CORE Metadata, citation and similar papers at core.ac.uk Provided by Digital Commons @ Boston College Law School Boston College Law School Digital Commons @ Boston College Law School Boston College Law School Faculty Papers 6-1-1996 Policy Perspectives on Revised U.C.C. Article 8 James S. Rogers Boston College Law School, [email protected] Follow this and additional works at: http://lawdigitalcommons.bc.edu/lsfp Part of the Banking and Finance Commons, Commercial Law Commons, and the Secured Transactions Commons Recommended Citation James S. Rogers. "Policy Perspectives on Revised U.C.C. Article 8." CLA Law Review (1996): 1432-1503. This Article is brought to you for free and open access by Digital Commons @ Boston College Law School. It has been accepted for inclusion in Boston College Law School Faculty Papers by an authorized administrator of Digital Commons @ Boston College Law School. For more information, please contact [email protected]. POLICY PERSPECTIVES ON REVISED U.C.C. ARTICLE 8 James Steven Rogers* INTRODUCrION .. ............................................ 1432 I. ARicLE 8 REmSION AND CLEARAN CE AND SErrLEMENr REFoRM ...... 1435 A. Systemic Risk ......................................... 1437 B. From Trade to Settlement ................................ 1438 C. Providing an Adequate Legal Structure for the Indirect Holding System-General Requirements ...................... 1441 II. THs BASIC DRAFriNo TECHNIQUE OF REVISED ARTICLE 8 ............ 1449 III. SOME ADVANTAGES OF THE NEW SECURITY ENTITLEMENT STRucTURE .. 1453 A. Direct/Indirect Versus Certificated/Uncertificated ............... 1453 B. An Entitlement Holder's Rights Can Be Asserted Only Against Its Own Intermediary .................................... 1455 C. Coherent Choice of Law Rules ............................. 1457 IV. POST-SETTLEmENT FiNA TY ................................... 1460 V. SECURED TRANSACrION RULEs ................................ 1473 A. Outline of Secured Transaction Rules ........................ 1473 B. The Control Principle and Its Application to Key Transaction Categories ............................... 1477 C. Drafting Approach: General Structural Principles Versus Transaction Specific Rules ................................ 1483 1. Would a Purchase Money Security Interest Priority Rule Serve Better than Rules Based on the Control Principle? ...... 1485 2. Are There Better Alternatives to the Rule Giving Intermediaries Priority over Other Secured Parties? ........... 1486 3. Would Priority Rules Based upon Knowledge or Notice of Prior Claims Work Better than Rules Based on the Control Principle? . 1488 VI. REVISED U.C.C. ARTICLE 8 AND THE INDIvDUAL INVESTOR .......... 1493 A. Revised Article 8 Deals with the Custodial Function ............. 1494 B. Rules Protecting Securities Intermediaries Against Adverse Claim Liability .................................. 1497 C. Agreements Concerning the Statutory Duties of Securities Intermediaries ................................. 1503 * Professor, Boston College Law School. The author served as Reporter to the Drafting Committee to Revise U.C.C. Article 8. My thanks to Fred Miller, Paul Shupack, and Richard B. Smith for comments on an earlier draft. 1431 1432 43 UCLA LAW REVIEW 1431 (1996) D. Risk of Intermediary Wrongdoing: Customers Versus Creditors and Transferees ................................. 1511 1. Could Customer Protection Goals Be Achieved by a Simple Rule that the Customers Get Their Securities? .............. 1514 2. Customers Do Not Take Intermediary Credit Risk ........... 1517 3. Theft Risk ........................................ 1520 4. Should the Finality Rules Differ for Transferees Who Take Securities as Collateral, Rather than as Outright Buyers? ....... 1523 5. Choice of Words for Statement of the "Bad Actor Transferee" Exception to the Finality Rule ................. 1530 6. Is Honesty Bad? .................................... 1537 CONCLUSION: THE NEED FOR PROMPT, UNIFORM ENACTMENT ........... 1540 INTRODUCTION In 1994, the sponsors of the Uniform Commercial Code, the American Law Institute ("ALI") and the National Conference of Commis- sioners on Uniform State Laws ("NCCUSL"), approved a revision of U.C.C. Article 8-Investment Securities, along with related amendments to Article 9 and conforming amendments to various other articles.' The state enactment process is proceeding promptly. Before the end of the second year of legislative activity, Revised Article 8 had been adopted by more than one-half of the states, including such major commercial jurisdic- tions as Illinois, Pennsylvania, and Texas. Article 8 is one of the more recondite branches of commercial law. Neither the generalist practicing lawyer nor the commerical law expert is likely to feel comfortable with this subject. Article 8 is not commonly taught in law school commercial law courses and is omitted or given scant coverage in the principal secondary sources on commercial law. Even among the initiates, the particular concerns that led to the 1994 revision project are the major arcana of the field. The revision project was a re- sponse to expressions of concern by numerous governmental bodies and others that the prior version of Article 8 provided an inadequate structure for the modern book-entry system of securities holding and transfer. The operations of the modern book-entry system are not matters within the daily experience of ordinary lawyers, law professors, legislators, or judges. It 1. The American Law Institute & National Conference of Commissioners on Uniform State Laws, Uniform Commercial Code Revised Article 8. Investment Securities (With Con- forming and Miscellaneous Amendments to Articles 1, 4, 5, 9, and 10) (1994 Official Text with Comments). The final text appears in 2C Uniform Laws Annotated (West Supp. 1995). Citations herein without other indication are to the 1994 version. The prior revision is cited as the 1978 version. Revised Article 8 1433 is, therefore, not an easy task for a nonexpert lawyer to understand, let alone feel an intuitive mastery of, some of the concerns that were the prin- cipal reason for the Article 8 revision project. One of the major challenges that I faced in my capacity as Reporter for the Article 8 revision project was to acquire a sufficient level of informa- tion. about these matters not only to feel confident that I was not making errors in my work as a drafter, but also to serve as a "translator? between the clearance and settlement experts and the group of intelligent and dedi- cated generalist lawyers who served as the key decision makers in the pro- ject, both on the drafting committee and within the review process in the ALl and NCCUSL. The principal objective of this Article is to memorial- ize and more widely publicize the results of that education and translation effort so that lawyers working with Revised Article 8, both during the process of review and enactment by the states and thereafter in the process of application and interpretation, will have the benefit of some of the information and perspective that those involved in the drafting process brought to or acquired during the project.' The topics covered in the principal portions of this Article are as follows: Part I describes the reasons for the revision project and explains the concept of "systemic risk" as well as the systems that are being developed by securities market participants and securities regulators to control sys- temic risk. Part I also explains how revision of the commercial law rules in Article 8 is essential if these risk control measures are to operate as intended-to protect the interests of investors in times of financial crisis. 2. Inasmuch as the objective of this Article is to provide a basis for understanding the policies that underlie Revised Article 8, it makes no effort at a comprehensive explanation of the operation of the statute itself. The prefatory note and official comments that accompany Revised Article 8 provide quite extensive explanation both of the statute and the modem securities hold- ing system. Readers not familiar with Revised Article 8 should find these an adequate basis for obtaining a general understanding of the new substantive provisions. Detailed section-by-section explanations will be available in a forthcoming volume of William D. Hawkland's Uniform Com- mercial Code Series on Revised Article 8, which I am currently preparing. Similarly, no effort has been made in this Article to provide comprehensive citations to the literature discussing Article 8. The best sources for such references are the articles included in the December 1990 issue of the Cardozo Law Review. See 12 CARDOZO L. REV. 305 (1990). It may also be worth noting that the objectives of this Article complicate the usual disclaim- er. While the views expressed herein are mine alone, a considerable amount of the explanatory material in this Article is adapted from various memoranda, explanatory articles, and reporter's notes that I prepared in the course of my work as Reporter. In those formats, much of this mate- rial was presented to the members of the Article 8 Drafting Committee, to the ALl and NCCUSL, and to other bodies that reviewed drafts of Revised Article 8 during the drafting process. 1434 43 UCLA LAW REVIEW 1431 (1996) Part II provides a summary of the organization and basic drafting tech- nique of Revised Article 8, including a brief explanation of the concept of "securities entitlement," the term used in Revised Article 8 to describe, for purposes