there be any limit to the procedural provisions to which the parties can contract?” (P. 6.)

Winship’s short answer is “yes.“ Bylaws should be limited by mandatory provisions in the statute, including the newly adopted fee-shifting prohibition. But if the underlying aspiration is to allow individual firms to act as “laboratories of corporate governance,” the number of mandatory provisions must remain rather small. Thus, bylaw provisions altering discovery rules, requiring the posting of a bond, implementing contemporaneous ownership requirements, identifying additional prerequisites to filing derivative lawsuits, and myriad other issues are candidates for private ordering under a robust contracting system.

This article is a full-throated defense of private ordering in corporate governance. It is well written, thoroughly researched, doctrinally sophisticated, and conceptually challenging. And, if it is not clear by now, I add that it is well worth reading.

Cite as: D. Gordon Smith, Private Ordering in Corporate Litigation, JOTWELL (August 10, 2015) (reviewing Verity Winship, Shareholder Litigation by Contract, __  B.U. L. Rev. (forthcoming, 2015, available at SSRN),

Whistleblowers as Securities Fraud Detectors

Securities fraud presents one of the more vexing challenges for financial regulators and policymakers. Each new financial crises and catastrophic fraud frequently begets new tools to fight securities fraud. In a thoughtful recent article, Better Bounty Hunting: How the SEC’s New Whistleblower Program Changes the Securities Fraud Class Action Debate, Professor Amanda Rose examines the SEC’s new whistleblower program as a tool for securities fraud detection, and explores its potential impact on the old fraud detecting tool of class action lawsuits.   The motivating argument of the article is that the SEC’s new Whistleblower Bounty Program (WBP) created by Dodd-Frank can serve as a superior alternative to the traditional fraud-on-the-market (FOTM) class action lawsuits as a tool for securities fraud detection and deterrence.

Professor Rose articulates this argument in a logical, measured fashion. She begins by providing background information on the origins of FOTM class actions and the WBP, which is designed to pay large sums to eligible individuals who provide valuable, original information about frauds that result in $1 million or more of penalties. Building on that background, Professor Rose then contends that the WBP could reduce the relative benefits associated with FOTM lawsuits while increasing their relative costs thereby making them a less desirable tool to combat securities fraud. With cautious optimism, she believes that the generous bounty of the WBP and the steep costs often associated class action lawsuits could ultimately lead tipsters who are aware of securities fraud to pursue redress through the whistleblower route rather than the class action route. However, to the extent that the WBP does not function as a feasible replacement for FOTM suits, Professor Rose introduces the innovative idea of adding a qui tam provision in the current whistleblower program as a modest improvement over FOTM suits.

The success and impact of the WBP remains to be seen as the program is still in its infancy. According to the SEC’s 2014 WBP report to Congress, a total of only fourteen awards have been granted since the creation of the program.   That said, the SEC has received thousands of tips annually since its inception, and those tips have been increasing year to year. The long term, sustainable success of the program will depend largely on the willingness of individuals with high-quality information about securities fraud to use the program, and the program’s vigilant administration by the SEC. While a more definitive verdict on the WBP remains forthcoming, Professor Rose has provided a promising, underappreciated preview of the program’s full potential.

Ultimately, perfect fraud detection and deterrence in the securities marketplace is a noble but elusive goal. Securities fraud is a persistent, diverse problem that requires a diverse toolkit to solve in a better way. Traditional tools like class action lawsuits are not always the best tools for tackling the diverse variations of securities fraud in the marketplace. In the end, traditional tools like class action lawsuits will have to be complemented, refined, and possibly supplanted by new and better tools such as smart whistleblower-based solutions, as Professor Rose has skillfully articulated in her article, in order to better detect and deter securities fraud in the marketplace.

Cite as: Tom C.W. Lin, Whistleblowers as Securities Fraud Detectors, JOTWELL (July 7, 2015) (reviewing Amanda Rose, Better Bounty Hunting: How the SEC's New Whistleblower Program Changes the Securities Fraud Class Action Debate, 108 Nw. U. L. Rev. 1235 (2014)),

Rethinking Insider Trading Regulation

  • Yesha Yadav, Insider Trading in Derivatives Markets, 103 Georgetown L.J. 381 (2015)
  • Yesha Yadav, Structural Insider Trading, Vanderbilt Law and Economics Research Paper No. 15-8 (March 27, 2015), available at SSRN.

The question of distinguishing between the informational advantages insiders and outsiders may and may not legitimately exploit in trading in the financial markets is perennial: is securities regulation about achieving a level playing field for investors or about imposing sanctions for certain fiduciary and fiduciary-like breaches of duty which go beyond traditional remedies for such breaches. The Second Circuit’s decision in US v Newman emphasizes the fiduciary duty component of liability: at least in a criminal case involving tipping by insiders “the Government must prove beyond a reasonable doubt that the tippee knew that an insider disclosed confidential information and that he did so in exchange for a personal benefit.”

In these papers Yesha Yadav focuses on two specific problem areas in insider trading regulation, relating to trading in credit default swaps (CDS) by lenders and “structural” trading using a combination of preferential access to information and locational advantages. Both examples present arguments for a rethinking of how insider trading regulation should address the realities of modern, complex, financial markets.

The contexts of the two papers differ. With respect to Insider Trading in Derivatives Markets, Professor Yadav is addressing a context in which regulators have decided to extend insider trading prohibitions to derivative markets. In Structural Insider Trading, on the other hand, Professor Yadav identifies “cracks in regulation” (p. 4).

Congress extended the prohibition of insider trading to transactions in swaps and futures in the Dodd-Frank Act in 2010 and the CFTC implemented the prohibition in rules issued in 2011. By 2010 concerns about the risk of insider trading in credit derivatives was not exclusively a US domestic concern: the Joint Forum of transnational standard setters for financial regulation had identified this as an issue in 2008. But Professor Yadav persuasively argues that trading on insider information in CDSs may improve the informational efficiency of the securities markets, benefiting shareholders. Lenders with access to inside information about their borrowers have incentives to transfer the credit risk associated with their lending, and their ability to hedge risk encourages lending, which benefits shareholders “at least in the near term.”(p. 416) The story is not all positive, however, as lender activity with respect to CDSs may harm shareholders, and shareholders have limited capacity to monitor lenders (p. 417). Lenders may transact in ways that over-emphasize bad news (p. 419).

Professor Yadav suggests that lenders and borrowers might be able to contract around insider trading liability to fix the doctrinal problem. However, she notes that this fix might not work because corporate debtors suffer from a weak bargaining position and monitoring a lender’s compliance with the terms of a contract would be challenging. As usual in the insider trading context disclosure could play a role, although a borrower would have limited options to respond to a lender’s disclosed proposed CDS trades (p. 428). Insider CDS trading raises more general questions about the fit between established doctrine and the realities of the markets: the “tension between law and reality…dismantles long-held assumptions in theory.”

Structural Insider Trading similarly focuses on realities of the financial markets to challenge established assumptions about insider trading law. High speed algorithmic trading strategies combined with geographic proximity to trading venues provides an informational edge (p5) (of course, this development, together with the complex harmonization-differentiation picture of financial regulation also challenges some of the thinking about the decreasing relevance of geography to finance). The informational edge creates a tension between “speed in trading and the policy goal of ensuring broad and equal access to information.”(p 5) Professor Yadav argues:

structural insider trading inverts the traditional policy priority underpinning the prohibition against insider trading. Under Rule 10b-5, liability is justified as a way to protect insiders despite negative effects on market efficiency. By contrast, structural insider trading privileges market efficiency over investor protection, in giving structural insiders the ability to trade on soon-to-be public information despite costs to investors-at-large.

These are two papers which demonstrate very clearly and usefully a need to rethink one area of financial regulation for a complex, evolving, market reality.

Cite as: Caroline Bradley, Rethinking Insider Trading Regulation, JOTWELL (May 11, 2015) (reviewing Yesha Yadav, Insider Trading in Derivatives Markets, 103 Georgetown L.J. 381 (2015) and Yesha Yadav, Structural Insider Trading, Vanderbilt Law and Economics Research Paper No. 15-8 (March 27, 2015)),

Deterring Both Spur-of-the-Moment and Carefully Planned Corporate Crimes

Miriam H. Baer, Confronting the Two Faces of Corporate Fraud, 66 Fl. L. Rev. 87 (2014).

How many different law review articles cite work by Kahneman and Tversky, progenitors of law and behavioral economics? At least two thousand, two hundred and seventy-three (2,273).1 And this does not include articles like Professor Baer’s which do not cite Kahneman and Tversky, but cite law review articles which do. Law and behavioral economics is a law professor industry. And, why not? It doesn’t require math and who doesn’t like Brain Games?

How many different law review articles cite work by Oliver Williamson, progenitor of the new institutional economics? At least one thousand, two hundred and fifty-four (1,254).2 Although smaller, this also reflects an industry which incorporates ideas of agency cost or of just opportunism, which Baer says is, “according to Oliver Wiliamson’s famous definition, a form of self-interest seeking with guile” (P. 99.)

What is the overlap between these 3,527 articles? That is, how many articles cite both Kahneman and Tversky and Williamson? At most 82 (2.3%).3 Of course, one might also ask what percentage of the smaller number of Williamson-citing papers cite Kahneman and Tversky, yielding a larger but still small number (6.5%). By and large, these appear to be two different lines of scholarship; two different industries.

Miriam H. Baer argues that both lines need to be considered concurrently. Why? The methods and structures of organizational compliance need to deter both deviance originating in individual departures from rationality (the law and behavioral economics line) and individuals whose rationality departs from that of the organization as an entity (the new institutional economics line). To complicate matters, in ways Professor Baer doesn’t highlight, such deterrence also sometimes cut against each other. Call it “the lure of the taboo.” Creating a culture that enshrines non-opportunistic values creates psychological pressures to evade. Sociologists talk about the normality of deviance, but you can just think of the attractiveness of shrimp to those raised in an Orthodox Jewish culture. (And let’s agree to not discuss other taboos).

Professor Baer chooses to focus on one bias, the immediacy bias (exceedingly valuing present over future rewards), which yields a short-term perspective, and temporally inconsistent actions. This bias may result in spur-of-the-moment fraud, unlike the well-planned deceptions of opportunistic individuals.

Compliance measures aimed at preventing spur-of-the moment frauds will either accelerate sanctions or delay the desired gratification. Professor Baer insightfully points out how red-tape has the positive effect of deflecting spur-of-the-moment fraud by delaying or burdening the desired gratification (P. 110.)

Professor Baer continues in this article her earlier important contribution in distinguishing between a “policing approach” to compliance and an “architectural” one (see, Miriam H. Bear, Governing Corporate Compliance, 50 B. C. L. Rev. 949 (2009). She nicely has employees involved in designing architectural constraints to their opportunism by engaging them in identifying areas of operational and compliance risk.

She very nicely describes the limits of the policing approach, which so dominates our culture, not only corporate compliance. And, she urges an integrated effort combining both approaches.

Legal scholarship, in my opinion, too often is determined by theory. Like lemmings, the legal academy follow a theory craze, hence the thousand of articles in behavioral economics and in institutionalism. Articles are written which trace out the implications of a theory for situation after situation.

Situations, however, are not determined by theory. Theory is imbricated in situations. Multiple theories need to be applied to understand, let alone control, situations. A theory might be highly illuminative (as are Williamson’s and Kahneman & Tversky’s), but that which is illuminated by a single theory will likely not suffice to guide pragmatic action. What makes Professor Baer’s article a treat is her recognition of this fact.

  1. Lexis Advance Law Reviews and Journals Database (February 27, 2015). A search for “(kahneman /3 tversky)” of the WestlawNext Law Reviews and Journals Database found another hundred articles (2,373). []
  2. Lexis Advance Law Reviews and Journals Database (February 27, 2015). A search for “oliver Williamson” OR “o. Williamson” OR “o. e. Williamson” of the WestlawNext Law Reviews and Journals Database found another hundred and thirty articles (2,384). []
  3. WestlawNext Law Reviews and Journals Database (February 27, 2015). A search for “(“oliver Williamson” OR “o. Williamson” OR “o. e. Williamson”) AND (kahneman /3 tversky)” of the Lexis Advance Law Reviews and Journals Database found two fewer articles (80). []
Cite as: Robert Rosen, Deterring Both Spur-of-the-Moment and Carefully Planned Corporate Crimes, JOTWELL (April 13, 2015) (reviewing Miriam H. Baer, Confronting the Two Faces of Corporate Fraud, 66 Fl. L. Rev. 87 (2014)),

Human Rights for Corporate Persons?

Turkuler Isiksel, The Rights of Man and the Rights of the Man-Made: Corporations and Human Rights (January 7, 2015), available at SSRN.

The Citizens United and Hobby Lobby decisions have drawn heavy fire from critics of the Supreme Court’s ascription of constitutional and statutory rights to corporations. According to Professor Turkuler Isiksel, a political scientist at Columbia, things may be even worse than those critics appreciate. In the paper referenced above, Isiksel illuminates and offers a trenchant critique of disturbing developments in the transnational arena that may be unknown to specialists in U.S. corporate law. Multinational corporations are claiming that, as legal persons, they are entitled to the rights of human persons under international human rights law.

These assertions seek to shield corporations from domestic regulations imposed by host countries in which they do business. Isiksel’s primary focus is the international investment regime, consisting of a large web of bilateral investment treaties and regional free trade agreements. These are designed to promote foreign investment by guaranteeing protection from expropriation and excessively costly regulations for corporations that have invested in countries that are parties to these agreements. When disputes arise between a corporation and the host state, they are typically resolved through arbitration. Arbitral tribunals are supposed to apply the terms of the particular investment agreement but “they increasingly also make use of human rights law to assess state behavior toward foreign investors.” (P. 38.) Isiksel notes that “[i]nternational human rights law is congenial to firms looking to challenge state measures because it offers a framework for contesting the treatment of private actors by states.” (P. 40.)

Arbitral tribunals have yet to declare that corporations as rights-bearing legal persons actually possess human rights. Nevertheless, these tribunals often look to international human rights law as a source for basic rights to property, due process, and access to justice, as well as principles like proportionality and least restrictive means to assess state imposed burdens. At a time when it is difficult to hold multinational corporations responsible under international law for human rights violations, there is irony in the ability of these firms to protect their own economic interests by couching their complaints against state regulation in the rhetoric of human rights. As Isiksel points out, the “moral stature” of human rights discourse is “appealing to firms looking to challenge state measures that prejudice their profit margins while claiming the moral (and legal) high ground.” (P. 40.)

Human rights claims asserted by corporations come at the expense of the political autonomy of host countries, including their power to enact regulations aimed at protecting their citizens from harm. For example, in one case a Spanish firm operated a landfill in Mexico that handled toxic substances. The facility was located a short distance from an urban center. It became the target of a local citizens’ campaign that eventually resulted in termination of the necessary operating license pursuant to a law already on the books that had previously gone unenforced. An arbitral tribunal sided with the corporation, finding that the public authorities’ response was disproportionate in relation to the asserted public health concerns and was contrary to the legitimate expectations of the corporation that the law would not be enforced against it.

While the notion of a corporation as a legal person possessing the same rights as natural persons might seem absurd, at least a first blush, Isiksel is not content with that intuition. Rather, she takes a close look at the three theories of corporate personhood that have dominated U.S. legal discourse about the nature of the corporation. These are the artificial entity, natural entity, and aggregate theories, all familiar to corporate law scholars in this country. She shows convincingly that none of these theories provides a sufficient basis for claims that a corporate person should be thought of as essentially the same as a human person or at least the moral equivalent of one. For example, she is surely right in stating that the idea of the corporation as an aggregation of humans does not imply that the corporation itself is a human being in its own right; while the constituent humans obviously enjoy human rights and those rights might be implicated by state actions taken against the corporation, it does not follow that the corporation itself somehow enjoys human rights. Beyond her effective analysis of the standard theories found in the legal literature, Isiksel does not offer an in-depth exploration of philosophically grounded ontological or metaphysical claims about what corporations are as potential grounds for human rights claims. Given the stakes, we might expect such arguments to be advanced, but whether they will gain traction remains to be seen. For now, though, Isiksel seems correct to reject the idea that sophisticated theories of corporate agency—of which there are thoughtful and persuasive instances—would also support claims of corporate humanity.

Isiksel is concerned that that the opportunistic use of human rights discourse by corporations threatens to devalue its moral stature. At the end of the day, investment arbitration cases are based on disappointed expectations of financial gain. “Claiming the mantle of human rights is therefore not only a way for firms to offload the risks of doing business to the shoulders of host states, but it also implies a non-existent human right to immunity from investment risk.” (P. 60.) Needless to say, these concerns are altogether different from basic rights to be free from torture, enslavement, arbitrary detention, religious persecution, and other kinds of suffering that can only be experienced by human beings. Might expansion of the human rights tent end up problematizing the idea that people enjoy certain freedoms simply by virtue of our shared humanity?

Isiksel ends with a provocative point that I, by no means an expert on human rights law, found quite interesting. She sees the appropriation of human rights discourse by corporations for use against the states in which they operate as based on a notion of human rights as “fundamentally supranational and anti-statist . . . located above states, making their impact on domestic politics as foreign impositions.” (P. 98.) Contrasting with this model is one that links human rights norms to local normative controversies, where norms are “developed, enriched, and transformed through domestic struggles aimed at reforming domestic public institutions, which in turn reverberate across societies and shape international instruments.” (P. 100.) According to this view, human rights norms emanate from local communities, elevating political discourse and providing standards by which states may be held accountable to their citizens. Seen in this light, efforts by multinational corporations to use human rights norms as levers against domestic regulations aimed at protecting a population’s well-being threaten the ability of local communities to elaborate and enforce human rights norms.

The deployment of human rights discourse by multinational corporations—like the claims for constitutional and statutory rights under U.S. law—are made possible by the idea of the corporation as a legal person in its own right, existing in the eyes of the law separately from the human beings who constitute it. One might attempt to ground objections to these kinds of rights claims on rejection of the idea of corporate personality, but Isiksel does not do this and she is right not to try. The corporate personality idea is too deeply entrenched in western law and legal theory to be susceptible to that strategy and, in any event, the corporation’s separate legal identity serves a socially useful function with respect to capital formation. The challenge therefore is to present strong arguments against particular assertions of rights, whether they are said to arise from international human rights law or domestic constitutions and statutes. In this paper, Isiksel succeeds admirably in exposing the weaknesses of human rights claims in an area of great importance that may not yet be well known to U.S. scholars of corporate law.

Cite as: David Millon, Human Rights for Corporate Persons?, JOTWELL (March 13, 2015) (reviewing Turkuler Isiksel, The Rights of Man and the Rights of the Man-Made: Corporations and Human Rights (January 7, 2015), available at SSRN),

Governance by the Sword

Etiquette guides suggest that one has a year from the wedding to send a gift. I just read Larry Cunningham’s elegant article published precisely a year ago. So I’m on time to comment.

This piece addresses the explosion in the federal government’s use of deferred prosecution agreements (DPAs) in combatting corporate crime, a phenomenon that has increasingly become the subject of debate, at least in part because of the extraordinary fines that typically constitute a part of these deals. The corporate (or, as Larry corrects the record, partnership) death of Arthur Andersen, and enforcement in the pharmaceuticals industry (where conviction can lead to exclusion from federal health care programs to the detriment of patients) have made prosecutors sensitive to the collateral damage they can cause by indicting and trying (or obtaining guilty pleas from) corporations suspected of misconduct. Much of the literature focuses on the potential abuses inherent in the use of DPAs, which have a fitful history of prescribed guidelines and standards, and which present significant potential for prosecutorial abuse due to the one-sided nature of the bargain. (Among the abuses have been mandated—sorry, bargained-for—waivers on behalf of employees of work product and attorney-client privileges.) Further concern has been their secrecy, precluding interested corporations from tailoring compliance to address prosecutor’s concerns. While commentators see the utility of these agreements in avoiding litigation costs and achieving some measure of deterrence (in addition to avoiding collateral damage), much of the analysis has been negative.

Larry has taken a practical and sensible approach to the problem. DPAs can be useful, he tells us, but only if prosecutors approach the negotiation and structuring of an agreement as a governance problem. Ever since the 1996 Delaware Caremark decision, Delaware law at least formally has required that its corporations structure governance in a manner that discourages unlawful conduct and that makes it detectable when it occurs. Sarbanes-Oxley supplemented this approach with its own regulations. And who better to understand the governance of any particular corporation than its own board and executives? Yet, as Larry shows us, principally through his examination of the travails of AIG during the middle of the first decade of this century, prosecutors can be less than thoughtful about the appropriate, compliance-ensuring governance regime for any particular corporation. He rather convincingly demonstrates that AIG’s role in the financial crisis may well have been a direct consequence of the standardized “best practices” corporate governance regime imposed under Arthur Levitt’s supervision. (I point out that his knowledge of AIG is as a result of a book he co-authored with Hank Greenberg, who has a dog in this particular hunt, but Larry’s careful and scholarly approach give me confidence in the veracity of his reporting.)

I would do a disservice to Larry by attempting to summarize this careful and thorough piece of scholarship, so I suggest that you read it. He does an excellent job of understanding and explicating the theoretical legal place of DPAs (not quite contract, not quite regulation), as well as providing a thorough analysis of the costs and benefits of his own proposal. I will say that he left me with many questions, not least of which are the role of compensation structure, the efficacy of deterrence versus prevention, the role of punishment, and the decision to engage with the corporation rather than prosecute individual malefactors. But this, to me, is a sign that Larry has done a superb job. Indeed he has stimulated me to engage in my own research to address some of these questions. I can think of no higher praise.

Cite as: Lawrence Mitchell, Governance by the Sword, JOTWELL (February 10, 2015) (reviewing Lawrence A. Cunningham, Deferred Prosecutions and Corporate Governance: An Integrated Approach to Investigation and Reform, 66 Fla. L. Rev. 1 (2014)),

Hypothesizing Regulatory Instability

Erik Gerding’s recent book, Law, Bubbles, and Financial Regulation, is an ambitious and fascinating project that seeks to explain how asset bubbles—a perennial staple of economic history—lead to and, in turn, are exacerbated by financial regulation. Gerding makes it clear from the outset that his goal is to move beyond “fixing immediate symptoms” of a financial crisis and try to uncover the fundamental factors that explain how disasters happen. To this end, he advances what he calls the Regulatory Instability Hypothesis, a conceptual framework for explaining how financial markets (traditionally, a realm of private ordering) and financial regulation (the public sphere) get locked into a deadly spiral leading to a crisis. Gerding identifies five key dynamics that define this interaction: the regulatory stimulus cycle, compliance rot, regulatory arbitrage frenzies, pro-cyclical regulation, and promoting of investment herding. His Regulatory Instability Hypothesis holds that these five distinct dynamics pose danger to financial stability by undermining laws and regulations designed to protect it.

In my opinion, one of the most interesting and novel elements of Gerding’s argument is his concept of the “regulatory stimulus cycle.” Various scholars before Gerding wrote about the multiple causes and consequences of various deregulation campaigns, including privatizations of previously public functions and repeal of specific laws viewed as constraining private markets. In the aftermath of the latest financial crisis, in particular, many were searching for specific legal mechanisms that enabled unsustainable growth in risk and leverage within the financial system in the pre-crisis decades. For example, some scholars argued that the latest crisis could be traced directly to the partial repeal of the Glass-Steagall Act in 1999 and/or the passage of the Commodity Futures Modernization Act of 2000—the two most significant deregulatory legislative acts in recent times. Others (including myself) have focused on specific regulatory or legislative actions enabling financial institutions to conduct business activities that fed the pre-crisis asset bubble.

Gerding brings together all of these strands to construct a convincing and creative explanation of the entire complex of legislative and regulatory actions and failures to act, which form a single historical pattern that cannot be reduced to a simple notion of “deregulation.” Gerding argues that asset bubbles and busts create similar cycles of “regulatory stimulus” (which encompasses “loosening” of various legal restrictions on bubble-conducive financial activities) and “regulatory backlash” (which inevitably follows an implosion of the bubble). He analyzes this phenomenon of regulatory stimulus through three theoretical lenses—public choice, behavioral economics, and social norms—and demonstrates the complexity and multiplicity of factors that create and reinforce pernicious regulatory cycles. Gerding’s argument is original, thoughtful, and quite illuminating even for those of us who are well-versed in this subject-matter.

Gerding follows a similar approach when he examines the complex factors behind the other four aspects of his Regulatory Instability Hypothesis. He continues this densely packed discussion, which forms the bulk of the book, by applying his conceptual framework to the Panic of 2007-08. Here, Gerding shows his mastery of the rise and growth of the so-called shadow banking system, which he uses as a vivid example of the bubble-bust dynamics not only in financial markets but also in financial regulation.

The last part of the book lays out the author’s vision of how to design a more effective and adaptive financial regulation that would be less vulnerable to the pernicious dynamics of regulatory instability. It’s a sweeping but thoughtful discussion of high-level principles of regulatory design that could potentially alleviate specific problems he identifies earlier. While admitting “profound challenges” of trying to counter these deeply-rooted dynamics, Gerding methodically catalogues a wide range of measures aimed at redesigning regulatory institutions, with a view toward breaking the historical pattern of boom-and-bust cycles. Necessarily lacking in specificity, this forward-looking discussion nevertheless is very impressive and effective as a conceptual framework outlining the avenues for future policy work in the area.

As with any large-scale and ambitious work, Gerding’s book may invite legitimate criticism on a variety of specific points. I do not agree with every statement, diagnosis, or recommendation for future reform that he advances in his book. I would even argue against some of his assertions (and, especially, some of his recommendations). If I were writing this book, I might have chosen a different theoretical device to construct the argument. Yet, none of these disagreements diminish the significance of the book. On the contrary, by defining the contours of the debate and creating a helpful vocabulary for discussion, Erik Gerding’s new book provides a great benefit to the scholarly community. To be sure, this book is a dense read that requires an extra effort from its readers. Yet, the result if well worth the effort.

Cite as: Saule T. Omarova, Hypothesizing Regulatory Instability, JOTWELL (January 7, 2015) (reviewing Erik Gerding, Law, Bubbles, and Financial Regulation (2013)),

Surmounting the Control Paradigm

Colin Mayer’s Firm Commitment is not exactly a book about corporate law, but it’s still best corporate law book I have encountered in a long while. Here a leading academic in business and finance challenges the status quo, bringing financial economics, agency theory, and corporate law to bear to persuade us that something has gone very wrong with corporate organizations in English-speaking economies.

Unlike many critics of corporate institutions, Mayer approves of large corporate entities. He points out that they allow us to partition assets off from individuals and create stable productive environments conducive to group participation. They are ubiquitous for very good reasons and do great things. But there’s also a dark side. In describing it, Mayer pulls together a number of things that we all know are out there and builds them into a binary theory. On one side of the description there’s a long list of phenomena, bundled up and characterized as the “control” paradigm. The market for corporate control sits at the top of the list, followed by environmental degradation, reductions in workforces, the shareholder value maximization norm, the trend to shareholder empowerment, short termism, leveraged restructuring, asset substitution, and leveraged speculation. All these work together with and within corporate entities to lead to disastrous results for society and the economy, manifested in the form of both externalities and opportunity costs. As society tries to cope with this onslaught of injury, there result layers and layers of choking regulation.

On the other side of the description of corporations lies commitment, conceived as the restraint of control. More particularly, there are layers of unenforceable cooperative obligations that encourage stakeholders to invest in corporate enterprises. Indeed, it’s the genius of the corporate form that it encourages people to make these commitments. Yet, in the English-speaking economies (especially the UK), corporations are not taking advantage of this possibility due an obsession with control—a sacrifice of all to the interests of market shareholders. Other national economies have more stable corporate environments protected by controlling families or corporate groups, and their corporations do better in the sectors where commitment matters most.

This is a formidable indictment of the mindset that has held sway in academic corporate law for the past three decades. The same mindset more and more holds sway within corporate boardrooms. Mayer’s description and diagnosis pull no punches, occasionally crossing the line over to argumentative exaggeration. Even so, I can’t think of a more persuasive account. The question concerning constituent commitment has been fundamental to corporate law and governance for those same three decades, and no one has done a better job of laying it out.

Mayer would like to see some structural changes made in corporate entities, administering a strong dose of what’s called “new governance,” although the appellation doesn’t seem right for a book as hard hitting as this one. If you need to constrain corporate decision-making, says Mayer, it’s better to look inside the firm and take advantage of better information and more focused incentives than to look to outside regulation. He celebrates corporate diversity, counseling us that there are all sorts of organizational ways to make a widget and that some modes are better suited for some production functions. It’s not the one size fits all agency account that we hear in the conventional wisdom.

He gives us a two part reform suggestion. The first part is a weighted voting scheme that instead of rewarding with more votes as the holding period extends, rewards more votes up front in exchange for an advance commitment to hold for five or ten years. The second part is a variation on two-tier governance structure: a board of trustees whose job it is to assure that management adheres to a statement of purpose, a statement that by definition is non-shareholder value maximizing in significant respects. The trustees shield the firm from market pressures, enabling commitment.

Question: Is US law flexible enough to facilitate Mayer’s trust firm? Our corporate codes certainly are, if one reads them literally. You can draft any kind of voting and governance scheme you want into a corporate charter. But there still could be some questions about the operation of the duty of loyalty mandate on a board of directors subject to other constituent-directed trustee instructions. And, in fact, there is a narrow range of situations in which favoring employees over shareholders might be a breach of fiduciary duty, although I don’t think the range is economically salient and I doubt it would seriously get in the way of anything Mayer advocates. Even so, the theoretical implications are sufficiently momentous that I suspect a bit of statutory tweaking would be necessary to bring in Colin’s trust corporation, much as we have seen happen with B Corporations.

Tweaking aside, the lawyer in me wants to make a larger point about the connection between corporate law and the adverse conditions identified in the book. While the law facilitates the conditions, it does not require them. The law allows companies to merge and the removal of antitrust barriers makes mergers easier than ever. Yet there are no legal shotguns at these corporate weddings. The law lets corporations despoil the environment, but it doesn’t force them. The law lets corporations fire people who have bestowed a lot of human capital because it doesn’t give unorganized labor any rights, but it doesn’t require corporate restructuring. The bad results result from market pressures.

And that leaves me in a state of disquiet as I put down the book. Corporate law is endlessly flexible. It takes national political economies as it finds them and makes adjustments necessary for widget production in particular national contexts. But can we look to it jumpstart political economic change? I doubt it.

Cite as: Bill Bratton, Surmounting the Control Paradigm, JOTWELL (December 1, 2014) (reviewing Colin Mayer, Firm Commitment: Why the Corporation is Failing Us and How to Restore Trust in It, Oxford University Press (2013)),

Exhausting Regulatory Arbitrage

Annelise Riles, Managing Regulatory Arbitrage: A Conflict of Laws Approach, 47 Cornell Int'l. L.J. 63 (2014).

A recent gathering of regulators opened with a round of congratulations: bailouts were history, bail-ins were on the march, and victory was in sight, just as long as the assembled continued to speak with one voice and kept their bankers well-clear of the public trough. Moments later, it became clear that delegates from continental Europe were marching in different directions, while delegates from certain Nordic and African countries wanted no part of the march. The U.S. and the U.K. held the line, and the meeting closed on a cheerful note, with renewed pledges of regulatory unity.

It is fashionable to criticize regulatory harmonization as hopeless, pointless and potentially harmful. Yet harmonization continues to dominate regulation of international finance in good part because it feels like the obvious answer to two problems: regulatory competition and regulatory arbitrage. Scholarly criticism of harmonization tends to focus on competition. Annelise Riles’ liberating article shows why harmonization loses to arbitrage, and offers an intriguing alternative.

At the outset she revisits definitions. Regulatory arbitrage is a strategy for managing legal difference: by “locating” an activity in one corner of the market rather than another, the arbitrageur gets the same economic result at a lower regulatory cost. Arbitrage is a problem for the regulator when it puts the activity beyond his reach, but leaves him stuck with its effects.1 The fix seems obvious: ending difference ends arbitrage. Enter regulatory harmonization.

For Riles, harmonization and arbitrage are analogs and competitors, since both try to overcome difference. Harmonization starts the race at a big disadvantage because it requires coordination at home and abroad (a regulators’ cartel), and must contend with local politics. The arbitrageur is better off alone; borrowing a phrase from another part of the article, she is working “bottom-up.”

Governments too can fight difference alone—hegemony can displace harmonization—but they are too cheap, too weak, or too squeamish to do it. This follows from Riles’ discussion of harmonization as North Atlantic law-making, a formal convergence subverted in local practice. Inept harmonization is better than hegemony, but it is haphazard and undemocratic. When states commit to harmonize, they give up a “vocabulary” of difference that should be used to articulate local and functional aspirations. Differences “worth fighting for” become unspeakable. Here too, the arbitrageur is unburdened by the public’s constraint: while regulators profess harmony, she is free to exploit difference.

While harmonization fumbles, national courts treat global finance as a local law problem—and feed regulatory arbitrage. They describe financial activity as in-or-out, onshore or offshore, regulated or shadow. In Riles’ example, Morrison v. Nat’l Austl. Bank, U.S. courts apply U.S. law to block regulation by the United States, but also to preempt regulation altogether—they project power to create a regulatory vacuum.2 The field is clear for the arbitrageur.

Riles’ contribution addresses the combined failure of the regulators and the courts. The former paper over national differences; the latter ignore them. She would restore the vocabulary of difference using weedy, elaborate Conflict of Laws doctrines. The result would be a mode of authoritative decision-making that is transnational from the start, but also both structured and dynamic.

Knowing nothing about Conflicts, I found two arguments most startling for contemporary regulation. First, there is no vacuum. Problems of “regulatory perimeter” and shadow finance give way to problems of competing authority and competing laws. There is no offshore, just iterating choices among multiple onshores, with the burden of proving applicable law on the party resisting regulation. This goes against the textbook presumption that governments should stay out of the market, echoes Katharina Pistor’s vision of constructed markets, and adds technique.

Second, I was drawn to the capacity for slicing and iteration in Riles’ description of Conflicts reasoning. In the last part of the article, she unpacks a barely-hypothetical transaction involving a U.S. investor and a French employee at a London branch of a U.S. firm, under an English-law contract. The investor claims fraud in New York. For every aspect of the dispute, the court can (must) engage in thick contextual analysis to determine the scope of its own authority and, separately, applicable law, based on competing interests of different jurisdictions. No single factor—not “location,” not nationality, not party autonomy embedded in contractual choice of law—forecloses inquiry into compelling values.

The result is a problem for regulatory arbitrage, because the law applicable to the activity emerges in a thick substantive inquiry designed to go behind formal attributes and test the multiple values and interests at stake. This feels immensely unsettling to a transactional lawyer, but that may well be the point. Designing around regulation becomes expensive and exhausting, more trouble than it’s worth.

This is an exciting and hopeful insight, which could take many different paths in future work. The analysis is expressly meant to go beyond judicial reasoning, although examples in this article focus on the courts. Regulatory applications, to be explored in a promised sequel, could recast debates about home-host tensions, substituted compliance, and cross-border resolution. Perhaps more importantly, the erstwhile harmonizers would recover a platform for asserting difference without projecting distrust or defeat. A different project could spin out transactional implications: how should contract drafters and deal designers work in a radically dynamic regulatory regime implied by Riles’ argument?

Part of me wishes the article would invest less in sounding pragmatic. Conflict of Laws has deep roots in multiple jurisdictions, but this is an ambitious way of thinking Conflicts in a new context. Deploying Conflicts reasoning against arbitrage would not require new statutes or compacts, but it would require courts, legislators, and regulators committed to formal stability to embrace disruption—and a lot more work. The U.S. Supreme Court’s choice of nineteenth-century Conflicts reasoning in Morrison is not by default. I am also less sanguine about the “bottom-up” inclusive potential of Conflicts. The rules would let small states, people, groups and firms argue about competing values directly, but the voices most likely to percolate from the bottom up are already well-heard in global finance. Meaningful participation would take more institutional work—perhaps for another sequel.

Riles offers a rich frame for talking about difference in global finance. It opens a research agenda, and feels “doable” at multiple levels of ambition. Thinking of conflict as a mode of regulatory cooperation is a relief. Let the arbitrageur worry about harmony.

  1. It also distorts capital allocation and diverts revenues. []
  2. Consider similarities with recent prosecutions of French and Swiss banks for U.S. sanctions running and helping U.S. tax evasion. Here too, one country’s law occupies the field to the exclusion of others. Pending harmonization, U.S., French and Swiss authorities negotiate competing interests behind the scenes. []
Cite as: Anna Gelpern, Exhausting Regulatory Arbitrage, JOTWELL (October 29, 2014) (reviewing Annelise Riles, Managing Regulatory Arbitrage: A Conflict of Laws Approach, 47 Cornell Int'l. L.J. 63 (2014)),