Definitions

Various legal scholars who have written on the gatekeeping strategy are not entirely clear as to the meaning of the “gatekeeping” term. Opinions vary as to what is the gate that is being kept and who is on which side of the gate.⁷²⁷ However, what is widely accepted by most scholars is that a gatekeeper is usually an external party who is able to monitor and screen the activities of a third party to make sure that these activities comply with some rules and standards.⁷²⁸ The term

722 Coffee, Gatekeepers, p. 606.

723 Kraakman, Journal of Law, Economics and Organization, 1986, 53, pp. 56-7.

724 Oh, Journal of Corporation Law, 2004, 735, p. 754.

725 For example the whistleblowing strategy requires a more active role by third parties to call attention to the misconduct to the potential victims or enforcement authorities. See Kraakman, Journal of Law, Economics and Organization, 1986, 53, p. 55.

726 Oh, Journal of Corporation Law, 2004, 735, p. 746.

727 Partnoy, Washington University Law Quarterly, 2001, 491, p. 491.

728 Coffee, Gatekeepers, p. 2.

“gatekeeper” has often been defined by taking into consideration the specific professional nature of the third party who plays the gatekeeping role, for example the investment bank, auditor or securities analyst. One of the most widely researched contexts where gatekeeping occurs is the issuing of securities. In this context, the definition of gatekeepers takes into consideration the relationship between the issuer and the various gatekeepers, such as the investment banks, auditors and lawyers. For conceptual reasons, this paper refers to the gatekeeper definitions in the securities issuer’s context to explain the gatekeeping concept.

Various scholars in their definitions on gatekeepers refer mainly to three roles played by a gatekeeper, which are explained below.

1. The disruptive function of gatekeepers

In a first effort to define the gatekeeping concept, Kraakman provides a broad definition to mean by “gatekeepers” private parties who are able to prevent misconduct by withholding their cooperation from the wrongdoer.⁷²⁹ Examples of such gatekeepers are for example an investment bank that refuses to underwrite an issuer’s securities if it considers that the issuer’s representations about the securities are inaccurate and incomplete. According to Kraakman, there is a duty imposed on gatekeepers to prevent or disrupt misconduct by refusing to provide the support, the service or the certification that is essential for the wrongdoer to carry out its wrongdoing.⁷³⁰ The disruption of misconduct takes usually two forms: The first one is an outright refusal to transact with would-be wrongdoers, thus keeping them completely out of the market.⁷³¹ In this case, the person intending to commit wrongdoing is denied access through the gate, and therefore he is not able to defraud potential investors. The second form of disruption is when the gatekeeper refuses requests by wrongdoers for substandard or illicit performance during the course of a broader transaction.⁷³² In this second case, a person has already accessed the market through the gate by using the support or service of the gatekeeper, but after entering the market wishes to carry out wrongdoing. This type of disruption requires more intensive monitoring skills by gatekeepers as wrongdoing in these cases is more difficult to detect.⁷³³

In a similar vein, others refer to gatekeepers as “parties who sell a product or a service that is necessary for clients wishing to enter a particular market in certain activities.”⁷³⁴ Both definitions

729 Kraakman, Journal of Law, Economics and Organization, 1986, 53, p. 53-4.

730 Ibid., p. 54.

731 Ibid., p. 63 uses the term “bouncer regimes” for this type of misconduct disruption.

732 Ibid., p. 63. Also termed “chaperone regimes”.

733 Ibid., p. 63.

734 Hamdani, Southern California Law Review, 2003, 53, p. 58.

rest on the assumption that the support or the service by the gatekeeper is necessary for entering a particular market or for carrying out the misconduct. The gatekeeper is in a position to oversee the gate that allows a particular person to carry out an activity. Both definitions see to the gatekeeper as a private policeman who has been given a key place in the process to prevent wrongdoing.⁷³⁵

2. The information intermediary function of gatekeepers

The second important role allocated to gatekeepers is that of helping to reduce information asymmetries between parties and economise on information costs in a transaction.⁷³⁶ They are allocated an important monitoring role by putting them in a position to decide whether to grant or withhold support. Without the support there would be no fraud, but in order to withhold the support, gatekeepers would need to engage in monitoring activities to ascertain the accuracy and the fullness of the representations made by the party wishing to carry out the transaction.⁷³⁷ In this respect, gatekeepers serve to ensure the quality of information distributed by the party wishing to carry out the transaction. In a securities issuing transaction, the investment bank as a gatekeeper serves to check the representations made by the issuer of securities before they reach the investing public.⁷³⁸ Gatekeepers function in this way as a valve in the channel of information flow sanctioning the accuracy of the representations made by the issuer. The interdiction strategy of gatekeeping functions when gatekeepers, due to accuracy concerns, decide to refuse to let the information flow to investors.⁷³⁹ This strategy however assumes that gatekeepers are an indispensable knot in the communication line which cannot be evaded by the issuers. In this respect, gatekeepers serve to inform the investing public. They reduce information asymmetries⁷⁴⁰ that exist, for example in a securities issuing transaction, by facilitating the verification of information provided by the issuer of securities. This is especially the case when the issuer is a new player in the market. On the one side, this issuer will find it difficult to convince investors about the worth of its securities and the truthfulness of his representations.

Problems of reputation are pervasive in such a situation and for the issuer it would be prohibitively costly to educate each investor individually.⁷⁴¹ On the other side, also for the

735 Coffee, Gatekeepers, p. 2.

736 Gilson/Kraakman, Virginia Law Review, 1984, 549, p. 616.

737 Oh, Journal of Corporation Law, 2004, 735, p. 746 738 Ibid., p. 790.

739 Ibid., 735.

740 Habersack, Zeitschrift für das gesamte Handels- und Wirtschaftsrecht, 2005, 185.

741 Gilson/Kraakman, Virginia Law Review, 1984, 549, p. 619.

investor it is difficult and costly⁷⁴² to verify ex-ante the accuracy of the information provided by the issuer.⁷⁴³ Therefore, the gatekeeper as an information intermediary helps in solving the problem of information verification. By using its expertise and standardized procedures, the gatekeeper can process the information delivered by the issuer at a lower cost⁷⁴⁴ and could also externalize these costs more effectively to the future investors, resulting in overall savings in the production of information relevant to investors.⁷⁴⁵

Closely connected to the informational intermediary role of gatekeepers is the reputation of the gatekeeper. For the gatekeeper to perform the informational intermediary function effectively, the role of reputation is of essential importance. This reputational intermediary role of the gatekeepers is considered by some scholars as the most important contribution of gatekeepers in the enforcement strategy.⁷⁴⁶ When gatekeepers suffer reputational problems, the value of information and verification services declines, ⁷⁴⁷ and thus of the market for gatekeepers risks collapse.

3. The reputational intermediary function of a gatekeeper

Coffee considered the definition by Kraakman as too broad because it would risk imposing a liability for failing on their gatekeeping duties on persons who are completely disconnected to the wrongdoer and with absolutely no possibility to detect and disrupt misconduct.⁷⁴⁸ Therefore in his definition, Coffee focuses on the reputational aspect of the gatekeeping role by defining

“gatekeeper” to mean “a reputational intermediary who provides verification or certification services to investors.”⁷⁴⁹ This definition builds on the assumption that the gatekeeper has a

742 Husisian, Cornell Law Review, 1990, 410, p. 413.

743 Heukamp, Zeitschrift für das gesamte Handels- und Wirtschaftsrecht, 2005, 471, p. 472-3 referring to the benefits from a reduction in costs due to control and informational functions of auditors. See also Kraakman, Journal of Law, Economics and Organization, 1986, 53, p. 96 claiming that reputation is particularly important where buyers cannot verify ex-ante the quality of the goods prior to the purchase.

744 Choi, Northwestern University Law Review, 1998, 916, p. 946 considers the traditional gatekeeper to function as a centralized source of information.

745 Gilson/Kraakman, Virginia Law Review, 1984, 549, p. 619.

746 Coffee, Gatekeepers, p. 2.

747 Partnoy, Washington University Law Quarterly, 2001, 491, p. 493.

748 Coffee states that pursuant to the definition by Kraakman, gatekeeper liability would also be imposed on persons who sold pencils to Al Capone’s gang on the grounds that one could not run a brewery and tavern business without using the pencils to keep records. Coffee, in: Ferrarini et al. Reforming company law, p. 460. However, Coffee does seem to consider the requisite stipulated by Kraakman regarding holding a gatekeeper liable, namely that the gatekeeper should possess the ability to disrupt misconduct.

Kraakman, Journal of Law, Economics and Organization, 1986, 53, p. 54.

749 Coffee, Business Lawyer, 2002, 1403, p. 1405 and Coffee, in: Ferrarini et al. Reforming company law, p. 460.

reputation to lose. Third parties that fit this definition are for example auditors, who certify the financial statements of a security issuer, or credit rating agencies that issue credit ratings to certify the level of creditworthiness of a certain person. The definition by Coffee puts the focus on the reputational aspect of the gatekeeper’s service towards investors, without reference to the fact whether or not the investors need the service of the gatekeeper to finalize their transaction.

Although one could derive from the definition that without the verification or certification services provided by the gatekeeper, the party wanting to carry out a transaction might not be able to initiate it at all in the first place, the definition by Coffee seems to concentrate more on the facilitative, rather on the disruptive, role that gatekeepers can play in the performance of a transaction by an interested party. For Coffee, gatekeepers essentially pledge their reputation to ensure investors as to the honesty and completeness, i.e. quality, of the “signal” sent through disclosures by the transacting party.⁷⁵⁰ Building reputational capital requires various⁷⁵¹ long-term investments by a market player. Gatekeepers as repeat players in the market accumulate reputational capital over the years and by serving many clients.

Central to this gatekeeping role is the assumption that a gatekeeper holds its reputation as a very important and precious asset, and that it is not willing to sacrifice it for the payment it will obtain from the wrongdoer. In the end, without reputational capital, a gatekeeper is not any longer credible⁷⁵², and the loss of credibility would practically mean the demise of the gatekeeper. ⁷⁵³ In theory, this assumption should function so long as the value of the gatekeeper’s reputation exceeds the expected gain from compromising its credibility. According to this theory, the gatekeeper would not be willing to sacrifice the reputation built through hard work and investment⁷⁵⁴ only for any single client or a modest fee. Because the gatekeeper draws only a limited payoff for the service provided as well as from the involvement in the misconduct, compared to the profit that the party carrying the transaction or the misconduct makes from the activity, it is assumed that the gatekeeper will not have the incentive to sacrifice it reputation and thus also its existence.⁷⁵⁵ This was also the essence of the analysis by Williamson who suggested long-term contracts, even in the absence of legal remedies, can be self-enforcing by the use of

750 Coffee, Business Lawyer, 2002, 1403, p. 1405; Coffee, in: Ferrarini et al. Reforming company law, p.

460; Coffee, Gatekeepers, p. 2.

751 Such as e.g. investments in recruiting qualified people, enacting procedures and standards to verify the accuracy of information, buying and using systems and software that assist the verification of information, etc.

752 Coffee, Gatekeepers, p. 3.

753 Coffee, in: Ferrarini et al. Reforming company law, p. 461.

754 Kraakman, Journal of Law, Economics and Organization, 1986, 53, p. 70.

755 Coffee, Gatekeepers, p. 5.

bonding mechanisms that are created when a party making the representations in a contract offers a hostage as a security for the accuracy of its representations.⁷⁵⁶ Offering a hostage as a security is done for efficiency purposes as it reduce the cost of transaction for all the parties. Transposing the hostage model into the gatekeeping model, gatekeepers are considered to offer their reputation as hostage (the bonding mechanism) to vouch for the accuracy of their client’s disclosures.