Securities Law
Part of my professional life has been working in capital markets law, and part of my amateur academic interests involves the same. I became particularly interested in the development of securities markets through studying the history of corporations, and through my own experience working in them.
Related Blog Entries
Theory of security markets: link.
Watching policy be developed at the OSC: link.
Income trusts: link, link, link, link, and link.
I have several research interests in this area.
Political economy of decision-making, with emphasis on capital structure as constraint
The first is related to some research I am doing on the capital structures of corporations. I am interested in the relative importance of securities markets, primary and secondary, to financing of corporations, and more broadly, therefore, to the central function of corporations in a market system, or as we used to call it more broadly, capitalism.
Certainly in popular discourse, the “stock market” is considered synecdochal of “the economy”. The evening news shows the ticker and bright red indicates a bad day, bright green a good day. Fairly complex information about securities markets has become daily news along with the “rise of the shareholder” in corporate law.
The use of capital markets — issuing stock or debt — is one of the very core justifications of the corporate form itself. The legal form of corporation is at least partly justified by its ability to aggregate the “savings” of disparate “investors” who otherwise would not be able to know or efficeiently choose to allocate their savings to a productive enterprise.
More theoretically, securities markets in general are held out as model forms of functioning, if not near-perfect markets. Capital markets become the focus of much research in law and economics.
My questions are, does the rhetoric match the reality? Is this focus justified, and if not, where ought other inquiry to look? These are massive questions, but fruitful.
Anecdotal and partially systematic empirical research suggests this focus is not justified, and I am hoping to explore these questions. I can offer a few factoids to suggest a flavour of these inquiries.
At the level of general discourse I have outlined above, it is a matter of economic literacy that stock markets and more broadly capital markets (which include bond markets, the size of which dwarfs equity markets, and in which the main form of security exchanged is government-issued bonds) are not necessarily, and perhaps not often, related to broader economic “development”, “growth” or well-being. Labour and union economists spend a lot of energy pointing out that what is good for GMs equities is not necessarily and these days, not often good for broader society (see for e.g., Stanford, 1999).
At the level of the corporation I have set out above, we also suspect that corporations have probably 75% of their financing needs met through retained earnings, or “internal” finances, which would suggest that capital markets have little to do with the financing and perhaps even allocation decisions of corporations (although there may be significant other type of influence on decision-making, such as perception of reported earnings or equity price movements, even if they are unrelated to actual financing decisions). This insight, combined with empirical data on corporate finance structures (debt versus equity) and on how wide-spread and how thick equity holding actually is in a “dispersed ownership system” (i.e., the U.S.), suggests that, far from facilitating or spreading the owenship of equities among disparate investors, the function of capital markets has been to provide a system for the re-arrangement of ownership among owner-managers and large private owners. This may seem like a leap, but I speculate will be a better explanatory framework for the mergers and acquisitions phenomenon of the past 20 years.
Who is the “investor”?
At the level of the justification of the corporate form, in today’s capital markets, who is the “investor”? There are several interesting angles here, one of which has been explored relatively well, that of institutional investors as aggregates of risk capital for productive enterprise. These institutional investors primarily include pension, insurance and mutual funds. Here, it turns out that corporations have not functioned to “aggregate” the disparate investors, some with explicitly social mandates to create savings and be ‘risk averse’ or passive in their holding of equities. (There are many other explanatory factors of the rise of institutional investors-as-aggregated-small-savers, not least including tax policy, collective bargaining and labour relations generally).
What are capital markets for?
Finally, there are some very interesting issues raised for legal theory by capital markets. The most intriguing to me at the moment is the historical development of secondary capital markets. It is variously speculated that these markets developed as a way to alienate property — holding property in corporations — from very limited rights of transfer in the early days of the 1800s to freely transferable interests by 1900. Some hold that this development is one of the important developments of “intangible property”, a form of property, it is argued, that is highly if not entirely reliant upon a larger state administrative structure to function. Securities law became in effect consumer protection legislation as abuses in unregulated capital markets became more wide-spread. Instead of banning corporations altogether (as was originally attempted in the Bubble Act of the 1700s), the solution became to more closely regulate what constituted a security, and when it could be issued, and for what purpose, and under what standardized metrics of valuation (accounting standards). Could such a thing be considered a “contract” anymore? Could it even exist in a modern form in the absence of a significant regulatory body and practice? If not, then what are the implications of this conclusion for globalized security markets, and for the role of the state/regulator/government in controlling one of the key functions of corporate law, and one of the central functions of capitalism?
Fragmentation and de-centring of regulation?
I have one small starting place to begin asking these questions of contemporary development. One paper I am drafting on the development civil liability for secondary market disclosure (a.k.a. the “fraud on the market” rule) in Ontario, which will be passed into law January 1, 2006. This rule permits securityholders to sue issuers for false or misleading public statements. It is a private cause of action that was brought into our law in part to “balance” the rights of investors and issuers, especially where the regulatory agency responsible for oversight of secondary markets, the Ontario Securities Commission, is considered under-resourced for its job. The rule has been around in the U.S. for some 30 years, but funnily enough, not here: an interesting example of “political determinants of securities law”, as Mark Roe would have it.
Exact how those political determinants forestalled and then permitted this new law, which is responsible for over $3bn in settlements per year in the U.S., is an interesting story. My framework is to analyse the development of this legislation at a fairly general level from its first serious proposition in 1979 to the drafting of the regulations, which is happening right now. A traditional analysis of regulatory development would examine “interests” and probably “ideas” as driving or explanatory factors in the development of such a rule (see Condon, 1998). Borrowing from and perhaps applying an institutional economics approach, I propose to add two further useful explanatory factors in this particular instance: “actors” and “accidents” (Heilbronner, generally; Sheikh, 2002). Each of these four factors plays a role in the development of a heavily contested new legal rule, and can partly explain its final form.
This may also represent an interetsing “fragmentation” or “de-centring” of securities regulation (a shift to private enforcement). Can securities markets function under these conditions, or do they require a central regulatory presence to standardize exchanges? The proliferation of unusual financial instruments over the past 15 years raises these questions. One theory of financial instruments as property — as an early and very sophisticated form of intangible property — is that strong central regulatory presence is required for functioning markets. Is there a tension here?