Deep pocket

Abstract: This essay, prepared for a University of Cambridge conference on Principles Versus Rules in Financial Regulation, posits a new issue in that debate. Although principles-based regulation is thought to more closely achieve normative goals than rules, the extent to which that occurs can depend on the enforcement regime. A person who is subject to unpredictable liability is likely to hew to the most conservative interpretation of the principle, especially where that person would be a potential deep pocket in litigation. This creates a paradox: Unless protected by a regime enabling one in good faith to exercise judgment without fear of liability, such a person will effectively act as if subject to a rule and, even worse, an unintended rule.

Abstract: This article focuses on the standard of secondary liability of technology providers under copyright law. It shows that contrary to conventional understanding of the law as granting a safe harbor for technologies, courts have created a de facto open-ended liability standard in an attempt to enhance copyright enforcement. With the law becoming increasingly unpredictable, the market has developed a dual, polarized reaction. One path, which this article terms “the risk-minimizing channel”, has typically been taken by rather established and “deep pocket” companies, and is epitomized by over-protectiveness of copyrights, often at the expense of users’ interests. The second course, termed in this paper “the legal escapism route”, has been prevalent among peer-to-peer network and is best characterized as continuing the unauthorized transmission of copyrighted works while employing various measures to avoid the legal consequences which may stem from this behavior. The implications of this dichotomous market behavior on the effectiveness of secondary liability are critical. Ironically, not only has the open-ended standard been prominently ineffective in enhancing copyright enforcement, it has also fueled the processes which have led to the copyright enforcement crisis. Instead of effective enforcement, the law has resulted in market substitution, in which infringement simply shifted from one platform to another, becoming more sophisticated and evasive. The article concludes that in the face of enforcement challenges, copyright law must set a clear, predictable standard in order to effectively direct market behavior in an era of rapid technological change.

Abstract: I. INTRODUCTION Even before the multi-billion dollar collapse of Enron1 and public allegations of auditor misconduct against Arthur Andersen,2 there was a history of demands for IMAGE FORMULA7 reforming the audit process.3 A wide variety of factors contributed to the public calls for reform. First among these was the emergence and explosive growth of the financial derivatives industry,4 which was widely misunderstood and posed new challenges for accounting.5 Also contributing to the cry for increased oversight were large-scale and highly publicized collapsed Ponzi schemes run by rogue traders.6 Legal decisions fueled the flames. In Central Bank of Denver v. First Interstate Bank of Denver,7 the Supreme Court shocked the securities bar and overturned twenty years of appellate court precedent with its holding that secondary liability under section IOb of the Securities Exchange Act IMAGE FORMULA9 is an invalid theory for liability in private actions.8 In other cases, the Court also systematically eliminated secondary liability under section 12 of the Securities Exchange Act.9 Judge Easterbrook's seemingly obvious proposition in DiLeo v. Ernst & Young,10 that financial losses alone do not constitute evidence of fraud by auditors,11 prompted critical commentary.12 Legislation also spurred the discussion for reform. Specifically, the Private Securities Litigation Reform Act13 and the Securities Litigation Uniform Standards Act14 resulted in allegations that the large auditing firms had bought the legislation.15 These reforms were marketed as efforts to deter frivolous strike suits, alleged to cost deep pocket defendant auditing firms large sums of money.16 Along with the two litigation reform acts, another historical factor in the current reform movement was the consolidation of several of the already large public accounting firms.17 This clearly invited increased visibility and scrutiny of auditors culminating with the then-chair of the SEC, Arthur Levitt, making auditor reform his personal mission.18 Suggestions for IMAGE FORMULA11 reform came from many commentators.19 However, conspicuously absent from this policy debate were the economists.20 Although there is currently room for reforms, it is critical that calm prevail and that the mood of the present moment not result in senseless regulation. Regulatory proposals for financial markets are often pushed by advocates who lack knowledge of the empirical facts because they lack knowledge of economic theory and statistical inference and may lack data as well.21 For example, Professor Helen Scott recently developed some Nasdaq regulations pertaining to audit committees and justified the regulations in part with the assertion that "[t]he presence of large numbers of active, technologically capable investors and the reduced costs of securities transactions has resulted in increased market volatility."22 However, the empirical evidence raises questions as to whether volatility has increased, and arguments for increased volatility depend critically on the assumption that the parameters ruling the financial world are stationary, rather than time-varying and sensitive to demographic changes.23 The assertion that reduced costs and more competition are the causes of increased volatility is even more of a stretch. As a second brief example, Professor Lynn Stout advocates a tax on stock trading to increase the well-being of investors. She also criticizes conventional financial theory on IMAGE FORMULA13 the grounds that the efficient-market hypothesis depends on the capital-asset-pricing model, which depends on the unrealistic assumption of homogenous beliefs about the future.24 Neither asserted dependency is correct, but both are based on a confusion between the assumptions of the theory and the assumptions underlying statistical tests of the theory. …