The competing paradigms of securities regulation

Duke Law Journal

Volumn 57, Issue 3, 2007, Pages 625-689

  Park, James J ^a  

^a BROOKLYN LAW SCHOOL   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

EID: 38549093072     PISSN: 00127086     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (376)

1. In the realm of securities regulation, the distinction between rules and principles has been discussed in terms of whether the regulatory scheme should shift from a rules-based system to a principles-based system. See, e.g., COMM. ON CAPITAL MKTS. REGULATION, INTERIM REPORT OF THE COMMITTEE ON CAPITAL MARKETS REGULATION 8-9 (2006) [hereinafter INTERIM REPORT ON CAPITAL MARKETS REGULATION], available at http://www. capmktsreg.org/pdfs/11. 30Committee_Interim_ReportREV2.pdf (advocating a shift from prescriptive rules to broader principles);
2. John C. Coffee, Jr., Gatekeeper Failure and Reform: The Challenge of Fashioning Relevant Reforms, 84 B.U. L. REV. 301, 342-43 (2004) ("SarbanesOxley ushers in and accelerates a major and probably inevitable transition, which will move us from a rules-based system of financial disclosure to a principles-based system.");
3. Cristie Ford, New Governance, Compliance, and Principles-Based Regulation, 45 AM. BUS. L.J. (forthcoming 2008), available at http://ssrn.com/abstract=970130 (analyzing Canada's consideration of principles-based regulation). Lawrence Cunningham argues persuasively that no system is entirely rules-based or entirely principles-based.
4. See Lawrence A. Cunningham, A Prescription to Retire the Rhetoric of "Principles-Based Systems" in Corporate Law, Securities Regulation and Accounting, 60 VAND. L. REV. (forthcoming Oct.-Nov. 2007).
5. The distinction between rules and principles is amorphous. Ronald Dworkin simply refers to "principles" as "the whole set of... standards other than rules ...." RONALD DWORKIN, TAKING RIGHTS SERIOUSLY 22 (1977). While this Article uses the rules/principles distinction, it does not attempt to precisely define it or take a position on whether a rules-based system is better than a principles-based system. Instead, its focus is on the regulatory tools of rulemaking and enforcement, which have distinguishable procedural characteristics.
6. Such decisions have been referred to as a "choice in policymaking form" by M. Elizabeth Magill in an article describing how courts give agencies such as the Securities and Exchange Commission (SEC) wide discretion in choosing between regulatory tools such as rulemaking, enforcement, and adjudication. See M. Elizabeth Magill, Agency Choice of Policymaking Form, 71 U. CHI. L. REV. 1383, 1437 (2004).
7. Magill notes that little has been written about the way in which regulators choose between rulemaking and enforcement. Id. at 1442-43 ("There are few efforts to describe or explain how agencies choose among their available policymaking forms.");
8. see also Steven P. Croley, Theories of Regulation; Incorporating the Administrative Process, 98 COLUM. L. REV. 1, 6 (1998) (noting that administrative law theories "fail to incorporate any well developed vision of the administrative process-that is, of administrative law and administrative practice").
9. 17 C.F.R. §240.15c3-l (2007).
10. Id, pts. 210, 228.
11. Id. §240.15.
12. Id. §§242.100-.105.
13. Because rules themselves can set forth principles, I distinguish rules reflecting general principles from rules that make specific prescriptions, which have been referred to as "prescriptive rules." See INTERIM REPORT ON CAPITAL MARKETS REGULATION, supra note 1, at 8;
14. MCKINSEY & Co., SUSTAINING NEW YORK'S AND THE US' GLOBAL FINANCIAL LEADERSHIP 3-5, 95-129, available at http://www.senate.gov/∼schumer/SchumerWebsite/ pressroom/special_reports/2007/NY_REPORT%20_FINAL.pdf. I include rules reflecting principles in the category of "principles." When I refer to "rules" I am referring only to "prescriptive rules."
15. 17 C.F.R. §240.10b-5 (prohibiting certain deceptive devices);
16. see Ernst & Ernst v. Hochfelder, 425 U.S. 185, 203 (1976) (noting that legislative history described section 10(b) as a "catchall" clause enabling the SEC "to deal with new manipulative (or cunning) devices." (internal quotations omitted));
17. The Martin Act, N.Y. GEN. Bus. LAW §352 et seq. (McKinney 2006).
18. Nat'l Ass'n of Sec. Dealers, NASD Manual, Rules of the Association, Rule 2110, http://finra.complinet.com/finra/index.html (last visited Oct. 12, 2007).
19. Investment Company Act of 1940 §36(a), 15 U.S.C. §80a-35 (2000);
20. see also SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191 (1963) ("The Investment Advisers Act of 1940 thus reflects a congressional recognition 'of the delicate fiduciary nature of an investment advisory relationship,' as well as a congressional intent to eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser-consciously or unconsciously - to render advice which was not disinterested."); EBC I, Inc. v. Goldman, Sachs & Co., 832 N.E.2d 26, 11 (2005) (discussing the common-law fiduciary duty).
21. There are obviously different degrees of "arguable misconduct," and I do not attempt to precisely define the term.
22. In contrast, straightforward enforcement of a rule can be called a "rules-based enforcement action."
23. See Charles Gasperino & Michael Schroeder, Pitt and Spitzer Butted Heads to Overhaul Wall Street Research, WALL ST. J., Oct. 31, 2002, at Al ("The SEC chairman believed that the solution to the problem was developing a new set of standards for analysts, while at the same time directing self-regulatory organizations, such as the National Association of Securities Dealers and the New York Stock Exchange, to examine conflicts of interest and draw up new rules on analyst compensation and disclosure practices.").
24. See id. Of these three results, this Article focuses on the initial decision to punish arguable misconduct with a principles-based enforcement action. I leave analysis of the imposition of penalties and structural reforms resulting from such actions for another day.
25. In this Article, when I refer to "securities regulators," I include not only the Securities and Exchange Commission (SEC) but also state securities regulators such as the New York Attorney General as well as self-regulatory organizations such as the National Association of Securities Dealers (NASD) and the New York Stock Exchange (NYSE). Of course, there are differences in the ways that state regulators and the SEC regulate. For example, only the SEC can pass nationwide rules. Although state regulators cannot pass such rules, they have the choice of deferring to SEC rulemaking rather than bringing a principles-based enforcement action. For the sake of simplicity, I refer to these actors collectively and leave the implications of the trend toward increased state involvement in securities regulation for another day.
26. See, e.g., Complaint, New York v. Canary Capital Partners, LLC (N.Y. Sup. Ct. Sept. 3, 2003) (undocketed) [hereinafter Canary Complaint], available at http://www.oag.state.ny.us/ press/2003/sep/canary_complaint. pdf; Complaint, SEC v. Credit Suisse First Boston Corp., No. 02-90 (D.D.C. Jan. 22, 2002) [hereinafter CSFB Complaint]; Affidavit of Eric R. Dinallo in Support of Application for an Order Pursuant to General Business Law Section 354, In re Spitzer v. Merrill Lynch & Co., No. 02-401522 (N.Y. Sup. Ct. Apr. 8, 2002) [hereinafter Dinallo Aff.]; Stephen M. Cutler, Dir., Div. of Enforcement, SEC, Speech to the 24th Annual Ray Garrett Jr. Corporate & Securities Law Institute, Chi, Ill. (Apr. 29, 2004), available at http://www.sec.gov/ news/speech/spch042904smc.htm ("[A]ll but three of the 12 penalties of $50 million or more obtained in Commission settlements since 1986 were obtained in the last twelve months.").
27. This emphasis on rulemaking was part of a general trend among administrative agencies. See Magill, supra note 2, at 1398 ("[B]y the mid-1970s, rulemaking was the primary and preferred mode of making policy for many agencies.").
28. The shift by securities regulators to principles-based enforcement actions may be part of a more general trend toward using litigation as a policymaking tool. Id. ("Some [scholars] point to the rise of agency litigation as a strategy for achieving regulatory objectives.").
29. See 17 C.F.R. §§243.100-.103 (2007).
30. See, e.g., INTERIM REPORT ON CAPITAL MARKETS REGULATION, supra note 1, at 9 ("Enforcement actions in recent years have been used as a basis for ad hoc rule-writing.");
31. Jonathan R. Macey, Who is Protecting the Investor?: State-Federal Relations Post-Eliot Spitzer, 70 BROOK. L. REV. 117, 128 n.36 (2004) ("Rulemaking by enforcement refers to the presumptively illegitimate process by which regulators proceed with rulemaking 'ex post,' i.e. after certain conduct occurs, rather than through more legitimate formal notice-and-rulemaking procedures.");
32. Daniel Dunaief, SEC to Set Tough Analyst Rules, DAILY NEWS (N.Y.), Apr. 10, 2003, at 68 ("There are a lot of smart people who haven't been consulted ... [t]his is regulation by enforcement." (quoting Saul Cohen, partner at the firm Proskauer Rose));
33. Michael G. Oxley, Letter to the Editor, Who Should Police the Financial Markets?, N.Y. TIMES, June 9, 2002, at B11 ("In this time of lagging investor confidence, policymaking through litigation discussed in a closed conference room is not healthy for the U.S. capital markets, and not good for investors.");
34. Tom Petruno, SEC, Fund Firm May Face Off, L.A. TIMES, Dec. 11, 2005, at Cl ("A key question is whether the Republican majority on the commission would consider a solid case, or an example of what some SEC critics label 'regulation by enforcement'-rewriting industry rules by suing a particular party instead of simply ordering changes for all players.");
35. Stephen M. Cutler, Dir., Div. of Enforcement, SEC, Remarks at the F. Hodge O'Neal Corporate and Securities Law Symposium (Feb. 21, 2003), available at http://www.sec.gov/news/speech/ spch022103smc.htm ("As an enforcement lawyer, I am quite familiar with the complaint raised by defendants or respondents, and even by an occasional SEC Commissioner, that a proposed settlement amounts to rulemaking by enforcement.");
36. Karen Donovan, Under Siege, REGISTERED REP., Sept. 1, 2005, http://registeredrep.com/regulatory/finance_siege/ ("The defense bar alleges that regulators are now making up rules as they go along, a phenomenon they call 'regulation by enforcement.' The enforcement cases keep coming, even as the SEC proposes rules to broaden and clarify duties that it says [broker-dealers] have been violating.").
37. The role of litigation in establishing norms has been an issue in other areas such as environmental regulation. E.g., Andrew P. Morriss, Bruce Yandle & Andrew Dorchak, Choosing How to Regulate, 29 HARV. ENVTL. L. REV. 179, 248-50 (2005) (analyzing when agencies such as the EPA decide whether to use rulemaking versus litigation to promulgate norms).
38. See generally REGULATION THROUGH LITIGATION (W. Kip Vicusi ed., 2002) (analyzing the formation of norms in tobacco regulation, firearms, lead-based paint hazards, breast implants, malpractice and legal reform);
39. Thomas O. McGarity, Douglas Kysar & Karen Sokol, The Truth about Torts: Lawyers, Guns, and Money, CENTER FOR PROGRESSIVE REFORM PUBLICATION, July 2006, at 3 (criticizing regulation by litigation trope);
40. Robert B. Reich, Regulation Is Out, Litigation Is In, THE AMERICAN PROSPECT ONLINE, Feb. 11, 1999, http://www.prospect.org/cs/articles?article-regulation_is_out_litigationJs_in (discussing tobacco and handgun litigations and observing: "The era of big government may be over, but the era of regulation through litigation has just begun.").
41. See ROBERTA KARMEL, REGULATION BY PROSECUTION (1982) (first setting forth the "Regulation by Enforcement" critique). A later article coined the phrase "Regulation by Enforcement."
42. See Harvey L. Pitt & Karen L. Shapiro, Securities Regulation by Enforcement: A Look Ahead at the Next Decade, 7 YALE J. ON REG. 149, 149 (1990).
43. KARMEL, supra note 20.
44. Id, at 146-59.
45. Pitt & Shapiro, supra note 20, at 155 (emphasis omitted). An article in the environmental law context refers to the strategy as "Regulation-by-litigation," where [r]ather than issue a proposed rule or invite affected parties to negotiate, an agency sues one or more regulated entities, charging them with violation of an existing statute, regulation or common law rule. The lawsuit is often based on a novel interpretation of the statute or regulation and may concern behavior that the regulated entities believe the agency has accepted in the past. Using the threat of substantial liability for the alleged breach, the agency then persuades or coerces the regulated entity to agree to a consent decree or injunctive relief that includes imposition of substantive regulatory provisions.
46. Morriss, Yandle & Dorchak, supra note 19, at 203.
47. KARMEL, supra note 20, at 95-98.
48. Pitt & Shapiro, supra note 20, at 156.
49. See id, at 199-200.
50. See id, at 206-08 (analyzing the pitfalls of possible definitions). While making this observation, Pitt and Shapiro do not propose a definition.
51. See id. at 207-08.
52. Id. at 207.
53. Id. at 167 (emphasis omitted).
54. Id.
55. See id. at 199-201 (describing insider trading as the "Centerpiece of the Enforcement Program of the 1980s" and observing that "[i]nsider trading cases provided a ready vehicle for pursuing individuals rather than issuers, since it was thought that, only in the rare case, if at all, would a company play a role in insider trading other than as the source or object of the information in question").
56. That is not to say that the SEC was not bringing enforcement actions during this period. Indeed, the SECs action against the NASD in 1996 for anticompetitive practices was a major principles-based enforcement action. JOEL SELIGMAN, THE TRANSFORMATION OF WALL STREET: A HISTORY OF THE SECURITIES AND EXCHANGE COMMISSION AND MODERN CORPORATE FINANCE 698-701 (3d ed. 2003).
57. But it appears that for the most part, the focus was on areas directed at individuals or smaller firms such as "microcap or penny stock fraud and day trading abuses as well as traditional areas such as unregistered securities, financial fraud, and insider trading." Id. at 638 (footnote omitted).
58. See James D. Cox & Randall S. Thomas, Public and Private Enforcement of the Securities Laws: Have Things Changed Since Enron?, 80 NOTRE DAME L. REV. 893, 897-98 (2005).
59. Post-2002, the study shows that the SEC has begun targeting much larger companies. Id. at 901-02.
60. Securities Enforcement Remedies and Penny Stock Reform Act of 1990, Pub. L. No. 101-429, 104 Stat. 931 (codified in scattered sections of 15 U.S.C). Prior to this statute, the impact of enforcement actions was also limited by the remedies regulators had at their disposal. See, e.g., Pitt & Shapiro, supra note 20, at 295 ("Under the Commission's old enforcement program, which emphasized injunctive relief, and permitted defendants to walk away from litigation by promising to do what the law already required those defendants to do (namely, to obey the law), without any acknowledgment of wrongdoing, the prospects of settlement were quite high.");
61. see also Cutler, supra note 16 ("[U]ntil very recently, the Commission necessarily relied almost exclusively on forward-looking relief, such as federal court injunctions, orders of disgorgement, and remedial undertakings such as procedural reforms and independent monitors, to enforce compliance with securities laws.").
62. See Richard A. Spehr & Michelle J. Annunziata, The Remedies Act Turns Fifteen: What Is Its Relevance Today?, 1 N.Y.U. J. L. & Bus. 587, 596-97 (2005) ("It has been observed that in the decade or so following the enactment of the Remedies Act, the SEC did not often seek or obtain penalties against public companies.");
63. see also John C. Coffee, Jr., Understanding Enron: "It's About the Gatekeepers, Stupid," 57 BUS. LAW. 1403, 1409-10 & n.33 (2002) (noting that the SEC pursued individuals rather than the Big Five accounting firms during the 1990s);
64. Cox & Thomas, supra note 33, at 897-98 (discussing the SEC's tactics in using its expanded statutory powers).
65. Selective Disclosure and Insider Trading, Securities Act Release No. 7881, Exchange Act Release No. 43,154, Investment Company Act Release No. 24,599, 65 Fed. Reg. 51,716, 51,716 (Aug. 24,2000) (codified at 17 C.F.R. pts. 240, 243, 249).
66. Dirks v. SEC, 463 U.S. 646 (1983).
67. Id. at 661-62.
68. 17 C.F.R. §§ 243.100-.103 (2007).
69. Richard H. Walker, Dir., Div. of Enforcement, SEC: Regulation FD-An Enforcement Perspective (Nov. 1, 2000), available at http://www.sec.gov/ news/speech/spch415.htm.
70. Selective Disclosure and Insider Trading, 65 Fed. Reg. at 51,718 (citations omitted). In a lecture panel presentation discussing Regulation FD, Harvey Goldschmid, who was General Counsel of the SEC when Regulation FD was first presented, noted that he believed that the SEC could have won an extension of Dirks so the insider trading laws would apply to issuers, but that litigation might have imposed too many costs and would have caused a chilling effect on corporate communications. Lecture: Panel Discussion: The SEC's Regulation FD (Feb. 12, 2001), in 6 FORDHAM J. CORP. & FIN. L. 273, 279-81 (2001).
71. An example of a principle is the general prohibition against "manipulative or deceptive devices" and fraud set forth in section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5. These provisions are intentionally broad and were described as "a 'catchall' clause to enable the Commission 'to deal with new manipulative (or cunning) devices.'" Ernst & Ernst v. Hochfelder, 425 U.S. 185, 203 (1976) (quoting a statement of Thomas Corcoran in a hearing before the House Committee on Interstate and Foreign Commerce).
72. The law review literature often refers to the distinction between rules and standards. See, e.g., Louis Kaplow, Rules Versus Standards: An Economic Analysis, 42 DUKE L.J. 557, 559 (1992) ("Arguments about and definitions of rules and standards commonly emphasize the distinction between whether the law is given content ex ante or ex post.")
73. Cass R. Sunstein, Problems with Rules, 83 CAL. L. REV. 953, 961 (1995) ("[W]e have a rule, or rule-ness, to the extent that decisions about cases have been made ex ante rather than ex post.").
74. When I use the word principles, I am essentially referring to standards. I use the word principles because much of the literature specific to the securities regulation refers to a distinction between rules and principles rather than rules and standards. See supra note 1.
75. SEC v. Chenery Corp., 332 U.S. 194 (1947).
76. Id. at 197.
77. Id. at 198.
78. Id. at 199.
79. Id. at 199-200.
80. Id. at 202.
81. Id.
82. Id. at 203 ("[T]he choice made between proceeding by general rule or by individual, ad hoc litigation is one that lies primarily in the informed discretion of the administrative agency.").
83. See Cristie L. Ford, Toward a New Model for Securities Law Enforcement, 57 ADMIN. L. REV. 757, 766 (2005) ("The [SEC] Enforcement Division has filed an unprecedented number of actions, especially against organizations, in the last two years."). In addition, the enforcement response to the corporate scandals that erupted in the early part of this century has included criminal prosecutions, private class actions, and civil regulatory enforcement actions. Prosecutors have won criminal convictions against high level executives of bankrupt companies who committed accounting fraud.
84. See, e.g., John R. Emshwiller et al., Symbol of an Era: Lay, Skilling are Convicted of Fraud-Jurors Reject Defense Claim That Enron Was Clean; Question of Credibility - Two 'Very Controlling People, ' WALL ST. J., May 26, 2006, at Al;
85. Barry Meier, 2 Guilty in Fraud at a Cable Giant, N.Y. TIMES, July 9, 2004, at Al;
86. Dionne Searcey et al., Ebbers is Sentenced to 25 Years for $11 Billion WorldCom Fraud, WALL ST. J., July 14,2005 at Al. Class action plaintiffs have brought numerous suits and negotiated billions of dollars in settlements against the gatekeepers who should have detected such fraud.
87. See, e.g., Robin Sidel, J.P. Morgan to Pay $2 Billion As Street's Bill for Bubble Soars, WALL ST. J., Mar. 17, 2005, at Al;
88. Randall Smith & Robin Sidel, J.P. Morgan Agrees To Settle IPO Case for $425 Million, WALL ST. J., Apr. 21, 2006, at C4;
89. Jonathan Weil & Robin Sidel, WorldCom Investors Settle Lawsuits-Investment Banks Will Pay Almost All of $651 Million in Pact Tied to Bond Deals, WALL ST. J., Oct. 27, 2005, at A3.
90. While all three responses have had success, I would argue that civil regulatory enforcement actions have been the most instrumental in communicating legal norms to industry. Criminal law is limited by its stringent burden of proof and the collateral effects of corporate indictments. See, e.g., Ken Brown et al., Called to Account: Indictment of Andersen in Shredding Case Puts Its Future in Question-Obstruction of Justice Count May Speed the Departure of Clients and Partners - Firm Calls It 'Death Penalty,' WALL ST. J., Mar. 15, 2002, at Al. Private class actions focus on private interests and terms of settlements are often classified.
91. See, e.g., Joseph A. Grundfest, Disimplying Private Rights of Action Under the Federal Securities Laws: The Commission's Authority, 107 HARV. L. REV. 963, 1000 (1994) ("Although private claims play an undeniably important role in the enforcement of the securities laws, they are brought for entirely private ends. Private damages actions focus narrowly on how much the individual lost as a result of the illegal conduct and whether that injury can be reasonably quantified." (quoting SEC v. Rind, 991 F.2d 1486, 1490 (9th Cir. 1993))). Because of their civil nature, enforcement actions do not suffer from the restrictions of criminal prosecutions. Because they are brought by government officials serving the public interest, they do not suffer from the same limits as private class actions. Through the use of subpoena power, the government can obtain evidence and craft complaints that are based on more than conjecture. The allegations can be widely publicized so that the precise evidence of wrongdoing and why it was wrong is communicated to the public. By doing so, the application of the legal norm can be communicated to industry with great speed.
92. CSFB Complaint. supra note 16, at paras. 1-2;
93. see also SEC Sues CSFB for IPO Violations; CSFB Will Pay $100 Million, SEC Litigation Release No. 17327 (Jan. 22, 2002). available at http://www.sec.gov/litigation/litreleases/lrl7327.htm (discussing abuses relating to the allocation of IPO shares to brokerage customers).
94. CSFB Complaint, supra note 16, at paras. 1-2.
95. Id. at para. 8.
96. See In re Initial Pub. Offering Sec. Litig., 241 F. Supp. 2d 281, 293-94 (S.D.N.Y. 2003);
97. Sean J. Griffith, Spinning and Underpricing: A Legal and Economic Analysis of the Preferential Allocation of Shares in Initial Public Offerings, 69 BROOK. L. REV. 583, 590-92 (2004).
98. Typically, there is more than one investment bank involved in the deal. Most IPOs are "offered to the public through an 'underwriting syndicate,' a group of underwriters who agree to purchase the shares from the issuer and then sell the shares to investors." SEC, Initial Public Offerings: Why Individuals Have Difficulty Getting Shares, Nov. 24, 1999, http://www.sec.gov/ answers/ipodiff.htm [hereinafter SEC, Initial Public Offerings]; see also Billing v. Credit Suisse First Boston Ltd., 426 F.3d 130. 137-38 (2d Cir. 2005) (noting the risk management function of forming underwriting syndicates as well as syndicates' prominence), rev'd on other grounds, 127 S. Ct. 2383 (2007).
99. See generally NYSE/NASD IPO ADVISORY COMM., REPORT AND RECOMMENDATIONS 4-5 (2003) ("We encourage underwriters to engage in an open discussion with the issuer's pricing committee, explaining to the issuer the context and significance of indications of interest from various investors, as well as sharing their perspective on this demand.").
100. See CSFB Complaint, supra note 16, at para. 11.
101. Studies show that this commonly occurs. See In re Initial Pub. Offering Sec. Litig., 241 F. Supp. 2d at 300 ("For at least five decades, studies have shown that IPOs generally trade on the open market at a price significantly higher than the offering price, a phenomenon known as underpricing.").
102. John C. Coffee, Jr., The IPO Investigations: Who's the Victim? What's the Harm?, http://www.pbs.org/wgbh/pages/frontline/shows/dotcon/crying/ coffeeipos.html (last visited Nov. 27, 2007) ("[P]rice spikes occur because the offering is oversubscribed-that is, the underwriters have solicited 'indications of interest' from potential buyers amounting to many times the number of shares that the issuer ... wishes to sell.").
103. See In re Initial Pub. Offering Sec. Litig., 241 F. Supp. 2d at 294;
104. CSFB Complaint, supra note 16, at para. 17.
105. See Billing v. Credit Suisse First Boston Ltd., 426 F.3d 130, 139 n.7 (2d Cir. 2005), rev'd on other grounds, 127 S. Ct. 2383 (2007);
106. CSFB Complaint, supra note 16, at para. 8;
107. SEC, Initial Public Offerings, supra note 56 ("When an IPO is 'hot,' appealing to many investors, the demand for the securities far exceeds the supply of shares. The excess demand can only be satisfied once trading in the IPO shares begins.").
108. See generally In re Initial Pub. Offering Sec. Litig., 241 F. Supp. 2d at 306 ("[T]he IPO market of 1998-2000 was more extraordinary than the previous three hot issues markets.");
109. NYSE/NASD IPO ADVISORY COMM., supra note 57, at 1, 4 (noting that the late 1990s was "a period in which an unusually large number of offerings traded at extraordinary and immediate aftermarket premiums"). IPO shares would frequently double or triple in price on the first day of trading. For example, shares of the company VA Linux rose from an initial offering price of $30 to $239 in the first day of trading, an increase of 697 percent.
110. See CSFB Complaint, supra note 16, at para. 54. Of course, there is no guarantee that over time the initial rise in price is sustainable.
111. See, e.g., Howard Schilit, FINANCIAL SHENANIGANS 104-08 (2d ed. 2002) (describing collapse of Boston Chicken stock after a successful IPO).
112. See CSFB Complaint, supra note 16, at para. 15.
113. Id. at para. 13;
114. see also Arthur Levitt, Chairman, SEC, Speech at the Los Angeles Times Fourth Annual Investment Strategies Conference: Investing with Your Eyes Open (Feb. 12, 2000), available at http://www.sec.gov/news/speech/spch345.htm ("Shares often are allocated according to business relationships and other subjective criteria.").
115. See CSFB Complaint, supra note 16, at para. 46. This commission covers the cost of execution and the value of advice and other services such as research provided by the brokerdealer.
116. Coffee, supra note 60 ("[L]arge institutional investors implicitly pay for receiving priority in the allocation of 'hot' offerings by directing their brokerage business to the major underwriters.... [A large mutual fund] could direct this brokerage business to a cheap discount broker, or it could negotiate a somewhat higher commission rate with a broker dealer that was also a major underwriter in return for a priority in the latter's IPO allocations.");
117. see also Jonathan Reuter, Are IPO Allocations for Sale? Evidence from Mutual Funds, 61 J. OF FIN. 2289, 2290, 2322 (2006) (finding that underwriters allocate based on amount of overall "brokerage business").
118. News Release, NASD Regulation, Inc., Statement of Mary Schapiro on Announcement of CSFB Action (Jan. 22, 2002), available at http://www.finra.org/PressRoom/NewsReleases/ 2002NewsReleases/P002966.
119. CSFB Complaint, supra note 16, at paras. 19-20.
120. Id. at paras. 42-43.
121. Id. at paras. 21-22.
122. Id at para. 22.
123. Id. at para. 2.
124. Id at para. 20.
125. See Susan Pulliam et al., Coming to Terms: CSFB Agrees to Pay $100 Million to Settle Twin IPO Investigations-Probes by SEC and NASD Grew out of Conduct During Dot-Com Frenzy - A Legacy of Wheat's Reign, WALL ST. J., Dec. 11, 2001, at Al ("Investigators began focusing last year on CSFB's alleged practice of awarding shares of hot IPOs to some investors who agreed to pay the firm large commissions on other transactions. As detailed in a series of Wall Street Journal stories beginning in December 2000, some of these commissions came on big batches of trades at hugely inflated rates.").
126. SEC Sues CSFB for IPO Violations; CSFB Will Pay $100 Million, supra note 53;
127. News Release, NASD Regulation, Inc., supra note 68.
128. See CSFB Complaint, supra note 16, at paras. 74-75. NASD Rule 2330(f) provides in relevant part: [N]o member or person associated with a member shall share directly or indirectly in the profits or losses in any account of a customer carried by the member or any other member; provided, however, that a member or person associated with a member may share in the profits or losses in such an account if (i) such person associated with a member obtains prior written authorization from the member employing the associated person; (ii) such member or person associated with a member obtains prior written authorization from the customer; and (iii) such member or person associated with a member shares in the profits or losses in any account of such customer only in direct proportion to the financial contributions made to such account by either the member or person associated with a member.
129. Nat'l Ass'n of Sec. Dealers, NASD Manual, Rules of the Association, Rule 2330(f)(1)(A), http://finra.complinet.com/finra/index.html (last visited Nov. 27, 2007).
130. CSFB Complaint, supra note 16, at paras. 70-72.
131. See SEC v. Credit Suisse First Boston Corp., No. 1: 02-00090-RWR, 2002 WL 479836, at *2 (D.D.C. Jan. 29, 2002).
132. NASD rules prohibit underwriters from allocating IPO shares to themselves, relatives, or to accounts where they have a "beneficial interest." Nat'l Ass'n of Sec. Dealers, NASD Manual, Rules of the Association, Rule 2790, http://finra.complinet.com/finra/index.html (last visited Nov. 27, 2007).
133. SEC, Initial Public Offerings, supra note 56;
134. see also John C. Coffee, The SEC's IPO Probe, NAT'L L.J., July 9, 2001, at B8 ("No duty to prorate IPO stock among all customers, or to otherwise apportion it 'fairly' has ever been recognized within the industry.");
135. SEC, Allocation of New Issues of Securities, 1994 WL 744595, at *1 (Oct. 18, 1994) ("Broker-dealers are free to establish their own procedures and priorities for allocating new shares to investors, as long as the allocation is not conducted in a fraudulent or manipulative manner and is consistent with the rules of the broker-dealers' self-regulatory organization (SRO). . . . None of the SROs, however, prescribe procedures that broker-dealers must use to allocate offering securities among their customers.").
136. Interview by Martin Smith with Arthur Levitt, Former Chairman, SEC (May 2001), available at http://www.pbs.org/wgbh/pages/frontline/shows/dotcon/ interviews/levitt.html;
137. see also Levitt, supra note 65 ("Shares often are allocated according to business relationships and other subjective criteria.").
138. See Randall Smith, NASD Proposes Tougher Rules on IPO Abuses -
139. NASD Rule 2330(f) provides: "Except as provided in paragraph (f)(2) no member or person associated with a member shall share directly or indirectly in the profits or losses in any account of a customer carried by the member or any other member...." Nat'l Ass'n of Sec. Dealers, NASD Manual, Rules of the Association, Rule 2330(f)(1)(A), http://finra.complinet. com/finra/index.html (last visited Nov. 27, 2007).
140. See Pulliam et al., supra note 75 ("In the CSFB case, the regulators have struggled with what law to apply to the firm's practices.").
141. Early speculation had been that the conduct could violate other rules such as the Free-riding and Withholding Rules or bans against undisclosed underwriting compensation. See Susan Pulliam & Randall Smith, Two at CSFB Put on Leave amid IPO Probe - Action Shows Inquiry Touches Tech Team of Frank Quattrone, WALL ST. J., Apr. 20, 2001, at C1.
142. NASD Rule 2330(f) was modeled after section 205 of the Investment Advisers Act, which also prohibits certain profit sharing arrangements. See NASD Notice to Members 01-24: SEC Approves Proposed Rule Changes to Rule 2330(f)(2) Relating to Performance Fees (Apr. 2001), available at http://www.finra.org/web/groups/rules_regs/documents/notice_to_members/ p003885.pdf. The legislative history of Section 205 indicates that the rationale for the prohibition against profit sharing was the concern that customers would be harmed if advisers had an incentive to make risky investments in hopes of a larger fee.
143. See Exemption To Allow Registered Investment Advisors to Charge Fees Based Upon a Share of Capital Gains Upon or Capital Appreciation of a Client's Account, 50 Fed. Reg. 48,556, 48,557 (Nov. 26, 1985) ("Congress enacted the prohibition of Section 205(1) against performance fees in 1940 to protect clients of investment advisers from fee arrangements which in Congress' view could encourage advisers to engage in speculative trading practices while managing client funds in order to realize or increase an advisory fee.").
144. See Coffee, supra note 81.
145. See The Impact of the Global Settlement: Hearing Before the S. Comm. on Banking, Housing, and Urban Affairs, 108th Cong. 44 (2003) (statement of Robert E. Glauber, Chairman and CEO, National Association of Securities Dealers) (describing enforcement actions as underscoring the principle "that hot IPOs cannot be doled out to corporate insiders as virtual commercial bribes").
146. See generally 12 AM. JUR. 2D Bribery § 1 (2007) ("[B]ribery is the criminal offense of offering, giving, soliciting, accepting, or agreeing to accept something of value with an intent to corruptly influence the action of... an employee of a private business.... The purpose of bribery is to cause certain matters that should be decided or handled in an objective way to be decided or handled in the private interest of the bribegiver or the bribetaker. It is something that directly affects the community at large. It offends the public sense of decency and tends to pervert justice." (footnotes omitted)).
147. Nat'l Ass'n of Sec. Dealers, NASD Manual, Rules of the Association, Rule 2110, http://finra.complinet.com/finra/index.html (last visited Oct. 12, 2007).
148. See generally D.E. Ytreberg, Annotation, Validity and Construction of Statutes Punishing Commercial Bribery, 1 A.L.R.3d 1350 (1965) (collecting state and federal commercial bribery statutes).
149. See, e.g., Coffee, supra note 81.
150. See Securities Exchange Act of 1934 § 28(e), 15 U.S.C. § 78bb(e) (2000).
151. Indeed, the typical market commission of $0.06 per share already includes an extra payment for research and other services. Thus, payments of $1.00 per share go far beyond the industry standard for a reasonable commission.
152. On July 25, 2002, the NASD proposed conduct rules regulating IPO abuses. News Release, Nat'l Ass'n of Sec. Dealers, NASD Board Approves Proposed Conduct Rules for IPO Activities (July 25, 2002), available at http://www.finra.org/PressRoom/NewsReleases/2002News Releases/P002921. It proposed explicitly prohibiting the quid pro quo arrangements at issue in the CSFB case as well as "spinning" and "laddering." Id. In August 2002, at the request of the SEC Commissioner, the NYSE and NASD formed the NYSE/NASD IPO Advisory Committee to study the IPO process.
153. See NYSE/NASD IPO ADVISORY COMM., supra note 57, at app. A. In May 2003, the NYSE/NASD IPO Advisory Committee published its report, recommending various measures to improve the transparency of the IPO process, including the prohibition of laddering, spinning, and quid pro quo arrangements.
154. Id. at 10-13.
155. In addition to these structural reform proposals, the CSFB investigation was followed by a number of enforcement actions against other market participants. See, e.g., SEC Sues J.P. Morgan Securities Inc. for Unlawful IPO Allocation Practices; J.P. Morgan Agrees to Settlement Calling for Injunction and Payment of $25 Million Penalty, SEC Litigation Release No. 18385 (Oct. 1, 2003), available at http://www.sec.gov/litigation/ litreleases/lr18385.htm; SEC Sues Robertson Stephens, Inc. for Profit Sharing in Connection with Initial Public Offerings;
156. Robertson Stephens Consents to Pay $28 Million, SEC Litigation Release No. 17923 (Jan. 9, 2003), available at http://www.sec.gov/ litigation/litreleases/lr17923.htm;
157. News Release, Nat'l Ass'n of Sec. Dealers, NASD Fines J.P. Morgan for Sharing in Profits from Hot IPOs (Feb. 20, 2003), available at http://www.finra.org/PressRoom/NewsReleases/2003NewsReleases/P002951;
158. News Release, Nat'l Ass'n of Sec. Dealers, NASD Sanctions Investment Banks for IPO Violations: Bear Stearns, Deutsche Bank and Morgan Stanley to Pay Over $15 Million (May 18, 2004), available at http://www.finra. org/PressRoom/NewsReleases/2004NewsReleases/P002829.
159. Cf. Griffith, supra note 56, at 623-30, 637-43 (discussing the hypothesis that spinning "may amount to a quid pro quo arrangement, according to which the managers accept the benefit of the allocation in exchange for the underpricing of their company's offering").
160. See, e.g., Billing v. Credit Suisse First Boston Ltd., 426 F.3d 130, 144 (2d Cir. 2005) ("The purported 'bribes' consisted of underwriter promises to make 'exceptionally large' allocations of IPO securities in return for the institutional defendants' promises to comply with the rules set by the underwriter defendants for the resale of the securities and to divide profits with them."), rev'd on other grounds, 127 S. Ct. 2383 (2007).
161. State of New York v. McLeod, No. 403855/02, 2006 N.Y. Misc. LEXIS 1227, at *2 (Sup. Ct. Feb. 9, 2006).
162. See, e.g., Complaint at paras. 15-17, SEC v. J.P. Morgan Sec. Inc. 03 Civ. 2939, (S.D.N. Y. Apr. 28, 2003);
163. SEC, Investor Alert: Analyzing Analyst Recommendations, Apr. 20, 2005, http://www.sec.gov/investor/pubs/analysts.htm.
164. See SEC, supra note 99.
165. See id
166. This is permissible under section 28(e) of the Securities Exchange Act. See Securities Exchange Act of 1934 § 28(e), 15 U.S.C. § 78bb(e) (2000).
167. See Complaint at para. 18, SEC v. Merrill Lynch, Pierce, Fenner & Smith Inc., 03 CV 2941 (S.D.N.Y. Apr. 28, 2003); Jonathan R. Macey, Positive Political Theory and Federal Usurption of the Regulation of Corporate Governance: The Coming Preemption of the Martin Act, 80 NOTRE DAME L. REV. 951, 971 (2005) ("In response to complaints that brokerage commissions had sunk so low that brokers could no longer afford to pay analysts, analysts became more involved in marketing IPOs in order to justify their retention by investment banks.").
168. See DAN REINGOLD, CONFESSIONS OF A WALL STREET ANALYST 36 (2006). Reingold describes the end of the genteel old world of banking, in which belonging to the same country club and living in the same town was as much of a draw for a corporate executive choosing a banker as the actual services the bank was offering. As banking became more competitive, these relationships weren't enough anymore. Banks needed to offer something extra, some special sauce. As time went on, that special sauce would often involve bullish research.
169. Id.
170. See, e.g., Complaint at para. 17, SEC v. U.S. Bancorp Piper Jaffray Inc., 03 Civ. 2942 (S.D.N.Y. Apr. 28, 2003) [hereinafter U.S. Bancorp Complaint];
171. Complaint at para. 15, SEC v. Morgan Stanley & Co., 03 Civ. 2948, (S.D.N.Y. Apr. 28, 2003) [hereinafter Morgan Stanley Complaint] ("Morgan Stanley typically competed with other investment banks for selection as the lead underwriter, or 'bookrunner,' for securities offerings, including IPOs and follow-on offerings.... Sole or joint bookrunners generally received the largest portion of underwriting fees, which were typically divided among the participating investment banks. The bookrunner also established the allocation of shares in an offering and typically retained the greatest number of shares for itself. The typical IPO generated millions of dollars in investment banking fees for the bookrunner.").
172. See Morgan Stanley Complaint, supra note 105, at para. 16 ("In selecting the lead underwriters, issuers assessed a host of factors, including the strength and quality of the bankers' research coverage. Issuers sought research coverage of their stocks, believing such coverage would enhance the credibility of their businesses, potentially lead to higher stock prices, and increase their exposure to the investing public.");
173. REINGOLD, supra note 104, at 75 ("[A] bank's research analyst was beginning to be one of the most important factors determining which investment banks companies and countries chose to handle their deals.");
174. Jill E. Fisch, Regulatory Responses to Investor Irrationality: The Case of the Research Analyst, 10 LEWIS & CLARK L. REV. 58, 63-64 ("In the late 1990s, Wall Street research analysts were powerful and influential. . . . The ability of an investment bank's research department to influence investor sentiment was a key factor in the bank's ability to attract underwriting business.").
175. Interview by Martin Smith with Arthur Levitt, supra note 82 ("When fixed commissions were eliminated [in 1975], more and more of Wall Street's profits had to come from investment banking. But what is the very best way to get investment banking business? The language of Wall Street is, 'We'll get you coverage.' And what kind of coverage does that mean? An overwhelming number of research reports written about investment banking clients are favorable.").
176. See Dinallo Aff., supra note 16, at 2.
177. See In re Spitzer v. Merrill Lynch & Co., No. 02-401522 (N. Y. Sup. Ct. Apr. 8, 2002) (order granting a preliminary injunction).
178. See Dinallo Aff., supra note 16, at 13 (detailing in a chart instances in which public rating diverged from private comments).
179. See id. at 17, 20-23 ("Investment banking also was involved in criticizing and editing the internet group's reports for client companies, opining on whether a particular rating would be acceptable and, in at least one instance, apparently opposing a proposed rating.").
180. See id at 15-17.
181. See id. at 20-21.
182. See Martin Act, N.Y. GEN. BUS. LAW § 352 et seq. (McKinney 2006);
183. Affidavit of Eric R. Dinallo, supra note 16, at 35-37.
184. See Charles Gasparino, Merrill Lynch to Pay Big Fine, Increase Oversight of Analysts-New York Attorney General Wins $100 Million Penalty; E-mails Exposed Research, WALL ST. J., May 22, 2002, at Al.
185. See Barbara Moses, They Were Shocked, Shocked: The "Discovery" of Analyst Conflicts on Wall Street, 70 BROOK. L. REV. 89, 91 (2004) ("[T]he basic facts 'discovered' by Eliot Spitzer, by other regulators, and ultimately by the plaintiffs' bar after the collapse of the Internet bubble were actually well known to sophisticated market participants throughout the 1990s."). Indeed as early as 1992, the Wall Street Journal published an article describing one investment bank's policy that research analysts not make negative comments about investment banking clients.
186. See Michael Siconolfi, At Morgan Stanley, Analysts Were Urged to Soften Harsh Views, WALL ST. J., July 14, 1992, at Al.
187. See, e.g., In re Merrill Lynch & Co. Research Reports Sec. Litig., 273 F. Supp. 2d 351, 383-88 (S.D.N.Y. 2003) (collecting examples of news stories describing analyst conflicts of interest);
188. Wall Street Has an Unlikely New Cop: Spitzer-State Office, Used to Policing Junk Mail, Finds Fertile Ground in Stock Research, WALL ST. J., Apr. 25, 2002, at C1 ("For years, newspaper articles have detailed how Wall Street firms provided overly optimistic research about companies that were investment banking clients, he noted, but there was no serious effort by regulators to address this issue.").
189. See Robert A. Prentice, The Inevitability of a Strong SEC, 91 CORNELL L. REV. 775, 790 (2006) ("For various reasons, courts and commentators were hostile to SEC regulation of securities analysts, who remained relatively unregulated until recently.").
190. Anita Raghavan, Jack of All Trades: How One Top Analyst Vaults 'Chinese Wall' To Do Deals for Firm-For Salomon, Grubman is Big Telecom Rainmaker; Investors Heed Him, Too - A Role That's Hard to Police, WALL ST. J., Mar. 25, 1997, at Al.
191. See Merrill Lynch, Pierce, Fenner & Smith Inc., SEC No-Action Letter, 1997 SEC No-Act. LEXIS 1014, at *4 (Oct. 21, 1997).
192. Lori Richards, Dir., Office of Compliance Inspections & Examinations, SEC, Speech to the Fin. Women's Ass'n: Analysts Conflicts of Interest: Taking Steps to Remove Bias (May 8, 2002), available at http://www.sec.gov/news/ speech/spch559.htm.
193. Analyzing the Analysts: Hearing Before the Subcomm. on Capital Markets, Insurance, and Government Sponsored Enterprises of the H. Comm. on Financial Services, 107th Cong. 228, 229 (2001) (written statement of Laura S. Unger, acting chair, SEC).
194. See Gasperino & Schroeder, supra note 13 ("The SEC chairman believed that the solution to the problem was developing a new set of national standards for analysts, while at the same time directing self-regulatory organizations, such as the National Association of Securities Dealers and the New York Stock Exchange, to examine conflicts of interest and draw up new rules on analyst compensation and disclosure practices.").
195. See Dinallo Aff., supra note 16, at 36.
196. See Dura Pharms., Inc. v. Broudo, 544 U.S. 336, 341-42 (2005). The New York Attorney General investigates and prosecutes fraud based on a broadly worded New York State statute called the Martin Act. Martin Act, N. Y. GEN. Bus. LAW, § 352 et seq. (McKinney 2006). While the Martin Act is a broad statute, it basically covers the same type of fraud prohibited by the federal securities laws. However, there are differences between the two statutory regimes. Federal securities law requires the showing of scienter or proof that the misrepresentation was made knowingly.
197. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 212 (1976). In contrast, the Martin Act does not require such a showing.
198. See People v. Federated Radio Corp., 154 N.E. 655, 658 (N.Y. 1926). In the Merrill Lynch case, while the case was brought under the broader state statute, it appears the scienter requirement was met. The Martin Act was enacted by the New York State Legislature in 1921, giving the Attorney General the power to investigate securities transactions and seek injunctive relief. Act of May 7, 1921, 1921 N.Y. Laws 1989. In 1955, the New York State Legislature added section 352-c to the Martin Act, giving the Attorney General the power to seek criminal indictments in securities fraud cases. Act of Apr. 21, 1955, 1955 N.Y. Laws 1255.
199. See Va. Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1095 (1991).
200. E.g., SEC v. Merrill Lynch & Co., SEC Litigation Release No. 18083, Accounting and Auditing Enforcement Release No. 1742 (Mar. 17, 2003), available at http://www.sec.gov/litigation/litreleases/lr18038.htm.
201. On May 8, 2002, the SEC approved rules proposed in February 2002 by the NASD meant to regulate the relationship between research and investment banking. News Release, Nat'l Ass'n of Sec. Dealers, Statement of NASD Chairmen and CEO Robert R. Glauber Regarding SEC Approval of New Analyst Rules (May 8, 2002), available at http://www.finra.org/PressRoom/NewsReleases/ 2002NewsReleases/P002935. On October 3, 2002, the NYSE and NASD proposed additional rules relating to research analysts and the formation of a committee to investigate practices relating to IPOs.
202. See News Release, Nat'l Ass'n of Sec. Dealers and N.Y. Stock Exch., NYSE, NASD Move to Strengthen Rules Concerning Analysts, IPOs Both Efforts In Support of Joint Effort with SEC, NY Attorney General (Oct. 3, 2002), available at http://www.finra.org/PressRoom/NewsReleases/ 2002NewsReleases/P002895.
203. On April 25, 2002, the SEC, NASD, NYSE and NASAA announced they were commencing a joint investigation with the New York Attorney General directed at research analysts. See Press Release, SEC, SEC Launches Inquiry into Research Analyst Conflicts (Apr. 25,2002), available at http://www.sec.gov/news/press/2002-56.htm.
204. On December 20, 2002, regulators announced a $1.4 billion global settlement in principle with ten firms. See Press Release, SEC, SEC, NY Attorney General, NASD, NASAA, NYSE and State Regulators Announce Historic Agreement to Reform Investment Practices: $1.4 Billion Global Settlement Includes Penalties and Funds for Investors (Dec. 20, 2002), available at http://www.sec.gov/news/press/2002-179.htm. On April 28, 2003, the regulators announced the final settlement with those firms as well as additional factual findings.
205. See Joint Press Release, SEC et al., Ten of Nation's Top Investment Firms Settle Enforcement Actions Involving Conflicts of Interest Between Research and Investment Banking: Historic Settlement Requires Payments of Penalties of $487.5 Million, Disgorgement of $387.5 Million, Payments of $432.5 Million to Fund Independent Research, and Payments of $80 Million to Fund Investor Education and Mandates Sweeping Structural Reforms (Apr. 28, 2003), available at http://www.sec.gov/news/press/2003- 54.htm. The firms paid a total of $875 million in penalties and disgorgement, $432.5 million to fund independent research, and $80 million to fund and promote investor education.
206. See id. The firms agreed to wide-ranging structural reform, essentially separating research and investment banking. See SEC, SEC Fact Sheet on Global Analyst Research Settlements, Apr. 28, 2003, http://www.sec.gov/news/speech/factsheet.htm.
207. See John P. Freeman & Stewart L. Brown, Mutual Fund Advisory Fees: The Cost of Conflicts of Interest, 26 IOWA J. CORP. L. 609, 614 (2001) ("Mutual funds historically have provided their shareholders with the ability to pursue a vast array of different investment objectives as co-owners of an entity offering three main services: diversified investment risk, professional investment management, and a redeemable security.");
208. SEC, Invest Wisely: An Introduction to Mutual Funds, http://www.sec.gov/ investor/pubs/inwsmf.htm (last visited Nov. 27, 2007);
209. SEC, Mutual Funds, http://www.sec.gov/answers/mutfund.htm (last visited Nov. 27, 2007).
210. In the 1990s, mutual funds experienced unprecedented growth as millions of individuals began investing in securities in response to a rising stock market and the decline of traditional pension plans. See Mutual Funds: Who's Looking Out for Investors?; Hearing Before the Subcomm. on Capital Markets, Insurance, and Government Sponsored Enterprises of the H. Comm. on Financial Services, 108th Cong. 174 (2003) (testimony of Stephen M. Cutler, Dir., Div. of Enforcement, SEC) ("With more than 95 million Americans invested in mutual funds, representing approximately 54 million U.S. households, and a combined $7 trillion in assets, mutual funds are a vital part of this nation's economy and millions of investors' financial security.");
211. JOINT ECON. COMM., 107TH CONG., THE MUTUAL FUND INDUSTRY: AN OVERVIEW AND ANALYSIS 5 (2002) (reporting that mutual fund assets grew from $1.065 trillion in 1990 to $6.965 trillion in 2000).
212. See Ajay Khorana & Henri Servaes, Conflicts of Interest and Competition in the Mutual Fund Industry 2 (July 2004), available at http://ssm.com/abstract=240596 ("[T]he revenues of mutual funds families are a function of assets under management.").
213. See Brian Reid & Stefan Kimball, Mutual Fund Industry Developments in 2002, 9 INVESTMENT COMPANY INST. 1, 2-4 (2003) (describing outflow in mutual fund investments).
214. BROOKE A. MASTERS, SPOILING FOR A FIGHT: THE RISE OF ELIOT SPITZER 135-41 (2006).
215. There were also allegations of "late trading," which violated existing rules. See 17 C.F.R. § 270.22c-1 (2007). This rule is referred to as the "forward pricing" rule.
216. See Disclosure Regarding Market Timing and Selective Disclosure of Portfolio Holdings, Securities Act Release No. 8343, Investment Company Act Release No. 26,287, 68 Fed. Reg. 70,402, 70,403 (proposed Dec. 17, 2003) (describing the rule as the "forward pricing" rule). In 1968, the SEC passed this rule "in order to reduce riskless short-term trading in mutual funds by eliminating the ability to use late-breaking news to take advantage of NAVs fixed before that news was released to the markets." DH2, Inc. v. SEC, 422 F.3d 591, 593 (7th Cir. 2005).
217. DH2, Inc., 422 F.3d at 592;
218. see also Canary Complaint, supra note 16, at para. 23 (discussing the strategy of market timing in mutual funds).
219. See DH2, Inc., 422 F.3d at 592 ("A mutual fund's share price does not fluctuate throughout the trading day, but the prices of the securities held by the fund do.").
220. Id. at 593;
221. see also Canary Complaint, supra note 16, at para. 23 (discussing how the market timing strategy involves using stale prices that do not reflect the value of a foreign security).
222. Canary Complaint, supra note 16, at para. 25;
223. see also Jason T. Greene & Conrad S. Ciccotello, Mutual Fund Dilution from Market Timing Trades, 4 J. INVESTMENT MGMT. 31, 37 (2006) (discussing a model of mutual fund dilution).
224. Canary Complaint, supra note 16, at para. 27;
225. see also SEC v. Pimco Advisors Fund Mgmt. LLC, 341 F. Supp. 2d 454, 458 (S.D.N.Y. 2004) ("[Market timing] can also harm investors ... by increasing trading and brokerage costs, as well as tax liabilities, incurred by a fund and spread across all fund investors.");
226. Christopher Oster & Karen Damato, How Market Timers Can Drain Returns for Some Investors, WALL ST. J., Sept. 8, 2003, at C1 ("Waves of cash flowing rapidly in and out of a fund increase the commissions that managers pay to buy and sell securities, and those expenses eat into returns.").
227. Canary Complaint, supra note 16, at para. 27;
228. see also Pimco Advbors Fund Mgmt. LLC, 341 F. Supp. 2d at 458 ("The quick pace of investments and redemptions associated with market timing may also hinder the ability of mutual fund managers to act in the best interests of fund investors who seek to maximize their long-term investment gains. It would make little sense for a fund manager to invest in assets with significant long-term potential but high short-term volatility if a market timer's redemptions could force the quick sale of fund assets.").
229. Canary Complaint, supra note 16, at paras. 30-33.
230. See Windsor Sec., Inc. v. Hartford Life Ins. Co., 986 F.2d 655, 658 (3d Cir. 1993) ("[As early as 1993,] Hartford. . . began to observe a negative impact caused by market timing activity: increased trading and transaction costs, disruption of planned investment strategies, forced and unplanned portfolio turnover, lost opportunity costs, and large asset swings in a fund's asset base that adversely affected Hartford's ability to provide maximal investment return to all contract owners.");
231. Tamar Frankel & Lawrence Cunningham, The Mysterious Ways of Mutual Funds: Market Timing 235, 256 (Boston College Law School Faculty Papers, Paper 187, 2007), available at http://lsr.nellco.org/cgi/viewcontent.cgi? article=1188&context-bc/bclsfp ("The SEC knew of the excessive purchases and redemptions of mutual fund investors. However, it seems to have assumed, perhaps reasonably, that fund managers had self-interest in preventing harmful turnover of investments.");
232. Macey, supra note 103, at 965-66 ("Late trading and market timing were not only common practices, but the existence of such practices was well known to the SEC, which acquiesced in such practices until Mr. Spitzer came along to change the political climate.").
233. See Memorandum from Lori A. Richards, Office of Compliance Inspections & Examinations, to William H. Donaldson, Chairman, SEC, 3 (Mar. 10, 2004), available at http://www.sec.gov/news/extra/apx-ts0310041ar. pdf.
234. See Pimco Advisors Fund Mgmt LLC, 341F. Supp. 2d at 464.
235. Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (2000); 17 C.F.R. § 240.10b-5 (2007);
236. see also Ernst & Ernst v. Hochfelder, 425 U.S. 185, 203 (1976) (noting that legislative history described section 10(b) as a "catchall" clause enabling the SEC "to deal with new manipulative [or cunning] devices" (quoting a statement of Thomas Corcoran made on behalf of the section's drafters during the Hearings before the House Committee on Interstate and Foreign Commerce) (internal quotations omitted, bracketed insertion in original)).
237. See In re Mut. Funds Inv. Litig., 384 F. Supp. 2d 845, 856 (D. Md. 2005) ("Although market timing itself may be lawful, it nevertheless is prohibited by Rule 10b-5 if it is engaged in by favored market insiders at the expense of long-term mutual fund investors from whom it is concealed and who have a right to rely upon its prevention by fund advisers' and managers' good faith performance of their fiduciary obligations.");
238. Pimco Advisors Fund Mgmt. LLC, 341 F. Supp. 2d at 472.
239. Investment Company Act of 1940 § 36(a), 15 U.S.C, § 80a-35 (2000); SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191 (1963) ("The Investment Advisers Act of 1940 thus reflects a congressional recognition 'of the delicate fiduciary nature of an investment advisory relationship,' as well as a congressional intent to eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser - consciously or unconsciously -to render advice which was not disinterested."); EBC I, Inc. v. Goldman, Sachs & Co., 832 N.E.2d 26, 31-32 (N.Y. 2005) (recognizing a common-law fiduciary duty).
240. RESTATEMENT (THIRD) OF AGENCY § 8.01 (2006).
241. See, e.g., In re Canadian Imperial Holdings Inc., Securities Act Release No. 8593, Exchange Act Release No. 52,064, Administrative Proceeding File No. 3-11987 (July 20, 2005), available at http://www.sec.gov/ litigation/admin/33-8593.pdf;
242. In re Banc of Am. Capital Mgmt., LLC, Securities Act Release No. 8538, Exchange Act Release No. 51,167, Investment Company Act Release No. 26,756, Administrative Proceeding File No. 3-11818 (Feb. 9, 2005), available at http://www.sec.gov/litigation/admin/33-8538.htm;
243. In re Janus Capital Mgmt. LLC, Investment Company Act Release No. 26,532, Administrative Proceeding File No. 3-11590 (Aug. 18, 2004), available at http://www.sec.gov/litigation/admin/ia-2277.htm;
244. In re Strong Capital Mgmt., Inc., Exchange Act Release No. 49,741, Investment Company Act Release No. 26,448, Administrative Proceeding File No. 3-11498 (May 20, 2004), available at http://www.sec.gov/litigation/admin/ 34-49741.htm;
245. In re Mass. Fin. Servs. Co., Investment Company Act Release No. 26,347, Administrative Proceeding File No. 3-11393 (Feb. 5, 2004), available at http://www.sec.gov/litigation/admin/ia-2213.htm;
246. In re Alliance Capital Mgmt., L.P., Investment Company Act Release No. 26,312, Administrative Proceeding File No. 3-11359 (Dec. 18, 2003), available at http://www.sec.gov/litigation/admin/ia-2205.htm.
247. See, e.g., Disclosure Regarding Market Timing and Selective Disclosure of Portfolio Holdings, Securities Act Release No. 8408, Investment Company Act Release No. 26,418, 69 Fed. Reg. 22,300 (Apr. 23, 2004).
248. In contrast, it is more difficult for the regulated to influence principles-based enforcement actions. See John T. Scholz & Feng Heng Wei, Regulatory Enforcement in a Federalist System, 80 AM. POL. SCI. REV. 1249, 1250 (1986) ("[The] ability [of interest groups] to influence enforcement (as opposed to rulemaking) decisions - particularly in regulatory agencies ... is limited by case processing requirements ....").
249. See Kaplow, supra note 43, at 562-63 ("[Standards are more costly for legal advisors to predict or enforcement authorities to apply because they require later determinations of the law's content.").
250. For example, regulators may wrongly conclude that isolated misconduct is indicative of greater problems that may not exist, falling into the trap of the availability heuristic. See Stephen J. Choi & A.C. Pritchard, Behavioral Economics and the SEC, 56 STAN. L. REV. 1, 25-26 (2003);
251. Christine Jolls, Cass R. Sunstein & Richard Thaler, A Behavioral Approach to Law and Economics, 50 STAN. L. REV. 1471, 1519 (1998);
252. Jeffrey J. Rachlinski, Rulemaking Versus Adjudication: A Psychological Perspective, 32 FLA. ST. U. L. REV. 529, 538-46 (2005).
253. See Sunstein, supra note 43, at 971-74.
254. See INTERIM REPORT ON CAPITAL MARKETS REGULATION, supra note 1, at 63-67.
255. See Grundfest, supra note 52, at 1018 (observing that Congress "wanted to establish an agency that would specialize in securities-related matters and build expertise not easily captured within the legislature");
256. Jerry L. Mashaw & David L. Harfst, Regulation and Legal Culture: The Case of Motor Vehicle Safety, 4 YALE J. ON REG. 257, 305 (1987) ("Delegation is justified primarily by the complexity of the regulatory tasks assigned and the need for a high level of expertise.");
257. Mark Seidenfeld, A Civic Republican Justification for the Bureaucratic State, 105 HARV. L. REV. 1511, 1518-19 (1992) (describing a New Deal theory justification of bureaucracy based on agency expertise).
258. See Grundfest, supra note 52, at 966 ("Congress created the Commission as an expert agency with the capacity to address significant problems affecting the nation's securities markets.").
259. See Billing v. Credit Suisse First Boston Ltd., 426 F.3d 130, 172 (2005) ("The SEC and defendants have vigilantly reminded us that the securities markets in toto might be better entrusted to an expert agency than to the federal courts."), rev'd on other grounds, 127 S. Ct. 2383 (2007);
260. SELIGMAN, supra note 32, at xix ("A primary purpose of 'independent' regulatory agencies like the SEC is to allow an experienced and expert staff to resolve specific, highly technical regulatory problems."). Gerald Frug illustrates how the law legitimizes bureaucracies through a rhetoric of expertise.
261. Gerald E. Frug, The Ideology of Bureaucracy in American Law, 97 HARV. L. REV. 1276, 1322 (1984) ("The concept of administrative expertise, while not itself a 'doctrine,' is part of the rhetoric of administrative law opinions that invokes the same kind of deference to bureaucratic decisions, with the same qualifications, when made by administrative agencies.").
262. See Frug, supra note 159, at 1326 ("Administrators are 'experts'; they decide many similar cases and they presumably come from backgrounds which make them specialists; all of this produces a special knowledge in addition to the record.");
263. Grundfest, supra note 52, at 967 (arguing that the SEC should apply its expertise through rulemaking defining the scope of Rule 10b-5);
264. Thomas O. McGarity, Some Thoughts on "Deossifying" the Rulemaking Process, 41 DUKE L.J. 1385, 1407 (1992) ("Much modern rulemaking is highly technical in nature.").
265. Of course, there may be cases in which this ideal is not met and not even the agency has true expertise. See McGarity, supra, at 1398 ("Although the theoretical rationale for creating regulatory agencies is to lodge decisionmaking power in the hands of experts, the scientific and technical needs of modern informal rulemaking have in many cases outstripped the expert resources of the agencies themselves.").
266. See Frug, supra note 159, at 1298 ("The [bureaucratic] machine is also a highly technical and complex device, one that would be damaged by a mere layman's tinkering.");
267. Jonathan R. Macey, Lawyers in Agencies: Economics, Social Psychology, and Process, 61 LAW & CONTEMP. PROBS. 109, 123-25 (1998) ("The shift to an agency process dominated by rulemaking reflected an embrace of the idea of a disinterested 'science' of rulemaking, in which quality of the decisions generated by technological sophistication triumphs over the quality of the decisions generated by the adversarial process."). In contrast, a litigation approach may not adequately mobilize broad expertise.
268. See Frederick Schauer, Do Cases Make Bad Law?, 73 U. CHI. L. REV. 883, 916 (2006) ("[C]ase-deciding bodies may not be well situated to engage in the large-number, systematic, and empirical inquiry that effective rulemaking requires.").
269. See MASTERS, supra note 134, at 90, 92-93.
270. Investment Advisors Act of 1940,15 U.S.C. § 80b-3(e)(4) (2000).
271. See MASTERS, supra note 134, at 93-94.
272. The Administrative Procedure Act requires agencies to give notice of "the terms or substance of the proposed rule" and "give interested persons an opportunity to participate in the rule making through submission of written data, views, or arguments with or without opportunity for oral presentation." 5 U.S.C. § 553(b)-(c) (2000);
273. see also Chamber of Commerce v. SEC, 443 F.3d 890, 899 (D.C. Cir. 2006) (discussing the Administrative Procedure Act's requirement that agencies give notice of a proposed rule).
274. See NLRB v. Bell Aerospace Co., 416 U.S. 267, 295 (1974) ("[Rulemaking would provide the Board with a forum for soliciting the informed views of those affected in industry and labor before embarking on a new course.");
275. Prentice, supra note 118, at 802 ("When the SEC considers new rules, it uses a process that guarantees that it will receive information and arguments from all points of view, unlike an individual decision maker prone to seeking out only information to support preexisting views.");
276. Seidenfeld, supra note 157, at 1561 (arguing that rulemaking allows for greater deliberation by providing access to different views).
277. See Choi & Pritchard, supra note 154, at 24 ("Devising new regulations is costly, requiring analysis of complicated economic phenomena. Market participants are likely to know far more about these phenomena than regulators.").
278. Selective Disclosure and Insider Trading, Securities Act Release No. 7,787, Exchange Act Release No. 42,259, Investment Company Act Release No. 24,209, 64 Fed. Reg. 72,590 (proposed Dec. 28, 1999).
279. Selective Disclosure and Insider Trading, Securities Act Release No. 7,881, Exchange Act Release No. 42,43,154, Investment Company Act Release No. 24,599, 65 Fed. Reg. 51,716 (Aug. 24, 2000).
280. Walker, supra note 40.
281. See Macey, supra note 161, at 125 ("[I]n the rulemaking context, government lawyers are supposed to be weighing both the costs and the benefits of their actions when formulating rules.").
282. National Securities Market Improvement Act of 1996 § 106, Pub. L. No. 104-290, 110 Stat. 3416, 3425 (codified in scattered sections of 15 U.S.C). Executive agencies are required to go through a more formal cost-benefit analysis under executive orders issued by President Reagan in 1981 that have essentially been ratified by other administrations.
283. The emphasis on cost-benefit analysis with respect to regulations is likely to continue. In 2006, the Committee on Capital Markets Reform recommended that the SEC should implement a formal process akin to that of executive agencies and "engage in a more risk-based process, focused explicitly on the costs and benefits of regulation." INTERIM REPORT ON CAPITAL MARKETS REGULATION, supra note 1, at 8, 60-62.
284. See, e.g., Chamber of Commerce v. SEC, 443 F.3d 890, 908-09 (D.C. Cir. 2006); Chamber of Commerce v. SEC, 412 F.3d 133, 144-45 (D.C. Cir. 2005).
285. Chamber of Commerce, 412 F.3d at 144 ("[T]he Commission violated its obligation ... to consider the costs imposed upon funds by the two challenged conditions.").
286. See Kaplow, supra note 43, at 562 ("Rules are more costly to promulgate than standards because rules involve advance determinations of the law's content...."); McGarity, supra note 160, at 1387 ("[I]t is difficult to disagree with the conclusion that it is much harder for an agency to promulgate a rule now than it was twenty years ago.");
287. Ronald J. Pierce, Jr., Two Problems in Administrative Law: Political Polarity on the District of Columbia Circuit and Judicial Deterrence of Agency Rulemaking, 1988 DUKE LJ. 300, 301-02 ("[A]n agency realistically must conclude that making an important policy decision through the rulemaking process will require it to commit a significant proportion of its scarce resources to that process for as much as a decade.").
288. See Lawrence A. Cunningham, Principles and Rules in Public and Professional Securities Law Enforcement: A Comparative U.S.-Canada Inquiry, 6 CANADA STEPS UP 255, 312 (2006) ("An enforcement policy should be supplemented, from time to time, by focused enforcement activity trained on publicly visible crises. These may erupt as a result of insufficiently specified underlying laws that require enforcement activity bearing a more principles-like character, although some public debacles also involve bald violation of clear rules. Either way, enforcement activities that consciously respond to public outcries are intended to promote all securities regulation's goals, of efficiency and fairness and of confidence and protection. They do so by highlighting and then exterminating behavior deemed undesirable based upon the public rebuke that provokes stepped-up enforcement.").
289. The public generally will cast aside expertise when it is perceived as ineffectual. As James Q. Wilson explains, "Americans value expertise but they do not defer to it; an expert who takes an unpopular position or acts contrary to the self-interest of an individual or group will be treated as roughly as any other adversary." JAMES Q. WILSON, BUREAUCRACY 304 (1989).
290. See supra note 75 and accompanying text.
291. See supra Part II.B.2;
292. see also MASTERS, supra note 134, at 75-79 (discussing investigations performed by the New York Attorney General).
293. The concept of public values was first articulated in the realm of constitutional law, where scholars such as Owen Fiss argued that adjudication allows courts to give meaning to the public values embodied in broad constitutional phrases. Owen M. Fiss, The Supreme Court: 1978 Term, 93 HARV. L. REV. 1, 2 (1979). William Eskridge applied the idea to the realm of statutory interpretation when he observed that statutes embody broad public values that should influence the way such statutes are interpreted.
294. William N. Eskridge, Jr., Public Values in Statutory Interpretation, 137 U. PA. L. REV. 1007, 1036 (1989) ("[Statutes themselves can be the source of public values."). As Eskridge notes, it is extremely difficult to precisely define the meaning of public values. See id. at 1036 n.2. I do not attempt to set forth a general theory of public values with respect to securities regulation, but instead identify particular values expressed by recent enforcement actions. See supra Parts II.A.4, II.B.4, II.C.4.
295. See Macey, supra note 161, at 123-25 (contrasting the role of generalist lawyers in adjudication with the use of experts in the rulemaking process); Mashaw & Harfst, supra note 157, at 263 (noting in case study of National Highway Traffic Safety Administration that the agency was utilizing "case-by-case adjudication which requires little, if any, technological sophistication and which has no known effects on vehicle safety").
296. Of course, the Commissioners of the SEC must approve actions by the Enforcement Division.
297. See MASTERS, supra note 134, at 133-69.
298. See Croley, supra note 2, at 116 ("While the effects of adjudicatory decisions can, like rulemakings, be far reaching, adjudication processes are less open.");
299. McGarity, supra note 160, at 1393 (observing that, unlike rulemaking, adjudication fails to provide for notice and comment, thus "both regulatees and regulatory beneficiaries are deprived of the open opportunity that informal rulemaking provides to influence the agencies' thinking").
300. MASTERS, supra note 134, at 102.
301. See supra note 115 and accompanying text.
302. This has been controversial. As the Commission on the Regulation of U.S. Capital Markets in the 21st Century reported:
303. [T]he Commission repeatedly heard concerns about the SECs use of 'undertakings' in enforcement action settlements to impose requirements that suggest industry-wide application to regulated entities.... [T]he concerns addressed instances in which the SEC required an undertaking in a settlement agreement that itself constituted a change in the law, which was then later applied to the entire securities industry.
304. COMM'N ON THE REGULATION OF U.S. CAPITAL MARKETS IN THE 21ST CENTURY, REPORT AND RECOMMENDATIONS 123 (Mar. 2007), available at http://www.capitalmarketscommission.com/portal/ capmarkets/default.htm.
305. For example, in the context of automobile safety, Professor Mashaw and Mr. Harfst observe that issues are framed technically when rulemaking is involved, and framed in layperson's terms in enforcement cases involving defective vehicles. See Mashaw & Harfst, supra note 157, at 304 ("[T]he defects question is not framed as a technological, scientific, or economic issue. The questions are straightforward and commonsensical. Should people expect steering arms to break, wheels to collapse, or windshield wipers to fly off? Obviously not.").
306. Of course, there is a large body of economics literature that analyzes enforcement decisions through a cost-benefit framework. See, e.g., George J. Stigler, The Optimum Enforcement of Laws, 78 J. POL. ECON. 526, 526-27 (1970) (arguing that society gives up complete enforcement of a rule because enforcement is costly). But as a practical matter, there are no legal standards requiring agencies to consider cost-benefit factors in deciding whether to bring an enforcement case.
307. Donald C. Langevoort, Rereading Cady, Roberts: The Ideology and Practice of Insider Trading Regulation, 99 COLUM. L. REV. 1319, 1328 (1999).
308. Press Release, Office of the N.Y. State Att'y Gen., Merrill Lynch Stock Rating System Found Biased by Undisclosed Conflicts of Interest: Spitzer Obtains Court Order Requiring Key Disclosure (Apr. 8, 2002), available of http://www.oag.state.ny.us/press/2002/apr/apr08b_02.html.
309. See INTERIM REPORT ON CAPITAL MARKETS REGULATION, supra note 1, at 66.
310. See supra notes 95, 151 and accompanying text.
311. See INTERIM REPORT ON CAPITAL MARKETS REGULATION, supra note 1, at 66.
312. See supra note 19 and accompanying text.
313. See Dan M. Kahan, The Secret Ambition of Deterrence, 113 HARV. L. REV. 413, 414 (1999) (describing the role of the deterrence idiom in muting societal conflict relating to controversial norms).
314. See, e.g., Elena Kagan, Presidential Administration, 114 HARV. L. REV. 2245, 2353 (2001) ("[A]gency experts have neither democratic warrant nor special competence to make the value judgments-the essentially political choices-that underlie most administrative policymaking.");
315. Seidenfeld, supra note 157, at 1570-71 (noting risk that administrative "decisionmakers will implement their idiosyncratic conceptions of the public interest rather than society's consensus about that interest").
316. Of course, one might argue that the SEC did not really choose to bring a principles-based enforcement action in the research analyst and mutual fund cases. Rather, the SEC was pressured by the success of the New York Attorney General's approach to bring its own cases. It is difficult to know whether the SEC would have taken the same approach without the prompting of the New York Attorney General. In any event, the SEC at the very least had the discretion to follow the New York Attorney General's lead in bringing principles-based enforcement actions. And the New York Attorney General had the choice to defer to the SECs rulemaking approach.
317. As noted before, under Chenery, it is widely accepted that administrative agencies have broad discretion in making such choices. Elizabeth Magill theorizes that courts give agencies such leeway because they can regulate the aftereffects of agency decisions.
318. See Magill, supra note 2, at 1437 ("Courts' ability to shape some of the consequences of an agency's choice of procedure explains the continued strength of the Chenery principle."). This dynamic was evident in the mutual fund cases. Regulators chose to use enforcement actions to impose fines and structural reforms such as requiring that a settling mutual fund agree that 75 percent of its board would consist of independent directors. The SEC then attempted to apply the 75 percent independent director requirement to the mutual fund industry as a whole through rulemaking.
319. See Investment Company Governance, 69 Fed. Reg. 3472 (proposed Jan. 23, 2004). The rule was challenged and the D.C. Circuit struck it down on the basis that the SEC had not adequately assessed the cost of the rule.
320. See Chamber of Commerce v. SEC, 443 F.3d 890, 908-09 (D.C. Cir. 2006);
321. Chamber of Commerce v. SEC, 412 F.3d 133, 144-45 (D.C. Cir. 2005).
322. See, e.g., Erik F. Gerding, The Next Epidemic: Bubbles and the Growth and Decay of Securities Regulation, 38 CONN. L. REV. 393, 396 (2006) (discussing the interplay between the business cycle, the cycle of investor confidence/investor trust, and the political economy/regulatory cycle);
323. Joseph A. Grundfest, Punctuated Equilibria in the Evolution of United States Securities Regulation, 8 STAN. J.L. BUS. & FIN. 1,1 (2002) (noting that changes in securities law have been provoked by perceived failures in the capital markets);
324. Larry E. Ribstein, Bubble Laws, 40 HOUS. L. REV. 77, 79-83 (2003) (describing the boom-bubble-bustregulate cycle of financial market regulation).
325. See generally Stuart Banner, What Causes New Securities Regulation? 300 Years of Evidence, 75 WASH. U. L.Q. 849 (1997) (arguing that new technology over time has not caused new securities regulation, but rather, crashes have);
326. Frank Partnoy, Why Markets Crash and What Law Can Do About It, 61 U. PITT. L. REV. 741 (2000) (using finance and legal scholarship to critique theories of why markets crash, and to make recommendations regarding what law can do about crashes).
327. Roberta Romano argues that statutes passed after periods of market turmoil often contain problematic provisions and that such statutes should provide for reevaluation at a later date. See Roberta Romano, The Sarbanes-Oxley Act and the Making of Quack Corporate Governance, 114 YALE L.J. 1521, 1599-1602 (2005).
328. See Vivek Ghosal & Joseph Gallo, The Cyclical Behavior of the Department of Justice's Antitrust Enforcement Activity, 19 INT'L J. INDUS. ORG. 27, 30 (2001);
329. Sam Peltzman, Toward a More General Theory of Regulation, 19 J.L. & ECON. 211, 212 (1976);
330. George Stigler, The Theory of Economic Regulation, 2 BELL J. ECON. 3, 4 (1971). For a summary of public choice theory,
331. see Croley, supra note 2, at 34-41.
332. See Stigler, supra note 201, at 3.
333. See Peltzman, supra note 201, at 212.
334. See supra note 199 and accompanying text.
335. See Magill, supra note 2, at 1442-43 ("There are few efforts to describe or explain how agencies choose among their available policymaking forms.").
336. See John C Coates, IV, Private vs. Political Choice of Securities Regulation: A Political Cost/Benefit Analysis, 41 VA. J. INT'L L. 531, 535 (2001) (predicting that devolution of securities regulation would lead to backlash and reregulation).
337. As Joel Seligman describes: A widespread belief evolved in the United States financial community that time honored rules such as those that discourage conflicts of interest were quaint and easily circumvented. Too frequently, sharp practitioners in business, investment banking, accounting or law challenged the fundamental tenets of "full disclosure of material information" or "fair presentation of accounting results." A deterioration in the integrity of the corporate governance and mandatory disclosure systems occurred, not because of a novel strain of human cupidity, but because there was so much success, for so long, that some began to forget why fundamental principles of full disclosure and corporate accountability long were considered essential.
338. SELIGMAN, supra note 32, at 623.
339. See, e.g., INTERIM REPORT ON CAPITAL MARKETS REGULATION, supra note 1, at xi (arguing that the increase in regulatory intensity in the U.S. has hurt its markets).
340. See id.; McKINSEY & Co., supra note 7, at ii; COMMISSION ON THE REGULATION OF U.S. CAPITAL MARKETS IN THE 21ST CENTURY, supra note 187, at 1.
341. See Scholz & Wei, supra note 152, at 1253 ("Business, on the other hand, can increase the cost of enforcement actions [through appeals].").
342. See id. at 1251 ("[Many studies] discount political influences over bureaucratic activities, explaining agency behavior in terms of the professionalism of enforcement staffs, established work routines, task requirements for detecting and prosecuting violations, attitudes towards regulated firms, and more idiosyncratic behavior of inspectors.").
343. A regulator would contend that its choices are unlike the legislative responses to recessions described in the boom/bust literature. Legislatures have more discretion to pass legislation for political reasons. Indeed, that is their job. Securities law statutes are rarely, if ever, challenged on constitutional grounds. In contrast, regulators must assume they will have to prove their cases in court and must follow administrative procedures when passing rules.
344. See CSFB Complaint, supra note 16, at paras. 31-45;
345. Canary Complaint, supra note 16, at paras. 59-62, 68-72, 75-76, 89, 93;
346. Dinallo Aff., supra note 16, at 2, 17.
347. Louis Kaplow, An Economic Analysis of Legal Transitions, 99 HARV. L. REV. 509, 534 (1986) ("[T]here is little to distinguish losses arising from government and market risk. For purposes of analyzing risk and incentive issues, the source of the uncertainty is largely irrelevant. A private actor should be indifferent as to whether a given probability of loss will result from the action of competitors, an act of government, or an act of God ....").
348. See INTERIM REPORT ON CAPITAL MARKETS REGULATION, supra note 1, at 66 ("When new standards are introduced through specific enforcement actions and only later codified as explicit rules, confusion and distrust are likely to be the consequences.").
349. See MCKINSEY & Co., supra note 7, at 81-85.
350. 17 C.F.R. § 240.10b-5 (2007).
351. See, e.g., Ackerman v. Schwartz, 947 F.2d 841, 847 (7th Cr. 1991) ("The optimal amount of fraud is zero.").
352. See TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976); Ernst & Ernst v. Hochfelder, 425 U.S. 185, 203 (1976).
353. Of course, there is always room for more clarity with respect to the standard of liability. See INTERIM REPORT OF THE COMMITTEE ON CAPITAL MARKETS REGULATION, supra note 1, at 12, 80 (arguing that the SEC should further define the elements of Rule 10b-5).
354. 17 C.F.R. pts. 210, 228.
355. The question of the appropriateness of the structural reforms that resulted should be addressed in a separate paper.
356. See supra note 77 and accompanying text.
357. See supra notes 88-89 and accompanying text.
358. See SEC v. Pimco Advisors Fund Mgmt. LLC, 341 F. Supp. 2d 454, 471 (S.D.N.Y. 2004) (noting that defendant "seeks to avoid liability by asserting what may be considered the 'everyone was doing it' defense; since secret market timing arrangements were widespread in the industry... [the defendant] seems to suggest that he cannot be charged with violating his own fiduciary duties towards his investors").
359. Of course, there was a rule prohibiting late trading. See 17 C.F.R. § 270.22c-l (2007). But that rule did not address the issue of market timing.
360. See Lori A. Richards, Dir., Office of Compliance Inspections & Examinations, SEC, Speech to the Eighth Annual Investment Adviser Compliance Summit, Wash., D.C: Fiduciary Duty: Return to First Principles (Feb. 27, 2006), available at http://www.sec.gov/news/speech/spch022706lar.htm.
361. See Canary Complaint, supra note 16, at paras. 76, 89.
362. See id. at paras. 34, 74, 84-85, 92, 94;
363. see also supra note 142 and accompanying text.
364. See Credit Suisse Sec. (USA) LLC v. Billing, 127 S. Ct. 2383, 2392 (2007). Clear repugnancy is determined through consideration of four factors: (1) the existence of regulatory authority under the securities law to supervise the activities in question; (2) evidence that the responsible regulatory entities exercise that authority; and (3) a resulting risk that the securities and antitrust laws, if both applicable, would produce conflicting guidance, requirements, duties, privileges, or standards of conduct.... (4)... the possible conflict affect[s] practices that lie squarely within an area of financial market activity that the securities law seeks to regulate.
365. Id.
366. United States v. Simon, 425 F.2d 796 (2d Cir. 1969).
367. Id. at 805-06.
368. Id. at 806.
369. And the "fairly presents" principle has been codified by Sarbanes-Oxley. See Sarbanes-Oxley Act of 2002 § 906(a), 18 U.S.C. § 1350 (Supp. V 2005).
370. See Credit Suisse Sec. (USA) LLC, 127 S. Ct. at 2391.
371. Id, Of course, the "implied immunity" standard has not been applied to bar liability based on the securities laws, and I do not mean to imply that it should, but the concept is useful in analyzing the interaction between rules and principles.
372. See Securities Exchange Act of 1934 § 28(e), 15 U.S.C. § 78bb(e) (2000).
373. See, e.g., Christopher Oster & Tom Lauricella, Mutual Funds' Soft Fees Getting a Hard Look, WALL ST. J., Dec. 26, 2003, at C1.
374. Indeed, the SEC published guidance on the scope of Section 28(e) in 2006. See Commission Guidance Regarding Client Commission Practices Under Section 28(e) of the Securities Exchange Act of 1934, Release No. 34-54165, 71 Fed. Reg. 41,978 (July 24, 2006).
375. William W. Bratton, Enron, Sarbanes-Oxley and Accounting: Rules Versus Principles Versus Rents, 48 VILL. L. REV. 1023, 1043 (2003).
376. Id.