Social Productivity, Law, and the Regulation of Conflicts of Interest in the Investment Industry

Cardozo Public Law, Policy and Ethics JournalNbr. III-3, January 2006

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Summary


Introduction. I. Background. II. Definitions and Context. III. Social Productivity and Societal Institutions. IV. Standards for Behavior and Societal Institutions. V. The Outputs of Social Productivity. A. Reputation. B. Symbols. C. Trust and Perceptions of Fairness. VI. Investment Companies, Investment Advisers, and the Regulation of Conflicts of Interest. A. Securities. B. Directors of Investment Companies. C. Fiduciary Duty of Investment Advisers. D. Compensation of Investment Advisers. Conclusion.

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Social Productivity, Law, and the Regulation of Conflicts of Interest in the Investment Industry

Professor, School of Law, Widener University. Postal address: Post Office Box 7474, Wilmington, Delaware 19803-0474 USA; e-mail address: ldbarnett@widener.edu. I want to thank four members of the staff of the Widener University Legal Information Center who provided invaluable assistance in the preparation of this article: Enza Klotzbucher, Janet Lindenmuth, Mary Jane Mallonee, and Kelly Pierce.

Introduction.

The article proposes a concept-social productivity-that focuses on the social outputs of organized groups and underscores their importance. Four outputs are discussed: (1) standards for behavior, (2) reputation, (3) symbols, and (4) trust and perceptions of fairness. Because the social outputs of a group affect both commitment to the group by its participants and conduct toward the group by others, the outputs of a group can benefit or harm the group. When society is being damaged by the outputs of an organized group, government will adopt formal standards of behavior (i.e., law) to influence the outputs in a way that increases the cohesiveness and stability of the social system. To illustrate the concept of social productivity, this article reviews federal law concerned with conflicts of interest affecting investment companies and investment advisers.

I. Background.

In the economic sector, productivity is-and is widely acknowledged to be-a critical variable determining the pecuniary success or failure of profit-seeking entities that furnish goods and services. Productivity, however, affects not just the profitability of particular business enterprises, but the material wealth of society as a whole. All else being equal, the financial prosperity of a society is a function of: (1) the ability of the goods that are manufactured and the services that are furnished in an economy to satisfy what consumers perceive to be their needs; and (2) the influence that the prices of those goods and services exert on the purchasing power of the basic consuming units in a society (individuals, households, and families) and, in turn, on their standard of living. Productivity, by affecting the monetary cost of goods and services, is a key variable in the economy.1

While an economic concept of productivity is undeniably important in explaining the material wealth of groups, personal observation suggests that understanding organized groups-including business firms-requires a sociological concept of productivity. The need for such a concept is illustrated by a number of significant instances during the last several decades in which Americans in decision-making positions failed to appreciate and concern themselves with the critical, albeit often subtle, social consequences of policies and actions. According to available evidence, these consequences weakened the social system by creating inter alia alienation from and mistrust of the system.2The instances were harmful to the fabric of society not because the activities involved were found to be unlawful but because they eroded implicit expectations that decision-makers would act in a fair manner and in the group's long-term interests. If "[djiscovery consists in seeing what everyone else has seen and thinking what no one else has thought,"3decision-makers in recent decades have too often failed to discover, and respect, fundamental principles of group dynamics.

The instances that injured the social system, in short, breached unwritten rules that defined social equity for Americans. Through civil actions and/or criminal prosecutions in courts, confidence in society may be restored for violations of rules of law, but government does not supply justice for violations of rules that are implicit in social life. Since society's cohesion is reduced when justice is not obtainable for breaches of implicit rules that are basic to interpersonal relationships, government converts some of these rules into law through legislative, administrative agency, or judicial action. Thus, when relationships between individuals became difficult or impossible because of uncertainty whether a particular form of conduct (e.g., fraud or violence) would occur, common law developed to penalize such conduct and allow each participant in a relationship to expect that all participants will act in a manner consis- tent with the requirements of the relationship: "[T]he early common law posited 'rights and duties upon the relationship of parties within the socio-economic system rather than upon factors, such as consensual agreement, dependent on the will of individual litigants' and such relationship concepts served as the major framework of the legal structure."4Thus, the protection and promotion of interpersonal relationships were important goals of law in its initial stage, suggesting that these goals are part of the foundation of law. As such, they help to explain both the emergence and the continued existence...

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