Barbarians at the Gatekeepers?: A Proposal for a Modified Strict Liability Regime

Abstract

This article attempts to fill a few of the gaps in current scholarship about gatekeepers, and sets forth a proposal for a modified strict liability regime that would avoid many of the problems and costs associated with the current due diligence-based approaches. Under the proposed regime, gatekeepers (investment banking, accounting, and law firms) would be strictly liable for any securities fraud damages paid by the issuer pursuant to a settlement or judgment. Gatekeepers would not have any due diligence-based defenses for securities fraud. Instead, gatekeepers would be permitted to limit their liability by agreeing to and disclosing a percentage limitation on the scope of their liability for the issuer's damages.

For example, a gatekeeper for an issue might agree ex ante to be strictly liable for 10 percent of the issuer's liability related to the issuance, measured by the present value of any payment by the issuer pursuant to a settlement or judgment. A particular gatekeeper's liability would be limited to the issuer's liability related to that gatekeeper's role (e.g., counsel for the issuer or the underwriters generally would not be liable for material misstatements or omissions in audited financial statements). The percentage for each gatekeeper could range based on competitive bargaining and market forces, with a minimum limit (e.g., the amount of the gatekeeper's fee, or perhaps a fixed amount of 1 to 5 percent) set by law.

This modified strict liability proposal is intended to solve two important and parallel problems in securities regulation. The first problem is the rapidly increasing and substantial costs related to the role of gatekeepers in securities fraud, including both the costs of behavior designed to capture the benefit of due diligence-based defenses and - more importantly - the costs of resolving disputes about gatekeeper behavior. The second problem is that the value of gatekeeper certification is declining at the same time costs are increasing. The article gathers evidence to demonstrate these two problems, and shows how a strict liability regime might ameliorate them. Throughout this discussion, the article challenges the assumption that gatekeepers act as reputational intermediaries.

JEL Classification: M49, K22