My forthcoming article, Irredeemably Inefficient Acts: A Threat to Markets, Firms, and the Fisc, identifies a category of acts that clearly and inevitably reduce social welfare. These acts—which I call irredeemably inefficient—have not been expressly recognized in previous work. Yet the distinction I draw reflects a fundamental feature of the U.S. antitrust law, justifies several recent Delaware Chancery Court decisions, and suggests substantial rethinking of some important aspects of securities and commodities regulation.
Irredeemably inefficient acts have remained outside of the standard theory of public enforcement of law. That theory holds that inefficient conduct may be converted into efficient behavior by forcing actors to internalize the harm caused by their decisions. For some acts, however, such a conversion is impossible. These acts are not just inefficient forms of otherwise socially beneficial activities—that is, they are not just contingently inefficient. Rather, they are inefficient at their core; they reduce social welfare no matter what the regulator does. These irredeemably inefficient (or just irredeemable) acts are private, intentional, non-consensual transfers of money. While this definition certainly describes theft, I explain in the article that it also covers naked price fixing and bid rigging, market manipulation and insider trading, churning, scalping, front running, and cherry picking, as well as all option backdating, spring loading, and bullet dodging, to name just some examples.
All these acts are irredeemably inefficient because while the money transfer in and of itself is welfare-neutral (that is, the loser loses as much as the winner wins), the transfer’s intentional and non-consensual nature inevitably gives rise to real costs. Yet, for two reasons, irredeemable acts may be overdeterred if enforcement is imperfect. First, enforcement increases the costs of irredeemable acts that remain undeterred. (If anti-churning rules are strengthened, some brokers will stop churning, but others will redouble their efforts to churn and get away with it.) Second, enforcement burdens efficient conduct that yields outcomes indistinguishable from those produced by irredeemable acts. (The same observable act—a broker trading a security in a discretionary account—may reveal irredeemable churning or an efficient act of a faithful agent.) These considerations, rather than the familiar cost-benefit inquiry necessary to address contingently inefficient acts, underlie the unique optimal deterrence analysis of irredeemable acts.
The main doctrinal payoff from distinguishing between contingently and irredeemably inefficient acts is that it is optimal to regulate them separately. Separate regulation yields a number of benefits. First, it eliminates confusion when the same vague term embodies different underlying tradeoffs presented by the two types of acts. (For instance, an inquiry into whether a corporate forecast was “excessively” optimistic reflects a cost-benefit tradeoff, but an inquiry into whether a broker engaged in “excessive” trading does not.) Second, it allows regulators to combine mental state inquiries with objective tests such as materiality only when appropriate—that is, only for contingently inefficient acts. Third, separate regulation avoids misguided analysis of irredeemable acts—such as an inquiry as to whether the actor was “reckless”—without impeding the same analysis for contingently inefficient ones. (Thus, as I explain in the article, while reckless accounting misstatements certainly exist, reckless churning does not. Deciding whether to sanction the former should have no implications for analyzing the latter.) Finally, separate regulation of contingent and irredeemable acts allows regulators to vary the penalty structure for the two types of acts, as may well be necessary in order to provide efficient deterrence in each case.
The divide between per se and rule of reason offenses in antitrust (including the gradual shrinking of the per se category) is entirely consistent with my analysis. Differences between contingent and irredeemable acts also supply the missing efficiency-based justification for treating certain corporate board actions lacking “good faith” as duty of loyalty (rather than duty of care) violations even where no conflict of interest exists. In contrast, regulation of securities fraud (and, especially after Dodd-Frank, commodities fraud) ignores the distinction between contingently and irredeemably inefficient acts. If securities law experts are persuaded by my analysis, they may see the benefits of separate regulation of the two types of acts.
I expect to continue my work in this area and welcome comments on, and reactions to, the paper. The full article, which is forthcoming in the Georgetown Law Journal, can be found here.