The Advantage of Competitive Federalism for Securities

312 Pages·2003·4.47 MB·English

by  Robert Romano

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The Advantage of Competitive
Federalism for Securities Regulation
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The Advantage of Competitive
Federalism for Securities Regulation
Roberta Romano
The AEI Press
Publisher for the American Enterprise Institute
WASHINGTON, D.C.
2002
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Available in the United States from the AEI Press, c/o Publisher Resources Inc.,
1224 Heil Quaker Blvd., P.O. Box 7001, La Vergne, TN 37086-7001. To order,
call toll free: 1-800-937-5557. Distributed outside the United States by arrange-
ment with Eurospan, 3 Henrietta Street, London WC2E 8LU, England.
Library of Congress Cataloging-in-Publication Data
Romano, Roberta.
The advantage of competitive federalism for securities regulation /
Roberta Romano.
p. cm.
Includes index.
ISBN 0-8447-4173-6 (pbk.)
1. Securities—United States—States. 2. Securities—United States—
State supervision—Economic aspects. 3. Corporation law—United
States—States. I. Title.
KF1439 .R66 2002
346.73'092—dc21
2002025360
ISBN 0-8447-4173-6 (pbk.: alk. paper)
1 3 5 7 9 10 8 6 4 2
© 2002 by the American Enterprise Institute for Public Policy Research,
Washington, D.C. All rights reserved. No part of this publication may be used or
reproduced in any manner whatsoever without permission in writing from the
American Enterprise Institute except in the case of brief quotations embodied in
news articles, critical articles, or reviews. The views expressed in the publications
of the American Enterprise Institute are those of the authors and do not neces-
sarily reflect the views of the staff, advisory panels, officers, or trustees of AEI.
Printed in the United States of America
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Contents
PREFACE vii
1 INTRODUCTION 1
2 RATIONALES FOR SECURITIES REGULATION, THE EFFECTIVENESS
OF THE SEC, AND COMPETITIVE FEDERALISM 12
Underproduction of Information 13
Underproduction of Information Concerning Interfirm
Externalities 29
Protection against Fraud and Manipulation 42
The Essence of Competitive Federalism 45
Benefits of a Competitive Securities Regime 48
Should Initial Offerings and Secondary Trading Markets Be
Distinguished? 50
What Are the Implications of the Collapse of Enron? 53
3 STATE COMPETITION FOR CORPORATE CHARTERS 63
The Evidence That State Competition for Charters Benefits
Shareholders 64
Do U.S. States Compete for Charters? 75
Is State Competition Inefficient Because of Network
Externalities? 83
Is State Takeover Regulation Evidence That a National
Regime Would Be Superior to State Competition? 92
4 IMPLEMENTING COMPETITIVE FEDERALISM FOR SECURITIES
REGULATION 112
What Must Be Done to Achieve Competition? 112
Additional Requirements for Competitive Federalism
to Be Effective 124
How Would State Competition for Securities Regulation
Work? 131
v
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vi COMPETITIVE FEDERALISM FOR SECURITIES REGULATION
Uniformity and Variety in Securities Regulation under
Competitive Federalism 137
Is Securities Regulation Sufficiently Different from
Corporate Law to Render Competition Ineffectual? 142
Regulation by Exchanges 144
5 COMPETITIVE FEDERALISM AND INTERNATIONAL SECURITIES
REGULATION 147
Implementing Competitive Federalism in the International
Setting 147
Feasibility of International Competition 149
Implications for Foreign Issuers in U.S. Markets 152
Investor Protection Concerns under International Regulatory
Competition 156
Comparison with Other Reform Proposals 168
6 CONCLUSION 172
NOTES 177
INDEX 293
ABOUT THE AUTHOR 301
LIST OF TABLES
4-1 Delaware’s Revenue from Corporate Charters 133
4-2 The SEC’s Financing 134
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Preface
I initially contemplated the thesis of this book, that the production of U.S.
securities law should be subject to the same market forces that produce
U.S. corporate law, in my previous book published by the American
Enterprise Institute on state competition for corporate charters, The
Genius of American Corporate Law. But it was not until several years later
that I decided to pursue the idea, and it was published in 1998 as an
article, “Empowering Investors: A Market Approach to Securities
Regulation,” in the Yale Law Journal. Because the thesis, opening up U.S.
securities regulation to competition, questioned fundamental beliefs
of many securities and corporate law commentators regarding the efficacy
of present-day securities regulation, it drew a number of critiques. I
responded to those critics in “The Need for Competition in International
Securities Regulation,” an article written for the Conference on Protection
of Investors in the Global Economy, sponsored by the Cegla Institute for
Comparative and Private International Law of the Tel Aviv University Law
School, that was published in the institute’s journal, Theoretical Inquiries in
Law,in 2001. This book synthesizes and expands upon the ideas in those
two publications for a broader audience willing to consider rethinking the
regulation of capital markets and corporations.
A number of individuals commented on drafts of the earlier articles.
They include Barry Adler, Anne Alstott, Yakov Amihud, Ian Ayres, Lucian
Bebchuk, Boris Bittker, Stephen Choi, John Coates, Robert Daines, Boris
Feldman, Allen Ferrell, Jill Fisch, Merritt Fox, Henry Hansmann, Howell
Jackson, Marcel Kahan, Ehud Kamar, Michael Klausner, Alvin Klevorick,
John Lott, Jonathan Macey, Paul Mahoney, Geoffrey Miller, Richard Painter,
Edward Rock, Peter Schuck, Alan Schwartz, Joel Seligman, Linda
Silberman, Erik Sirri, and Michael Solimine. In addition, I wish to
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viii COMPETITIVE FEDERALISM FOR SECURITIES REGULATION
thank participants at a number of seminars, including the University of
California at San Diego Political Science Department Law and Behavioral
Studies Seminar, a seminar at the Commissione Nazionale per le Società e
la Borsa in Rome, the Harvard Law School Seminar in Law and
Economics, the Max Planck Institut Symposium on Comparative
Corporate Governance in Hamburg, the New York University Center for
Law and Business Law and Finance Seminar, the Stanford Law School
Law and Economics Workshop, the Yale Law School Faculty Workshop,
and the Cegla Institute Conference on Protection of Investors in the
Global Economy in Tel Aviv. While I have benefited from the suggestions
of those individuals and seminar participants, they are, of course, not
responsible for what several consider to be my wayward thinking. Finally,
I would like to thank Christopher DeMuth for providing me with the
encouragement and opportunity to revise and expand upon my articles so
as to make them more widely accessible.
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1
Introduction
The Securities and Exchange Commission, an independent agency of the
federal government, regulates securities transactions in the United States.
The establishment of the commission is widely considered to be one of the
great achievements of the New Deal Congress. The Securities Exchange
Act of 1934,1 which covers trading in secondary markets and created the
SEC, followed the enactment of the Securities Act of 1933,2 which had
established a system of registration and disclosure requirements for
new issues of publicly traded securities. All firms with securities listed
on a national stock exchange, or with 500 shareholders and assets of
$1 million, must register with the SEC and comply with its requirements.
With investor protection as the stated objective, the SEC’s regulation
of issuers consists of a comprehensive set of mandatory disclosure require-
ments, which include extensive financial accounting information as well
as more qualitative disclosures concerning business operations and top
personnel. The detail prescribed by the agency is substantial: a prospec-
tus, the name of the SEC document that must accompany the sale of a
new issue, runs in the hundreds of pages. The mandatory disclosure is
also continuous. After an issue starts trading, the firm must make quanti-
tative and qualitative disclosures on a periodic basis, in public filings with
the agency and in an annual report distributed to shareholders in prepa-
ration for voting at the annual shareholders’ meeting to elect directors.
The SEC further regulates the disclosures that accompany the proxy
process by which public corporations accomplish shareholder voting.
Included in those regulations are the rules governing the provision of
shareholder proposals in the disclosure materials. The disclosure regime
is bolstered by statutory antifraud provisions that prohibit material
misrepresentations or omissions in the prescribed disclosure documents
1
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2 COMPETITIVE FEDERALISM FOR SECURITIES REGULATION
and restrict the right of insiders to trade on private information.3 Beyond
the agency’s enforcement powers, individuals who have purchased or sold
shares can bring private rights of action for damages under the antifraud
provisions.
The New Deal legislation included several other important grants of
authority to the SEC, including jurisdiction over mutual funds and public
utility holding companies. In addition, the 1934 act gave the SEC the
authority to regulate market professionals, such as brokers and dealers,
and stock exchanges. The commission’s power was further extended in
1968 to regulate the terms and conditions of cash tender offers to
purchase all or a significant number of registered firms’ shares.
Until recently, the ability of the states to regulate securities transac-
tions was preserved as an area of jurisdiction overlapping with the federal
securities laws. Most states did not, however, vigorously exercise that
authority. For example, although new issues must be registered in each
state in which they are sold under state securities laws, a majority of states
exempted from their registration requirements corporations whose shares
are listed on national exchanges and piggybacked instead on the SEC’s
regime for new issues. It should also be noted that nonexempt firms could
avoid state registration requirements by not selling their shares in a state
without losing the state’s citizens as an investor pool, because the states
did not prevent the unsolicited purchase of unregistered shares by their
citizens in the secondary market.
States do undertake antifraud enforcement actions for violations of
antifraud provisions in state securities laws, often in coordination among
themselves to deal with interstate fraud. Moreover, New York state has
engaged in several high-profile securities fraud prosecutions, sometimes
in competition with federal prosecutors.4But as a generalization, it would
be most descriptively accurate to say that federal securities law has occu-
pied the securities field and that state law development has been marginal.
Most recently, when Congress tightened the requirements for bringing a
private action for damages—as opposed to suits by state agencies—under
the federal securities laws in the Private Securities Litigation Reform Act
of 1995, filings in state courts under state securities laws increased.
Because of concern that state lawsuits were undermining Congress’s