What Can Managers Privately Disclose to Investors?

* Harvard Business School. I would like to thank Jeff Guo (editor), Brian Bushee, Jihwon Park, and workshop participants at Temple University for their thoughtful feedback. This research is funded by the Harvard Business School.

Regulators have long been aware that differential access to information can undermine the efficiency and fairness of financial markets. In an effort to place investors on equal footing, the Securities and Exchange Commission in 2000 created Regulation Fair Disclosure (Reg FD), which prohibits public firms from disclosing material information to certain parties but not others. Nevertheless, managers have continued to meet privately with select investors, possibly sharing information in violation of Reg FD. A key weakness of Reg FD is that its definition of materiality remains unclear. Using a series of vignettes based on actual private investor meetings, I investigate how managers and regulators understand Reg FD. I find considerable uncertainty and disagreement among both managers and regulators as to what kind of information may be lawfully communicated. Many managers interpret Reg FD subjectively, often relying on individual industry norms to decide where to draw the line. Ultimately, the ambiguity of Reg FD leads to considerable variation in the information managers privately provide to investors, undermining the notion of a level playing field in financial markets.


I. Leveling the Playing Field

Well-functioning equity markets are predicated on investors’ ability to acquire accurate and timely information about firms. This information is gathered from a variety of sources, including press releases, regulatory filings, conference calls, and private meetings with management. Historically, executives provided information selectively, sharing it with certain investors during private meetings. To the extent that only some investors had access to certain material information (e.g., advance knowledge of earnings-related information), it placed these investors in a more favorable trading position.1 Notably, the prohibition against insider trading did not restrict managers from providing information during private meetings with investors, since the information was neither being misappropriated nor traded upon for personal gain by insiders.2 Out of concern that the selective disclosure of news by managers could undermine investor confidence and the integrity of financial markets, the Securities and Exchange Commission (SEC) implemented Regulation Fair Disclosure (Reg FD) in October 2000. Reg FD requires any material information disclosed by managers to be released publicly so that all investors may consume it.3 The regulation effectively closed the gap that existed around insider trading restrictions that permitted managers to convey some non-public, material information legitimately to outsider parties.

When Reg FD was promulgated, some commenters raised concerns that the regulation could sharply curtail or even eliminate private dialogue between managers and investors.4 However, in the years since, private meetings have flourished despite the apparent restrictions on what may be conveyed during these offline interactions. For example, Brown, Call, Clement, and Sharp (2018) recently surveyed hundreds of investor relations officers and found that seventy percent of firms granted investors offline access to senior executives.5 Researchers have tried to understand how private meetings persisted in the wake of Reg FD. One explanation is that managers merely provide immaterial information to investors during meetings, which is permitted under the regulation. An alternative hypothesis is that managers commonly disclose material information, but that these violations are difficult to enforce because the meetings are private. Indeed, these private meetings appear to be quite valuable: Academic papers have found that those in attendance make more informed trading decisions—buying before the stock rises and selling before it falls.6 To better understand how both managers and regulators view the appropriateness of information disclosed during private meetings, I present a series of vignettes of private meeting interactions to managers and regulators to ascertain what types of dialogues they view as appropriate. As will be shown, the answers by both managers and regulators suggest that there is considerable uncertainty about what is acceptable. Managers operate in the penumbra of regulatory ambiguity when they privately meet with investors.

II. Assessing Managerial and Regulatory Views of Acceptable Private Dialogue

Reg FD requires that whenever a firm seeks to disclose material information, the information must be disclosed publicly (e.g., via press release, conference call, etc.). The regulation does not explicitly prohibit managers from speaking privately with investors and analysts, but restricts them to communicating information that is immaterial. However, Reg FD does not define what is meant by material information.7 In its preamble to the final rule, the SEC explicitly noted that Reg FD relies on existing definitions of materiality in the case law—i.e., “[i]nformation is material if ‘there is a substantial likelihood that a reasonable shareholder would consider it important’ in making an investment decision.”8 Numerous law firms have noted the uncertainty in the interpretation of the regulation and the difficult position it places managers in,9 Morrison & Foerster, Frequently Asked Questions About Regulation FD(2017), https://media2.mofo.com/documents/faqs-regulation-fd.pdf [https://perma.cc/DF52-D6X3].] and ultimately no clear guidance about what information could be conveyed privately under the regulation was provided.10.] Adding to the ambiguity, the SEC considers some information immaterial even if it can be used by investors and analysts in conjunction with their other information to make material insights.11 The continued ubiquity of private investor meetings suggests that some norms have developed about what information managers may convey. However, it is uncertain whether these practices comport with the expectations of regulators. To better ascertain the boundaries of permissible private dialogue under Reg FD, I asked both managers and regulators to evaluate a series of vignettes depicting private meetings between investors and managers.

To design the vignettes, I relied on a dataset collected by observing and recording the private interactions between investors and managers at nearly seventy private meetings at two publicly traded companies.12.] During these meetings, investors posed more than 1,200 questions to executives.I focused on questions that asked information about management impressions of the firm and those that sought more timely information since these inquires raise the most salient concerns with potentially conveying material information. I sought to also select questions that not only raised challenging issues, but ideally also ones that were routinely asked by investors.For instance, twenty-six different investors in the database asked managers of a biotechnology firm for an update on the firm’s cash position and cash burn rate.13 I worked with two investor relations officers (who have more than fifteen years of experience each and have collectively attended hundreds of private investor meetings) to script representative investor-manager conversations based on these questions.14In each vignette, the investor asks for a certain kind of information about the company, and the manager offers an answer (all seven vignettes are provided in the Appendix). Survey respondents read the vignettes and were asked: “Would you consider the information the investor received during the meeting with COMPANY to be a violation of Reg FD?”

Participating managers were randomly selected from a list of chief financial officers and investor relations officers of large publicly traded firms.15Participating “regulators”—specifically, individuals charged with investigating possible violations of the securities laws and helping enforce those laws—were shown the vignettes during an annual training conference.16 The order of the vignettes was randomized to avoid rank-order effects. I received completed surveys from thirty managers and seventy regulators.17 Managers responded to every vignette with significant disagreement, some seeing the disclosure as a potential violation of Reg FD and others deeming the information immaterial. In every case there were some managers who believed the disclosure was unambiguously illegal, while others found it “likely not” or “not” a violation of Reg FD. On average, 65% of the managers responding to each vignette stated that the depicted disclosure likely or certainly violated Reg FD. Even for the vignette that the most managers found acceptable (Situation A: expressing sell-side analyst interest), a significant minority—38%—still believed the information violated or likely would violate Reg FD. The aggregated responses for all the vignettes are shown in Table 1.

Perhaps even more notable is that regulators had equally mixed responses to the vignettes. Although these respondents are charged with supporting the enforcement of securities regulation like Reg FD, there was considerable heterogeneity in what regulators viewed as appropriate under the policy. On average, 62% of the regulators responding to a vignette stated that it likely or certainly violated Reg FD—a level nearly identical to the manager respondents. Regulators were not consistently more strict about finding Reg FD violations. In three of the seven vignettes, regulators were more prone than managers to view the dialogue as acceptable under Reg FD. None of the differences in responses between managers and regulators in the vignettes are statistically significant (as shown in last two columns of Table 1 through the χ2 test statistic).

The qualitative responses provide insight into how managers interpret Reg FD. Consider Situation A, where the hypothetical CFO tells investors that that additional analysts had expressed interest in covering the company. Here, 38% of managers and 48% of regulators said such a disclosure would likely or certainly violate Reg FD. Managers who believed this to be a violation of Reg FD explained that they felt the CFO’s disclosure would influence the company’s share price.

“Learning that specific analysts may initiate coverage on a company is insider information.”

“Launch of coverage can significantly impact the share price and is material information that an investor shouldn’t know. It’s a bad form of management to share that info, not to mention illegal under FD.”

In contrast, the 62% of managers who did not believe that Situation A violated Reg FD explained why they felt the information was immaterial:

“Additional sell-side coverage does not guarantee additional liquidity, neither does it indicate any movement in the company’s value up or down.”

“To allege a violation of Reg FD assumes coverage by the new analysts is both positive and differentiated from the existing analysts as to cause a material appreciation in share price.”

This variation in responses relies on the respondents’ assessments of whether additional analyst coverage is enough to move the price of a stock. Studies on analyst initiation decisions support the view that new analyst coverage is sufficient to generate changes in prices and liquidity, suggesting that the information could be viewed as material.18 At the same time, this does not resolve the question of a potential violation since these academic studies are not known to most investors. The regulation is based on the beliefs of “reasonable investors,” not academic researchers. Thus if analysts’ initiations are believed to be inconsequential to the average investor (despite academic research to the contrary), then under a strict interpretation of the regulation, it ought not be a violation. The variation in responses by managers reflects the ambiguity of what a “reasonable investor” understands about sell-side coverage and therefore what is material.

Others vignettes generated considerably higher percentages of respondents identifying a Reg FD violation. In Situation D, the hypothetical CEO discloses that she is likely to continue purchasing additional shares in the firm. Comporting with evidence that a CEO’s desire to purchase shares is a significant signal of a firm’s prospects, 69% of manager respondents judged that this was material information that had been disclosed in violation of Reg FD. However, some argued that a CEO’s personal views about the company stock are not material.

“Just because the CEO thinks the stock is worth purchasing doesn’t mean it will perform well.”

“I don’t feel like the intention to buy shares personally is significant enough to materially move the stock beyond what a track record of purchases would do.”

Notably, the second respondent stated, as did others, that the disclosure was not material because of how the situation “felt.” Thus, it appears that some managers evaluate the acceptability of providing a piece of information not by some well-defined definition of materiality or prior evidence of the impact of a particular action, but rather subjectively based on their intuitive impression of whether the information “feels” material. 19
“If you flipped the question to say he told the investor he would very likely be selling shares I would have said yes, a violation of Reg FD.”

Prior research finds that insider purchases tend to be more informative about future stock returns than sales because insider sales arise for both information and liquidity reasons.20
Thus, this manager appeared to rely on a different set of beliefs (i.e., sales occur for information, rather than liquidity reasons) to form his or her views of what conduct would be viewed as material.

In other instances, responses appear largely unguided by the regulation, but instead by what is perceived to be acceptable practice based on norms in the industry. This was most clear with Situation F, where the CEO discloses that there have been informal discussions about potentially selling the firm. Here, 72% of managers saw a likely violation of Reg FD. The 28% of managers who disagreeed cited the commonplace nature of such takeover discussions.

“M&A discussions between firms are common and disclosing that discussions have been held should not be considered material for disclosure purposes.”

“Most CEOs think their company is worth more than where it is trading . . . Informal meetings with competitors and strategic partners are not uncommon.”

Merger and acquisition (“M&A”) discussions are one of the few areas where the SEC has offered specific guidance related to Reg FD, suggesting that such information “should be reviewed carefully” because it is “more likely to be considered material.”21 But the guidance also includes the explicit warning that information about mergers is not per se material, and that determinations must still be made case by case.22 This vagueness may explain why even 24% of regulators said the M&A information conveyed in Situation F was unlikely to violate Reg FD.

In this situation, the guidance might have confused more than it clarified. One manager, an investment relations officer, strongly believed that the information discussed in the vignette would be a clear violation of Reg FD:

“Discussing M&A suitors, meetings, or discussions would be material non-public information. Period.”

Here, the IRO seems to be misinterpreting the SEC’s guidance by divining a bright-line rule where one does not actually exist.

The differences in perspectives suggest that there are discrepancies between how the regulation is written, how it is interpreted and, and how it is complied with by managers in practice. Managers may believe that some disclosures violate Reg FD, but still view it as acceptable behavior because it has become a widespread practice in their industry. In particular, several respondents explicitly discussed the divergence of Reg FD in practice from Reg FD “in theory.”

“By the letter of the law, if management is discussing anything they haven’t said publicly before about their strategy, it’s a violation of Reg FD. But realistically, management is going to answer strategic questions when asked.”

“Speaking from experience, investor relations and management routinely say things like ‘we have more analysts interested in us’ or ‘we’ve talked to this sell-side guy or that one’ in private investor meetings. It’s not best practice, but it’s also a reasonable assumption that anyone might make.”

One manager respondent suggested that how much information would be conveyed was less a function of what regulation guided, but more of a matter of who they were speaking with. In response to one vignette where the respondent believes the executive’s answer violated Reg FD, the respondent stated:

“I can say that the exact situation described here happens every day, and management typically wants to answer it. How clearly and how detailed they answer the question depends on who that investor is. If it’s Wellington or Fidelity, or a long-only type shop that they’d love to have as long-term investors, he’s going to bend over backwards and divulge information. If it’s a high-turnover hedge fund, he’ll be very careful. If it’s a no-name investment firm, the meeting wouldn’t even be happening.”

In practice, based on the few administrative proceedings that the SEC has initiated against firms for violating Reg FD, the SEC seems to take note of large, unexplained swings in the stock price.23 However, relying on stock price changes to identify Reg FD violations raises the problem of defining fraud by hindsight.24 Courts have consistently rejected the notion that information has to necessarily change an investor’s mind to be viewed as material. For instance, in SEC v. Mayhew, the court reasoned that “to be material, the information need not be such that a reasonable investor would necessarily change his investment decision.”25 None of the disclosures described in the vignettes would be considered per se material by a court. As the Supreme Court held in TSC Industries, Inc.. v. Northway, Inc., “only if the established omissions are ‘so obviously important to an investor that reasonable minds cannot differ on the question of materiality’ is the ultimate issue of materiality appropriately resolved ‘as a matter of law.’”26
Since both managers and regulators found the information disclosed as material in each vignette, none of the disclosures in the vignettes could be described as unambiguously material or immaterial.

Given the difficulty that managers—and regulators—seemingly have in assessing materiality in a consistent manner across the vignettes, one potential concern is that the vignettes themselves are unusually vague. Put differently, the concern is that there would be greater agreement among respondents if the vignettes included more specific information and facts.

There are two considerations which help mitigate this concern and support the premise that the responses accurately reflect the inability of individuals to consistently assess what is appropriate under Reg FD. First, although these vignettes were invented, they are representative of actual conversations as observed by two experienced investor relations officers and the author. Their realism was further confirmed by several of the surveyed managers. For example, one respondent commented:

“I’ve personally experienced this many times as an analyst and as an IRO. Of course, the investor is going to ask the question. And, of course, this is exactly how most management teams would answer the question.”

Thus the vignettes accurately reflected casual and vague nature of these private investor conversations in the real world. Any examination of how individuals interpret the restrictions created by Reg FD needs to be under representative circumstances as they arise in practice, rather than a more clinical and artificial context where any ambiguity has been removed. While greater information may help regulators resolve whether particular information ought to be conveyed under Reg FD, such detail is simply not representative of how most information is conveyed by managers during actual private meetings.

A second observation which suggests that managers’ inability to consistently ascertain what information can be provided under Reg FD is a function of the regulation and not the design of these particular vignettes is the conviction in managers responses which is unrelated to the specific information provided by firms. For example, the manager who wrote that “discussing M&A suitors, meetings, or discussions would be material non-public information. Period.” indicates that he/she felt that any conversation related to M&A was inappropriate. The specific information in the conversation about the M&A conversation was not pertinent to this manager’s determination (i.e., the only appropriate managerial response to an investor question about M&A is “no comment”). Perhaps even more significantly, numerous managers explicitly stated that that the amount of detail that would be appropriate to provide in response was not guided by Reg FD restrictions, but instead by who they were speaking with (e.g., “[h]ow clearly and how detailed they answer the question depends on who that investor is”). In this way, the determining factor such mangers consider in practice about what to convey is “who” the investor is, not what material information is formally restricted under Reg FD. Thus, even if more specific information was provided in each vignette, it is not clear that this would alter managers’ judgments since managers’ assessments of the appropriateness of the information conveyed is often divorced from the notion of materiality.

III. Clearer Expectations

The lack of agreement among managers leads to divergent practices that undermine Reg FD’s objective of creating a more level playing field where all investors have access to the same material information. As indicated by the survey responses, managers often confront this ambiguity by devising their own regulatory interpretations. For example, if managers observe competitors providing cash updates privately to investors during meetings, then such disclosures become tacitly accepted practice even when communicating such information violates both the spirit and literal reading of the regulation.

Managers also appear to decide how much information to convey based on who they are meeting with and whether providing the information is likely to benefit their relationship with the investor. Such decisions appear to more deliberately ignore regulatory restrictions, but the lack of enforcement limits the risk of such practices. Problematically, this means that Reg FD creates a greater burden on firms that more faithfully and conservatively adhere to the regulation, while posing little downside to managers who, at least in part, ignore it.

Private discussions have the opportunity to improve investors’ ability to more effectively allocate capital, thereby improving market efficiency. Yet, when some managers feel less constrained by the regulation than others, this creates a heterogeneous disclosure environment where some managers are providing more information to investors than others. To the extent that investors value this more privileged access, this can benefit managers and implicitly reward firms for violating the regulation. Moreover, to the extent that managers continue to provide quasi-material or material information to select investors they meet privately with, market participants as a whole gain a misleading impression that they are operating on a “level” information playing field—undermining the impetus for creating Reg FD.

In the eighteen years since the passage of the regulation, there have been thirteen Reg FD enforcement cases. One explanation for lack of cases, given the nearly ten million estimated private interactions that have occurred since Reg FD’s passage,27. On average, there were 4,640 publicly traded operating firms (i.e., non-REIT) each year since the passage of Reg FD, according to author calculations from CRSP data. Thus, there have been an estimated 9.5 million private meetings between managers and investors in the eighteen years since the passage of Reg FD.] is that managers largely abide by Reg FD’s restrictions, thereby creating few opportunities for SEC enforcement. Yet, in light of managers’ responses to the vignettes in this study, a more plausible explanation for the paucity of enforcement is that the SEC is effectively unable to “police” markets for Reg FD violations. Offline manager-investor meetings are, by definition, private. Thus, without any disclosure requirement on the part of firms, regulators cannot ascertain where or when such interactions occur, let alone the specifics of the discussion, unless information leaks out of a meeting. Lacking the ability to observe such interactions, the SEC is neither capable of evaluating such dialogue for its appropriateness (in contrast to public securities filings) nor capable of sanctioning private manager-investor communications that violate Reg FD.

A regulation that is heterogeneously interpreted by market participates and unable to be effectively enforced by regulators undermines rather than enhances market integrity. The heterogeneity in responses by both managers and regulators suggest that the regulation is failing to fulfill its original objective of creating a more level playing field with respect to information access. To amend the regulation and help it further achieve its original goal, four considerations must be taken into account. First, changes that would prevent or curtail institutional investors’ private access to senior executives could have negative externalities (e.g., hinder capital allocation decisions in the United States by large institutional investors) and face considerable political obstacles to passage. Practically speaking, some investors will continue to gain considerable private, one-on-one time with executives. Second, creating regulations that the SEC cannot effectively police is unsatisfactory policy. Therefore, changes to the regulations should recognize the impediments that the SEC currently faces in evaluating whether managers are providing information that violates Reg FD. Third, as the SEC itself acknowledged in its original rule, bright-line standards about what information is and is not material are unlikely to be effective and exhaustive. At the same time, for each vignette, at least some regulators found the dialogue appropriate and others inappropriate, suggesting a potential degree of arbitrariness depending on the individual characteristics of the specific regulator looking at the case. Creating a more consistent and rigorous set of guidelines of what can be appropriately disclosed, while avoiding bright-line standards, would help reduce ambiguity both among managers and regulators. Finally, in line with the original goal of the regulation, all investors should have access to information that may be viewed as material (i.e., that at least some investors see as material).

In line with these expectations, regulators could create a requirement that firms publicly disclose records of their private discussions shortly after each meeting in the form of detailed minutes or transcripts.28
Such a proposal would acknowledge the potential value of private interactions, but also provide for the fact that some information that managers convey to investors may be material to other investors. This disclosure requirement would also remedy regulators’ current inability to observe potential violations by making private material disclosure effectively moot.29 By disclosing all meeting contents, material information, even if privately communicated to an investor during a meeting, would be disseminated to all market participants. Regulatory enforcement could focus on firms that fail to disclose or do not adequately disclose their private interactions, rather than trying to assess whether a specific piece of information is material or not. This proposal would bolster transparency by providing investors access to all information disclosed by managers and place the SEC in a more effective position to enforce its policies.

There are several potential criticisms to the idea of requiring firms to publicly release meetings data in a timely manner. First, historically some institutional investors have conveyed proprietary insights during their private dialogue with executives. Timely public disclosure of an investor’s strategy could hinder an investor’s ability to capitalize on their plan. Investors could respond by becoming more nuanced in the information they convey to management to avoid its dissemination, or the investor could simply participate in public conversations (e.g., earnings conference call). Exceptions to public disclosure could also be made in some limited circumstances (e.g., private placement negotiation) where its immediate public disclosure could adversely impact firms. Second, between the time of the meeting and the public disclosure of the meeting conversation, investors who attended the meeting could be placed at an information advantage. Although this time could be short (perhaps less than 24 hours), other market participants would be at an information disadvantage during this time. One solution would be to prohibit investors who attend private meetings from trading until the records are publicly released. Alternatively, firms could publicly disclose when meetings are planned to occur so that other investors could choose to avoid trading during that time. While there are different externalities associated with each of these considerations, further analysis could seek to design policy to minimize any adverse effects. Finally, some firms are likely to object on the basis of the cost of preparing and releasing such records. However, many firms already prepare informal logs of questions that are frequently asked by investors during private meetings. The regulatory disclosure would simply be a more complete and rigorous compilation of the meeting dialogue. The monetary outlay associated with preparing minutes/transcripts would additionally not be a material expenditure for firms. Overall, it is possible to address many of the preceding concerns in designing an updated disclosure policy.

IV. Conclusions

Managers should not be forced to play a game of roulette when privately meeting with investors. While managers could take a conservative approach and either not engage in private meetings or not provide any information that any investor could view as material, such a choice would likely prove detrimental to both the firm and the efficiency of capital allocation within capital markets. At the same time, managers who divulge information risk violating Reg FD, albeit without necessarily intending or even appreciating that they are doing so.

Although Reg FD operates in a civil context, the constitutional doctrine of vagueness, which prohibits ambiguous criminal codes, offers an apt warning to regulators. The Supreme Court has held that it violates the Fifth Amendment to “take[] away someone’s life, liberty, or property under a criminal law so vague that it fails to give ordinary people fair notice of the conduct it punishes, or so standardless that it invites arbitrary enforcement.”30 It is not clear why securities regulations such as Reg FD, which have sweeping personal consequences for individuals and firms who are sanctioned, should be held to a lesser standard.31 When both regulators and the regulated disagree vehemently among themselves and between each other over the appropriate interpretation of a rule, it verges on being “standardless.” Such arbitrariness should give all parties pause.


Figure 1: Vignettes Responses

Figure 1 presents histograms showing the percentage of respondents that answered “no,” “likely not,” “likely yes,” or “yes” to the question “Would you consider the information the investor received during the meeting with COMPANY to be a violation of Reg FD?” after reading each vignette. The blue bar represents the frequency of responses by managers (n=29 except in Situation B where n=30) and the orange bar represents the frequency of responses by regulators (n=70). The seven vignettes (labeled Situation A through Situation G) are presented in the Appendix.

Table 1: Vignettes Responses Aggregated by “Yes” and “No” Responses

Table 1 shows the responses of both managers and regulators to the question “Would you consider the information the investor received during the meeting with COMPANY to be a violation of Reg FD?” after reading each vignette. The No column aggregates the “No” and “Likely Not” responses, and the Yes column aggregates the “Yes” and “Likely Yes” responses. The Pearson Chi-square test (χ2 test) evaluates observed differences between aggregated Yes and No responses between managers (n=29 except in Situation B where n=30) and regulators (n=70). The table shows the Pearson χ2 test statistic and the associated p-value. The seven vignettes (labeled Situation A through Situation G) are presented in the Appendix.

For the appendix to this essay, please see the PDF version.

  1. See, e.g., Lauren Cohen et al., Sell-Side School Ties,65 J. Fin.1409 (2010) (showing that prior to Reg FD, sell-side analysts outperformed their predictions by nearly ten percent a year on average when they shared an educational background with members of senior management at a firm); Andreas Gintschel & Stanimir Markov, The Effectiveness of Regulation FD, 37 J. Acct. & Econ.293 (2004) (showing that after Reg FD, the impact of analyst reports on stock prices diminished by 28%).
  2. See 17 C.F.R. § 240.10b-5 (2018).
  3. See Regulation FD, 17 C.F.R. § 243 (2018).
  4. See, e.g., Joanna E. Barnes, Regulation FD Will Result in Poorer Disclosure and Increased Market Volatility, 29 Pepp. L. Rev.3 (2002).
  5. Lawrence D. Brown et al., Managing the Narrative: Investor Relations Officers and Corporate Disclosure, J. Acct. & Econ.(forthcoming 2018).
  6. See Brian J. Bushee et al., Do Investors Benefit from Selective Access to Management?, 2 J. Fin. Reporting, no. 1, 2017, at 31; David Solomon & Eugene Soltes, What Are We Meeting For? The Consequences of Private Meetings with Investors, 58 J.L. & Econ.325 (2015).
  7. See 17 C.F.R. § 243.101 (2018).
  8. Selective Disclosure and Insider Trading, 60 Fed. Reg.51,716, 51,721 (August 24, 2000) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449(1976)).
  9. See, e.g., Latham & Watkins, The SEC’s Regulation FD—Fair Disclosure(2000), https://www.lw.com/upload/pubContent/_pdf/pub302.pdf [https://perma.cc/BUZ8-BCPG
  10. There have been only thirteen enforcement cases since the enactment of Reg FD. See Martin Bengtzen, Private Investor Meetings in Public Firms: The Case for Increasing Transparency, 22 Fordham J. Corp. & Fin. L.33, (2017). For a discussion of the ambiguity of Reg FD, see alsoJohn L. Campbell et. al., Selective Disclosure After Regulation Fair Disclosure: More than Simply ‘Completing the Mosaic’? (Kelley School of Business, Research Paper No. 16-52, 2017), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2803308 [https://perma.cc/SK7Y-5Z7Z
  11. See Selective Disclosure and Insider Trading, 60 Fed. Reg.51,716, 51,722 (August 24, 2000) (“At the same time, an issuer is not prohibited from disclosing a non-material piece of information to an analyst, even if, unbeknownst to the issuer, that piece helps the analyst complete a “mosaic” of information that, taken together, is material.”)
  12. See Jihwon Park & Eugene Soltes, What Do Investors Ask Managers Privately? (April 9, 2018) (unpublished manuscript), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3087369 [https://perma.cc/99GG-FJMC
  13. The cash questions served as the basis for the Situation C vignette shown in the Appendix.
  14. To protect firm managers, the dataset recorded the investors’ questions but not the managers’ answers. Thus, the manager responses provided in each vignette are plausible answers that reflect the experience of the investor relations officers who helped design the vignettes, rather than the literal response of managers in the Park and Soltes (2018) field work.
  15. Firms were selected from the CRSP/Compustat database if they met all of the following criteria: They held at least one earnings conference call in 2016, had a share price of greater than $5, were an operating firm (i.e., not a holding firm or REIT), and were incorporated in the United States. From these 2,695 firms, I randomly selected 150 firms and went to each firm’s website to find an e-mail contact for their investor relations officer or chief financial officer, of which I found 134 direct e-mail addresses.
  16. Under the terms of confidentiality that were agreed to in order to distribute this survey at the training conference, the author is not permitted to publicly disclose the name of the agency whose employees responded to the vignettes.
  17. The study was submitted to Harvard University’s Committee on the Use of Human Subjects (IRB). Harvard’s IRB exempted the study under 45 C.F.R. 46.101(b)(2). For the managers, twenty-nine completed all seven vignettes while one manager completed only the Situation B vignette (i.e., Describe Contract Proposals After Election). While this manager did not complete the survey in its entirety, I included this manager in the relevant analysis of Situation B.
  18. See Bruce C. Branson et al., Information Conveyed in Announcements of Analyst Coverage, 15 Contemp. Acct. Res.119 (1998); Cem Demiroglu & Michael Ryngaert, The First Analyst Coverage of Neglected Stocks, 39 Fin. Mgmt. 555 (2010); Paul J. Irvine, The Incremental Impact of Analyst Initiation of Coverage, 9 J. Corp. Fin.431 (2003); Kevin K. Li & Haifeng You, What is the Value of Sell-side Analysts? Evidence from Coverage Initiations and Terminations, 60 J. Acct. & Econ. 141 (2015).
  19. For a discussion of how intuition can contribute to the decision to engage in misconduct, see Eugene Soltes, Why They Do It: Inside the Mind of the White-Collar Criminal(2016).
  20. See, e.g., Josef Lakonishok & Inmoo Lee, Are Insider Trades Informative?, 14 Rev Fin. Stud.79 (2001).
  21. Selective Disclosure and Insider Trading, 60 Fed. Reg.51,716, 51,721 (August 24, 2000).
  22. Id.
  23. Yvonne Ching Lee Lee, The Elusive Concept of “Materiality” Under U.S. Federal Securities Laws, 40 Willamette L. Rev. 661, 677 (2004).
  24. For a discussion of fraud by hindsight, see G. Mitu Gulati et al., Fraud by Hindsight, 98 Nw. U.L. Rev. 773(2004).
  25. 121 F.3d 44, 52 (2d Cir. 1997).
  26. 426 U.S. 438, 450(1976) (quoting Johns Hopkins Univ. v. Hutton, 422 F.2d 1124, 1129 (C.A.4 1970)).
  27. According to an informal survey conducted by Ipreo, the average firm conducted 114 private, one-on-one investor meetings in 2015. Ipreo, Corporate Access Survey (2016), https://ipreo.com/blog/corporate-access-survey-2016/ [https://perma.cc/TBA2-KHW9
  28. An earlier precedent is with quarterly earnings conference calls. For background of the environment, see Brian J. Bushee et al., Open Versus Closed Conference Calls: The Determinants and Effects of Broadening Access to Disclosure, 34 J. Acct. & Econ.149 (2003).
  29.  Other markets have required disclosure of private meetings. Although there are questions about the quality of disclosure, beginning in 2009, listed firms on the Shenzhen Stock Exchange in China were required to disclose investor meetings within two days of their occurrence. SeeQiang Cheng, Seeing is Believing: Analysts’ Corporate Site Visits,21 Rev. Acct Stud.1245 (2016).
  30. Johnson v. United States, 135 S. Ct. 2551, 2557 (2015).
  31. See Nicholas Kappas, A Question of Materiality: Why the Securities and Exchange Commission’s Regulation Fair Disclosure is Unconstitutionally Vague, Note, 45 N.Y.L. Sch. L. Rev. 651 (2001).

Shaming Big Pharma

*Sharon Yadin is Associate Professor, PAC School of Law. sharon@yadin.com. She would like to thank Ron Shapira, Barak Orbach, Oren Perez, and Yoav Dotan for their helpful thoughts and comments and Peres Academic Center for supporting this research. She also wishes to thank the editorial team at the Yale Journal on Regulation.

The FDA recently published a list of top branded drug companies that are suspected of purposely blocking competition from the generic drug industry. Calling out big pharma by “naming and shaming” them into good behavior is an innovative, still largely experimental, regulatory tool designed to harness public opinion and build on pharma’s reputational sensitivities. This Essay analyzes the FDA’s new initiative as a form of regulation by shaming, points to crucial flaws in the agency’s use of the tactic, and suggests key points for improvement.


Novartis, Mylan, Roche, Pfizer, Celgene, Actelion—all these are examples of mega pharmaceutical companies that were recently “named and shamed” by the Food and Drug Administration (FDA).1 This “shaming list,” which was uploaded to the FDA’s website, includes the names of more than 50 branded drug companies that allegedly tried to block competition from generic drug companies.2 The drugs that these generics are trying to produce and sell for a more affordable price to patients range from acne medication to blood thinners, pain killers, antipsychotic drugs, and drugs prescribed for treating cancer and other serious diseases.3 FDA Commissioner Scott Gottlieb has stated that he hopes that the publication of the list will discourage this type of bad behavior by branded drug companies.4 This initiative is indicative of the growing interest of the FDA and other health regulators in adopting “naming and shaming” tactics toward drug companies.5 Can such “regulation by shaming” work?

In general, the term “shaming” is often perceived negatively, causing shaming to be regarded as illegitimate.6 However, shaming can be useful when applied properly by regulatory agencies. In this Essay, I discuss the concrete characteristics and theoretical framing of the innovative regulation recently employed by the FDA, and I argue that, generally, shaming pharma can work but not in the manner in which it was executed in the case of the recent pharmaceutical company “shame list.” I explain how, in this instance, the FDA employed shaming tactics ineffectively, as it failed to convey the message to the public in a comprehensible and accessible manner. In conclusion, I suggest guidelines for successful regulatory shaming that the FDA can administer in the future, drawing on the regulatory shaming tactics employed by regulators in other fields and on regulatory shaming theory and principles. 7

I. Naming and Shaming by the FDA

“Naming and shaming” tactics have been used by the FDA with regards to the pharma industry in recent years, mainly through online publication of non-compliance and warning letters.8 For example, the FDA posted on its website a table listing companies that failed to meet the regulatory requirements of the Pediatric Research Equity Act (PREA),9 primarily the obligation to conduct pediatric studies, along with copies of non-compliance letters issued by the agency and the companies’ responses to these letters.10 According to the FDA, when a company fulfills the requirement to conduct relevant studies, the date it does so is added by the agency to the last column of the table,11 and thus this online database is kept updated.

It now seems that the FDA is interested in further exploring and experimenting with this approach. Only a few months ago, in May 2018, the agency published an online “black list,” in which it named dozens of branded drug companies that are supposedly using unlawful or unethical means to attempt to impede competition from generic drug companies.12

“Generics” are the unbranded versions of branded drugs that appear after the latter have lost patent and regulatory protection.13 Generics contain the same active ingredients, but not necessarily the same inactive ingredients, as branded drugs.14 As generics are not based on the expensive research and development efforts invested in the branded drugs, they cost between 80% and 85% less than the brand-name equivalent.15 Thus, generic drugs can provide an affordable alternative for patients in need.

According to the FDA, potential applicants for generic drug approval are being prevented from obtaining samples of certain branded products named in the list, which are necessary for attaining FDA approval of generic drugs.16 Branded drug samples are vital for generic applicants because the applicants need to demonstrate to the FDA that their version of the product is bioequivalent to the branded drug.17 A generic drug developer generally needs 1,500 to 5,000 units of the branded drug to perform studies needed to gain FDA approval.18

The list names branded drug companies that failed to provide the necessary samples despite requests from prospective generic applicants, and despite the fact that no regulatory restrictions with regard to the samples’ safety and distribution were imposed.19 Generally, the FDA may impose distribution limitations on branded products, as part of an FDA safety program called REMS (Risk Evaluation and Mitigation Strategy).20 But according to the FDA, some companies are falsely arguing that safety issues prevent them from distributing drug samples to generic companies.21 For example, according to the list, one branded drug company (Celgene) that was authorized by the agency to distribute samples to generic companies was nevertheless the subject of 13 complaints received by the FDA from generic companies that were unable to receive such samples.22

The FDA’s publication included open condemnation of big pharma conduct. In the text accompanying the list of companies, the agency explained that “‘gaming’ tactics were being used to delay generic competition,”23 and in a statement, the FDA Commissioner asserted that the pharma companies on the list “have potentially been blocking access to the samples of their branded products.”24 Despite efforts made by the Commissioner to stress that publishing the list was merely an attempt to promote transparency,25 the data, the accompanying text, and the statement made to the press are all indicative of shaming.26

Indeed, this step was clearly intended to draw public attention to big pharma misconduct. As the FDA Commissioner stated regarding the list, “We’ll continue to look at more ways we can expand upon today’s action and call public attention to situations where the careful balance that Congress sought between product innovation and access may be being disrupted.”27 The Commissioner also stated that the agency’s decision to publish the list was rooted in the idea that “no patients should be priced out of medicines they need to support their health” and that it was intended to “increase competition as a way to help make drugs more affordable and improve access.”28

It is worth noting that the FDA’s efforts to maintain competition in the pharma industry are somewhat secondary to, or even beyond, its main mandate. Overall, the agency—which is located within the Department of Health and Human Services—is responsible for regulating drugs for safety and effectiveness and is thus considered “the gatekeeper of the American pharmaceutical marketplace.” Meanwhile, the main agency responsible for addressing anticompetitive business practices is the Federal Trade Commission (FTC). This possible tension was addressed directly by the FDA Commissioner, who stated that the agency’s efforts to improve generic drug competition aimed to improve access and affordability and that the FDA will cooperate in this with the FTC.

The existence of generic drug companies, ensuring fair competition in the market, is in the public interest and is therefore a regulatory goal. Laws such as the Federal Food, Drug and Cosmetic Act (FDCA)29 and the Drug Price Competition and Patent Term Restoration Act (“Hatch-Waxman”)30 to strike a balance between the need to encourage the development of new drugs, which is typically an expensive and lengthy process,31 and the need to make these drugs affordable to all patients. As long as the branded drug company enjoys exclusivity in marketing, based on its patent, the price of the drug can remain as high as the pharma company desires in order to recoup its research and development costs and make a profit.32 The term of a new patent is generally twenty years from the date on which the application was filed with the Patent and Trademark Office, which can occur anytime during the development of a drug.33 When a branded drug company no longer enjoys exclusivity in the market, generic drug companies can enter the market and supply patients with cheaper versions. In reality, though, branded drug companies constantly deploy various means to impede competition from generics—from filing frivolous drug patents and citizen petitions to engaging in various other anti-competitive strategies, such as paying generic manufacturers to delay their entry into the market, reaching anti-competitive agreements, shifting market demand to a new formulation of a drug, and withholding samples.34 These practices are an ongoing concern of legislators and regulators in the health industry.

II. Regulation by Shaming

Shaming is often perceived negatively as a phenomenon that needs to be eradicated35 in which citizens, and sometimes even the state in the criminal context,36 shame other citizens.37 It is often regarded as a despicable act that can cause irreparable harm to individuals.38 Civilian shaming may be based on nothing more than false accusations or insults39 designed to humiliate and inflict pain.40 But administrative shaming is something different. It can achieve regulatory goals effectively, since it is cheaper and faster than other forms of regulatory sanctions, either criminal or administrative, and when designed properly it can efficiently deter organizations from non-compliance.41 Unlike civilian shaming, regulatory shaming is subject to public law norms; it does not aim to humiliate or hurt individuals’ feelings, but to inflict reputational harm on business organizations42 and nudge them in the right direction. Regulation by shaming adds to a growing toolkit of innovative regulatory apparatuses that are meant to enforce norms without relying solely on “command and control.”43 Much like its sibling—disclosure regulation44—regulatory shaming takes place in the “expressive space” of regulation,45 in which the regulator conveys messages and “speaks” to the public. Shaming is not to be confused with the concept of transparency, as it is designed to encourage action by third parties against a non-compliant firm, and it focuses on a condemning rather than an informative message.46

Shaming initiatives by regulatory agencies are becoming more and more common.47 These policies take many forms, including “naming and shaming,” star ratings, color ratings, league tables, public statements, publication of enforcement actions, and publication of inspection results.48 All of them aim to harm the reputation of companies that fail to comply with regulations or that are thwarting regulatory goals in some other way. Shaming highlights actions by these regulated entities that may be illegal or unethical and allows the administrative agency to publicly condemn a specific action (or non-action) of a named company or companies. For instance, regulators shame companies for non-compliance with workplace safety regulations, environmental regulations, or health regulations.49 They also shame companies for “gaming the system” through legally grey area tactics,50 and for overly high salaries paid to CEOs.51

The idea of regulatory shaming is to convey a message to a shaming community—such as employees, investors, peers, consumers, interest groups, politicians, or the general public—which will then act in accordance with the negative feelings invoked by the adverse publication.52 The shaming community can feel betrayed, disgusted, appalled, outraged,53 or otherwise disappointed with the shamed organization or with its behavior. But the main point is that these feelings are translated into action. Without some form of response from the public or other third parties, regulatory shaming cannot work. Customers can protest, file complaints, or boycott the products sold by the condemned regulatee; shareholders may withdraw their investment; employees can demonstrate or even strike; peers and competitors may refuse to engage in any kind of business ventures with the company; and suppliers may refuse to work with it.

Regulation by shaming harnesses firms’ sensitivity to reputational damage. A qualitative research study into environmental regulation found that corporate officials care not only about complying with formal regulations but also with their “social license,” that is, public expectations with regard to environmental performance.54 Public opinion, influenced by a trustworthy organ of the state that openly condemns a company’s actions, can cause financial damage to firms.55 Adverse publications made by administrative agencies can thus become a powerful tool in regulatory enforcement endeavors.56

But in order for regulatory shaming to work, there are several essential components to the shaming process:

  1. Choosing a topic for regulatory shaming that third parties (shaming communities) will be interested in or passionate about
  2. Identifying the right shaming group—those people who can and will act in order to influence the company’s behavior
  3. Taking a regulatory moral stand that is non-controversial and that the shaming community can easily agree with
  4. Properly shaping a shaming message that is well-communicated and specifically designed for the chosen shaming group
  5. Disseminating the shaming message through suitable media channels

These are important steps that need to be carefully implemented in order for the shaming action to fulfill its public interest goal. Shaming initiatives that fail may cause more harm than good. Regulators that do not succeed in correcting market failures through adverse publications may suffer all kinds of consequences.57 For example, they may themselves be scolded by the targeted companies or by third parties, including the intended shaming community. They may harm their relationship with the industry in general and with the shamed entity in particular, causing irreparable damage to regulatory goals and hurting industry willingness to cooperate and comply with regulations and with the regulator in general. They may jeopardize their reputations as professional regulators, and they may become entangled in costly and prolonged legal battles with the shamed regulatees.58


III. What’s Wrong with the FDA’s Shaming Tactic?


Generally, shaming big pharma can be an effective part of the FDA’s regulatory agenda with regards to fair competition in the drug market, for several reasons.

First, the public can easily identify with the need to keep drugs affordable and can be expected to react strongly to branded companies’ attempts to manipulate the market.59 Obviously, patients who depend on a specific drug cannot afford to boycott it. However, public attention to adverse behavior of specific drug companies can, in principal, deter the drug industry in general (as well as specific companies) from engaging in unethical or illegal practices. For instance, Eli Lilly, one of three companies in the world that hold a patent for insulin, was recently the target of harsh public criticism and outrage due to a very steep increase in its product prices.60 It was subject to protests outside its Indianapolis headquarters, as well as calls for tighter regulation and more transparency, and for greater affordability and accessibility of insulin, from advocacy groups such as Patients for Affordable Drugs and the American Diabetes Association.61 Consequently, the House of Representatives is conducting an inquiry into insulin pricing, with the intent of eventually introducing legislation.62 Furthermore, many pharma companies, including those listed in the FDA’s shame list, also sell generics63 and are thus in competition with other companies in a manner that facilitates consumer leverage. Therefore, though medication is clearly different from sportswear in terms of consumer choice, regulatory shaming that is directed towards patients and patient advocacy groups can certainly be effective.

There are also other effective shaming audiences that the FDA can reach, such as potential investors and current shareholders in the pharma industry, and pharma employees. These stakeholders can also play an important role in the “private regulation” process being advanced by the FDA. For example, many investors are unwilling to invest in companies with whose values, actions, and goals they cannot identify,64 a common phenomenon with tobacco, alcohol, and arms companies.65 Sometimes, such investors are driven by fear that investing in such companies may in turn cause them to be personally shamed by others who consider such investments immoral.66 These issues are central to an approach known as “corporate social responsibility” (CSR), which now plays a prominent role in investors’ considerations.67 Under the terms of CSR, the corporate entity is understood through a communitarian prism, which focuses on the social and moral aspects of the corporation’s community activities, rather than its own individualistic interests.68 FDA shaming of pharmaceutical companies for intentionally manipulating the market in order to keep prices high, and hurting patients in need, may trigger a similar effect with pharma shareholders and potential investors. Additionally, pharma employees who learn that their company is acting in a way that is not considered socially responsible may elect to strike, thus causing the company not only indirect reputational harm but also direct financial losses.

The second reason why shaming can be an important tool for the FDA’s regulatory agenda is that the big pharma companies named in the FDA’s list generate annual revenues of billions of dollars.69 With such large sums at the disposal of the regulatees, monetary sanctions may well be an ineffective form of regulatory enforcement and deterrence.70 Indeed, drug prices have been and still remain a major concern of public health regulators and legislators, who have been largely unable to restrain rising drug prices.71 It is thus worth considering other, more sophisticated sanctions, even if only as a complementary measure. Furthermore, since this shaming is mostly directed toward big drug companies, the risk of over-deterrence and of causing disproportionate reputational damages is relatively small.72

Finally, because the drug industry is heavily regulated,73 it is familiar with regulatory intervention and is therefore less likely to be hostile to regulatory endeavors to enforce regulation, minimizing the regulatory risks of shaming.74

Therefore, in theory, shaming big pharma can work. However, the FDA’s recent list of shame was lacking in both form and in substance, failing to include items 4 and 5 (and possibly 2) in the list of critical stages for successful regulatory shaming, as presented in the previous section.75 The FDA’s shaming list is extremely uncommunicative in both the language used and in the ways in which the data has been processed, organized, and presented, and it was not distributed through appropriate channels for effective impact. These findings suggest that the agency has not fully considered the shaming process, its relevant participants, and its intended results and effects.

Figure 1 below shows the FDA’s list (for convenience, only the first few rows are presented).76 A quick glance reveals that the list is not at all designed to be easily accessible for the general public, which is not fluent with the pharma regulation terminology used by the FDA both in the table itself and in the “explanatory” text in the webpage in which the table appears.


Figure 1: Excerpt from the FDA’s Pharma “Shame List” (2018)

Yadin Figure 1

For instance, terms like RLD, REMS, and ETASU are used as the building blocks for this table, which is even called “RLD Access Inquiries.”77 Of the five columns in the table, only the names of the companies and the names of the drugs in columns 1 and 2 are easily understood. Footnotes to the accompanying text which attempt to explain some technical terms only add to the confusion by using even more pharma jargon.78 The table is thus immediately comprehensible only to people within the pharma industry; for a person from outside the pharma industry to understand it would require reading and re-reading the accompanying text (over 2,000 words) as well as the data provided in the table.

Even for those who are able to decipher the lingo in which the FDA describes the condemned behavior of big pharma, the data is very confusing. It includes both pharma companies on which regulatory restrictions on sharing drug samples have been imposed (for safety reasons) and companies that have no such restrictions. However, in an accompanying statement, the FDA Commissioner explains that branded drug companies should always make available “a path to securing samples of brand drugs for the purpose of generic drug development.”79 Also, different kinds of anti-competitive behaviors are described by the agency in the explanatory text, including contractual restraints imposed by branded drug companies on sellers, such as pharmacies.80

Thus, the FDA publication obscures, diffuses, and dilutes its main message, and thereby fails to realize the full potential of regulatory shaming of the pharma industry.

Examples of regulatory shaming by other regulatory agencies show how the FDA could have done a much better job of shaping its message and making it comprehensible to relevant shaming communities. For example, the webpage in which the FDA lengthily explains the idea of the list and its complex database uses dense pharma regulation terminology and lacks any graphic support besides the table itself.81 By contrast, the Department of Health and Human Services provides an online rating of nursing homes that is based on a highly intuitive five-star scale, incorporating an easily understood graphic measuring tool (see Figure 2).82 In this form of regulation by shaming, each rated facility is assigned a star rating based on its weighted score from recent health inspections, its staff-resident ratio, and clinical data, saving the public the task of wading through the underlying data and navigating technical language.83 The star ratings are posted online, which can shame poorly rated nursing homes into doing better in the inspected areas.


Figure 2: Medicare, “Nursing Home Compare”

Yadin Figure 2


Another example is the Environmental Protection Agency’s (EPA) Toxics Release Inventory (TRI) program (see Figure 3), in which the agency publishes facility-based information regarding air, water, and land pollution, as well as compliance status.84 Here, significantly non-compliant facilities are marked red, while compliant facilities are marked blue.


Figure 3: EPA Toxics Release Inventory Program

Yadin Figure 3


The methods used by the Department of Health and Human Services and the EPA, in which data are formulated and presented in a clear and communicative manner, can be very effective in soliciting public attention and facilitating corporate shaming to achieve regulatory goals.

The chosen distribution methods for the FDA’s message were also flawed. The list of pharma companies was only mentioned on a few of the FDA’s Twitter accounts,85 with a concise informative notification (see Figure 4) referring the readers to the FDA Commissioner’s statement.86


Figure 4: FDA Tweet about its “Shame List”


This relative paucity of communication is particularly surprising given that the FDA has a fairly heavy social media presence and conducts extensive interactive media activity. The agency sends out email alerts to subscribers and provides RSS feeds and also maintains a Facebook page in both English and in Spanish, a Pinterest page with dozens of infographics, more than 20 Twitter accounts, a blog, a YouTube channel, and a Flickr page, most of which are updated daily, even several times a day.87 (last visited Aug. 28, 2018).]

By contrast, an example from the Occupational Safety and Health Administration (OSHA) shows how social media, as well as administrative agencies’ webpages and news releases, can be properly harnessed for regulatory shaming. Figure 5 below is an example of OSHA’s almost daily tweets on enforcement actions taken against companies that violate workplace safety regulations.88 The tweet links to a webpage (news release) in which the agency clearly and concisely explains the case,89 without unnecessary OSHA jargon or undecipherable data (see Figure 6).


Figure 5: OSHA Shaming Tweet


Figure 6: OSHA News Release


In short, the FDA’s efforts at shaming big pharma would be much more effective if it was to follow the five-step process laid out in this Essay.90 First, it must choose a topic that people are interested in or passionate about. Drug companies’ behavior can generally be considered a fitting subject for shaming since patients are dependent on these companies for their health. Therefore, issues that relate to illegal or unethical practices of pharmaceutical companies, such as price gouging, exclusion of competitors, or poor transparency regarding their activities, can be considered good candidates for regulatory shaming. Second, the FDA should carefully identify the right shaming audience, and consider patients, health advocacy groups, investors in the pharma sector, pharma employees, and the pharma industry in general. Defining the right target group will improve the effectiveness of any regulatory shaming effort. Third, the FDA should consider whether its moral stand regarding the pharma industry is fully shared by the targeted shaming communities. In all of these first three steps, the FDA’s regulatory shaming of big pharma is on fairly solid ground, though some improvements may be needed in step two.

The final two steps, however, need significant improvement if the FDA’s shaming tactics are to achieve more effective results. The fourth step is that the FDA must shape its shaming message in a much more communicative manner. The message needs to be simple and direct. Instead of lengthy text embedded with pharma jargon, or undecipherable charts and data, use should be made of short statements; infographics; easily digestible numbers, scores, and ratings; and intuitive and attractive design. Messages of this type are far more suited to most shaming audiences, as well as to the media, and thus can be much more effective in changing drug companies’ behavior. In this regard, short messages that name specific companies can be more effective than general sector-wide shaming; and converting data into simple ratings and scores can offer a more straightforward message for widescale dissemination.

And fifth, proper use of social media and digital media in general is crucial for regulatory communication with the public in today’s world. Short shaming messages and related graphics are highly suited for platforms such as Facebook and Twitter. The FDA should harness multiple media outlets that have high visibility in order to disseminate the message as broadly as possible, and can issue repeated publications as needed. These communications can also include reports to the public on how FDA shaming efforts have helped change pharma companies’ behavior, thus encouraging further public participation in “private regulation” based on regulatory shaming.



The FDA has been accused by some commentators of being an agency that engages in “regulatory silence”—that is, it is reluctant to take action that may be viewed as aggressive or outside the clear scope of product safety and efficiency.91 But in fact, the FDA has shown real initiative in the regulatory tools arena, experimenting with “naming and shaming” of drug companies that engage in anti-competitive behavior to impede competition from generics. Though some may consider shaming to be “soft” rather than “hard” regulation, it is definitely not passive or neutral, and it is a clear example of “thinking outside the box.” Naming and shaming practices are most certainly an embodiment of the FDA’s regulatory philosophy, developed in the 1970s, which advocates achieving the general objectives of the law in creative ways that do not violate statutory restrictions.92

The rising prices of drugs across the country are currently a major public policy problem, one with which regulators are still grappling.93 Under these circumstances, there is a great need for creative regulatory solutions. Only recently, the Department of Health and Human Services proposed requiring that TV ads for prescription drugs include their list price, in order to incentivize drug companies to lower their prices.94 Officials in the Department have also declared that they intend to shame drug companies that do not comply with the new rule once it is passed.95

It therefore seems that in the health industry, regulatory shaming is more relevant than ever. But can shaming big pharma work? Can it efficiently achieve regulatory goals, such as enhancing competition in the pharma industry and bringing down drug prices? Can shaming by the FDA in other regulatory fields work as well? And can it also work for other health regulators? The answer to all these questions, in my opinion, is yes.96 But first, the regulatory agency has to properly identify the intended shaming group (the general public, the pharma industry, investors, etc.) and then both correctly formulate the shaming message and select the appropriate media channels, so as to communicate its message in an efficient and accessible manner.

Although this Essay has focused on deficiencies in the implementation of the regulatory shaming approach by the FDA, some elements of its approach were entirely correct. One of the smartest things the FDA did was to publicly notify, in advance, that regulatory shaming was going to take place in a certain subject area. In fact, the head of the FDA stated almost a year in advance that the agency had identified that “gaming tactics” were being employed by branded drug companies to impede competition from generics and that the agency planned to publicize the letters it had received from authorized generics that had requested samples from branded drug companies and were denied.97 Announcing regulatory shaming ahead of time can create deterrence in the drug industry and reduce unwanted behaviors by big pharma companies, even before the shaming itself takes place.

In conclusion, regulatory shaming holds great promise for curtailing bad behavior by big pharma. Regulators in health and other sectors, as well as legal scholars, should further develop this interesting and innovative approach to regulation.

  1. See Reference Listed Drug (RLD) Access Inquiries, U.S. Food & Drug Admin. (FDA), https://www.fda.gov/Drugs/DevelopmentApprovalProcess/HowDrugsareDevelopedandApproved/ApprovalApplications/
    AbbreviatedNewDrugApplicationANDAGenerics/ucm607738.htm [https://perma.cc/K3E5-C9DZ] (last visited Aug. 27, 2018) [hereinafter FDA list]. The list was published on May 17, 2018. See FDA Statement, Statement from FDA Commissioner Scott Gottlieb, M.D., On New Agency Efforts to Shine Light on Situations Where Drug Makers May Be Pursuing Gaming Tactics to Delay Generic Competition, U.S. Food & Drug Admin. (FDA), https://www.fda.gov/NewsEvents/Newsroom/PressAnnouncements/ucm607930.htm [https://perma.cc/SA29-QNAN] [hereinafter Statement from FDA Commissioner].
  2. See id.; FDA list, supra note 1.
  3. See id.
  4. See Statement from FDA Commissioner, supra note 1.
  5. See, e.g., FDA Statement, Statement from FDA Commissioner Scott Gottlieb, M.D., On New Agency Actions to Further Deter ‘Gaming’ of the Generic Drug Approval Process by the Use of Citizen Petitions, U.S. Food & Drug Admin. (FDA), Oct. 2, 2018, https://www.fda.gov/NewsEvents/Newsroom/PressAnnouncements/ucm622252.htm [https://perma.cc/H9XB-K9N3].
  6. See, e.g., James Q. Whitman, What Is Wrong with Inflicting Shame Sanctions?, 107 Yale L.J. 1055, 1055-56 (1998).
  7. See Sharon Yadin, Regulatory Shaming, 49 Envtl. L. (forthcoming 2019), https://ssrn.com/abstract=3290017 (developing the theory and basic principles of “regulatory shaming”).
  8. See, e.g., Warning Letters and Notice of Violation Letters to Pharmaceutical Companies, U.S. Food & Drug Admin. (FDA), https://www.fda.gov/Drugs/GuidanceComplianceRegulatoryInformation/EnforcementActivitiesbyFDA/
    WarningLettersandNoticeofViolationLetterstoPharmaceuticalCompanies/default.htm [https://perma.cc/VDJ6-FSFR] (last visited Aug. 30, 2018).
  9. Pediatric Research Equity Act of 2007, Pub. L. No. 110-85, 121 Stat. 866 (codified as amended in 21 U.S.C. § 301).
  10. See Non-Compliance Letters under 505B(d)(1) of the Federal Food, Drug, and Cosmetic Act, U.S. Food & Drug Admin. (FDA), https://www.fda.gov/drugs/developmentapprovalprocess/developmentresources/ucm343203.htm [https://perma.cc/9ETR-C7EK] (last visited Aug. 30, 2018).
  11. See id.
  12. See Statement from FDA Commissioner, supra note 1.
  13. See Kathleen Craddock, Improving Generic Drug Approval at the FDA, 7 Mich. J. Envtl. & Admin. L. 421, 423 (2018).
  14. See Cheryl Spector, Generic Copies: Are They New Drugs, 3 Cardozo L. Rev. 131, 131 (1981).
  15. See Shyam Goswami, Windfall Profits and Failed Goals of the Bayh-Dole Act, 19 J. Gender Race & Just. 375, 382 (2016).
  16. See FDA list, supra note 1.
  17. See Statement from FDA Commissioner, supra note 1.
  18. See FDA list, supra note 1.
  19. See id.
  20. See Risk Evaluation and Mitigation Strategies (REMS), U.S. Food & Drug Admin. (FDA), https://www.fda.gov/Drugs/DrugSafety/REMS/default.htm [https://perma.cc/M9VL-VKK4] (last visited Nov. 3, 2018).
  21. See FDA list, supra note 1.
  22. See id.
  23. See id.
  24. See Statement from FDA Commissioner, supra note 1.
  25. See id. See also Beth Mole, Shame, Shame, Shame — FDA has Named Names of Pharma Companies Blocking Cheaper Generics, arsTECHNICA (May 17, 2018), https://arstechnica.com/science/2018/05/fda-to-start-naming-names-of-pharma-companies-blocking-cheaper-generics [https://perma.cc/EW6Y-XUPS].
  26. See also infra Part II; Yadin, supra note 7 (discussing the difference between shaming and transparency).
  27. See Statement from FDA Commissioner, supra note 1.
  28. See id.
  29. 21 U.S.C. § 301 (2015).
  30. Pub. L. 98-417, 98 Stat. 1585 (1984).
  31. See, e.g., Margaret Gilhooley, FDA and the Adaptation of Regulatory Models, 49 St. Louis U. L.J. 131, 132 (2004); Jordan Paradise, Regulatory Silence at the FDA, 102 Minn. L. Rev. 2383, 2395 (2018).
  32. See Craddock, supra note 13, at 425-26; Christine S. Paine, Brand-Name Drug Manufacturers Risk Antitrust Violations by Slowing Generic Production through Patent Layering, 33 Seton Hall. L. Rev. 479, 480-81 (2003).
  33. See 35 U.S.C. § 154(a)(2). For more information see Frequently Asked Questions on Patents and Exclusivity, U.S. Food & Drug Admin. (FDA), https://www.fda.gov/drugs/developmentapprovalprocess/ucm079031.htm#howlongpatentterm [https://perma.cc/XU3P-EH5R] (last visited Sep. 2, 2018). There are also “exclusivity periods,” given for six months to seven years upon approval of certain drugs, regardless of a patent. See id.
  34. See Paine, supra note 32, at 479-81; Paradise, supra note 31, at 2398.
  35. See, e.g., Whitman, supra note 6, at 1055-56.
  36. In criminal contexts, the government, mostly through the judiciary, shames offenders by publishing information about crimes and criminals after crimes are committed. See, e.g., Dan M. Kahan, What Do Alternative Sanctions Mean?, 63 U. Chi. L. Rev. 591, 631-32 (1996).
  37. See generally Kristine L. Gallardo, Taming the Internet Pitchfork Mob: Online Public Shaming, the Viral Media Age, and the Communications Decency Act, 19 Vand. J. Ent. & Tech. L. 721 (2017); Kate Klonick, Re-Shaming the Debate: Social Norms, Shame, and Regulation in an Internet Age, 75 Md. L. Rev. 1029 (2016).
  38. See, e.g., John Braithwaite, Crime, Shame, and Reintegration 68 (1989); Danielle Keats Citron, Hate Crimes in Cyberspace 11 (2014).
  39. See, e.g., Emily Chiang, Institutional Reform Shaming, 120 Penn St. L. Rev. 53, 84 (2015).
  40. See id.
  41. See Yadin, supra note 7.
  42. See id.
  43. See id. The legal concept of “regulation” is often perceived as control or constraint. See Barak Orbach, What is Regulation?, 30 Yale J. on Reg. Online 1, 4 (2012).
  44. Disclosure regulation focuses on requiring manufacturers and service providers to actively reveal information about their products. See Yadin, supra note 7.
  45. See generally Alex Geisinger, Reconceiving the Internal and Social Enforcement Effects of Expressive Regulation, 58 Wm. & Mary L. Rev. Online 1, 8-9 (2016).
  46. See Yadin, supra note 7.
  47. See id.
  48. See infra Part III. See also Yadin, supra note 7.
  49. See id.
  50. As discussed in the FDA example which is the focus of this Essay.
  51. The Securities and Exchange Commission (SEC) recently adopted a shaming strategy through a regulation that requires companies to disclose the compensation ratio between their median employee (by salary) and their CEO. See 15 U.S.C. § 78I note (2012); 17 C.F.R §§ 229, 240, 249 (2015).
  52. See Yadin, supra note 7.
  53. See generally Cass R. Sunstein, Growing Outrage, Behavioural Public Policy (Aug. 30, 2018), https://www.cambridge.org/core/journals/behavioural-public-policy/article/growing-outrage/07A7377940D8BA0E503DDB8C10EEC70F#.W4lw6NdmaBE [https://perma.cc/27Z7-CU3U].
  54. See Dorothy Thornton et al., General Deterrence and Corporate Environmental Behavior, 27 Law & Pol’y 262, 264 (2005).
  55. See, e.g., Andrea A. Curcio, Painful Publicity—An Alternative Punitive Damage Sanction, 45 DePaul L. Rev. 341, 372-76 (1996).
  56. See generally Yadin, supra note 7.
  57. See generally Barak Orbach, What is Government Failure?, 30 Yale J. on Reg. Online 44 (2012) (discussing the concept of “regulatory failure”).
  58. Regulatory shaming may sometimes be legally problematic. Examples of possible illegality of regulatory shaming include harsh reputational damage; publication of citations prior to final orders, which implicates due process; and lack of statutory authority to sanction by public shaming. See, e.g., Eric J. Conn & Casey M. Cosentino, Hot Off the Press: Two Attorneys Argue That OSHA’s Enforcement Press Releases Violate the Federal Administrative Procedure Act, EHSToday (Sep. 1, 2011), http://www.ehstoday.com/standards/osha/hot-off-press-0901 [https://perma.cc/EV8Z-TDPD]. Since shaming practices vary from one agency to another, and even within the same agency, each with a different legal basis, a complex generalized analysis in this regard will remain outside the scope of this Essay.
  59. See supra Part II (Items 1-3).
  60. See Nathaniel Weixel, Skyrocketing Insulin Prices Provoke New Outrage, The Hill (June 21, 2018), https://thehill.com/policy/healthcare/393378-skyrocketing-insulin-prices-provoke-new-outrage [https://perma.cc/W44W-PTEG].
  61. See id.; John Russell, Lilly Insulin Prices Come Under Microscope, IBJ (Aug. 26, 2017), https://www.ibj.com/articles/65163-lilly-insulin-prices-come-under-microscope [https://perma.cc/ZL8K-PMFQ].
  62. See Weixel, supra note 60.
  63. See, e.g., Sheila Kaplan, F.D.A. Names and Shames Drug Makers to Encourage Generic Competition, NY Times (May 17, 2018), https://www.nytimes.com/2018/05/17/health/drug-prices-generics-fda.html [https://perma.cc/7DLY-29C4].
  64. See, e.g., Douglas M. Branson, Corporate Social Responsibility Redux, 76 Tul. L. Rev. 1207, 1219 (2002).
  65. See id.
  66. See id.
  67. See id.
  68. See id. at 1217. See also Oren Perez, Reuven Cohen & Nir Schreiber, Governance through Global Networks and Corporate Signaling, Reg. & Governance (forthcoming 2019), https://ssrn.com/abstract=3265793 [https://perma.cc/XV4L-Q365] (discussing the reasons why companies adopt CSR schemes) (manuscript at 4-5).
  69. For instance, Roche grossed more than $42.2bn in 2017; Pfizer—$52bn; Novartis—$49bn; and Bayer—$29.1bn. See Vasanthi Vara, The World’s Biggest Pharmaceutical Companies by Revenue in 2018, Pharmaceutical Technology (June 20, 2018), https://www.pharmaceutical-technology.com/features/worlds-biggest-pharmaceutical-companies-2018 [https://perma.cc/PAY3-D3QA].
  70. Between 1991 and 2015, financial penalties imposed amounted to just five percent of the $711 billion in net profits made by the eleven largest global drug companies during just ten of those twenty-five years (2003-2012). See Twenty-Five Years of Pharmaceutical Industry Criminal and Civil Penalties: 1991 Through 2015, PUBLICCITIZEN (March 31, 2016), https://www.citizen.org/our-work/health-and-safety/twenty-five-years-pharmaceutical-industry-criminal-and-civil-penalties-1991-through-2015 [https://perma.cc/6EBH-97YL].
  71. See generally U.S. Dep’t. of Health & Human Servs., American Patients First: The Trump Administration Blueprint to Lower Drug Prices and Reduce Out-of-Pocket Costs (May 2018), https://www.hhs.gov/sites/default/files/AmericanPatientsFirst.pdf [https://perma.cc/ZAQ7-YLSQ].
  72. See Yadin, supra note 7.
  73. See, e.g., Adrian Towse & Patricia M. Danzon, The Regulation of the Pharmaceutical Industry, in The Oxford Handbook of Regulation 548, 548 (Robert Baldwin, Martin Cave & Martin Lodge eds., 2010).
  74. See supra Part II.
  75. See id.
  76. See FDA list, supra note 1.
  77. REMS stands for “Risk Evaluation and Mitigation Strategy”; ETASU, for “Elements to Assure Safe Use”; RLD for “Reference Listed Drug”.
  78. Such as GDUFA II, ANDA, and RS. See FDA list, supra note 1. GDUFA stands for “The Generic Drug User Fee Act”; ANDA for “Abbreviated New Drug Application”; and RS for “Reference Standard.”
  79. See Statement from FDA Commissioner, supra note 1.
  80. See FDA list, supra note 1.
  81. See id.
  82. See Nursing Home Compare, CTRS. for Medicare & Medicaid Servs., https://www.medicare.gov/nursinghomecompare/search.html [https://perma.cc/74WB-QGVS] (last visited Aug. 27, 2018). Figure 2 is an example of a low-star rating given to a specific nursing home in New York.
  83. See id.
  84. See Toxics Release Inventory (TRI) Program, Envtl. Prot. Agency,
    http://www.epa.gov/toxics-release-inventory-tri-program [https://perma.cc/X4YG-NWHT] (last visited Aug. 27, 2018). Figure 3 is an example of a rating that signals non-compliance, including significant non-compliance of a specific company found in the EPA’s database.
  85. See, e.g., FDA Media Affairs (@FDAMedia), Twitter (May 17, 2018, 6:57 AM), https://twitter.com/FDAMedia/status/997113935747829760 [https://perma.cc/WLS7-RX5R].
  86. In the statement page, another link provides access to the table itself.
  87. See Interactive Media, FDA, U.S. Food & Drug Admin., https://www.fda.gov/NewsEvents/InteractiveMedia/default.htm [https://perma.cc/Z63B-Q99P
  88. See OSHA (@OSHA_DOL), Twitter (June 29, 2018, 7:50 AM), https://twitter.com/OSHA_DOL/status/1012709797282680832 [https://perma.cc/M8YD-LQEK].
  89. Meanwhile, the FDA Commissioners’ statement was 1,200 words long. See Statement from FDA Commissioner, supra note 1.
  90. See supra Part II.
  91. See Paradise, supra note 31, at 2409-10; Carl Tobias, FDA Regulatory Compliance Reconsidered, 93 Cornell L. Rev. 1003, 1004, 1009 (2008).
  92. See Gilhooley, supra note 31, at 132.
  93. See generally American Patients First, supra note 71.
  94. See What You Need to Know about Putting Drug Prices in TV Ads, HHS.gov, (Oct. 15, 2018), https://www.hhs.gov/about/news/2018/10/15/what-you-need-to-know-about-putting-drug-prices-in-tv-ads.html [https://perma.cc/J7PE-4ZA].
  95. See Amy Goldstein & Carolyn Y. Johnson, Drugmakers May Have to Disclose Prices of Medicine in Television Ads, Wash. Post (Oct. 15, 2018), https://www.washingtonpost.com/national/health-science/tv-ads-for-drugs-will-send-patients-to-websites-with-pricing-information/2018/10/15/b74ac344-d090-11e8-b2d2-f397227b43f0_story.html?utm_term=.47f67cc81e3a [https://perma.cc/69E9-9BFP].
  96. These, of course, warrant additional study. But see generally Yadin, supra note 7.
  97. See Jayne O’Donnell, FDA Chief Says Drug Makers Are Gaming the System to Slow Generic Competition; Vows Action, USA Today (Aug. 15, 2017), https://www.usatoday.com/story/news/politics/2017/08/15/fda-chief-says-drug-makers-gaming-system-slow-generic-competition-vows-action/568698001 [https://perma.cc/A8ZX-KXQ4].

The Quiet Undoing: How Regional Electricity Market Reforms Threaten State Clean Energy Goals

Danny Cullenward is Policy Director, Near Zero; Research Associate, Carnegie Institution for Science; and Lecturer in Law, Stanford Law School. Shelley Welton is Assistant Professor, University of South Carolina School of Law.

In a series of largely unnoticed but extremely consequential moves, two regional electricity market operators are pursuing reforms to make it more difficult for states to achieve their clean energy goals. The federal energy regulator, FERC, has already approved one such reform and ordered a second market operator to go farther in punishing state-supported clean energy resources than it had initially proposed. In this Essay, we bring to light the ways in which the intricate, technical reforms underway in regional electricity markets threaten state climate change objectives and the durability of FERC’s regional market constructs. If FERC allows private market operators to impose their policy preferences on participating states—or if FERC requires pro-fossil market designs—progress in decarbonizing the electricity sector will likely slow. At the same time, the potential for greater regional cooperation in electricity markets—a critical strategy for integrating a high penetration of renewable energy onto the electricity grid—will diminish.

I. Introduction1

In the past year alone, the Trump Administration has announced two brazen new strategies to prop up ailing coal and nuclear power plants.2
Each of these has been the subject of many headlines.3 Neither, however, has yet come to fruition—in large part because they have been opposed by the key federal agency in charge of wholesale electricity markets, the Federal Energy Regulatory Commission (FERC).4 FERC’s commissioners have all spoken out against any strategies that would undo the decades of progress that the agency has made in crafting robust, well-functioning regional energy markets.5 At the same time, in a series of lawsuits challenging state support for nuclear power, FERC has encouraged the federal courts to defer to FERC’s decisions about how best to manage the intersection of state clean energy goals and federally overseen electricity markets.6

FERC’s stance in these debates might seem to provide some comfort that the agency will refuse political efforts to stymie the clean energy transition by propping up fossil fuel resources. But in fact, in a pair of a deeply divided and technically dense decisions, the Commission has recently approved two extraordinary market reforms that threaten to undermine state clean energy goals.7 These decisions, we submit, present a “quiet undoing” of state progress in tackling climate change, and although they are less blatant than President Trump’s dramatic proposals, they are pernicious in their own right.

FERC’s reforms have gotten little attention due to their maddeningly technocratic veneer.8 In this Essay, we describe the Commission’s aggressive interventions to bring to light the ways in which its recent reforms present a serious threat to states’ autonomy over their energy mix—at the same time that state clean energy policies are shaping up to be the only progress forward on climate change under the Trump Administration.

II. The Battles in Eastern Markets

In this Part, we begin by describing the basic structure of regional energy markets. Next, we turn to the role that state financial support plays in determining market outcomes, which leads to tension between different kinds of generators. Finally, we describe the reforms undertaken by two East Coast market operators, which are pursuing market designs that aim to “correct” for state policy choices, and in so doing, frustrate state clean energy policy goals.

A. Energy and Capacity Market Basics

At the dawn of the U.S. electricity industry in the late nineteenth century, energy regulation was a matter left exclusively to the states. Over time, however, the creation and integration of federal authority has altered the regulatory landscape.9 The Federal Power Act of 1935 created the enduring divide between federal and state authority in the electricity sector that applies today: the federal government oversees interstate “wholesale” electricity sales, whereas states retain control over “retail” sales and “facilities used for the generation of electric energy.”10 States have long relied on the Federal Power Act’s reservation of state control over generation as an explicit sanction of states’ authority to control their own resource mix.11 And state control over generation has persisted, even as federal regulators have increasingly ushered market-based competition into the industry under their authority to ensure “just and reasonable” interstate wholesale rates.12

The modern FERC was created in 1977 and began in the late 1990s to encourage (but not require) federally regulated electricity markets, which now serve two-thirds of national electricity demand.13 These markets sought to replace the previous system of vertically integrated utilities and bilateral transactions with a more robust and transparent market mechanism for facilitating the exchange of power among utilities.14 Through a series of orders, FERC asked utilities to voluntarily join regional market constructs known as Independent System Operators (ISOs) and Regional Transmission Organizations (RTOs), subject to the approval of their home states.15 (For convenience, we will refer only to RTOs in this essay, although our analysis applies equally to ISOs as well.16)

Unlike FERC and its state counterparts, these market operators are private, non-profit organizations charged with developing electricity markets that ensure open access to the transmission systems they operate. Market operators develop and reform market rules via complex stakeholder processes; some use weighted sector voting by RTO members (predominantly utilities and generators) to advance proposals.17 Although state governments and civil society can participate as stakeholders in these processes, market operators’ independent governing boards make the ultimate decisions about what gets filed with FERC.18

RTOs operate two broad categories of federally regulated electricity markets: energy and capacity markets.19 Energy markets are the more intuitive of the two. RTOs operate real-time and day-ahead energy markets for electricity, matching supply and demand based on customer load, power plant generators’ bids, and the physical constraints of the transmission network they operate. RTOs select the lowest-cost bids (expressed as dollars per megawatt-hour ($/MWh) of electrical energy) capable of serving customer loads; all generators whose bids are accepted receive the market-clearing price, which is set by the highest accepted bid necessary to meet demand.

Capacity markets address a different issue. Not only must electrical energy be available at the instant it is demanded, but regulators must also ensure that sufficient generation capacity will be available to meet future projected demand. Some foresight is needed because power plant construction and permitting take years, not seconds. Many areas of the country rely on state- or utility-level “resource adequacy” obligations that achieve this outcome by requiring utilities to own or contract for future electricity supply adequate to meet their anticipated customer demand.20 But in several of the RTOs—located predominantly in the eastern part of the country—market operators have instead decided to ensure adequate future electricity supply through running separate, centralized capacity markets.21

In centralized capacity markets, the regional market operator first determines the amount of future generation capacity the region needs throughout its footprint, typically three years in the future. Then, the RTO accepts bids from power plant owners that reflect the price at which they would commit to have future generation available when called upon.22 Just as with energy markets, the market-clearing price for capacity markets (typically expressed as dollar per megawatt ($/MW) of capacity) is based on the amount necessary to compensate a sufficient number of generators with the necessary capacity. However, the economics of capacity markets are significantly more complex, due to the variety of market designs, the bidding strategies of market participants, and the presence of state and federal subsidies.23

B. A Brief Overview of Prominent Subsidies

Like all energy markets, electric energy and capacity markets include market participants that receive a wide range of subsidies.24 Fossil fuel generators receive an implicit subsidy because most are not forced to internalize the costs of environmental pollution, including greenhouse gas emissions.25 Although significant, these externalized social costs are less visible than the explicit financial subsidies that many resources also receive. As one FERC commissioner has noted, “[s]ince 1950, the federal government has provided roughly a trillion dollars in energy subsidies, of which 65 percent has gone to fossil fuel technologies.”26 Clean energy has increasingly received explicit subsidies, in forms including federal tax credits for wind energy (provided on a $/MWh basis),27 state renewable portfolio standards (which require utilities to procure a certain share of their total resource mix from qualified renewables, often through the purchase of environmental attributes called RECs),28 and state support to keep nuclear power plants in operation.29

Each of these policies affects capacity market outcomes. To take just one example, consider the case of a wind farm that receives financial support from the state and federal governments. In this case, the wind farm will be able to bid less than its “true” costs because the power plant’s owner does not need to recover this full amount from the capacity market as a result of the subsidies she receives. This will have two effects. First, the wind farm is more likely to produce a winning bid, which would make it eligible to receive the capacity market’s clearing price. Second, by bidding in at a lower price, the wind farm may decrease the overall market-clearing price, reducing the compensation all successful bidders receive.

What should one make of these consequences? Given the breadth of subsidies that permeate energy markets, there is no obvious way to parse which subsidies should or should not be allowed to influence markets.30 Historically, RTOs have hesitated to make any value judgments in this regard, identifying themselves as neutral technocrats charged with developing efficient market designs within the policy confines imposed on them by state and federal policymakers—even when those policies work at competing ends from a theoretical economic perspective.31
Consequently, market operators that follow this philosophy have generally attempted to accommodate the heterogeneous policy preferences of their member states.

As the ambition of many states’ clean energy policies grows and diverges with respect to that of their neighbors, however—and as U.S. electricity markets find themselves with excess capacity—market operators are increasingly viewing heterogeneous state policies as a threat to economically efficient markets. From the perspective of a non-renewable power plant, the lower market prices to which state clean energy subsidies contribute translate into lower revenues. These price impacts become more relevant as renewable energy resources make up a growing share of capacity additions in federally regulated energy markets. Whereas most new generation capacity in the 2000s came from non-renewable resources, more than half of the nameplate capacity added since 2010 comes from renewable facilities.32 But there is no free lunch: the full costs of these facilities are paid by a combination of capacity market participants (with costs ultimately borne by utility customers) and taxpayers. Critically, renewables do not impose direct costs on legacy fossil generators, although they may capture market share and therefore reduce fossil generators’ revenues. Moreover, however they are financed, these additions to the grid help to satisfy the region’s needs for additional capacity.33

The substantial impact of these policies, then, is to redistribute power plant compensation levels through state support for certain resources—largely away from one set of resources (fossil fuel generators) and towards another (new renewable energy generation).34 One could view this result as a problem undermining theoretically ideal markets—or, as we prefer, simply as the inevitable consequence of hard-won state progress toward decarbonization in the absence of a federal price on carbon. Below, we describe the view taken by certain market operators and recently endorsed by FERC, before explaining why we think it is a blinkered approach to the long-term challenges confronting electricity markets and electricity federalism.

C. Case Studies

Two regional markets stand out for having gone the furthest in restructuring their capacity markets in response to state clean energy policies: New England (ISO-NE) and the mid-Atlantic (PJM). A divided FERC accepted New England’s reforms earlier this year. More recently, the Commission held that PJM’s proposals do not go far enough in insulating markets from state clean energy policies, leading FERC to demand even more stringent reforms from PJM. Here, we summarize these intricate reforms in plain English to help a broader set of readers understand why these changes portend a troubling turn for energy federalism and clean energy politics.

    1. ISO-NE

New England is the first region to have adopted a substantial re-design of its capacity market to respond to state renewable energy policies. In January 2018, ISO-NE responded to low capacity market prices and the expected surge in regional clean energy by proposing a novel two-stage capacity auction, which FERC approved two months later.35 In the first stage, resources receiving state “sponsorship”36 must bid in at an administratively determined “minimum offer price” (also called a “MOPR”)—thus eliminating the possibility that state-supported renewable resources might suppress capacity market prices by submitting lower bids that factor in their state support.37 In practice, this structure means that few state-sponsored resources will clear the first-stage capacity auction.38

A second stage then attempts to shift capacity commitments from near-end-of-life generation to state-sponsored (typically renewable) resources by allowing older resources to name a price at which they would be willing to transfer their capacity commitments to state-supported renewables and retire.39 In essence, this design means that state-sponsored renewables may only enter the market after ratepayers first buy out old fossil fuel or nuclear generators, which then receive a severance payment equal to the difference between the first (higher) and second (lower) capacity auction prices.40 Under this market design, renewable and other state-supported resources receive less revenue from the capacity market than their fossil-fuel counterparts. ISO-NE celebrates this design for “closely coordinating the entry (of sponsored) and exit (of retiring) capacity resources.”41

Although FERC approved this design in March 2018, three of five commissioners wrote separately to express reservations42 and a fourth subsequently expressed agreement with some of these concerns.43 It is thus unsurprising that several petitions for rehearing are pending.44 We turn below to our arguments as to why FERC should reconsider its approval of these reforms, after exploring the second regional capacity market transformation currently underway.

    2. PJM

PJM took a different tack than ISO-NE in its capacity market reforms, largely due to fierce infighting within the region as to their necessity and advisability. Unable to reach stakeholder agreement on a single path forward, PJM filed two alternative proposals with FERC in April 2018, expressing its preference for one but leaving the ultimate choice to the Commission.45 Each proposal suggests a different way to deal with what PJM calls “subsidized resources.”46

Under PJM’s preferred option, “Capacity Repricing,” the market operator would run the market one time with “subsidized resources” included at their self-determined bid price, to figure out which resources receive capacity obligations.47 Then, the market would be run a second time, with subsidized bids “repriced to a competitive level” in order to set higher compensation levels to be paid to all resources that cleared the first market.48 Alternatively, PJM proposed extending its “minimum offer price rule extension” (or MOPR-Ex)—which currently requires some resources to submit mandated minimum bids—to state-supported resources, with the possible exception of resources needed specifically to meet state renewable portfolio standards.49 In this model, covered renewables would only clear the capacity market if they were cost-competitive with other resource types after factoring out any state support.50

In a move that stunned many, FERC rejected both of these proposals in a 3-2 decision issued June 29, 2018—but not because it thought they intruded too deeply into states’ sovereignty over their own resource mix. Instead, the essence of FERC’s order was that neither went far enough in insulating markets from state policy choices.51 For this reason, the Commission decided to declare PJM’s existing capacity market rules “unjust and unreasonable,” and to initiate its own “paper hearing” to consider yet a third alternative capacity market reform.52

The Commission’s preferred approach would expand the MOPR to all resources that “receive out-of-market payments,” while allowing state-supported renewable resources to choose to remove themselves from the capacity market “along with a commensurate amount of load, for some period of time.”53 It analogized this structure to PJM’s existing “Fixed Resource Requirement” (FRR) option, which allows a utility to elect to secure its capacity obligations via bilateral contracts made outside the region’s centralized capacity market.54 The majority admitted in its order that this proposal leaves many questions unanswered about how the FRR construct should apply to renewable resources.55 For this reason, it requested interested parties to file comments on FERC’s proposal within 60 days.56

Two FERC commissioners—as it happens, the two Democratic Commissioners whose appointments are required by statute to maintain ideological balance on the five-member Commission57—offered vigorous dissents. One decried the majority’s procedural choices, arguing that the Commission’s decision to open a paper hearing focused on a modified FRR constituted a rush-job end-run around the region’s stakeholder processes and mechanisms of state engagement.58 The other focused on the substantive reasoning underpinning the majority’s FRR proposal, arguing that the Commission fundamentally misconstrues the relationship between federally overseen markets and state energy policies in deciding that the goal of market design is to “‘mitigate’ state efforts to shape the generation mix.”59 Below, we explain why we find this second critique particularly compelling, before turning to discuss the broader implications of FERC’s rulings on ISO-NE’s and PJM’s proposed reforms.

III. A Dangerous Transformation in the Role of RTOs

For readers not steeped in energy market theory, it is tempting to view these capacity market reform debates as arcane and technocratic squabbles. But construing these changes as nothing more than inside baseball would be a major mistake. In this section, we describe how capacity market debates highlight a growing tension between state clean energy goals and federal electricity markets—one that threatens to undermine the delicate balance at the heart of U.S. energy law. In the next Part, we explain the larger federalism and clean energy implications of FERC’s and certain RTOs’ apparent disdain for state policy objectives.

A. The Contested Hierarchy of State Policies and Federal Market Prices

Although ISO-NE and PJM have responded with different capacity market modifications, their proposed reforms—and FERC’s responses—are driven by similar concerns. All paint these reforms as striking a balance that resolves the fundamental tension between “investor confidence” as the touchstone of capacity markets’ “integrity,” on the one hand, and concededly legitimate state policy goals, on the other.60 When allegedly impossible to reconcile, FERC and the market operators have “favored the preservation of competitively-based capacity pricing” over accommodation of state clean energy goals.61

This favoritism inverts the proper relationship between state public policy objectives and the oblique aim of “investor confidence” in capacity markets. The Federal Power Act explicitly reserves authority over generation resources to the states.62 As the Supreme Court recently reaffirmed,63 the Act allows states broad control over the type of resources they prefer, including the ability to “limit new construction to more expensive, environmentally-friendly units.”64 The policies that FERC is now targeting as “interferences” that threaten the “integrity” of its otherwise “perfect” markets are in fact perfectly legitimate state efforts to reward and promote different (and worthy) objectives: healthy citizens and a stable climate.65 What the Federal Power Act gives, FERC and the RTOs should not be allowed to take away through policies that subserviate state goals to investor earnings.66

Indeed, “investor confidence” and the ill-defined concept of “market integrity” are not—and should not be—end goals for capacity markets.67 Although these concepts are worthwhile in the abstract, they are not self-obvious, sacrosanct objectives that can justify a transfer of economic wealth made in retaliation against legitimate state policy decisions. For one thing, we see no reason to focus exclusively on the confidence of those who invested in legacy fossil resources, while destabilizing the investment environment for those who invest in new clean energy resources—we would assert that this hardly comprises a market with true “integrity.”

Nor is investor confidence itself an absolute virtue. As FERC explained in approving ISO-NE’s market redesign, the goal of these markets is “to ensure resource adequacy at just and reasonable rates”—in other words, to provide reliable electricity as affordably as possible over time.68 Investor confidence is a means to ensuring this end, but only under certain conditions. If a region is substantially over-supplied with generation capacity, the market should not give investors confidence that they will recover their investment costs—otherwise, the region will end up with more generation than it needs, paid for by customers, in contravention of FERC’s obligations to protect consumers.69

As it happens, electricity markets in both New England and the mid-Atlantic have substantially more generation than they need for reliability purposes.70 For this reason, these RTOs should be celebrating lower prices in their capacity markets, rather than resisting them.71 If and when resource adequacy again presents a challenge for these markets, prices in the markets should accordingly rise, even with the unfettered participation of state-sponsored renewables.72

Ignoring these dynamics, RTOs have decided that protection of investor interests—in other words, the assurance of certain levels of profit for fossil fuel generators that might have prevailed in the absence of state preferences for clean energy—trumps respect for democratically determined state requirements for clean air and climate safety. This posture is particularly galling given the strange institutional position that RTOs occupy as private entities, whose members are predominantly for-profit companies in the electricity industry and whose decision-making processes are generally not subject to the administrative law requirements that apply to state and federal regulators.73 No longer neutral grid facilitators, a majority of FERC commissioners and the RTOs in the examples discussed here appear to be taking the side of legacy corporations, working against the public health and welfare.

B. The Ongoing Duty to Ensure Just and Reasonable Rates

Although states control which power plants get built in their territories, RTOs are not without tools to manage the markets that affect the costs of competing choices. The Federal Power Act gives FERC authority over “rates and practices” that “directly affect” federal markets,74 allowing RTOs and the Commission to refine market rules to respond to state policy changes that render market rates unjust or unreasonable. But on this score, it is unclear that either ISO-NE’s approved reform, or the Commission’s new FRR proposal in PJM, is a just and reasonable solution.75

The ISO-NE capacity market reforms will raise rates by billions of dollars for consumers, as PJM’s proposed reforms also would have.76 The precise impacts of FERC’s PJM proposal are not yet known, but these reforms are also designed to raise capacity prices and thus the expense to customers in the region.77 In exchange for what? It remains unclear: neither FERC nor the RTOs have identified any problem that the proposals are designed to solve, beyond increasing capacity payments to non-clean energy resources.78 But since neither region’s market is currently having trouble attracting the investment it needs to ensure reliability, it is hard to understand how increasing these payments is just or reasonable.

As Commissioner Glick observed in his partial dissent to FERC’s approval of ISO-NE’s reforms: “the fact that state policies are affecting matters within the Commission’s jurisdiction is not necessarily a problem for the Commission to ‘solve,’ but rather the natural consequence of Congressional intent.”79 And as he further pointed out in dissenting from FERC’s curious PJM decision, the Commission continues to act upon nothing but a hunch that capacity markets could theoretically be harmed, sometime in the future, by an influx of state-supported resources.80 As of yet, however, no concrete evidence of actual challenges to the grid’s long-term reliability has been adduced.81 If FERC and its RTOs believe that state policies create concrete resource adequacy concerns that have not yet been voiced, then they should explicitly identify these challenges and look for targeted solutions. Otherwise, the reforms on the table appear to be an exceedingly complex and misguided effort to shield certain market players from the impacts of personally disfavored but utterly legitimate state policy goals.

IV. Beyond Capacity Markets: The Risks of FERC Accepting RTOs’ Expanded Role

The big-picture implications of accepting RTOs’ reforms have largely been sidelined in the tussles over critical market design details. In this final Part, we call attention to the ways in which these changes are likely to reduce the growth of clean energy and threaten the delicate cooperative balance that FERC has established with its state counterparts in the energy sector.

A. Slowing Down the Clean Energy Transition

In their reform proposals, both ISO-NE and PJM suggest that one of the primary consequences of capacity market reforms will be to raise prices for consumers forced to over-purchase capacity, because states are not likely to eliminate their clean energy goals.82 In the short-to-medium term, this assumption probably holds. PJM, though, nods to potential longer-term consequences, noting that some proponents of its minimum-offer-price reform “hope that it will work to dis-incent states from providing subsidies in the first instance.”83

We fear that PJM has the long-term diagnosis correct—and that all the proposals on the table are likely to push in the direction of undermining state clean energy policy preferences. Ultimately, to stabilize the global climate, the electricity sector will need to approach zero emissions.84 That’s a tall task for a sector that currently produces 63% of its power from fossil fuels.85 To date, residents of the more ambitious clean energy states have proven willing to accept some additional costs to meet these goals. But there may be a breaking point at which the pendulum of public sentiment swings the other way, should the costs of the transition rise too high—especially since some states are currently shouldering all the burden of greenhouse gas emissions cuts while their neighbors shirk. By raising the cost to ambitious states of meeting their energy goals by potentially hundreds of millions of dollars,86 the capacity market reforms under consideration could cause a backlash against ambitious state policies. At the same time, these reforms prop up fossil fuel resources at the expense of customers in many states whose democratically elected representatives chose a different path—clean energy.

We write this Essay at a time of significant uncertainty with respect to how PJM’s market reforms will play out, and therefore we must acknowledge that there is a scenario in which our concerns regarding the Commission’s proposed reforms might be overblown. Some commentators have suggested that the reforms could prove a surprising boon for clean energy by allowing states more flexibility in deciding which resources should supply capacity directly to in-state utilities, and which should participate in regional capacity markets.87 Others echo concerns similar to those expressed in this Essay, arguing for an outcome that respects state policy autonomy and more adequately compensates state-supported renewable and nuclear energy resources.88 Currently, a utility must be either “all out,” or “all in,” with respect to capacity market participation; in contrast, under the next phase of FERC’s PJM Order, the Commission might allow utilities to pursue clean energy capacity procurement outside the capacity market, turning to the capacity market only for whatever fraction of their capacity needs remain.89 But this result will obtain only if FERC allows states substantial flexibility in determining how to match renewable energy supply with load in ways that allow renewable resources to make up the payments lost from the capacity market, in addition to being compensated for their renewable attributes.

Given the Commission’s demonstrated antipathy to state clean energy policy and its aggressive timeline for reform, we are skeptical that the Commission will design a program that treats clean energy resources fairly in light of their full social benefits. But we strongly encourage the Commission to prove us wrong. For example, FERC might allow states to self-determine which resources to pull from capacity markets and might then devise a collaborative scheme in which these resources could be reasonably compensated for both their capacity provisioning and environmental attributes. This flexibility would go a long way towards easing the jurisdictional tension at the heart of this Essay—although largely by facilitating a de facto withdrawal from regional capacity markets.90 While this outcome might seem problematic to those who had hoped to see regional capacity markets support a robust approach to resource adequacy, in our view, shifting the responsibility of maintaining resource adequacy back to the states may be the only sensible path remaining in light of FERC’s unfortunate decision to punish state-supported resources in capacity markets.

B. Implications for RTOs Without Capacity Markets

It might be tempting to dismiss the East Coast policy debates as matters that only affect RTOs with mandatory capacity markets, in which utilities must participate to fulfill their regionally assigned resource adequacy obligations.91 (In other regions, including the Midwest and California, no such rigid construct exists; capacity markets are voluntary in the Midwest and non-existent in California, which manages resource adequacy via other mechanisms.92 But this response misses the mark. The capacity market reform debates currently underway are only the latest episode in a longer battle for policy-making control between private market operators, state regulators, and FERC. If RTOs are empowered by FERC to propose market designs that punish state clean energy policies in capacity markets, what is to stop them from taking a similar approach in energy markets? In our view, the question of RTO governance should be front and center, no matter the market. To paraphrase Sinclair Lewis, those who say “it can’t happen here” fail to acknowledge that, at least as far as the governance concerns discussed in this Essay go, “it has already happened there.”

Even if the impacts of the shift in governance illustrated by the ISO-NE and PJM reforms remain limited to RTOs with mandatory capacity markets—a containment we find implausible—this is little comfort. Capacity markets themselves are the result of market operators exerting increased control over state regulators: states whose markets now feature centralized capacity markets first joined energy-only regional markets, only gradually acceding to a construct in which the RTO also controlled resource adequacy after the decision to delegate their market governance to the RTO had been made. Previously, some PJM and ISO-NE states expressed serious reservations about the creation of mandatory capacity markets, which they worried would interfere with states’ historical right to choose their mix of power plants.93 But states’ objections didn’t stop FERC from eventually ordering the RTOs to construct new systems that went beyond bilateral resource adequacy requirements.94 Subsequently, FERC negotiated settlements between each RTO and its stakeholders that established centralized capacity markets in 2006.95

As the history of capacity market formation in ISO-NE and PJM indicates, states within RTOs—whether single- or multi-state—do not have unfettered control over whether FERC might eventually decide that a centralized capacity market is required to satisfy the Federal Power Act’s “just and reasonable” ratemaking standards.96 Because the decision of whether to require a capacity market “directly affects” wholesale rates, FERC maintains jurisdiction in this domain.97 Certainly state wishes matter, but as PJM and ISO-NE states’ recent experiences illustrate, a majority of today’s FERC Commissioners feels free to disregard them. Thus, even where state law might ostensibly preclude participation in a centralized capacity market, an RTO—or any private party, such as an out-of-state generator in the regional market—might nevertheless propose a centralized capacity market to FERC.

Should such a proposal be made, the identity of the proposing party is legally significant. When an outside party petitions FERC for a change in an RTO’s rules, FERC must find the current market structure “unjust” or “unreasonable” to force a change upon an RTO under Section 206 of the Federal Power Act.98 In contrast, when an RTO itself petitions for a change to its market structure under section 205 of the Act, FERC need only find that the RTO’s new proposal is one among potentially many “just and reasonable” alternatives.99 For this reason, RTO-sanctioned proposals are more likely to win FERC approval—making RTO composition and governance central to any analysis of the potential for a regional capacity market.

Already, private parties that have taken note of the capacity market reforms in the East are seeking to expand these markets’ footprint. A natural gas power plant recently petitioned FERC to declare California’s current resource adequacy regime “unjust and unreasonable” under Section 206 of the Federal Power Act and replace it with a centralized capacity market.100 Although the Commission may well refuse this outside request, the filing nevertheless indicates how the Commission, not the state, has the final word on capacity market formation.101

At its core, the history of capacity markets indicates that no state within an RTO can insulate itself from the possibility that its RTO may ultimately pursue—or be forced to accept—market changes that FERC deems just and reasonable. Critically, the RTO’s position on proposed changes determines the legal standard under which FERC reviews market proposals. Accordingly, states wary of the recent FERC decisions regarding ISO-NE and PJM capacity markets would be wise to focus on RTO governance as an important channel for preserving and accommodating state resource preferences—a topic to which we turn in our final subsection. Yet even a governance structure that precludes an RTO from proposing a capacity market to FERC cannot prevent FERC from declaring the RTO’s approach to resource adequacy unjust or unreasonable, and possibly even ordering a capacity market in its place.

C. Implications for California and the West

Thus far, we have only considered the ways in which capacity markets—present and potential—can stymie the clean energy goals of their participating states. But the precedents that FERC has established with respect to PJM and ISO-NE capacity markets are likely to have reverberations that extend far beyond the question of capacity market design. The broader trend of regional RTOs asserting their primacy over state policy preferences—as FERC has sanctioned in recent months—threatens the conditions under which states with divergent environmental policies can cooperate in regional electricity markets.

The most prominent example of expanded regional cooperation concerns California, which has a federally regulated wholesale electricity market, and the rest of the West, which does not. Currently, the California Independent System Operator (CAISO) operates an energy market that covers most of the state and a small portion of Southern Nevada.102 For several years, California policymakers have considered expanding CAISO’s footprint to include other states’ utilities, forming a regional energy market similar to those in place in PJM and ISO-NE.103 Advocates of regionalization argue that a broader market will facilitate increased and more efficient renewable energy deployment by integrating the broader region’s renewable resources and allowing renewables in California to sell their excess power to neighboring states.104 However, it is widely understood that other states would not join a regional CAISO without a significant change in CAISO’s governance structure.

Such a change would carry with it the risk of increasing regional and private-sector influence over California’s clean energy trajectory, as is occurring in the ISO-NE and PJM states. Currently, each of CAISO’s five Governors is appointed by the Governor of California and subject to confirmation by the California Senate—a unique arrangement that may not be possible to recreate under current FERC regulations.105 What would happen if this arrangement changed is an open and critical question. The integration of state policy priorities in the management of CAISO’s energy markets is among the most complex in the country, which makes the close alignment between the current CAISO governance structure and state political structure extremely relevant. CAISO also manages a voluntary regional energy market called the Energy Imbalance Market (EIM), which includes portions of Oregon, Washington, Idaho, Nevada, Arizona, Utah, and Wyoming106—a list that includes several interior states that explicitly prefer coal, in contrast to the low-carbon preferences of their coastal neighbors.

To date, CAISO has deftly managed the challenging politics of being a regional trailblazer on climate change. Most notably, CAISO secured the first FERC-approved carbon price, integrating California’s cap-and-trade program into the EIM market tariff such that the carbon price applies to electricity voluntarily exported from the EIM territory to serve CAISO load.107 After nearly two years of negotiations with the state climate regulator, CAISO has transmitted a greenhouse gas accounting mechanism for the regional EIM market to FERC, which is reviewing the petition as of this writing.108 CAISO has done all of this under its power to petition FERC for market changes the Commission finds to be “just and reasonable”109—a power that has worked to the good of California climate policy in a context where the RTO’s goals are aligned with those of state policymakers.

CAISO deserves enormous credit for the work that has gone into navigating the technical and legal issues that arise when trying to fully account for the net greenhouse gas emissions impacts of cross-border carbon pricing. However, it is critical to observe that this work has occurred in a context where CAISO’s entire Board of Governors is fundamentally accountable to the state political process. Would this work continue unperturbed if the control of CAISO governance shifted to appointees made by states or private parties without a longstanding commitment to clean energy and climate policy—or even a demonstrated antipathy towards climate policy?110 Would a new governance structure continue to support the application of California’s carbon price to imports from within the broader regional market? If not, what would prevent coal-fired generators in neighboring states from selling their power to California customers, thereby undercutting California’s climate goals? And even if a regional RTO were formed with a governance structure that preserves California’s interests alongside those of its neighbors, regionalization still might create greater practical risks of FERC’s meddling. Given the many market rules necessary to accommodate disparate state regulatory regimes, and the enlarged pool of players in a regional RTO, a regional market has more potentially dissatisfied market participants that might petition FERC to declare the RTO’s market design unjust or unreasonable.

In our view, California policymakers should acknowledge the mounting evidence that regional market operators are no longer required to be neutral “takers” of state policy preferences, as exemplified by the experiences in PJM and ISO-NE. The shift in power towards private market regulators increases the risks that a regional market operator could work to undermine the progress that CAISO and state regulators have achieved to date. Similarly, the hostility to state clean energy policies from FERC raises questions about what guarantees state law can offer in advance of FERC’s review of an expanded market design proposal. Given the inability of state law to constrain FERC’s review of RTO market designs—either on its own initiative, or at the petition of any market participant—many of our questions cannot be resolved through legal guarantees. Rather, their resolution would instead be contingent on the political economy of electricity markets and the policy perspectives FERC’s commissioners bring to future regulatory disputes.

In our view, the potential gains of an enlarged, regional RTO are significant and should be considered alongside the governance risks outlined above. We make no judgment here about whether regionalization is worth pursuing on balance, and if so, under what conditions and institutional forms. Our aim is simply to bring to the regionalization conversation an account of the increasing risks that confront states whose policy preferences are not respected by those who participate in or govern their electricity markets.

V. The Delicate Future of Energy Federalism

Energy federalism is in flux following a string of three recent Supreme Court cases that re-considered the state-federal relationship in energy law.111 In decades past, the Supreme Court interpreted the Federal Power Act to draw a “bright line, easily ascertained” between federal and state spheres of control.112 That understanding no longer holds in the modern world of energy markets. In Hughes, Justice Sotomayor described the Act as a “collaborative federalism statute[], [which] envisions a federal-state relationship marked by interdependence.”113 As this jurisprudential evolution suggests, states and FERC are still finding their way in regional energy markets. This challenge is unfolding in rapidly changing conditions, as states within RTOs also happen to be some of the most ambitious supporters of clean energy.

Regional energy markets hold the potential to play an important role in states’ clean energy transitions. We count ourselves among those who view well-designed regional markets as vital tools for integrating higher quantities of variable wind and solar resources on the grid. As a further testament to RTOs’ success, most of the states involved in the recent acrimony over capacity markets have professed their desire to preserve these regional constructs, even as they oppose onerous capacity market reforms114—although New Jersey’s utility regulator recently expressed willingness to contemplate leaving PJM.115

Nevertheless, East Coast states’ faith in RTO governance has clearly been shaken.116 Some are frustrated that ISO-NE ignored key components of the regional compromise reached in advance of its filing with FERC.117 PJM more brazenly put forward two proposals to FERC that each failed to earn stakeholder or state support: in fact, a majority of stakeholders and states preferred “no action” to either of PJM’s alternatives.118

FERC, for its part, approved the controversial ISO-NE proposal and called for even more substantial reform of the PJM market on a timeline that will leave little space for state engagement, leading some to predict that the reforms that FERC demands within PJM may portend an “unraveling” of the region’s capacity market.119 With this move, the Commission is signaling more strongly than ever that participation in its markets may well come at the expense of state policy priorities. That is a message that few states are likely to want to hear—and it may upset the fundamental balance of state-federal and public-private relations that sustains energy market constructs today.

To preserve the neutral, well-functioning markets FERC has created and nourished over the past two decades, the Commission should stop pretending that regional electricity markets are a pristine construct under siege from state clean energy goals. These markets are merely a tool in the larger project of ensuring “just and reasonable” electricity rates in the United States—subject to any constraints states and other actors impose on them through legitimate legal means. Climate change is an existential problem and mustering the political will to tackle it is no small feat. FERC must not allow nebulous appeals to preserving “investor confidence” or “market integrity”—which in reality mask certain generators’ attempt to use private energy markets to end-run state political processes—to stand in the way of states’ efforts. If FERC does, states would be wise to reevaluate who really controls their energy mix—and whether that’s an arrangement their citizens can afford to endure.

  1.  We are grateful for comments and feedback from Steve Weissman, Ari Peskoe, Justin Gundlach, Michael Panfil, Robbie Orvis, and Miles Farmer. Any errors and all opinions are ours alone.
  2.  Department of Energy Grid Resiliency Pricing Rule, 82 Fed. Reg. 46,940 (Oct. 10, 2017) (proposing a rule to FERC that would require ISOs and RTOs to compensate coal and nuclear power plants for their full costs, independent of market prices); White House, Statement from the Press Secretary on Fuel-Secure Power Facilities (June 1, 2018), https://www.whitehouse.gov/briefings-statements/statement-press-secretary-fuel-secure-power-facilities/ [https://perma.cc/M7TX-666A] (directing Secretary of Energy Rick Perry “to prepare immediate steps to stop the loss of” fuel-secure resources); Letter from FirstEnergy Solutions Corp. to Department of Energy Secretary James Richard Perry (Mar. 29, 2018), https://statepowerproject.files.wordpress.com/2018/03/fes-202c-application.pdf [https://perma.cc/D2GN-H89S] (requesting an emergency order to require cost recovery for FirstEnergy’s coal and nuclear power plants in PJM, pursuant to Section 202(c) of the Federal Power Act).
  3.  See, e.g., Steven Mufson, Trump Orders Energy Secretary Perry to Halt Shutdown of Coal and Nuclear Plants, Wash. Post (June 1, 2018), https://www.washingtonpost.com/business/economy/trump-officials-preparing-to-use-cold-war-emergency-powers-to-protect-coal-and-nuclear-plants/2018/06/01/230f0778-65a9-11e8-a69c-b944de66d9e7_story.html?utm_term=.cc80aaa8e373 [https://perma.cc/63QZ-W7PB]; Brad Plumer, Trump Orders a Lifeline for Struggling Coal and Nuclear Plants, N.Y. Times (June 1, 2018), https://www.nytimes.com/2018/06/01/climate/trump-coal-nuclear-power.html [https://perma.cc/LNY6-46VH]; Timothy Puko, Energy Department Urges Pricing Shift that Could Bolster Coal, Nuclear, Wall St. J. (Sept. 29, 2017), https://www.wsj.com/articles/energy-department-urges-pricing-shift-that-could-bolster-coal-nuclear-1506698449 [https://perma.cc/3WG3-TKR8].
  4.  FERC, Grid Reliability and Resilience Pricing, 162 FERC ¶ 61,012 (2018) (denying Sec. Perry’s proposed rule and opening a new proceeding to consider grid resiliency issues).
  5.  Id.; see also U.S. Senate Committee on Energy and Natural Resources, Full Committee Oversight Hearing of the Federal Energy Regulatory Commission (June 12, 2018), https://www.energy.senate.gov/public/index.cfm/2018/6/full-committee-oversight-hearing-of-the-federal-energy-regulatory-commission [https://perma.cc/6P3K-QMJH] (featuring testimony from all five FERC Commissioners).
  6.  Brief for the United States and the Federal Energy Regulatory Commission as Amici Curiae in Support of Defendants-Respondents and Affirmance at 10, Vill. of Old Mill Creek v. Star, Nos. 17-2433 & 17-2445 (consolidated) (7th Cir. May 29, 2018); see also Danny Cullenward & Shelley Welton, Will FERC Uphold State Support for Clean Energy?, Utility Dive (June 4, 2018), https://www.utilitydive.com/news/will-ferc-uphold-state-support-for-clean-energy/524819/ [https://perma.cc/4YLR-UUWY]. The Second and Seventh Circuits subsequently adopted FERC’s position, declining to preempt state subsidies for nuclear energy while also indicating that FERC retains the authority to impose punitive wholesale electricity market designs. Elec. Power Supply Ass’n v. Star, Nos. 17-2433 & 17-2445, slip op. at *7 (7th Cir. Sept. 13, 2018); Coal. Competitive Elec. v. Zibelman, No. 17-2654cv, slip op. at *6 (2d Cir. Sept. 27, 2018).
  7.  See infra Section II.C.
  8.  For two important exceptions, see Miles Farmer & Bruce Ho, Federal Power Rules Threaten New England Renewable Energy, Nat’l Res. Defense Council Blog (Apr. 10, 2018), https://www.nrdc.org/experts/bruce-ho/federal-power-rules-threaten-new-england-renewable-energy [https://perma.cc/6EPQ-2RE9]; and David Roberts, Trump’s Crude Bailout of Dirty Power Plants Failed, but A Subtler Bailout Is Underway, Vox (Mar. 23, 2018), https://www.vox.com/energy-and-environment/2018/3/23/17146028/ferc-coal-natural-gas-bailout-mopr [https://perma.cc/J5H7-HSKT].
  9.  For an overview, see Scott Hempling, Regulating Public Utility Performance: The Law of Market Structure, Pricing and Jurisdiction § 3.A.1 (2013). See generally Richard F. Hirsh, Power Loss: The Origins of Deregulation and Restructuring in the American Electricity Utility System (1999) (charting the course of electricity law in the twentieth century).
  10.  16 U.S.C. § 824(b) (2018).
  11.  See Hughes v. Talen Energy Marketing, LLC, 136 S. Ct. 1288, 1299 (2016) (holding that states act within their traditional domain by “encouraging production of new or clean generation” so long as they do not condition programs on federal wholesale market participation); Elec. Power Supply Ass’n v. Star, slip op. at *6 (affirming “state authority over power generation” in upholding state support for nuclear power against a federal preemption challenge).
  12.  See David Spence, Can Law Manage Competitive Energy Markets?, 93 Cornell L. Rev. 765, 772-75 (2008) (describing the U.S. transition to electricity markets).
  13.  FERC, Energy Primer: A Handbook of Energy Market Basics 1, 40 (2015).
  14.  See Spence, supra note 12, at 770-72.
  15.  Order No. 888, Promoting Wholesale Competition Through Open Access Non-discriminatory Transmission Services by Public Utilities, Recovery of Stranded Costs by Public Utilities and Transmitting Utilities, 75 FERC ¶ 61,080 (1996); Order No. 2000, Regional Transmission Organizations, 89 FERC ¶ 61,285 (1999). RTOs are very similar to ISOs; for the purposes of this Essay, we will refer to RTOs to mean either RTOs or ISOs, leaving aside the subtle differences in their legal and historical origins.
  16.  FERC first created ISOs with Order 888, which established open-access interstate transmission policy. FERC later refined these concepts with Order 2000, which created RTOs more specifically. Some market operators qualify as both an ISO and an RTO; the names currently in use typically reflect the initial origin of the operators’ formation (i.e., in response to Order 888 or Order 2000), rather than any particular legal or organizational function.
  17.  See generally Kyungjin Yoo & Seth Blumsack, Can Capacity Markets Be Designed by Democracy?, 53 J. Reg. Econ. 127 (2018) (breaking down PJM’s voting members into categories).
  18.  See, e.g., Stephanie Lenhart, Natalie Nelson-Marsh, Elizabeth J. Wilson & David Solan, Electricity Governance and the Western Energy Imbalance Market in the United States: The Necessity of Interorganizational Collaboration, 19 Energy Res. & Soc. Sci. 94 (2016); see also Benjamin A. Stafford & Elizabeth J. Wilson, Winds of Change in Energy Systems: Policy Implementation, Technology Deployment, and Regional Transmission Organizations, 21 Energy Res. & Soc. Sci. 222 (2016).
  19.  Astute readers might add a third category: ancillary services markets, which procure a highly technical set of resources that help ensure grid load balancing at the speed of light. Although critically important, ancillary services are not implicated in this Essay’s focus on jurisdictional tension.
  20.  For a more in-depth discussion, see James Bushnell, Michaela Flagg & Erin Mansur, Capacity Markets at a Crossroads § 2 (Energy Institute at Haas Working Paper No. 278, 2017).
  21.  Four of the nation’s seven wholesale electricity markets have a centralized capacity market: the Midcontinent Independent System Operator (MISO), the New York Independent System Operator (NYISO), PJM Interconnection (PJM), and the Independent System Operator of New England (ISO-NE). Three do not: the California Independent System Operator (CAISO), the Southwest Power Pool (SPP), and the Electricity Reliability Council of Texas (ERCOT). Most areas of the western and southeastern United States lack wholesale markets of any kind. Id.
  22.  Companies that reduce electricity demand may also bid in to provide “demand response” services and energy efficiency, in lieu of power plant generation capacity. For an overview, see generally Yingqi Liu, Demand Response and Energy Efficiency in the Capacity Resource Procurement: Case Studies of Forward Capacity Markets in ISO New England, PJM and Great Britain, 100 Energy Pol’y 271 (2017).
  23.  See generally Bushnell et al., supra note 20.
  24.  We use the term “subsidy” for convenience and not to express judgment as to the merits of a particular policy.
  25.  National Academies of Science, Hidden Costs of Energy: Unpriced Consequences of Energy Production and Use § 3 (2009).
  26.  Calpine Corp. v. PJM Interconnection, L.L.C., Order Rejecting Proposed Tariff Revisions, Granting in Part and Denying in Part Complaint, and Instituting Proceeding under Section 206 of the Federal Power Act, 163 FERC ¶ 61,236, at pp. 92-93 (2018) [hereinafter “PJM Order”] (Glick, Comm’r, dissenting) (citations omitted).
  27.  North Carolina Clean Energy Technology Center, DSIRE Database, Renewable Energy Production Tax Credit (PTC) (Feb. 28, 2018), http://programs.dsireusa.org/system/program/detail/734 [https://perma.cc/4EHF-EN99].
  28.  See generally Galen Barbose, U.S. Renewable Portfolio Standards, 2017 Annual Status Report, LBNL Report No. 2001031, 1, 8 (July 2017). Renewable Energy Certificates (RECs) are created by state law to represent the environmental attribute of pollution-free energy that may be “bundled” with renewable energy generation or sold separately as a tradable commodity. See generally WSPP Inc., Order Conditionally Accepting Service Schedule R, 139 FERC ¶ 61,061 (2012) (discussing the legal structure of RECs and disclaiming federal jurisdiction over unbundled RECs).
  29.  See, e.g., Joel B. Eisen, The New(Clear?) Electricity Federalism: Federal Preemption of States’ “Zero Emissions Credit” Programs, Ecology L. Currents 149 (2018) (arguing that states’ use of ZEC subsidies that reference wholesale prices are preempted); Ari Peskoe, State Clean Energy Policies at Risk: Courts Should Not Preempt Zero Emissions Credits for Nuclear Plants, Ecology L. Currents 172 (2018) (arguing that such policies should not be preempted).
  30.  See PJM Order, supra note 26, at pp. 92-95 (Glick, Comm’r, dissenting); N.Y. Pub. Serv. Comm’n v. N.Y. Indep. Sys. Operator, Inc., 158 FERC ¶ 61,137, at p. 19 (2017) (Bay, Comm’r, concurring) (“The fact of the matter is that all energy resources receive federal subsidies, and some resources have received subsidies for decades..” (citing U.S. Energy Info. Admin., Direct Federal Financial Interventions and Subsidies in Energy in Fiscal Year 2016 (Apr. 2018), https://www.eia.gov/analysis/requests/subsidy/pdf/subsidy.pdf [https://perma.cc/GAM7-L4DW[)).
  31.  See Stafford & Wilson, supra note 18, at 229 (quoting RTO staffer explaining: “We are a taker of policy not a maker of policy . . . . We don’t create policy. We attempt to interpret policy as handed to us.”); see also ISO New England Inc., 162 FERC ¶ 61,205, at P. 26 (2018) (FERC insisting that the agency remains resource neutral) [hereinafter “ISO-NE Order”].
  32.  Bushnell et al., supra note 20, at 42-43.
  33.  Renewable capacity presents additional technical grid integration challenges due to the fact that grid operators often cannot dispatch it at will and therefore individual facilities require backup resources to ensure system reliability. Id. at 42-46; see generally Joachim Seel, Andrew D. Mills & Ryan H. Wiser, Impacts of High Variable Renewable Energy Futures on Wholesale Electricity Prices, and on Electric-Sector Decision Making, LBNL Rep. No. 2001163 (May 2018). But RTOs are not currently asserting challenges with integrating renewables as a basis for their proposed reforms, and so we consider these challenges to be beyond the scope of this Essay.
  34.  Existing nuclear energy power plants are also affected by low capacity prices and the rise of state-subsidized renewables. In many cases, however, states with large nuclear fleets have created state policies to support these resources using compensation mechanisms called Zero Emission Credits (ZECs) that mirror the RECs awarded to renewable generators. See generally Eisen, supra note 29; Peskoe, supra note 29.
  35. See generally ISO-NE Order, supra note 31.
  36.  ISO-NE’s tariff defines a “Sponsored Policy Resource” as one that is renewable or clean and receives “an out-of-market” revenue source. Tariff § I.2.2 (quoted in ISO-NE Order, supra note 31, at P. 3 n.6).
  37.  See ISO New England, Transmittal Letter re: Revisions to ISO New England Transmission, Markets and Services Tariff Related to Competitive Auctions with Sponsored Policy Resources, Docket No. ER18-619-000, at 5-6 (Jan. 8, 2018) [hereinafter “ISO-NE Transmittal Letter”].
  38.  See Partial Protest and Comments of the Mass. Attorney General, ISO New England, FERC Docket No. ER-18-000, at 2 (Jan. 29, 2018).
  39.  The second stage is conducted through a sealed-bid auction, where near-end-of-life generators’ bids are matched with bids from renewable resources. ISO-NE Transmittal Letter, supra note 37, at 6.
  40.  Id. at 21 (calling these “severance payments”); ISO-NE Order, supra note 31, at 5.
  41.  ISO-NE Transmittal Letter, supra note 37, at 6.
  42.  See ISO-NE Order, supra note 31 at p. 57 (LaFleur, Comm’r, concurring in part); id. at p. 60 (Powelson, Comm’r, dissenting); id. at p. 65 (Glick, Comm’r, dissenting in part and concurring in part). However, much of the debate centered on one particular paragraph discussing FERC’s intended “standard solution.” See id. at P. 22. We note that these concerns were expressed by the Commission’s two Democratic members (LaFleur and Glick) as well as one Republican (Powelson), who subsequently retired from the Commission well ahead of the end of his term. Rod Kuckro & Sam Mintz, Powelson Upends FERC with His Departure. EnergyWire (June 29, 2018), https://www.eenews.net/stories/1060087361 [https://perma.cc/7ZTE-B666] (highlighting Commissioner Powelson’s previous experience as a state utility regulator and his opposition to the Trump Administration’s most aggressive attempts to bail out coal and nuclear power plants).
  43.  Gavin Bade, Chatterjee Opposes MOPR as ‘Standard Solution’ for State Policies, Utility Dive (Apr. 19, 2018), https://www.utilitydive.com/news/chatterjee-opposes-mopr-as-standard-solution-for-state-policies/521731/ [https://perma.cc/8R97-9ZHF] (reporting Commissioner Chatterjee’s reservations about a paragraph in the decision that suggested the MOPR reforms should be a standard response to state clean energy subsidies).
  44.  See FERC, Order Granting Rehearings for Further Consideration, ISO New England Docket No. ER18-619-001 (May 7, 2018).
  45.  See PJM Interconnection, L.L.C., Transmittal Letter re: Capacity Repricing or in the Alternative MOPR-Ex Proposal: Tariff Revisions to Address Impacts of State Public Policies on the PJM Capacity Market, FERC Docket No. ER18-1314-000, at 17 (Apr. 9, 2018) (hereinafter “PJM Transmittal Letter”) (“After a lengthy PJM stakeholder process on this challenging issue, two alternatives emerged, but neither could gain the two-thirds affirmative sector vote needed for endorsement.”).
  46.  See id., Attachment A: Revisions to the PJM Open Access Transmission Tariff, Option A, § 5.14(j); id., Attachment C: Revisions to the PJM Open Access Transmission Tariff, Option B, § 5.14(h) (setting forth PJM’s complex proposed definitions for “actionable subsidy”).
  47.  Id. at p. 42.
  48.  Id. at pp. 42-43, 51.
  49.  Id. at p. 1; see also id. at p. 15 (describing how its proposals create certain “non-actionable” subsidies).
  50.  Id. at 43.
  51.  FERC found “Capacity Repricing” to be too generous to renewable resources, since this approach would have awarded renewable resources a higher capacity price in addition to their state support. PJM Order, supra note 26, at ¶¶ 63-68. Regarding the “MOPR-Ex” proposal, FERC found PJM’s proposed exception for resources necessary to meet state renewable portfolio standards to be unsupportable. Id. at ¶¶ 100-06.
  52.  The Commission instituted this paper hearing under the authority provided to it in Section 206 of the Federal Power Act, which allows it to void utility rates found to be unjust and unreasonable. See 16 U.S.C. § 824e (2018); PJM Order, supra note 26, at ¶ 149.
  53.  PJM Order, supra note 26, at ¶¶ 8, 160.
  54.  Id.
  55.  Id. at ¶¶ 164-71.
  56.  Id. at ¶ 172.
  57.  42 U.S.C. § 7171(b)(1) (2018).
  58.  PJM Order, supra note 26, at pp. 82-84 (LaFleur, Comm’r, dissenting).
  59.  Id. at p. 87 (Glick, Comm’r, dissenting).
  60.  ISO-NE Order, supra note 31, at ¶ 29; PJM Order, supra note 26, at ¶¶ 1, 150. But see id. at p. 90 (Glick, Comm’r, dissenting) (criticizing FERC for focusing on “investor confidence” as the critical issue in the ISO-NE Order and then shifting, without explanation or serious mention of “investor confidence,” to a new market “integrity” standard in the PJM Order).
  61.  ISO-NE Transmittal Letter, supra note 37, at 5; ISO-NE Order, supra note 31, at ¶ 72 (endorsing this decision); PJM Order, supra note 26, at ¶¶ 150-56.
  62.  See 16 U.S.C. § 824(b)(1) (2018) (providing that the Commission “shall not have jurisdiction . . . over facilities used for the generation of electric energy”).
  63.  See Hughes v. Talen Energy Marketing, LLC, 136 S. Ct. 1288, 1299 (2016).
  64.  See Connecticut Dep’t of Pub. Util. Control v. FERC, 569 F.3d 477, 481 (D.C. Cir. 2009).
  65.  See PJM Order, supra note 26, at p. 91 (Glick, Comm’r, dissenting).
  66.  On the impacts that capacity market reforms are likely to have on state clean energy policies, see infra Part IV.
  67.  See ISO-NE Order, supra note 31, at p. 68 (Glick, Comm’r, dissenting in part and concurring in part) (questioning the aim of “investor confidence”); PJM Order, supra note 26, at p. 92 (Glick, Comm’r, dissenting) (observing that the majority order never defines market “integrity”).
  68.  Id. at ¶ 9.
  69.  FERC has previously explained the goal of market design reform as “ensur[ing] that capacity prices will reflect the price needed to elicit new entry when new capacity is needed.” PJM Interconnection, L.L.C., 119 FERC ¶ 61,318 at P. 165 (2007) (quoting Devon Power LLC, 115 FERC ¶ 61,340, at P. 113 (2006)) (emphasis added) (internal quotation marks omitted); see also Order on Rehearing, 158 FERC ¶ 61,138, at P. 11 (2017) (describing the ideal capacity price as one that “provide[s] an incentive to develop and retain a sufficient level of capacity to ensure reliability” while “protecting customers from overpaying for that capacity” (emphasis added)).
  70.  See North American Electricity Reliability Corporation, 2018 Summer Reliability Assessment (May 30, 2018) at 20 (finding that ISO-NE has more than sufficient capacity reserve margins that protect against reliability concerns), https://www.nerc.com/pa/RAPA/ra/Pages/default.aspx [https://perma.cc/46A4-JQNU]; ISO-NE Transmittal Letter, supra note 37, at 11 (“[T]he region now has significant excess capacity . . . “); PJM Transmittal Letter, supra note 45, at 36 (“[C]apacity commitments in PJM are well above the installed reserve margin . . . “); id. at 24 (reporting PJM’s reserve margin at 32.8%, more than double the reference margin of 16.1%). Reserve margins represent the extra generation capacity available above and beyond the forecasted peak capacity demand in a given year and reference margins are the levels needed to ensure resource adequacy. U.S. Energy Information Administration, NERC’s Summer Reliability Assessment Highlights Seasonal Electric Reliability Issues (June 29, 2018), https://www.eia.gov/todayinenergy/detail.php?id=36592 [https://perma.cc/3PNJ-T8LL].
  71.  See Comments of the Organization of PJM States, Inc., FERC Docket No. ER18-1314-000, at 6 (May 7, 2018) (urging FERC to reject both options) (“Rather than rising, there is significant data that shows capacity prices should be falling.”).
  72.  See Sylwia Bialek & Burcin Unel, Capacity Markets and Externalities: Avoiding Unnecessary and Problematic Reforms, Institute for Pol’y Integrity 18 (2018) [hereinafter IPI Report] (arguing that capacity markets that include state-supported resources will still “self-correct” in the event of an actual resource adequacy challenge). In fact, PJM’s capacity market prices did rise substantially in the region’s most recent auction, without their proposed reforms in place. See PJM, 2021/2022 RPM Base Residual Auction Results, at 6 (May 2018), http://www.pjm.com/-/media/markets-ops/rpm/rpm-auction-info/2021-2022/2021-2022-base-residual-auction-report.ashx [https://perma.cc/4X5Y-MCGN].
  73.  See Christina Simeone, Kleinman Ctr. For Energy Pol’y, PJM Governance: Can Reforms Improve Outcomes? 1, 22 (2017); Michael H. Dworkin & Rachel Aslin Goldwasser, Ensuring Consideration of the Public Interest in the Governance and Accountability of Regional Transmission Organizations, 28 Energy L.J. 543, 553 (2007); Shelley Welton, Electricity Markets & the Social Project of Decarbonization, 118 Colum. L. Rev. ­­1067 (2018).
  74.  Fed. Energy Regulatory Comm’n v. Electric Power Supply Ass’n, 136 S. Ct. 760, 774 (2016); see also Order on Rehearing, 158 FERC ¶ 61,138, at P. 7 (2017) (“The Commission has acknowledged the right of states to pursue their own policy interests but must be mindful of state regulatory actions that impinge on FERC-jurisdictional market mechanisms to set price.”).
  75.  See NRG Power Mktg., LLC v. Fed. Energy Regulatory Comm’n, 862 F.3d 108, 113 (D.C. Cir. 2017) (interpreting the roles of RTOs and FERC under FPA Section 205 filings); see also 16 U.S.C. § 824d (2018) (establishing the Commission’s “just and reasonable” standard).
  76.  One expert estimates that PJM’s proposals will cost somewhere between $9.1 billion and $24.6 billion annually. See Protest of Clean Energy Advocates, FERC Docket No. ER18-1314, at 7 (May 7, 2018).
  77.  See PJM Order, supra note 26, at ¶ 2 (describing one key impetus for its reforms as “lower auction clearing prices,” thus implying that the goal is to raise auction clearing prices).
  78.  Id. at p. 92 (Glick, Comm’r, dissenting) (arguing that FERC’s order inappropriately stymies state climate change policies, illegally “deploy[ing] the FPA to make it ever more difficult for states to address this existential threat); see also IPI Report, supra note 72, at i (finding “no conclusive evidence that capacity markets are under threat”). To the extent that FERC has previously endorsed generalized balancing efforts absent showing a particular market challenge, see, for example, New England States Committee on Electricity v. ISO New England Inc., 142 FERC ¶ 61,108, at P. 35 (2013), reh’g denied, 151 FERC ¶ 61,056 (2015), we would urge the Commission to reconsider this precedent in light of the growing tension it creates for states within regional markets.
  79.  See ISO-NE Order, supra note 31, at p. 66 (Glick, Comm’r, dissenting in part and concurring in part).
  80.  See PJM Order, supra note 26, at pp. 95-96 (Glick, Comm’r, dissenting).
  81.  Id. (“Today’s order is all the more troubling because there is not substantial evidence in the record to support a finding that there is a resource adequacy problem in PJM or that the capacity market is otherwise unjust and unreasonable or unduly discriminatory or preferential.”).
  82.  See id. at 49; PJM Transmittal Letter, supra note 45, at 56; see also Request for Rehearing of Clean Energy Advocates, FERC Docket No. ER18-619-000, at 1 (Apr. 9, 2018) (arguing that “the predictable result” of ISO-NE’s re-design is that “thousands of megawatts of clean energy will be barred from accessing the ISO-NE capacity market, and the region’s customers will be forced to spend vast sums to buy an equivalent amount of redundant capacity.”).
  83.  PJM Transmittal Letter, supra note 45, at 56 n.138.
  84.  Intergovt’l Panel on Climate Change, Summary for Policymakers, in Climate Change 2014: Mitigation of Climate Change, Contribution of Working Group III to the Fifth Assessment Report of the Intergovernmental Panel on Climate Change 1, 20 (O. Edenhofer et al. eds., 2014) (“In the majority of low-stabilization scenarios, the share of low-carbon electricity supply . . . increases from the current share of approximately 30 percent to more than 80 percent by 2050, and fossil fuel power generation without [carbon capture and storage] is phased out almost entirely by 2100.”).
  85.  Frequently Asked Questions, Energy Info. Admin., https://www.eia.gov/tools/faqs/faq.php?id=427&t=3 [https://perma.cc/9ME4-QDPP].
  86.  See Protest of Clean Energy Advocates, supra note 76.
  87.  Gavin Bade, How FERC’s ‘Unprecedented’ PJM Order Could Unravel Capacity Markets, Utility Dive (July 3, 2018) (quoting analysts’ suggestions that an opt-out “Fixed Resource Requirement” (FRR) rule could enable state-supported clean energy resources to bypass the punitive capacity market entirely), https://www.utilitydive.com/news/how-fercs-unprecedented-pjm-order-could-unravel-capacity-markets/527053/ [https://perma.cc/UH5J-CXDG]; see also PJM Order, supra note 26, at ¶¶ 160-62 (describing how a “resource-specific FRR alternative” might operate).
  88.  Ann McCabe and Miles Farmer, How FERC Can Protect Customers and Respect State Energy Policy Authority in its PJM Capacity Market Proceeding, Utility Dive (Sept. 25, 2018), available at https://www.utilitydive.com/news/how-ferc-can-protect-customers-and-respect-state-energy-policy-authority-in/533095/ [https://perma.cc/B9VD-NKU9].
  89.  See PJM Order, supra note 26, at ¶ 70 (explaining that utilities may currently enter and exit the capacity market only on a “utility-wide basis,” but that under the new proposal, a utility could “remove a specific resource”).
  90.  See ISO-NE Order, supra note 31, at pp. 58-59 (LaFleur, Comm’r, concurring) (expressing concern that overly blunt capacity market reforms may lead to utilities exiting RTOs and states re-regulating markets); PJM Order, supra note 26, at p. 86 (LaFleur, Comm’r, dissenting) (same).
  91.  Some regions with ostensibly “mandatory” markets do offer exit options under stringent conditions, usually requiring a utility to exit the capacity market entirely for a multi-year period. See PJM, Fixed Resource Requirement Alternative—Overview (Sept. 17, 2017), https://www.pjm.com/-/media/committees-groups/task-forces/ccppstf/20170817/20170817-fixed-resource-requirement-overview.ashx [https://perma.cc/CZ4A-44GB]; see also Bushnell et al., supra note 20, at 26-27 (describing the mandatory capacity market construct and exceptions to it).
  92.  California currently sets its own “resource adequacy” requirements that utilities can meet through self-supply or bilateral contracting. The Midcontinental ISO runs a non-mandatory capacity market, which utilities can use as a backstop to self-supply or bilateral contracting. See id. at 25-26 (describing California’s and the Midwest’s capacity schemes); see also Midwest Indep. Transmission Sys. Operator, Inc., 153 FERC ¶ 61,229, at P. 46 (2015) (refusing to make MISO’s capacity market mandatory in response to a petition under Section 206 of the Federal Power Act).
  93.  Harvard Electricity Law Initiative, Comment of the Harvard Electricity Law Initiative to FERC re: PJM Interconnection, Revisions to Address Impacts of State Policies, FERC Docket No. ER18-1314 (May 7, 2018).
  94.  Conn. Dept. of Pub. Util. Control v. FERC, 569 F.3d 477, 480 (D.C. Cir. 2009) (dismissing state challenge to ISO-NE’s authority to determine an installed capacity requirement to drive a regional forward capacity market); PJM Interconnection LLC, 115 FERC ¶ 61,079, at P. 1 (2006) (concluding, in response to a filing under Section 206 of the Federal Power Act, that PJM’s previous system of bilateral resource adequacy requirements was no longer “just and reasonable”); Devon Power LLC, et al., 103 FERC ¶ 61,082, at P. 29 (2003) (ordering ISO-NE to create a “market-type mechanism” as a superior method of managing regional resource adequacy).
  95.  PJM Interconnection LLC, 117 FERC ¶ 61,331, at P. 6 (2007); Devon Power LLC, 115 FERC ¶ 61,340, at P. 2 (2006)
  96.  16 U.S.C. §§ 824d(a), 824e(a) (2018).
  97.  See, e.g., PJM Interconnection LLC, 119 FERC ¶ 61,318, at P. 42 (2007) (finding that resource adequacy and resource requirements in PJM “directly affect” wholesale rates subject to the Commission’s jurisdiction); see also supra note 74 and accompanying text (explaining “directly affecting” jurisdiction).
  98.  16 U.S.C. § 824e(a) (2018).
  99.  Id. at § 824d(a).
  100.  CXA La Paloma, LLC v. California Indep. Sys. Operator, Inc., FERC Docket No. EL18-177 (June 20, 2018).
  101.  To help resolve this uncertainty, we would encourage FERC to articulate a clear principle for whether and under what conditions the Commission might consider imposing a capacity market under Section 206 of the Federal Power Act. Ultimately, however, so long as the Commission asserts jurisdiction to review resource adequacy requirements under Section 206—as it has done in previous capacity market decisions for ISO-NE, PJM, and MISO—any such principle would be a Commission policy, not a jurisdictional limitation, and therefore subject to change.
  102.  Technically, CAISO is not a single-state market, although it is governed like one. Not all of California is in CAISO territory; CAISO territory also includes a small portion of southern Nevada.
  103.  Cal. Pub. Util. Code § 359.5 (as added by Senate Bill 350, Stats. 2015, Ch. 547, § 13).
  104.  See, e.g., Frequently Asked Questions, Fix the Grid, https://www.fixthegridcalifornia.org/frequently-asked-questions/ [https://perma.cc/J6ZA-2D2Y].
  105.  Cal. Pub. Util. Code § 337 (defining the appointment process for CAISO Governors). FERC originally disapproved of this governance structure, ordering California to replace its state-appointed Governors with representatives determined by a private governance structure. See Order Concerning Governance of the California Independent System Operator, 100 FERC ¶ 61,059 (2002). CAISO successfully challenged this order, which the D.C. Circuit Court of Appeals vacated two years later. See Calif. Ind. System Operator v. FERC, 372 F.3d 395 (D.C. Cir. 2004). Although the court left open the possibility that FERC could de-certify the current CAISO governance structure under FERC’s Order 888, FERC never took any such action and CAISO continues to operate under the formerly disputed governance structure. Although the status quo approach seems workable given CAISO’s track record of performance, it is an open question whether any future ISO or RTO could be structured with state-appointed governance—at least not without a change in FERC policy.
  106.  Governance of the CAISO EIM is shared with participating states. See Lenhart et al., supra note 18. But CAISO maintains exclusive control over California’s core energy markets.
  107.  Generators located in California automatically include carbon prices in their CAISO bids because they are subject to California’s cap-and-trade program. Generators outside the state decide whether to bid to supply electricity to CAISO on a voluntary basis; they are only dispatched to serve CAISO load if they affirmatively elect to do so and submit a winning bid that includes a supplemental greenhouse gas bid adder reflecting California’s carbon price. For an overview, see Andy Coghlan & Danny Cullenward, State Constitutional Limitations on the Future of California’s Carbon Market, 37 Energy L.J. 219 (2016); see also CAISO Tariff § 29.32 (Feb. 15, 2018), http://www.caiso.com/rules/Pages/Regulatory/Default.aspx [https://perma.cc/FC6X-HJCN]; CAISO, Regional Integration California Greenhouse Gas Compliance Issue Paper (Aug. 29, 2016), http://www.caiso.com/Documents/IssuePaper-RegionalIntegrationCaliforniaGreenHouseGasCompliance.pdf [https://perma.cc/QWN3-XCHQ]; see also generally California Independent System Operator, Order on Rehearing, Clarification, and Compliance, 149 FERC ¶ 61,058, at PP. 56-59 (2014) (describing the voluntary nature of the “GHG Bid Adder” that out-of-state generators must include in their bids in order to be dispatched to serve CAISO load).
  108.  As of this writing, CAISO has submitted a concept to FERC for approval in the EIM. See CAISO, Transmittal letter re: California Independent System Operator Corporation Energy Imbalance Market, Docket No. ER18-2341-000, at 5-6 (Aug. 29, 2018), http://www.caiso.com/Documents/Aug29_2018_TariffAmendment-RegionalIntegration_EIMGHGCompliance-EIMBidAdder_ER18-2341.pdf [https://perma.cc/QWN3-XCHQ]. However, questions remain about the efficacy of the EIM design. See, e.g., William W. Hogan, An Efficient Energy Imbalance Market with Conflicting Carbon Policies, 30(10) Electricity J. 8 (2017). Professor Hogan’s analysis concerned an earlier version of the proposed greenhouse gas accounting mechanism, but it raises several conceptual issues that remain in CAISO’s subsequent proposal and California’s treatment of imported electricity in its cap-and-trade program for greenhouse gases.
  109.  See 16 U.S.C. § 824d (2018).
  110.  Tom Lutey, Coal States Montana and Wyoming Push Back on Washington State Proposed Carbon Tax, Billings Gazette (Feb. 21, 2018) (reporting that the Attorneys General of Montana and Wyoming sent a letter to Washington Governor Jay Inslee asserting that Washington’s proposed carbon tax raises constitutional concerns); Brian Maffly, Lawmakers Considering Spending Millions to Sue California and Fight the ‘War on Utah Coal’, Salt Lake Trib. (Feb. 18, 2018), https://www.sltrib.com/news/environment/2018/02/16/lawmakers-considering-spending-millions-to-sue-california-and-fight-the-war-on-utah-coal/ [https://perma.cc/LW8C-BWVJ] (reporting that the Utah Legislature was considering a $2M appropriation to fund a lawsuit against California’s climate policies, including its application of the carbon price in the CAISO EIM); Letter from Tim Fox, Montana Attorney General, and Peter K. Michael, Wyoming Attorney General, to Governor Jay Inslee (Feb. 20, 2018), https://media.dojmt.gov/wp-content/uploads/Letter-Re-Washington-SSB-6203-002.pdf [https://perma.cc/ZT9S-QDGM].
  111.  FERC v. Elec. Power Supply Ass’n, 136 S. Ct. 760 (2016); Hughes v. Talen Energy Marketing, LLC, 136 S. Ct. 1288 (2016); OneOK, Inc. v. Learjet, Inc., 135 S. Ct. 1591 (2015).
  112.  Fed. Power Comm’n v. So. Cal. Edison Co., 376 U.S. 205, 215 (1964).
  113.  Hughes, 136 S. Ct. at 1299 (Sotomayor, J., concurring); see also Matthew R. Christiansen, FERC v. EPSA: Functionalism and the Electricity Industry of the Future, 68 Stan. L. Rev. Online 100 (2016) (arguing that the Court’s opinion in FERC v. EPSA shifts the “bright line” from a formalist to a functionalist interpretation); Robert R. Nordhaus, The Hazy “Bright Line”: Defining Federal and State Regulation of Today’s Electric Grid, 36 Energy L.J. 203 (2014) (discussing the increasingly complex division between state and federal authority under the Federal Power Act prior cases like Hughes and EPSA).
  114.  See FERC Technical Conference, State Policies and Wholesale Markets Operated by ISO New England Inc., New York Independent System Operator Inc., and PJM Interconnection L.L.C., Docket No. AD17-11-000, Panel I, Remarks of State Regulators (May 1-2, 2017), http://www.ferc.gov/EventCalendar/EventDetails.aspx?ID=8663&CalType=%20&CalendarID=116&Date=&View=Listview [https://perma.cc/N95K-NEWS].
  115.  Rory D. Sweeney, NJ Regulator Threatens to Exit PJM Amid States’ Complaints, RTO Insider (July 2, 2018), https://www.rtoinsider.com/pjm-joe-fiordaliso-95702/ [https://perma.cc/EE9H-E3P2].
  116.  Some independent experts have called for RTO governance reforms in PJM and across FERC-regulated markets. See, e.g., Simeone, supra note 73.
  117.  See Protest by the Conn. Pub. Util. Reg. Auth. et al., FERC Docket No. ER18-619, at 14-15 (Jan. 29, 2018).
  118.  See Protest of Clean Energy Advocates, supra note 76, at 62.
  119.  Id.

The $1 Trillion Question: New Approaches to Regulating Stock Buybacks

*Lenore Palladino is Senior Economist and Policy Counsel at the Roosevelt Institute and a Lecturer at Smith College. Palladino is Of Counsel at the law firm of Jason Wiener P.C.. Palladino earned her Ph.D. from the New School University and her J.D. from Fordham Law School. Special thanks to William Lazonick and the Roosevelt Institute staff for their support.

Stock buybacks—transactions in which public companies buy back their own equity securities on the open market—are on track to reach $1 trillion in 2018. Such repurchases manipulate the market price for issuer securities. They represent a choice by firms to prioritize shareholder payouts over other uses of corporate funds, contributing to widening economic inequality. Currently, stock buybacks are regulated by the Securities and Exchange Commission’s Rule 10b-18, a “safe harbor” rule that does not ameliorate market manipulation. This Essay recommends a new regulatory regime, outlining several alternative approaches to ensure the integrity of capital markets and corporate productivity.


Stock buybacks1 by America’s public companies are on track to hit $1 trillion in 2018.2 Stock buybacks are regulated by the Securities and Exchange Commission’s Rule 10b-18 (the “Rule”),3 but the Rule has not stopped a surge in buyback activity. In the recent hearings for Securities and Exchange Commissioner nominees, two future Commissioners agreed that they would be open to a fresh look at the Rule.4 More recently, Commissioner Robert Jackson Jr. followed up on this commitment and called for an open comment period on the Rule in response to a major increase in the dollar volume of stock buybacks.5 This Essay argues that it is past time to take a fresh look at the policies that govern stock buybacks and examines the range of policies available to rein in this practice.

Rule 10b-18 creates a “safe harbor” in which companies are free from risk of liability for manipulation under the Securities and Exchange Act as long as they follow the conditions as laid out in the Rule. The Rule allows for firms to conduct virtually unlimited stock buybacks, impacting the market in contravention of the spirit of Section 10b of the Securities and Exchange Act.6 The conditions concern the volume, manner, price, and timing of repurchases, and disclosure is required on quarterly reports. The justification for the Rule is to ensure that companies would not face liability for market manipulation for conducting buybacks. But the regulatory approach of Rule 10b-18 is broken. The original purpose behind the regulatory regime, “a scheme of regulation that limits the ability of an issuer . . . to control the price of the issuer’s securities,”7 is not met by Rule 10b-18’s framework or the enforcement approach the Commission has taken.

Beyond their impact on stock price, stock buybacks matter because they contribute to widening economic inequality. Corporations face an opportunity cost when allocating funds to shareholder payouts rather than to increasing employee compensation, funding retained earnings that are the foundation of firm growth, or investing in future productivity.8 This tradeoff is in part a result of incentives for corporate insiders to conduct buyback programs for their own personal profit.

I argue that there are two regulatory paths available: the Securities and Exchange Commission could adopt an entirely new regulatory regime for stock buybacks, or Congress could enact new legislation that would either ban or seriously constrain the practice. Congress can enact legislation that restricts repurchases outright; conditions repurchases according to another set of corporate variables; or places a tax on such transactions in order to disincentivize the behavior. Alternatively, the Securities and Exchange Commission can repeal Rule 10b-18 and replace it with new regulations that either revert to the pre-1982 status for buybacks, or create new regulations in line with other advanced economies: rules that place bright-line limits on the volume, manner, price, and timing of repurchases; mandate immediate disclosure; prohibit insider sales of their own holdings within a certain time period after a repurchase program; and put a new governance process in place for the initiation of repurchase programs. This Essay will describe and evaluate each of these policies with respect to the three core harms of stock buybacks: the potential for stock price manipulation, opportunity costs for other uses of corporate funds, and the perverse incentives for insiders to sell their own shares for personal gain.

This Essay proceeds in two Parts. Part I outlines the problems with stock buybacks and Rule 10b-18, both substantive and in terms of corporate governance. Part II first presents a landscape of other regulatory models and then proposes several paths forward for regulation.

I. The Problems with Stock Buybacks

In this Part, I describe why stock buybacks are justified by a “shareholder primacy” approach to the firm. I will then briefly describe their rise in dollar volume and the categories of harm: their effect on stock price; their relationship to broader economic inequality; and their incentive structure for corporate executives. Finally, I examine the flaws of Rule 10b-18’s regulatory approach.

A. Justifications for Stock Buybacks

Driving the practice of stock buybacks is the “shareholder primacy” corporate legal framework. This theory claims that shareholders are the “owners” of a firm and due the profits that the firm does not require for contractual obligations to other stakeholders, such as employees, suppliers, or customers, or for investment purposes.9 The idea that shareholders are a firm’s owners—the primary risk-takers because they invest capital with no guarantee of return, and thus the residual claimants of its wealth, popularized by Michael Jensen and Milton Friedman—is, according to corporate law scholar Lynn Stout, based on a misunderstanding of corporate law.10 Shareholders do not own “the firm”—they own their shares, which entitles them to an income flow, the right to sell their shares, and a certain set of limited rights to vote for the board of directors and shareholder resolutions,11 as well as the right to bring a claim for a breach of fiduciary duty.12 Other scholars claim that, regardless of whether or not shareholders “own” the firm, under the Delaware General Corporation Law (“DGCL”), maximizing shareholder wealth is the fiduciary duty of corporate boards of directors.13

Though its basis in corporate law is contested, shareholder primacy dominates business practices today, and justify widespread use of stock buybacks. The premise of stock buybacks is that shareholders should be “returned” this available cash when it has not found another productive use.14 This framework itself gives rise to two reasons to question stock buybacks. First, even if we accept the primacy of shareholders in corporate law, stock buybacks primarily benefit short-term shareholders who sell their stock after the price goes up, rather than longer-term shareholders who want corporations to invest in future productivity to ensure a long-term rising share price, not dependent on the company’s repurchase of its own shares. Even under shareholder primacy, corporations have variable needs for funds to ensure long-term growth, and we can see that stock buybacks constitute an opportunity cost for further investment, employee compensation, or even the build-up of reserves.15

The second problematic framework for repurchases has to do with the theory of the interaction between finance and the real economy. Defenders of repurchases argue that buybacks serve an important function by reallocating capital to where it would be most useful.16 Under this theory, when executives determine that they have no investment opportunities where the rate of return is above the cost of capital, they should logically return the cash to shareholders, who will invest the funds in companies that do have investment opportunities that are profitable to pursue. One problem with this argument is that the majority of shares are bought and sold on the secondary market, meaning that very little of the funds from a shareholder purchasing shares make their way back into a firm’s coffers. Firms have to issue new equity in order to directly benefit from any purchase of their stock. This points to a larger misunderstanding about the purpose of the stock market historically: that the primary reason companies issue shares has been to raise cash. Instead, shareholders primarily buy and sell stocks with each other, raising the value of shares without directly raising available funds for companies.

There is also little evidence that there is a financing constraint for the long-term capital necessary for the development of lower-cost, higher-quality products.17 Firms have large stocks of cash with which to conduct internal financing. Interest rates for corporate borrowing are historically low.18 And most importantly for evaluating stock buybacks, net issuances in the non-financial corporate sector have been negative for every year since 1997, sometimes sharply so.19 This means that more equity is pulled out of the market through buybacks than is created through new issuances. Even though buybacks could in theory be an efficient way for capital to be reallocated between companies with publicly-traded stock, the evidence does not show that this is occurring.

Furthermore, claims that buybacks are useful for the capital-allocation reason do not grapple with the other reasons why firms conduct buybacks: to raise the share prices and thus reward large share-sellers, especially executives. It could be that shareholders are taking the gains from buybacks and investing in private firms, but there is a decline in the rate of business startups in the economy.20 Wealthy shareholders may also be investing in large private companies, but the use of buybacks to transfer wealth from public to private companies means that the majority of investors, who are non-accredited investors, will be locked out of the potential for wealth appreciation.21 The problems with buybacks have magnified as the dollar volume has grown, particularly as companies (outside of the financial sector) have spent more on shareholder payouts than they had available in profits. Stock buybacks have grown from $469 million in 1979 to $748 billion in 2016.22 Projections for 2018, following the adoption of the TCJA, posit that repurchases could top $1 trillion for the first time.23 In many industries repurchases exceeded profit in multiple years.24

B. The Harms of Stock Buybacks

What are the specific harms of stock buybacks? I describe several types of harm as a result of stock buybacks. The first is their potential to manipulate stock price, in violation of Section 9(a)(2) of the Exchange Act. The second is the opportunity cost that they represent for other uses of corporate profits, from long-term investment to improvements in employee compensation. Finally, and perhaps the biggest driver of repurchases, is their perverse incentives on executives and other insiders who are compensated in stock in order to tie their personal motivations to firm outcomes to instead sell their shares. A distinct harm is the lack of accountability under Rule 10b-18 and the lack of other constraints on stock buybacks.

First, and most simply, repurchases may be used to manipulate stock prices because the very nature of buying back stock means that the remaining shares rise in value.25 Though the question of whether trading activity alone can be considered manipulation remains contested, and the legal framework for manipulation “lacks precision, cogency, and consistency of application,”26 large volumes of stock buybacks undoubtedly move securities prices, and before 1982 left firms open to liability for market manipulation. Stock buybacks have become a favorite corporate practice because they are a straightforward and fast mechanism to raise share prices and boost earnings per share (EPS). Rule 10b-18 enables firms to conduct buybacks, within its timing,27 volume,28 price,29 and manner conditions30 (although there is no assumption of liability if buybacks happen outside those conditions), so that, in theory, repurchases would not have a manipulative effect on the market. But the main effect of repurchases in the short term is to reduce the number of shares available on the open market for trading, meaning that the value of each remaining share goes up in value. Though there is no practical improvement in the sales of a company’s goods, customer satisfaction, or efficiency gains in the production process, share prices go up through the removal of share volume. At the volume of repurchases seen today, conducted intentionally by corporate executives, it is worth considering whether this could be considered manipulation of share prices.31 One study has shown that the probability of share repurchases is sharply higher for firms that would have just missed EPS forecasts in the absence of repurchases.32

A second harm of stock buybacks is their impact on wealth and income inequality. In terms of wealth inequality, stock buybacks only benefit those who hold stock. Less than half of households own any stock at all, and less than a third of households own at least $10,000 worth of stock.33 Stock ownership is concentrated at the top of the wealth distribution: 93% of households in the top one percent of households by income own more than $10,000 of stock.34 Stock ownership reflects broader racial stratification as well: while approximately 60% of white households own stock either directly or indirectly, only 34% and 30% of Black and Latino households, respectively, hold stock.35 All of this means that increasing stock value driven by stock buybacks disproportionately benefits wealthier families. Stock buybacks are also an opportunity cost for other uses of corporate funds, and their rise correlates with a long-term decline in corporate investment.36 If corporations redirected funds spent on buybacks to employee compensation, wage increases could lift low-income workers out of poverty.37

Another harm is the incentives created for corporate insiders, particularly executives. Only corporate insiders know about buybacks when they are actually conducted; disclosure comes after the fact. Corporate executives hold large amounts of stock and their compensation is often tied to an increase in the company’s earnings per share (EPS) metric. That gives executives a personal incentive to time buybacks so that they can profit off of a rising share price.38 That means that the decision of whether and when to execute a stock buyback can affect his or her compensation by tens of millions of dollars. Recent research by SEC Commissioner Robert Jackson Jr. found that the likelihood of insiders selling shares increased five-fold in the week after the announcement of a repurchase program.39 In other words, insiders have a personal incentive to announce buyback programs that they know will raise share price, because they can then turn around and sell their own personal holdings for profit.

Despite these facts—that stocks constitute a substantial proportion of executives’ pay, and that stock buybacks provide a way for executives to raise their pay by millions of dollars—the rules that govern how a company authorizes stock buyback programs fail to account for this significant conflict of interest. The decision to authorize a new stock buyback program is made by the board of directors.40 The actual execution of buybacks is left to the executives and financial professionals inside the companies, with no board oversight as to the timing or amount of such buybacks, as long as the buybacks stay within the limit previously authorized. As long as directors are using their best “business judgment” to authorize programs, and there is no other insider trading violations, there is no recourse to hold directors accountable for extremely high repurchase programs.41 Further, executives are required to disclose the monthly volume of actual open-market repurchases, but only after the fact.42 This means that longer-term investors who hold a small amount of stock, and who could be disadvantaged by the decision to execute a stock buyback program if it is at the expense of investments that could lead to the company’s long-term growth, have no say whatsoever in the company’s decision-making process, and no access to real-time disclosure about buybacks that could be used for selling decisions.

A distinct set of problems with stock buybacks is the lack of oversight as to whether companies are staying within the limits of Rule 10b-18. Stock buybacks that are higher than the safe harbor’s volume limits would, in theory, be subject to action by the SEC for market manipulation. However, assumptions of liability are not automatic even when the safe harbor is exceeded. Because the data is not actually collected as to whether or not a company’s buybacks are within the daily safe harbor limits or not (data is reported by month rather than by day),43 and is not required to be collected, it is impossible for the Commission to bring such actions, and thus all stock buybacks are protected from charges of market manipulation. In response to a letter from Senator Tammy Baldwin in 2015, then-SEC Chair Mary Jo White said, “because Rule 10b-18 is a voluntary safe harbor, issuers cannot violate this rule.”44 To date, the SEC has not investigated companies for violating the daily limit because “performing data analyses for issuer stock repurchases presents significant challenges because detailed trading data regarding repurchases is not currently available.”45 There have been only two enforcement actions related to Rule 10b-18.46 As it stands today, Rule 10b-18 has been insufficient to curb the harms of stock buybacks.

II. A New Regulatory Regime for Stock Buybacks

In this Part, I outlined the path forward for new regulation. In Part II, Section A, I give a broad landscape of regulatory alternatives from two sources: first, earlier rules proposed by the Commission that preceded Rule 10b-18 and differed significantly; and second, rules from a variety of international jurisdictions. In Section B, I develop more specificity to the new rules that the Commission could promulgate. In Section C, I outline new legislative approaches that could be complementary to new Commission rules.

A. A Landscape of Regulatory Alternatives

The Securities and Exchange Act of 1934 (the “Act”) governs secondary trading of equities and lays out anti-fraud and anti-manipulation provisions to govern such activity. Prior to the adoption of Rule 10b-18, stock buybacks were subject to potential liability under several anti-fraud and manipulation statutes of the Act: Sections 9(a)(2)47 and 10(b)48 of the Act and its promulgating Rule 10b-5.49 Because there was no explicit permission nor denial of permission for stock buybacks, they operated in a legally hazy area, inhibiting their use. Congress passed the Williams Act Amendment to the Securities and Exchange Act in 1968,50 which focused on the tender offer process. It gave the Commission authorization to adopt rules and regulations to prohibit buybacks, by defining them as fraudulent, deceptive or manipulative, based on their role protecting investors and the interest of the public. Section (2)(e)(1) stated specifically that it is unlawful for issuers to repurchase their own securities if the purchase “is in contravention to such rules and regulations as the Commission . . . may adopt (A) to define acts and practices which are fraudulent, deceptive or manipulative and (B) to prescribe means reasonably designed to prevent such acts or practices.”51

Throughout the 1970s, the Commission proposed but failed to adopt a series of rules to regulate repurchases. In 1970, Rule 13e-2 was proposed to make stock buybacks “unlawful as acts and practices which are fraudulent, deceptive or manipulative” unless the transactions were conducted according to a certain set of conditions.52 The conditions included: one broker per transaction; no sales before the opening transaction and a half-hour before the close of daily trading; prices could not exceed the highest current independent bid price or the last sale price, whichever is higher; and the volume was limited to not exceeding fifteen percent of the average daily trading volume in the four calendar weeks preceding the week in which the buybacks were conducted.53 These same conditions, with the volume increased by ten percentage points, would become the conditions for the safe harbor. The critical difference in proposed Rule 13e-2 was that all other transactions were unlawful. The proposed Rule did not include specific disclosure requirements but did include a provision under which the Commission could approve repurchases on a case-by-case basis that would otherwise be unlawful.54

In 1973 and 1980, amendments to proposed Rule 13e-2 were added, including a significant proposal for disclosure. In 1973, the Commission was more forthright about its purpose for the rule, describing it as “prescrib[ing] means . . . to prevent an issuer from effecting repurchases which may have a manipulative or misleading impact on the trading market in the issuer’s securities.”55 The Commission later described the conditions for repurchases as “designed to ensure that an issuer neither leads nor dominates the trading market in its securities.”56 This language points to the rationale behind the types of conditions outlined, such as disallowing issuers to set the first or last price for a trading day. The Commission included an initial disclosure regime, including several questions about whether officers or directors should be required to disclose if they are considering buying or selling securities in conjunction with a repurchase that they are in charge of executing. The language points to awareness by the Commission that officers and directors face conflicts of interest, requesting comments on “[w]hether any officers or directors intend to dispose of the issuer’s securities they might presently hold.”57 The proposal invited comments on the idea that the source of funds to be used for the repurchases should be disclosed, and how public such disclosures should be made, along with volume and manner disclosure requirements.58

A revised proposed Rule 13e-2 also laid out the rationale for a need to limit stock buybacks. The Commission explained that the “regulatory predicate . . . [is a] need for a scheme of regulation that limits the ability of an issuer . . . to control the price of the issuer’s securities.”59 Such a need “stems in part from the unique incentives60 that an issuer . . . [has] to control the price of the issuer’s securities.”61 The Commission explained that the guidance was intended to help issuers avoid securities law liability that they could not otherwise predict, since the antifraud and anti-manipulative provisions of the Act are general in nature.62 The Commission once again explained that limits it was proposing were intended to “prevent the issuer from leading or dominating the market through its repurchase program. In fashioning those limitations, the Commission has balanced the need to curb the opportunity to engage in manipulative conduct against the need to avoid excessively burdensome restrictions.”63 Again the Commission left room for a case-by-case exemption of transactions that otherwise would exceed the proposed Rule.64

Even though the elaborate description of the need for the proposed rule was new, the substantive conditions put in place were mainly the same as in the 1970 and 1973 proposals, with one significant difference: transactions that took place outside of its conditions would not be automatically suspect.65 The Commission gave specific reasoning as to why each of the volume, timing, pricing, and manner conditions were critical to designing procedures that would limit the impact of repurchases on the market.66 The Commission also proposed specific disclosure requirements for large-volume repurchase programs but noted that disclosure was not a substitute for substantive regulation, explaining at some length that disclosure would not be enough to curb activity that could be manipulative to the market.67 Disclosure would, however, “give the market an opportunity to react to the fact that the issuer may account for a substantial amount of purchasing activity in its securities.”68

In 1982, rather than proposing another revision to proposed Rule 13e-2, the Commission instead proposed Rule 10b-18, which was adopted later in the year.69 An analysis published at the time claimed that this was a “regulatory about-face,” and that the new safe harbor should be viewed as “constructive deregulatory action . . . [that] contrasts markedly with past Commission views on the regulation of issuer repurchases.”70 Rule 10b-18 stood in contrast to proposed Rule 13e-2, which had the purposes of preventing manipulation by prohibiting the issuer from raising the market price; prohibiting the perception of wide-spread interest by the use of several broker-dealers, and limiting domination of the market with high repurchase volumes.71 The purpose of Rule 10b-18 instead was to facilitate repurchases and limit intrusive regulation into corporate decision-making.72

It is useful to be aware of how stock buybacks are regulated in other jurisdictions. Internationally, most countries with robust capital markets have some regulation in place for curbing stock buybacks, including both disclosure and substantive limitations.73 To summarize, the significant differences from the U.S. model of regulation include: requiring shareholder rather than board approval; placing bright-line limits on buybacks rather than adopting a safe-harbor approach; requiring immediate disclosure; and requiring insiders to not trade during buyback programs.74 Many countries follow the U.S. model with restrictions on timing, price, volume, and manner. Among the ten countries with the largest capital markets, all others place clear limits on repurchase activity, and most have more specific repurchase requirements.75 In the United Kingdom, approval is required at a shareholder meeting, not just from the board of directors.76 Open market share repurchases must be reported immediately to the Financial Supervisory Authority, and disclosure of volume and price is required.77 Requirements put in place by the Tokyo Stock Exchange restrict repurchases in terms of price, quantity and timing, and disclosure is required on execution at the close of the trading day.78 There are also restrictions on insiders, including limiting trading of an insider’s own holdings while a buyback program is underway, and mandating the establishment of trading rules to avoid conflicts of interest.79

In European Union member states, approval at a shareholder meeting is also required, and the authorization is valid for eighteen months.80 In France, significantly, the regulatory agency (the Commission des Operations de Bourse) must also approve the program.81 In Italy, shareholders must also approve the maximum number of shares to be acquired and the minimum and maximum purchase price.82 There is a bright-line limit that a firm cannot buy back more than 10% of outstanding shares in France, Germany, Italy, Switzerland, and the Netherlands.83 E.U. countries require repurchases to be made out of distributable profits, i.e., not purchased with debt.84 Canada’s Toronto Stock Exchange (“TSE”) also requires the board to seek authorization from the TSE and repurchase activity must be filed with the TSE within ten days after the end of each month. Repurchasing firms must also disclose whether insiders plan to sell their holdings during the firms’ buyback program.85 In Switzerland, buybacks are conducted according to a second trading line, and these transactions are fully disclosed on a real-time basis, visible to the public because the firm is the only buyer of this trading line. When a repurchase program is completed, a firm must immediately make a public announcement.86 Several countries also disallow buybacks within ten days prior to earnings announcements.87

B. New Rules at the Securities and Exchange Commission

Rule 10b-18 has not stopped the tremendous growth in stock buybacks. Additionally, because the Commission does not track whether companies are complying with the conditions of the Rule, there is virtually no accountability for potential market manipulation. In order to address the narrower potential problem of market manipulation and the wider problems of the social role of the corporation and widening economic inequality, a new regulatory regime is required.88

There are a variety of new rules that could be promulgated by the Commission to curb repurchases. The Commission can issue new rulemaking to again allow for companies to be held liable for open market share repurchases as market manipulation, in violation of Section 10(b) of the Securities and Exchange Act, pursuant to the authorization given to it by the Williams Act Amendment of 1968, § 2(e)(1). This would return essentially stock buybacks to pre-1982 regulation, in which the potential for liability led companies to largely avoid buybacks. Another approach is to place a bright-line limit on the dollar amount of buybacks that a company can conduct. The Commission places many bright-line limits on companies’ securities offerings pursuant to the 1933 and 1934 Acts.89 A bright-line rule prohibiting companies from conducting repurchases over certain limits would have the effect of lowering the potential for market manipulation, while leaving room for repurchases at the lower level.

In the alternative, the Commission could decide that it must authorize a company’s use of stock buybacks and could promulgate rules giving it wide latitude to reject buybacks that come at the expense of other corporate stakeholders. As proposed by Senators Baldwin and Schumer in an amendment to the 2018 banking reform bill, the Commission would have the authority to require detailed disclosure of buyback plans and execution, reject buybacks plans, and require boards and the CEO to certify that the buybacks are in the long-term “best interest” of the company.90 Elements of the above approaches were in the proposed Rule 13e-2 versions from the 1970s.

Alternately, the Commission could focus on corporate governance rather than substantive limitation, and could require that disinterested directors only authorize repurchase programs, or that companies must meet financial benchmarks to conduct repurchases. In the United Kingdom, a public company can only use distributable profits or the proceeds from a fresh share issuance to conduct a repurchase.91 Insiders could also be either prohibited from trading during repurchase programs or at least required to disclose such plans. As discussed above, boards and executives face conflicting incentives when authorizing stock buybacks. In many of the countries with the largest stock market capitalization—Japan, France, Canada, the Netherlands, Hong Kong, and the United Kingdom—there are explicit restrictions on trading by insiders during a period of buyback activity. For example, Japan delegates the setting of guidelines to the Tokyo Stock Exchange, which requires that “an insider who is in a position to make a firm’s share repurchase decisions should not trade his own holdings of the firm’s shares while a buyback program is underway.”92 In France, monthly disclosure is required to the state agency regulating the stock market (the Commission des Operations de Bourse).93 In Canada and the Netherlands, proactive disclosure is required if interested individuals are planning to sell their holdings during the course of a repurchase program.94 The Commission could put both limitations on insider selling of shares and immediate disclosure requirements in place.

General company disclosure requirements, though not sufficient to curb substantive behavior, would at minimum inform the Commission when bright-line rules are violated, and put directors and officers on notice that repurchase activity will be scrutinized in real time. As noted above, other countries like Japan and the United Kingdom mandate daily disclosure of repurchases. Former Chair Mary Jo White stated that the Commission did not have the data necessary to tell when the Rule was violated.95 Perhaps the simplest solution of all would be to require firms to disclose repurchases immediately and publicly, as is required in several countries. It is certainly within the technological capabilities of firms and the Commission to collect and immediately disclose daily data.

C. Congressional Approaches to Reining in Stock Buybacks

Congress can take steps that the Commission cannot. Congress can ban open market share repurchases by passing affirmative legislation that prohibits purchases by an issuer of its own equity on the national securities exchanges. Such legislation was proposed by Senator Tammy Baldwin in the “Reward Work Act,” which adopts this prohibition and additionally gives Rule 10b-18 “no force or effect.”96 Another approach, similar to what was proposed above for the Commission, is to limit the volume or other conditions for repurchases to a bright-line rule. The rationale behind these policies is that the main purpose of buybacks is to increase the price per share without an increase in real productivity inside the firm. In other words, shares are supposed to rise in value as companies become more profitable, though efficiencies, increased market share, more customers, etc. An increase in share price purely driven intentionally by a reduction in the number of shares on the market is out of step with larger social values that Congress seeks to uphold.

Congress could choose to condition or prohibit the ability of a company to conduct repurchases based on other corporate variables. For example, Congress could amend the Internal Revenue Code to levy a tax of equal amount on a public company if the company does not pay a “workers’ dividend” that is commensurate with company spending on stock buybacks.97 Congress could prohibit buybacks if companies have unfunded pension liabilities, have engaged in layoffs, have failed to meet a certain level of productive investment, have wage dispersion below a certain threshold, or have executive compensation above a certain limit. In the alternative, Congress could condition the ability of a company to engage in buybacks only if they meet certain affirmative thresholds, based on conditions like a median worker-to-CEO compensation ratio or job creation metrics.

Congress could use its tax-and-spend power to directly impose a specific tax on stock buyback transactions by amending the Internal Revenue Code, regardless of other corporate behavior. Taxation would disincentivize firms to conduct stock buybacks. Financial transaction taxes are a broad category of taxes that applies small levies on financial transactions, analogous to sales taxes for transactions of goods and services.98 Such taxes are common globally and have historically been used in the United States. Financial transaction taxes serve to raise revenue but also dampen the trading volume of whatever financial asset is being traded because they take a percentage of profits per trade. They can be structured in a variety of ways on a variety of financial assets, from a very low basis point level that would likely serve to only reduce the lowest-margin trading, to higher rates that would affect trading volume significantly.

In this case, the relevant policy is to institute a stock buyback transaction tax, in which each stock buyback transaction costs the firm a certain percentage of the dollar value of the trade in taxes. Critics of transaction taxes often claim that the tax would serve to dampen market liquidity and lower trading volume; in this case that would be the purpose of the tax. Revenue would be a secondary consideration. Though it is extremely difficult to estimate the elasticities of trading volume with respect to financial transaction taxes generally, it is likely that a tax on repurchases would serve to significantly reduce their use, if the tax was set higher than capital gains taxes.99


The volume of stock buybacks suggests that such repurchases have the potential to lead and dominate the entire market for that issuer’s securities. Rule 10b-18 has both substantive and democratic flaws in its implementation and is not an effective mechanism to appropriately curb issuer repurchasing behavior. Two paths are available for updated regulation: the Commission could repeal Rule 10b-18 and replace it with a regime in which companies are again subject to liability for market manipulation if appropriate; bright-line substantive rules with true enforcement capabilities; or promulgate new processes for ensuring that insiders cannot benefit from buybacks and that decisions to conduct buybacks are made in the true best interest of the company. Alternately, Congress could create new statutes to ban repurchases as impermissible, tax repurchases to dampen activity, impose rules where firms cannot conduct repurchases without meeting other criteria for corporate behavior, or impose governance requirements so that shareholders and disinterested parties authorize repurchase activity. In order to ensure that capital markets are not manipulated by tremendous repurchase activity and that firms undertake true innovative enterprises that sustain prosperity, a new regulatory regime is required.

  1. Stock buybacks are known by a variety of terms, including issuer repurchases and open-market share repurchases. All refer to the same activity.
  2. Jeff Cox, Companies Set to Buy Back $1 Trillion Worth of Shares This Year, and That Should Keep Market Afloat, Goldman Says, CNBC (Aug. 6, 2018, 11:01 AM), https://www.cnbc.com/2018/08/06/companies-set-to-buy-back-1-trillion-worth-of-shares-this-year-to-kee.html [https://perma.cc/VE5J-BBW2].
  3. 17 C.F.R. 240.10b-18 (2018).
  4. Both Commissioner Robert Jackson Jr. and Commissioner Hester Pierce responded affirmatively to a question posed by Senator Brian Schatz as to whether they would be willing to reconsider the Rule. SeeNominations of David J. Ryder, Hester M. Peirce, and Robert J. Jackson, Jr.:Hearing Before the S. Comm. on Banking, Hous., and Urban Affairs, 115th Cong. 34 (2017).
  5. Commissioner Robert J. Jackson Jr., Speech at the Center for American Progress: Stock Buybacks and Corporate Cashouts (June 11, 2018), https://www.sec.gov/news/speech/speech-jackson-061118 [https://perma.cc/CBP3-ASWG].
  6. Securities and Exchange Act of 1934 § 10(b), 15 U.S.C. § 78j (2018).
  7. Purchases of Certain Equity Securities by the Issuer and Others, 45 Fed. Reg. 70,890 (Oct. 27, 1980).
  8. For a full discussion of the relationship between stock buybacks and employee outcomes, see generally Lenore Palladino,Stock Buybacks: Driving a High-Profit, Low-Wage Economy, Roosevelt Inst.(Mar. 20, 2018), http://rooseveltinstitute.org/stock-buybacks-high-profit-low-wage [https://perma.cc/4HKX-X3CJ].
  9. See Kent Greenfield, the Failure of Corporate Law: Fundamental Flaws and Progressive Possibilities 1 (2006).
  10. Lynn A. Stout, The Shareholder Value Myth3 (Cornell Law Faculty Publ’n No. 771, 2013), https://scholarship.law.cornell.edu/cgi/viewcontent.cgi?referer=&httpsredir=1&article=2311&context=facpub [https://perma.cc/YT3W-Z3SH] (discussing the rise of the ideology of shareholder primacy and its critical flaws as a matter of law).
  11. Id.
  12. Activist shareholders are able to dominate board elections through the proxy voting system. See generally Jang-Sup Shin, The Subversion of Shareholder Democracy and the Rise of Hedge-Fund Activism,Institute for New Economic Thinking, Working Paper No. 77 (2018).
  13. See, e.g., David Yosifon, Corporate Friction: How Corporate Law Impedes American Progress and What to Do About It (2018).
  14. For a full discussion of the the role of investors in providing investment capital to public companies, see William Lazonick, The Theory of Innovative Enterprise: A Foundation of Economic Analysis4–16 (Acad.-Indus. Research Network, Working Paper No. 13-0201, 2013, revised 2015), http://www.theairnet.org/v3/backbone/uploads/2015/08/Lazonick.TIE-Foundations_AIR-WP13.0201.pdf [https://perma.cc/C8J5-429A].
  15. There are important reasons to question whether shareholder primacy is the most useful approach to corporate law normatively, but those considerations are outside the scope of this paper.
  16. See, e.g., Jesse M. Fried & Charles C.Y. Wang, Short-Termism and Capital Flows (Harvard Bus. Sch. Accounting & Mgmt. Unit Working Paper No. 17-062, European Corp. Governance Inst. (ECGI)- Law Working Paper No. 342/2017, Feb. 9, 2017), http://www.law.harvard.edu/programs/olin_center/papers/pdf/Fried_897.pdf [https://perma.cc/78YS-NT5L].
  17. See id.
  18. See, e.g., Moody’s Daily Corporate Bond Yield Averages, https://fred.stlouisfed.org/series/AAA [https://perma.cc/QN4Z-WMCE].
  19. Financial Accounts of the United States: Flow of Funds, Balance Sheets, and Integrated Macroeconomic Accounts, Bd. of Governors of the Fed. Reserve Sys. 68 tbl.F-223 (Sep. 20, 2018, 12:00 PM ET), https://www.federalreserve.gov/releases/z1/20180920/z1.pdf [https://perma.cc/BAT4-4JKE]; see also Palladino, supra note 8. In the financial sector, new equity issuances ballooned after the financial crisis because banks issued new equity to the U.S. government in order to be bailed out. Therefore these new equity issuances cannot be considered along with standard issuances of equity in private markets. See generally Lazonick, supra note 14.
  20. Mike Konczal & Marshall Steinbaum, Declining Entreprenurship, Labor Mobility, and Business Dynamism: A Demand-Side Approach, Roosevelt Inst. (July 21, 2016), http://rooseveltinstitute.org/wp-content/uploads/2016/07/Declining-Entrepreneurship-Labor-Mobility-and-Business-Dynamism-A-Demand-Side-Approach.pdf [https://perma.cc/VP76-8T25].
  21. This is not an argument to remove limits on investing in private markets, because doing so risks increasing the negative impact of the hype and even fraud that takes advantage of limited disclosure requirements.
  22. Author’s analysis of data from S&P Compustat (on file with author).
  23. Cox, supra note 2.
  24. Author’s analysis of data from S&P Compustat (on file with author).
  25. What constitutes market manipulation legally is complex. See generally Merritt Fox et al., Stock Market Manipulation and Its Regulation, 35Yale J. on Reg.67 (2018); seealsoWilliam Lazonick, Profits Without Prosperity, Harv. Bus. Rev.(Sept. 2014), https://hbr.org/2014/09/profits-without-prosperity [https://perma.cc/53WG-TAGR] [hereinafter Profits Without Prosperity] (describing the rise of stock buybacks and their role in corporate investment decisions).
  26. Fox et al., supra note 25 at 71.
  27. 17 C.F.R. 240.10b-18(b)(2) (2018).
  28. 17 C.F.R. 240.10b-18(b)(4) (2018).
  29. 17 C.F.R. 240.10b-18(b)(3) (2018).
  30. 17 C.F.R. 240.10b-18(b)(1) (2018).
  31. See generally Fox et al., supra note 25.
  32. Heitor Almeida et al., The Real Effects of Share Repurchases, 119 J. Fin. Econ.168 (2016).
  33. Edward Wolff, A Century of Wealth in America125 (2017).
  34. Id.at 127.
  35. Lisa J. Dettling et al., Recent Trends in Wealth-Holding by Race and Ethnicity: Evidence From the Survey of Consumer Finances, Bd. of Governors of the Fed. Reserve Sys.(Sep. 27, 2017), https://www.federalreserve.gov/econres/notes/feds-notes/recent-trends-in-wealth-holding-by-race-and-ethnicity-evidence-from-the-survey-of-consumer-finances-20170927.htm [https://perma.cc/6ZS7-KJBQ].
  36. J.W. Mason, Disgorge the Cash: The Disconnect Between Corporate Borrowing and Investment, Roosevelt Inst.(2015), http://rooseveltinstitute.org/wp-content/uploads/2015/09/Disgorge-the-Cash.pdf [https://perma.cc/8FCT-A4BJ].
  37. See Lenore Palladino, Making the Case: How Ending Walmart’s Stock Buyback Program Would Help to Fix Our High-Profit, Low-Wage Economy, Roosevelt Inst.(2018), http://rooseveltinstitute.org/making-case [https://perma.cc/CN8E-DSQH].
  38. See Jackson, supra note 5.
  39. Id.
  40. While stock buybacks do not generally require board action (DGCL § 160), generally boards do approve stock buyback programs. See generally James D. Honaker & Eric S. Wilensky, Dividends, Redemptions and Stock Purchases, Practical Law Company (2012), https://www.mnat.com/files/1-519-2507.pdf [https://perma.cc/NV4J-YYDD].
  41. Id.
  42. 17 C.F.R. 229.703 (2018).
  43. Id.
  44. See David Dayen, SEC Admits It’s Not Monitoring Stock Buybacks to Prevent Market Manipulation,The Intercept(Aug. 13, 2015, 9:08 AM), https://theintercept.com/2015/08/13/sec-admits-monitoring-stock-buybacks-prevent-market-manipulation [https://perma.cc/6RW9-NDQ5].
  45. Id.
  46. Email from Steven G. Johnston, Special Counsel, the Office of Investor Education and Advocacy, Securities and Exchange Commission (June 19, 2018) (on file with author); see also Incomnet, Inc., SEC Release No. 40281 (July 30, 1998), https://www.sec.gov/litigation/admin/3440281.txt [https://perma.cc/89CN-3JJV]; SEC v. Wachovia Corp.,SEC Litigation Release No. 18958 (Nov. 4, 2004), https://www.sec.gov/litigation/litreleases/lr18958.htm [https://perma.cc/L2DN-RQPV].
  47. 15 U.S.C. § 78i (2018).
  48. 15 U.S.C. § 78j (2018).
  49. 17 C.F.R. 240.10b-5 (2018).
  50. Williams Act, Pub. L. No. 90-439, 82 Stat. 455 (1968).
  51. Id.
  52. Purchase of Equity Securities by Issuer Thereof, 35 Fed. Reg. 11,411 (July 16, 1970).
  53. Id.
  54. Id. at 11412.
  55. Repurchases of Securities and Prohibitions Against Certain Trading, 38 Fed. Reg. 34341 (Dec. 13, 1973).
  56. Id.
  57. Id.at 34342.
  58. The revisions dealt with: broker-dealers who are the issuers; “block” trading; volume quotes with respect to NASDAQ, a new entity, and other minor revisions. See id. at 34341–42. Several additional exemptions were included because “neither situation appears to present any appreciable potential for market impact,” again demonstrating that the Commission was grappling with how to prevent the issuer from interfering in the market for its own securities. Id. at 34343.
  59. Purchases of Certain Equity Securities by the Issuer and Others, 45 Fed. Reg. at 70890.
  60. They went on to describe the incentives that face directors and officers, both as to giving an appearance of prosperity for the firm, and for insiders who may be conflicted in their own transactions. Id.
  61. Id.
  62. Id.
  63. Id.at 70891.
  64. Id. at 70896.
  65. Id.
  66. Id.at 70898.
  67. Id.at 70897.
  68. Id.
  69. 17 C.F.R. 240.10b-18 (2018).
  70. Lloyd H. Feller & Mary Chamberlain, Issuer Repurchases,17 Rev. Sec. Reg. 993 (1984).
  71. See id. at 995.
  72. See id.
  73. See Jaemin Kim, Ralf Schremper & Nikhil Varaiya, Survey on Open Market Repurchase Regulations: Cross-Country Examination of the Ten Largest Stock Markets, 9 Corp. Fin. Rev. 29 (2005).
  74. Id.
  75. Id.
  76. Id.at 32.
  77. Id.
  78. Id. at 32.
  79. Id.
  80. Id. at 35.
  81. Id. at 32.
  82. Id. at 34.
  83. Id.
  84. E.U. rules stem from a 1976 EC Directive on share repurchase regulations, which specified that share repurchases should be made out of distributable profits only, not out of cash proceeds from debt issuances. Id. at 35.
  85. Id. at 33.
  86. Id. at 34.
  87. Id.
  88. Though critics may say curbing buybacks will simply lead companies to raise dividends, proper regulation of buybacks will limit the potential for insider incentives, and promote increased attention to long-term corporate profitability, as dividends benefit shareholders while buybacks benefit share-sellers.
  89. See generally 17 C.F.R. 230.501 (2018) (rules defining dollar thresholds for accredited investors).
  90. See U.S. Senator Tammy Baldwin and Senate Democratic Leader Chuck Schumer Introduce Amendment to Rein in Corporate Stock Buybacks in Banking Deregulation Bill, Office of Senator Tammy Baldwin (Mar. 7, 2018), https://www.baldwin.senate.gov/press-releases/amendment-to-rein-in-corporate-stock-buybacks [https://perma.cc/CDB4-847Q].
  91. Companies Act 2006, c. 46 (Eng). The Act covers England and Wales; Scotland; and Northern Ireland.
  92. Kim,supranote 73 at 32.
  93. Id.
  94. Id. at 33 – 34.
  95. Dayen,supra note 44.
  96. The Reward Work Act of 2018, H.R. 6096, 115th Cong. (2018).
  97. The Worker Dividend Act of 2018, S. 2505, 115th Cong. (2018).
  98. Wall Street Trading and Speculators Tax Act of 2011, H.R. 3313, 112th Cong. (2011).
  99. For the relevant literature on financial transaction taxes and their effect on stock trading volume, see generally Robert Pollin et al., The Revenue Potential of a Financial Transaction Tax for U.S. Financial Markets,Pol. Econ. Research Inst.(2017), https://www.peri.umass.edu/publication/item/698-the-revenue-potential-of-a-financial-transaction-tax-for-u-s-financial-markets [https://perma.cc/MR8P-353N]. For additional analysis on the effects of a stock buybacks transaction tax, unpublished research is on file with the author.

The Mandatory Repatriation Tax Is Unconstitutional

*J.D. Stanford Law School, 2016. The Author wishes to thank Joe Bankman, David Forst, Adam Halpern, and Mike Knobler for their incredibly helpful comments on drafts of this Essay, as well as his colleagues at Fenwick & West LLP for their support. He also wishes to thank the editorial team at the Yale Journal on Regulation Bulletin. All errors are his own.

In late 2017, Congress passed the first major tax reform in over three decades. This Essay considers the constitutional concerns raised by Section 965 (the “Mandatory Repatriation Tax”), a central provision of the new tax law that imposes a one-time tax on U.S.-based multinationals’ accumulated foreign earnings.

First, this Essay argues that Congress lacks the power to directly tax wealth without apportionment among the states. Congress’s power to tax is expressly granted, and constrained, by the Constitution. While the passage of the Sixteenth Amendment mooted many constitutional questions by expressly allowing Congress to tax income from whatever source derived, this Essay argues the Mandatory Repatriation Tax is a wealth tax, rather than an income tax, and is therefore unconstitutional.

Second, even if the Mandatory Repatriation Tax is found to be an income tax (or, alternatively, an excise tax), the tax is nevertheless unconstitutionally retroactive. While the Supreme Court has generally upheld retroactive taxes at both the state and federal level over the past few decades, the unprecedented retroactivity of the Mandatory Repatriation Tax—and its potential for taxing earnings nearly three decades after the fact—raises unprecedented Fifth Amendment due process concerns.


In December 2017, President Trump signed H.R. 1, originally introduced as the Tax Cuts and Jobs Act of 2017 (the “TCJA”).1 The TCJA is the most wide-ranging change in federal tax law since the Tax Reform Act of 1986, a bipartisan rewrite of the Code signed into law by President Reagan.2 The TCJA’s many changes to the Code3 include: a reworking of the individual tax brackets,4 the near doubling of the standard deduction5 and the elimination of the personal exemption,6 the doubling of the estate tax exemption,7 the cutting of the corporate tax rate from thirty-five percent to twenty-one percent (along with the elimination of the corporate AMT8 and the imposition of a new excise tax on universities.9

Notably, the TCJA transforms the United States’ system of international taxation. In the corporate realm, the TCJA moves the United States away from something akin to a worldwide system of taxation, and into a quasi-territorial system of taxation.10 Under the U.S. international tax regime before the passage of the TCJA, many large U.S.-based multinationals11 accumulated considerable earnings overseas, deferring perhaps $2.5 trillion in earnings from U.S. taxation.12 While multinational entities’ overseas earnings have generally been subject to tax in the source jurisdiction—that is, taxed in the jurisdiction where the income is deemed to have been earned or attributable—accumulated overseas earnings have never been subject to tax in the United States.13 In the past, Congress has incentivized corporations to repatriate cash by providing a substantial deduction for such dividends, which lowered the effective U.S. rate on that overseas income.14

However, the TCJA goes beyond offering an optional deduction to incentivize repatriation. The TCJA imposes a tax on all post-1986 accumulated foreign earnings.15 Speaking generally, this “Mandatory Repatriation Tax”16 in the new Section 965 applies to certain United States shareholders of foreign corporations that have accumulated deferred foreign income.17

This tax is imposed on accumulated earnings whether or not such earnings are held in liquid or illiquid assets. There is a difference in rate between earnings held in liquid and in illiquid assets: all earnings held in cash or cash equivalents (as of late 2017) are to be taxed at a 15.5 percent rate, and earnings held in illiquid assets are to be taxed at an 8 percent rate.18 Corporations may elect to pay this tax in installments over the course of eight years.19

The imposition of this new, mandatory tax raises a constitutional question.20 The Mandatory Repatriation Tax appears to be a tax on wealth accumulated by a U.S. corporation’s foreign subsidiaries. Such a tax is not, at least on its face, a tax on income as permitted under the Sixteenth Amendment.21 Nor is it strictly a repatriation tax. Unlike past “repatriation holidays,” this tax is imposed on accumulated foreign earnings whether or not the entity repatriates any of its foreign assets.22

This Essay discusses, and challenges, the constitutionality of this tax on two independent grounds. First, I will argue that the Mandatory Repatriation Tax is an unconstitutional direct tax. Second, even if the tax is considered to be an income tax, it is a retroactive tax on income, and it is therefore vulnerable to a challenge under the Due Process Clause of the Fifth Amendment.

I. The Mandatory Repatriation Tax

This Part is intended to provide a nontechnical discussion concerning the basics of the U.S. international tax system and to discuss how past and current repatriation taxes have altered and fit into that system.

A. International Taxation of U.S. Multinationals

Domestic corporations in the United States are taxed on their worldwide income, including any income that the corporation earned from the direct conduct of a foreign business.23 This includes, for example, direct sales or the operation of a branch in a foreign jurisdiction.24 In general, income that a domestic corporation earned indirectly from the foreign operation of its foreign corporate subsidiaries was not taxed until the income was distributed to the domestic parent corporation.25 The U.S. tax on the earnings of foreign corporate subsidiaries can therefore be deferred until the multinational entity elects to repatriate the income by distributing it to its domestic parent corporation.26

A notable element of this tax system is the anti-deferral regime known as subpart F.27 Under Section 951(a), a U.S. shareholder of a “controlled foreign corporations” (a “CFC”), 28 is required to include in gross income for the current taxable year its pro rata share of certain items that are attributable to the CFC.29 These inclusions are commonly referred to as “subpart F income.”30

Congress enacted subpart F as part of the Revenue Act of 1962.31 Subpart F singles out a specific class of taxpayers—U.S. shareholders who have a substantial degree of control over a foreign corporation—and subjects them to immediate taxation on the grounds that they have the ability to treat the corporation’s undistributed earnings as they see fit.32 Thus, certain income of CFCs would be subject to immediate taxation.33

Subpart F income generally includes “passive income and other income that is readily movable from one taxing jurisdiction to another.”34 Subpart F income is comprised of: foreign base company income,35 insurance income,36 and certain other income relating to boycotts and other violations of public policy.37 Foreign base company income includes: certain types of passive income (including certain dividends, interest, rents, and royalties),38 certain foreign sales income,39 certain foreign services income,40 and—prior to the passage of H.R. 1—certain foreign oil-related income. 41 Subpart F operates as an anti-deferral regime, requiring the immediate inclusion of these limited types of income earned by controlled foreign corporations to major U.S. shareholders.

B. Past Attempts at Repatriation Taxes.

The most significant attempt to tax corporations’ accumulated overseas earnings occurred with the passage of Section 96542 in 2004 as part of the American Jobs Creation Act of 200443 (the “old Section 965”). The old Section 965 allowed CFCs to repatriate, at their election, accumulated foreign profits at a U.S. tax rate of 5.25 percent to the domestic corporate owners, rather than the standard 35 percent corporate rate.44 Various limitations existed on this “tax holiday,” including45: (1) a cap of $500 million in dividends applicable to most corporate taxpayers,46 (2) requirements that any dividends paid be extraordinary,47 and (3) a reduction in such benefit if the amount of indebtedness of the CFC to any related person increased as of the close of the taxable year for which the old Section 965 was in effect.48 This tax was markedly different than the TCJA’s Mandatory Repatriation Tax. Since the 2004 law offered an optional deduction, corporations could elect to benefit from the lower rate, but were not required to pay any tax if they chose to keep their profits permanently invested overseas.

Over the past decade, various individuals have suggested a tax holiday of some form as a way to generate revenue. In 2014, the Camp Plan—advanced by then Chairman of the House Ways and Means Committee Dave Camp—also proposed having a one-time tax on accumulated foreign earnings and profits (at an 8.75 percent rate).49 A repatriation holiday was potentially an integral part of bipartisan tax reform; even the Obama Administration suggested a one-time tax on overseas earnings as a potential revenue-raiser.50

The taxation of accumulated foreign profits would ultimately be a central component of the TCJA. The TCJA dramatically changed the tax treatment of foreign earnings with three new provisions: the foreign dividends received deduction, the deemed repatriation tax, and the tax on global intangible low-taxed income.

C. The TCJA and the New Quasi-Territorial Regime

The TCJA, the most substantial tax reform since the passage of the Tax Reform Act of 1986, transforms the world of international corporate tax. It drops the corporate rate from 35 percent to 21 percent51 and it imposes several new and extraordinarily complex and acronym-heavy taxes on multinational corporations, including: a tax on multinationals’ “global intangible low-taxed income” (their “GILTI”),52 a deduction for Foreign-Derived Intangible Income (“FDII”),53 and the base erosion and anti-abuse tax (the “BEAT tax”).54

But, in transitioning from a worldwide system to this new quasi-territorial regime, a key policy question for Congress was what it would do about already-deferred foreign-source earnings of U.S. multinationals. Many U.S.-based multinationals had accumulated billions in foreign-sourced earnings of its subsidiaries that had never been subject to U.S. taxation.55 Congress could have merely allowed for a full deduction on repatriation without any payment of tax, but given the need for revenues to fund the corporate tax rate cut, such an outcome seemed unlikely.56 The TCJA provides that these accumulated earnings and profits are subject to a one-time tax, payable over eight years.57

1. New Section 965: The Mandatory Repatriation Tax.

The TCJA provides that certain deferred foreign-source earnings and profits, accumulated by U.S.-owned foreign corporations between 1986 and 2017, are now deemed to be repatriated and are thus subject to immediate taxation, albeit at a reduced rate.58 Specifically, certain U.S. shareholders that own foreign corporations will now be taxed on such accumulated earnings at a rate of 15.5% for earnings held in cash or cash equivalents, and at a rate of 8% for all other earnings.59 It is not the foreign corporations themselves paying the tax, but rather the U.S. shareholders who own at least a 10% stake in the foreign corporations. Moreover, the shareholders will be responsible for this tax whether or not they are able to cause the foreign corporation to pay dividends.60

The mechanics of this tax are extraordinarily complicated.61 Put simply, all of a U.S.-parented multinational entity’s deferred foreign earnings—deferred profits which have never been subject to U.S. tax—are now subject to a 15.5 percent tax if they are cash or cash equivalents, or an 8 percent tax if they are not. This tax occurs as if the profits accumulated in late 2017,62 even though taxpayers may defer some of their payment of the tax to a later year.63 Importantly, the Mandatory Repatriation Tax is imposed on U.S. shareholders whether or not a multinational entity elects to repatriate the cash.

II. Constitutional Challenges to the Mandatory Repatriation Tax

This Essay raises two independent arguments that the Mandatory Repatriation Tax is unconstitutional. First, the Mandatory Repatriation Tax is not a tax on income, but is instead an unconstitutional direct tax, since it taxes wealth.64 Second, even if the tax is found to be an income tax, it should be considered to be a retroactive tax on income and is therefore unconstitutional under the Due Process Clause of the Fifth Amendment.

A. The Mandatory Repatriation Tax is an Unconstitutional Direct Tax on Accumulated Wealth.

1. The Mandatory Repatriation Tax is Not an Income Tax

Our starting point is to ask whether the tax is an income tax, and therefore is permissible under the Sixteenth Amendment (but still subject to due process limitations).65 If the tax is not an income tax, then the question turns to whether it is a “direct” tax (and therefore subject to apportionment66), or an “indirect” tax that is not subject to apportionment (e.g., an excise tax, or an automobile tax).

a. Defining Income Tax.

The Sixteenth Amendment allows for the taxation of income “from whatever source derived.”67 But an income tax must tax income, and the Mandatory Repatriation Tax—levied against a U.S. shareholder of a controlled foreign corporation—ultimately fails to do so.

Merriam-Webster defines “income” as “a coming in” and as “a gain or recurrent benefit usually measured in money that derives from capital or labor; also: the amount of such gain received in a period of time.”68 `
Any definition of income implies some type of transfer of property during a specific timeframe. To illustrate, Lucas v. Earl69—known to any tax student as the seminal case for the assignment of income doctrine—makes a theoretical distinction between the fruit of the tree (the income) and the tree itself (the income-producing entity).70

In Eisner v. Macomber, the Supreme Court carefully considered the definition of income, as it applied to a pro rata dividend of stock that did not impact an individual’s ownership of a corporation. In Macomber, the Court concluded that a pro rata stock dividend was not income. Rather, it was analogous to taxing the underlying earnings of the corporation rather than taxing a cash dividend. This analysis highlights how the Court conceptualized income. The Court held that “from every point of view, we are brought irresistibly to the conclusion that neither under the Sixteenth Amendment nor otherwise has Congress power to tax without apportionment a true stock dividend made lawfully and in good faith, or the accumulated profits behind it, as income of the stockholder.”71

It appears to follow from the holding of Macomber that, until actually distributed, accumulated foreign earnings and profits of a controlled foreign corporation are not income to a U.S. shareholder of such controlled foreign corporation. While later cases challenged the holding of Macomber in the context of subpart F,72 those cases all involved the current-year attribution of current earnings. They do not address the novel issue presented here, which is whether past, accumulated earnings are properly considered to be income to the 10-percent shareholders of a controlled foreign corporation without any dividend being paid.73

Some special cases need to be addressed. There are certain circumstances where a taxpayer could be taxed on “accumulated earnings” without the payment of a dividend to the U.S. parent corporation or to a U.S. shareholder. Under Section 956, an investment of current or accumulated earnings in certain U.S. property can trigger a subpart F inclusion.74 The Tax Court has held that such investment into U.S. property can be seen as “manifesting the shareholder’s exercise of control over the previous income of the corporation.”75 That is, even in the case of a subpart F inclusion triggered by investment in U.S. property, it is the investment in U.S. property that creates the event that is substantially equivalent to the payment of a dividend into the United States.76

In another case, a corporation may be subject to the “accumulated earnings tax,” imposed on the undistributed current earnings and profits of the corporation’s taxable year that are in excess of those retained by the corporation for its reasonable business needs.77 This tax is not self-assessed; it is imposed only when the IRS issues a notice of deficiency requiring the payment of such tax. Importantly, the base of the accumulated earnings tax is the corporation’s “accumulated taxable income.”78 A corporation’s accumulated taxable income is a modification of its taxable income, allowing for certain deductions (including taxes paid and charitable contributions), but disallowing certain others (including a deduction for net operating losses). Despite its name, the accumulated earnings tax is nevertheless a further tax on the income of the corporation.

b. Section 965 does not tax income, nor does it tax current-year inclusions of deferred income.

The Mandatory Repatriation Tax uses as its base the accumulated foreign earnings of certain controlled foreign corporations.79 The mechanism of the tax itself—as discussed above—is to include a taxpayer’s earnings as subpart F income in their last taxable year beginning before January 1, 2018, along with a deduction (that, in effect, lowers the rate of tax owed on such income). But such an inclusion is not necessarily for income earned during the taxable year under which the Mandatory Repatriation Tax is imposed.80 Calling something income does not make it so.

Importantly, there is no requirement under new Section 965 that cash or property be repatriated to a U.S. corporation in order for the U.S. shareholders to be liable for the taxes owed.81 Further, there is no transfer, no disposition, and no recognition event which must occur to create income. This is how this tax can be distinguished from, say, the estate tax, which requires an event (death) which causes a transfer of assets. The tax is treating accumulated wealth as income to the taxpayer in the current year. It matters not if the taxpayer actually transfers the income into the United States.

Further, the Mandatory Repatriation Tax does not take into account whether the taxpayer has the actual ability to, at their election, repatriate foreign earnings. In this light, it is worth considering the mark-to-market provisions of Sections 475 and 1256.82 In the 1993 case Murphy v. United States, the Ninth Circuit rejected a constitutional challenge to Section 1256.83 The Court found that the taxpayer was entitled to withdraw his profits at any time. Relying on the doctrine of constructive receipt, the Court found that a taxpayer who traded futures contracts received profits as a matter of right daily, and thus could be taxable on a mark-to-market basis due to “the unique accounting method governing futures contracts.”84

A taxpayer subject to the Mandatory Repatriation Tax, however, is not necessarily receiving profits as a matter of right daily, or annually. A ten-percent shareholder in a controlled foreign corporation is not in control of that corporation; such a shareholder cannot unilaterally access the profits of the foreign corporation by forcing a dividend.85 Thus, unlike the taxpayer in Murphy, the taxpayer subject to the Mandatory Repatriation Tax has not constructively received the profits of the controlled foreign corporation; the Ninth Circuit’s reasoning should not apply.

An additional argument against this position might assert that Section 965 goes no further than does subpart F, which taxes U.S. shareholders on certain earnings of controlled foreign corporations in the United States immediately—in the year that the income was earned—despite the fact that the income may not be brought into the United States. The rationale behind subpart F, and its requirement that U.S. shareholders immediately include certain forms of passive income as U.S. gross income, is that certain U.S. persons with some substantial degree of control over a foreign entity (a controlled foreign corporation must have at least 50 percent of its shareholders be 10 percent U.S. shareholders)86 should be required to include easily moveable passive income as their own income.87

As discussed above, a taxpayer may have a subpart F inclusion where a taxpayer invests accumulated earnings in U.S. property. The Tax Court found that the act of investing in U.S. property was an event that was substantially similar to the payment of a dividend. And the accumulated earnings tax under Sections 531 and 532 imposes a tax on the current earnings and profits of a corporation. And further, the accumulated earnings tax is levied at the level of the corporation, not at the level of the shareholder.

With the Mandatory Repatriation Tax, there is no such event that creates a rational basis for Congress to attribute income to a taxpayer.88 And unlike older repatriation holidays, there is no requirement that taxpayers elect to repatriate cash or other property. Absent such a clear recognition event (or the constructive receipt of income), there is no income to be taxed, and the constitutional basis for the tax is not established under the Sixteenth Amendment.

All that said, even if a court finds that the Mandatory Repatriation Tax is properly characterized as an income tax, there are still potential constitutional challenges to the tax on due process grounds, discussed below in Section II.B.

2. The Mandatory Repatriation Tax is Best Characterized as Direct Tax on Wealth

If the Sixteenth Amendment does not provide for the constitutionality of an income tax, we must turn to the taxation provisions of Article I. In particular, Section 9, Clause 4 of Article I of the Constitution provides that no “Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.”89 It is somewhat unclear what the Constitution and the framers meant when they used the term “direct tax.” To Justice Chase, writing in 1796, only capitation taxes and taxes on real property ought to be considered direct taxes. In Fernandez v. Wiener90 the Court held that a “tax imposed upon the exercise of some of the numerous rights of property is clearly distinguishable from a direct tax, which falls upon the owner merely because he is owner, regardless of his use or disposition of the property.”91

Scholars have also weighed in as to what it means for a tax to be properly considered a “direct tax.” For instance, Erik Jensen believes a “direct tax” is any tax that cannot be shifted, a definition that should encompass any tax on the economic attributes of persons—including a consumption tax.92 Joseph Dodge has taken what he calls a “middle of the road position”93 arguing that apportionment “should be required of taxes on real and personal tangible property only, excluding taxes on intangible property.”94 Dodge further asserts that personal wealth taxes are “unconstitutional at least to the extent that the value of real estate and tangible property is included in the tax base.”95

There has also been a notable scholarly challenge to the validity of the apportionment requirement itself. Bruce Ackerman argues that, after the Reconstruction Amendments were passed, the apportionment clauses were effectively repealed, since those clauses have a tainted history due to their invention during the Constitutional Convention as a compromise regarding slavery.96

Notwithstanding Ackerman’s objection, a scholarly consensus appears to be that the taxation of some forms of personal wealth is unconstitutional under the apportionment provisions of Article I.97 The Mandatory Repatriation Tax is best characterized as a direct tax on wealth because it is levied on the taxpayer not because some recognition event is occurring—like the repatriation of cash into the United States under the old Section 965, the investment in U.S. property under Section 956, or even the death of an individual with respect to the estate tax—but rather is levied solely because the U.S. shareholder is the owner of an asset that, as of an arbitrary date,98 has accumulated foreign earnings. That is, to apply the Court’s framing in Fernandez v. Weiner, the tax is being levied upon the owner of stock in a foreign CFC merely because of the fact that owner is the owner.99

Of course, the Mandatory Repatriation Tax is not apportioned among the states. This means that, if classified as a direct tax, it should be an unconstitutional exercise of Congress’s limited taxing powers.100 That said, even if the tax is characterized as an income tax, it presents unprecedented due process concerns, as discussed in the next Section.

B. If the Mandatory Repatriation Tax Is an Income Tax, it is Unconstitutionally Retroactive

Even if a court finds that the Mandatory Repatriation Tax is an income tax,101 it nevertheless should consider constitutional challenges to the tax on due process grounds under the Fifth Amendment. The Supreme Court has considered similar challenges to other, less problematic, tax laws. While courts have often found retroactivity constitutionally permissible, the reasoning that courts have provided suggests that the Mandatory Repatriation Tax raises unprecedented due process concerns.

1. Carlton and Retroactive Taxes.

The Fifth Amendment provides that no person shall be “deprived of life, liberty, or property without due process of law.”102 In the tax caselaw that developed under the Fifth Amendment, two distinct bodies of law are relevant to the Mandatory Repatriation Tax: (1) the doctrine concerning the constitutionality of retroactive taxation, and (2) the doctrine concerning the lack of notice.

The last Supreme Court case to consider a due process challenge to a retroactive tax law was United States v. Carlton in 1994.103 In Carlton, the Supreme Court considered a provision of the federal estate tax statute that limited the availability of a recently added deduction for certain employee stock-ownership plans.104 Congress provided that this deduction would apply retroactively, taking effect roughly one year before it was passed.105 The Court considered “whether the retroactive application of the [amendment to the estate tax law] violates the Due Process Clause of the Fifth Amendment.”106

The Court concluded that the 1987 amendment’s retroactive application met “the requirements of due process.”107 The Court applied rational basis review in evaluating whether the law in issue violated substantive due process.108 More specifically, the Court applied the same standard that is generally applicable to retroactive economic legislation: a “legitimate legislative purpose furthered by rational means.”109

First, the Court noted that “Congress’ purpose in enacting the amendment was neither illegitimate nor arbitrary.”110 The law itself was “adopted as a curative measure,” as the Court found that Congress “did not contemplate” that the deduction—without amendment—would have such broad applicability.111 The Court saw the law as a technical correction, making the law work the way Congress had clearly intended for it to work. This justified Congress’s choice to make the amendment retroactive back to the date of the law’s original passage.

In addition, the Court concluded that “Congress acted promptly and established only a modest period of retroactivity.”112 In Carlton, the period of retroactivity was slightly longer than a year. The Court at least suggests that a much longer period of retroactivity should present greater constitutional concern. Noting all of these factors, the Court nevertheless held that the 1987 amendment’s limited retroactive application ultimately met the constitutional requirements of due process.113

The Supreme Court has recently had multiple opportunities to reconsider its holding in Carlton in the context of a retroactive state tax law, but has so far declined to do so.114 It is possible that the Supreme Court will expand the notion of what constitutes an acceptable retroactivity when it considers such a case. But no such case has been granted certiorari. Given the unprecedented retroactivity of the Mandatory Repatriation Tax, a court that considered it to be an income tax should still seriously grapple with the Fifth Amendment concerns the law raises.

2. The Mandatory Repatriation Tax has an Unconstitutionally Extended Period of Retroactivity.

In Carlton and in related cases, courts have held taxes constitutional where there has been a modest period of retroactivity (in Carlton, the period was slightly over a year).115 In Carlton, the curative nature of the law (it merely corrected what seemed a good faith oversight by Congress in the drafting of the bill) made retroactivity back to the main law’s date seem sensible.116 Congress quickly acted, and the error was resolved with new legislation (with retroactive effect).

However, quite unlike the law at issue in Carlton, The Mandatory Repatriation Tax has a period of retroactivity back to 1986—over three decades prior to the imposition of the tax. Almost certainly there exist multinationals who will be able to demonstrate that they are being effectively subject to a new income tax on their overseas earnings from over thirty years ago. Unlike the cases considered in Carlton, this is not a mere readjustment of an earlier law, or a minor change to an existing regime. Rather, this is the imposition of a new tax with a retroactive effect lasting over three decades.

A counterargument to this point—a position it seems likely the government will take if and when the retroactivity of Section 965 is litigated —is that Section 965 is not a retroactive tax, but merely an acceleration of an already imposed income tax. To put it another way, the government could argue that the realization event occurred when the income was earned, and the deferral of the tax was merely a timing issue. Thus, the government has the right to accelerate the timing—since that income was always to be subject to tax—and has done so through the imposition of Section 965. The tax is merely a lower rate on deferred incomes.

This argument has multiple flaws: its assumption that the earnings of CFCs would eventually have been subject to U.S. tax, and its characterization of all transactions in which a CFC earns income as realization events for U.S. tax purposes. Under the pre-TCJA U.S. tax regime, CFC income that was not subpart F income was generally not subject to U.S. tax as long as it was not repatriated.117 In general, U.S. multinationals took the position that it would never be repatriated, and by taking that position they were able to avoid accruing the U.S. tax as a deferred liability on their financial statements.118

Furthermore, the pre-TCJA system of international tax did not impose a tax on foreign income that fell outside the net of the subpart F anti-deferral regime. It imposed a tax on the act of repatriation. The act of bringing the dividend into the United States was the recognition event, except in the case of subpart F income (which Congress and the government asserted was stripped from domestic income), which was immediately recognized as U.S. gross income. This is not a timing issue. Rather, it is the imposing of a new income tax retroactively on income that was not subject to taxation in the past year.

Hence, Congress did not act to correct some technical failure in a tax law. There was no defect—unless the defect is the entire structure of the U.S. international tax regime. Congress is, in effect, attempting to raise the income tax rate on corporations over the past thirty years by retroactively subjecting their international earnings to an additional tax. This is not a mere timing issue, unless the very nature of the pre-TCJA system of international taxation is overlooked.

And considering the Court’s balancing of interests in Carlton, a court might consider whether the retroactivity of the Mandatory Repatriation Tax is a rational means to further a legitimate legislative purpose. The government could argue that as a matter of fairness, imposing some type of mandatory repatriation tax was necessary to avoid rewarding those who had never repatriated their overseas earnings. But this would ignore the fact that many companies had permanently reinvested overseas income, as reflected on their financial statements.

Ultimately, the Mandatory Repatriation Tax—if characterized as an income tax—should not stand up to a court’s rational basis review due to its retroactive imposition on taxpayers. Congress has violated the substantive due process of U.S. persons by subjecting them to a retroactive income tax in the form of Section 965.

3. The Mandatory Repatriation Tax Might Be Unconstitutional Because Taxpayers Lacked Notice.

Taxpayers could raise an additional procedural argument; they could argue that they lacked notice of the Mandatory Repatriation Tax. That said, when Congress changes the law, taxpayers don’t have any inherent right to rely on past provisions.119

The Revenue Act of 1924120 enacted a gift tax in June 1924, retroactive back to all gifts made after January 1, 1924. Two cases, Blodgett v. Holden121 and Untermyer v. Anderson,122 held that the retroactive application of the tax was unconstitutional.123 Congress had created a totally new tax and imposed it upon taxpayers who had no notice that their gifts could be subject to federal taxation.

In Carlton, the Supreme Court distinguished Blodgett and Untermyer. First, the Court noted that Blodgett and Untermyer “were decided during an era characterized by exacting review of economic legislation under an approach that ‘has long since been discarded.’”124 That caveat aside, the Court continued to discuss the merits of the case. The Court believed that Blodgett and Untermyer “do not control” when considering the retroactivity of a 1987 amendment to the 1986 tax law.125 The gift tax cases had involved the creation of a “wholly new tax,” not an amendment to an existing tax law—as was the case in Carlton.126

These cases suggest a limited possibility that a taxpayer may have its due process rights violated because it lacked notice of a wholly new tax.127 However, in 1937—roughly a decade after Blodgett and Untermyer—the Supreme Court held in United States v. Hudson128 that a totally new tax—a tax on silver passed as part of the Silver Purchase Act of 1934—was constitutional even though it was retroactive.129 The Court did not explicitly discuss notice as mandated by the Fifth Amendment, but the Court noted that “[f]or some months prior to this period there was strong pressure for legislation requiring increased acquisition and use of silver by the Government, and several bills providing therefor were presented in the Senate and House of Representatives.”130

With respect to the Mandatory Repatriation Tax, it is at least possible that a court might consider and apply the reasoning in Blodgett and consider that it is wholly unreasonable for a taxpayer to expect that her ten percent stake in a foreign corporation would subject her to a tax on that corporation’s accumulated earnings all the way back to 1986, regardless of whether the corporation had repatriated cash.131

To put it bluntly, the Mandatory Repatriation Tax is not an adjustment to a bill, a change in rate, or technical correction of the law. This is a dramatic altering of the U.S. system of international tax that fundamentally shifts the economics for individuals who hold investments in a foreign corporation in 2017. It is certainly reasonable for a taxpayer to plausibly argue that they should have had notice that their investments could be subject to further taxation.


This Essay has sketched out some arguments that could underlie a constitutional challenge to Section 965. Such a challenge will present the courts with a fundamental question that will forever define Congress’s power to tax, what Alexander Hamilton called one of the most fundamental powers interwoven into the framework of the federal government.132 Holding Section 965 constitutional would render the constitutional language on direct taxation all but meaningless. And a tax on, say, the earnings of an individual twenty years prior—payable in the year the bill passed—would appear constitutionally permissible if Section 965 is held to be a constitutional income tax.

These outcomes might seem extreme, but they highlight the importance of courts considering constitutional limitations carefully. Even amid the field of “invisible boomerangs”133 that is the federal tax code, Section 965 (whether a retroactive tax or a wealth tax) is inapposite to the defined constitutional powers granted to Congress. The Framers—including Hamilton himself—clearly intended some limitation on the federal government’s power to tax. Courts should not be afraid to consider these constitutional questions, and to enforce the limitations on the taxing power imposed by the text of the Constitution.

  1. An Act to Provide for Reconciliation Pursuant to Titles II and V of the Concurrent Resolution on the Budget for Fiscal Year 2018, Pub. L. No. 115–97, 131 Stat. 2054 (2017) [hereinafter “TCJA” ].
  2. Tax Reform Act of 1986, Pub. L. No. 99-514, 100 Stat. 2085.
  3. All references to “Code” refer to the Internal Revenue Code of 1986, as amended. References to “old” Code sections refer to the Code prior to amendment by the TCJA, while “new” Code sections refer to those as amended by the TCJA.
  4. See TCJA § 11001 (to be codified at I.R.C. § 1).
  5. See TCJA § 11021 (to be codified at I.R.C. § 63).
  6. See TCJA § 11041.
  7. See TCJA § 11061.
  8. See TCJA § 13001–02 (to be codified at I.R.C. §§ 11, 243, 245) (lowering the corporate tax rate); TCJA §§ 12001-02 (to be codified at I.R.C. §§ 53, 55) (repealing the corporate AMT).
  9. TCJA § 13701 (to be codified at I.RC. § 4968).
  10. Generally speaking, a true territorial system of international corporate tax would tax only an entity’s profits sourced in that country. Likewise, a true worldwide system would tax an entity’s worldwide income, irrespective of where that income was paid.
  11. Throughout this Article, the term “multinational entity” refers to corporate entities with subsidiaries in multiple jurisdictions.
  12. Tatyana Shumsky, Tax Overhaul Could End Record Pileup of Offshore Cash, Wall St. J. (Nov. 20, 2017), https://blogs.wsj.com/cfo/2017/11/20/tax-overhaul-could-end-record-pileup-of-offshore-cash/ [https://perma.cc/NM84-2ZAN].
  13. See J. Clifton Fleming Jr. et al., Getting from Here to There: The Transition Tax Issue, 154 Tax Notes 69, 69 (2017). But see Edward D. Kleinbard, Stateless Income, 11 Fla. Tax Rev. 699, 701-06 (2011) (criticizing the generation of what Kleinbard describes as “stateless income,” income derived by a multinational group from “business activities in a country other than the domicile (however defined) of the group’s ultimate parent company, but which is subject to tax only in a jurisdiction that is not the location of the customers or the factors of production through which the income was derived, and is not the domicile of the group’s parent company”). See generally Paul R. McDaniel et al., Introduction to United States International Taxation 69-74 (2014) (discussing the system of U.S. international corporate taxation prior to the passage of H.R. 1).
  14. See TCJA § 14103 (to be codified at I.R.C. § 965).
  15. See TCJA § 14103 (to be codified at I.R.C. § 965).
  16. Throughout, I use the term “Mandatory Repatriation Tax” to refer to the tax imposed under the new Section 965.
  17. See I.R.C. § 965(a) (West 2018); id. § 965(e)(1).
  18. TCJA § 14103 (to be codified at I.R.C. § 965).
  19. See TCJA § 14103 (to be codified at I.R.C. § 965).
  20.  The constitutional question surrounding a transition tax has been suggested before. See J. Clifton Fleming Jr. et al.¸ supra note 13, at 70 n.6 (raising the possibility of a constitutional challenge to a tax on accumulated overseas profits of a U.S. multinational). Fleming Jr. et al. argue that the primary basis for such a challenge would be a retroactivity argument, and that “the Supreme Court will just as likely find a way to uphold Congress’s selection of a transition tax regime.” Id.
  21. U.S. Const. amend. xvi.
  22. See supra note 14 and accompanying text.
  23.  This is in line with how the United States taxes individuals—based on their citizenship, rather than their place of residence. See Ruth Mason, Citizenship Taxation, 89 S. Cal. L. Rev. 169, 170-77 (2016).
  24. See Joint Comm. on Taxation, JCX-96-15, Present Law and Selected Proposals Related to the Repatriation of Foreign Earnings 2 (2015) [hereinafter JCT Repatriation Report].
  25. See Dave Fischbein Mfg. Co. v. Comm’r, 59 T.C. 338, 353 (1972); see also JCT Repatriation Report, supra note 24, at 2 (discussing the deferral of foreign source income earned by controlled foreign corporations).
  26. See JCT Repatriation Report, supra note 24, at 2.
  27. See generally I.R.C. §§ 951-965 (West 2018).
  28.  A “controlled foreign corporation” is defined in the Code as “any foreign corporation in which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned directly, indirectly, or constructively by U.S. shareholders on any day during the taxable year of such foreign corporation or more than 50% of the total value of the stock is owned directly, indirectly or constructively by U.S. shareholders on any day during the taxable year of the corporation.” IRS I.R.M.; see also I.R.C. § 957(a) (West 2018) (defining “controlled foreign corporation”).
  29. See I.R.C. § 951(b) (West 2018); id. § 957; id. § 958; SIH Partners LLLP v. Comm’r, 150 T.C. No. 3, slip op. at 12; see also JCT Repatriation Report, supra note 24, at 2.
  30. See, e.g., JCT Repatriation Report, supra note 24, at 2.
  31.  Revenue Act of 1962, Pub. L. No. 87-834, § 12, 76 Stat. 960, 1006.
  32. See Dougherty v. Comm’r, 60 T.C. 917, 928 (1973).
  33.  Subpart F has never been found unconstitutional, despite some challenges to its constitutionality being levied. See, e.g., Richard J. Horwich, The Constitutionality of Subpart F of the Internal Revenue Code, 19 U. Miami L. Rev. 400, 400-09 (1965).
  34.  JCT Repatriation Report, supra note 24, at 2.
  35. See I.R.C. § 954 (West 2018).
  36. See id. § 953.
  37. See id. § 952(a)(3)-(5); see also JCT Repatriation Report, supra note 24, at 3.
  38. See I.R.C. § 954(c) (West 2018) (defining “foreign personal holding company income”). The definition of foreign personal holding company income includes myriad exceptions, a full discussion of which lies outside the scope of this Article. See id. § 954(c)(2) (discussing exceptions to subpart F). For example, rents and royalties derived in the active conduct of a trade or business are excluded from treatment as subpart F. See id. § 954(c)(2)(A).
  39. See id. § 954(d) (defining foreign base company sales income).
  40. See id. § 954(e) (defining foreign base company services income).
  41. See id. § 954(g) (defining foreign base company oil related income), repealed by TCJA § 14211.
  42.  I.R.C. § 965 (West 2018).
  43.  American Jobs Creation Act, Pub. L. No. 108-357, 118 Stat. 1418.
  44. See I.R.C. § 965(a) (West 2018).
  45.  These are some of the key limitations. A full review of the technical mechanics of the old Section 965 is outside the scope of this Article; this list should thus not be read as complete.
  46. See id. § 965(b)(1).
  47. See id. § 965(b)(2).
  48. See id. § 965(b)(3); see also BMC Software, Inc. v. Comm’r, 780 F.3d 669 (5th Cir. 2015); Analog Devices, Inc. v. Comm’r, 147 T.C. No. 15 (2012).
  49. See Tax Reform Act of 2014 Discussion Draft (as prepared by Rep. Dave Camp, Feb. 26, 2014), https://waysandmeans.house.gov/UploadedFiles/Statutory_Text_Tax_Reform_Act_of_2014_Discussion_Draft__022614.pdf [https://perma.cc/7U99-EKN4]; see also Kyle Pomerleau & Andrew Lundeen, The Basics of Chairman Camp’s Tax Reform Plan, Tax Foundation (Feb. 26, 2014), https://taxfoundation.org/basics-chairman-camp-s-tax-reform-plan/ [https://perma.cc/63BG-BR3M].
  50. See Nick Timiraos & John D. McKinnon, Obama Proposes One-Time 14% Tax on Overseas Earnings, Wall St. J. (Feb. 2, 2015), http://www.wsj.com/articles/obama-proposes-one-time-14-tax-on-overseas-earnings-1422802103 [https://perma.cc/V5QN-2YB4].
  51.  TCJA § 13001 (to be codified at I.R.C. § 11).
  52.  TCJA § 14201 (to be codified at I.R.C. § 951A). The GILTI tax creates a new anti-deferral regime for CFCs, imposing a tax on the CFCs of a U.S.-parented multinational by looking to their overall foreign tax rate, and imposing an immediate U.S. tax on the income that isn’t found to be sufficiently taxed under the complex GILTI statutory framework. Id.
  53. TCJA § 14202 (to be codified at I.R.C. § 250).
  54. See TCJA § 14401(a) (to be codified at I.R.C. § 59A) (imposing a tax on what is called the “base erosion minimum tax amount”).
  55. See Timiraos & McKinnon, supra note 50.
  56. See Jim Tankersley et al., Republican Plan Delivers Permanent Corporate Tax Cut, N.Y. Times (Nov. 2, 2017), https://nyti.ms/2iV3TJI [https://perma.cc/U4T7-M5G2].
  57. See TCJA § 14103 (to be codified at § 965).
  58. See TCJA § 14103(a) (to be codified at § 965).
  59. See id.
  60. For instance, if a taxpayer is only a 10 percent shareholder of a CFC, it is quite plausible that they would not be able to cause such payment.
  61.  For a more technical overview of the Mandatory Repatriation Tax, see Patrick J. McCormick, Effects of the Deemed Repatriation Provisions of the Tax Cuts and Jobs Act, 89 Tax Notes Int’l 607 (Feb. 12, 2018).
  62. See I.R.C. § 965(a) (West 2018).
  63. The Mandatory Repatriation Tax will take effect for the foreign corporation’s last taxable year that begins before January 1, 2018. Id. § 965(a). Therefore, for a calendar-year taxpayer, the tax will occur in 2017. For other taxpayers, the tax liability will not arise until the calendar year of the taxpayer ends. Taxpayers may elect to pay the tax liability in installments over eight years. Id. § 965(h). Further, the taxpayer will have some ability to offset the tax with certain foreign tax credits. See id. § 965(g); see also Adam Halpern, A Concise Summary of the New Tax Law, Fenwick & West LLP (January 5, 2018), https://www.fenwick.com/publications/Pages/A-Concise-Summary-of-the-New-Tax-Law.aspx [https://perma.cc/RQB4-HTPU] (“Foreign tax credits can be used to reduce a corporate U.S. shareholder’s U.S. tax liability, but credits are only allowed for foreign taxes on the taxable portion of the deemed repatriated earnings, based on the reduced rates. Individual U.S. shareholders can elect to be taxed as corporations to obtain the benefit of foreign tax credits.”).
  64. Berg and Feingold have discussed the first possibility for levying a constitutional challenge—they assert that Section 965 is an unapportioned direct tax on incomes. Mark E. Berg & Fred Feingold, The Deemed Repatriation Tax – A Bridge Too Far, 158 Tax Notes 1345, at 1352-56 (2018). This Essay hopes to build upon their analysis as to whether Section 965 ought to be considered an income tax and presents new challenges as to the potential issues with the tax’s retroactivity.
  65. Some commentators—notably Berg and Feingold—have concluded that the Mandatory Repatriation Tax is an unconstitutional direct tax. See Berg & Feingold, supra note 64, at 1353.
  66.  U.S. Const. art. I, § 2, cl. 3 (“Representatives and direct taxes shall be apportioned among the several States which may be included within this Union, according to their respective numbers . . . .”); U.S. Const. art. I, § 9, cl. 4 (“[No] Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census or Enumeration herein before directed to be taken.”).
  67.  U.S. Const. amend. xvi.
  68. Income, Merriam Webster Online, https://www.merriam-webster.com/dictionary/income [https://perma.cc/N3LA-T2G3] (last visited June 6, 2018).
  69.  281 U.S. 111 (1930).
  70. Id.
  71. Id. at 219.
  72. See Garlock v. Comm’r, 58 T.C. 423, 438 (1972), aff’d 489 F.2d 197 (2d Cir. 1973); Estate of Whitlock v. Comm’r, 59 T.C. 490, 505-10 (1972), aff’d 494 F.2d 1297 (10th Cir. 1976); Dougherty v. Comm’r, 60 T.C. 917, 927-30 (1973); see also Berg & Feingold, supra note 64, at 1353-55 (discussing subpart F challenges). As Berg and Feingold note, Dougherty represents perhaps the “high water mark” in these cases, where the Tax Court found a rational basis for an inclusion of past earnings by looking to the combination of the CFC’s investment in U.S. property in the current year under Section 956 and the U.S. shareholders’ control over the CFC. Berg & Feingold, supra note 64, at 1353.
  73.  Berg and Feingold correctly point out that taxpayers might face an inclusion under Section 965 “even when the DFIC has neither current nor accumulated earnings” under certain circumstances. Berg & Feingold, supra note 64, at 1354.
  74. See I.R.C. § 956 (West 2018).
  75. Dougherty, 60 T.C. at 930.
  76. See id.
  77. See I.R.C. § 531 (West 2018); id. § 532. This tax is not applicable to certain corporations, including personal holding companies, certain corporations exempt from tax, and passive foreign investment companies. Id. § 532(b).
  78. See Id. § 531; id. § 532.
  79. See Id. § 965(a).
  80. I say “not necessarily” because this argument would not apply to a taxpayer’s earnings during the taxable year when the Section 965 tax is imposed. That would be income to the taxpayer and could be subject to taxation under the Sixteenth Amendment.
  81. This differentiates it from the old Section 965, which provided an 85% tax break for whatever income a taxpayer repatriated. See I.R.C. § 965 (2006).
  82. See I.R.C. § 475 (2012); id. § 1256.
  83. 992 F.2d 929, 931-32 (9th Cir. 1993).
  84. Id. at 931 (emphasis added).
  85. It is worth noting that a controlled foreign corporation is “controlled” insofar as more than 50 percent of the total combined voting power is owned by 10 percent U.S. shareholders.
  86. See I.R.C. § 954 (West 2018).
  87. See supra notes 34-41 and accompanying text.
  88. See Berg & Feingold, supra note 64, at 1355-56.
  89.  U.S. Const. Art. 1, § 9, cl. 4.
  90.  326 U.S. 340 (1945).
  91. Id. at 362 (emphasis added).
  92. Erik M. Jensen, The Taxing Power, the Sixteenth Amendment, and the Meaning of “Incomes,” 33 Ariz. St. L.J. 1057, 1091-1107 (2001).
  93.  Joseph M. Dodge, What Federal Taxes Are Subject to the Rule of Apportionment Under the Constitution, 11 U. Pa. J. Const. L. 839, 842 (2009).
  94. Id. at 932. He further notes that taxes on tangible personal property can easily be structured as excises, and therefore their characterization as direct taxes is inconsequential. Id.
  95. Id. at 933.
  96.  Bruce Ackerman, Taxation and the Constitution, 99 Colum. L. Rev. 1, 28, 58 (1999) (“Given the Reconstructionist Amendments, there is no longer a constitutional point in enforcing a lapsed bargain with the slave power.”).
  97. If Ackerman is correct, his conclusion effectively limits the reach of the apportionment provision so as to render any argument about direct taxation requiring apportionment to be invalid.
  98. Specifically, as of two arbitrary dates. See I.R.C. § 965(a) (West 2018).
  99. 326 U.S. 340 (1945). This conclusion aligns with the conclusion drawn by Berg and Feingold, that the Mandatory Repatriation Tax is a direct Tax under the Constitution. See Berg & Feingold, supra note 64, at 1352.
  100. See, e.g., Nat’l Fed’n of Indep. Bus. v. Sebelius, 567 U.S. 519, 570 (2012).
  101.  As discussed in Section III.B, supra, this Article argues that treating the Mandatory Repatriation Tax as an income tax is incorrect.
  102.  U.S. Const. amend. v.
  103.  512 U.S. 26 (1994).
  104. Id at 27.
  105. Id.
  106. Id.
  107. Id. at 32.
  108. Id. at 30-31.
  109. Id. (quoting Pension Benefit Guaranty Corp. v. R.A. Gray & Co., 467 U.S. 717, 733 (1984)).
  110. Id.
  111. Id. at 31.
  112. Id.
  113. Id. at 32.
  114.  The cases denied for certiorari were: Sonoco Products Co. v. Mich. Dep’t of Treasury, 137 S. Ct. 2157 (2017); Skadden, Arps, Slate, Meager, & Flom LLP v. Mich. Dep’t of Treasury, 137 S. Ct. 2157 (2017); Gillette Comm. Operations v. Mich. Dep’t of Treasury, 137 S. Ct. 2157 (2017); IBM Corp. v. Mich. Dep’t of Treasury, 137 S. Ct. 2180 (2017); Goodyear, et al. v. Mich. Dep’t of Treasury, 137 S. Ct. 2157 (2017); DirecTV Grp. Hldgs. v. Mich. Dep’t of Treasury, 137 S. Ct. 2158 (2017).
  115. See United States v. Carlton, 512 U.S. 26, 32 (1994); United States v. Darusmont, 449 U.S. 292, 299-300 (1981).
  116. Carlton, 512 U.S. at 32.
  117.  However, certain types of income, including effectively connected income, fixed, determinable, annual or periodical income from sources within the U.S. that are not effectively connected with a trade or business, and FIRPTA income earned by a CFC, could all be subject to U.S. tax prior to repatriation.
  118. Accounting Principles Board, APB Opinion No. 23, Accounting for Income Taxes—Special Areas (1972). (allowing such treatment of so-called “permanently invested earnings” where “sufficient evidence shows that the subsidiary has invested or will invest the undistributed earnings indefinitely”).
  119. Notice arguments are difficult in the tax context—and none have been successful at the Supreme Court since the 1920s. See Untermyer v. Anderson, 276 U.S. 440 (1928); Blodgett v. Holden, 275 U.S. 142 (1927).
  120. Revenue Act of 1924, Pub. L. No. 68-176, 43 Stat. 253.
  121.  275 U.S. 142 (1928).
  122.  276 U.S. 440 (1928).
  123. See Blodgett, 275 U.S. at 147; Untermyer, 276 U.S. at 445-46.
  124. Carlton, 512 U.S. at 34 (quoting Ferguson v. Skrupa, 372 U.S. 726, 730 (1963)).
  125. Id.
  126.  Id. (noting that the gift tax cases’ authority is “of limited value in assessing the constitutionality of subsequent amendments that bring about certain changes in operation of the tax laws” (quoting United States v. Hemme, 476 U.S. 558, 568 (1986)).
  127. See Erika Lunder et al., Cong. Research Serv., R42791, Constitutionality of Retroactive Tax Legislation 4 (2012).
  128.  299 U.S. 498 (1937).
  129. Id. at 501.
  130. Id.
  131.  Blodgett v. Holden, 275 U.S. 142, 147 (1927).
  132.  The Federalist No. 30 (Alexander Hamilton).
  133.  Arrowsmith v. Comm’r, 344 U.S. 6, 12 (1952) (Jackson, J. concurring).

Reforming the True-Sale Doctrine

*Professor of Law, American University, Washington College of Law. I thank Mark Yurich, JD ‘18, for excellent research assistance.

The true-sale doctrine is central to the multi-trillion dollar asset-backed securities (ABS) market. The assets backing ABS are only bankruptcy-remote if they were assigned in a true sale, rather than as collateral for a loan, and it is the true-sale doctrine that distinguishes sales from loans. Despite its importance, the doctrine is inconsistent, lacks normative direction, and is under-theorized. Negotiations regarding the status of securitized assets in bankruptcy—affecting creditors such as employees, retirees, and tort claimants—happen in the shadow of the law. This Essay argues that state lawmakers should formulate true-sale rules that codify the relevance of price in true-sale analyses. The price that a company receives in exchange for securitized assets represents value with which to distinguish between problematic judgment-proofing on the one hand, and, on the other hand, assignments that isolate assets from bankruptcy in a way that is fair and produces efficiencies. Reforming the true-sale doctrine to ensure economic substance-based determinations that consider price terms could fortify unsecured creditors’ positions. In addition, such reform would reinforce appropriate boundaries between state commercial laws and federal bankruptcy policy.


The true-sale doctrine determines the status of securitized assets: it is the state-law doctrine that distinguishes sales from loans. When companies assign large pools of receivables to a special-purpose entity in order to raise capital, the true-sale doctrine governs characterization of the assignment, and therefore whether creditors can reach such assets in bankruptcy. Despite the fact that the true-sale doctrine governs transactions that are central to the multi-trillion-dollar securitization market, the doctrine is inconsistent, lacks normative direction, and is under-theorized.1 This Essay argues that lawmakers should formulate state, statutory true-sale rules and that such rules should establish the relevance of price in true-sale analyses.2

This Essay builds directly upon my recent work, Property and the True-Sale Doctrine.3 That article maps arguments about the efficiency and desirability of securitization4 to varying formulations of the true-sale doctrine.5 While discussion of securitization’s efficiency is plentiful, scholars and policy-makers have not sufficiently related positions on securitization to formulations of the true-sale doctrine. Different views on securitization would suggest different normative positions on true-sale rules. Property and the True-Sale Doctrine does the work of mapping descriptions of securitization’s efficiency to varying normative positions on the true-sale doctrine.6 This Essay will not repeat that exercise. Property and the True-Sale Doctrine fills a gap in the literature by (i) explicitly linking true-sale rules to views on securitization’s efficiency and by (ii) elucidating how we might better ground true-sale rules in property law principles. In doing so, it demonstrates the importance of the doctrine and its current lack of normative direction or consistency.7 However, it is agnostic on the question of what approach to the true-sale doctrine is the right or the best approach.

This Essay takes the next step of proposing an approach to true sales of receivables that confers rights of exclusion from securitized assets in a way that is better justified and clearer than the current law. It argues that states should consider statutory provisions to codify the relevance of price as a factor in true-sale analyses. Enacting an approach to true sales that is rooted in an economic substance analysis that considers price would ground true-sale rules and the legal underpinnings of receivables securitization in well-established property law strategies for determining the scope of a conveyance and the rights of exclusion it creates.8 Price terms are relevant and important,9 and their relevance in true-sale determinations should therefore be codified. The price that a company receives in exchange for securitized assets represents value with which to distinguish problematic judgment proofing10 from assignments that are more likely to be efficient and more likely to be fair to non-adjusting creditors.11

Some commercial law scholars entertain creating a model act or revising the uniform commercial code only in the context of industry demand for change or clarification.12 There is at present no such industry demand for true-sale doctrine reform. This Essay contends that maintaining the rule of law in capital markets and protecting the positions of creditors in weak bargaining positions, warrants the custodial work of improving the true-sale doctrine regardless of the financial industry’s lack of urgency or concern. Currently, negotiations regarding the status of securitized assets in bankruptcy—affecting creditors such as employees, retirees, and tort claimants—happen in the shadow of the law. A true-sale doctrine that ensures economic substance-based determinations could fortify such creditors’ positions and would ground the legal infrastructure of securitization in well-established commercial law principles.

In addition, true-sale rules operate within an allocation of institutional authority that distinguishes states’ authority over commercial law and private-law rights from federal authority under the bankruptcy code. True-sale rules that contravene established property or commercial law principles to direct bankruptcy outcomes may face federal preemption.13 Statutory provisions codifying an approach to true sales that is economic substance-based would ground the doctrine within the scope of states’ commercial law rulemaking authority.14

This Essay advances a type of rule-of-law project. True-sale rules are property law—they determine the scope of interest that an assignment of receivables creates in any given transaction. Yet the property-based nature of the true-sale doctrine is obscured by statutes and confusing factors-based approaches that suggest that a contract’s form—rather than the economic substance of the transaction the contract reflects—controls characterization of receivables assignments15 The doctrine is meant to align property rights and risk. Characterizing a deal according to its actual economic content prevents regulatory arbitrage. If the doctrine is well-administered, parties cannot avoid bankruptcy rules or UCC Article 9 rules for disposition of collateral by calling their transaction a “sale” when it reflects intent to create a loan.

By arguing for property-based true-sale rules in which the relevance of price is codified, this Essay adds to a larger project on the under-explored potential of property-law doctrines for market governance.16 This larger project seeks to fortify the legal infrastructure of capital markets by (i) asserting that property-law concepts have untapped potential for market governance,17 (ii) explicating the relationship between one private-law doctrine (the law of true sales of receivables) and the extensive financial market to which it is integral (securitization),18 and now (iii) proposing an approach to the true-sale doctrine that is rooted in property-law strategies for characterizing the scope of a conveyance and that improves the doctrine’s coherence while contemplating its potential externalities.

Part I summarizes the true-sale doctrine and the inadequacy of current formulations and academic recommendations. It then contends that uniform state statutory provisions are appropriate to reform the doctrine. It argues in favor of state laws that codify an economic substance-based approach to true-sale determinations, and it discusses the relationship between commercial law and bankruptcy law. Part II argues for codifying the relevance of price as a factor in distinguishing sales of receivables from loans collateralized by receivables. Part III calls for a Uniform Law Commission19 drafting committee to create a model act, or to revisit relevant provisions of the Uniform Commercial Code (UCC), to engage in the task of formulating better true-sale rules.

The Case for Uniform True-Sale Rules

The true-sale doctrine distinguishes assignments to secure loans from true sales, after which assets are the property of a special-purpose entity,20 reachable exclusively by investors. Given that the doctrine governs receivables securitizations,21 bankruptcy and, in some instances, accounting outcomes22 hinge on this doctrine’s correct administration.

The importance of the true-sale doctrine may not be obvious given that, regardless of how true-sale disputes are resolved, investors in securitized receivables prevail over competing claimants. But focusing on investor priority regardless of deal characterization underestimates the consequences of true-sale rules. Assets reachable in bankruptcy, even if subject to a first-priority security interest, may be used to service obligations during bankruptcy proceedings and may be assigned to obtain continuation financing.23 Bankruptcy-remote assets, on the other hand, cannot be used in these ways. Also, whether a company can reach assets in bankruptcy affects the efficiency of continuation and liquidation decisions.24 In short, the fact that investors can assert the priority of their interests regardless of whether they obtained them in a true sale does not mean that the true-sale doctrine is inconsequential for unsecured creditors.

At present, the true-sale doctrine lacks consistency and normative direction. Factors-based common law approaches do not cohere around an established list of factors, though price and recourse often emerge as important.25 Statutory true-sale rules enacted in a minority of states override economic substance-based true-sale determinations and disregard the interests of unsecured creditors, creating uncertainty regarding the application of such rules in bankruptcy proceedings.26

Commercial law scholars Steven Harris and Charles Mooney have proposed a “property-based methodology” for making true-sale determinations that disregards both recourse and price and asks only whether a company retains an interest in securitized assets that secure an obligation.27 Their proposal does not sufficiently explicate the property interest a company retains, and it relies on an analogy to the true-lease context that does not fully consider important distinctions between receivables securitizations and leasing transactions.28 In short, each existing approach or proposal is problematic.

The UCC leaves the task of determining true sales of rights to payment to the courts. Given the fact-specific nature of characterizing assignments of receivables, it may seem infeasible to codify true-sale rules that root characterization in economic substance.29 Uniform true-sale provisions, however, do not need to determine characterization in all contexts. Provisions that create a safe harbor, or that codify the relevance of specific factors, could provide clarity and coherence without requiring statutory language that disposes of fact-specific, true-sale analyses. In fact, in 2001 Uniform Law Commissioner Edwin Smith suggested that the Commission consider a uniform law to create a safe harbor as to what will qualify as a true sale of rights to payment and to determine which state’s law applies when determining whether there is a true sale.30 Commissioner Smith issued a discussion draft outlining reasons for codifying true-sale rules,31 but his proposal did not ultimately result in draft provisions.32

The reasons cited in 2001 for proposing the possibility of uniform true-sale rules included: (i) that lawyers’ true-sale opinion letters create “considerable transaction costs”33 because the result is not clear, (ii) that “quirky statutes and decisions”34 exist, (iii) that “some states are passing legislation that ignores creditors’ rights issues,”35 and (iv) that the federal government was considering the issue in the bankruptcy law context.36 Today, some of Smith’s reasons for proposing uniform true-sale rules are still salient, while others are less so. True-sale opinions still involve considerable cost. However, the “quirky” decision in Octagon Gas Systems, Inc.37 to which Smith presumably refers, has been widely criticized, including by the Permanent Editorial Board of the Uniform Commercial Code.38 On the other hand, the “quirky” interim order issued in In re LTV Steel Company to which Smith presumably refers continues to shape discussion of securitization and true sales despite the fact that it is not a true-sale doctrine precedent.39 On the legislative front, a number of states do enact asset-backed securities facilitation acts (“ABS statutes”)—legislation that ignores creditors’ rights issues.40 However, the proposed federal bankruptcy law provisions regarding true sales of receivables in Section 912,41 to which Smith presumably refers, were withdrawn in 2002.42

The Uniform Law Commission responded to Smith’s suggestion by declining to move forward with a drafting effort,43 citing the difficulties that arise from the fact-intensive true-sale determinations, and the absence of a need for such effort given the lack of industry demand for revised rules.44

Again, this Essay rejects the notion that reforming true-sale rules should only happen in response to industry demand. Lack of industry demand may be a function of the fact that the financial industry potentially benefits from approaches that fortify investors’ positions at the expense of unsecured creditors. In theory, bringing clarity to the legal foundations of asset-backed securities is in the interest of investors as well as companies securitizing assets. But in practice creditors in weak bargaining positions have more to gain from the type of approach articulated here than investors, and it is investors who would articulate industry demand to which uniform law commissioners would respond.

The true-sale doctrine is integral to capital markets and can affect the positions of non-adjusting and non-consenting creditors.45 When a company is in financial distress, the state of the law informs negotiations and proceedings regarding the status of securitized assets. Rules that codify an economic substance-based approach to true sales could fortify the positions of such creditors. In addition, proposing uniform, statutory true-sale rules is a type of rule-of-law project; it is custodial. In addition to clarifying the law, codifying an economic substance-based approach that establishes the relevance of price terms reinforces appropriate boundaries between state commercial laws and federal bankruptcy policy.

Ronald Mann discusses the federalism concerns that securitization presents when state true-sale rules are formulated to direct bankruptcy outcomes, calling out the ABS statutes as problematic.46 The bankruptcy code generally leaves to state law the determination of property rights in a bankruptcy estate.47 Therefore, the rules governing commercial transactions affect bankruptcy outcomes. The bankruptcy code attempts to maintain a boundary between state rulemaking authority (which includes elucidating contract and property rights) and federal rulemaking authority (to administer the kinds of relief and asset disposition that bankruptcy contemplates). Mann observes that states challenge this boundary, however, when they “cheat” by issuing “rules that formally operate as ordinary rules of commercial law but in fact are directed at situations of business failure, i.e., state-promulgated bankruptcy-directed legislation.48

The ABS statutes present an example of such legislation. As Mann states:

[T]hose statutes allow the parties to have their transaction treated as a sale for bankruptcy purposes without obligating the purchaser to take on the risks that would be inherent in a complete transfer of the assets from the purported seller. Again, because the principal purpose of those statutes is to affect bankruptcy outcomes, they afford a prime example of bankruptcy-directed legislation.49

Mann undertakes the tricky task of distinguishing legitimate state laws from problematic, boundary-violating laws by focusing on a statute’s effects. He asserts that the concern lies with laws that have no notable effect outside of bankruptcy.50

Mann’s approach raises complex questions. For example, one might ask what effects any true-sale rules, or UCC Article 9 priority rules for that matter, have outside of bankruptcy. The point here is to identify that true-sale rules are state commercial laws that operate within an allocation of institutional authority that distinguishes states’ authority over private-law rights from federal authority under the bankruptcy code. If state true-sale rules depart from established property or commercial law concepts, they may be preempted by federal bankruptcy law.51 Uniform, statutory provisions codifying an approach to true sales based on economic substance would ground the doctrine within the purview of states’ commercial law rulemaking authority.

Uniform, state statutory provisions face the challenge that state legislatures may decline to enact them. States that already enact an ABS statute, for example, may not consider replacing that legislation with a proposed alternative along the lines discussed here. Given the risk that an ABS statute could be preempted in bankruptcy,52 and given the current state of the true-sale doctrine, Congress could consider adding provisions to the bankruptcy code to effectuate state statutory true-sale rules devised by a Uniform Law Commission drafting committee regardless of how widely states adopt them. The Uniform Law Commission and federal statute drafters have contemplated this approach when a federal law would require UCC reform to achieve its objectives, but not all states will necessarily enact the reform provisions.

The Federal Reserve Bank of New York has been drafting a “National Mortgage Note Repository Act” for possible enactment by Congress.53 The act would create a national note registry to clarify questions such as who is a holder of a note with enforcement capacity, thereby addressing issues that can destabilize foreclosure proceedings. The Uniform Law Commission has convened a committee to draft revisions to UCC Articles 1, 3, 8, and 9, to harmonize the UCC with the proposed federal law. The UCC drafting committee has created draft choice-of-law provisions for the Repository Act that direct a court to look to state law to resolve a commercial law matter. However, the provisions direct the court to “apply the law of that State if the UCC Amendments are in force in that State . . . . If the UCC Amendments are not in force in that State, the court would resolve the commercial-law matter by applying the law of that State as if the UCC Amendments are in force in that State.”54

The Repository Act has a very different purpose from the bankruptcy code, and a different relationship to state commercial laws given its objectives. Drafters are still formulating the Repository Act. The related UCC amendments are under construction as well. While lawmakers may ultimately reject the Repository Act’s approach, the concept that a federal law could generate the effect of uniform enactment of Uniform Law Commission statutory provisions with this type of federal statutory provision raises an interesting possibility for reforming the true-sale doctrine.

II. The Relevance of Price Terms

Literature on the efficiency of securitization impliedly assumes that companies receive an adequate price for assets assigned for purposes of securitization.55 For example, Steven Schwarcz distinguishes “legitimate securitization transactions from judgment proofing”56 by explaining that in a securitization, originators receive value in exchange for assets securitized. Schwarcz responds to critics who contend that securitization is an inefficient and unfair form of judgment proofing against claims of unsecured creditors.57 These critics point out that securitization artificially depresses costs of capital for originators by shifting those costs to non-adjusting creditors.58 Some critics find both securitization and first-priority secured lending to be an unfair form of judgment proofing in that it permits companies and investors to contract away the claims of non-adjusting third parties. Critics also find securitization, and secured lending, to be inefficient in the sense that these transactions externalize costs onto non-adjusting creditors.

The responses to these criticisms vary and include the observation that many forms of established commercial activity could be called “judgment proofing.” Consider the “judgment proofing” effects, for example, of limited liability entities or of property conveyances creating rights of exclusion generally. Commentators respond on the efficiency point as well, arguing that the wealth generated by securitization is greater than the costs externalized to unsecured creditors.

This Essay takes the view that we do not know, as an empirical matter, whether securitization is in fact efficient. As such, this Essay works from the premises that securitization can present the possibility of inefficient externalization of costs onto non-adjusting creditors, and that the isolation of assets from company bankruptcy proceedings should correspond to added value contributed to the company in order to mitigate the risks of unfairness and inefficiency. The distinction between problematic judgment proofing and legitimate securitization implies that originators are exchanging assets for cash of equivalent value. If the true-sale doctrine does not assess price provisions, then companies are free to securitize assets on terms that extract an unfair and inefficient subsidy from non-adjusting creditors.

While many courts consider the purchase price as a factor in true-sale analyses, they are not obligated to do so, as there is no codified list of factors.59 In states that enact an ABS statute, price is explicitly irrelevant.60 While some commentators disagree on the relevance and importance of price terms in characterizing assignments of receivables,61 this Essay argues that the relevance of price terms should be codified to ensure that true-sale determinations take price into account.

Price terms may be challenging to evaluate given the complexity of receivables securitization and the intricate combinations of recourse, servicing obligations, and discounting that receivables assignments involve.62 Yet despite this complexity, scholars have argued before that true-sale analyses should tackle the question of adequate price.63 For example, Thomas Plank has stated that “[t]he first and most significant element of economic substance is the price paid for the loans,”64 along with the parties’ ostensible characterization in the deal documents. In addition to price and the parties’ characterization, Plank argues that courts should determine how a transaction allocates the burdens and benefits of ownership. Determining which party has the preponderance of burdens and benefits of ownership, according to Plank, should be undertaken as a legal analysis, not an economic one.65 The economic value of the burdens and benefits of ownership is relevant to assess whether the purchase price is of fair-market value for the receivables.66 Aicher and Fellerhoff also direct courts to assess the adequacy of price when they characterize receivables assignments, despite the complexity of such assessment. They state that if the price paid by the purchaser—taking into account recourse provisions—is significantly less than what an informed buyer would pay a willing seller, then the transaction should be treated as a secured loan.67

This Essay builds on these earlier calls for the consideration of price in true-sale determinations by focusing on the significance of price in establishing the fairness and efficiency of the rights of exclusion from securitized assets that sale characterization creates. If investors have property rights in receivables sufficient to exclude non-adjusting creditors in bankruptcy, they should have completed a fair-market-value exchange for those receivables.

III. Directive for a Drafting Committee

This Part discusses the possibility of creating a model act or revising relevant UCC provisions to codify an economic substance-based approach to true sales that considers price terms.68 A model act would be a stand-alone, state statute that enacts true-sale rules. Alternatively, there are a number of UCC sections that could be appropriate sites for provisions addressing true sales of receivables, such as Article 9’s section 9-109, or Article 1’s definitional provisions.

In order to formulate true-sale rules grounded in economic substance that establish the relevance of price, the Uniform Law Commission would need to convene a drafting committee. Drafting committees typically assume responsibilities in response to industry directives to facilitate certain types of transactions, to lower transaction costs, to allocate burdens of due diligence, and to complete other such goals. However, as discussed above, this Essay contends that industry demand is not a pre-requisite for engaging in the process of lawmaking to improve the rules governing a market-dominant transaction.69 Taking seriously the custodial work of maintaining clear commercial law doctrines, grounded in private-law principles, supports Uniform Law Commission engagement with statutory true-sale rules.

The UCC maintains that although the question of deal characterization is left to the courts; it is economic substance that determines the status of a deal.70 The UCC generally governs receivables securitizations (as defined in this project)71 because the scope of Article 9 extends to “a sale of accounts, chattel paper, payment intangibles, or promissory notes.”72 In other words, Article 9 covers both secured loans and true sales of these assets. Section 9-318 confirms that a “debtor that has sold an account, chattel paper, payment intangible, or promissory note does not retain a legal or equitable interest in the collateral sold.”73

This Essay concerns the integrity of state commercial laws and the expression of property principles to fortify the legal bases of securitization within the proper scope of states’ rulemaking authority.74 The federal bankruptcy code could be a viable site for true-sale reform as well.75 The bankruptcy code could enact substantive true-sale rules along the lines of a model state act, or it could enact provisions designating certain state law provisions to be in effect for purposes of true-sale characterizations in bankruptcy.76

Model act. A number of states enact free-standing ABS statutes.77 A drafting committee could undertake the task of formulating an alternative model of asset-backed securities act.

The ABS statutes call for broad construction of the term “securitization transaction.”78 An alternative model act could follow this same approach or could undertake a definition that specifies the category of deals to which the rules apply, providing a substantive formulation of “receivables securitization.” As noted above and discussed elsewhere, the term securitization often lacks definition.79 A model true-sale act could add definitional clarity.

To the extent lawmakers want simply to clarify the doctrine and fortify the legal infrastructure of securitization in a way that comports with states’ commercial law rulemaking authority, a model act that references securitization generally and that construes the term broadly may be desirable. To the extent lawmakers agree with the contention of this Essay that true-sale rules should confer rights of exclusion against unsecured creditors in a way that is more likely to be fair and efficient, it may make sense to define “securitization” to limit the rules to contexts in which the transaction could, possibly, extract a subsidy from non-adjusting creditors.80

A model act could provide that in determining the legal characterization of an assignment of receivables, courts (i) may consider various factors, and (ii) shall consider price terms. Factors courts have considered, and could consider under a true-sale statute, include recourse to the seller, retention of servicing and commingling of proceeds, investigation of account debtors’ credit, seller rights to excess collections, seller repurchase options, rights to unilaterally adjust pricing terms, rights to unilaterally alter other terms of transferred assets, the language of the documents, and the conduct of the parties.81 The model act could authorize consideration of such factors, along with any other factor a court finds relevant to determining the economic substance of the transaction at issue.

The model could then include provisions stating that courts shall consider the adequacy of the price that the purchaser paid to the seller for the receivables, taking into account any relevant terms of the transaction. After such consideration, if the price the purchaser paid is inconsistent with what an informed buyer would pay an informed seller for the risks and benefits transferred,82 then the court shall find that the assignment constitutes security for a loan and not a true sale.

This type of approach would leave the heavy lifting of true-sale determinations to the courts. A model act could merely establish that true-sale determinations, to the extent the state’s laws apply, are based on economic substance and sensitive to the relationship between price and intent to convey an ownership interest.

A drafting committee could consider any number of formulations, of course. A model act could delineate factors more precisely and it could create presumptions or allocate burdens of proof. The concept expressed here is a broadly conceived alternative to the existing ABS statutes. If those statutes codify an approach that elevates form over substance, an alternative model could codify the authority of economic substance while requiring consideration of price terms.83

UCC Article 1. Article 1 contains provisions that apply throughout the UCC, including important definitions. A drafting committee could revise Article 1 to contain: (i) a definition of true sale of receivables that creates a safe harbor for conforming transactions84 (ii) a definition of value, specific to the securitization context, that establishes a connection between the value given for receivables, and the scope of the interest a receivables assignment creates.

UCC Article 1 enacts a provision for distinguishing a true lease from a secured loan.85 In the context of equipment finance, companies frequently acquire equipment in transactions that take the form of a lease, even though the transaction’s objective is for the company to purchase the equipment. If the financing party is a lessor, then it owns the equipment and does not have to enforce its interest as a lien in the event the company files for bankruptcy. The true-lease doctrine distinguishes transactions that have the economic substance of a lease from those that are secured financings, taking the form of a lease solely for the purpose of avoiding UCC Article 9 and bankruptcy rules that protect debtors.

Equipment leasing presents a market context quite different from receivables securitization in which transacting parties enter into deals that may require re-characterization in the event of bankruptcy. In the true-sale context, a safe harbor that establishes when a sale of receivables occurs, but then directs courts to do a case-by-case characterization analysis in any context involving ambiguity may also make sense.86 Harris and Mooney argue that the residual interest test in Section 1-203 provides a useful analogy for the true-sale context.87 Whereas Section 1-203 looks to the existence of a residual interest in determining true-lease status, Harris and Mooney state that the law should ask whether or not an originator retains an economic interest in receivables it assigned to an SPE that secures an obligation.88

There are significant differences between the equipment leasing and the receivables securitization contexts that call into question the desirability of treating true sales as analogous to true leases for purposes of determining when assets will be bankruptcy remote.89 However, a version of Harris and Mooney’s proposal—one that more substantively defines “economic interest”—could lead to welcome true-sale doctrine reform. Determining whether an originator retains an economic interest in securitized receivables could involve, for example, consideration of whether investors paid a full, fair market value for the loans. A drafting committee could explore the validity of creating a safe harbor for true sales, drawing on Section 1-203 as a model.

For example, the beginnings of a draft provision could read:

[Section 1-__] Sale of Receivables Distinguished from Security Interest.

(a) Whether a transaction in the form of a sale of receivables creates a sale or security interest is determined by the facts of each case.

(b) “Receivables” for purposes of this section shall mean [accounts, chattel paper, payment intangibles, or promissory notes].

(c) A transaction in the form of a sale of receivables creates a security interest if the consideration that the purchaser is to pay the seller for the assignment of receivables [reflects an amount that is significantly less than what an informed buyer would pay a willing seller, taking into consideration all terms of the transaction].

The definition of “receivables” here tracks Section 9-109(a)(3).90 A broader (or narrower) definition could be appropriate. The language in subsection (c) tracks Aicher and Fellerhoff,91 but a more formulaic approach could be better.

UCC Article 1 contains a general definition of “value.”92 “Value” for a sale of receivables contemplated by Section 9-109(a)(3), as opposed to an assignment of collateral within the scope of Section 9-109(a)(1), could be defined to mean a price that “an informed and willing buyer would pay a willing seller for the risks and benefits transferred.”93 (UCC Article 9 requires that value be given in order to create an enforceable security interest.)94

A drafting committee may have a more precise method of expressing adequacy of price or may prefer a broad formulation. The purpose here is to identify a concept: model provisions to establish the relevance of price in a true-sale determination based on economic substance could take the form of a definition of “value” which distinguishes Section 9-109(a)(3) transactions from those that fall under 9-109(a)(1).

UCC Section 9-109. Texas and Louisiana enacted a non-uniform provision 9-109(e) that overrides the common-law true-sale doctrine,95 with content and effect similar to the ABS statutes enacted elsewhere. A drafting committee could explore the possibility of an alternative form of Section 9-109(e), taking the approach described above for a free-standing model true-sales act. It could authorize courts to consider various factors to determine economic substance and require them to consider price.96

Other possibilities. A committee of experts, empaneled to draft model provisions, and receiving advice from a range of interested participants, may identify approaches to codification not contemplated here. Such a committee could take up related questions, such as governing law for true-sale analyses. This Essay calls for the Uniform Law Commission to convene a drafting committee to undertake the task of expressing the relevance of price in codifying an economic substance-based approach to true sales.


A better approach to true-sale rules—one that would create rights of exclusion from securitized assets in a way that is better justified and more coherent than the current law—is overdue. By arguing for such an approach, this Essay tends to the legal infrastructure of the multi-trillion dollar securitization market. The relevance of price terms in true-sale determinations should be codified. The price that a company receives in exchange for securitized assets represents value with which to distinguish between problematic judgment proofing on the one hand, and assignments that isolate assets from bankruptcy in a way that is fair and produces efficiencies on the other hand.

Industry demand is not a pre-requisite for convening a uniform law commission drafting committee to undertake true-sale doctrine reform. Negotiations about the status of securitized assets, affecting creditors in weak bargaining positions, are happening in the context of current true sale rules—rules that are inconsistent and lack normative direction, or, alternatively, are codified to eliminate creditors’ positions and that raise federalism concerns. Maintaining the rule of law in capital markets demands the custodial work of clarifying the true-sale doctrine, regardless of the financial industry’s lack of concern.

  1. See Heather Hughes, Property and the True-Sale Doctrine, 19 U. Pa. J. Bus. L. 870 (2017) [hereinafter Hughes, Property]; Robert D. Aicher & William J. Fellerhoff, Characterization of a Transfer of Receivables as a Sale or a Secured Loan Upon Bankruptcy of the Transferor, 65 Am. Bankr. L.J. 181, 186-98 (1991); Steven L. Harris & Charles W. Mooney, Jr., When Is a Dog’s Tail Not a Leg?: A Property-Based Methodology for Distinguishing Sales of Receivables from Security Interests That Secure an Obligation, 82 U. Cin. L. Rev. 1029 (2014); Peter V. Pantaleo et al., Rethinking the Role of Recourse in the Sale of Financial Assets, 52 Bus. Law. 159, 161 (1996).
  2. This Essay is not the first call to clarify and codify the true-sale doctrine. Edwin E. Smith proposed a drafting committee to formulate true-sale rules in 2001. See Edwin E. Smith, Proposal for a Uniform State Law on What Constitutes a True Sale of a Right to Payment (Confidential Discussion Draft in Process, 2002) (on file with author). Steven L. Harris and Charles W. Mooney, Jr. published an article in 2014 calling for true-sale rules that mirror the uniform commercial code true-lease provisions. See Harris & Mooney, supra note 1. These existing proposals have not yielded model provisions or other codified reform. This Essay, along with Property and the True-Sale Doctrine, builds upon and departs from these prior proposals. It joins them in calling for coherent true-sale rules. It builds upon the notion that true-sale rules should look to economic substance of a transaction and should be explicitly property-based. It departs from prior efforts in that it (i) overtly links the doctrine to the literature on the efficiency and fairness of securitization, and (ii) focuses on the relevance of price terms and the property concept of rights of exclusion, considering when and why companies should exclude unsecured creditors from securitized assets. (The minority of states that enact asset-backed securities facilitation acts, of course, do have statutory true-sale rules, albeit very different ones from what this Essay, or Smith, or Harris and Mooney would propose. See infra text accompanying notes 27, 35; Hughes, supra note 1, at 905-910.)
  3.  Hughes, Property, supra note 1. This piece is the third in a series about the under-explored potential of state private laws for market governance and financial regulation. The first such article explores the emerging relevance of property concepts for financial product regulation. See Heather Hughes, Financial Product Complexity, Moral Hazard, and the Private Law, 20 Stan. J. L. Bus. & Fin. 179 (2015) [hereinafter Hughes, Financial Product Complexity] The second, Property and the True-Sale Doctrine, considers a particular doctrine integral to the creation of financial products—the true-sale doctrine—and its relationship to arguments about securitization’s efficiency and to property law.
  4.  The term “securitization” often lacks definition in secondary sources and in laws that reference the term. See Jonathan C. Lipson, (Re)Defining Securitization, 85 S. Cal. L. Rev. 1229, 1232-33 (2012) (arguing for a coherent definition of “securitization”). Lipson finds “over two dozen regulatory and statutory definitions of the word ‘securitization,’” compounded by various definitions used by market actors and commentators. Id. at 1257. This Essay refers specifically to receivables securitizations: transactions in which a company (the originator) assigns receivables to a bankruptcy-remote special purpose entity (SPE) that issues securities that are backed by the pool of receivables. In order to successfully isolate the assets from bankruptcy risk of the originator, the SPE must be a separate entity not subject to consolidation, and the assignment of receivables must be a true sale (not a secured loan). For a more extensive definition of “receivables securitization,” see Hughes, Property, supra note 1, at 881.
  5. See Hughes, Property, supra note 1.
  6. Id.
  7. Id. at 875.
  8. See Hughes, Property, supra note 1, at 914-19.
  9. See infra text accompanying note 55.
  10. For discussion of “judgment proofing” and its relevance here, see infra text accompanying notes 56-59.
  11. Non-adjusting creditors are parties (like employees or suppliers) who extend credit to the company but cannot adjust their rate of return in response to the increased risk that a change in capital structure may present. For citations and discussion of non-adjusting creditors, Franco Modigliani’s and Merton Miller’s irrelevance theorem, and “the puzzle of secured credit,” see Hughes, Property, supra note 1, at 884.
  12. See Ronald J. Mann, The Rise of State Bankruptcy-Directed Legislation, 25 Cardozo L. Rev. 1805, 1819 (2004); Tara L. Carrier, Unsafe Harbors: Why State Securitization Statutes Won’t Protect Against Recharacterization in Bankruptcy (March 19, 2018) (unpublished manuscript) (on file with author); infra text accompanying note 51.
  13. See Ronald J. Mann, The Rise of State Bankruptcy-Directed Legislation, 25 Cardozo L. Rev. 1805, 1819 (2004); Tara L. Carrier, Unsafe Harbors: Why State Securitization Statutes Won’t Protect Against Recharacterization in Bankruptcy (March 19, 2018) (unpublished manuscript) (on file with author); infra text accompanying note 51.
  14. Mann, surpa note 13.
  15. See Hughes, Property, supra note 1, at 914.
  16. See supra note 3.
  17. See Hughes, Financial Product Complexity, supra note 3.
  18. See Hughes, Property, supra note 1.
  19. The Uniform Law Commission, in conjunction with the American Law Institute (ALI), creates model laws. The Commission convenes drafting committees to craft model acts or provisions that then may be enacted by state legislatures.
  20. This entity isolates assets from bankruptcy risk. See infra text accompanying note 21. In some instances, the entity is also off-balance sheet. See Thomas E. Plank, Securitization of Aberrant Contract Receivables, 89 Chi.-Kent L. Rev. 171, 187 n.56 (2013).
  21.  Again, these are transactions in which a company assigns receivables to a bankruptcy-remote special purpose entity (SPE) that issues securities backed by the receivables. The SPE is a distinct legal entity not subject to consolidation with the originator in bankruptcy; the assignment of receivables is a true sale, not a secured loan. The true-sale doctrine determines whether the assignment from the originator to the SPE is actually a sale as opposed to an assignment of collateral. See Hughes, Property, supra note 1, at 871.
  22. See Fin. Accounting Standards Bd. [hereinafter FASB], Accounting Standards Codification, Topic 860, Transfers and Servicing (2009) (replacing FASB, Statement of Financial Accounting Standards [hereinafter FAS] No. 166, which replaced FAS No. 140); Summary of Statement of No. 140: Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities – A Replacement of FASB Statement No. 125, FASB (Sept. 2000), http://www.fasb.org/summary/stsum140 [http://perma.cc/EK5M-R4NE].
  23. See Hughes, Property, supra note 1, at 872.
  24. See Kenneth Ayotte & Stav Gaon, Asset-Backed Securities: Costs and Benefits of Bankruptcy Remoteness, 24 Rev. Fin. Stud. 1299; Hughes, Property, supra note 1, at 872.
  25. See Hughes, Property, supra note 1, at 901.
  26. Id. at 905.
  27. See Steven L. Harris & Charles W. Mooney, Jr., When Is a Dog’s Tail Not a Leg?: A Property-Based Methodology for Distinguishing Sales of Receivables from Security Interests That Secure an Obligation, 82 U. Cin. L. Rev. 1029 (2014).
  28. See Hughes, Property, supra note 1, at 877.
  29. See, e.g., National Conference of Commissioners of State Laws, Committee on Scope and Program, Minutes of January 11, 2002, meeting, Baltimore, Maryland, http://www.uniformlaws.org/Shared/meetings/Sp011102mn.pdf [http://perma.cc/V5QW-BU5P] (discussing Commissioner Smith’s report on whether there should be a uniform law on what constitutes a true sale of a right to payment and noting concern about “whether such an act could be effective in a fact-specific area”).
  30. See National Conference of Commissioners of State Laws, Committee on Scope and Program, Minutes of August 11, 2001, meeting, White Sulphur Springs, West Virginia, http://www.uniformlaws.org/shared/minutes/scope_081101mn.pdf [http://perma.cc/7VH5-UN56].
  31. See Smith, supra note 2.
  32. See National Conference of Commissioners of State Laws, Committee on Scope and Program, Minutes of January 11, 2002, meeting, Baltimore, Maryland, http://www.uniformlaws.org/Shared/meetings/Sp011102mn.pdf [https://perma.cc/V3VR-URMK]; see also Kenneth C. Kettering, True Sale of Receivables: A Purpose Analysis, 16 Am. Bankr. Inst. L. Rev. 511, 524-25, 560 (2008) (mentioning Smith’s proposal and that it did not result in model provisions).
  33. See National Conference of Commissioners of State Laws, Committee on Scope and Program, Minutes of January 11, 2002, meeting, Baltimore, Maryland, supra note 30, at 8.
  34. See id. at 8.
  35. See id. at 8. Smith is referring to the ABS statutes, presumably. See Hughes, Property, supra note 1, at 905-09.
  36.  National Conference of Commissioners of State Laws, Committee on Scope and Program, Minutes of August 11, 2001, meeting, White Sulphur Springs, West Virginia, http://www.uniformlaws.org/shared/minutes/scope_081101mn.pdf [http://perma.cc/H7K2-XFB2].
  37.  Octagon Gas Systems, Inc. v. Rimmer, 995 F.2d 948 (10th Cir. 1993), cert. denied, 114 S. Ct. 554 (1993).
  38. See PEB Commentary No. 14, June 10, 1994.
  39. See Hughes, Property, supra note 1, at 899.
  40.  These statutes deem all assignments of receivables for purposes of securitization to be sales, regardless of economic substance. They confer “sale” status on transactions the economic substance of which would not otherwise warrant that status. See Ala. Code § 35-10A-2(a)(1) (2016); Del. Code Ann. tit. 6, §§ 2701A-2703A (West 2016); La. Stat. Ann. § 109-109(e) (2016); Nev. Rev. Stat. §§ 100.200-100.230 (West 2017); Ohio Rev. Code Ann. § 1109.75 (West 2016); N.C. Gen. Stat. Ann. §§ 53-425, 53-426 (West 2015); S.D. Codified Laws § 54-1-10 (2016); Tex. Bus. & Com. Code Ann. § 9-109(e) (West 2015); Va. Code Ann. § 6.1-473 (West 2008); see also Hughes, Property, supra note 1, at 876.
  41. See Bankruptcy Reform Act of 2001, S. 220, 107th Cong.; H.R. 333, 107th Cong. § 912(i) (2001).
  42. See Hughes, Property, supra note 1, at 924.
  43. See National Conference of Commissioners of State Laws, Committee on Scope and Program, Minutes of January 11, 2002, meeting, Baltimore, Maryland, at 2, http://www.uniformlaws.org/Shared/meetings/Sp011102mn.pdf [http://perma.cc/2CJL-S8HM].
  44. Id.
  45.  Non-consenting creditors (like tort judgment holders) are not only non-adjusting, they did not consent to extend credit to the company in the first place. See infra text accompanying note 58.
  46. See Mann, supra note 13.
  47. Butner v. United States, 440 U.S. 48, 54-55 (1979); Mann, supra note 13, at 1808.
  48. Mann, supra note 13, at 1810.
  49. Id. at 1818.
  50. Id. at 1819.
  51. Id.
  52. See Carrier, supra note 13; Hughes, Property, supra note 1, at 908.
  53. See Draft of the National Mortgage Note Act of 2018 (January 28, 2018), http://www.uniformlaws.org/shared/docs/UCC%201,%203,%209/2017AM_UCC139_NatlMortRepAct_PublicDraft.pdf [http://perma.cc/MGN5-YAHQ].
  54.  Steven L. Harris, Reporter, Memorandum re: Choice of Law in the National Mortgage Note Repository Act of 2018 (February 22, 2018), http://www.uniformlaws.org/shared/docs/UCC%201,%203,%209/2018mar_UCC1389_Memo%20re%20Choice%20of%20Law_Harris_2018feb22.pdf [http://perma.cc/7L3U-2QSW].
  55. See Hughes, Property, supra note 1, at 886-87.
  56.  Steven L. Schwarcz, Ring-Fencing, 87 S. Cal. L. Rev. 69, 83 n.94 (2013); Steven L. Schwarcz, The Conundrum of Covered Bonds, 66 Bus. Law. 561, 583-84 (2011).
  57. See Lynn M. LoPucki, The Irrefutable Logic of Judgment Proofing, 52 Stan. L. Rev. 55, 59-67 (1999) (analyzing Steven L. Schwarcz’s response to LoPucki’s The Death of Liability to refute the argument that the costs of judgement-proofing outweigh the benefits); Lynn M. LoPucki, The Death of Liability, 106 Yale L. J. 1 (1996). But see Steven L. Schwarcz, The Inherent Irrationality of Judgment Proofing, 52 Stan. L. Rev. 1 (1999) (arguing, through an economic analysis, that judgment-proofing techniques, such as LoPucki’s, may not be standard practice); James J. White, Corporate Judgment Proofing: A Response to Lynn LoPucki’s The Death of Liability, 107 Yale L.J. 1363 (1998) (arguing that American businesses are making themselves increasingly judgment-proof).
  58. See Richard Squire, The Case for Symmetry in Creditors’ Rights, 118 Yale L.J. 806, 838-42 (2009) (stating that debtor opportunism in shifting costs to non-adjusting creditors is the most likely explanation for the persistence of asymmetrical asset partitioning). Cf. Yair Listokin, Is Secured Debt Used to Redistribute Value from Tort Claimants in Bankruptcy? An Empirical Analysis, 57 Duke L.J. 1037, 1076 (2008) (finding that firms with high uninsured tort risk do not issue more secured debt than other firms, negating the redistribution theory of secured credit).
  59. See Harris & Mooney, supra note 27, at 1040; see also Robert D. Aicher & William J. Fellerhoff, Characterization of a Transfer of Receivables as a Sale or a Secured Loan Upon Bankruptcy of the Transferor, 65 Am. Bankr. L.J. 181, 186-98 (1991) (detailing the various factors courts use in examining sale and loan determinations for purposes of the true-sale doctrine); Hughes, Property, supra note 1, at 901.
  60. See Hughes, Property, supra note 1, at 905-910.
  61. See Hughes, Property, supra note 1, at 910.
  62. See id. at 902-903; Aicher & Fellerhoff, supra note 59, at 209.
  63. See Hughes, Property, supra note 1, at 876-877.
  64. Plank, supra note 20, at 334.
  65. Id. at 337-39.
  66. Id. Plank notes that although courts have not always considered price in true-sale determinations, “using an analysis of the price paid for the loans would not have significantly changed the results of many court decisions.” Id. at 334-335.
  67. Aicher & Fellerhoff, supra note 59, at 207.
  68.  A drafting might also take up the issue of governing law. See Smith, supra note 2.
  69. See supra text accompanying notes 44-45.
  70. The UCC as enacted in Louisiana and Texas depart from this baseline for receivables assignments, as discussed above, by enacting non-uniform section 9-109(e). See infra text accompanying notes 95-96.
  71. See supra note 4; Hughes, Property, supra note 1, at 880-881 n.54.
  72. See U.C.C. § 9-109(a)(3). Article 9 generally applies to secured transactions—meaning assignments of personalty to secure obligations. See U.C.C. § 9-109(a)(1). However, it extends its reach to commercial consignments and to sales of certain assets for policy reasons that are not at issue here. See U.C.C. § 9-109(a)(3) and (4).
  73. See U.C.C. § 9-318(a).
  74. See supra text accompanying notes 51-52; Mann supra note 13.
  75. See Hughes, supra note 1, at 921-924.
  76. See supra text accompanying note 54.
  77. See Ala. Code § 35-10A-2(a)(1) (2016); Del. Code Ann. tit. 6, §§ 2701A-2703A (West 2016); Nev. Rev. Stat. §§ 100.200-100.230 (West 2017); N.C. Gen. Stat. Ann. §§ 53-425, 53-426 (West 2015); Ohio Rev. Code Ann. § 1109.75 (West 2016); S.D. Codified Laws § 54-1-10 (2016); VA. Code Ann. § 6.1-473 (West 2008).
  78.  Del. Code Ann. tit. 6 § 2702A (“It is intended by the General Assembly that the term ‘securitization transaction’ shall be construed broadly.”).
  79. See supra note 4; Hughes, Property, supra note 1; Lipson, supra note 4.
  80. See supra text accompanying notes 56-58.
  81. See Aicher & Fellerhoff, supra note 59, at 186-94; Hughes, Property, supra note 1, at 901.
  82.  This formulation tracks Aicher and Fellerhoff’s approach to true-sale determinations. See Aicher & Fellerhoff, supra note 59, at 207.
  83. See supra text accompanying notes 55-67.
  84. Cf. Harris & Mooney, supra note 27, at 1049-1053.
  85. See U.C.C § 1-203.
  86.  For example, in bankruptcy, a true lease finding may permit the bankrupt lessee to continue to use the equipment as long as it makes lease payments. In contrast, a true sale finding for a receivables assignment means that the bankrupt company has no further access to an important cash flow. For discussion of distinctions between the equipment leasing and receivables securitization contexts, see Hughes, Property, supra note 1, at 910-914.
  87. See Hughes, Property, supra note 1, at 911-913.
  88. See Harris & Mooney, supra note 27, at 1031.
  89. See Hughes, Property, supra note 1, at 877.
  90.  U.C.C. § 9-109(a)(3).
  91. See Aicher & Fellerhoff, supra note 59, at 207.
  92. The definition reads: “Value. Except as otherwise provided in Articles 3, 4, [and] 5, [and 6], a person gives value for rights if the person acquires them: (1) in return for a binding commitment to extend credit or for the extension of immediately available credit, whether or not drawn upon and whether or not a charge-back is provided for in the event of difficulties in collection; (2) as security for, or in total or partial satisfaction of, a preexisting claim; (3) by accepting delivery under a preexisting contract for purchase; or (4) in return for any consideration sufficient to support a simple contract.” U.C.C. § 1-204.
  93. Aicher and Fellerhoff, supra note 59, at 207.
  94. See U.C.C. § 9-203(b)(1).
  95. See La. Stat. Ann. § 10:9-109(e) (2016); Tex. Bus. & Com. Code Ann. § 9-109(e) (West 2015).
  96. See supra text accompanying note 81.

In-House Regulators: Documenting the Impact of Regulation on Internal Firm Structure

*J.D. 2017, The University of Chicago Law School. Thanks to Christina Bell, Anthony Casey, Brian Feinstein, Annie Gowen, Matt Ladew, Jennifer Nou, and Jonathan Masur for thoughtful comments on earlier drafts. Thanks also to the editors of the Yale Journal on Regulation for their hard work on this piece. All errors and views are, of course, my own.

In a deregulatory environment, what do regulated firms do? The standard assumption is simple: firms revert to their pre-regulatory form. This Essay challenges that basic assumption. Increasingly, regulation is conducted through broad standards foisted on firms to implement internally. Congress articulates a policy goal; agencies enact specific standards for regulated entities; and firms are left to sort out how to comply with such standards. Recent mandates in financial, privacy, and medical regulation exemplify this approach. Despite these changes, scholars have not turned their attention to how this new form of regulation changes the structure of the regulated entity. Using case studies and theoretical insights, this Essay hypothesizes that the structures firms create in a regulated environment will not immediately disappear in a deregulatory world. Rather, they will persist. Modern regulation causes firms to make department-specific investments and centralize information gathering. Firms accomplish this, in part, by increasing the presence of regulatory-related staff. And, once these investments are completed, they will insulate regulatory-related staff from immediate removal in a deregulatory environment. That is, in-house regulators will be sticky. This Essay aims to provide an array of theories to support this phenomenon.


Deregulation is an integral part of President Trump’s agenda.1 Scholars have been quick to point out that there are multiple headwinds to his deregulatory agenda. The Senate stymied efforts to repeal and replace the Affordable Care Act, for instance.2

Congressional repeal is not Trump’s only option—regulatory changes have focused on agency process. But scholars are also quick to point out that deregulation faces both legal and practical hurdles. In the legal realm, the repeal of rulemaking must go through the standard notice-and-comment process,3 and can be challenged as arbitrary and capricious.4 On the more practical side, deregulation requires the cooperation of a vast bureaucracy consisting of agency employees with their own incentives.5

These hurdles are significant, and I do not dispute them here. However, this Essay’s aim is to recognize regulation’s impact on how firms are organized and suggest that regulation changes firm structure and that this change may persist, albeit mildly, in a deregulatory state. This Essay’s hypothesis is simple: regulation creates extragovernmental hurdles to deregulation by changing how firms are organized.

New regulation brings about observable changes to firms. In areas such as finance, privacy, and medicine, regulation is now accomplished through broad standards that firms must implement themselves. 6 This regulation through delegation requires regulated firms to gain regulatory expertise. To do this, firms hire experts—they invest in processes that will allow them to comply with inherently opaque regulatory pronouncements.

The increased hordes of in-house regulators will “not go gentl[y] into that good night.” 7 That is, they will attempt to fortify their influence within the firm regardless of deregulation. Within the administrative state, this fortification is not surprising, and administrative law scholars have studied it extensively.8 But their focus has generally been inward, looking at administrative agencies and their agents.9 This Essay looks outward, at the agents within regulated entities tasked with regulatory implementation. These in-house regulators have their own incentives and want to keep their jobs even in a deregulatory environment. How they go about accomplishing that has not been systematically documented or studied.

The aim of this Essay, then, is both positive and theoretical. Administrative law is inwardly focused, with scholars turning their lens toward either controls on the administrative state or the structure of the administrative state.10 Often overlooked in this literature is the impact of regulation on the regulated entities.11 Even the scholarly debate surrounding cost-benefit analysis tends to be about its impact on agency discretion.12 Lacking so far in the literature is an account of how regulations impact the structure of regulated entities. To supplement the literature, this Essay first provides a brief overview of the modern regulatory state, documenting two phenomena: the tendency of the administrative state to reject deregulation or, at least, slow a deregulatory tide, and an increasingly standards-based or delegatory administrative state. After briefly highlighting the impact of regulation’s shift on firms, this Essay explores how changes in firm structure may insulate firm regulatory staff in a deregulatory environment.

I. Deregulation Inside the Administrative State: The Impediments Posed by Administrative Agencies

As others have observed, deregulation is not easy. Practical and legal impediments hinder deregulation’s speed13 Before taking up deregulation’s effect on regulated entities, it is important to survey these hurdles. In part, these hurdles may explain this Essay’s hypothesis—if deregulation inside the administrative state proceeds at a lethargic pace, firms may respond accordingly.

Regardless, understanding regulatory effects on firms requires a basic understanding of two key features of the modern administrative state. First, the evolving nature of regulation—the shift from command-and-control regulatory schemes to more deregulatory schemes—changes how firms implement and respond to regulatory pressures.14 Second, in part due to this shift, the significance of practical hurdles to deregulation—such as ossification and burrowing—increases. And more complex, standards-based regulation necessarily places more discretion in bureaucrats whose policy preference may not align with the administration’s.

Bureaucracies can resist outside pressure (or political pressure from the top). To deregulate, agencies must show, via studies, fact-finding, and comments received, that the proposed rule (or proposed removal of a rule) is not a “clear error of judgment.”15 And “[t]he high costs associated with rule change lead[s] to ‘ossification’—a powerful status quo bias.”16 Burrowing serves to increase the costs of deregulation. By placing members of a former president’s staff in career positions within agencies, the view of agency staff aligns with the former, not the current, political order.17 But agency heads must rely on these staffers to conduct the laborious and methodical work required for deregulation to pass judicial muster. The problem for deregulation is obvious—the burrowed staffers will drag their feet on policies they dislike.

These theoretical insights, of course, are currently bumping up against a messy reality. Data suggest that “civil servants are bailing,” contrary to the burrowing hypothesis.18 Political appointees’ requests for budget cuts may exacerbate this exodus.19 Nevertheless, an understanding of the current state of play in how the administrative state regulates and operates has implications for how firms respond. And an outline of current agency process will serve as a backdrop for an understanding of why regulated entities respond the way they do to regulation and deregulation. To that end, this Part first highlights the practical realities of agency administration in a deregulatory environment before documenting the evolving nature of regulation and discussing how the theoretical hurdles to deregulation work in a standards-based regulatory system.

A. Practical Challenges to the Deregulation Inside the Agency

1. Ossification

Changes to regulations must be “based on a consideration of the relevant factors,” and courts will want to see the agencies “examin[ing] the relevant data and articulat[ing] a satisfactory explanation for its action including a rational connection between the facts found and the choice made.”20 In practice, this standard increases the time and cost it takes to repeal or change regulation—it “requir[es] that agencies provide detailed explanations of their behavior, consider viable alternatives, explain departures from past practices, and make policy choices that are reasonable on the merits.”21 Currently, Trump has directed the heads of executive agencies to investigate deregulatory avenues.22 But, even where regulation can be identified and modified, the process of actually doing so will require executive agencies to show, via studies, fact-findings, and comments received, that the proposed rule is not a “clear error of judgment.”23 The high costs associated with rule changes make the status quo sticky.24

Besides the issues raised by State Farm and arbitrary-and-capriciousness review, the cost of notice-and-comment rulemaking remains. “Rule making” as defined by the Administrative Procedure Act,25 includes “repealing a rule,” 26 and even informal rulemaking requires notice and comment.27 Rulemaking is not a painless process. For example, in April 2009, the GAO found that even simple rulemakings can take six months to complete, and that was on the lower end of estimates for agencies. Some agencies, like the FDA, estimated “that a straightforward rulemaking may take up to 3½ to nearly 4 years from initiation to final publication.”28 Despite increasing presidential control of the administrative process, these figures have not changed.29 For instance, in 1992 Professor Thomas O. McGarity reported that rulemaking by the FTC took, on average, five years and three months. 30

And if history is any indicator, the lethargic pace of agency rulemaking is unlikely to change in the future. Ossification, then, has the effect of keeping regulation in place despite expressed deregulatory pressures.

Agency staff exacerbates this ossification because they will be required to carry out Trump’s deregulatory policies. 31 And while agency staff has become, over the past few administrations, “more [of] an extension of the President’s own policy and political agenda . . . no President . . . c[an] . . . supervise so broad a swath of regulatory activity.” 32 At a technical level, staff is required to carry out the studies necessary to survive arbitrary and capriciousness review. If they are antagonistic towards Trump’s deregulatory agenda, they can stall the process. Moreover, while the actual requirements of regulation can be changed, agency staff can protest the deregulatory action by increasing the number of audits or internal investigations at individual financial firms—changing their oversight policy from one of capital requirements to one of more extensive auditing.

Finally, at the end of a presidential administration, agencies may finalize a tremendous amount of rules in order to stay the hand of the new president.33 This can create hurdles for the new president for the reasons discussed above—changing a rule requires costly and time-consuming rulemaking. And ossified rules present a challenge for regulated entities in that political rhetoric does not immediately translate into laxer regulatory schemes. For regulations that require large capital investments, this can be seen as a positive—ensuring regulated parties that the regulatory scheme will not be upended before the return on their investments are realized.34 But for structural regulation—such as bank capital requirements or privacy concerns—ossification imposes costs and limitations on firms far after the administration has deemed those costs unwarranted.

2. Burrowing

Just as new rules are promulgated at the end of a presidential administration, so too do abrupt staffing changes occur. At the end of President Clinton’s administration, over “one hundred political appointees moved to civil service positions35 Furthermore, “[o]utgoing political appointees may also hire significant numbers of civil servants or promote individuals to key supervisory positions inside the agency, [] with an eye to ensuring that the outgoing administration’s viewpoints and priorities remain represented within the agency.”36

Junking up an agency with those sympathetic to an outgoing president’s point of view imposes costs on the new administration. Antagonistic staff can hamper agency heads from engaging in a cohesive policy strategy. Moreover, agency staff is usually tasked with identifying the agency’s agenda or the pathways through which the political agenda can be accomplished.37 This subversive behavior can be “passive,” by letting deadlines slip, dragging out assignments, or overloading political appointees with needless information to stall agency activity.38 Of course, this subversion can also take an active form through leaks and other signs of disagreement. Like the legal hurdles to deregulation, these too can be overcome by a presidential administration bent on deregulating. But it is important to note that they increase the costs and time to deregulate in ways that may harm the effort globally.

Agency burrowing can also take the form of enforcement shifting whereby agency staff antagonistic towards the political views of the president increases other forms of regulatory burdens (e.g., audits or inspections) due to a perceived decline in top-down regulation. This is not merely a theoretical exercise. Scholars have observed that the rank-and-file agency staff responds to what they perceive as negative changes in policy.39 For instance, in response to President Ronald Reagan’s “outright assault . . . on environmental programs” and a decline in the agency’s budget, the Environmental Protection Agency’s monitoring and abatement activity surprisingly increased during the early part of the Reagan administration.40 The EPA was able to successfully circumvent parts of Reagan’s assault on environmental regulations because the “bureaucratic interest in shaping policy outputs” is sometimes strong enough to overcome presidential control.41 Ultimately, presidential administrations can impact policy, but agencies themselves are “responsible for much of the . . . public policy” implementation.42

This too has obvious deleterious effects on regulated entities. While official regulation is being slowly repealed, firms may be exposed to increased regulatory action through audits and other informal regulatory processes. This mismatch creates uncertainty that makes it difficult for firms to plan ahead. Although they can see formal deregulation occurring and plan investment changes accordingly, they simultaneously see an increased need to spend more time working with regulators. Firms may be accustomed to such bipolar regulatory responses, but they nonetheless force internal regulatory processes to persist within firms.

3. Prosecutorial Discretion

Finally, agencies—and their staff—possess extraordinary discretion when bringing enforcement actions. As SEC v. Chenery Corporation 43 tells us, agencies may choose between rules and adjudication in creating policy positions. But that does not end the story. After Heckler v. Chaney, 44 an agency’s decision to not bring enforcement action—as well as its decision to bring enforcement action—is effectively unreviewable. Except for the fact that the agency personnel bringing the enforcement action must be separated from those adjudicating the action45 agency personnel have complete discretion to bring enforcement actions.

Traditionally, enforcement was an after-thought in terms of agency policy—the focus on rulemaking either through notice and comment or adjudication. But increasingly, agencies have used enforcement—or the threat of enforcement—to regulate entities in ways that may expand the regulator’s purview or the agency’s policy portfolio46 The lengthy procedural processes that the APA and the courts have foisted on agency rulemaking makes regulation via enforcement attractive—the courts have limited review of these decisions, and settlement agreements allow for tailored enforcement of individual firms.

Regulation through enforcement and settlement also has ripple effects on other firms in the industry. The potential for enforcement threats, especially after enforcement against a similar firm has been observed, may change how firms behave. If firms in an industry observe an agency threatening enforcement against a competitor for a practice that might be prohibited by current regulation, they may change their policies in anticipation47 The cost of litigating against the agency is high and generally unrecoverable. So a firm must balance the cost of litigating (and the probability-adjusted cost of losing that litigation) against the cost of compliance. In that sense, it is easy to see why firms settle and other firms comply with the thrust of the settlement ex post.

Especially as regulation has become more standards-based48 the potential to expand the scope of regulation through the threat of enforcement increases. Of course, given the relative newness of enforcement through settlement, the persistence of this approach has not been studied. It may cut both ways. Appointed enforcement chiefs can stop bringing enforcement actions and can allow firms to stop complying with previously signed DPAs or stop ongoing litigation and investigation.49 On the other hand, burrowing may allow for ongoing minor enforcements and the continued enforcement of settlements. And even for deregulatory administrations, high-level enforcements may be politically attractive.

B. The Evolving Nature of Regulation

“[P]rivate firms increasingly exercise regulatory discretion of the type delegated to agencies.” 50 regulation’s goals have become more complex, regulators have shifted their focus from command-and-control directives to more performance-based models51 This is not a recent phenomenon. President Clinton required that agencies, “to the extent feasible, specify performance objectives, rather than specifying the behavior or manner of compliance that regulated entities must adopt.”52

Historically, regulators employed “technology-based” regulation that “intervene[d] in the acting stage, specifying technologies to be used or steps to be followed53 But increasingly, regulators are employing “performance-based” and “management-based” regulatory schemes. “Performance-based approaches intervene at the output stage, specifying social outputs that must (or must not) be attained. In contrast, management-based approaches intervene at the planning stage, compelling regulated organizations to improve their internal management so as to increase the achievement of public goals.”54

For example, the Nuclear Regulatory Commission’s Reactor Oversight Process does not mandate particular technologies or processes. Rather, it relies on a bevy of performance indicators to “assess the safety and security performance of operating commercial nuclear power plants.”55 Mandating specific technologies risks becoming outdated or depresses innovation, so the agency allows plants to conduct their operations organically. Inspections are conducted annually to observe the plant’s conditions and understand any trends or emerging risks, but the design and implementation of a safety and soundness program is left to the individual plants.56

Another “prominent example is the No Child Left Behind Act,” which “requires schools to achieve specified academic results as measured by a variety of indicators.”57 No Child Left Behind gave discretion to individual schools districts—they could choose what strategy, technologies, and processes worked best to accomplish the Act’s broad goals.

These are not isolated examples. Financial regulation, environmental regulation, and food safety regulation, to name a few, allocate some regulatory authority to the regulated entities.58 A full review of the regulatory shift is outside the scope of this Essay, but the examples help change the general perspective of what regulation is, especially as it relates to regulated entities. Typically, regulation is thought of as a binary—build X to decrease carbon emissions, add Y to cars to make them safer—but in more complex industries, the regulation is more prudential—implement changes to make the financial system safer, ensure that users’ data is protected and private, consider the efficacy of medical procedures on a hospital’s treatment policies. This shift is a necessary part of this Essay’s thesis.

Take, for example, the canonical case of Motor Vehicles Manufacturers Association v. State Farm Mutual Automobile Insurance Company.59 The fight in that case was over whether seatbelts or airbags would be installed in cars (and when)—a binary outcome. Either car manufacturers would have to invest capital to change their production process or they wouldn’t. But once they changed the process, there would be no thought about it—the capital invested, the regulation was effectively implemented. Modern regulatory schemes have changed this binary outcome. To use a highly politicized example, the Patient Protection and Affordable Care Act,60 requires the development of a National Quality Strategy to promote efficiency and efficacy of healthcare delivery.61 That is not a binary outcome for insurers and healthcare providers—it requires these firms to build internal units that can collect data, analyze the data, and propose recommendations (in addition to thinking about what data is valuable). These changes in regulatory strategy affect how firms structure their responses to regulation and, ultimately, may have persistent effects on firms’ structure even in a deregulatory environment.

II. Firm Responses to Regulation: Theories of Institutional Change in Response to Deregulatory Pressures

Firms respond to regulatory pressures. But missing from recent analysis is an understanding of how more complex, bottom-up regulation affects firm structure. Structure matters. Investment in a plant can be abandoned if deregulation makes its operation inefficient or unnecessary. But structure dictates how decisions are made. Responding to traditional, top-down regulation is easy: firms purchase the required equipment or invest in the necessary preventative apparatus. In essence, it is binary and likely does not require much change to current processes or procedures. For instance, when the FDA mandates that warnings be in a certain sized font,62 pharmaceutical manufactures change the label, but they do not change their research processes. But adhering to more complex regulation, such as the Federal Reserve requiring systemically important financial institutions conduct stress tests on their assets, requires increased staff, centralization of information, and coordination inside the firm. Responding to regulation by structurally changing organizational processes may fundamentally alert the organization and allow these changes to persist in the absence of regulation. To make that point clear, this Essay first proceeds by highlighting financial firms’ responses to Dodd-Frank through related antidotes. This Essay then turns to the heart of the matter—providing several theories of institutional change that will keep internal firm structures changed in the absence of regulation.

A. Firm Responses to Increased Regulation Through the Lens of Dodd-Frank

After the passage of Dodd-Frank, the rise of the regulatory, risk, and compliance staffs at financial institutions has been stunning. Or, as Bloomberg put it, the last few years have witnessed “the [r]ise of the [c]ompliance [g]uru.”63 For instance, JPMorgan Chase, the largest US bank by assets,64 increased the number of in-house regulators by over seventy-five percent from 2011 to 2015.65 JPMorgan is not an isolated example—other financial institutions have seen a similar rise in the number of staff devoted to regulation, risk, and compliance. At Goldman Sachs, in just one year, “[t]otal staff increased 8% . . . primarily due to . . . continued investment in regulatory compliance.”66 Perhaps more tellingly, it is becoming more difficult to staff these types of jobs, with senior compliance officers complaining of “staffing challenges.”67 Even non-US banks are increasing the size of their internal regulatory staff—by 2014, one-in-ten HSBC employees was an in-house regulator.68 Moreover, based on a 2016 survey of bank chief risk officers and other senior in-house regulators, “the upward [hiring] trend will likely continue overall, as the majority of firms expect to add more professionals to headcount in the next year.”69

Regulatory demands have driven most of the increases in in-house regulator headcount. But this unprecedented growth has been coupled with increased institutionalization of these functions. For instance, prior to 2008, the Chief Risk Officer at Morgan Stanley reported solely to the Chief Executive Officer.70 But now the Chief Risk Officer reports directly to both the Board of Directors and the CEO.71 A similar transition has occurred at Citigroup, where the Chief Risk Officer now “has regular and unrestricted access to the Risk Management Committee of the Board.”72 In perhaps a greater transformation, the Chief Risk Officer of Goldman Sachs previously reported to senior management (including the CEO, President, and CFO).73 Now Goldman’s Chief Risk Officer reports to both the CEO and the Board of Directors.74

Banks responded to Dodd-Frank in predictable ways—regulated entities generally seek to comply with new rules. But most scholars assume that firms will respond to deregulation in the same predictable way, by deconstructing the regulatory apparatus they created internally. The basic understanding of firms as profit-maximizing machines—and managers as agents for shareholders focused on earnings—highlights why this understanding is persuasive. This view of firms is present in both administrative law and corporate law literatures.75

Most of the current literature on firm regulatory response is focused on mandates—forced firm behavior.76 It does not seek to explain how complex, standards-based regulatory frameworks change regulated entities and cannot explain their response to deregulation. It suggests that sunk costs and switching costs may make singular investments or choices stable in a deregulatory environment77 That theory has some purchase in this context—the specter of regulations’ return poses switching costs—but is not robust in the presence of most modern regulatory schemes. Dodd-Frank required financial firms to hire an enormous amount of regulatory staff and was enormously costly,78 but the switching costs seem limited—laying off the regulatory staff may have psychic costs, but is otherwise a profitable move.

Cutting against that logic, I suggest that forces inside and outside the firm moderate the tendency to “deregulate” inside the firm. Indeed, Judge Richard Posner has noticed, “[d]eregulation does not bring about automatic changes in firm behavior. It changes the incentives facing management, and managers differ in their ability to respond intelligently to changes in incentives.”79 Below, I suggest several theories that may explain why firms will not respond to deregulation as expected. These theories are not mutually exclusive and some are more likely to be present in certain types of industries. Although some empirical evidence “suggests that older firms, firms that were profitable before deregulation, and family firms are apt to be more sluggish in responding to the challenges of deregulation than firms having the opposite attributes80 limited work has been done to construct theoretical arguments explaining that sluggishness.

The point is not to draw absolute conclusions about how firms will react; rather, the aim is positive and theoretical—to present a series of theories that punch against prevailing wisdom. Certainly more study of individual firms and industries will be necessary to test these theories, but they suggest prevailing wisdom may be incomplete.

B. Internal Forces of Regulatory Inertia

1. Agency Costs

Jensen and Meckling revolutionized corporate governance by conceptualizing firms as a nexus of contracts. A firm—in their view—“is a legal fiction which serves as a focus for a complex process in which the conflicting objectives of individuals . . . are brought into equilibrium with a framework of contractual relations.”81 The result of these contracts—between a principal, owner and agent, manager—is agency costs. Agency costs arise from the divergent interests of the principal and the agent. An owner has delegated responsibility of the firm to the manager. The owner wants the manager to maximize profits, but the manager is striving to maximize her compensation, potentially to the detriment of the owner. And, as the gap between principal and agent grows, so does this relationship’s agency costs.82

Agency costs exist not just at the owner–manager level, but also between senior and junior managers.83 As such, agency costs may stymie managers attempting to trim the size of their firm’s regulatory staff in a deregulatory environment. Regulatory staff has great autonomy and, within the firm, is expert on its processes and regulatory developments. In a deregulatory environment, they can use this expertise to their advantage. Ossification, burrowing, and prosecutorial discretion slows deregulatory rhetoric from directly translating to reduced regulatory burdens.84 While senior managers may want to reduce regulatory staff, the regulatory staff wants to maintain its size, stature, and salary. But because senior managers have less expertise in the guts of regulation, in-house regulators can use their expertise—coupled with the technicalities around ossification and the like—to encourage managers to reassess their initial inclinations.

Highlighting recent regulatory actions that occur in a deregulatory environment could be one technique regulatory staff employs to mitigate management’s view on deregulation. Even though presidential rhetoric is favorable, burrowing and prosecutorial discretion create enforcement opportunities that in-house regulators can seize. Take, for example, the Federal Reserve’s recent treatment of Wells Fargo. Because of regulatory lapses in the past, in February of 2018, the Federal Reserve fined Wells Fargo and prevented them from expanding until the issues are fixed.85

Bank compliance staff can employ this example should their managers seek to trim staff because of deregulatory presidential rhetoric. All else equal, compliance staff prefer to preserve their jobs than increase bank profits, so they can use the Wells Fargo example to argue that their positions are valuable—the staff may still be able to regulate despite top-down guidance. Moreover, because their knowledge of the regulatory landscape is greater than senior management’s, the regulatory staff can use burrowing and prosecutorial discretion to their advantage. They can assert that the Wells Fargo example is not an anomaly, but the result of regulatory resistance that will persist even as deregulation makes its way through the ossified process.

And despite agency costs theory’s prescription to centralize decision-making,86 management theory and practice increasingly push firms to decentralize decision-making.87 Decentralization has a pernicious downside—divisions will seek rents. This rent-seeking behavior can manifest itself in increased salaries or, more likely, larger budgets.88 Scharfstein and Stein develop a two-tier model of agency costs—agency costs between investor and manager, and manager and division heads.89 To maintain the division heads of weaker divisions, they predict that the manager will “pay” them with increased budgets, rather than increased salary. Weaker divisions will always rent seek while stronger divisions will not, and to retain the division head, the manager will “tilt the capital budget in his direction.”90 That is optimal for both the manager—who prefers to pay in capital investment rather than salary—and the division head.

The theory applies to in-house regulators. The division head—the Chief Risk Officer, the Chief Privacy Officer—will rent-seek in a deregulatory environment because their divisions will be “weaker” all else equal. The manager cannot do away with the division head, but will prefer to expand his budget rather than pay cash wages. In theory, cash wages reduce the manager’s flexibility to pay himself and others, but the “successful” units can subsidize the capital investment in the weaker division without harming the manager’s cash flexibility.

Theory aside, Scharfstein and Stein suggest that the agency costs that afflict managers and division units manifest themselves in greater budgets for the weaker units. For in-house regulators, this creates a type of one-way ratchet.91 In times of increasing regulation, firms spend capital to comply. But in deregulatory environments, rent seeking causes firms to undercompensate in-house regulators in real terms, but overinvest in in-house regulators (that is, in-house regulator’s may see their budgets grow while their wages stagnate). Agency costs theory, then, supports the notion that deregulation does not swiftly flow through firms—the internal dynamics of firms belie an immediate reduction in the size and sophistication of the firm’s regulatory staff.

2. Manager-Specific Investments

Managers are subject to pressures that align their interest with that of shareholders. The board and other senior leaders monitor managers for compliance with their profit-maximizing strategy. Moreover, the active labor market also reigns in a manager’s tendency to shirk, that is act in a way that is beneficial to her but to the shareholders’ detriment.

But these mechanisms are imperfect. Managers often act in self-interested ways. One theory for this is managerial entrenchment—the idea that managers make specific investments that subsequently make them “valuable to shareholders and costly to replace.”92 entrenchment may occur at any level of the organization. “A secretary, for example, has an incentive to design ways of keeping records or computer files that are very costly for anyone else to figure out.”93

In the mine-run case of entrenchment, boards (or anyone with oversight authority) allow managers to make entrenching investments because they are “insufficiently well informed to evaluate the investment, or because board members approve of the manager’s basic corporate strategy.”94 This may prove especially troublesome in the regulatory context, as boards cannot protect themselves from such investments. New regulation forces firms to invest in new, specific functions, and out of necessity, those implementing the regulation within the firm will be best positioned to determine how to invest. This creates an incentive for in-house regulators to invest inefficiently, that is invest to entrench.

Recent examples from financial regulation are apt. As financial regulators have placed increased demand on firms to oversee the risks being taken and develop comprehensive systems to analyze and monitor these risks, the in-house regulators tasked with this project have seen their staff and budgets balloon. Off-the-cuff risk management techniques traditionally done on trading desks moved to sophisticated risk tracking systems done by in-house regulators. The models and data that these systems spit-out is opaque—knowledge of risk metrics and other ideas is a necessary prerequisite to understanding what is going on. In the presence of regulation, the in-house regulators have made themselves valuable because they have built systems that they have a comparative advantage at understanding and decoding. Moreover, the centralization has meant that those on the trading desks that historically were called upon to do the quick-and-dirty risk management tasks of yore, no longer exist or have the expertise to do so. Therefore, investment in specific technology has increased the value of in-house regulators and made them more difficult to get rid of even in a deregulatory universe.

Of course, if the regulatory function is no longer valuable in a deregulatory universe, these investments will not lead to entrenchment—managers may eliminate the investments.95 But modern regulation’s scope has pervasive effects on firm operations. As the example above illustrates, the investments that in-house regulators make change how the firm itself is organized and operates. In line with the manager-specific investment thesis, in-house regulators will overinvest in systems that provide them with control over information or other inputs into firm operations. Normally, Boards would curtail overinvestment, but because of regulation’s complexity, they may not have the tools to properly account for what is needed, and the risk of undercompliance is high (and Boards may well be risk averse when it comes to compliance). The traditional check on manager-specific investments is muted in the regulatory landscape because the person with the most information about costs—the in-house regulator—has an incentive to inflate the costs to entrench herself and her staff.

3. Specific Knowledge, Centralization, and Switching Costs

“[M]anagement-based regulation will typically require information collection.”96 This is not surprising; modern regulation emphasizes monitoring and modeling—approaches that require centralized information collection. But this centralization may make in-house regulators sticky.

Another theory of the firm posits that it is an institutional arrangement to integrate the individuals’ knowledge.97 Knowledge is not held by the firm, but rather by individuals employed by the firm. Some of that knowledge is easily transferable (e.g., the number of employees in Human Resources or the price of a necessary input per a contract with the supplier). But most valuable knowledge is not easily communicated or transferable—“[t]acit knowledge is revealed through its application.”98

Much of the knowledge housed in the minds of in-house regulators is this less transferable knowledge. The ability to monitor, analyze, and synthesize data is not easily transferred, even if the data itself is easily communicated. Moreover, decision making housed in firm regulatory departments is a classic form of tacit knowledge—the combinations of data that each situation requires taking into account is not routine and can only be developed through use.99

Firm production requires the integration of multiple people’s knowledge. As in-house regulators emerge or grow, they are likely to centralize tasks—and thus knowledge—in themselves. This makes them essential components of firm production. Once “production requires the integration of many people’s specialist knowledge, the key of efficiency is to achieve effective integration while minimizing knowledge transfer through cross-learning by organizational members.”100 Dependence on in-house regulators’ knowledge makes them a valuable component of production. Deregulation should, thus, not have as great an impact as previously imagined because, although regulatory responsibilities are one component of their tasks and their origin, the integration of their knowledge into firm production means that they are now a more essential component of firm production. The firm’s ability to aggregate knowledge towards a productive means is what makes it competitive and profitable. Once in-house regulators are part of the knowledge aggregation process, removing them may change the firm’s production function and impact profitability.

After Dodd-Frank, financial firms were required to stress test their entire portfolios annually for the Federal Reserve. As discussed above, this herculean effort required centralizing data—and the ability to understand, manipulate, and synthesize that data—in risk departments. But this knowledge is valuable for everyday production. The profitability of a trade depends on whether it will offset overall risk, and now risk departments are central to understanding the complexity of a firm’s portfolio.

Moreover, the most efficient way to organize knowledge in a hierarchical organization is through bureaucracy.101 “In the knowledge-based firm, rules and directives exist to facilitate knowledge integration; their source is specialist expertise which is distributed throughout the organization.”102 Generally, in-house regulators are viewed as setting up procedures and protocols that facilitate compliance. But these same procedures are used to integrate knowledge across the firm—they exist not just to satisfy compliance but to structure knowledge integration to coordinate production.

The neoclassical retort to this line of reasoning is simple: if these processes and groups were valuable before regulation, they would have existed. Perhaps, but internal efficiency must be balanced against the high switching cost of knowledge transfer. Of course, it may be the case that the structure of firms ex ante was efficient, but once forced to restructure by regulation, the unraveling of the structure in a deregulatory universe imposes switching costs that may mitigate any efficiency gains that materialized in the previous organizational form.

4. Professionalization, Advocacy, and Culture

Regulating a firm requires expertise, and in-house regulators have become increasingly professionalized. The oft-maligned revolving door is one manifestation of professionalization—in-house regulators’ expertise is difficult to acquire and ex-regulators may be best positioned to understand in-house regulators’ roles. Regulation may also drive professionalization.103 Isolating or signaling out specific expertise may lead individuals across firms to associate. For example, privacy officers became increasingly professionalized after regulation encouraged firms to hire more of them.104

But increased professionalization has a downside for organization: it creates individual tension between professional norms and organizational priorities.105 Because most in-house regulators are, necessarily, somewhat separated from the other operations of the firm, they may develop a professional ethos or culture focused on attaining their perceived goal rather than focusing on optimizing firm goals. Given the headwinds to downsizing in-house regulators, the establishment of a culture of compliance not only leaves the in-house regulators in place but also leaves traces of the regulatory mandate in place.106

This is not to say that in-house regulators won’t change their culture or focus in a deregulatory environment—over time, they will respond to the incentive scheme that exists. And environmental factors may contribute. For example, financial risk managers and compliance professionals may be more likely to develop a culture of compliance because they co-located—most of these professionals live in the same few metropolitan areas. But there may be less cross-industry cultural development in privacy professionals or hospital administrators because of their geographic diversity. In any event, change may be slow, and given deregulation in fact already lags deregulatory rhetoric, the shadow of regulation in a deregulatory universe may be longer than previously anticipated. Indeed, it may outlast the administration proposing the deregulation, at which point the future fear of regulation may become another force that creates persistence among in-house regulators (see below).

5. Repositioning the Regulatory Agenda

What’s more, regulatory staff may entrench themselves by repositioning their role. What starts out as a regulatory mandate becomes a competitive advantage.

Take, for example, State Street’s “Fearless Girl,” the bronze statue of a young woman placed in front of the notorious Wall Street Bull.107 By building the statue, State Street signaled its commitment to employing its power to increase diversity on corporate boards. State Street may have legitimate business reasons for doing so,108 but it also bolstered State Street’s progressive reputation and likely aided its quest to manage pension and endowment assets.109

Regulation, in part, led to this approach. In its 2003 rule on Proxy Voting by Investment Advisors,110 the SEC issued regulations that required Investment Advisors, like State Street, to vote in the best interest of their shareholders. Most large investment managers, including State Street, created dedicated corporate governance groups to consider how to vote the shares State Street controlled.111

The policy goal behind the regulation is simple. If Investment Advisors consider only the interest of shareholders when voting, they will use their considerable power to increase the value of the firms that their shareholders are invested in. But, at State Street at least, this regulatory function was able to use its newfound expertise and power to reposition the regulatory function. Because of the nebulous nature of what is in the best interest of the shareholders, the corporate governance group was able to reposition itself as part of the sales force—using its votes to signal State Street’s values to current and future clients.

Although there is currently no proposal to remove the regulation that started this chain reaction, the group at State Street would likely persist even if that regulation were withdrawn. This reposition of the regulatory enterprise represents another way that in-house regulators attempt to entrench themselves. And in the State Street example, the corporate governance group gains more resources and maintains most of the group’s mission—voting in the interest of shareholders—while ensuring their future even in a deregulatory environment.

Empirical evidence suggests that board diversity has positive shareholder returns.112 But even if those empirical results are not robust, State Street’s governance team may be avoiding the regulatory mission with regard to some corporate governance decisions—for example, supporting directors on the basis of their gender—while accumulating resources and credibility with respect to its original mission. In this sense, if in-house regulators can reposition some of their tools to the firm’s benefit, it may allow them to continue to exercise most of the regulatory discretion they were initially given despite deregulatory pressures.

State Street’s “Fearless Girl” is not an isolated example. Energy firms have advertised how environmentally friendly they are.113 Similarly, the internal group driving this started because of regulatory pressure, but the group was able to reposition itself as a selling point to some clients—it turned regulatory compliance into a competitive advantage. This creates a feedback loop that furthers entrenchment. It may be that sales teams are expropriating the in-house regulators’ work for sales, but that does not undercut the point. If revenue-generating units perceive in-house regulators as valuable, they will continue to support internal regulatory efforts. Indeed, the more symbiotic the relationship becomes, the more sales goals may change how the in-house regulators operate and shift the sales teams dialogue with clients around how in-house regulators are a value-driver for clients. In part related to external reporting requirements discussed above, once clients are focused on this attribute, the firm will be loath to disband the group—it makes the group a profit center.

6. Regulatory Persistence as a Barrier to Entry

Finally, regulated industries may act strategically in keeping regulation to deter new entrants into the field. High compliance costs raise the cost of new entry and reduce the number of potential entrants. A reduction in potential entrants allows an industry to operate at higher profits than they would otherwise achieve, and thwarts threats to their business model.114

Even in deregulatory environments, firms may use the professionalization of in-house regulators to increase barriers to entry. This insight combines two forces of in-house regulatory persistence: repositioning and professionalization. For instance, privacy protections can be seen not just as a compliance function but as a source of value—customers are more comfortable transacting with a company that has robust privacy protections. In the technology space, this may allow incumbents to increase the costs for new entrants. “Don’t give your data to New Company because they do not have robust protections,” can be a persuasive way to transfer industry professionalization into a barrier to entry, increasing profitability for incumbents.115

This isn’t hypothetical. For example, industry experts expect Google and Facebook to benefit from Europe’s new privacy regulation, at the expense of smaller online advertising firms.116 Likewise, the Affordable Care Act gave hospitals and other healthcare organization an incentive to merge—larger organization can amortize regulatory costs over a larger sales base.117

C. External Forces of Regulatory Inertia

1. Board Risk Taking and Caremark Duties

Under Delaware law, boards have a duty to monitor the firm. That is, the board must “exercise a good faith judgment that the corporation’s information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as a matter of ordinary operations, so that it may satisfy its responsibility.”118 In-house regulators further this mission, and increased regulation gives them greater access to the board. Chief Risk Officers of financial firms now report directly, and regularly, to the board, as do privacy leaders.119

In 2006, the Delaware Supreme Court affirmed the Board’s duty to monitor under Caremark stating that:

Caremark articulates the necessary conditions predicate for director oversight liability: (a) the directors utterly failed to implement any reporting or information system or controls; or (b) having implemented such a system or controls, consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention. In either case, imposition of liability requires a showing that the directors knew that they were not discharging their fiduciary obligations. Where directors fail to act in the face of a known duty to act, thereby demonstrating a conscious disregard for their responsibilities, they breach their duty of loyalty by failing to discharge that fiduciary obligation in good faith.120

While Caremark appears to be a robust doctrine when spelled out on its terms, it is severely limited. For instance, in 2009, Chancellor Chandler dismissed a claim against the Citigroup Board for failure to monitor. The plaintiffs alleged a violation of the Board’s Caremark duty for failure to monitor risk in Citigroup’s subprime mortgage portfolio.121 The court saw these claims as attempting to hold the directors liable for business decisions, and quickly dismissed the claim.122

Given the limited nature of the doctrine, Caremark may not create enough incentive for the board to retain in-house regulators in a deregulatory environment. However, to overcome a Caremark claim, directors “must make sure their risk oversight duties are met.”123 And directors familiar with only the presence of a duty to monitor, but not the fine gradations of the doctrine, will likely err on the side of additional monitoring and reporting to ensure compliance. As such, once a monitoring system is put into place, it may act as a one-way ratchet—the Board will be unlikely to remove the system because it fears that it may subject it to Caremark liability under the first doctrinal hook (failure to establish an adequate monitoring system). While these incentives may not be especially powerful, they present another avenue through which the board may encourage the maintenance of in-house regulators.

2. Reputation and External Reporting Pressures

Caremark’s oversight duty is not the only external pressure on boards and management to perpetuate regulatory staffs’ existence in a deregulatory environment. Just as internal actors rely on information produced by in-house regulators, external actors also rely on it. Privacy officers are responsible for producing and refining a firm’s privacy policy—a key document that the media and watchdog groups use to inform consumers.124 Similarly, hospitals are now able to provide more precise information to ratings organizations and potential donors.

Some legal regimes—like securities law—mandate disclosure. But there are non-legal explanations for revealing information. Reducing information asymmetry between management and the market reduces a firm’s cost of capital and enhances the liquidity of the firm’s securities.125 The release of information by one firm has two immediate effects. First, it pressures other firms to release similar information, else those interested will assume the worse. Second, it puts pressure on the firm to continue to disclose the information, else interested parties will assume nondisclosure reflects negatively on the firm.

Therefore, external reliance on information produced by in-house regulators can occur even absent a firm’s affirmative disclosure. Once one firm within an industry discloses, pressure on others will grow to disclose similar information.126 And if the information is dynamic—that is, it changes overtime—reliance interests will pressure the firm for continued reliance else a negative inference is drawn about the firm.

For example, bank equity analysts have started to drill down on capital and risk numbers in recent years. Because firms rely on the in-house regulators to supply these numbers, their value to management increases as external parties become more-and-more reliant on this information. Several financial firms have started to release forward guidance on their risk plans, and firms that did not have been chided by equity analysts.127 Irrespective of the regulatory environment, equity analysts strive to collect a full picture of the firm, which requires the information supplied by in-house regulators. Moreover, firms may have an incentive to disclose information to equity analysts, as those firms that disclose more tend to have higher returns, likely because investors’ expectations were appropriately calibrated.128 Reliance by third parties on information supplied by in-house regulators can bolster the credibility, importance, and, ultimately, resilience of in-house regulators in a deregulatory environment.

3. The Revolving Door and the Human Capital Hypothesis

The revolving door may also connect prosecutorial discretion with firm regulatory staff entrenchment. The human capital hypothesis posits that future job prospects will motivate regulators to regulate aggressively to show off their expertise and talents. In a deregulatory administration, regulators may foresee their future job prospects thinning. The alternative revolving door hypothesis—the rent seeking hypothesis in which regulators attempt to curry favor with regulated firms by going easy on them—is no longer attractive to regulators. Lax enforcement will not translate into a job if deregulation occurs—the regulator’s expertise won’t be needed. As a result, deregulatory rhetoric may, at least in the short-run, lead to more aggressive enforcement. Although generally thought to be explained by resistance, the EPA’s increased enforcement of environmental regulations after Reagan became president may reveal that deregulatory rhetoric hones regulators to focus on their future prospects.129

This goes back to the earlier point that agency costs allow in-house regulators to overstate their value in a deregulatory environment through examples of ongoing regulation. But these examples, then, are not flukes—they are likely systematic in a deregulatory environment. In many ways, the rent-seeking is recursive. As regulation increases, the regulators may have mixed incentives and pursue either more aggressive regulation (the human capital thesis) or less aggressive regulation (the revolving door hypothesis). In any event, in-house regulators have an incentive to communicate that harshness of regulation (regardless of the regulator’s actions).130 Therefore, in times of regulatory formation, the size and stature of in-house regulatory departments increases.

But then in deregulatory periods, regulators’ incentives change, and they are more likely to pursue aggressive regulation. The Wells Fargo example above might be an expected repercussion of deregulatory rhetoric, not an insolated, idiosyncratic example. In that case, in-house regulators have ready experiences to bring to bear on keeping their size (if not their stature). Although managers may observe deregulatory rhetoric, their inability to monitor in-house regulators (and the changed incentives of regulators) means that they may be more likely to defer.131

Again, this is not to say the persistence is infinite. Eventually, deregulation will become a reality and regulators will no longer be equipped with the tools to be aggressive (even if they are incentivized to be so). So, over time, in-house regulators will have less ammunition to fight off impending decreases in size and stature. The point, again, is not to posit infinite persistence but to show the time lag between rhetoric and on-the-ground change is burdened not just by administrative barriers but also by how those barriers can encourage and aid in-house regulators.

Future Regulatory Uncertainty

Regulated firms also face the possible return of regulation. Agencies need a commitment mechanism to regulate effectively into the future.132 The same impulse may exist with deregulation. In the regulatory context, regulated entities use administrative processes, like notice and comment, and political pressure, through lobbying, to mitigate regulation’s impact.133 In anticipation of the regulation, firms have rewired their operations to conform ex ante.

This same dynamic may hedge against deregulation’s immediacy within firm. In the event regulation returns, firms want the ability to shape regulation. They can do this by maintaining some in-house regulators. New regulation generally looks to the private sector for models,134 so when regulation reappears, regulated firms lobby to have the regulatory scheme fit their existing program. For this to work, they need some level of compliance—without any compliance, they will lack credibility in the face of regulatory pressures. As such, maintaining in-house regulators can be thought of as an affirmative future defense to the return of regulatory pressures.

Just as the revolving door may increase regulatory aggressiveness immediately following deregulatory rhetoric, future regulatory uncertainty may encourage firms to maintain regulatory staffs. Although presently in a deregulatory environment, firms know that they are just one election, appointment, or scandal away from regulation’s return. Swiftly returning to a regulatory environment requires experts, and firms may well want to maintain regulatory staff to hedge against the return of regulation. Their in-house regulators will be best positioned to take up the mantle of regulation, ensuring that the regulation isn’t too onerous, and they will understand the challenges firms actually face. Gutting in-house regulators in a deregulatory, but uncertain, environment depletes the firm’s regulatory expertise. In the event that expertise becomes valuable again, the underinvested firm will have to spend time and resources reacquiring this knowledge.

Moreover, uncertainty is, unexpectedly, stabilizing. Often, commentators talk about uncertainty as a drag on future investment—firms are loath to invest in the future if they cannot accurately anticipate future constraints or pressures on their operations. But the same force is at work in divesting. In an uncertain environment, removing regulatory staff is just as risky as hiring more regulatory staff.

Finally, in light of potential regulatory return, firm managers may fall into the sunk cost fallacy—the time and money spent on developing in-house regulators may make them averse to gutting the program at the hint of deregulation. Moreover, the cost of decreasing the program—severance, loss of knowledge, etc.—may future exacerbate this thinking. That is not to say it cannot be overcome; just that it creates a behavioral barrier that, in conjunction with other barriers, may exacerbate the tendency to retain in-house regulators.


Economic and sociological theory suggest that the response of regulated entities to deregulation will not be swift. If anything, it will be slow, plodding, and constrained by a host of internal and external forces. The effect on various companies and industries will depend on a variety of factors—firm size, the remaining regulatory burden, and the length of previous regulation, to name a few.

This evaluation does suggest regulation that causes firms to centralize and create internal and external dependencies on in-house regulators will be more persistent. Of course, deregulation may change the motivation and force of in-house regulations. For instance, as financial deregulation continues, risk managers will have less of a bludgeon to push back on risky trades—no longer will the regulatory mandate be a fait accompli to stop risky activity. But those same risk managers will continue to be present in the firm. Their participation in decision-making persists, and the new tools and processes developed to monitor and manage risk continue. Financial firms may get riskier in a deregulatory environment, but their internal structure may be less risky than in the pre-regulatory environment. In that way, regulation persists because of its impact on firm structure.

These theories may not operate simultaneously in all firms in all industries. But, from these theories, hypotheses can be formed and tested. Empirical analysis and case-study methods can help determine which pathways are most likely to make in-house regulators stick, and how those forces operate in different firms and industries. And these insights may impact how agencies conduct cost-benefit analysis, or suggest changes in regulatory design at both the congressional and agency level. Nevertheless, thinking about deregulatory inertia outside the administrative state paints a more realistic and multifaceted picture of how organization respond to the ebbs and flows of regulatory change.


Some may view this Essay’s predictions as positive—the persistence of regulation ensures ongoing safety and soundness in a deregulatory environment. Others may see the prediction as another argument against the administrative state. In any event, this Essay aims to be an opening salvo in thinking about regulatory persistence outside of the administrative state. As regulation increasingly becomes standards-based, the firms implementing the regulation become a key feature of the regulation, and must be a key feature of study to understand the effectiveness and persistence of regulatory arrangements.

Future research is, of course, needed to prove out the hypothesis that in-house regulators are “sticky.” Case studies of particular firms and industries will help expose which theories of persistence are more robust, and may highlight how firms have overcome the forces described by this Essay. But as we march through a period of deregulation, scholars should keep firms in their peripheral vision. Whether the parade of horribles some predict will result when deregulation manifests itself completely will be predicated, in part, on how firms respond. And if scholars and advocates can understand how firms adapt to deregulation, as well as regulation, they will be bettered positioned to craft regulation that is persistent regardless of administrative change.

  1. See Reducing Regulation and Controlling Regulatory Costs, Exec. Order No. 13,771, 82 Fed. Reg. 9,339 (Feb. 3, 2017); Core Principles for Regulating the United States Financial System, Exec. Order No. 13,772, 82 Fed. Reg. 9,965 (Feb. 8, 2017).
  2. Erica Werner & Alan Fram, GOP Dealt Stiff Blow in Senate’s Bid to Repeal ‘Obamacare,’ Associated Press (July 28, 2017), http://apnews.com/a3286ef6fca74cac93fac360ad76f3d4 [ https://perma.cc/SHR5-QZBG].
  3. 5 U.S.C. §§ 551(5), 553 (2012).
  4. See, e.g., Motor Vehicles Mfrs. Ass’n of United States v. State Farm Mut. Auto. Ins., 463 U.S. 29 (1983); see also Jonathan S. Masur & Eric Posner, Cost-Benefit Analysis and the Judicial Role, 85 U. Chi. L. Rev. (forthcoming 2018) (discussing the “arbitrary and capricious” standard applied by courts); Daniel Hemel, Jonathan Masur & Eric Posner, How Antonin Scalia’s Ghost Could Block Donald Trump’s Wall, N.Y. Times (Jan. 25, 2017), http://www.nytimes.com/2017/01/25/opinion/how-antonin-scalias-ghost-could-block-donald-trumps-wall.html [ https://perma.cc/3UMN-DTF3].
  5. See Jennifer Nou, Taming the Shallow State, 36 Yale J. on Reg.: Notice & Comment (Feb. 28, 2017), http://yalejreg.com/nc/taming-the-shallow-state-by-jennifer-nou [https://perma.cc/PT9C-JSYY].
  6. “With the passage of HIPAA, Congress set in motion the development of specific security and privacy guidelines for the healthcare domain through standards-based regulation.” Paul N. Otto, Reasonableness Meets Requirements: Regulating Security and Privacy in Software, 59 Duke L.J. 309, 324 n.74, 325, (2009) (“There are several examples of other recent laws and regulations that adopt a standards-based approach to regulating security and privacy in software.”).
  7. The Collected Poems of Dylan Thomas, 1934–1952, at 128 (New Directions 1971). In fact, they may “[ r] age, rage against the dying of the light.” Id.
  8. See generally Nina A. Mendelson, Agency Burrowing: Entrenching Policies and Personnel Before a New President Arrives, 78 N.Y.U. L. Rev. 557 (2003).
  9. Kenneth A. Bamberger, Regulation as Delegation: Private Firms, Decisionmaking, and Accountability in the Administrative State, 56 Duke L.J. 377, 381 (2006) (“In general, however, administrative law’s sophisticated vision of organizational decisionmaking ends at the doors of the regulated firm.”).
  10. Similarly, business law scholars have, for the most part, presumed that deregulation causes firms to revert back to their pre-regulatory form. See Timothy F. Malloy, Regulating by Incentives: Myths, Models, and Micromarkets, 80 Tex. L. Rev. 531, 533 (2002) (“[ A]ssum[ ing] that the organization is a monolithic entity that essentially makes decisions as a natural individual would . . . [mean] the collective nature of the firm and its internal features are largely ignored.”).
  11. While recent scholarship has started to think about regulated entities, its focus remains on how administrative law or process changes incentives for firms, but does not address how those incentives work to actually change the structure and operations of the regulated entities. See, e.g., James W. Coleman, Policymaking by Proposal: How Agencies Are Transforming Industry Investment Long Before Rules Can Be Tested in Court, 24 Geo. Mason L. Rev 497 (2017) (documenting how, in regulated-rate industries such as power generation, regulators write excessively burdensome proposed rules that incentivize investment by increasing the certainty of regulation, even if the final rule is less burdensome than originally proposed); Aaron Nielson, Sticky Regulations, 85 U. Chi. L. Rev 85 (2018) (asserting that ossification creates incentives for firms to invest because it provides certainty that the rule will remain on the books for a prolonged period of time).
  12. See, e.g., John C. Coates IV, Cost-Benefit Analysis of Financial Regulation: Case Studies and Implications, 124 Yale L.J. 882, 882, 887 (2015) (arguing that cost-benefit analysis of financial regulation would result in a “guesstimation” and proposing that expert judgment is central to financial regulation); Masur & Posner, supra note 4 (celebrating judicial review of cost-benefit analysis and noting that such a review constitutes a “decision procedure” that agencies are then required to comply with).
  13. See Daniel Hemel, President Trump vs. the Bureaucratic State, Yale J. on Reg.: Notice & Comment (Feb. 18, 2016), http://yalejreg.com/nc/president-trump-vs-the-bureaucratic-state-by-daniel-hemel [https://perma.cc/BE56-R5DU] (observing that President Trump “might not have the bureaucratic buy-in necessary to carry those [deregulatory] policies through”).
  14. See generally Bamberger, supra note 9 (documenting the change in regulatory form from top-down to bottom-up regulation that relies on private actors to accomplish administrative goals).
  15. Motor Vehicle Mfrs. Ass’n of United States, Inc. v. State Farm Mut. Auto. Ins., 463 U.S. 29, 43 (1983) (citation and internal quotation marks omitted).
  16. Note, Judicial Review of Agency Change, 127 Harv. L. Rev. 2070, 2085 (2014).
  17. See generally Mendelson, supra note 8.
  18. Jennifer Nou, Bureaucratic Exit and Loyalty Under Trump, Yale J. on Reg.: Notice & Comment (Jan. 9, 2018), http://yalejreg.com/nc/bureaucratic-exit-and-loyalty-under-trump [https://perma.cc/X3CV-6XKA].
  19. See, e.g., Zeeshan Aleem, Trump Wants to Gut the State Department by 25 Percent. You Read That Right., Vox Media (Feb. 12, 2018, 6:50 PM EST), https://www.vox.com/policy-and-politics/2018/2/12/17004372/trump-budget-state-department-defense-cuts [https://perma.cc/T4U4-W6JJ].
  20. State Farm, 463 U.S. at 42–43 (citation and internal quotation marks omitted).
  21. Note, Rationalizing Hard Look Review After the Fact, 122 Harv. L. Rev. 1909, 1914 (2009).
  22. Core Principles for Regulating the United States Financial System, Exec. Order No. 13,772, 82 Fed. Reg. 9965 (Feb. 8, 2017).
  23. State Farm, 463 U.S. at 43.
  24. Note, Judicial Review of Agency Change, supra note 16, at 2085.
  25. 5 U.S.C. § 500 et seq. (2012).
  26. 5 U.S.C. § 551(5) (2012).
  27. See 5 U.S.C. § 553 (2012).
  28. Federal Rulemaking: Improvements Needed to Monitoring and Evaluation of Rules Development as well as to the Transparency of OMB Regulatory Reviews, Gov’t Accountability Off. 17 (Apr. 2009), http://www.gao.gov/assets/290/288538.pdf [https://perma.cc/A5N3-5DDH].
  29. For instance, OMB and OIRA review has been embraced and enhanced by presidents since President Ronald Reagan “creat[ed] a mechanism by which the Office of Management and Budget . . . would review all majority regulations of executive branch agencies.” Elena Kagan, Presidential Administration, 114 Harv. L. Rev. 2245, 2247 (2001).
  30. Thomas O. McGarity, Thoughts on “Deossifying” the Rulemaking Process, 41 Duke L.J. 1385, 1389 n.22 (1992).
  31. Throughout this Essay, I refer to the current administration as a pertinent example. The impediments to deregulation in the face of a pro-deregulation presidential administration are not limited to the current administration.
  32. Kagan, supra note 29, at 2248, 2250.
  33. See Mendelson, supra note 8, at 561–64.
  34. See Nielson, supra note 11.
  35. Mendelson, supra note 8, at 563 n.27.
  36. Id. at 563–64.
  37. Cf. id. at 610–16.
  38. See id. at 612–13.
  39. See, e.g., Dan Wood, Principals, Bureaucrats, and Responsiveness in Clean Air Enforcements, 82 Am. Pol. Sci. Rev. 213, 213 (1988) (finding “that the influence of elected institutions is limited when an agency has substantial bureaucratic resources and a zeal for their use”); see also Hemel, supra note 13 (briefly summarizing the literature and noting that Trump “might not have the bureaucratic buy-in necessary to carry those policies through”).
  40.  Wood, supra note 39, at 217–27.
  41. Id. at 229.
  42. Id.
  43. 332 U.S. 194 (1947).
  44.  470 U.S. 821 (1985).
  45. See 5 U.S.C. § 554(d) (2006).
  46. See Matthew C. Turk, Regulation by Settlement, 66 Kansas L. Rev 259 (2017).
  47. See Id.
  48. See infra Part I.B.
  49. See, e.g., Patrick Rucker, Exclusive: Trump Official Quietly Drops Payday Loan Case, Mulls Others – Sources, Reuters (Mar. 23, 2018, 3:04 AM), https://www.reuters.com/article/us-usa-cfpb-payday-exclusive/exclusive-trump-official-quietly-drops-payday-loan-case-mulls-others-sources-idUSKBN1GZ1A9 [https://perma.cc/7WJ3-S82Z].
  50. Bamberger, supra note 9, at 383.
  51. See id. at 385–89.
  52. Regulatory Planning and Review, Exec. Order No. 12,866, § 1(b)(8), 3 C.F.R. 638 (1994); see also Improving Regulation and Regulatory Review, Exec. Order 13,563, § 1(b)(4), 3 C.F.R. 13,563 (2012) (continuing the mandate).
  53.  Cary Coglianese & David Lazer, Management-Based Regulation: Prescribing Private Management to Achieve Public Goals, 37 Law & Soc’y Rev. 691, 694 (2003).
  54. Id.
  55. See NRC: Reactor Oversight Process (ROP), U.S. Nuclear Reg. Comm’n (Apr. 20, 2018), https://www.nrc.gov/reactors/operating/oversight.html [ https://perma.cc/DC9D-WPCF].
  56. See NRC Inspection Manual, U.S. Nuclear Reg. Comm’n (Oct. 3, 2017), https://www.nrc.gov/docs/ML1726/ML17264A782.pdf [https://perma.cc/BX7U-ER6L].
  57. Galit A. Sarfaty, Regulating Through Numbers: A Case Study of Corporate Sustainability Reporting, 53 Va. J. Int’l L. 575, 583 (2013).
  58.  “Dissatisfaction . . . with traditional regulatory strategies has prompted interest in alternatives to traditional command and control regulation” including “a wide range of ‘rule at a distance’ methods in which various forms of standard-setting and self-regulation are used instead of more command-and-control based forms.” Scott Burris, Michael Kempa & Clifford Shearing, Changes in Governance: A Cross-Disciplinary Review of Current Scholarship, 41 Akron L. Rev. 1, 38 (2008). For instance, in the context of financial regulation scholars have noted that “[t]he administrative state, through regulatory law, uses internal corporate structures to effectuate public policy, which effectively transforms the large corporation into a quasi-governmental actor that functions as a kind of self-regulatory organization.” Mercer Bullard, Caremark’s Irrelevance, 10 Berkeley Bus. L. J. 15, 22 (2013). In food safety regulation, the Federal Food, Drug, and Cosmetic Act “requires owners and operators of food facilities to evaluate the hazards that could affect food, and implement and monitor preventative controls.” Diana R. H. Winters, Not Sick Yet: Food-Safety-Impact Litigation and Barriers to Justiciability, 77 Brook. L. Rev. 905, 911–12 (2012).
  59. 463 U.S. 29 (1983).
  60. 42 U.S.C. § 18,001 (2012).
  61. Id. at §§ 3011–15.
  62. See, e.g., 21 C.F.R. § 1143.5(a) (2018) (requiring cigar manufacturers to place warning on their products “in at least 12-point font” that is “printed in conspicuous and legible Helvetica bold or Arial bold type”).
  63. Anthony Effinger, The Rise of the Compliance Guru—and Banker Ire, Bloomberg, (June 25, 2015, 3:00 AM PDT), http://www.bloomberg.com/news/features/2015-06-25/compliance-is-now-calling-the-shots-and-bankers-are-bristling [https://perma.cc/CQ5C-4XH8].
  64. Large Commercial Banks, Fed. Res. (Sept. 30, 2017), https://www.federalreserve.gov/releases/lbr/current [[https://perma.cc/AK3X-SAKR].
  65. Annual Report 2015, JPMorgan Chase & Co. 15 (2016), http://www.jpmorganchase.com/corporate/investor-relations/document/2015-annualreport.pdf [https://perma.cc/AHM8-247W] (“Since 2011, our total headcount directly associated with Controls has gone from 24,000 people to 43,000 people, and our total annual Controls spend has gone from $6 billion to approximately $9 billion annually over that same time period.”).
  66. Annual Report 2016, The Goldman Sachs Group, Inc. 57 (2017), http://www.goldmansachs.com/investor-relations/financials/current/annual-reports/2016-annual-report/annual-report-2016.pdf [https://perma.cc/XZT8-X68P].
  67. Thomson Reuters Annual Cost of Compliance Survey Shows Regulatory Fatigue, Resource Challenges and Personal Liability to Increase Throughout 2015, Thomson Reuters (May 13, 2015), https://www.thomsonreuters.com/en/press-releases/2015/may/cost-of-compliance-survey-shows-regulatory-fatigue-resource-challenges-personal-liability-to-increase.html. [https://perma.cc/G72B-VN4E]
  68. Margot Patrick, HSBC Third-Quarter Earnings: Key Takeaways, Wall St. J. (Nov. 3, 2014, 6:05 AM ET), http://blogs.wsj.com/moneybeat/2014/11/03/hsbc-third-quarter-earnings-key-takeaways [https://perma.cc/YDA2-XHDV].
  69. A Set of Blueprints for Success, EY & Institute of International Finance 13 (2016), http://www.ey.com/Publication/vwLUAssets/ey-a-working-set-of-blueprints-to-deliver-sustainable-returns/$FILE/ey-a-working-set-of-blueprints-to-deliver-sustainable-returns.pdf [https://perma.cc/WF4A-YC5W].
  70. See Form 10-K: Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Year Ended December 31, 2010, Morgan Stanley 97, https://www.sec.gov/Archives/edgar/data/895421/000119312511050049/d10k.htm [https://perma.cc/EQB3-HNW3].
  71. See Form 10-K, Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Year Ended December 31, 2016, Morgan Stanley, 75–76, https://www.sec.gov/Archives/edgar/data/895421/000119312517059212/d328282d10k.htm [https://perma.cc/R5GQ-S5T7].
  72. Form 10-K: Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Year Ended December 31, 2016, Citigroup, Inc. 65, https://www.sec.gov/Archives/edgar/data/831001/000083100117000038/c-12312016x10k.htm [https://perma.cc/B5BA-4RR7].
  73. See Form 10-K: Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Year Ended December 31, 2011, Goldman Sachs Group, Inc. 84, http://www.sec.gov/Archives/edgar/data/886982/000119312512085822/d276319d10k.htm [ https://perma.cc/B2L2-75K4].
  74. See Form 10-K: Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Year Ended December 31, 2016, Goldman Sachs Group, Inc. 84, https://www.sec.gov/Archives/edgar/data/886982/000119312517056804/d308759d10k.htm [https://perma.cc/6NYA-E4P5].
  75. See Timothy F. Malloy, Regulation, Compliance and the Firm, 76 Temp. L. Rev. 451, 453–55 (2003); Robert A. Prentice, The Inevitability of a Strong SEC, 91 Cornell L. Rev. 775, 780 (2006) (“In the deregulation worldview, investors, securities professionals, and ancillary actors such as auditors and attorneys are rational.”). See also supra note 10.
  76. See, e.g., Tom Ginsburg et al., Libertarian Paternalism, Path Dependence, and Temporary Law, 81 U. Chi. L. Rev. 291 (2014) (discussing the stickiness of a smoking moratorium in bars).
  77. See Nielson, supra note 12, at 133.
  78. For instance, Dodd-Frank alone costs banks an estimated $36 billion. Dodd-Frank Costs Reach $36 billion in Sixth Year, Bloomberg Brief (July 22, 2016), https://www.bloomberg.com/professional/blog/dodd-frank-costs-reach-36-billion-sixth-year-2 [ https://perma.cc/NRR5-RT2S].
  79.  Richard A. Posner, The Effects of Deregulation on Competition: The Experience of the United States, 23 Fordham Int’l L. J. S7, S17 (2000).
  80. Id.
  81. Michael C. Jensen & William H. Meckling, Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure, 3 J. Fin. Econ. 305, 311 (1976).
  82. See id. at 334–37.
  83. See, e.g., Sungbin Cho, Specialization, Agency Cost and Firm Size, Econometric Soc’y 2004 Far Eastern Meetings 705 (2004).
  84. See supra Part I.A.
  85. Emily Flitter et al., Federal Reserve Shackles Wells Fargo After Fraud Scandal N.Y. Times (Feb. 2, 2018), https://www.nytimes.com/2018/02/02/business/wells-fargo-federal-reserve.html [https://perma.cc/YQ7X-FGFF].
  86. See Fletcher Cyclopedia of the Law of Private Corporations, § 1037 (2017).
  87. See generally Thomas W. Malone, Decentralization is the New Center of Command (Harvard 2010).
  88. See generally David S. Scharfstein & Jeremy C. Stein, The Dark Side of Internal Capital Markets: Divisional Rent-Seeking and Inefficient Investment, 6 J. Fin. 2537 (2000).
  89. Id.
  90. Id. at 2551.
  91. Id.
  92. Andrei Shleifer & Robert W. Vishny, Management Entrenchment: The Case of Manager Specific Investments, 25 J. Fin. Econ. 123, 123 (1989).
  93. Id. at 124.
  94. Id. at 126.
  95. But see infra Part II.A.3 (The value may come from transferability of knowledge that occurs.).
  96. Coglianese & Lazer, supra note 53, at 695.
  97. See generally Robert M. Grant, Toward a Knowledge-Based Theory of the Firm, 17 Strategic Mgmt. J. 109 (1996).
  98. Id.
  99. See generally Michael C. Jensen & William H. Meckling, Specific and General Knowledge and Organizational Structure, 8 J. Applied Corp. Fin. 251 (1995).
  100. Grant, supra note 97, at 114 (emphasis added).
  101. See id. at 118 (Once firms are viewed as institutions for integrating knowledge, a major part of which is tacit and can be exercised only by those who possess it, then hierarchical coordination fails . . . . Only one of the integration mechanism . . . is compatible with hierarchy: integration through rules and directives.”).
  102. Id.
  103. See generally David B. Clarke et al., No Alternative? The Regulation and Professionalization of Complementary and Alternative Medicine in the United Kingdom, 10 Health & Place 329 (2004) (discussing the increased professionalization of alternative medicine after Parliamentary Inquiry).
  104.  Kenneth A. Bamberger, Privacy on the Books and on the Ground, 63 Stan. L. Rev. 247, 277 (2010) (noting the importance of “the increasingly professionalized privacy-officer community”).
  105. See Margali S. Larson, The Rise of Professionalism: A Sociological Analysis 190–91 (Transaction Publishers 1977).
  106. See William A. Birdthistle & M. Todd Henderson, Becoming a Fifth Branch, 99 Cornell L. Rev. 1, 46 (2013) (noting that financial compliance staffs may build a “culture of compliance” that is difficult for the rest of the firm to overcome).
  107.  Sapna Maheshwari, Statue of Girl Confronts Bull, Captivating Manhattanites and Social Media, N.Y. Times (Mar. 8, 2017), https://www.nytimes.com/2017/03/08/business/media/fearless-girl-statue-wall-street-womens-day.html [https://perma.cc/64CF-YSXF].
  108. See George Tepe, Boards Should Use Diversity as a Defense Against Activists, CLS Blue Sky Blog (Sept. 21, 2017), http://clsbluesky.law.columbia.edu/2017/09/21/boards-should-use-diversity-as-a-defense-against-activists [https://perma.cc/5YQC-D6P2].
  109. See Maheshwari, supra note 107.
  110. See Final Rule: Proxy Voting by Investment Advisors, 17 C.F.R. § 275.206(4)-6, § 275.204-2 (2012), https://www.sec.gov/rules/final/ia-2106.htm [https://perma.cc/9HGF-PWQT].
  111. See Dorothy S. Lund, The Case Against Passive Shareholder Voting, 43 J. Corp. L. 493, 515-20 (2018).
  112.  See Tepe, supra note 108.
  113. See Miriam A. Cherry & Judd F. Sneirson, Chevron, Greenwashing, and the Myth of “Green Oil Companies,” 3 Wash & Lee Energy, Climate & Env’t 133 (2012).
  114. See Leora Klapper et al., Entry Regulation as a Barrier to Entrepreneurship, 82 J. Fin. Econ. 591 (2006).
  115. See Birdthistle and Henderson, supra note 106, at 44.
  116.  Sam Schechner & Nick Kostov, Google and Facebook Likely to Benefit From Europe’s Privacy Crackdown, Wall St. J. (April 23, 2018, 10:18 PM ET), https://www.wsj.com/articles/how-europes-new-privacy-rules-favor-google-and-facebook-1524536324 [https://perma.cc/998P-JA3K].
  117. See Jeffrey A. Singer, Obamacare’s Catch 22, U.S. News (Aug. 11, 2016, 3:15 PM), https://www.usnews.com/opinion/articles/2016-08-11/obamacare-gave-rise-to-the-health-care-mergers-its-advocates-oppose [https://perma.cc/8FT6-UEVS].
  118.  In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959, 970 (Del. Ch. 1996).
  119. See Kenneth A. Bamberger & Deirdre K. Mulligan, New Governance, Chief Privacy Officers, and the Corporate Management of Information Privacy in the United States: An Initial Inquiry, 33 L. & Pol’y. 477 (2011).
  120. Stone v. Ritter, 911 A.2d 362, 370 (Del. 2006).
  121. See In re Citigroup Inc. Shareholder Derivative Litig., 964 A.2d 106, 123–24 (Del. Ch. 2009).
  122. Id. at 124 (“When one looks past the lofty allegations of duties of oversight and red flags used to dress up these claims, what is left appears to be plaintiff shareholders attempting to hold the director defendants personally liable for making (or allowing to be made) business decisions that, in hindsight, turned out poorly for the Company.”).
  123.  Brian J. McCarthy and Janisha Sabnani, Risk Governance Will Be the Talk in Corporate Boardrooms in 2010, S.F. Daily J. (Dec. 28, 2009).
  124. See Bamberger & Mulligan, supra note 119.
  125. See generally Douglas W. Diamond & Robert E. Verrecchia, Disclosure, Liquidity, and the Cost of Capital, 46 J. Fin. 1325 (1991) (suggesting that decreasing the information asymmetry between investors and the firm can reduce the firm’s cost of capital).
  126. Prentice, supra note 75, at 780–81 (discussing how rational issuers will self-regulate disclosures because of reputational constraints).
  127. See, e.g., Analysts Grill Goldman CFO Over Lack of Leverage Ratio Detail, Reuters (July, 16, 2013, 8:15 AM), http://www.reuters.com/article/goldman-results-call-idUSL1N0FM0U920130716 [https://perma.cc/AG5D-CPCP].
  128. See Alexandra Niessen-Runzi, Jerry Parwarda & Stefan Rueniz, Information Effects of the Basel Bank Capital and Risk Pillar 3 Disclosures on Equity Analyst Research—An Exploratory Examination, CIFR Working Paper Series (Aug. 2015), https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2670418 [https://perma.cc/8PU7-QJV3].
  129. See Wood, supra note 39, at 217–27.
  130. See Donald C. Langevoort, Monitoring: The Behavioral Economics of Corporate Compliance With Law, 2002 Colum. Bus. L. Rev. 71, 83–90 (noting the difficulties managers have in monitoring compliance professionals).
  131. See id.
  132. See Jonathan Masur, Judicial Deference and the Credibility of Agency Commitments, 60 Vand. L. Rev. 1021, 1041–42 (2007).
  133. See Nielson, supra note 11.
  134. See David Zaring, Best Practices, 81 N.Y.U. L. Rev. 294, 304–05 (2006) (noting that scholars suggest agencies “look to the private sector for assistance with rule generation”).