This multi-enforcer approach to securities fraud deterrence is more a product of historical event than coherent design choice.8. The neglect of enforcement-focused reforms would be understandable if it were clear that the securities fraud enforcers we currently employ are as good as they get.
OPTIMAL SECURITIES FRAUD DETERRENCE: A PRIMER
It suggests that, rather than favoring the status quo, policymakers should consider unifying securities fraud enforcement authority under a single federal regulator, while at the same time addressing any increased risk of systematic underdeterrence that this change would create by introducing reforms that design is to the federal enforcer's incentives. State and private enforcers may continue to play a role in securities fraud deterrence after such a change, but a role that is subordinate to that of the federal enforcer.
The Social Costs of Securities Fraud
W hatAre They?
An effective deterrence regime for securities fraud would reduce all of these social costs, which I will call “sub-deterrence costs.” Granted, this settlement will not always be perfect.'' In addition, there are forms of securities fraud that present investors with non-diversifiable risks of loss, such as primary offering fraud, money manager fraud, and fraud involving insider trading. .
What Determines Their Severity?
If this view is correct, securities fraud should be less of a problem in countries with concentrated ownership structures. Another very important factor affecting the magnitude of the social costs of securities fraud is the efficiency of the market-based mechanisms that would emerge to prevent such fraud.
The Social Costs of Enforcement
THE VALUE OF A WELL-INCENTIVIZED ENFORCER
There is an alternative path: Legislators could instead focus on the incentives of the enforcer. 57 Accordingly, if legislators are concerned about excessive deterrence, they would be wise to first focus their attention on improving as much as possible the incentives of the enforcer to exercise this kind of laudable self-restraint. Moreover, the discussion in subsection I.A.2 reveals that the magnitude of the social costs of fraud may change over time as the ownership and management structures of firms evolve.
Certainly, lawmakers could make these adjustments by expanding or reducing the scope of the substantive fraud prohibition, by increasing or decreasing allowable sanctions, or by amending the relevant procedural rules. It may seem self-evident to the reader that enforcer incentives are critical to the design and success of a securities fraud deterrent regime. Nevertheless, the literature critical of the United States regime tends to take the current mix of enforcers as a given, focusing instead on how the content, sanctions, or procedure should be modified to regime toward optimality.'' Not surprisingly, there is an air of inevitability to the academic debate, as scholars with differing intuitions about the prevalence of securities fraud and excessive deterrence take opposing sides on issues that defy empirical resolution.
However, if this belief exists, it lacks foundation: the optimality of the United States' multi-enforcement approach to securities fraud deterrence has not been subjected to rigorous scrutiny. Thomas, Mapping the US Shareholder Litigation Experience: A Survey of Empirical Studies of US Enforcement.
WHEN WILL MULTIPLE ENFORCERS PROMOTE
Public Servants as Social Welfare Maximizers
- Public vs. Private Enforcement
- Concurrent vs. Exclusive Enforcement
- Federal vs. State Enforcement
- Other Considerations
Notably, most of the limitations that have been imposed on private Rule lOb-5 litigation do not limit the SEC. Apparently, the framers of these reforms believe that the SEC presents fewer over-deterrence risks than private enforcers, so that authority that is intolerable in the hands of the latter is not when entrusted to the former. Only if we question the motivations of the public enforcer (or the state actors who control it) does private enforcement emerge as a potentially rational approach to deterring securities fraud.
One might expect that any of the above regime adjustments would lower the cost of under-deterrence, albeit at the cost of some (hopefully minor) increase in the cost of over-deterrence. This is because market participants will predictably respond to and adjust their behavior to the signals of the most stringent performer who has authority over them. Coffee, Jr., Saving the Private Prosecutor: Why the Lauyer-as-Bounty-Hunter Model Doesn't Work, 42 MD.
A) the general belief in the efficient functioning of markets does not provide any basis for concluding good results in assessment (unless the form of assessment itself is chosen by the market, such as when it is contractually specified). Second, in a regime of concurrent enforcement (in stark contrast to a regime of true regulatory competition), the significance of states' "experiments" in deterring securities fraud will be impossible to discern, given that the combined choices of multiple enforcers are responsible for a single result.
Public Servants as... Something Else
Systematic Underdeterrence?
What will members of the relevant congressional subcommittees prefer when it comes to enforcement of securities fraud. During periods of 'normal' politics when security-related issues are not on the 'public agenda'. .most voters do not concern themselves with the ordinary activities of the SEC.") (footnote omitted) (citing Michael E. The strength of any incentive on the part of individuals or firms to push for underdeterrence (or for ' However, a weakened enforcement agency (more generally) must be evaluated in the light of the possibility.
using the theory of maximizing political support to explain the SEC's elimination of fixed-rate fees on the NYSE in the face of the rise of institutional investors as a powerful interest group). Rather, the discussion is simply intended to illustrate that, under some of the most standard assumptions in the public choice literature, it is not obvious that we should expect excessively low deterrence from exclusive federal enforcement. According to the "bureaucratic slack" model, to predict agency behavior, we should focus not only on the utility functions of members of relevant congressional subcommittees, but also on the functions of law enforcement agency personnel.
Again, a caveat is in order: my purpose here is not to make a prediction about the likely motivations of agency personnel, but simply to illustrate the uncertainty of the proposition that excessive underdeterrence would necessarily arise from exclusive federal securities fraud enforcement. even if one admits that there is a so-called “revolving door” between the government and the private sector. Behavioral biases can also impact securities fraud enforcement by influencing lawmakers' decisions regarding the scope of the enforcer's authority and the size of the enforcer's budget.
Net Savings in Social Costs?
But such a conclusion ignores the fact that vicarious liability remains a feature of the private enforcement regime. Dishonest officials at large companies, apart from reputational damage, also have little to fear from class action lawsuits under Rule lOb-5 because, as just noted, they are rarely called upon to contribute financially to the resolution of the lawsuit. For example, if we predict that an exclusive federal enforcer would systematically underdeterminate because members of the Congressional Oversight Committee are "political support maximizers" who would become "captured" by forces that favor underdeterrence, then consistency requires that we also assume that the elected supervisors of state enforcers (or the state enforcers themselves, if they are elected officials) behave as political support maximizers.
Armed forces that prefer optimal deterrence need only conquer one of the fifty states to overcome the influence of a special in-force. This is due to the dynamics described in section III.A.2: if there are concurrent enforcers, regulated parties will adapt their behavior to comply with the orders of the strictest regulator that has authority over them. The plaintiffs' lawyer would, if – as in the United States – private enforcement is also a feature of the regime.
A "political entrepreneur"—such as a law enforcement officer seeking to propel himself to higher office—might "exploit [the] prejudices of the electorate, and play up recent cases of fraud to gain electoral support." . This discussion barely scratches the surface of the considerations that a rigorous examination of the costs and benefits of state enforcement would provide.
Superior Alternatives?
For example, if we believe that systematic underdeterrence would occur because congressional oversight committees "captured" by industry would periodically starve an exclusive federal enforcer of funds, instead of responding by adding new enforcers to the mix, we could make the enforcement agency self-funding . In the wake of the recent financial crisis, Senate Banking Committee Chairman Christopher Dodd circulated a bill proposing this idea to the SEC, and the idea has the support of SEC Chair Mary SchapiroTM and the Investors Working Group, a nonpartisan group led by former SEC- chairmen Arthur Levitt Jr. Another way to deal with funding problems would be to allow the federal enforcer to tap state and private resources without relinquishing control over enforcement policy.
For example, we can allow private enforcement but give federal enforcement authority the authority to screen class action complaints before filing them.13 3 Similarly, we can allow state enforcement but authorize the federal enforcement agency to invalidate state orders that it believes they are in conflict with it. the public interest. in which the authors argue for an “auction buyback” mechanism that would allow the public enforcer to “auction a private license to prosecute the class action, while retaining the option to buy it back at the price of the winning bid.” If we instead anticipate systematic underdeterrence by an exclusive federal enforcer because of the “revolving door” between the enforcement agency and Wall Street, another set of potential reforms would logically present itself.
For example, we can try to increase the transparency of agency enforcement decisions so that cases of favoritism are more easily detected and punished. Finally, if we believe that behavioral biases would bias an exclusive federal enforcer toward systematic under-deterrence, we could enforce-.
A NEW PATH FORWARD: ENFORCER-FOCUSED REFORM
The foregoing is by no means a complete list of possible alternative ways to mitigate the risk of systematic under-deterrence that an exclusive federal securities fraud authority may pose. Such reforms would also greatly simplify our securities fraud deterrence regime, making it easier to assess—and ultimately improve—its performance. 143 The SEC could function better in such a world by being more accountable for its securities fraud enforcement policy than it is today.
In a world without miscarriages of justice or vicarious liability, designing an effective regime to deter securities fraud would be relatively simple. But in a world like ours, with both legal error and vicarious liability, lawmakers must design a securities fraud deterrent regime in a way that takes into account the risk of over-deterrence. But the optimality of our multi-enforcement approach to deterring securities fraud has remained largely unexplored.
But the status quo approach to deterring securities fraud in the United States is largely the result of historical accident and has few disinterested advocates. It is difficult enough to assess the effectiveness of a securities fraud deterrence regime implemented by a single prosecutor; when multiple prosecutors pursuing potentially conflicting enforcement priorities are added to the mix, the task becomes immeasurably more complex.
