August 21, 2009
Deep Economic Theory in Jones v. Harris.
Posted by William Birdthistle

Josh Wright at ToTM has a terrific post up this morning that wonderfully illustrates just how fascinating the Jones argument and decision could be for broad swaths of legal theory.  Eschewing relatively obvious issues of corporate and securities law, he jumps right into the thick of the theoretical implications of the Supreme Court's attempt to evaluate competing econometric analyses of the fund market, briefly detouring along an important byway through competing behavioral and classical economic approaches.

Several factors conspire to make this case fascinating viewing: the case's timing in the current economic moment, the leading role played by Easterbrook and Posner as adversarial protagonists, and the staggering amounts of money involved.  But Professor Wright focuses on the weightier issues that situate this case at a crossroads in the scholarly development of economic theory and regulation.

To oversimplify his very thoughtful post, Wright raises two questions.  First, which strain of economic analysis -- behavioral or "standard 'vanilla' neoclassical" -- more accurately characterizes the effectiveness of this particular market?  Second, how should a court assign "the empirical burden" in cases dominated by competing economic literature?

Wright suggests that in this and other cases, the behavioralists may be too quick to convert findings of investor irrationality or unsophistication into calls for regulatory intervention.  His point is a sound one, but I have two objections to it in the context of this litigation.

First, Wright suggests (as do Easterbrook and Coates & Hubbard) that a lack of sophistication on the part of certain mutual fund investors may not by itself imperil competitiveness because, in the words of Easterbrook quoting Schwartz & Wilde, "sophisticated investors who do shop create a competitive pressure that protects the rest."  What neither Easterbrook nor Wright discusses, however, is that the mutual fund industry features a uniquely rigid segregation of sophisticated investors from unsophisticated -- with the former buying one set of investments and the latter buying a very differently priced one -- which neutralizes the possibility that sophisticated sentinels will protectively police for all.

(Easterbrook's argument that institutions pay higher rates for private equity or hedge fund investments seems strikingly inapt given the wholly different risk profile of those investments.)

Second, Wright may himself be the one reversing the burden in this case.  He wonders when behavioralists have produced sufficient evidence to warrant regulation.  But here the regulation -- Section 36(b) of the Investment Company Act -- is already firmly in place, and it is the neoclassicists who therefore must adduce sufficient evidence for courts to ignore or override it.

Nonetheless, I certainly agree with Wright's suggestion that this case will provide a compelling window into the Supreme Court's views on the most important economic issues of the moment.

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