Redesigning the sec: Does the treasury have a better idea?

Virginia Law Review

Volumn 95, Issue 4, 2009, Pages 707-784

  Coffee Jr , John C ^a   Sale, Hillary A ^a  

^a NONE

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EID: 67650510043     PISSN: 00426601     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (368)

1. See Fifty Years of Securities Regulation: Symposium on Contemporary Problems in Securities Regulation, 70 Va. L. Rev. 545 (1984). The Virginia Law Review earlier memorialized the SECs "silver" anniversary in 1959.
2. See Louis Loss, Contemporary Problems in Securities Regulation, 45 Va. L. Rev. 787 (1959) and accompanying articles,
3. id. at 787-1072.
4. In alphabetical order, the participants included Professor Alison Grey Anderson, John C. Coffee, Jr., Frank H. Easterbrook, Daniel R. Fischel, Ronald J. Gilson, Edmund W. Kitch, Reinier H. Kraakman, Saul Levmore and Walter Werner. SEC Chairman John S.R. Shad provided the Introduction, and Donald L. Calvin of the New York Stock Exchange also participated.
5. Professor Fisch argues that our analysis is "incomplete." See Jill E. Fisch, Top Cop or Regulatory Flop?: The SEC at 75, 95 Va. L. Rev. 785, 788 (2009). In her view, what is most needed at the SEC is "a renewed emphasis on leadership-leadership that entails a commitment to regulation."
6. Id. at 821. Leadership is an ineffable quality, more discussed by editorialists and politicians than law professors; nor is it easily measured, and we leave this task to the financial press and media. Yet, as we read Professor Fisch, her primary criticism of the SEC's recent performance is its diminished enforcement effort. We share her concern and agree that there has been a recent shortfall in enforcement.
7. See, e.g., Eric Lichtblau, Federal Cases of Stock Fraud Drop Sharply: Many Questions About Wall St. Oversight, N.Y. Times, Dec. 25, 2008, at Al. Still, even if securities fraud cases had been prosecuted more aggressively over recent years, we doubt that this would have saved Bear Stearns, Lehman Brothers, or Merrill Lynch from insolvency. Moreover, underenforcement becomes more likely under some regulatory structures than others. Indeed, we believe that this problem would be aggravated under a consolidated financial regulatory system.
8. The Committee on Capital Markets Regulation, which has recently been the leading proponent of further deregulation in securities regulation in the United States, has called for a consolidation of financial regulators through the merger of the Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission, and the Commodities Futures Trading Commission into a single body that it would term the United States Financial Services Authority - a name obviously patterned after the U.K.'s body of the same name. See Committee on Capital Markets Regulation, Recommendations for Reorganizing the U.S. Financial Regulatory Structure (Jan. 14, 2009) (on file with the Virginia Law Review).
9. We appreciate that others see the increasing institutionalization of the U.S. market as reducing the need for transparency. Professor Langevoort ably voices this theme in his contribution to this Symposium. See Donald C. Langevoort, The SEC, Retail Investors, and the Institutionalization of the Securities Markets, 95 Va. L. Rev. 1025 (2009). We disagree with at least the stronger assertions of this position (and here agree with Professor Fisch), both because we believe transparency improves corporate governance at the issuer level and because we believe that institutional investors also desire greater transparency and are not as "self-fending" as the proponents of deregulation believe. The Bernard Madoff scandal is only the most recent example that even institutional investors can be defrauded, need public enforcement, and will often fail to contract for necessary protections.
10. Professors Anderson and Kitch expressly debated the significance of federalism in defining the SECs authority. Compare Alison Grey Anderson, The Meaning of Federalism: Interpreting the Securities Exchange Act of 1934, 70 Va. L. Rev. 813, 856 (1984) ("In the corporate and securities area, the rhetoric of federalism should not be allowed to confuse and obscure discussion of the major substantive policy choices that usually lie behind the invocation of state interests . . ."),
11. with Edmund W. Kitch, A Federal Vision of the Securities Laws, 70 Va. L. Rev. 857, 873 (1984) ("As a simple matter of sensible allocation of power and coherent administration, it makes sense to limit national rules to areas such as the securities markets, which are the subject of comprehensive federal legislation, and leave to the states the development of the law governing internal relations with corporations."). Federalism is, of course, the opium of law professors, which they can rarely avoid, even if there is nothing new to be said.
12. See Ronald J. Gilson & Reinier H. Kraakman, The Mechanisms of Market Efficiency, 70 Va. L. Rev. 549, 604-05, 619-21 (1984).
13. For a fuller development of the theme that certain intermediaries pledge their reputational capital as a bonding strategy and an examination of when and why this strategy often fails, see John C. Coffee, Jr., Gatekeepers: The Professions and Corporate Governance 4-10 (2006).
14. Thus, a few years later, Judge Frank Easterbrook, a participant in the 1984 Symposium, declared in an opinion that, because auditors would lose more in reputational capital than they could gain in audit fees from a dishonest client, it would be "irrational for any of them to have joined cause with" such a client. See DiLeo v. Ernst & Young, 901 F.2d 624, 629 (7th Cir. 1990).
15. For leading works in this field, all raising challenges to the ECMH, see generally Advances in Behavioral Finance 153-65, 167-70 (Richard H. Thaler ed., 1993);
16. Robert J. Shiller, Market Volatility 77-79, 431-32 (1991);
17. Andrei Shleifer, Inefficient Markets: An Introduction to Behavioral Finance 10-23 (2000). Of course, many scholars continue to defend the ECMH.
18. See Paul G. Mahoney, Is There a Cure for "Excessive" Trading?, 81 Va. L. Rev. 713, 718-21 (1995).
19. A vigorous debate is in progress over whether firms and financial institutions are migrating away from U.S. markets to less regulated foreign markets (most notably London). Compare Craig Doidge, G. Andrew Karolyi & Rene M. Stulz, Has New York Become Less Competitive in Global Markets? Evaluating Foreign Listing Choices Over Time 43-44 (European Corporate Governance Inst., Working Paper No. 173/2007, 2007), available at http://ssrn.com/abstract=982193 (finding New York has held at least even with London as a venue for foreign listings), with Comm. on Capital Mkts. Regulation, Interim Report 2-6 (Nov. 30, 2006), http://www.capmktsreg.org/pdfs/11. 30Committee-Interim-ReportREV2.pdf (finding United States has suffered a decline in competitiveness). Regardless of the empirically correct answer to this question of decline, U.S. policy makers have been bombarded since the passage of the Sarbanes-Oxley Act in 2002 with advice and predictions that stricter regulation will entail a flight by regulated entities to less demanding markets (with London being the usual asserted beneficiary of this flight).
20. Indeed, Professors Gilson and Kraakman, writing in 2003, have conceded their "naivete" on this point. See Ronald J. Gilson & Reinier Kraakman, The Mechanisms of Market Efficiency Twenty Years Later: The Hindsight Bias, 28 J. Corp. L. 715, 736-37 (2003).
21. See generally Coffee, supra note 7, at 1-10.
22. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, § 101, 116 Stat. 745, 750-53 (2002) (codified at 15 U.S.C. § 211 (2006)) (creating the Public Company Accounting Oversight Board (PCAOB), a non-profit corporation whose board is accountable to the SEC for adopting and enforcing regulations of public accountants).
23. Coffee, supra note 7, at 265-68. New York's Attorney General Eliot Spitzer discovered a widespread pattern under which securities analysts at investment banks were pressured or induced to inflate their recommendations and ratings for their firms' clients. Spitzer and his staff discovered internal emails written by research analysts at Merrill Lynch that showed some analysts protesting this pressure. In April 2002, Spitzer settled with Merrill Lynch for $100 million. Soon thereafter, the SEC, NYSE, and NASD investigated other large investment banks and found similar behavior. In April 2003, Spitzer and these agencies settled with 10 major underwriting firms for $1.3875 billion.
24. Id.
25. see also Hillary A. Sale, Banks: The Forgotten(?) Partners in Fraud, 73 U. Cin. L. Rev. 139, 161-62 (2004) (discussing Spitzer's role in uncovering the investment banking issues and analyzing the resulting settlements).
26. For a discussion of credit rating agencies as gatekeepers and why they failed, see Coffee, supra note 7, at 34-35, 283-98.
27. See Howard M. Friedman, The Impact of NSMIA on State Regulation of BrokerDealers and Investment Advisers, 53 Bus. Law. 511, 532-34, 539-45, 551-52 (1998). The National Securities Markets Improvement Act ("NSMIA") significantly impacted the role of federal and state regulators and enforcers in dealing with securities offerings and professionals.
28. Id. at 511.
29. The NSMIA preempted many state regulations and transferred many enforcement responsibilities from the states to the federal government. In states that have not adopted regulations to mirror the NSMIA, for example state enforcers cannot take any action to prosecute offenders. Instead, they must wait for the SEC or one of the SROs to step in. Id. at 522-23;
30. see also G. Philip Rutledge, NSMIA . . . One Year Later: The States' Response, 53 Bus. Law. 563, 570-74 (1998) (discussing NSMI A's impact on states and how states are responding to the new shift in regulatory authority).
31. There are hints to this effect in the U.S. Treasury Department's recent "Blueprint." See Dep't of Treasury, Blueprint for a Modernized Financial Regulatory Structure 9-10, 53-58, 128-29 (2008) [hereinafter Blueprint].
32. See Comm. on Capital Mkts. Regulation, supra note 10, at 2-6. Popularly known at the "Paulson Report," this document does conclude that the United States' more stringent regulatory policies have injured its international competitiveness.
33. Id.
34. See Roberta Romano, Empowering Investors: A Market Approach to Securities Regulation, 107 Yale L.J. 2359, 2410-17 (1998). To be sure, Professor Romano does not expressly discuss the special case of financial institutions, but her prescription of investor choice is unqualified, and choice as to disclosure rules is not fundamentally different from choice as to other regulatory regimes.
35. See Blueprint, supra note 17, at 8-22.
36. For such a view, see Julie Satow, Will Bernanke Doom the SEC?, N.Y. Sun, July 11, 2008, available at http://www.nysun.com/business/will-bernanke-doom- the-sec/81689 (reporting that some officials feared that Federal Reserve oversight of investment banks would eclipse the SEC).
37. Blueprint, supra note 17, at 4, 27.
38. The Conference Report to the Gramm-Leach-Bliley Act clearly states this: Both the House and Senate bills generally adhere to the principle of functional regulation, which holds that similar activities should be regulated by the same regulator. Different regulators have expertise at supervising different activities. It is inefficient and impractical to expect a regulator to have or develop expertise in regulating all aspects of financial services. H.R. Rep. No. 106-434, at 157 (1999) (Conf. Rep.), reprinted in 1999 U.S.C.C.A.N.
39. For this same assessment, see Heidi Mandanis Schooner & Michael Taylor, United Kingdom and United States Responses to the Regulatory Challenges of Modern Financial Markets, 38 Tex. Int'l L. J. 317, 328 (2003).
40. See 15 U.S.C. §78o-5(a)(1)(B) (2006a);
41. - 15 U.S.C. § 78(c)(a)(34)(G) (2006);
42. - 15 U.S.C. § 78o-5(g)(2) (2006)
43. See 15 U.S.C. § 78(c)(a)(4)-(5) (2006).
44. See Kathleen Day, Regulators Battle Over Banks: 3 Agencies Say SEC Rules Overstep Securities-Trading Law, Wash. Post, July 3, 2001, at E3. Eventually, the SEC backed down in this particular skirmish and modified its original position.
45. See Exchange Act Release No. 34-44570, [2001 Transfer Binder] Fed. Sec. L. Rep. (CCH) ¶ 86,515 (July 18, 2001).
46. This is all well described in the Blueprint. See Blueprint, supra note 17, at 31-41.
47. Blueprint, supra note 17, at 4.
48. In particular, the Blueprint hypothesizes that the United Kingdom has enhanced its own competitiveness by regulatory reforms, adopted in 2000, that are principles-based and rely on self regulation for their implementation. Id. at 3.
49. For recent overviews, see Giorgio Di Giorgio & Carmine D. Noia, Financial Market Regulation and Supervision: How Many Peaks for the Euro Area?, 28 Brook. J. Int'l L. 463, 469-78 (2003);
50. Eilis Ferran, Examining the United Kingdom's Experience in Adopting the Single Financial Regulator Model, 28 Brook. J. Int'l L. 257, 257-59 (2003);
51. Jerry W. Markham, Super Regulator: A Comparative Analysis of Securities and Derivatives Regulation in the United States, the United Kingdom, and Japan, 28 Brook. J. Int'l L. 319, 319-20 (2003).
52. Scandinavian countries were the first to establish unitary financial regulators. See Di Giorgio & Noia, supra note 31, at 469-78. Norway established the first integrated regulatory agency in 1986, followed by Denmark in 1988, and Sweden in 1991. See Ferran, supra note 31, at 258.
53. See Bryan D. Stirewalt & Gary A. Gegenheimer, Consolidated Supervision of Banking Groups in the Former Soviet Republics: A Comparative Examination of the Emerging Trend in Emerging Markets, 23 Ann. Rev. Banking & Fin. L. 533, 548-49 (2004). As discussed later, in some countries (most notably Japan), the change seems more one of form than of substance, with little in fact changing.
54. See Markham, supra note 31, at 383-92, 396.
55. See Ferran, supra note 31, at 258.
56. See Schooner & Taylor, supra note 24, at 329. Schooner and Taylor also observe that the precursors to the United Kingdom's centralized regulator, which were mainly in Scandinavia, had a "predominantly prudential focus."
57. Id. at 331. That is, the unified new regulator was more a guardian of "safety and soundness" and less oriented toward consumer protection.
58. Blueprint, supra note 17, at 3.
59. Ferran, supra note 31, at 259.
60. Id. at 261-62.
61. Id. at 265.
62. Id. at 266. The most important of these were the Securities and Futures Authority ("SFA"), the Investment Managers' Regulatory Organization ("IMRO"), and the Personal Investment Authority ("PIA").
63. Two scandals in particular stood out: the Robert Maxwell affair in which a prominent financier effectively embezzled the pension funds of his companies and a "pension mis-selling" controversy in which highly risky financial products were inappropriately sold to pension funds without adequate supervision or disclosure. Id. at 267-68.
64. Id. at 268.
65. See infra notes 113-15 and accompanying text.
66. Blueprint, supra note 17, at 3.
67. For a recent discussion of the Australian reorganization, which began in 1996 (and thus preceded the United Kingdom), see Schooner & Taylor, supra note 24, at 340-41.
68. The Australian Securities and Investments Commission ("ASIC") is the "consumer protection" agency under this "twin peaks" approach, and the Australian Prudential Regulatory Authority ("APRA") supervises bank "safety and soundness." Still, the "twin peaks" model was not fully accepted in Australia, as ASIC, the securities regulator, does retain supervisory jurisdiction over the "financial soundness" of investment banks. Id. at 341. Thus, some element of functional regulation remains.
69. Michael Taylor, "Twin Peaks": A Regulatory Structure for the New Century (Centre for the Study of Financial Innovation 1995).
70. For a brief review of Taylor's work, see Cynthia Crawford Lichtenstein, The Fed's New Model of Supervision for "Large Complex Banking Organizations": Coordinated Risk-Based Supervision of Financial Multinationals for International Financial Stability, 18 Transnat'l Law. 283, 295-96 (2005).
71. Lichtenstein, supra note 45, at 295 (quoting Taylor, supra note 45, at 4) (emphasis omitted).
72. See infra notes 58, 104 and accompanying text (discussing average annual SEC penalties and class action settlements).
73. See Richard A. Booth, The End of the Securities Fraud Class Action as We Know It, 4 Berkeley Bus. L.J. 3, 3 (2007).
74. See Financial Services and Markets Act, 2000, c. 8, § 6 (U.K.).
75. See Schooner & Taylor, supra note 24, at 335.
76. Id. at 335-36.
77. Id. at 336.
78. Japan has a history and a regulatory culture of economic management of its financial institutions through regulatory bodies that is entirely distinct from that of Europe or the United States. Although it has recently created a Financial Services Agency, observers contend that it remains committed to its traditional system of bureaucratic regulation that supports its large banks and discourages foreign competition. See Markham, supra note 31, at 383-92, 396. Nonetheless, scandals have been the primary force driving institutional change there too, and Japan's FSA was created at least in part because Japan's Ministry of Finance ("MOF") had become embarrassed by recurrent scandals.
79. For the most acerbic of these attacks on Sarbanes-Oxley, see Roberta Romano, The Sarbanes-Oxley Act and the Making of Quack Corporate Governance, 114 Yale L.J. 1521 (2005).
80. For an overview, see John C. Coffee, Jr., Joel Seligman & Hillary A. Sale, Securities Regulation: Cases and Materials 3 (10th ed. 2007).
81. As of October 2008, the percentage of shares held by "private investors" (that is, non-institutional shareholders) in U.K.-listed companies had fallen to 9.6% (which was consistent with the level of such ownership in the 1980s, prior to later privatization efforts by the British government). See Matthew Vincent, Value of Private Holdings Hits Low, Fin. Times, Oct. 18, 2008, at 15. At its peak, private ownership hit 20% in 1994.
82. Id. During the 1990s, the level of individual ownership rose as the result of the Thatcher government's privatization of government-owned enterprises, but even this 20% level never approached the U.S. level of individual ownership, which has not fallen below 30%.
83. See John Armour & David A. Skeel, Jr., Who Writes the Rules for Hostile Takeovers and Why?-The Peculiar Divergence of U.S. and U.K. Takeover Regulation, 95 Geo. L.J. 1727, 1768-69 (2007) (comparing U.S. and U.K. institutional ownership and revealing institutional levels of ownership in the United Kingdom in 2004 were approximately 10% higher than the United States).
84. For detailed comparisons, see John C. Coffee, Jr., Law and the Market: The Impact of Enforcement, 156 U. Pa. L. Rev. 229, 268-74 (2007);
85. Howell E. Jackson, Variations in the Intensity of Financial Regulation: Preliminary Evidence and Potential Implications, 24 Yale J. on Reg. 253, 278-86 (2007).
86. In 2004, 2005, and 2006, the total of SEC obtained restitution, disgorgement, and penalties was, $3.1 billion, $3.1 billion and $3,275 billion, respectively. See Eric Zitzewitz, An Eliot Effect? Prosecutorial Discretion in Mutual Fund Settlement Negotiations, 2003-07 Table 1 (Apr. 21, 2008) (unpublished manuscript, available at http://ssrn.com/abstract= 1091035).
87. See Jonathan Sibun, Tough-Talking Regulator Hands Out Smaller Fines, Sunday Telegraph, Dec. 30, 2007, at 1;
88. Watchdog Fines at Six-Year Low as City Keeps to Rules, Yorkshire Post, Dec. 31, 2007, at 15. The average fine in 2007 was £232,000 and only one fine was over one million pounds.
89. As of 1990, equity-based compensation for chief executive officers of large public corporations in the United States averaged approximately five percent of their total annual compensation; by 1999, this percentage had risen to an estimated sixty percent. See John C. Coffee, Jr., What Caused Enron?: A Capsule Social and Economic History of the 1990s, 89 Cornell L. Rev. 269, 275 (2004).
90. See John C. Coffee, Jr., A Theory of Corporate Scandals: Why the USA and Europe Differ, 21 Oxford Rev. Econ. Pol'y 198, 204 (2005).
91. Interestingly, this is the diagnosis that SEC Chairman Christopher Cox recently presented to the Senate Banking Committee. See infra notes 100, 101 and accompanying text. He stressed the failure of Congress to give the SEC jurisdiction over investment bank holding companies or over-the-counter derivatives (including credit default swaps).
92. For example, the high-tech internet bubble that burst in early 2000 was a demanddriven bubble. Investors simply overestimated the value of the internet, and for a time initial public offerings of dot-com companies would trade at ridiculous and unsustainable multiples. But full disclosure was provided to investors and the SEC cannot be faulted in this bubble-unless one assigns it the very paternalistic responsibility of protecting investors from themselves.
93. This is best evidenced by the work of two University of Chicago Business School professors discussed below. See Atif Mian & Amir Sufi, The Consequences of Mortgage Credit Expansion: Evidence from the U.S. Mortgage Default Crisis 2 (Dec. 12, 2008) (unpublished manuscript, available at http://ssrn.com/abstract=1072304).
94. Id. at 11-13.
95. Id. at 18-19.
96. Id. at 19.
97. Id. at 20-21.
98. Id.
99. See Benjamin J. Keys, Tanmoy Mukherjee, Amit Seru & Vikrant Vig, Did Securitization Lead to Lax Screening? Evidence From Subprime Loans 2-3 (Dec. 25, 2008) (unpublished manuscript, available at http://ssrn.com/abstract=1093137). The authors conclude that securitization did result in "lax screening."
100. The President's Working Group on Financial Markets, Policy Statement on Financial Market Developments 1 (Mar. 2008), available at http://www.ustreas. gov/press/releases/reports/pwgpolicystatemktturmoil-03122008.pdf.
101. Investment banks formerly relied on "due diligence" firms that they employed to determine whether the loans within a loan portfolio were within standard parameters. These firms would investigate and inform the underwriter as to the percentage of the loans that were "exception" loans (that is, loans outside the investment bank's normal guidelines). Subsequent to 2000, the percentage of "exception loans" in portfolios securitized by these banks often rose from the former level of 25% to as high as 80%. Also, the underwriters scaled back the intensity of the investigations that they would authorize the "due diligence" firm to conduct, reducing from 30% to as few as 5% the number of loans in a portfolio that it was to check. See Vikas Bajaj & Jenny Anderson, Inquiry Focuses on Withholding of Data on Loans, N.Y. Times, Jan. 12, 2008, at A1.
102. See Richard E. Mendales, Collateralized Explosive Devices: Why Securities Regulation Failed to Prevent the CDO Meltdown, and How to Fix It, 2009 U. Ill. L. Rev. (forthcoming 2009) (manuscript at 34-38, on file with the Virginia Law Review).
103. See Asset-Backed Securities, Securities Act Release No. 33-8518, Exchange Act Release No. 34-50,905, 70 Fed. Reg. 1506 (Jan. 7, 2005) (to be codified at 17 C.F.R. pts. 210, 228, et al.). Regulation AB codified a series of "no-action" letters and established disclosures standards for all asset-backed securitizations.
104. See Asset-Backed Securities (Regulation AB), 17 C.F.R. §§ 229.1100-229.1123 (2008). Although it did not represent a sharp deregulatory break with the past, Regulation AB did reduce the due-diligence obligation of underwriters by eliminating any need to assure that assets included in a securitized pool were adequately documented. Professor Mendales has pointed out that government sponsored entities, such as Ginny Mae, had required such documentation.
105. See Mendales, supra note 73, at 35-36. His point is that Regulation AB should have adopted the procedures used by housing-related GSEs, such as Ginny Mae, which mandated quality control procedures.
106. Id.
107. For a concise overview of these developments, see Jon Hilsenrath, Damian Paletta & Aaron Lucchetti, Goldman, Morgan Scrap Wall Street Model, Become Banks in Bid to Ride Out Crisis, Wall St. J., Sept. 22, 2008, at A1 (reporting that Goldman Sachs and Morgan Stanley were pressured by the Federal Reserve to convert into bank holding companies).
108. See Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities; Supervised Investment Bank Holding Companies, Exchange Act Release No. 49,830, 69 Fed. Reg. 34,428 (June 21, 2004) (to be codified at 17 C.F.R. pts. 200, 240).
109. The SEC's "net capital rule," which dates back to 1975, governs the capital adequacy and aggregate indebtedness permitted for most broker-dealers. See Net Capital Requirements for Brokers or Dealers, 17 C.F.R. § 240.15c3-1 (2008). Under subparagraph (a)(1)(i) of this rule, aggregate indebtedness is limited to fifteen times the broker-dealer's net capital. 17 C.F.R. § 240.15c3-1(a)(1)(i) (2008). A broker-dealer may elect to be governed instead by subparagraph (a)(1)(ii) of this rule, which requires it to maintain its net capital at not less than the greater of $250,000 or two percent of "aggregate debit items" as computed under a special formula that gives "haircuts" (that is, reduces the valuation) of illiquid securities. 17 C.F.R. § 240.15c3-1(a)(1)(ii). Both variants place fixed limits on leverage. 17 C.F.R. §240.15c3-1(a)(1).
110. This chart comes from Sec. & Exch. Comm'n, Office of Inspector Gen., SEC's Oversight of Bear Stearns and Related Entities: The Consolidated Supervised Entity Program 120 (Report No. 446-A, Sept. 25, 2008), available at http://www.sec-oig.gov/Reports/AuditsInspections/2008/446-a.pdf [hereinafter SEC Inspector General Report No. 446-A].
111. See id. at 19.
112. For the strongest statement of this thesis, see Stephen Labaton, S.E.C. Concedes Oversight Flaws Fueled Collapse, N.Y. Times, Sept. 27, 2008 at A1. Nonetheless, this analysis is oversimplified. Although SEC Chairman Cox did indeed acknowledge that there were flaws in the "Consolidated Supervised Entity" Program, he did not concede that it "fueled" the collapse or that it represented deregulation. As discussed below, the SEC probably legitimately believed that it was gaining regulatory authority from the CSE Program (but it was wrong).
113. See Council Directive 2002/87/EC, 2003 O.J. (L35) 1.
114. For an overview of this directive and its rationale, see Jorge E. Viñuales, The International Regulation of Financial Conglomerates: A Case Study of Equivalence as an Approach to Financial Integration, 37 Cal. W. Int'l L.J. 1, 2 (2006).
115. Different European regulators appear to have been feared by different entities. Some commercial banks saw French regulation as potentially hostile, while U.S. broker-dealers, all largely based in London, did not want their holding companies to be overseen by the United Kingdom's Financial Services Agency ("FSA").
116. See Stephen Labaton, Agency's '04 Rule Let Banks Pile Up New Debt, and Risk, N.Y. Times, Oct. 3, 2008, at Al (describing major investment banks as having made an "urgent plea" to the SEC in April, 2004).
117. See Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities; Supervised Investment Bank Holding Companies, Exchange Act Release No. 49,830,69 Fed. Reg. 34,428 (June 21,2004) (to be codified at 17 C.F.R. pts. 200, 240).
118. See 17 C.F.R. § 240.15c3-1(a)(1) (2008).
119. See 17 C.F.R. § 240.15c3-1(a)(1)(ii) (2008). This alternative standard is framed in terms of the greater of $250,000 or two percent, but for any investment bank of any size, two percent will be the greater. Although this alternative standard may sound less restrictive, it was implemented by a system of "haircuts" that wrote down the value of investment assets to reflect their illiquidity.
120. The "Basel II Accords" refers to a revised version of the international agreement that purports to specify uniform capital adequacy standards for major banks. The "Basel I Accord" was reached in 1988 by the Basel Committee on Banking Supervision of the Bank of International Settlements (which is located in Basel, Switzerland). The Basel II Accords, which were driven by the growth of trading in over-the-counter derivatives and their uncertain impact on capital adequacy, underwent sustained negotiations in the years after 2000.
121. For a discussion of the politics surrounding this process, which did not conclude until Fall of 2005, see Stavros Gadinis, The Politics of Competition in International Financial Regulation, 49 Harv. Int'l L.J. 447 (2008). Gadinis finds that the Federal Reserve did not itself sign off on the Basel II Accords until late September 2005.
122. Id. at 506 n. 192. This was well after the SEC applied these standards to participants in its Consolidated Supervised Entity Program in 2004.
123. For a more general discussion of the Basel Committee and its non-transparent style of operation, see Anne-Marie Slaughter, Sovereignty and Power in a Networked World Order, 40 Stan. J. Int'l L. 283, 315-16 (2006).
124. See SEC Inspector General Report No. 446-A, supra note 78, at 10-11. Under these standards, a "well-capitalized" bank was expected to maintain a ten percent capital ratio. Id. Nonetheless, others have argued that Basel II "was not designed to be used by investment banks" and that the SEC "ought to have been much more careful in moving banks on to the new rules."
125. See Mewling and Puking: How Damaged is the Basel 2 Accord?, Economist, Oct. 25, 2008, at 89.
126. SEC Inspector General Report No. 446-A, supra note 78, at 11.
127. Id. at 10.
128. This critique has been most fully advanced by Daniel Tarullo, whom President Obama has recently nominated to join the Board of Governors of the Federal Reserve System. See Daniel K. Tarullo, Banking on Basel: The Future of International Financial Regulation 152-59 (2008). Professor Tarullo argues that the new riskadjusted criteria adopted by Basel II largely allowed the major banks to specify their own risk models and thereby reduce their capital ratios. Also, Basel II motivated them to move transactions off their balance sheets. In short, he argues that Basel II led to laxer bank supervision generally.
129. Id. at 160-66.
130. See Mewling and Puking, supra note 88, at 89. Ironically, the Federal Reserve hesitated and did not formally accept Basel II until September 30, 2005, nearly a year after its endorsement by the SEC.
131. See Gadinis, supra note 87, at 506 n. 192.
132. See also Rebecca Christie, Rules on Bank Capital Draw Fire: FDIC Move May Delay Final Accord Covering World Financial System, Wall St. J., Dec. 8, 2003, at B8. This suggests that the SEC moved faster and further towards deregulation and the use of private models for risk regulation than did the Federal Reserve, possibly with the result that financial disaster first struck at the investment banks.
133. The SEC adopted its CSE program in 2004. See Alternative Net Capital Requirements for Broker-Dealers That Are Part of Consolidated Supervised Entities; Supervised Investment Bank Holding Companies, Exchange Act Release No. 49,830, 69 Fed. Reg. 34,428 (June 21, 2004) (to be codified at 17 C.F.R. pts. 200, 240). The Federal Reserve only agreed in principle to Basel II in late 2005.
134. See Gadinis, supra note 87, at 506 n.192.
135. Citibank, for example, "actually boasted after the release of the Basel II formula in 2004 that it could reduce its minimum capital by about 15 percent." Robert Kuttner, A Fine Mess, Am. Prospect, Dec. 2008, at 37, 39.
136. SEC Inspector General Report No. 446-A, supra note 78, at 2.
137. Id. Similarly, the Office of CSE Inspectors had only seven staff.
138. Id.
139. Moreover, the process effectively ceased to function well before the 2008 crisis hit. After SEC Chairman Cox reorganized the CSE review process in the Spring of 2007, the staff did not thereafter complete "a single inspection." See Labaton, supra note 83, at A23.
140. SEC Inspector General Report No. 446-A, supra note 78, at ix.
141. Id. at xi.
142. See Turmoil in U.S. Credit Markets: Recent Actions Regarding Government Sponsored Entities, Investment Banks and Other Financial Institutions: Hearing Before the S. Comm. on Banking, Housing & Urban Affairs, 110th Cong. 4 (2008) [hereinafter Turmoil in U.S. Credit Markets] (testimony of Christopher Cox, Chairman, Sec. & Exch. Comm'n), available at http://banking.senate.gov/ public/-files/COXTestimony92308.pdf (emphasis added). Chairman Cox has repeated this theme in a subsequent Op-Ed column in the Washington Post, in which he argued that "[r]eform legislation should steer clear of voluntary regulation and grant explicit authority where it is needed."
143. See Christopher Cox, Op-Ed., Reinventing a Markets Watchdog, Wash. Post, Nov. 4, 2008, at A17.
144. Chairman Cox added in the next sentence of his Senate testimony: "There is simply no provision in the law that authorizes the CSE Program, or requires investment bank holding companies to compute capital measures or to maintain liquidity on a consolidated basis, or to submit to SEC requirements regarding leverage." Turmoil in U.S. Credit Markets, supra note 100, at 6. This is true, but if a CSE firm left the CSE Program, it would presumably become subject to European regulation (from which it was exempt only because the CSE participants were subject to U.S. financial supervision at the parent company level).
145. See supra notes 81-84 and accompanying text. Thus, the system was not entirely voluntary and the SEC might have used the threat to expel a non-compliant CSE firm.
146. See Gretchen Morgenson, How the Thundering Herd Faltered and Fell: Merrill Lynch Couldn't Escape the Housing Crash, N.Y. Times, Nov. 9, 2008, at B1 (analyzing Merrill Lynch's failure and emphasizing its acquisitions of loan originators);
147. Terry Pristin, Risky Real Estate Deals Helped Doom Lehman, N.Y. Times, Sept. 17, 2008, at C6 (discussing Lehman's expensive, multi-billion dollar acquisition of Archstone-Smith).
148. See Michiyo Nakamoto & David Wighton, Bullish Citigroup Is 'Still Dancing to the Beat of the Buy-Out Boom, FT.com, July 10, 2007, http://www.ft.com/cms/s/0/5cefc794-2e7d-11dc-821c0000779fd2ac.html?nclick-check= 1.
149. From 1996 to 1999, the settlements in securities class actions totaled only $1.7 billion; thereafter, aggregate settlements rose exponentially, hitting a peak of $17.1 billion in 2006 alone. See Laura E. Simmons & Ellen M. Ryan, Securities Class Action Settlements: 2006 Review and Analysis 1 (Cornerstone Research 2006), available at http://securities.cornerstone.com/ pdfs/settlements-2006.pdf. This decline of due diligence practices as liability correspondingly increased seems paradoxical, but may suggest that at least private civil liability does not effectively deter issuers or underwriters.
150. For a chart showing the growth of asset-backed securities in relation to conventional corporate debt issuances over recent years, see Coffee, Seligman & Sale, supra note 55, at 10.
151. For a detailed description of Merrill Lynch's late entry into the asset-backed securitization field and its sometimes frenzied attempt to catch up with Lehman by acquiring originators of mortgage loans, see Morgenson, supra note 102, at B1. Merrill eventually acquired an inventory of $71 billion in risky mortgages, in part through acquisitions of loan originators. By mid-2008, an initial writedown of $7.9 billion forced the resignation of its CEO. As discussed in this New York Times article, loan originators dealing with Merrill believed it did not accurately understand the risks of their field.
152. Id.
153. For Lehman's similar approach to acquisitions of loan originators, see supra note 102 and accompanying text.
154. The Commodity Futures Modernization Act of 2000 ("CFMA") largely withdrew swaps and other over-the-counter derivatives from the regulatory jurisdiction of both the SEC and the CFTC (although both retained anti-fraud jurisdiction). See Commodity Futures Modernization Act of 2000, Pub. L. No. 106-554, 114 Stat. 2763.
155. For an overview, see Thomas Lee Hazen, Disparate Regulatory Schemes for Parallel Activities: Securities Regulation, Derivatives Regulation, Gambling, and Insurance, 24 Ann. Rev. Banking & Fin. L. 375, 389-95 (2005). The SEC's authority to adopt antifraud rules relating to over-the-counter derivatives is set forth in Section 10(b) of the Securities Exchange Act of 1934.
156. See 15 U.S.C. § 78j(b) (2006). Because such transactions are effected on a bilateral basis, with little resulting transparency, however, the SEC has had little success to date in combating insider trading or manipulation in this area.
157. See Andrew Ross Sorkin & Michael J. de la Merced, Debt Linked to Huge Buyouts Is Tightening the Economic Vise, N.Y. Times, Nov. 3, 2008, at A1 (discussing problems with recent buyouts by private equity firms);
158. see also Peter Lattman, Craig Karmin & Pui-Wing Tarn, Private Equity Draws the Cold Shoulder-Endowments, Pension Funds Rebuff Calls to Make Investments as Some Aim to Offload Stakes, Wall St. J., Nov. 4, 2008, at C1.
159. In 1990, Drexel Burnham Lambert Group, Inc., the parent company in a financial conglomerate that included a large broker-dealer subsidiary, encountered a financial crisis and became unable to roll over its commercial paper, and its counter-parties similarly declined to trade with it. Its bankruptcy (and that of its broker dealer subsidiary) led Congress to enact the Market Reform Act of 1990 to add Section 17(b) to the Securities and Exchange Act of 1934. For a review of this last major broker-dealer insolvency before the current crisis,
160. see Sec. & Exch. Comm'n, Office of Inspector Gen., SEC's Oversight of Bear Stearns and Related Entities: Broker-Dealer Risk Assessment Program 1 (Report No. 446-B, Sept. 25, 2008), available at http://www.sec-oig.gov/Reports/ AuditsInspections/2008/446-b.pdf. The foregoing SEC Inspector General's Report found the Commission to have poorly implemented the Broker-Dealer Risk Assessment Program that had been established pursuant to §17(h) in response to the Drexel bankruptcy.
161. Id. at v.
162. For this view, see Richard Mendales, supra note 73, at 34-38. Professor Mendales argues convincingly that (1) the focus of disclosure should be on the quality of the collateral in the securitized pool, not on the historical returns on mortgages, and (2) underwriters should be required to perform sufficient due diligence to document all the loans in the pool. Regulation AB did neither.
163. See supra notes 100-101 and accompanying text.
164. See e.g., Jeremy Grant, US Firms Lobby for Regulation by Principles, Fin. Times Sept. 17, 2007, at 22 (reporting the praising of the proposed switch to a principles-based regulatory regime because it would improve both regulation enforcement and U S. capital market competitiveness in the world);
165. Adam Shell, Paulson Criticizes Regulation, USA Today, Nov. 21,2006, at 4B (quoting Paulson as saying that we must "rise above a rules-based mind-set... and adopt a more principles-based approach").
166. See e g., Jenny Anderson, On Paper, Wall Street Gets Its Way, N.Y. Times, Apr. 1 2008 at C1;
167. Grant, supra note 112, at 22;
168. Shell, supra note 112, at 4B (stating that Paulson's speech was spurred on by industry complaints about rules that dampen competitiveness). But see Doidge, Karolyi & Stulz, supra note 10, at 4-5 (arguing that it is "simply wrong" to interpret the growth of market share in London as "evidence of a decline in the attractiveness of U.S. exchanges").
169. See Anderson, supra note 113, at C1 (quoting Lehman Brothers CLO saying that he thought that the proposal for a principles-based system would be "a major step forward");
170. Grant, supra note 112, at 22 (noting that Jamie Dimon, chief executive at JP Morgan Chase, and Dick Kovacevich, chairman of Wells Fargo, spearheaded an effort to lobby Washington to change the regulatory structure from a rules-based system to a principles-based system because it would "improve the competitiveness of capital markets").
171. See Louis Kaplow, Rules Versus Standards: An Economic Analysis, 42 Duke L.J. 557, 559-60 (1992);
172. see also Henry M. Hart, Jr. & Albert M. Sacks, The Legal Process: Basic Problems in the Making and Application of Law 155-58 (1958);
173. Frederick Schauer, Playing by the Rules: A Philosophical Examination of Rule-Based Decision-Making in Law and in Life 12-15 (1991);
174. Duncan Kennedy, Form and Substance in Private Law Adjudication, 89 Harv. L. Rev. 1685 (1976);
175. Pierre Schlag, Rules and Standards, 33 U.C.L.A. L. Rev. 379 (1985).
176. Kaplow, supra note 115, at 560.
177. Almost all commentators seem to have used this example. See, e.g., Cristie L. Ford, New Governance, Compliance, and Principles-Based Securities Regulation, 45 Am. Bus. L.J. 1, 6 (2008);
178. Kaplow, supra note 115, at 560;
179. Frederick Schauer, The Tyranny of Choice and the Rulification of Standards, 14 J. Contemp. Legal Issues 803, 803-04 (2005).
180. See, e.g., Kennedy, supra note 115, at 1688 (noting that rules promote "restraint of official arbitrariness and certainty");
181. see also Schlag, supra note 115, at 384 (describing the argument that the "sharp line" drawn by rules promotes certainty and understandability).
182. See, e.g., Kaplow, supra note 115, at 563 ("Because learning about a rule is cheaper, individuals may spend less in learning about the law, and may be better guided by a rule since the law's content can be more readily ascertained.").
183. See, e.g., id. (arguing that rules are cheaper to enforce because the majority of costs are borne during promulgation, whereas principles require additional costs for each instance of enforcement).
184. See, e.g., id. at 573 (arguing that rules become cheaper than standards as the frequency of enforcement increases).
185. See, e.g., Schlag, supra note 115, at 384-85 (describing how the "sharp line" drawn by rules may mete out seemingly disproportionate punishment).
186. See Kennedy, supra note 115, at 1695 (noting that with rules, "sometimes perfectly innocent behavior will be punished, and that sometimes plainly guilty behavior will escape sanction");
187. see also Kaplow, supra note 115, at 591 (noting that rules may prohibit socially acceptable behavior while failing to prohibit undesirable behavior).
188. See, e.g., Kaplow, supra note 115, at 562 (noting that "[r]ules are more costly to promulgate than standards because rules involve advance determinations of the law's content").
189. See, e.g., id. at 560 (describing how "[a] standard may entail leaving both specification of what conduct is permissible and factual issues for the adjudicator").
190. See, e.g., Schlag, supra note 115, at 385 (describing how the uncertainty surrounding standards may create "confusion about what is or is not permissible").
191. See, e.g., id. at 387 (describing how standards require evaluative judgments by subordinates which "increase the likelihood of erroneous determinations").
192. See, e.g., Kaplow, supra note 115, at 562-63 (noting that "standards are more costly for. enforcement authorities to apply because they require later determinations of the law's content");
193. Schlag, supra note 115, at 385 (describing the argument that with unclear standards, "decision makers in borderline cases are likely to reach erratic results").
194. See, e.g., Kaplow, supra note 115, at 561 (noting that "legal commands mix [rules and standards] in varying degrees");
195. Kennedy, supra note 115, at 1688 (describing rules and standards as "distinct but overlapping").
196. See, e.g., Lawrence A. Cunningham, A Prescription to Retire the Rhetoric of "Principles-Based Systems" in Corporate Law, Securities Regulation, and Accounting, 60 Vand. L. Rev. 1411, 1413 (2007).
197. See 17 C.F.R. § 229.402 (2008) (defining the materiality threshold of compensation information by enumerating a list of material elements of the compensation);
198. C.F.R. § 229.601 (2008) (defining the materiality threshold of contracts that must be filed and disclosed with the registration statement to the SEC);
199. C.F.R. § 229.903 (2008) (defining, by an enumerated list, specific activities or events that constitute a "material risk" and should be reported in a disclosure statement to investors).
200. 13217 C.F.R. § 240.12b-20 (2008).
201. 13517 C.F.R. § 229.404 (2008).
202. See id.
203. See id.
204. See John C. Coffee, Jr., Joel Seligman & Hillary A. Sale, Federal Securities Laws: Selected Statutes, Rules and Forms 242-377 (2008).
205. See Cunningham, supra note 130, at 1424.
206. See Anderson, supra note 113, at C1 (quoting former SEC commissioner Harvey J. Goldschmid as opining that some principles-based "advocates want broad principles that will not be enforced").
207. Safe harbors, or delineated protections, exist throughout the securities laws and regulations. See, e.g., 15 U.S.C. §78u-5 (providing safe harbor protection for forwardlooking statements accompanied by meaningful cautionary language);
208. Rule 10b5-l, 17 C.F.R. §240.10b5-1 (2008) (defining when certain purchases or sales of securities by an insider are exempt from insider trading liability).
209. See, e.g., 17 C.F.R. § 240.10b5-1 (creating liability for purchasing or selling securities based upon "material nonpublic information");
210. TSC Indus., Inc. v. Northway, 426 U.S. 438, 445 (1976) (court states that liability may be conditioned upon material omissions of facts that a reasonable investor would have found important in deciding whether to invest).
211. TSC Indus., Inc., 426 U.S. at 449.
212. See, e.g., Basic, Inc. v. Levinson, 485 U.S. 224, 236 (1988) (rejecting industry's argument for a bright-line "agreement-in-principle" test to determine materiality).
213. See, e.g., Brief for Petitioners at 24, Basic, 485 U.S. 224 (No. 86-279), 1987 WL 881061
214. (quoting Flamm v. Eberstadt, 814 F.2d 1169, 1177 (7th Cir. 1987) (arguing that a rule would have "the benefits of certainty").
215. See, e.g., Basic, 485 U.S. at 236 (noting that support for a bright-line rule "seems to be directed solely at the comfort of corporate managers").
216. SEC Staff Accounting Bulletin No. 99, 64 Fed. Reg. 45,150 (1999) (rejecting the use of a numerical threshold to determine materiality).
217. See, e.g., Basic, 485 U.S. at 236 & n.14 (acknowledging the benefits of bright-line rules but dismissing the notion as " unrealistic");
218. see also In re Columbia Sec. Litig., 747 F. Supp. 237, 243 (S.D.N.Y. 1990) (noting that the Supreme Court has endorsed a fact-specific test for materiality despite some advantages of a bright-line rule).
219. See, e.g., Basic 485 U.S. at 236 ("A bright-line rule indeed is easier to follow than a standard that requires the exercise of judgment in the light of all the circumstances. But ease of application alone is not an excuse for ignoring the purposes of the Securities Acts and Congress' policy decisions. Any approach that designates a single fact or occurrence as always determinative of an inherently fact-specific finding such as materiality, must necessarily be overinclusive or underinclusive.").
220. 14817 C.F.R. §240.10b-5 (2008).
221. Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 128 S. Ct. 761, 773 (2008) (referring to 10b-5 claim as "prominent feature of federal securities regulation");
222. Coffee, supra note 57, at 267 (arguing that actual financial sanctions imposed by private enforcement exceed those of public enforcement);
223. see, e.g., A.C. Pritchard & Hillary A. Sale, What Counts as Fraud? An Empirical Study of Motions to Dismiss Under the Private Securities Litigation Reform Act, 2 J. Empirical Legal Stud. 125, 129-30 (2005).
224. See, e.g., Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 341 (2005);
225. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 197 (1976).
226. See Pritchard & Sale, supra note 149, at 129-30.
227. Private Securities Litigation Reform Act of 1995, Pub. L. No. 104-67, 109 Stat. 737 (codified as amended in scattered sections of 15 U.S.C.).
228. §101,109 Stat, at 737-49.
229. See, e.g., Pritchard & Sale, supra note 149, at 126-27;
230. Hillary A. Sale, Heightened Pleading and Discovery Stays: An Analysis of the Effect of the PSLRA's InternalInformation Standard on '33 and '34 Act Claims, 76 Wash. U. L.Q. 537, 552-61 (discussing and citing legislative history and calls for reform).
231. See Pritchard & Sale, supra note 149, at 129-31;
232. see also Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 2504-05 (2007).
233. See, e.g., Petition for a Writ of Certiorari at 3, Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499 (2007) (No. 06-484), 2006 WL 2849388 (arguing that the Supreme Court should resolve the "split of authority" regarding the "strong inference" standard).
234. See, e.g., Stephen Labaton, Investors' Suits Face Higher Bar, Justices Decide, N.Y. Times, June 21, 2007, at A1 (noting industry praise for the Supreme Court's heightened standard in Tellabs).
235. See, e.g., Press Release, Sec. Indus. & Fin. Mkts. Ass'n, Tellabs Case: Supreme Court Hands Industry 2nd Major Victory in 2 Weeks (June 21, 2007), available at http://www.sifma.org/news/46739784.shtml (arguing that the ruling "lends certainty and uniformity" to the standard).
236. Makor Issues & Rights, Ltd. v. Tellabs, Inc., 513 F.3d 702, 712 (7th Cir. 2008).
237. Id.
238. Mississippi Pub. Employees' Ret. Sys. v. Boston Scientific Corp., 523 F.3d 75. 7879 (1st Cir. 2008) (reversing district court dismissal and finding scienter adequately pleaded under Tellabs).
239. See Schauer, supra note 117, at 809-11 (arguing that decision-makers push standards into rule-like form).
240. See Anderson, supra note 113, at C1.
241. On the migration of standards to rules from the perspective of decision-makers, see Schauer, supra note 117, at 809-11.
242. See Ford, supra note 117, at 51.
243. See Simmons & Ryan, supra note 104, at 1.
244. Historically, the implied private cause of action arose under Rule 14a-9, which addresses fraud in proxy statements. See, e.g., J.I. Case Co. v. Borak, 377 U.S. 426, 432 (1964) (noting that private securities litigation is a "necessary supplement to Commission action").
245. See, e.g., Letter from Donald C. Langevoort, Professor of Law, Georgetown University Law Center, to Christopher Cox, Chairman, Securities and Exchange Commission, and Attached Questions and Issues for Discussion (Aug. 2, 2007) (on file with the Virginia Law Review)
246. [hereinafter Letter from Donald C. Langevoort] (signed on behalf of James D. Cox, Jill Fisch, Michael A. Peřino, Adam C. Pritchard & Hillary A. Sale) (noting diversity of signors and urging Commission to address concerns about investor protection, competitiveness, and litigation system).
247. See id. at 2.
248. In fairness, the Blueprint does concede this. See Blueprint, supra note 17, at 21 ("The United States has the strongest and most liquid capital markets in the world. This strength is due in no small part to the U.S. financial services industry regulatory structure, which promotes consumer protection and market stability.");
249. see also Letter from Donald C. Langevoort, supra note 168, at 1-2.
250. See, e.g., John C. Coffee, Jr., Competition Versus Consolidation: The Significance of Organizational Structure in Financial and Securities Regulation, 50 Bus. Law. 447, 447 (1995);
251. see also Blueprint, supra note 17, at 197-206 (documenting Executive Branch studies of markets and reform proposals over the years).
252. Historians have made the unsurprising point that revisions of securities laws have come in waves, which, over the last 300 years, have generally followed market crashes. See Stuart Banner, What Causes New Securities Regulation?: 300 Years of Evidence, 75 Wash. U. L.Q. 849, 850 (1997). Absent a market crash and its destabilizing impact on politics, powerful interest groups, such as the securities industry, can usually overcome or stall efforts by disorganized investors to adopt "reform" legislation.
253. See Henry M. Paulson, Sec'y, Dep't of Treasury, Remarks on the Competitiveness of U.S. Capital Markets Economic Club of New York (Nov. 20, 2006), available at http://www.ustreas.gov/press/releases/hp174.htm (stating that the U.S. capital markets are the "deepest, most efficient, and most transparent in the world" and that the regulatory structure is "second to none");
254. Roberta Romano, The Genius of American Corporate Law 136-37 (1993) (comparing the U.S. capital markets with those of other countries and showing how much more liquid the U.S. capital markets are);
255. Marcel Kahan, Some Problems with Stock Exchange-Based Securities Regulation, 83 Va. L. Rev. 1509, 1518-19 (1997) (stating that, as compared with other countries, the U.S. capital markets are fairly liquid and trading is cheap).
256. See, e.g., Pritchard & Sale, supra note 149, at 126 (noting "dearth" of empirical work on securities litigation reform);
257. see also Coffee, supra note 57, at 258-63 (showing greater enforcement "output" in United States versus other major market centers);
258. Stavros Gadinis & Howell E. Jackson, Markets as Regulators: A Survey, 80 S. Cal. L. Rev. 1239, 1297 (2007) (comparing foreign enforcement regimes).
259. Blueprint, supra note 17, at 179-80.
260. Id. at 178-79.
261. Id. at 21.
262. See, e.g., Donald C. Langevoort, Half-Truths: Protecting Mistaken Inferences by Investors and Others, 52 Stan. L. Rev. 87, 117 (1999) (explaining that both courts and SEC regulators require people to "volunteer any information necessary to make [their statements] not misleading" to avoid liability in fraud-on-the-market cases).
263. These costs have been thoroughly explored elsewhere and here are discussed only briefly. See, e.g., A.C. Pritchard, Markets as Monitors: A Proposal to Replace Class Actions with Exchanges as Securities Fraud Enforcers, 85 Va. L. Rev. 925 (1999).
264. See Dura Pharm., Inc. v. Broudo, 544 U.S. 336, 345 (2005).
265. See Pritchard, supra note 179, at 937-45 (noting that the wrong projects can also be funded);
266. see also Merritt B. Fox, Securities Disclosure in a Globalizing Market: Who Should Regulate Whom, 95 Mich. L. Rev. 2498, 2544 (1997). Thus, both investors and companies are making inefficient decisions.
267. See Pritchard, supra note 179, at 938-39.
268. But see Paul G. Mahoney, Precaution Costs and the Law of Fraud in Impersonal Markets, 78 Va. L. Rev. 623, 633-34 (1992) (remarking that inefficient decisionmaking by investors in secondary markets probably does not impose "much of an allocative loss on society").
269. See James D. Cox, Compensation, Deterrence, and the Market as Boundaries for Derivative Suit Procedures, 52 Geo. Wash. L. Rev. 745, 747 (1984).
270. See Nicholas L. Georgakopoulos, Frauds, Markets, and Fraud-on-the-Market: The Tortured Transition of Justifiable Reliance from Deceit to Securities Fraud, 49 U. Miami L. Rev. 671, 707 (1995);
271. Jonathan R. Macey & David D. Haddock, Shirking at the SEC: The Failure of the National Market System, 1985 U. 111. L. Rev. 315, 326 (1985).
272. See Coffee, supra note 57, at 300-11 (discussing evidence on the relationship between enforcement and the cost of capital).
273. See Dura Pharm., 544 U.S. at 345 (noting that deterring fraud is the key objective of securities laws).
274. See Stephanie Plancich, Svetlana Starykh & Brian Saxton, NERA (National Economic Research Associates) Economic Consulting, 2008 Mid-Year Update, 2008 Trends: Subprime and Auction-Rate Cases Continue to Drive Filings, and Large Settlements Keep Averages High (July 2008) at 20, available at http://www.nera.com/image/BRO-Recent-Trends-8.5x1l-0808.pdf (revealing that securities class action settlements average between 2.2% and 3.2% of investors' total market losses);
275. see also John C. Coffee, Jr., Reforming the Securities Class Action: An Essay on Deterrence and its Implementation, 106 Colum. L. Rev. 1534, 1547-56 (2006) (arguing that a class action system can be justified only in terms of deterrence);
276. Donald C. Langevoort, Capping Damages for Open-Market Securities Fraud, 38 Ariz. L. Rev. 639, 646-51 (1996) (arguing that compensation is not a necessary part of the securities package);
277. Pritchard, supra note 179, at 946-47 ("Deterrence, not compensation, is the answer to the problems of loss of liquidity, reduced managerial accountability, and distorted capital allocation.").
278. Blueprint, supra note 17, at 118. Interestingly, at several other points the Blueprint states that implied rights of action should be harmonized across securities.
279. See, e.g., id. at 116-18. At least with respect to the implied right of action for 10b-5 Claims, the Supreme Court has spoken.
280. See Stoneridge Inv. Partners, LLC v. Scientific-Atlanta, Inc., 128 S. Ct. 761, 773 (2008) (stating that with the PSLRA, Congress "ratified the implied right of action" and "accepted [the] private cause of action").
281. See, e.g., Howell E. Jackson & Mark J. Roe, Public and Private Enforcement of Securities Laws: Resource-Based Evidence 33, (Harvard Pub. Law Working Paper No. 08-28), available at http://ssrn.com/abstract=1000086 (concluding that public enforcement is at least as effective, if not more effective, as private enforcement in obtaining favorable financial market outcomes).
282. Blueprint, supra note 17, at 20.
283. See, e.g., Kathleen Day, Brokerage Settlement Leaves Much Unresolved: SEC Acknowledges Need for New, Specific Rules, Wash. Post, Apr. 30, 2003, at El (describing Wall Street's push "to make it clear that federal securities laws preempt state laws").
284. See, e.g., Vincent Di Lorenzo, Federalism, Consumer Protection and Regulatory Preemption: A Case for Heightened Judicial Review, 10 U. Pa. J. Bus. & Emp. L. 273, 275-80 (2008) (describing industry criticism of and efforts to preempt state regulatory enforcement).
285. Blueprint, supra note 17, at 172-73. Section 18(c)(1) of the Securities Act of 1933 does, however, preserve the authority of the states "to investigate and bring enforcement actions with respect to fraud or deceit, or unlawful conduct by a broker or dealer, in connection with securities or securities transactions."
286. See 15 U.S.C. § 77(r)(c)(l) (2006). Thus, in 1996 in enacting NSMIA, Congress did endorse a continued anti-fraud role for state attorneys general.
287. Coffee, Seligman & Sale, supra note 55, at 1277-78 (discussing role of Eliot Spitzer in Enron investigations and prosecutions).
288. Blueprint, supra note 17, at 172.
289. Coffee, Seligman & Sale, supra note 55, at 1277.
290. See, e.g., Sale, supra note 14, at 161-63.
291. See, e.g., Stephen Labaton with Patrick McGeehan, S.E.C. Queries Large Brokers On Research, N.Y. Times, May 1,2002, at C1 (quoting Spitzer's doubts about the SECs intentions of conducting an investigation);
292. see also Stephen Labaton, S.E.C. Chief Vows to Act on Mutual Funds, N.Y. Times, Nov. 8, 2003, at C1 (detailing criticism of the SEC for its failure to investigate fraud allegations as quickly as state regulators).
293. Andrew Ross Sorkin, Cuomo Seeks Settlements with 3 More Banks, N.Y. Times DealBook, Aug. 11, 2008, http://dealbook.blogs.nytimes.com/2008/08/11/ cuomotargets-3-more-banks-in-auction-rate-inquiry/?scp=1&sq= cuomo%20banks&st=cse (describing various settlements with Citigroup, UBS, Morgan Stanley, and Bank of America where the banks have either made or agreed to make settlements totaling $47.5 billion).
294. See Jenny Anderson & Vikas Bajaj, Rating Firms Seem Near Legal Deal On Reforms, N.Y. Times, June 4,2008, at C1 (listing various changes that Cuomo was negotiating with the credit rating agencies in order to improve the transparency of the ratings process); Reuters, Rating Agencies Reach Settlement Over Fees, N.Y. Times, June 6, 2008, http://www.nytimes.com/ 2008/06/06/business/06cuomo.html?-r=1&scp=1&sq= Rating%20Agencies%20Reach %20Settlement%20Over%20Fees&st=cse (discussing the deal that was reached with the credit rating agencies and the reforms that the agencies have agreed to implement).
295. See, e.g., Jennifer Bayot, Franklin Places Three on Leave for Fund Trading, N.Y. Times, Dec. 23, 2003, at C12 (detailing the investigative roles of state regulators in Massachusetts and California).
296. Zitzewitz, supra note 58.
297. Id. at 4 (noting that settlements not involving the New York Attorney General's office had the lowest restitution ratios among those in sample).
298. Id. (settlements involving New York had ratios of .78, while those with the SEC alone, had ratios of .07).
299. Id. at 4-5.
300. Id. at 30-31.
301. Blueprint, supra note 17, at 180 ("For example, given the experience of state officials with state-chartered financial institutions or other locally based knowledge of business conduct issues (e.g., complaints regarding certain business practices in local areas), state officials could bring these issues to CBRA's attention. Based upon that local information, state officials could be given the authority to proceed with full investigations and enforcement actions if approved by CBRA. An alternative to this grant of authority to state officials should be for CBRA (or the appropriate SRO) to use such information to further investigate compliance issues and take enforcement actions as necessary. In both cases, the goal should be to build off the local knowledge of state officials and to provide an appropriate role for states in business conduct oversight.").
302. Zitzewitz, supra note 58, at 4-5 (noting that when New York gets involved in prosecuting a case, the restitution-to-harm ratio increases significantly and implies that New York pursues such prosecution more aggressively).
303. Id. at 30-31.
304. See supra Section II.B;
305. see also Coffee, supra note 7;
306. William W. Bratton, Enron and the Dark Side of Shareholder Value, 76 Tul. L. Rev. 1275, 1333-58 (2002) (arguing that particularly high standards should be applied to accountant gatekeepers);
307. John C. Coffee, Jr., Gatekeeper Failure and Reform: The Challenge of Fashioning Relevant Reforms, 84 B.U. L. Rev. 301, 308-11 (2004);
308. John C. Coffee, Jr., The Attorney as Gatekeeper: An Agenda for the SEC, 103 Colum. L. Rev. 1293, 1300-02 (2003);
309. Lawrence A. Cunningham, Beyond Liability: Rewarding Effective Gatekeepers, 92 Minn. L. Rev. 323, 342-52 (2007);
310. Jill E. Fisch & Hillary A. Sale, The Securities Analyst as Agent: Rethinking the Regulation of Analysts, 88 Iowa L. Rev. 1035, 1078-80 (2003);
311. Jonathan Macey & Hillary A. Sale, Observations on the Role of Commodification, Independence, and Governance in the Accounting Industry, 48 Vill. L. Rev. 1167, 1167-70 (2003);
312. Sale, supra note 14, at 160-61;
313. John C. Coffee, Jr., The Acquiescent Gatekeeper: Reputational Intermediaries, Auditor Independence and the Governance of Accounting (Columbia Law & Econ. Working Paper No. 191, 2001), available at http://ssrn.com/ abstract=270944.
314. See supra Section LB.
315. Blueprint, supra note 17, at 178-79.
316. Id. at 179.
317. See United States v. O'Hagan, 521 U.S. 642, 658 (1997) (describing honest markets as "an animating purpose of the Exchange Act").
318. See supra Part III.
319. These have been explored at length in various articles, many of which were published in the University of Virginia Law Review. See, e.g., Paul G. Mahoney, The Exchange As Regulator, 83 Va. L. Rev. 1453, 1475-500 (1997) (exploring three assumptions underlying the argument that government regulation is necessary over the financial markets and concluding that a return to self regulation would improve U.S. competition while not unduly harming investors);
320. Kahan, supra note 173, at 1510-19 (1997) (analyzing potential problems with self-regulating exchanges and concluding that though Mahoney's argument for a deregulated securities market may be ideal for countries just beginning securities regulation, it should not be adopted wholesale in the United States where the current system is stable and performing relatively well);
321. Pritchard, supra note 179, at 982 (exploring role of exchanges as regulators).
322. See, e.g., NYSE Euronext Listed Company Manual (2009), available at http://www.nyse.com/Frameset.html?nyseref=http%3A//www.nyse.com/regulation/ny se/1182508124422.html&displayPage=/lcm/lcm-section.html.
323. About the Financial Industry Regulatory Authority, http://www.finra.org/ AboutFINRA/index.htm (last visited Mar. 8, 2009).
324. See supra note 13;
325. see also Free Enter. Fund v. Pub. Co. Accounting Oversight Bd., 537 F.3d 667, 669 (D.C. Cir. 2008) (upholding the constitutionality of the PCAOB against an attack that it violated the Appointments Clause of the Constitution).
326. See supra notes 76-101 and accompanying text (pointing out that self-regulation involving the investment banks and the CSE provisions was a failure).
327. For discussions of the different definitions of independence in use today, see Stephen M. Bainbridgc & Christina J. Johnson, Managerialism, Legal Ethics, and Sarbanes-Oxley Section 307, 2004 Mich. St. L. Rev. 299, 301-03 (approving Sarbanes-Oxley's definition of independence);
328. Usha Rodrigues, The Fetishization of Independence, 33 J. Corp. L. 447, 452-55 (2008);
329. Note, Beyond "Independent" Directors: A Functional Approach to Board Independence, 119 Harv. L. Rev. 1553, 1554-60 (2006).
330. See Mahoney, supra note 215, at 1454-55, 1458. There is some historical support for this proposition. Exchanges were involved in regulating their listed companies in 1933 and 1934 and the regulations then did not differ significantly from those adopted with the 1933 and 1934 Acts.
331. See id. at 1459-62, 1465-69.
332. Id. at 1454-55, 1458.
333. Pritchard, supra note 179, at 963.
334. Id. (noting that exchanges provide liquidity to listed companies).
335. In today's world, although the exchanges and markets have their own listing standards, FINRA now occupies the enforcement field for both NASDAQ and NYSE/Euronext. Thus, the competition argument is debatable for enforcement purposes. See id. at 976-81.
336. See Mahoney, supra note 215, at 1498 (stating that the benefits of allowing the exchanges to do the rulemaking outweigh the drawbacks because of the exchanges' superior knowledge about investors).
337. Blueprint, supra note 17, at 116.
338. See Craig Pirrong, A Theory of Financial Exchange Organization, 43 J.L. & Econ. 437, 438 (2000) (noting that when there is near perfect competition in the supply of financial transaction services, "exchanges adopt efficient rules and governance structures because they will not survive otherwise.");
339. Pritchard, supra note 179, at 964.
340. See Mahoney, supra note 215, at 1491-96;
341. Pritchard, supra note 179, at 1017-18.
342. Kahan, supra note 173, at 1517-18 (arguing that stock exchanges have an interest in portraying a favorable image to the investing public and therefore have little incentive to search for and disclose violations of companies listed on their exchanges).
343. See id.
344. Id.
345. As Professor Donald Langevoort has put it, "less business for Wall Street institutions is not necessarily a bad thing for investors." See Donald C. Langevoort, U.S. Securities Regulation and Global Competition, 3 Va. L. & Bus. Rev. 191, 195 (2008)
346. (citing Coffee, supra note 57, at 237-38). The basic point is that gains to the market professionals from more transactions could be offset by a higher cost of capital, and to this extent there is a "basic conflict between the interests of the public and those of the professionals and intermediaries active in the securities markets."
347. Coffee, supra note 57, at 311.
348. See Mahoney, supra note 215, at 1497-98.
349. See id. at 1499; Pritchard, supra note 179, at 976-77.
350. See Pritchard, supra note 179, at 976-77.
351. See id.
352. The Blueprint actually proposes a tripartite model with a "market stability" regulator, a "prudential financial" regulator, and a "business conduct" regulator. See Blueprint, supra note 17, at 13-14. Effectively, once one translates these terms into the current organizational environment, this means that the Federal Reserve would not be consolidated with the Office of the Controller of the Currency and that the SEC would not be merged into a unified financial regulator. We do not address the specific form of consolidation that should occur among banking regulators.
353. Federal net capital standards for broker dealers have been administered by the SEC since its inception in 1934, and the precursor of the current net capital rules, which are predicated on Section 15(c)(3) of the Securities Exchange Act of 1934, dates back to 1938. See Louis Loss & Joel Seligman, Fundamentals of Securities Regulation 853 (4th ed. 2004). Rule 15c3-1 dates back to 1975.
354. The literature on the prospects for "capture" of administrative agencies is voluminous, but there are strong arguments that agencies with broader jurisdiction are less subject to capture than "single purpose" agencies. See Jonathan R. Macey, Organizational Design and the Political Control of Administrative Agencies, 8 J.L. Econ. & Org. 93 (1992). The SEC is, of course, closer to a "special purpose" agency than the Federal Reserve, which, as proposed, would monitor the safety and soundness of all major financial institutions.
355. See Alternative Net Capital Requirement for Broker-Dealers That Are Part of Consolidated Supervised Entities, 69 Fed. Reg. 34,428 (June 21, 2004) (to be codified at 17 C.F.R. pts. 200 & 240).
356. Press Release, Sec. & Exch. Comm'n, Chairman Cox Announces End of Consolidated Supervised Entities Program (Sept. 26, 2008), available at http://www.sec.gov/news/press/2008/2008-230.htm (quoting Chairman Cox as saying that "voluntary regulation does not work").
357. See, e.g., Labaton, supra note 83, at A1.
358. See Press Release, Int'l Swaps and Derivatives Ass'n, ISDA Mid-Year 2008 Market Survey Shows Credit Derivatives at $54.6 Trillion (Sept. 24, 2008), available at http://www.isda.org/press/press092508.html (noting that the annual growth rate for credit derivatives from mid-2007 to mid-2008 was 20 percent).
359. See Securities Exchange Act of 1934 § 3A(b)(2), 15 U.S.C. § 78c-1(b)(2) (2006)
360. See Securities Exchange Act of 1934 § 3A(b)(3), 15 U.S.C. §78c-1(b)(3) (2006).
361. See Joanne Morrison, Fed's Kohn Sees CDS Clearinghouse Risks, Benefits, Reuters, June 19, 2008, http://www.reuters.com/article/gc06/ idUSN1962224820080619 (discussing role of New York Fed in establishing clearinghouse);
362. Aline van Duyn et al Plans for Central Clearing House for Derivatives, FT.com, July 31, 2008, http://www.ft.eom/cms/s/0/5c6eb2e4-5f37-11dd-91c0- 000077b07658.html (noting that by the end of 2008, there should be a central clearing house established for the credit derivatives market).
363. This example was suggested to us by Professor Donald Langevoort. As we see it, a prudential regulator that was instructed to monitor systemic risk could make a determination that "naked" short selling needed to be curbed or could decide to reimpose the traditional "tick" test that limited short selling to times when the market price was increasing, because these were judgments about the overall impact of the practice on systemic risk. But the SEC would remain the anti-fraud enforcer with respect to issues of market manipulation. Neither role necessarily interferes with the critical functions of the other agency, but consultation should be necessary before either acts.
364. For an overview of New York's Martin Act, see Coffee, Seligman & Sale, supra note 55, at 1277-78 (discussing broad reach of Martin Act and Spitzer's use of it);
365. see also Mike McIntire, Two Views of a Rising Star: Populist Warrior or Reckless Foe of Big Business, N.Y. Times, Oct. 15, 2006, at 35 (describing how Spitzer used the Martin Act to force large Wall Street firms such as Merrill Lynch to disclose conflicts of interest).
366. Of course, there would have to be a time limit on the application of any such power to veto or abrogate state rules and settlements. For example, it may extend for ninety days after the SEC receives formal notice from the state regulator of its action, which would incentivize the state regulator to provide early notice to the SEC and possibly to engage in pre-settlement discussions with it. Where a settlement's provisions were upset, both sides would have the right to renegotiate or to continue the litigation without prejudice. The concept of such a federal power over state regulators is not fundamentally different from the power that the SEC today has over the SROs to amend, repeal or abrogate their rules. See Securities Exchange Act of 1934 §19(c), 15 U.S.C. § 78s(c) (2006) (granting SEC authority to "abrogate, add to, and delete from the rules of a self-regulatory organization as the Commission deems necessary or appropriate to insure the fair administration of the self-regulatory organization or otherwise in furtherance of the purposes of this chapter"). We do not address the standard for judicial review of the SECs decisions in this regard.
367. But see Bus. Roundtable v. Sec. & Exch. Comm'n, 905 F.2d 406,408 (D.C. Cir. 1990) (discussing whether deference to the SEC is appropriate).
368. This is, of course, a paraphrase of Mr. Prince's quotation. See supra note 103, and accompanying text.