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The Investor Compensation Fund

Alicia J. Davis

University of Michigan Law School

Journal of Corporation Law, Vol. 33, No. 1, 2007
U of Michigan Law & Economics, Olin Working Paper No. 07-020

The prevailing view among securities regulation scholars is that compensating victims of secondary market securities fraud is inefficient. As the theory goes, diversified investors are as likely to be on the gaining side of a transaction tainted by fraud as the losing side. Therefore, such investors should have no expected net losses from fraud because their expected losses will be matched by expected gains. This Article argues that this view is flawed; even diversified investors can suffer substantial losses from fraud, presenting a compelling case for compensation.

The interest in compensation, however, should be advanced by better means than are currently in place. The present system relies on securities class action lawsuits to compensate victims, but these suits not only under compensate victims, but also underdeter fraud. To improve compensation and better deter fraud, this Article explores the creation of an investor compensation fund. Under this proposal, when a share of stock is sold in the secondary market, a fee, payable by the selling shareholder, will be placed into a fund for fraud victim restitution. The size of the fee will vary by the fraud risk rating assigned to the firm whose stock is sold and, naturally, will affect that stock's trading price. Therefore, firms will have incentives to institute corporate governance practices that minimize the likelihood of fraud.

Number of Pages in PDF File: 73

Keywords: securities fraud, securities class actions, compensation fund

JEL Classification: K22

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Date posted: November 20, 2007 ; Last revised: November 27, 2007

Suggested Citation

Davis, Alicia J., The Investor Compensation Fund. Journal of Corporation Law, Vol. 33, No. 1, 2007; U of Michigan Law & Economics, Olin Working Paper No. 07-020. Available at SSRN: https://ssrn.com/abstract=1031225

Contact Information

Alicia J. Davis (Contact Author)
University of Michigan Law School ( email )
625 S. State St.
Ann Arbor, MI 48109
United States
734-763-2221 (Phone)
734-763-9375 (Fax)
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