Do Institutional Investors Value the 10b-5 Private Right of Action?

The following post comes to us from Robert Bartlett, Professor of Law at UC Berkeley School of Law.

In my forthcoming article in the Journal of Legal Studies, I empirically test a claim made by institutional investors in the wake of the Supreme Court’s 2010 decision in Morrison v. National Australia Bank Ltd. In Morrison, the Supreme Court limited investors’ ability to bring private 10b-5 securities fraud actions to cases where the securities at issue were purchased on a United States stock exchange or were otherwise purchased in the U.S. Because many foreign firms’ securities trade simultaneously on non-U.S. venues and on U.S. exchanges, institutional investors claimed after Morrison that, such was the importance of the 10b-5 private right of action, they would look to such firms’ U.S-traded securities to preserve their rights under 10b-5.

Using a proprietary dataset of equity trading by 378 institutional investors, my article examines how a large sample of institutional investors allocated investments in cross-listed issuers during the thirty month period surrounding Morrison. The dataset, which was made available to the author by Ancerno, Ltd. (a leading provider to institutional investors of Trade Cost Analysis (TCA)), provides comprehensive trade-by-trade data on all U.S. and international equity trades of some of the largest money managers and pension plan sponsors in the country. Moreover, because Ancerno collects the data to provide TCA services, the dataset is remarkably rich in detail concerning the characteristics of each transaction and the identity of the securities, exchanges, and investors involved (although the specific identify of the investors has been anonymized). As such, the dataset provides an ideal means by which to examine the prediction that investors would respond to Morrison by altering their investments in cross-listed issuers while controlling for both investor-specific and issuer-specific confounders.

To isolate the effect of Morrison, the primary empirical test examines investors’ monthly percentage of purchases made on U.S. exchanges in 420 cross-listed firms relative to investors’ total monthly purchases in these same issuers. Overall, the results indicate that the 378 institutional investors tracked by Ancerno demonstrated remarkably little interest in reallocating their trades in these firms to the issuers’ U.S.-listed securities in the fifteen months following Morrison. On the contrary, examination of their trading behavior in these cross-listed firms reveals a decidedly business-as-usual approach to the manner in which investors purchased equity securities in these issuers. Moreover, the Ancerno dataset also provides no evidence that investors might have used Morrison to secure the potential value that private 10b-5 actions have in deterring financial fraud more generally. After Morrison, an investor seeking to maximize the likelihood that a foreign firm is subject to the risk of a potential 10b-5 private lawsuit (and thus, its deterrence against fraud) need only invest in the securities of foreign firms that are cross-listed on a U.S. exchange. Examination of investors’ non-U.S. equity portfolios after Morrison, however, reveals no signs that investors in the sample gravitated to these firms, notwithstanding the fact that these firms were now clearly subject to the risk of private 10b-5 suits.

These findings are further confirmed by cross-sectional analyses. In particular, the Ancerno data reveals no reliable evidence that trading in cross-listed issuers after Morrison (whether on U.S. exchanges or otherwise) was associated with proxies for investment risk, U.S. trading costs, or the level of investor protection in an issuer’s home market. Perhaps most striking, the analysis of the Ancerno data reveals that the persistence in investor trading behavior after Morrison cut across investors classified as both money managers and pension fund sponsors. Compared to money managers, pension plan sponsors were especially vocal with their concerns that Morrison would induce investors to reallocate trading in cross-listed issuers to U.S. venues. Utilizing a differences-in-differences design, however, reveals no such reallocation among plan sponsors relative to money managers, highlighting a significant disconnect between sponsors’ espoused public policy positions and their day-to-day trading decisions.

At their most general level, these findings suggest that the legal right of bringing a 10b-5 private right of action plays a remarkably small role in the trading decisions of large institutional investors. For those sponsors who have been critical of Morrison, this conclusion alone may raise concerns about the extent to which formal policy positions within an institution are effectively communicated and implemented among investment committees and portfolio managers. The paper’s findings also speak to researchers and policymakers seeking to identify which domestic institutions best facilitate capital formation and economic development in a world of global capital flows. Taking as a given that investor protection is essential for financial markets to develop, a debate now rages in international finance regarding whether private enforcement through private lawsuits or public enforcement through regulatory initiative is the most efficient mechanism to protect investors. That the presence or absence of the 10b-5 private right of action has such little consequence on institutional investor trading would thus seem to call into question the value of exporting the current system of private 10b-5 securities suits as a primary means of encouraging greater capital formation. Finally, in the wake of Halliburton Co. v. Erica P. John Fund, these findings suggest that Halliburton’s potential to contract the class of firms subject to fraud-on-the-market suits may be less consequential for investor trading strategies than has been suggested by investor advocates.

The full article is available for download here.

Both comments and trackbacks are currently closed.
  • Subscribe or Follow

  • Supported By:

  • Program on Corporate Governance Advisory Board

  • Programs Faculty & Senior Fellows