Reassessing the Distinction Between Corporate and Securities Law

James J. Park is Professor of Law at the UCLA School of Law. This post is based on a recent article by Professor Park.

For some time, there has been a rough separation between corporate and securities law in the United States. According to the conventional account, securities law requires public companies to make disclosures to investors while corporate law sets forth substantive norms regulating the internal affairs of the corporation. This distinction provides the foundation for a dual regulatory system of federal securities law and state corporate law. My article, Reassessing the Distinction Between Corporate and Securities Law (forthcoming in the UCLA Law Review), sets forth a new way of understanding the difference between corporate and securities law.

Because a primary goal of the federal securities laws is investor protection, there is a longstanding argument that such laws should preempt state corporate law to protect investors from corporate managers. Just one year after the passage of the Securities Act of 1933, William Douglas, then a corporate law professor, argued in an article called Protecting the Investor that the Act should do more to regulate corporate misconduct. Decades later, Professor William Cary argued that federal law should be expanded to protect “the real investors,” the shareholders, from the manager-friendly regulation of Delaware corporate law. In more recent years, the two federal statutes that have done the most to regulate corporate law, the Sarbanes Oxley Act (Sarbanes-Oxley) and the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), have cited investor protection in expanding the federal securities laws over territory traditionally thought to be covered by state corporate law.

While investor protection has thus been cited as a reason to unify corporate and securities law, my article makes the novel argument that investor protection provides a conceptual framework for resisting such unification. The investor protection argument is correct in that both corporate and securities law protect investors, but the argument as currently formulated is too imprecise in differentiating between the ways in which investors need protection. A more nuanced conception of investor protection would distinguish between two phases of the typical investment decision. The first relates to the purchase (or sale) of the security, where the trading investor is primarily concerned about paying (or receiving) a fair price. The second relates to the period when the investor owns the security when he is vulnerable to new corporate misconduct that reduces the value of the security.

Simply put, securities law protects the investor when trading and corporate law protects the investor while he is an owner. Disaggregating investor protection into trading protection and ownership protection, I will argue, is a better way of framing the difference between securities and corporate law than the traditional disclosure approach. The goal of the securities laws is not to protect investors in all aspects of their decision-making, but mainly with respect to their trading decisions.

The idea that securities law can be distinguished by their focus on trading is consistent with what was once a prominent judicial rule, the Birnbaum doctrine. In Birnbaum v. Newport Steel Corp., the Second Circuit ruled that only purchasers and sellers of securities can bring suit under Rule 10b-5, the primary anti-fraud provision of the securities laws. In Rule 10b-5’s early years, courts often used the Birnbaum rule to thwart attempts to extend Rule 10b-5 to recover for damages arising out of poor corporate governance mainly affecting shareholder-owners.

This article’s reframing of the distinction between corporate and securities law best justifies our two-tiered system for regulating public corporations. Securities law relies upon mandatory, uniform rules because it is targeted at the unified interests of trading investors in fair valuation. Corporate law is characterized by greater flexibility and diversity because it governs the competing interests of different shareholder-owners. Federal regulation of securities has been successful because it has facilitated the creation of a market that generates fair prices. The most significant creator of state corporate law, Delaware, has been successful in part because of its investment in judges who can ably balance the interests of long-term and short-term owners.

The full article is available for download here.

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