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E-MailThe following post comes to us from Henry T. C. Hu, Allan Shivers Chair in the Law of Banking and Finance at the University of Texas School of Law.
My article, Efficient Markets and the Law: A Predictable Past and an Uncertain Future (forthcoming in the Annual Review of Financial Economics (vol. 4, 2012)), analyzes the diverse situations in which the efficient-market hypothesis (EMH) has influenced — or has failed to influence — federal securities regulation and state corporate law, and the prospective roles for the EMH in both federal and state contexts. In federal securities regulation, the EMH has offered a theoretical construct to accompany the general belief in the value of accurate and complete information that has animated the US Securities and Exchange Commission (SEC) since its creation. Applications of the EMH have generally been straightforward and predictable: For instance, EMH concepts of the market processing of public information helped motivate the streamlining of procedural requirements as to corporate disclosures and, more controversially, as to Rule 10b-5-based securities class actions. In state corporate law, the EMH has helped shape thinking as to takeovers and the corporate objective.
However, the EMH and related learning have failed to properly inform governmental actions to address financial illiteracy. This is troubling as a social matter, especially in an era of increased individual responsibility for retirement well-being, inadequate savings, and highly uncertain financial times.
Belief in the EMH and the value of efficient markets has weakened in connection with recent market anomalies and stress. The May 2010 flash crash and certain subsequent events are not easily reconciled with the EMH, and related developments such as high frequency trading involve an equity market microstructure that is fundamentally different from the microstructure in place as the EMH emerged into public consciousness. Actions motivated by the global financial crisis (GFC), such as the SEC short-selling ban in September 2008, arguably suggest a greater willingness to subordinate market efficiency in favor of other governmental goals.
A number of significant EMH-related issues loom beyond those pertaining to financial illiteracy, the equity market microstructure, and governmental goals. Foremost are those relating to the informational predicate on which market efficiency rests. One material aspect of the informational predicate relates to the disclosure challenges associated with financial innovations (such as asset-backed securities) and business entities heavily involved in financial innovation activities (such as certain money center banks). In an earlier article, I conceptualized the SEC as having largely relied on an “intermediary depiction model” since the 1930s with respect to information. Such near-exclusive reliance on the intermediary depiction model is manifestly inadequate in financial innovation–related contexts. Another material aspect relates to the massive amounts of information that the Dodd-Frank Act requires to be provided to governmental bodies.
The full text of the article is available here.
