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Reassessing the Distinction Between Corporate and Securities Law James J Reassessing the Distinction Between Corporate and Securities Law James J. Park ABSTracT Public companies in the United States must comply with both federal securities law and CLA LAW REVIEW CLA LAW U state corporate law. This division of labor is premised on the assumption that there is a meaningful distinction between securities and corporate law. The most common view is that securities law is characterized by its use of disclosure, while corporate law sets forth substantive requirements. Critics respond that securities law is really just a federal version of corporate law. They argue that the federal policy of investor protection justifies preempting state corporate law to address corporate mismanagement. While investor protection concerns have been invoked as a reason for unifying corporate and securities law, this Article contends that corporate and securities law can be distinguished based on the type of protection they provide to investors. Both corporate and securities law serve to protect investors, but they do so at two different phases of the investment process. First, when purchasing or selling a stock, a trading investor is vulnerable to transacting at an unfair price. Second, during the period when an investor owns a stock, he is vulnerable to new corporate misconduct that reduces the value of the company. Simply put, securities law protects investors as traders while corporate law protects investors as owners. Distinguishing between trading and ownership protection provides a strong basis for regulating securities and corporate law in different ways. Securities law is uniform and mandatory because investors have a common interest in fair valuation when trading. Corporate law is diverse and enabling because the ownership interests of investors are more difficult to reconcile. AUTHOR Professor of Law, UCLA School of Law. Thank you to Stephen Bainbridge, Joel Feuer, Sung Hui Kim, and participants at the Corporate and Securities Litigation Workshop, UC Irvine School of Law Business Law Colloquium, and UCLA School of Law Summer Works-in-Progress Workshop for their helpful comments. Thank you to Matthew Brodsky for excellent research assistance. 64 UCLA L. REV. 116 (2017) Table OF CONTENTS Introduction.............................................................................................................118 I. Securities Law as Federal Corporate Law ...............................................122 A. Investor Protection and Federal Corporate Law .......................................123 B. Two Periods of Federal Corporate Law ....................................................125 1. Rule 10b-5 and the First Wave of Federal Corporate Law .............126 2. The Second Wave of Federal Corporate Law ..................................128 II. Two Ways of Distinguishing Between Corporate and Securities Law .........................................................................................131 A. Internal Affairs...........................................................................................131 B. Disclosure ..................................................................................................134 III. Investor Protection and the Distinction Between Trading and Ownership ................................................................................................137 A. TheBirnbaum Doctrine .............................................................................137 B. Two Types of Investor Harm .....................................................................141 C. Trading Protection and Ownership Protection .........................................143 1. Securities Law as Trading Protection ...............................................143 a. Public Offering Regulation .....................................................143 b. Periodic Disclosure and Fraud on the Market ........................144 c. Regulation of Markets and Intermediaries .............................147 2. Corporate Law as Ownership Protection ........................................148 a. Corporate Governance and Firm Value ..................................148 b. Fiduciary Duties ......................................................................149 c. Corporate Law Disclosure ......................................................151 d. Mergers and Acquisitions .......................................................153 e. Bondholders and Corporate Law ............................................154 IV. Identifying Federal Corporate Law ..........................................................155 A. Proxy Regulation .......................................................................................155 1. The Proxy Statement ........................................................................157 2. Shareholder Proposals ......................................................................158 B. Takeover Regulation ..................................................................................159 C. Mandatory Disclosure Requirements ........................................................163 1. Disclosure and Corporate Governance ............................................163 2. Internal Controls ..............................................................................164 D. Board Regulation Through Exchange Listing Requirements ...................166 V. Foundation for a Two-Tiered Regulatory System ..................................169 A. Uniform Protection of Trading Investors ..................................................169 1. Fair Valuation ...................................................................................169 2. Federal Securities Laws ....................................................................170 B. Diverse Protection of Owners ...................................................................172 1. The Divergence of Ownership Interests ...........................................172 2. Diversity and State Corporate Law..................................................175 VI. Making Federal Corporate Law .................................................................179 Conclusion ................................................................................................................182 117 118 64 UCLA L. REV. 116 (2017) INTRODUCTION For some time, there has been a rough separation between corporate and securities law in the United States. According to the conventional account, se- curities 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.1 The relationship between corporate and securities law has always been a close one,2 and scholars over the years have debated whether this traditional divide should be maintained. One group claims that securities law is just a federal version of corporate law that can and should be expanded.3 Another group argues that the federal securities laws are distinguished by their utiliza- tion of disclosure as a regulatory mechanism, and should not range into sub- stantive regulation.4 One commentator has described this exchange as “one of the longstanding and most contentious issues in the history of American securities regulation.”5 This Article reassesses the distinction between corporate and securities law, and offers a framework for defining the boundary between the two subjects. 1. Such dual regulation has been described as: “The Genius of American Corporate Law.” See generally ROBERTA ROMANO, THE GENIUS OF AMERICAN CORPORATE LAW (1993). 2. See, e.g., STUART BANNER, ANGLO-AMERICAN SECURITIES REGULATION: CULTURAL AND POLITICAL ROOTS, 1680–1860, at 245 (1998) (noting that early securities litigation cases were considered to be part of corporate law); Zohar Goshen & Gideon Parchomovsky, The Essential Role of Securities Regulation, 55 DUKE L.J. 711, 751 (2006) (“[T]he distinction between corporate law, whose goal is to reduce corporate agency costs, and securities regulation, the goal of which is to facilitate a competitive market for analysts, is not so clear.”). 3. See Lucian A. Bebchuk & Assaf Hamdani, Federal Corporate Law: Lessons From History, 106 COLUM. L. REV. 1793, 1813 (2006). 4. See, e.g., Stephen M. Bainbridge, The Short Life and Resurrection of SEC Rule 19c-4, 69 WASH. U. L.Q. 565, 618–19 (1991) (“[T]he New Deal Congresses’ rejection of a federal corporation law was probably the result of its satisfaction with the balance created by the securities laws. Federal law was to impose disclosure obligations, along with procedural and anti-fraud rules designed to make the disclosure requirements more effective. In contrast, corporate governance standards were left to the states.”). 5. Donald C. Langevoort, Seeking Sunlight in Santa Fe’s Shadow: The SEC’s Pursuit of Managerial Accountability, 79 WASH. U. L.Q. 449, 450 (2001); see also Paul G. Mahoney, Mandatory Disclosure as a Solution to Agency Problems, 62 U. CHI. L. REV. 1047, 1110 (1995) (“Is securities regulation more properly part of corporate law (as it was for a long time in England) or a separate discipline?”). Corporate and Securities Law 119 The traditional disclosure approach does not provide an adequate test for differentiating between corporate and securities law. Disclosure is not ex- clusive to securities law. Corporate law has long used disclosure obligations to regulate interested transactions and dealings
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