Multiple Gatekeepers

In my paper Multiple Gatekeepers, which was recently accepted for publication in the Virginia Law Review, I extend the literature on gatekeeper liability by considering the possibility that the fraud-deterrence capacity of gatekeepers will be interdependent, and not simply independent as previous scholars have assumed. Put differently, I envisage of gatekeepers as providing an interacting web of protection against wrongdoing. The paper thus goes beyond the unitary conception of the gatekeeper, under which a single gatekeeper is regarded as acting on a transaction or each of multiple gatekeepers is conceived of as being independently capable of deterring wrongdoing. My focus is on business transactions, such as securities offerings and mergers and acquisitions.

In this context, gatekeepers are lawyers, investment bankers, accountants and other actors with the capacity to monitor and control the disclosure decisions of their clients – and thereby to deter securities fraud. After each wave of corporate upheaval, including the recent financial crisis, the spotlight of responsibility invariably falls on gatekeepers for failing to avert the wrongs of their clients. Witness the focus on lawyers’ conduct in the controversial merger of Bank of America and Merrill Lynch. A rich literature on gatekeeper liability has considered what liability regime would lead gatekeepers to deter securities fraud optimally, but has adopted a unitary conception of the gatekeeper.

My paper explains the pattern of multiple gatekeeper involvement that characterizes business transactions. Drawing on the theory of industrial organization and the theory of the firm, it investigates why gatekeepers exist at all and why corporations turn to a multiplicity of them for most transactions. The paper considers the factors contributing to interdependencies among gatekeepers, which include the blurring of the traditional roles and spheres of expertise among gatekeepers. The analysis also demonstrates that the phenomenon may result in each gatekeeper having but a small, fragmented knowledge of both its client and the proposed transaction and having incentives to narrow the scope of its activities to reduce the likelihood it will acquire knowledge sufficient to attract gatekeeper liability.

The paper then extends gatekeeper liability theory to account explicitly for the possibility that the fraud-deterrence capacity of gatekeepers will be interdependent, rather than independent. In doing so, the paper analyzes how the phenomenon alters the prescriptions of optimal deterrence theory – the prevailing economic approach for evaluating liability regimes to deter wrongdoing. To date, uncertainty has pervaded the issue of what liability regime would lead gatekeepers to take optimal precautions to deter securities fraud by their corporate clients, with scholars split between strict liability and fault-based liability regimes. A primary contribution of this paper is to address this problem by analogizing the position of multiple gatekeepers to that of joint tortfeasors. While tortfeasors typically contribute to the risk of harm due to their capacity to create it, the contribution of gatekeepers is the mirror image of this – they contribute to the risk of harm by possessing the capacity to deter it. This paper thus draws on scholarship concerning the optimal deterrence of joint torts with a view to identifying liability regimes that would lead multiple gatekeepers optimally to deter securities fraud.

Explicitly connecting gatekeeper liability with tort liability enables the development of a simple taxonomy of interactions among multiple gatekeepers into either independent or interdependent gatekeepers. The analysis shows that scholars until now have focused only on independent gatekeepers, for which both strict and fault-based regimes are optimal – hence the split of scholarly opinion. This paper goes further, showing under relevant simplifying assumptions that only a fault-based regime would induce multiple interdependent gatekeepers to take optimal precautions. A strict liability regime would be inefficient because the existence of multiple gatekeepers reduces the benefit to any one gatekeeper of taking precautions. Under usual apportionment rules, liability would be shared among the gatekeepers – and for any one gatekeeper the benefit of taking precautions may be outweighed by its cost.

Extending gatekeeper liability theory in this way offers insights into what liability regimes would motivate multiple gatekeepers to deter securities fraud optimally. The theoretical extension also has implications, which the paper discusses, for post-financial reforms proposals, including those that would impose gatekeeper liability on credit rating agencies.

The paper is available here.