An enforceable duty to disrupt misconduct

Many subjects could be gatekeepers, but not many are in reality gatekeepers. The issue of gatekeeper liability for failure to detect wrongdoing is tightly related to the question whether the gatekeeper had in the first place such a duty? Additionally, the duty has to be an enforceable duty that allows damaged parties to hold the gatekeeper accountable for failure to observe gatekeeping requirements.⁸⁷² Without this precondition, the effectiveness of the enforcement mechanism delivered by the gatekeeping concept is severely curtailed. The only costs to the gatekeeper would be those that relate to reputation, and as it has been already discussed, the threat of reputation loss is in itself a limited threatening mechanism. Without the enforceability of the gatekeeping duty, the implicit or explicit gatekeeper might lack the incentives to perform its monitoring role in detecting and disrupting misconduct, where reputational concerns fail to provide sufficient motivation and incentives. However, determining whether there is an explicit or implicit enforceable duty on gatekeepers to detect and disrupt misconduct is far from being a simple task.

a) Public gatekeepers

Gatekeepers could be created by operation of the law that charges a public body, and sometimes also a private person, to prevent or disrupt misconduct when they detect it. A typical example of direct deterrence by public gatekeepers are the public bodies that authorise for instance a firm to operate as a bank subject to the fulfilment of defined criteria, or typically the securities commission that allow the issue of securities by a firm subject to the approval of the prospect.⁸⁷³ Alternatively, gatekeepers could arise also by virtue of market mechanisms that allow a private subject to exercise gatekeeping function due to their position in relation to wrongdoing third parties. A typical example of this kind of gatekeepers in the financial market would be the rating agencies or banks.

Direct deterrence or deterrence of misconduct by public bodies in charge of monitoring market players is the normal strategy for enforcing legal norms.⁸⁷⁴ In the case of public gatekeepers,

872 Kraakman, Journal of Law, Economics and Organization, 1986, 53, p. 57.

873 E.g. the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) in Germany or the Securities and Exchanges Commission (SEC) in the US.

874 Kraakman, Journal of Law, Economics and Organization, 1986, 53, p. 56.

there is normally a clear mandate on these gatekeepers to prevent misconduct by the subjects they are supposed to monitor. The duty to perform the gatekeeping tasks is enforced on them through regulation, and that should eliminate conflicts of interests or lack of incentives by the public gatekeepers to perform their tasks optimally.

The performance of tasks by public gatekeepers is motivated by pre-defined social goals⁸⁷⁵ and in this respect these gatekeepers provide a public good. The benefits of pursuing social goals while performing public gatekeeping functions are several. To mention just a few, considering that public gatekeepers are not motivated by the pursuit of profit, they are better positioned to perform gatekeeping free from conflicts of interest,⁸⁷⁶ which in turn increases their credibility as watchdogs. Moreover, public gatekeepers are independent of the subjects they monitor, and therefore able to critically evaluate the information presented to them and give unbiased opinions.⁸⁷⁷ They do not depend on the subjects they monitor for the generation of their incomes, and therefore do not need to align their interest with the monitored subjects for fear of losing important clients. Being independent from the subjects they monitor normally allows public gatekeepers to keep uncompromised their capacity to grant or withhold support impartially.⁸⁷⁸ Additionally, these gatekeepers are not subject to competition pressure, due to being mandated by law to keep the gate, and therefore do not need to compromise their performance for fear of losing market share when the subjects they are monitoring do what is called “opinion shopping”.

Being independent from the subjects they monitor, public gatekeepers are also in a position to monitor a broader class of subjects than just those that pay for the gatekeeper’s services.⁸⁷⁹ In this perspective, public gatekeepers should present a more economical solution to ensure enforcement than private gatekeepers.

b) Private gatekeepers

On the other side of the spectrum are the private gatekeepers, who perform their gatekeeping tasks not because they are mandated by law to deter misconduct, but because they are in a position to prevent wrongdoing due to their relation vis-à-vis potential wrongdoers, who need their service to conduct their business. Private gatekeepers face powerful market-based

875 Oh, Journal of Corporation Law, 2004, 735, p. 758.

876 Ibid., p. 759.

877 See Laby, Brooklyn Journal of Corporate, Financial & Commercial Law, 2006, 119, on the differentiation between dependent and independent gatekeepers.

878 Oh, Journal of Corporation Law, 2004, 735, p. 759.

879 Ibid., p. 760.

incentives⁸⁸⁰ to perform gatekeeping functions, i.e. incentives to maximize their own gains against the costs of detection and disruption of misconduct.⁸⁸¹ They are typically employed in the enforcement process when direct deterrence fails to avert a market failure.⁸⁸² Thus, instead of directly deterring the wrongdoer, the private gatekeeper theory aims at deterring the gatekeeper himself, who in turn will be incentivised to deter the potential wrongdoer.⁸⁸³ In the case of private gatekeepers, whose gatekeeping performance is not mandated by legislation, one could speak of implicit gatekeepers. Despite the lack of an explicit duty mandated by law, also from private gatekeepers, it is expected that they will expend efforts to detect and disrupt misconduct in the market where they operate. As already discussed above with respect to the intermediary role of gatekeepers, market actors rely on the information provided by the various private gatekeepers to make their investment decisions. The reputational theory of the gatekeeping model imposes also on the private gatekeepers an enforceable duty to disrupt wrongdoing.

It should be therefore irrelevant for the purposes of enforcing a duty of gatekeeping, and in the same time for the purposes of expecting that this duty will be consciously carried out, whether a subject is a public gatekeeper appointed by law or a private gatekeeper that became such due to the operation of, for example, market mechanisms.

What is relevant is the fact that the gatekeeper subject is an informational and reputational intermediary, on whose information and reputation third parties rely to make important investment and other business decisions. It is this reliance by the investing public that makes the performance by the gatekeeper of their interdicting role an important mechanism in the enforcement practice. Whether they carry out the gatekeeping tasks for free or against payment should not play a decisive role when judging their responsibility or liability towards the public.

One could probably say that the gatekeepers have become a “victim” of their own success.

Moreover, the fact whether a subject is a private or a public gatekeeper is irrelevant with regard to the question whether or not such a subject has a duty to perform its tasks with care and professionalism. In either case, it is expected from the gatekeeper that it will perform its duty of disrupting misconduct either by refusing to cooperate from the start or by discontinuing further support for the wrongdoer.

880 Kraakman, Journal of Law, Economics and Organization, 1986, 53, p. 62.

881 Oh, Journal of Corporation Law, 2004, 735, p. 758.

882 Kraakman, Journal of Law, Economics and Organization, 1986, 53, pp. 61-62.

883 Coffee, Columbia Law and Economics Working Paper Nr. 191, 2001, 1, p. 1.

§ 6 The Nature of Banks

In a perfect world with no information asymmetry and no transaction costs⁸⁸⁴, and where economic actors would have complete confidence on each other, banks would be redundant.⁸⁸⁵ Economic actors, capital-providers and capital-users, would transact directly with each other without the intermediation of a bank. Market information about where to best invest free capital would be available immediately and at no costs, and therefore capital would be used efficiently by investing it there where it is mostly needed as well as economically beneficial. This would result in a balanced supply and demand of capital.⁸⁸⁶ Because of the perfect confidence between the economic actors, the creditor would not need to expend money and time to monitor the behaviour of the borrower, while the borrower would need to provide guarantees to secure the claims of the creditor. Both parties would thus reduce the costs of the transaction and invest the savings in economically beneficial projects.⁸⁸⁷

However, in a real world economy, the role of banks has become an indispensable one, although not irreplaceable.⁸⁸⁸ In its simplest form, a bank is an institution that borrows money from the public in the form of deposits and lends the monies thus raised in the form of credits or loans.⁸⁸⁹ Seen from this consideration, a bank is not only a place of exchange where supply and demand meets, but also a market participant of its own. By accepting deposits from lenders and granting credits to borrowers, banks enter into financial contracts to exchange claims and liabilities with the respective parties, thus it trades with these parties. However, a bank is more than just a vehicle enabling the coordination between the supplier and the users of capital. As a matter of fact, the coordination of capital suppliers and capital users could be performed also outside the banking system, for example in the capital markets.⁸⁹⁰ In the same way, also the allocation of capital function, through which demand and supply of capital is balanced in order to ensure an efficient use of capital is not an exclusivity of banks. Banks, in their role as financial intermediaries⁸⁹¹ in the financial markets perform the functions highlighted above in competition

884 Leland/Pyle, Journal of Finance, 1977, 371; Diamond, Review of Economic Studies, 1984, 393.

885 Fischel/Rosenfield/Stillman, Virginia Law Review, 1987, 301, p. 306; Hartmann-Wendels et al., Bankbetriebslehre, p. 11.

886 The “allocation function” of markets.

887 Zimmer, in: DJT, Verhandlungen des 68. Deutschen Juristentages, 2010, p. G14.

888 Hartmann-Wendels et al., Bankbetriebslehre, p. 2.

889 Kashyap/Raghuram/Stein, National Bureau of Economic Research Working Paper Series, 1999, p. 1.

However, a bank today performs increasingly more complex tasks than simple deposit-taking and lending.

890 Hartmann-Wendels et al., Bankbetriebslehre, p. 4.

891 Ibid., p. 3 distinguishes between “financial intermediaries” in the narrow sense of the word and in the broad sense of the word. Accordingly, commercial banks are financial intermediaries in the narrow

with other market players who carry out same or similar functions. It is the purpose of this chapter to present a summary of functions performed by banks seen from the perspective of legal and economic reasons for the existence of banks. However, this chapter does not aim at making yet another contribution to the discussion as to which market player performs more efficiently functions performed also by banks in their role as financial intermediaries.