I formulate a rational expectations signaling model of vicarious liability for securities fraud, particularly the much-criticized "fraud on the market" private class action arising under Rule 10b-5. I show that fraudulent misreporting by managers occurs in the absence of managerial moral hazard -- i.e., where managers simply maximize shareholder payoffs -- and that vicarious liability can serve as an appropriate deterrent, creating separating equilibrium. I then show that the particular remedy under Rule 10b-5 can perfectly deter fraud and perfectly compensate purchasers, and that Rule 10b-5 class actions may function better than critics claim.
Corporation and Enterprise Law | Securities Law
Date of this Version
James C. Spindler, "Vicarious Liability for Bad Corporate Governance: Are We Wrong About 10b-5?" (April 2008). University of Southern California Law and Economics Working Paper Series. Working Paper 74.
Forthcoming in American Law and Economics Review (2010) (subject to revision).