CORPORATE LAW & GOVERNANCE
HOW TO IMPLEMENT SHAREHOLDER DEMOCRACY
Oliver Hart, Hélène Landemore & Luigi Zingales
Thanks to their popularity, a few index funds have achieved substantial voting power in all the leading American companies. We argue that this power lacks both internal (vis-à-vis investors) and external (vis-à-vis the public at large) legitimacy, and that this lack of legitimacy cannot be resolved simply through pass-through voting. We propose a novel approach to improve both internal and external legitimacy. Based on the experience of citizen assemblies in the political sphere, we propose that a randomly drawn assembly of an index fund’s investors or beneficiaries should have the power to decide (or recommend) how the fund should vote in corporate ballots on environmental, social, and political issues. We analyze the advantages and limitations of such an approach and discuss various implementation issues.
COPY TRADING AND THE RISE OF THE SHADOW INTERMEDIARY
Sue S. Guan
Over the last century or so, stock markets, investment opportunities, and the engines of wealth generation have grown exponentially in size and complexity. Navigating this world has required more and more expertise. Those with the most expertise and the greatest resources are best equipped to profit—and have profited spectacularly. Yet most ordinary Americans lack meaningful expertise and resources—and have been largely left behind.
Copy trading—which allows investors to link their portfolios to “leaders” and replicate those leaders’ portfolios automatically—offers a shortcut. Every time the leader buys or sells, so does the follower investor. Copy trading makes a tantalizing promise: simply link your portfolio to that of an expert, and let the expert make all your investment decisions for you. At least facially, copy trading provides a low-cost means for ordinary investors to “be in the club” of crypto, of private equity, and of powerful political and economic insiders. This is a deeply powerful message.
Yet in doing so, copy trading has given rise to an army of unregulated shadow intermediaries. Financial middlepersons essentially offer portfolio management services without the—or with only minimal—traditional guardrails of financial services regulation. Perils abound. The conflicts and costs presented by copy trading are well-known to the financial industry: conflicts of interest, fraud, behavioral and cognitive biases, and poor information. Yet unlike other, well-regulated parts of the financial industry, copy trading suffers from a lack of oversight, resulting in particularly pernicious harms.
DIVESTING UNIVERSITY ENDOWMENTS
Max M. Schanzenbach & Robert H. Sitkoff
The brutal conflict between Hamas and Israel convulsed higher education. Student protesters have demanded that university endowments “divest” from Israel. University leaders have largely resisted those demands on grounds of fiduciary obligation, institutional neutrality, or both. In response, protesters have pointed to prior instances of purported divestment. Confusion abounds over the applicable fiduciary principles and the scope of prior divestments. This paper synthesizes the law and finance of endowment divestment and applies that analysis to past divestments and present divestment demands.
We show that endowment divestment for nonfinancial reasons is permissible under prevailing law only if: (1) the divestment is consistent with the university’s charitable purpose of research and education, and (2) the divestment’s effect on the portfolio is reasonable in light of that purpose. Applied to the current state of university endowment management, this is a highly restrictive standard. The charitable purpose of most secular universities is research and education, full stop. Moreover, contemporary endowment practice relies on external managers, making a divestment today more costly to implement than in the past. Under current endowment practice, therefore, even a de minimis divestment, whether from Israel or otherwise, would likely be a fiduciary breach, potentially exposing university trustees to out-of-pocket damages for any resulting loss to the endowment.
We also examine current divestment policies and purported prior divestments, including South Africa under apartheid, tobacco, Sudan during the Darfur war, and fossil fuels. Consistent with our legal analysis, but contrary to conventional wisdom, we find that universities have generally not engaged in broad divestments, not even from South Africa under apartheid. Instead, most large university endowments do not divest or adhere to a narrow divestment policy for “moral abhorrence” that has rarely been invoked. We show that a divestment for moral abhorrence could pass fiduciary muster as consistent with the public benefit principle of charity law if supported by clearly established public policy.
INSIDER TRADING AGAINST THE CORPORATION
S. Burcu Avci, H. Nejat Seyhun & Andrew Verstein
Corporate officers and directors learn bad news about their companies before the public. They can avoid losses if they sell quickly, but such sales face problems. Potential buyers may be reluctant to buy what insiders are frantic to sell. They may also sue or alert law enforcement. Insiders would prefer counterparties who are slow to ask questions or complain. One such counterparty may be the corporation itself, because the insiders (by definition) control it.
In this empirical project, we examine a large sample of insider sales to their corporation. We find strong evidence that such sales tend to precede a large drop in company value. When an insider sells stock back to their company, it is indeed consistent with them shifting losses to the company and its public investors.
Despite our finding, the SEC has tended to assume that insider transactions with the corporation are especially trustworthy and granted them partial exemptions from prophylactic law. The insider trading literature likewise overlooks this strategy. Our project corrects the course for regulators and scholars and asks what it means that both groups underestimated this possibility for so long.
Technology & Innovation
ARTIFICIALLY INTELLIGENT MARKETS
William Magnuson
A remarkable transformation is taking place in our financial markets. The rise of machine learning algorithms and other artificial intelligence models has rapidly overtaken older methods of financial decisionmaking, and the consequences of the revolution are beginning to be felt across the capital markets ecosystem, from stock exchanges to derivatives markets to currency trading. These new technologies offer great promise, including more accurate prices, faster transactions, and more efficient trading. But they also create risks. From flash crashes to insider trading algorithms to adversarial attacks, artificial intelligence presents a range of unique vulnerabilities that could lead to significant and wide-ranging harm to our financial system. Legal frameworks devised to structure and constrain financial institutions, in turn, are ill-equipped to deal with these harms because they were designed based on outdated assumptions about the structure of markets, as well as the nature of its primary actors. This Article offers the first comprehensive account of the economic, political, and legal consequences of the rise of artificially intelligent markets. It demonstrates how the major driver of this shift has been the hedge fund industry, an opaque and lightly regulated sector of the financial ecosystem that has long been an early adopter of financial technology. It concludes by proposing a series of escalating regulatory reforms that might better fit financial regulation to our new artificially intelligent markets.