How Do Judges Maximize? (The Same Way Everybody Else Does - Boundedly): Rules of Thumb in Securities Fraud Opinions

Abstract

Judicial opinions in securities fraud class actions frequently do not conform to standard theories of adjudication. Instead of the complex modes of legal reasoning predicted by standard models, decisions in this area commonly rely on rules of thumb-decisionmaking heuristics or shortcuts. To the extent prior literature has focused on the use of decisionmaking heuristics in adjudication, commentators have emphasized procedural shortcuts, such as the doctrine whereby courts refuse to address issues that have not been squarely argued. In contrast, the heuristics we identify are substantive law doctrinal rules of thumb enabling a judge to avoid analysis of a case's full complexities. This distinction is significant. Procedural shortcuts do not affect the evolution of substantive legal doctrines, except as to produce no doctrine. Substantive heuristics, however, not only become doctrine but can come to dominate the on-going evolution of substantive law. We suggest that the desire to avoid complexity is an important factor in explaining the emergence of a number of the newer doctrines in the securities area. Underlying all of these doctrines are assumptions about either, (a) investor responses to information or (b) managerial responses to incentives. The standard approaches used by commentators in the area would be to explain either why the assumptions are accurate or why they are not and how they should be corrected. What we suggest, however, is that the real puzzle thus is that federal judges are claiming-at least implicitly-both a level of expertise about the workings of markets and organizations that, in some areas, not even the most sophisticated researchers in financial economics and organizational theory have reached. Federal judges, however, are far from being experts in these areas. As a group, they have little expertise on the topics of markets and organizational behavior. Further, they are consistently faced with overwhelming caseloads where only a small fraction of cases are securities cases. As a result, there is little opportunity to develop expertise in the area. Finally, judges are known to delegate much of the work of drafting their decisions to their law clerks, who are typically recent law school graduates. Generalizing from the securities regulation context, we contend that standard theories of adjudication are flawed because they fail to adequately account for institutional constraints. Drawing on the tools of new institutional economics (bounded rationality, transaction costs, and agency costs), we tell a story about recent doctrinal developments in the lower federal courts in the area of securities class actions. The story highlights the link between doctrinal developments and the characteristics of the institutions that produce them. That story is then extended to the contexts of the Supreme Court and the Delaware state courts. Our claim is that the institutional perspective provides insights into the evolution of doctrine that today's dominant models fail to provide.