This Article addresses the appropriate reach of the U.S. mandatory securities disclosure regime. While disclosure obligations are imposed on issuers, they are triggered by transactions: the public offering of, or public trading in, the issuers' shares. Share transactions are taking on an increasingly transnational character. The barriers to a truly global market for equities continue to lessen: financial information is becoming increasingly globalized and it is becoming increasingly inexpensive and easy to effect share transactions abroad.(1) There are approximately 41,000(2) issuers of publicly traded shares in the world. For an ever larger portion of these issuers, there will be significant numbers of transactions in their shares that have at least one U.S. dimension -- the investor will be a U.S. resident, the transaction will occur in the United States, or the issuer itself will be from the United States -- thereby generating some kind of claim for the United States to apply its disclosure regime. On which of these issuers is it in fact in the enlightened best interest of the United States to do so?
In a previous article in this Review, I addressed the question of what apportionment of regulatory authority among the countries of the world would most enhance global economic welfare.(3) The concern here is with the practical choices faced by U.S. officials as to the reach of their particular country's regime. Building on the earlier article, this piece thus extends the inquiry by examining the legal and political environment in which these officials operate and the impact of their decisions on U.S. economic welfare.(4)
The Securities and Exchange Commission ("SEC") has traditionally taken the position that the reach of the U.S. disclosure regime should be set so as to protect U.S. resident investors from making damaging securities choices due to poor information.(5) This has been the position of most academic commentators as well.(6) The goal of "investor protection" leads directly to the principle that the only transactions associated with an issuer that should trigger imposition of U.S. disclosure regulation are those involving U.S. investors.(7)
In 1988, the SEC, in proposing its subsequently adopted Regulation S, articulated a different, capital market protection goal for the U.S. approach to statutory reach.(8) The new goal still seeks to protect certain investors from being poorly informed, but reformulates the class of persons protected to include all investors, wherever resident, but only if they purchase in the U.S. market. This change in articulated goal suggests that the place where transactions in an issuer's shares occur should be the exclusive consideration in deciding whether to apply the U.S. regime. The United States should impose its regime on all issuers where a significant number of transactions in their shares are effected in the United States and on no other issuers. The nationality of the issuer and that of the buyers of its shares should be irrelevant.(9)
A third possible goal for the U.S. approach to statutory reach would be to maximize, to the extent cost effective, the benefits enjoyed by U.S. residents from disclosure's capital allocation improvement and managerial agency cost reduction effects.(10) The concern under this goal is the capacity of issuer disclosure to aid in the functioning of the real economy in the United States, i.e., in the production of goods and services. This goal, we will see, implies that U.S. practice should be changed so that we impose the U.S. regime only on issuers of U.S. nationality, but do so wherever transactions in the issuer's shares are effected and whatever the nationality of the buyers. The nationality of an issuer would be determined by where the issuer has its center of gravity as a firm.(11)
I conclude that this third goal -- capital allocation improvement and managerial agency cost reduction -- is the only viable goal for disclosure regulation in a world with a global market for securities. I thus recommend that the reach of the U.S. disclosure regime be determined by the nationality of the issuer.(12) I come to this conclusion by using the tools of financial economics to trace out the ultimate effects in different countries of the disclosure behavior of transnational issuers. The pattern of effects revealed by this exercise shows that the issuer nationality approach most enhances U.S. economic welfare. Because the adherents of the investor residency and transaction location approaches have not traced out the ultimate effects in this fashion, they have failed to appreciate the superiority of the issuer nationality approach.(13)
Two examples help show how this recommended change in approach would fundamentally alter current practices. The United States, unlike today, would apply the mandatory disclosure requirements of the Securities Act of 1933 and the Securities Exchange Act of 1934 even to a U.S. corporation that goes public abroad through an offering in the Euroequity market and that imposes restrictions on the offering designed to deter its "flowback" into the United States. The United States, also unlike today, would not apply these requirements to an established French public issuer conducting a share offering in the United States to U.S. residents as long as the issuer provides, pursuant to the French regime, the same disclosure as it would have if it had made a purely domestic public offering in France.
One other alternative should be noted at the outset. If the U.S. disclosure regime were made voluntary, the problem of defining its reach would disappear.(14) A few legal scholars, such as Professors Roberta Romano, Stephen Choi, and Andrew Guzman, suggest just such a change, in reaction, in part, to the increasing need to define the reach of the existing mandatory regime. Under their proposals, every issuer, whether U.S. or foreign, could choose whether to subject itself to the disclosure obligations of the U.S. regime or the regime of one of the fifty states or some other country.(15) Whether it is desirable to make the U.S. regime voluntary, however, rests largely on considerations that are equally present with or without globalization. It is thus separate from the question addressed in this article: What is the appropriate reach of a mandatory disclosure system if we do have one? As a practical matter, since we are likely to continue to have a mandatory disclosure system for the foreseeable future, this question needs to be answered regardless of the other debate.(16)
This paper has seven Parts. Parts I and II look at the formal legal landscape. Part I reviews existing U.S. practice. Part II reviews the extent to which the SEC, the courts, and Congress are constrained by law in changing this existing practice and thus gives a sense of the scope of the reforms necessary to implement the change to the issuer nationality approach recommended here.
Parts III, IV, and V assess the effects on U.S. economic welfare of adopting the issuer nationality approach compared with adopting either of the other two approaches or a uniform international disclosure regime. Part III shows why the issuer nationality approach discriminates more precisely than the investor residency approach between those of the world's issuers whose disclosure behavior primarily affects the welfare of U.S. residents and those whose disclosure behavior primarily affects other countries. When a country's issuers disclose at an appropriate level, the disclosure can, through its positive effects on managerial motivation and the choice of real investment projects, increase the returns generated by capital-utilizing productive activity in that country. The beneficiaries of these increased returns are the country's entrepreneurial talent and labor, not the issuers' investors. Because of capital's greater mobility internationally, competitive forces push capital toward receiving a single global expected rate of return (adjusted for risk) regardless of the disclosure practices of the particular issuers involved. The United States thus has a strong interest in the disclosure behavior of all U.S. issuers, even those whose shares are sold to or traded among foreigners, but not in that of any foreign issuers, even those that are sold to or traded among U.S. residents.
Part IV shows that if issuers have a choice of disclosure regimes, they have a preference for picking one requiring less disclosure than is socially optimal. The transaction location approach gives issuers the capacity to determine which regime governs them. Thus it hurts U.S. economic welfare by permitting U.S. issuers to disclose at a lower than optimal level. It also reduces the volume of transactions effected in the United States because the relative strictness of the U.S. regime scares issuers away. Part V shows why, in terms of U.S. welfare, the disclosure level required by any achievable uniform international regime would be inferior to that required by the U.S. regime.
Parts III-V assume that the choice of approach will not affect the level of disclosure required by the U.S. regime. Part VI relaxes this assumption. It shows that under the investor residency and transaction location approaches, the increasing globalization of the market for securities would lead to increased political pressures to lower the U.S. requirements, and that under the issuer nationality approach, it would not.
Part VII shows how these increased pressures are likely to result in the U.S. regime requiring too little disclosure. Some commentators believe that such regulatory competition would be helpful. Their arguments are found unpersuasive, however, in part because they do not account for the preference of issuers for disclosing too little. Thus the conclusion of Parts III-V that U.S. economic welfare would be enhanced by a switch to the issuer nationality approach is strengthened, not weakened, by the fact that such...