Civil Liability and Mandatory Disclosure

Abstract

This paper explores the appropriate system of civil liability for mandatory securities disclosure violations by established, publicly traded issuers. The U.S. system's design has become outmoded as the underlying mandatory disclosure regime that has moved from an emphasis on disclosure at the time that an issuer makes a public offering, to an emphasis on the issuer's ongoing periodic disclosures. An efficiency analysis shows that, unlike U.S. law today, the relevant actors should have equally great civil liability incentives to comply with the disclosure rules whether or not the issuer is offering securities at the time. An issuer not making a public offering of securities should have no liability because the compensatory justification is weak. Deterrence will be achieved instead by imposing liability on other actors. An issuer's annual filings should be signed by an external certifier - an investment bank or other well capitalized entity with financial expertise. If the filing contains a material misstatement and the certifier fails to do due diligence, the certifier would face measured liability. Officers and directors would be subject to similar liability. Damages would be payable to the issuer. When an issuer is making a public offering, it would be liable to investors for its disclosure violations as an antidote to what otherwise would be an extra incentive not to comply. This design would address two major complaints concerning the existing U.S. civil liability system: underwriter Section 11 liability for a lack of due diligence concerning disclosures that in modern offerings underwriters have no realistic ability to police, and litigation-expensive issuer class action fraud-on-market liability. The system suggested here would eliminate both sorts of liability. But unlike elimination reforms proposed by underwriters and issuers, it would retain deterrence by substituting in place of these liabilities more effective and efficient civil liability incentives for disclosure compliance.