Academic journal article Law and Contemporary Problems

Iterative Regulation of Securities Markets after Business Roundtable: A Principles-Based Approach

Academic journal article Law and Contemporary Problems

Iterative Regulation of Securities Markets after Business Roundtable: A Principles-Based Approach

Article excerpt



It is hard to believe there is a Securities and Exchange Commission (SEC) regulation that has had greater impact than the antifraud provision, Rule 10b-5. The provision broadly proscribes any material misrepresentation or omission in connection with the purchase or sale of a security by "any means or instrumentality of interstate commerce." (1) Due to its breadth, its impact is ubiquitous, stretching to include garden variety misrepresentations, (2) broker misappropriation of customer funds, (3) pump-and-dump schemes, (4) failures to update public announcements, (5) misstatements in proxy statements, (6) and, of course, insider trading. (7) Ambiguity regarding the rule's key components, such as what is a "misrepresentation," (8) what is "material," (9) and what facts establish the requisite scienter, (10) are generally fact-specific, such that the rule's scope is inherently ambiguous, with the effect that fear of a potential violation elicits a good deal of precautionary behavior, especially for the more risk averse. Those who engage in securities-related transactions have genuine cause to fear that a disclosure gaff in connection with a business transaction could visit uncertainty, delay, and liability. Caution is further underscored by the reality that, not only are violations of Rule 10b-5 subject to enforcement efforts by the world's best- funded securities regulator, but more significantly, private enforcement actions also exist.

Students of the history of Rule 10b-5 are well aware of the casualness by which the antifraud provision came into existence:

   I went to work one day in May, 1942, and I did my normal job as an
   Assistant Solicitor of the SEC. Somebody called me and said there
   is something wrong going on in Boston (a company president was
   buying in shares from his own shareholders without telling them of
   much improved earnings). He asked what we could do about it. I
   wasted no time; I got some people in, we drafted a rule, we
   presented it to the Commission, and, without any hesitation, the
   Commission tossed the paper on the table saying they were in favor
   of it. One Commission member said, "Well, we're against fraud,
   aren't we?" So, before the sun was down, we had the rule that is
   now Rule 10b-5. (11)

The casualness with which Rule 10b-5 was adopted reflects the very different regulatory era that existed in 1942; there was then no Administrative Procedure Act (APA). In contrast, agency rulemaking is presently conditioned not only on providing notice and opportunity for affected parties to comment, but also on ensuring that rulemaking, on review, not be arbitrary or capricious. (12) Certainly the former was lacking during Rule 10b-5's genesis and we can only surmise (but with good cause for such surmise) the outcome with respect to the latter. If concern for the APA were not sufficient, then today's 800-pound gorilla in the rulemaking room is Business Roundtable II. (13) In a decision that likely ranks as the most significant decision in the history of the SEC, the D.C. Circuit struck down the SEC's adoption of a Rule 14a-ll that provided very limited rights for shareholders of reporting companies to nominate directors. (14) In adopting the rule, the SEC was acting pursuant to the then-recently-enacted Dodd-Frank Wall Street Reform and Consumper Protection (Dodd-Frank) Act, which granted the Commission express power to adopt a rule providing shareholders authority to nominate directors. (15) The benefits of providing such access to shareholders had been a topic the SEC had studied for several years. (16)

Thus, looking back on the rainy afternoon, during far simpler times, when Rule 10b-5 was adopted, one might well conclude that Rule 10b-5 could never be adopted within the contemporary legal landscape. But, is this necessarily so? This article closely examines the limits of Business Roundtable II and, more specifically, sets forth one strategy that can be pursued in the present regulatory climate, in which cost-benefit analysis, although controversial--if not problematic--cannot presently be ignored. …

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