Law applicable to infringement of moral rights in Japan (Case Comments)
– “Chinese poem” case [Tokyo District Court decision of 31 May 2004, Case No. 26832 (wa) of 2002]

INTRODUCTION

Exploitation of creative works goes beyond national boundaries. By this very nature, an infringement on the rights of the author may lead to a question of applicable law.

The applicable law on the infringement of economic rights, illegal copy for example, is generally considered to be the law of the country where the illegal exploitation occurred. This idea is broadly accepted in many countries and is the dominant thinking within academia.

However, we should not forget that an author not only has economic interests but also moral interests on his creative work. With this in mind, could we then approach the question of applicable law regarding infringement of moral rights the same as we would an infringement of economic rights, considering that the object of moral rights is different from that of economic rights?

In Japan, though there have been decisions that dealt with the applicable law question on cases of infringement of economic rights, there has never been one on infringement of moral rights until the case at hand. The “Chinese poem” (Tokyo District Court decision of 31 May 2004, Case No. 26832 (wa) of 2002; Hanrei Taimuzu, No.1175, p.265) is the singular case that decided on the applicable law of infringement of moral rights.

The case covers two important issues. Firstly, what law should be applied to the question of infringement of moral rights? Secondly, given the fact that there exists no rule to determine the applicable law on infringement of intellectual property (including author’s rights) in the Japanese private international law, which legal provision can then be used in the determination of the applicable law?

For further reference, the Tokyo High Court Decision of 9 December 2004 on the koso appeal (Case No. 3656 (ne) of 2004) did not refer to the question of applicable law.

FACTS

A was a famous Chinese poet and composer from Xiamen City as well as an author of many literary works. He has published in journals and literary reviews, and is widely known all over China. One of his works, a poetry book (“the Parnassus”), contains around one hundred poems, some of which are brought into question in this case (“the Poems”).

Y2, one of the defendants, is a Chinese woman living in Japan and was dating A’s brother, B. She wrote a novel (“the Novel”) in Japanese based on her personal experiences. Y1, the other defendant, is the publishing company that printed and sold the Novel in Japan.

In the Novel, the heroine (modeled after Y2) is dating a guy (modeled after B) who has a brother; a “Chinese contemporary poet from Xiamen”. Y2 used the original text in Chinese and its translation in Japanese of the Poems in her Novel and introduced these as the works of the brother of the heroine’s partner who is a “Chinese contemporary poet from Xiamen”. Moreover, in the Novel, the “Chinese contemporary poet from Xiamen” is described as an alcoholic and a violent person.

Soon after the lawsuit was brought, A died. The plaintiffs Xs (A’s parents and child) are A’s heirs and asked for the injunction on the printing and distribution of the Novel as well as publication of remedial advertising, based on the infringement of A’s moral rights and of defamation, compensation was also demanded for the infringement of the A’s moral rights.

The issues on moral rights which were in question in this case are as follows:

-              Infringement of the right of attribution; in the Novel, the author of the Poems is described as a “Chinese contemporary poet from Xiamen”, the brother of the heroine’s partner. The plaintiffs insisted that the right of attribution of the real author A was infringed.

-              Infringement of the right of integrity on the title of the Poem; some of the Poems, the originals in Chinese and the translated versions in Japanese, were used in the Novel with the alteration to the titles. The plaintiff claimed the infringement of the right of integrity on the title provided for by the article 20(1) of Japanese Copyright Act[1].

-              Infringement of the right of integrity on the content of the Poem; there are mistranslations, lacks or misinterpretations beyond the original which were found in the translations of Y2. The Plaintiffs claimed the infringement of the right of integrity of the content of the Poems.

DECISION

The Court ruled in the negative on the claim of infringement of the right of attribution, but affirmed the claim of infringement of the right of integrity on the basis of the alteration of the titles and of the mistranslations.

The decision on the applicable law by the Court is as follows:

“The claim for injunction and for publication of the remedial advertising to protect the personal interests post mortem should be considered as remedy to conserve the personal interest of the author, that is, the right of the author. Therefore, it must be classified as a remedy to conserve the right of the author. Standing on the article 6bis(3) of the Berne Convention, the law applicable to the remedy to conserve the right of the author must be the law of the country for which the protection is sought. In this case, the country for which the protection is sought is Japan and the injunction and publication of the remedial advertising should be governed by Japanese law. In addition, according to the article 6bis(2) of the Berne Convention, the person who can enjoy the right of claim must be decided by Japanese law, the country for which the protection is sought.”

“The claim for compensation on the ground of the violation of the moral rights must be classified as tort and the article 11(1) of Hōrei[2] designates the applicable law. As to the claim for compensation, in this case, it is the “place where the facts forming the cause of such obligation have occurred” provided in the article 11(1) of Hōrei should be Japan, considering the fact that the printing and distribution of the Novel has taken place in Japan and it is the violation of moral rights in Japan that is being raised. Therefore, the law applicable to the claim for the compensation must be Japanese law.”

COMMENTS

(1)   Classification

The plaintiff made three claims: Injunction, compensation and publication of the remedial advertising. The Court classified the injunction and publication of the remedial advertising as “remedy to conserve the right of the author” and the compensation as tortuous claim.

In Japan, the classification to separate the injunction from the compensation can be found in the case concerning economic rights^[3]. This position was first shown in the Card Reader Case[4] and this became the jurisprudence of like cases. However, I see no reason to distinguish between the injunction and the compensation at the level of classification is problematic. The classification must be decided independently by private international law[5], the injunction and the compensation should be considered simply as remedy against the violation of the author’s economic right[6].

Also with regard to the moral rights, there is no necessity to distinguish between the injunction and compensation. These claims should be considered as the remedy to conserve the legal interests of the author, his moral rights.

Therefore, at the level of private international law, the claim of injunction, publication of the remedial advertising and compensation should be classified together as one, as remedy against the violation of moral rights.

(2)   Choice-of-law rule

In this case, the Court classified the claim for injunction and for publication of the remedial advertising as “remedy to conserve the personal interest of the author, that is, the right of the author”.

Since the author A has already passed away in this case, the court decided that to determine the person who can enjoy the right of claim should be in accordance to the article 6bis item (2) of the Berne Convention, and then applying item (3) in determining the applicable law.

The article 6bis provides as follows:

(1)   Where any country outside the Union fails to protect in an adequate manner the works of authors who are nationals of one of the countries of the Union, the latter country may restrict the protection given to the works of authors who are, at the date of the first publication thereof, nationals of the other country and are not habitually resident in one of the countries of the Union. If the country of first publication avails itself of this right, the other countries of the Union shall not be required to grant to works thus subjected to special treatment a wider protection than that granted to them in the country of first publication.

(2)   No restrictions introduced by virtue of the preceding paragraph shall affect the rights which an author may have acquired in respect of a work published in a country of the Union before such restrictions were put into force.

(3)   The countries of the Union which restrict the grant of copyright in accordance with this Article shall give notice thereof to the Director General of the World Intellectual Property Organization (hereinafter designated as “the Director General”) by a written declaration specifying the countries in regard to which protection is restricted, and the restrictions to which rights of authors who are nationals of those countries are subjected. The Director General shall immediately communicate this declaration to all the countries of the Union.

The provisions that concern this case are items (2) and (3).

The question of who can enjoy the right must first be decided. In this case, the actual author A has died after the action has been brought and the plaintiffs (Xs) are A’s heirs (A’s parents and child). Their claim is based on A’s moral rights and it is necessary to decide if they have the right to claim, standing on the moral rights. In this point, the court examined if Xs came under the definition of “persons or institutions authorized by the legislation of the country where protection is claimed” provided on article 6bis(2) of the Berne Convention. Here, however, the court simply decided that “the country for which the protection is sought is, in this case, Japan” and the reasoning why it is Japan has not been sufficiently explained.

If Japanese law is applicable, the article 116(1)[7] of the Japanese Copyright Act should be applied in deciding the person who can enjoy the moral rights after the author’s death. According to this provision, Xs are the parents and the child of A and they legitimately come under the definition of “bereaved family” and can therefore enjoy A’s right after his death.

Next, as to the remedy for the violation of the moral rights, the Court declared that the article 6bis(3) governs this question. Here again, the Court simply decided that Japanese law is the “law of the country for which the protection is sought” without showing any reason. Therefore, Xs could claim for the injunction provided by the article 112(1)[8] of the Copyright Act and the measure of the restoration of the honor provided by the article 115[9] of that Act.

Secondly the Court classified the claim for the compensation as tortuous claim and determined the applicable law standing on article 11(1) of Hōrei, the former law concerning the application of laws of Japan. This provision takes the “place where the facts forming the cause of such obligation have occurred” as the connecting factor for the tort. In this case, the Court decided on Japan for the reason that it is the place where both the printing and the distribution took place. This decision is justifiable because the “facts forming the cause” is no other than the publication and the distribution of the Novel done by the defendants.

In 2007, Hōrei was amended and Tsūsokuhō, the Act on General Rules for Application of Laws, entered into force. The article 17 of Tsūsokuhō prescribes “the law of the place where the result of the wrongful act occurred” is the applicable law of the tort. If this case were in question under this new law, where would “the place where the result of the wrongful act occurred” be? The Novel is published in Japan and distributed in the Japanese market. Considering this fact, “the place where the result of the wrongful act occurred” would be Japan and the conclusion reached would be the same as that of which the Court decided. The applicable law would be Japanese law.

In short, the stance of the Japanese court for the infringement of the moral rights is as follows: The claims of the injunction and publication of remedial advertising are classified as “remedy to conserve the right of the author” and the applicable law is the law of the country for which the protection is being claimed (lex loci protectionis) standing on the article 6bis(2) of the Berne Convention. On the other hand, the claim for compensation is classified as tortuous claim and the applicable law is the law of the place where the result of the illegal act occurred as per article 17 of the Tsūsokuhō.

(3)   Analysis

This is the only Japanese case on applicable law for transborder infringement of moral rights. The ruling of the court based on its interpretation of the Berne Convention is however, not appropriate.

The Court considers the Berne Convention in determining the choice-of-law rule. However, it must be understood that the Berne Convention does not provide a direct choice-of-law rule. Therefore, the decision of the Court to designate the applicable law based on the Berne Convention cannot be justified.

The question as to whether or not the Berne Convention has the choice-of-law rule is the issue actively discussed especially in the context of the economic rights, concerning article 5(2) of the Convention[10].

Comparing article 5(2) on economic rights and 14bis(2) on ownership of cinematographic works, article 6bis is less mentioned in the discussion on the choice-of-law nature of the Convention[11]. However, the wording used in article 6bis, “the country where protection is claimed” is exactly same as the wording in article 5(2) and 14bis(2). Therefore it is not reasonable to interpret one as the choice-of-law rule and not the other. Thus, both article 5(2)[12] and article 6bis can be treated in the same manner as an object in the discussion concerning choice-of-law rule of the Berne Convention.

As previously mentioned, the concept of moral rights was first introduced in the Rome Conference of 1928. At that time, Member States each had its own legislation on author’s rights and the rights in each country existed separately and independently from one other. Some countries, such as France and Italy, valued the concept of the moral rights, while others, such as the United Kingdom and the United States, did not have this legal concept.

Standing on this difference, when Italy proposed the introduction of moral rights into the Convention during the Rome Conference, many common-law countries strongly objected. This led to the provision, which was introduced in the Rome Amendment that included a reservation clause[13]. It seems like a product of compromise among Member States, with each State having different legislations on moral rights. The Convention “respected” this differences and left the decision on how to interpret moral rights to the individual Member States.

Taking into account the discussion made during the drafting, as previously mentioned, the Convention should not be the venue in deciding the choice-of-law rule[14] and article 6bis should not be used in determining the choice-of-law rule in matters of moral rights.

I. Introduction

Arguably, there is a relationship between company law, lawyers and innovation. The editorial in the Economist of 18 December 1926 clearly describes the relationship: “The economic historian of the future may assign to the nameless inventor of the principle of limited liability, as applied to trading corporations, a place of honour with Watt and Stephenson, and other pioneers of the Industrial Revolution. The genius of these men produced the means by which man’s command of natural resources has multiplied many times over; the limited liability company [provided] the means by which huge aggregations of capital required to give effect to their discoveries were collected, organized and efficiently administered.”^[3] To see this, consider the following principles of the public company form: (1) a corporation is a legal entity that holds the firm’s assets; (2) the limited liability feature allows shareholders, many of whom are wealth-constrained and risk-averse, to diversify their risks and trade their shares publicly; and (3) corporate law creates centralized management, to which shareholders delegate important control rights to a group of specialists. These principles facilitate the separation of residual control from residual risk-bearing – usually referred to as the separation of ownership and control – and, hence, make it possible to publicly raise capital from a large number of equity investors. Undoubtedly, firms’ decisions to embrace the public company and stock market listings have accelerated innovation and industry productivity.

Provocative work on law, finance and development argued that the protection of investors in corporations that were governed by common law rules and institutions were considerably more effective than the rules originating in their civil law counterparts.^[4] The difference in investor protection against expropriation by managers could even explain the divergences in the nature and effectiveness of financial systems, and hence the innovative capacities on a global scale. A widely accepted explanation for this is that common law statutes give the judiciary more latitude to fill gaps in the inherently incomplete statutory company law arrangements that constitute a firm. The argument is that open-ended fiduciary duty concepts in corporate law invite the judiciary to devise efficient remedies, providing an abundance of case law to guide the adjudicators in their efforts to resist opportunism within business settings. In this respect, common law statutes are arguably more conducive to economic and social change than comprehensive and largely mandatory civil law codes that discourage the adjudicators’ ability to complement and deviate from statutory law.

However, civil law countries have caught up with common law systems during the past decade by implementing a vast array of corporate governance reforms and introducing sophisticated hard law and soft law measures to protect passive equity investors. Restoring investors’ confidence in the integrity of capital markets and addressing deficiencies in the relationship between managers and shareholders of listed companies are two important factors motivating the constant drive for corporate governance improvements in the area of listed companies and stock markets in both common and civil law jurisdictions. This is exemplified by the recent global financial crisis, which has yet again spurred legislatures into action to address perceived market failures. It is only to be expected that the recent crisis lead to more mandatory rules and convergence in the corporate governance systems of listed companies around the world.^[5] This observation leads to an interesting conclusion: the rapid convergence in the legal protection of investors suggests that legal origin (common law or civil law system) is not a major barrier to change and innovation in the area of company law.^[6]

Breaking with the conventional wisdom on the differences between common law and civil law systems, this paper argues that the role of the legal industry – in particular the actions and non-actions of corporate lawyers and other legal practitioners – rather than legislatures and courts, explains the innovative lawmaking approach in common law systems. It is generally acknowledged that corporate law in common law countries tends to be more enabling than in civil law countries.^[7] This is particularly true for new “company law products” that, by combining the corporate feature of fully-fledged limited liability with the partnership law principles of flexibility and informality, completely changed the legal landscape in the United States in the 1990s. The statutes of these “hybrid business forms”, in particular the limited liability company (LLC), were largely a byproduct of practicing corporate lawyers’ drafting and lobbying efforts to better support their clients.^[8] The proactive attitude of lawyers can be explained by competitive pressures that encouraged them to push for more flexible rules.^[9] Failing to do so would arguably have negatively affected the attractiveness of a jurisdiction’s company laws, which, in turn, could hamper potential long-term fee revenue growth for the corporate lawyers and their firms.

Based on our research,^[10] corporate lawyers in civil law countries are generally inclined to pursue a reactive, non-competitive strategy. Concerned about legal certainty arguments, corporate lawyers and other legal advisors tend to maneuver within the boundaries set by the statutory company law and case law system in a particular jurisdiction. Interestingly however, and contrary to the regulatory trend of introducing stricter rules and mechanisms for listed firms, competitive pressures to encourage innovation and economic growth appear to have opened up opportunities for reform-minded lawmakers and lawyers in civil law jurisdictions to introduce new company law products. Indeed, legal innovators, who were previously blocked in their efforts to simplify and modernize company law, have found ways to successfully promote the contractual nature of their company law business forms.^[11] The result is that “private company law” reform projects in Asia, Europe and South America are increasingly influenced by legal transplants from common law jurisdictions.^[12] Convinced that more contractual freedom to establish the rights and obligations within an organizational structure not only plays a central role in the emergence of necessary industry partnerships and collaborations, but also attracts foreign investments, civil lawmakers have also started to introduce “hybrid business forms”. Still, most civil law jurisdictions, in their efforts to spur entrepreneurship and innovation, pursue a more conservative reform strategy. These reforms seek to promote flexibility and private ordering (and allow firms to set up governance structures that best suit their business needs) by updating and upgrading the existing company law statutes, thereby staying within the “safety zone” of legal certainty.^[13]

This essay investigates the hypothesis that common law systems outperform their civil law counterparts in terms of legal innovation and economic development. An analysis of the private company law reform efforts, more specifically the introduction and acceptance of new company law products in common law and civil law jurisdictions, may challenge or confirm the hypothesis. If a trend towards convergence between the two systems is found, it may be argued that the civil law versus common law divide is indeed overstated. Nevertheless, if common law systems innovate at a faster rate than their civil law counterparts, civil lawmakers may at best be viewed as early adopters of “legal innovations” that are generally developed in common law systems.

Our analysis proceeds as follows. Section II will start with briefly discussing studies that challenged the assumption that common law is superior to civil law.^[14] These studies point to the fact that separate private company forms were first introduced in civil law countries. A closer assessment of the history and development of private company law, however, shows that rules governing the private company forms, like the business forms for publicly listed firms, are mandatory in nature. Contrariwise, corporate lawyers and other interest groups in common law systems “lobbied” for more enabling and flexible company law statutes, thereby successfully eroding the mandatory nature of common company law products. Section III analyzes the recent introduction of hybrid business forms. In particular, the process and impact of their implementation in common law countries (the United States, the United Kingdom, India and Singapore) and civil law countries (France, Japan and Colombia) is evaluated. A distinction is made between (1) statutes that were implemented as a result of lobbying activities undertaken by industry groups and reform-minded corporate lawyers and (2) statutes that were proposed by public legislatures to generally encourage entrepreneurship and economic growth.

Evidently, in both cases the provision of new legal products is ultimately a decision of public legislatures. Additionally, it is acknowledged that legislatures often involve practicing corporate lawyers in the drafting process of company law provisions.^[15] However, if legislatures respond to reform-minded corporate lawyers and interest group pressures, it is shown that the chance of acceptance and success of innovative legal products is increasing significantly both in common and civil law systems. As will be discussed in Section IV, path dependency factors appear to play an important role in civil law systems when public legislatures initiate legal reform.^[16] In these cases, corporate lawyers in civil law jurisdictions seem to have strong incentives to block innovative legal measures and techniques (despite it becoming more and more apparent that there is a growing mismatch between the available legal “products” and the demands of the business world). This finding would suggest the existence of a correlation between legal innovation and legal origin. Section V offers concluding remarks.

II.         The History and Development of Company Law in a Nutshell

The corporate form is a success story. It gained popularity as economies developed and improved transportation and communication systems led to many larger-scale firms. As discussed in the previous section, these firms were attracted by the corporation-type management and financial structure.^[17] With the growth of commercial and industrial activity in the nineteenth century, the pressure from politically influential industrialists to make the corporate form available across the board grew steadily in most industrialized countries.^[18] The considerable use of the corporation and the further development of the common law of corporations resulted in increasing demands for codification measures in common law jurisdictions in the nineteenth century. By 1890, all states had adopted statutes that made the corporation – with the limited liability feature – easily accessible by means of a simple registration. These corporate law statutes were mere restatements of the law as developed in practice by the custom of merchants and courts.^[19]

During approximately the same era, civil law countries followed a different codification approach. In the spirit of revolution rather than evolution, judge-made law was viewed with suspicion and as a means of upholding the pre-codification regime. The lawmaking authority shifted from judges to public legislatures (established by constitutional documents and principles). These legislatures severed all ties with the past when engaged in their codification efforts. As a result, the corporate law statutes in common law and civil law jurisdictions differed significantly in features dealing with similar issues, reflecting the different codification approaches. More than their common law counterparts, the drafters of corporate law statutes in civil law jurisdictions attempted to mitigate the (potential) governance failures and errors by tightening the rules, giving the statutes a more mandatory character in terms of protection of shareholders’ and creditors’ rights.^[20]

With the tightening of the rules and regulations for publicly held corporations at the end of the nineteenth century and more generally in the twentieth century, civil law jurisdictions introduced separate private company law statutes for non-listed small and medium-sized enterprises. Germany, for instance, is renowned for the enactment of the first private company form. The Gesellschaft mit beschränkter Haftung (GmbH) was introduced on 19 May 1892. The private company form provided active investors in small and medium-sized enterprises with limited liability protection without having to abide by the onerous rules designed to protect passive investors in listed companies. The introduction of the GmbH-form, and its subsequent transplantation throughout the European continent, as well as in Asian and Latin-American civil law jurisdictions, is considered an important development in the history of company law (Table 1).^[21] Arguably, it challenges the superiority of common law systems.^[22] Nonetheless, the introduction of new business forms tailored to the needs of non-listed firms should not be looked at in isolation.^[23]

Table 1: Introduction of Private Companies in civil law jurisdictions

Source: Adapted from Lutter, Limited Liability Companies and Private Companies (Chapter 2) in International Encyclopedia of Comparative Law, Business and Private Organizations (Volume XIII)

Just to give one example, consider the development of corporation law in Delaware, which is the companies’ choice of state of incorporation in the United States. It is indeed true that Delaware (and the other states) was a laggard in terms of adopting a separate corporate business form for non-listed companies. However, for reasons of flexibility in the incorporation and operation of businesses, both listed and non-listed companies started to avail themselves of the corporate form, making the introduction of separate private company legislation superfluous. Contractual deviations from the corporate separation of ownership and control structure were used to tailor the corporate form to the needs of small and medium-sized non-listed companies. The fact that the initial tendency of courts was to treat these contracts with suspicion (by rendering shareholder agreements that provided the parties with partnership-type governance invalid) did not stop corporate lawyers from deviating from the general corporation statutes by opting out of stricter rules that negatively affected the operations of their corporate clients.^[24] The lawyers’ drafting persistence gradually resulted in (1) courts allowing the use of contractual arrangements despite the possible tension with the corporate structure,^[25] and (2) corporate statutes becoming more and more flexible by explicitly permitting to contract around statutory provisions.

For example, corporate lawyers, attentive to the specific needs and aspirations of fast-growing high-tech firms, are usually very much inclined to incorporate in Delaware.^[26] Delaware’s statutory law and case law permits the lawyers to contract around irrelevant and inconvenient default rules and tailor rights and duties that are more consistent with their organizational priorities. Research shows that these contractual arrangements, set forth in the articles of association, stock purchase agreement, investor rights agreement and other legal documents, offer an effective solution to the challenges of investing in high-tech companies.^[27] It appears that venture capital investments in start-up companies are optimally made against the issuance of convertible preferred stock. It allows for significant ex post flexibility in the determination of control rights and the conditions upon which venture capitalists are allowed to exit their investment. Convertible preferred stock is considered optimal because it, firstly, secures downside protection for venture capitalists and secondly, gives entrepreneurs incentives to take significant risks in order to obtain a higher final firm value in the event of success. In this respect, there is little doubt that the flexibility of Delaware’s General Corporation Law – in that it allowed corporate lawyers to experiment with innovative contractual provisions that encouraged venture capitalists to actually invest in start-up firms and at the same time stimulated a steady supply of entrepreneurs – has also been a key input to the development of the venture capital industry in the United States.^[28]

In contrast, statutory corporate law in civil law jurisdictions usually lacks the flexibility of Delaware law.^[29] Private company law in Europe, for instance, in many respects a mirror-image of the law for public corporations, was generally characterized by its mandatory nature and inflexibility, leaving little room for legal experimentation. Nevertheless, path-breaking decisions of the European Court of Justice, resulting in the improvement of the so-called ‘incorporation mobility’, have dramatically altered the Continental company law landscape.^[30] The court decisions allowed start-up firms to incorporate under the laws of other Member States if the foreign business form better serves the start-ups’ needs. The pressures of losing “business” to neighboring jurisdictions gave rise to a large number of company law reforms to offer firms a more flexible and adaptable regulatory framework similar to Delaware’s corporate law statute.^[31] It should be noted here that company law reforms are not limited to Europe. Stimulation of entrepreneurship, attraction of foreign investments and the facilitation of investor participation in local companies are all driving forces behind reform initiatives worldwide.^[32]

Company law of the twenty-first century thus offers a spectrum of incorporation and operation options to firms. On one end, there is the traditional public company form that becomes more and more regulated and controlled in order to restore investor confidence and prevent a next financial crisis.^[33] On the other end, lawmakers endeavor to provide firms with one or more flexible business forms that allow them to pursue entrepreneurial activities. Illustrations of recent company law developments allow us to see how the reforms tend to map on the spectrum of company law options. Here are some of the key findings:

-  Policymakers and lawmakers around the world are actively discussing the further regulation and control of listed firms. Some examples of this trend include the rules that are meant to promote the involvement of independent directors and long-term shareholders in the decision-making process of firms. In addition, certain policymakers have argued that changing the composition and compensation of corporate boards will deter fraud and abuse in the boardroom and, at the same time, foster firm performance.

-  Lawmakers are considering and introducing legal upgrades to their private company law forms leaving the core of the company law system untouched. These reforms are characterized by compromise legislation that mainly focuses on the simplification of formation requirements. Proponents of this view are of the opinion that legal certainty arguments prevent a more ambitious reform which offers business parties an environment of private ordering and contractual flexibility. The private company law reforms in the European Member States are examples of compromise reforms.

-  Company law reforms are also moved by interest group pressures with the effect of the promulgation of new hybrid business vehicles that combine the best features of the traditional partnership and corporate forms. The key drivers behind the development of new business forms are the benefits of maximum flexibility and autonomy of business parties to structure the firm’s internal organization free from historically determined rules and doctrines. It is to be observed that the introduction of new hybrid business forms has the potential drawback of being a relatively untested entity that has not generated a large body of case law and academic research. But, the statutory incompleteness is often mitigated by (1) developing improved statutory default rules to provide enhanced certainty and guidance to the business parties, (2) initiating regularly updates of the business law statutes and (3) providing model articles of association on a ‘think small first’ basis that offer, particularly, smaller firms ‘off-the-rack’ provisions reflecting the preferences of the majority of users of the business form, thereby reducing transaction costs. The Limited Liability Company in the United States, the Limited Liability Partnership in the United Kingdom, the French Société par Actions Simplifiée (SAS), and the Colombian Sociedad por Acciones Simplificada (SAS) are examples of these innovative hybrid business forms.^[34]

-  The success of hybrid business forms in the United States and the United Kingdom also inspired legislatures in other jurisdictions to implement hybrid business form legislation. For instance, limited liability partnerships were introduced in other common law jurisdictions, such as Singapore and India, to expand the governance options to be considered by small and medium-sized businesses and professionals. Importantly, Japan, which has a tradition of following Germany’s civil law system, also introduced new hybrid business forms in 2005 and 2006. The rationale behind this was to supply Japanese firms with more contractual flexibility, thereby encouraging the establishment of multinational joint ventures in the human capital-intensive and financial services sector. The developments described here can be distinguished from the introduction of hybrid business forms in the United States, France and Colombia in that the lawmaking initiatives were undertaken by public legislatures or groups affiliated to public state actors.

Important observations can be distilled from these developments. In general, lawmakers are reactive, rather than proactive. They are reluctant to take action before an actual problem has occurred and tend to only respond to competitive or interest group pressures. The question arises whether the reforms and modernizations in the area of private company law can better inform us about the efficiencies and inefficiencies of common law and civil law systems. To analyze this question, the focus lies on the hybrid business forms that facilitate freedom of contract and organization. The acceptance and impact of these business forms arguably give us more insights in the innovative strengths of legal systems as well as the willingness of corporate lawyers to experiment with new business forms. In the next section, the developments of the hybrid business forms are elaborated upon further.

III.       The Evolution of Hybrid Business Forms

Traditionally, the features of legal business forms – i.e., whether it is viewed as a legal entity, providing parties with limited liability protection or offering beneficial tax treatment – has dictated the process to select a business form. Due to the fact that this decision is made before the actual outcome of the venture is clear, the participants must engage in a comparative ex ante search for the organizational structure that maximizes the value of their investment. They tend to bargain over four fundamental elements – risk of losses, return, control and duration – subject to three major constraints: conflict of interest, government regulation and limits on specifying in complete detail all the terms of the relationship ex ante.^[35]

Rational business parties that decide to operate as a firm should agree upon the business form that best matches the legal status with their organizational needs. Three questions, which follow the bargaining elements and constraints, are crucial to choice-of-business-form decisions.^[36] Firstly, what is the relationship between the participants inside the firm? This choice relates to the function of the governance structure, break-up provisions and incentive mechanisms. Secondly, what is the relationship between the firm and outsiders? The latter focuses on limited liability regimes. Thirdly, what is the relationship between the government and the firm? This question primarily concerns the incorporation requirements and tax treatment of the business form. It goes without saying that the hybrid business forms offer significant inherent benefits in terms of increased flexibility. Cheaply available and combining the best of the partnership and corporate world, the hybrid business forms contain features that make them better suited to professional, start-up and family firms as well as for joint ventures, in which there is no strict separation of ownership and control. Even so, this does not necessarily entail a widespread use of the relatively new business forms. Firstly, these new entities do not have the tried and tested status of the older and more common public and private company forms and are therefore more prone to legal uncertainties and disputes. Secondly, sunk costs and learning effects often prevent corporate lawyers to adopt new and innovative legal products. Finally, reputation and commercial image concerns may complicate the decision to opt into the new an untested business forms.

Turning to the development of hybrid business forms in several common and civil law jurisdictions, the following questions shall be answered: (1) Is the hybrid business form accepted by businesses across the board?, (2) Is the hybrid business form recommended by corporate lawyers despite the possible legal uncertainties?, and (3) What are the distinctive features of the hybrid business form and how does it fit in the existing company law framework? Part A evaluates the development of hybrid business forms that were introduced as a response to interest group pressures. In Part B, hybrid business forms that were introduced as a result of competitive pressures without the direct influence of high-powered, reform-minded interest groups are discussed.

 A.  The Introduction of Hybrid Business Forms as Response to Interest Group Pressure

The Limited Liability Company in the United States

In 1975, corporate lawyers advising Hamilton Brothers Oil Company lobbied for the introduction of a new business form, the LLC. This business form bundled together limited liability, a flexible governance structure and preferential tax treatment. The hybrid business form required less ongoing paperwork than corporations. Also, it provided its members with an almost total shield against personal liability without cumbersome formation and capital maintenance rules. After a failed legislative effort in Alaska, corporate lawyers lobbied successfully for the enactment of the LLC statute in Wyoming, another state with significant gas and petroleum production facilities, in 1977. In 1980, the Internal Revenue Service (IRS) issued a private letter ruling to the Oil Company securing the favourable partnership taxation for its Wyoming LLC structure.

Florida enacted LLC legislation in 1982 to attract foreign investors, particularly from South and Central America. However, the uncertainties surrounding the tax classification of LLCs in general severely hampered the rush to conduct business under this new statute, and consequently did not lead to the expected upsurge of economic activity in Florida. As late as 1988, the IRS clarified the tax treatment of the LLC by issuing a ruling stating that the eligibility for partnership tax treatment is conditional upon the business form’s corporate features. If the LLC lacked two of the four corporate characteristics considered by the IRS to be crucial (continuity of life, centralization of management, limited liability and free transferability of interests), then the Treasury regulations would treat the LLC as a partnership for tax purposes. After this ruling, other states jumped on the LLC bandwagon, slowly and hesitantly at first. But, after 1990, LLC legislation swept rapidly through the United States, largely because of competitive pressures and lobbying activities by domestic interest groups, more specifically corporate lawyers expecting additional clients and work from the LLC. LLC provisions have been adopted in all 51 US jurisdictions by the close of 1996.

The success of the LLC in all states forced the federal tax authority (Internal Revenue Service, IRS) to explain in more detail the distinction between partnership and corporate tax treatment. This led eventually to the introduction of a new federal “check-the-box” tax rule. Under the Internal Revenue Service’s “check-the-box” regulations, which became effective on 1 January 1997, hybrid business forms are taxed as partnerships unless they affirmatively elect to be taxed as corporations. The partnership taxation – pass-through tax treatment – is based on the assumption that a partnership is a mere aggregate of individual partners who re-distribute profits among themselves. Consequently, LLC income is treated as if it were personal income realized by the members, and is taxed to the members as individuals. In contrast, corporate income is taxed first at the level of the corporation and later, if it is distributed as dividend, to the shareholders individually.

Figure 1: The Market Share of the LLC in Delaware

Source: 2007, 2008, 2009, 2010 Annual Report, Delaware Department of State, Divisions of Corporations

The LLC is a separate legal entity that attempts to take proper account of the concerns of economic actors in an increasingly competitive and litigious business environment. The most important feature is that it offers contractual flexibility. The Operating Agreement even overrides the Articles of Association in the event of a conflict. By doing so, the LLC keeps the price of limited liability down by not only providing for flexible tax rules, but also by giving the business planner the chance to opt into the most optimal governance structure. Due to the over-regulatory nature of the marketplace, it should come as no surprise that clear and flexible business forms that shun formation and operation formalities, such as LLCs, were heralded in the United States. The LLC is most popular in states which included the principle of maximum contractual flexibility in their statutes.^[37] The fact that businesses, apparently, put so much emphasis on organizational flexibility explains why Delaware is the preferred destination for large firms. Delaware’s specialized Chancery Court, which tends to respect the parties’ contractual arrangements, is arguably one of the determining factors in the choice of formation state decisions.^[38] Indeed, the Delaware court is very supportive of the dominance of “freedom of contract”:^[39] “The LLC is a relatively new entity that has emerged in recent years as an attractive vehicle to facilitate business relationships and transactions. The wording and architecture of the Act is somewhat complicated, but it is designed to achieve what is seemingly a simple concept — to permit persons or entities (“members”) to join together in an environment of private ordering to form and operate the enterprise under an LLC agreement with tax benefits akin to a partnership and limited liability akin to the corporate form.” It is therefore not surprising that the market share of the Delaware LLC is still increasing (Figure 1).

The Limited Liability Partnership in the United Kingdom

The introduction of the limited liability partnership (LLP) in the United Kingdom (UK) in 2001 was motivated by a myriad of factors, including election politics, which contributed to its speedy passage. The Department of Trade and Industry (DTI) was directly involved in the establishment of the LLP. Prompted by competition from offshore LLP statutes, particularly that of Jersey, the UK legislature, lobbied by British accountants, decided to promulgate a Limited Liability Partnership Act.^[40] The LLP has legal personality, a partnership governance structure, limited liability, and partnership tax treatment. In drafting this legislation, DTI responded to the pent-up demand from existing professional partnerships wishing to transfer to LLP status. Although the LLP act was initially drafted to address the liability concerns of large accounting and other service providers in England, the statutory provisions, as enacted, cover all types of businesses.

Firms that opt into the LLP form are required to comply with (1) provisions of the Companies Act 2006 concerning the preparation of audits and publication of accounts; (2) some provisions of the Companies Act relating to the registration of charges, the delivery of accounts, and the investigation of companies and their affairs; and (3) some provisions of the Insolvency Act relating to voluntary agreements, administrative orders, and the winding-up of the business. In other respects, and chiefly its decision-making rules, the LLP is closer to a partnership, offering parties, to a large extent, freedom of contract in the context of internal organization and the governance structures.

As mentioned, the United Kingdom has responded to the demands of a particular class of firms (i.e., multinational professional service firms) that possessed the resources and capacity to draft a comprehensive operational agreement that met their special requirements. The outcome is that, while the UK LLP extends limited liability to all types of firms, the effect of high transaction costs will arguably limit its suitability for most SMEs. While there are significant, unanticipated drawbacks during the pioneering development of the LLP statute, corporate lawyers have already taken steps to avoid the most costly aspects of the Act by experimenting with key provisions within the LLP agreement for the benefit of a mixture of large and small firms that decided to contract into this form. The result is that the UK LLP has become a practical and useful vehicle for a variety of small and larger businesses, such as professional firms and joint ventures for property development. Particularly, the LLP gained popularity during the recent economic downturn as it offers a simple and flexible business form with better protection for its members if the business runs into trouble (see Table 2).

Table 2: LLPs in the UK

Source: Companies House

The Société par Actions Simplifiée in France

The pressure of competition from businesses in other Member States, which were viewed as having more suitable closely held business forms, stimulated the French business community to lobby the legislature for the adoption a new organization structure for firms in the early nineties. The 1994 introduction of the Société par Actions Simplifiée (SAS) and its subsequent modification in 1999 is thus an example of responsive lawmaking in a civil law country. The SAS is a limited liability vehicle that provides for a flexible organization and administrative structure, but restricts free transferability of shares. The vehicle allows parties to choose the firm’s management and decision-making structure and the contents of its by-laws. As conceived the SAS creates the opportunity for partners in a joint venture to contractually arrange for the most effective organization and control mechanisms inside the firm. The 1999 modification proved highly successful in attracting large numbers of foreign firms to France for investment purposes. Subsequently, the legislature set out to improve the competitive environment for investments through the introduction of a series of company law and fiscal reforms. In particular, Law n° 2008-776, La Loi de modernisation de l’economie dated August 4th 2008 (LME), was promulgated to streamline and simplify the code, offering firms, for example, with easy access to the SAS, more contractual flexibility, and a more beneficial fiscal regime for SMEs.

Turning to accessibility, the French legislature succumbed to pressures to reduce the minimum capital requirements for the SAS. As from 2009, the legislation requires that an SAS must have a minimum authorized and paid up capital of EUR 1.00. Together with the SARL, the SAS can now compete, on cost terms, with the UK private limited company for attracting newly incorporating firms. At the same time, entrepreneurs and foreign investors have greater possibilities to invest their human capital and services in start up and investment oriented vehicles. Specifically, under article L. 227-1 of the French Commercial Code, a shareholder is permitted to make contributions in kind, as well as their experience, skills and knowledge. This measure is fashioned on the US LLC statute that permits shareholders to invest their experience and sweat equity in exchange for financial interests in the firm. However, unlike its US counterpart, the French SAS can only permit the issuance of non-transferable shares. Despite this limitation, the legislature has taken a significant step forward by introducing partnership-like principles in the core of French company law.

Even the appointment of a statutory auditor, a traditional French corporate law principle, has been abandoned under certain circumstances. The remaining two circumstances under which the shareholders of an SAS are required to appoint a statutory auditor are if the SAS is part of a group of companies and if the statutes require that an auditor must be appointed if a company exceeds, at the end of the fiscal year, two of the following three thresholds (i.e., total sales of EUR 2,000,000 (excluding VAT), a total balance sheet of EUR 1,000,000 or more than 20 employees).

Thus, the SAS, already in 1999, created the opportunity for partners in a joint venture – and for other purposes – to adopt a legal structure that is sufficiently flexible in the organization and control of the firm. This vehicle allows parties to freely choose the firm’s decision-making structure and the contents of its bylaws. The SAS holds out the potential to provide cost-saving benefits that may attract new ‘incorporations’, allowing France to compete effectively with Germany, the Netherlands and the United Kingdom. By making the corporate structure more adaptable to the business needs of SMEs and reducing barriers to incorporation, it is likely that the French government will indirectly increase the number of new domestic businesses and perhaps attract a larger number of foreign firms seeking a productive investment or joint venture.

Figure 2: The Market Shares of French Business Forms in the High-Tech Industry

Source: VentureSource

As shown, the recent SAS reforms were fashioned on the US LLC. While the effect has been to create a more accessible legal business form for investors, some features of the SAS may require further attention by lawmakers. For example, the requirement to appoint a President to represent and bind the company sets a clear limit on the degree of organizational flexibility for the SAS. Moreover, unlike the US LLC, the SAS does not provide a detailed set of default rules that could easily fill the contractual gaps for the parties’ omissions. Despite these shortcomings, the SAS is perhaps the most entrepreneur-friendly hybrid business form in Europe today that is also available to individuals. It should therefore come as no surprise that slowly but surely the SAS increasingly attracted high-tech start-ups and venture capital pioneers in France, which used to employ the public corporation (société anonyme) (see Figure 2).^[41]

The Sociedad por Acciones Simplificada in Colombia

The promulgation of hybrid business forms in civil law jurisdictions is not only restricted to France. Colombian corporate lawyers also initiated reform. They wanted new legal tools to better serve the business community. Their reform effort, headed by the Institute of Liberty and Progress (Insituto Libertad y Progreso) and Legis S.A., sought the support of local practitioners to create a more flexible business form. They not only studied other hybrid business forms, such as the French SAS and US LLC, but also the evolution of business law in Latin America. For example, Chilean Company Law inspired the creation of fixed share dividends as well as certain provisions setting maximum and minimum capital percentages. Consideration was also given as to how the new form would interact with traditional Colombian company laws[42].

A Senator, sponsored the institute’s draft legislation to create the Simplified Stock Corporation (SAS, by acronym in Spanish). The bill received the endorsement of the Ministry of Finance and Public Credit as well as the Ministry of Commerce, Industry & Tourism, The Office of Corporate Oversight, and the Colombian Federation of Chambers of Commerce. Numerous law professors, lawyers and unions also supported the bill. During the legislative process, detailed debate in both the House of Representatives and Senate focused on including the most innovative provisions of company law. After the debate, almost all of the proposed bill and its articles remained intact[43].

In December of 2008, the Congress of the Republic of Colombia enacted the new law introducing a new form of hybrid-business entity: the Simplified Stock Corporation (SAS).^[44] The result was astonishing. The SAS ushered in a new way of doing business. Interestingly, its flexibility and easy and cheap access to limited liability not only eclipsed the sole proprietorship as a form of doing business, but also gained substantial market share compared to the traditional company law forms, such as the private company and the stock corporation (see Figure 3).

Not only did the new law create a new hybrid business form, but its enactment method was innovative as well. The bill did not attempt to reform existing business law contained in the Commercial Code but instead created completely new law. This method wisely avoided prolonged dogmatic and doctrinal debate aimed at preserving the status quo. A completely new bill allowed the stability of older more predictable laws to survive along with the new freedoms of the SAS. The end result is the coexistence of both regimes which simultaneously compete and complement one another.[45]

Figure 3: The Growing Market Share of the SAS in Colombia

Business parties can establish an SAS by filing a simple registration before the Chamber of Commerce (without going through the complicated and time-consuming incorporation requirements that apply to the traditional business forms, such as the mandatory rule to have a multiple number of shareholders and the appointment of fiscal auditors). The Act made it clear that shareholders would be shielded from any liability concerning any obligations arising from the business activities of the corporation. Furthermore, it removed obsolete prohibitions regarding the activity of shareholders and managers and, most importantly, adopted the straightforward principle of freedom of contract. It is now, for instance, possible for shareholders to manage the company directly and/or obtain different classes of shares. The new law even introduced an innovative and alternative enforcement mechanism, which referred conflicting parties to an arbitration or administrative adjudication procedure. The simplified incorporation procedure allowed the Chamber of Commerce to design an online system that facilitated the electronic filing of new SAS registrations. Currently, the incorporation process can take less than two hours. This is because the website of the Chamber of Commerce of Bogota, for instance, provides for a six step process: (1) the creation of an account, including the application for a corporate name and tax ID-number, (2) the filing of the articles of incorporation (in order to expedite the process, model articles of association are made available), (3) the online payment, (4) the request to issue a digital signature, (5) digitally signing the incorporation documents and (6) review of the documents by the Chamber of Commerce.

A wide range of businesses employ the SAS. In only 4 months the SAS was the preferred business entity in Colombia. Ever since, the SAS has continued increasing its share within the number of new business entities that are daily filed in the Colombian Mercantile Registry. As Figure 3 demonstrates, by the end of 2011 the SAS controlled over 90% of the business associations market share. Besides the smallest companies and family firms benefitting from the dual class shares, international corporate groups, looking for cost-saving opportunities, rushed to convert their previous subsidiaries into the new flexible business form. What was thought to be a small to medium business solution has proven flexible enough to satisfy the needs of large business too.  In fact, there are approximately 1,000 large business incorporated as SAS. Therefore, this type of entity is ranked second amongst large businesses forms only behind Stock Corporations (sociedad anonima). With nearly 5,000 large business entities in Colombia, SAS comprises roughly 20% of the largest enterprises. Thus far the SAS’s growth has been phenomenal.  Figure 4 demonstrates the total growth of all registered corporations in Colombia since the creation of the SAS.  Registered entities grew from 33% in 2010 to over 56% in 2011.  This indicates that the significant surge in registered corporations can overwhelmingly be attributed to SAS.  An examination of the SAS monthly growth also confirms this conclusion. In 2009 the average SAS created per month was 1,516.  The next year, 2010, it almost doubled to 3,120 per month. This indicates that in 2010 the numbers of SASs grew 106% annually.  As of January 31 2012, a total of 135,641 SASs were registered in Colombia, with over 5,100 registered in January alone. Current projects place the monthly average for 2012 at over 5,000 SAS a month, indicating a growth rate of 37% over 2011.

Figure 4. Total number of Registered Corporations after creation of SAS

1. B.  The Introduction of Hybrid Business Forms Initiated by Public Legislatures

The Limited Liability Company and Limited Liability Partnership in Japan

Traditionally following Germany’s company model, Japan has also, inspired by the success of legal innovation in the United States and the United Kingdom, introduced two new legal forms: the J-LLP (Yigensekinin-jigyo-kumiai) and J-LLC (Godo-kaisha). These hybrid entities, which are intended to supply Japanese firms with more contractual flexibility, are arguably more suitable for firms involved in the human capital intensive technology sectors, such as software development companies.^[46]

There are numerous indications that the Japanese legislature has devoted considerable attention to the concerns of the largest and most established companies seeking to develop new technology, spin-off new opportunities and intellectual property, which can form the basis of joint ventures and alliances. Thus, by 2003, the Ministry of Justice had established a number of priorities involving the amendment of the Commercial Code. The end result was a package of legislative reform measures, comprised in The New Company Law, which were submitted to the Diet (Japanese legislature) in March 2005. The Japanese New Company Law (Kaisha Ho) abolishes the Yugen Kaisha (YK), the private company form, but leaves a modernized Kabushiki Kaisha (KK), the public corporation, in place (grandfathering the existing YKs).^[47] The New Company Law provides for the introduction of a new company form, the Japanese Limited Liability Company (J-LLC) or Godo Kaisha. The J-LLC is a flexible business form that bundles together limited liability, decentralized management by default, unanimous consent to transferability of members’ interests, fiduciary duties and no requirement to audit and disclose financial records. The Japanese vehicle bears a strong resemblance to the US LLC (e.g., voting and distribution rights are by default proportionate to the members’ contributions), but diverges in a number of important respects, including: (1) contributions to the J-LLC will be limited to cash or property, but no services, know-how or other agreements are permitted; and (2) the J-LLC will receive corporate, and not pass-through, tax treatment.

The Japanese legislature had not been able to adopt a hybrid business form that also provided for pass-through taxation due to doctrinal factors and principles. This encouraged the Ministry of Economy, Trade and Industry (METI) to step in and submit, subsequent to the introduction of the Godo Kaisha, the Limited Liability Partnership Bill to the Diet in February 2005. As a consequence, the J-LLP or Yugen Sekinin Jigyou Kumiai came into effect on 1 August 2005 to encourage the creation of new business ventures, joint ventures and other strategic partnerships between high tech companies and research institutions. The J-LLP provides for the introduction of a vehicle that is characterized by limited liability, a flexible organization structure, pass-through taxation, and restrictions to the free transferability of partners’ interests. Despite these attractive features, the legislation mandates a number of highly restrictive and costly features including: 1) registration of the J-LLP agreement; 2) disclosure of financial information including the profit and loss statements and the balance sheet upon the request of creditors; 3) the mandatory obligation of partners to participate in J-LLP management and its operation; and 4) the right of partners to exit at will. These shortcomings, which reflect political compromises to obtain partnership tax treatment, have arguably led to the slow start as well as the already declining use of the J-LLP. Indeed, with respect to incorporations, the J-LLC has proved the more popular and enduring structure, partly due to the possible preferable tax treatment in international transactions: The J-LLC (in contrast to the traditional KK) could opt for a pass-through tax treatment in the United States under the “check-the-box” regime. This pattern, which undoubtedly will improve the image and reputation of the J-LLC in the future, is revealed in Table 3, showing the increasing number of registrations from 2006 to 2010.

Table 3: Total Number of Registrations of Limited Liability Entities

Source: Government of Japan, Ministry of Justice

The Limited Liability Partnership in Singapore

Turning to Singapore, it has been observed that the public legislature, in order to respond to increased competition in Asia and the rapid development of China, has also enacted an LLP statute (which came into effect on 11 April 2005). The Company Legislation and Regulatory Framework Committee (CFRFC) spurred the introduction of an LLP in Singapore. The LLP reflects “the acute awareness of the need to recognize and accommodate current international business and commercial practices”.[48] The Singapore LLP (S-LLP) is a new type of hybrid form in Singapore fashioned on the Delaware LLC and the UK LLP. It is a legal entity that can sue and be sued and acquire and hold property. Like the Japanese counterpart, it offers a flexible management structure and pass-through taxation. The partners are not personally liable for the firm’s debts and obligations. Yet, the partners are personally liable in tort for their own wrongful act or omission. The internal relationship between the partners is governed by the limited liability partnership agreement. In the absence of an agreement or when the agreement is silent on a matter, the First Schedule, acting as a model agreement, will apply. Although the S-LLP is required to keep accounts and other records, it is not necessary to prepare profit and loss accounts or balance sheets nor to have them audited and disclosed.

Figure 5: Current Market Share LLP in Singapore

Source: Janus Corporate Solutions/Guide me Singapore

Initially, the implementation of the S-LLP was greeted enthusiastically by investors. In fact, the evidence shows that from 2006-2008 there were 5,234 LLPs incorporated, which was approximately eight percent of the newly established private firms registered in Singapore each year from 2006-2008. Even though this figure may appear small in absolute terms, the diffusion rate is considered a partial success due to the limitations of and limited experience with the new business form in Singapore. The continuing effects of the credit crunch on start-ups and other shareholders resulted only in a slight decline in the use of the S-LLP measured by the number of new formations (Figure 5). The dominant business form in Singapore is the Exempt Private Limited Company. Especially small and medium-sized enterprises are attracted by this business form, given its reputation, legal entity status and limited liability protection whilst simultaneously not subject to comply with cumbersome formational and operational procedures. Exempt private limited companies are, for example, not required to appoint an auditor and file audited accounts if their annual turnover is less than S$ 5.000.000. Another advantage compared to the S-LLP is that it is possible to establish sole shareholder exempt private limited companies. The S-LLP needs at least two members upon its inception.

The Limited Liability Partnership in India

The economy is growing and flourishing in India. The country is known for its highly-trained professionals and technicians. Western companies and firms are increasingly outsourcing their IT and legal services to India. Yet, the government in India is faced with a complex problem. The small and medium-sized enterprises are underdeveloped and provide only 10% of the number of available jobs in India.^[49] Against this background, the need has arisen for the modernization of the legal infrastructure. In particular the introduction of a hybrid business form, based on the UK LLP model and its separate LLP rules, should make it easier for entrepreneurs to start a business.^[50]  Although the first limited liability partnership bill was introduced in 2006, the LLP Act 2008 came only into effect on 1 April 2009. The delay seems to have provided opportunities for lawmakers to learn from the experiences in the United Kingdom.

The LLP is a legal entity with two or more partners, who, if not otherwise agreed upon, are also involved in dealing with the daily affairs of the business. Similar to the US LLC and UK LLP, the internal relationship among the partners is mainly governed by the LLP agreement. The 2009 Finance Bill has brought the taxation in line with a general partnership. This entails that the profits will be taxed at firm level. The distribution of profits is tax exempt. The LLP has at least two designated partners who are responsible for the registrations with the respective authorities. One of these partners must be resident in India. There are hardly any mandatory rules, except that the designated partners must file financial statements. An interesting feature of the India LLP is that, like in Colombia, it may be established through the Internet: the designated partners must apply for a Designated Partner Identification Number (DPIN) and a Digital Signature Certificate (DSC). The DPIN and DSC are necessary to register the LLP. After registration a trade name check will be conducted. The incorporation process is completed upon the payment of the registration fee by credit card. The website,[51] which was set-up by the Indian government, also offers assistance in drafting the LLP agreement and registering the LLP (within 30 days of the incorporation). The website contains tutorials and information about the number of LLP registrations. After sixteen months, 2265 were established. One year later (on 1 August 2011), the number of registered LLPs was 5788. The simplicity of the legislation, one of the advantages of the LLP, captured the attention of not only professionals, but also many other businesses across different sectors (Figure 6).

Figure 6: The LLP in India

Source: Government of India, Ministry of Corporate Affairs

Note: Total number of LLPs in India 5788 (1 August 2011)

IV.       Common Law or Civil Law: The Role of Corporate Lawyers

Are firms made better off by choosing to organize as a hybrid business form? As demonstrated, in making the choice for a particular business vehicle, three questions are relevant: (1) How does the statute govern the relationship between the parties inside the firm? (2) How does the statute govern the relationship between the firm and outsiders (third parties)? (3) How is the relationship between the government (society) and the firm governed? Table 4, providing a comparative overview of the hybrid business forms discussed in the previous section, reflects the answers to these questions. As for the last two questions, it is clear that limited liability protection is a common feature of the hybrid business forms. However, the accessibility, i.e., the incorporation and disclosure requirements, differs slightly among the hybrid forms. For instance, the business forms that carry the partnership name usually require two or more partners to set up the business, whereas the “corporate-type” hybrid business forms allow sole ownership structures. These variations partly explain the differences in popularity.

It is widely acknowledged that choice of entity decisions are often based on tax considerations. Consider the LLC in the United States, which became very popular very quickly due to its pass-through tax treatment. Yet, Table 4 seems to cast doubt on taxation being the most important driver behind the success of hybrid business forms. Clearly, the French and Colombian SAS, which are both treated as corporations for fiscal purposes, have become the most favourable choice of entity for non-listed firms for other considerations than a more beneficial tax status. Indeed, a closer look at Table 4 seems to indicate that the driving force behind the hybrid business forms is the concept of maximum flexibility and autonomy of the business parties (and their corporate lawyers) to structure the firm’s internal affairs as much as possible free from the established legal principles and doctrines.^[52] For instance, the fact that parties may be subject to broad fiduciary duties and partnership-type sharing principles, possibly requiring a party to forgo personal interests, could very well act as a deterrent to the establishment of international joint ventures.^[53] Also, recall that venture capitalists prefer to use convertible preferred stock in their transactions. Start-up businesses in need of equity capital cannot be expected to choose business forms that only offer mandatory and burdensome statutory measures, such as strict predefined management and ownership and control structures. This is especially true if the business form statutes – explicitly – fail to allow for the possibility to contract around its provisions by opting into a more effective organizational regime. To give an example, suppose that venture capitalists are not able to enforce their rights under a preferred stock agreement. They would become suspicious of using preferred shares and would have to look for other means to protect themselves against the downside of their risky investments. Of course, venture capitalists could structure their investments as common stock. However, common stock does not provide minority investors with special control rights when the start-up company is doing poorly and cash-flow preferences when things are going well. They would therefore be forced to acquire the majority of the common shares upon making the investment. This is usually counterproductive, as agency problems between the venture capitalists and the entrepreneur would augment. This could severely restrict entrepreneurs’ access to risk financing and other services necessary to start and grow a company.^[54] Ironically, this example shows that, particularly for firms involved in multinational joint ventures or in human capital intensive sectors, the lack of contractual flexibility could significantly increase legal uncertainty (and transaction costs) due to statutory obsolescence and ambiguity.

Table 4: Comparison: Hybrid Business Forms in Common Law and Civil Law Countries

That is not to say that contractual flexibility will automatically lead to efficiency.^[55] As noted, the new hybrid business forms have the potential drawback of being relatively new and untested entities. The fact that their statutes are inherently incomplete necessitates the involvement of corporate lawyers. Here a conundrum arises. Corporate lawyers are generally considered to be conservative, risk averse and fearful of legal change and innovation. They tend to recommend boilerplate standardized agreements and arrangements rather than customized and more optimal contractual solutions. It could therefore very well be argued that corporate lawyers contribute significantly to a “lock-in” effect in the context of the evolution and development of business forms. There are several reasons for this. Firstly, a network of court cases, legal opinions and precedents, standard articles of association and other legal materials have usually been created around existing legal business forms, providing corporate lawyers with a feeling of alleged legal certainty and comfort. Consequently, corporate lawyers tend to recommend the “standardized” legal business forms when advising their clients about incorporation decisions even if a new legal product could lead to a cheaper and more valuable business solution. Secondly, and related to this, a particular lawyer or law firm has usually invested considerable time and money in becoming familiar with an existing legal business form and its network. Obviously, “switching” from a standardized form to a new and innovative business form is costly in terms of developing a new legal network – even if it is cost-effective for clients – as it will most probably also benefit other competing lawyers and law firms generally.^[56] Thirdly, and even more important than the potential free-rider problem, promoting a new legal innovative product could, if it is later successfully challenged in court, damage the professional reputation of lawyers. This explains why lawyers tend to be risk-averse.^[57] The risk-averseness, in turn, confines corporate lawyers to a reactive “wait-and-see” strategy. Finally, and ironically, in the traditional legal environment, corporate lawyers are able to capture most benefits by recommending a sub-optimal business form to their clients. Simply consider the mismatch between the private company form in the books – with its statutory separation of managers and investors – and the usually active involvement of shareholders in non-listed companies in practice. In order to bridge the gap between the “law-in-the-books” and the “law-in-practice”, lawyers tend to generate complicated and, sometimes even, academic legal documents and provisions that hardly add any value to their clients or the business environment in general.^[58] Fortunately there are signs that corporate lawyers are in the process of altering their business models, thereby adapting to a more pro-active strategy.^[59] As corporate lawyers adopt such a new strategy, they are becoming more likely to recommend their client to use hybrid business forms. There are two examples to substantiate this statement.

The recent economic downturn shows that the “business model” that is traditionally followed by corporate lawyers/law firms is vulnerable in today’s fast-changing and international business environment. Clearly, new players, like online service providers, are rapidly entering the market for legal services that was until recently destined solely to law firms. Consider the following facts. LegalZoom is an online legal document provider, headquartered in California,[60] that was established by Brian Lu, Brian Lee, Eddie Hartman and Robert Shapiro in 2001.^[61] The mission behind the online provider is improving and simplifying the process of providing legal services, in particular the drafting of legal documents. LegalZoom also assist businesses in making choice of entity decisions. For instance, LegalZoom offers an LLC or Corporation Package for US$ 99.00. Since a corporation imposes specific incorporation and operation requirements on business parties, the LLC is probably better tailored to be sold as an online product. The LLC package not only includes assistance with the standard “incorporation” formalities, such as the clearance of the LLC name and the filing of the Articles of Association with the Secretary of State, but also with the customization of the Operating Agreement. LegalZoom developed a three-step process to assist their clients: (1) the client has to complete a relatively simple questionnaire, (2) LegalZoom will review the answers and create the Operating Agreement, while at the same time the Articles of Association will be filed with the Secretary of State, and (3) the client will receive the formation documents. The questionnaire contains questions (and assistance) about the preferred state of incorporation, the company name, dissolution requirements, management structure, transfer of ownership interests, and taxation (check-the-box). The cheaper legal services are certainly attractive to smaller enterprises in that they can now forgo a visit to a more expensive and time-consuming corporate lawyer, which charges approximately US$ 1000 for a less accessible and time-consuming service.

Evidently, it could be argued that legal services providers, such as LegalZoom, will only contribute to the popularity of LLCs among the smallest and simplest firms. Medium-sized and large enterprises, which usually retain a lawyer to assist in business planning activities,^[62] may still be more attracted to the traditional corporate form. Having a reputation of being the preferred choice of business entity for small firms could even have a detrimental effect on a wider use of LLCs in more complicated and sophisticated business transactions. The reputation of a business form is an aspect that often dominates choice of business form decisions.^[63] In this respect, the employment of the traditional corporate form radiates seriousness and confidence to the business parties. Particularly in complicated international or financial engineering transactions, the familiarity with a business form is considered to be of utmost importance. Oftentimes, these transactions are surrounded with issues that were not anticipated in advance. The parties and, especially their corporate lawyers, need an understanding how these issues will be handled. Being familiar and having experience with the corporate form, which present many similarities in the various jurisdictions, tend to make corporate lawyers more confident not only in their understanding of the used business form, but also in their discussions with local colleagues.^[64] However, as corporate clients increasingly complain about the costs and value of legal work, it becomes clear that it will be more difficult to justify choice of business form decisions by quoting the familiarity argument in the future.

Now onto the second example: there is growing criticism about the legal tools and assistance available to businesses to support their efforts to innovate in the fast-changing business environment. This is largely due to a widening “DNA-gap” between corporate lawyers and the businesses they support.^[65] Ideally, corporate lawyers should function as “transaction costs engineers”.^[66] In practice, however, it does not always turn out this way. Corporate lawyers increasingly view themselves as necessary (evil) to defend their clients against lawsuits and to lead them through the maze of cumbersome government regulations that they have to comply with. Generally, corporate lawyers do not think that the design of innovative and highly productive business models needs a visit to the legal department. Yet, there is a growing demand for lawyers who support businesses, faced with an ever-growing fierce and global competition, in their efforts to become more creative and competitive.

In this context, hybrid business forms could become an important tool for lawyers who are confronted with the technological advances and the internationalization of the economy. As we have seen, Delaware’s LLC statute gives maximum effect to the principle of freedom of contract. There is something to the introduction of an all-purpose contractual entity that can be tailored to the business needs and expectations of firms in particular circumstances. Parties in joint ventures, for instance, are likely to reduce agency problems by contracting into the preferred governance regime without necessarily taking the statutory regime into account. To give a more specific example, consider the following restructuring project: a company that contains two business units intends to sell and transfer one business unit to a third party. Business registrations and the potential for fiscal liabilities do not allow the company to immediately split-off one of its business units to a separate legal entity. Fortunately, Delaware’s LLC statute offers a solution.^[67] In 1996, Delaware became the first state to introduce the Series Limited Liability Company (Series LLC). A Series LLC offers a unique structure in which it is possible to partition the assets and liabilities between two business units. Each Series has its own assets, economic structure, members, and managers. Also, the profits, losses, and liabilities of the units are “contractually” separated, thereby creating a virtual “firewall” between the two units. Even though the Series LLC is a still-evolving business form (and the total number of Series LLC filings is relatively low) (see Table 5),^[68] its use is slowly but surely gaining prominence.^[69]

Table 5: Series LLC Filings in Three States from 2006 to 2010

Source: Adapted from Bradley and Vattamala, Series LLCs in Real Estate Transactions, 46 Real Property, Trust & Estate Law Journal (forthcoming 2011)

It follows from the above discussion that (1) the implementation of hybrid business forms and (2) pro-active corporate lawyers that embrace them to better serve their clients’ business planning activities determine the quality of the legal infrastructure available in a jurisdiction in the future. The acceptance and use of hybrid business forms are thus an indication of the innovative quality of a legal system, i.e., a legal system that is up to the challenge of satisfying the demands of the current and future business environment. Of course, new hybrid business forms can only be disruptive to the traditional legal framework (with its established doctrines and principles), if the corporate lawyers are able to capture enough benefits to justify coping with the  “legal uncertainty” surrounding the untested legal novelties. This corresponds to the findings in this paper. The history of the introduction and development of hybrid business forms indicates that if a new form is introduced and implemented at the behest of interest groups, innovative corporate lawyers promptly start establishing new networks of expertise and services around the “new legal product” (see Figure 7). This is most likely explained by the existing pent-up demand for the product, which will provide at least some economic return on the lawyers’ investment. But there is even a more interesting finding. Even if the accepted hybrid business form is still evolving, its use tends to spread rapidly across a wide range of business activities. This trend could even mark the beginning of the end of the life cycle of the traditional company forms as we know them.^[70] For instance, the UK LLP was designed to offer professional firms protection against excessive liabilities, but it is also largely employed by small and medium-sized enterprises and international joint ventures. The French SAS, as we have seen, is predominantly used by new start-up companies that require equity investors, while the first version of the SAS focused on international joint ventures.

Figure 7: The Eclipse of Traditional Company Law and the Evolution of Hybrid Business Forms and the Role of Corporate Lawyers

This brings us back to the question of which legal system, common law or civil law, offers the most flexible legal infrastructure. It has been shown that the US LLC and, to a lesser extent, the UK LLP awakened the law reformers’ interest in other countries. The Delaware LLC has even extended the statutory flexibility to give maximum effect to the freedom of contract concept, thereby enhancing the ability of corporate lawyers to experiment with the hybrid business form. While there is a growing acceptance of hybrid business forms in common law jurisdictions, such as Singapore and India, the evolution (and success) of hybrid business forms in the French and Colombian civil law systems suggests that the legal origin effect is overrated. As demonstrated, the SAS in France is currently widely considered to be an extremely business-friendly hybrid business form in Europe. In Colombia, the SAS has been a real legal revolution. It not only became the preferred business form in the first year of its existence, but it also started to erode the mandatory nature of company law in Colombia in general, offering online registration possibilities similar to LegalZoom and other websites that provide clients with incorporation assistance. However, hybrid business forms in civil law jurisdictions are less accepted when their introduction is not the direct result of interest group pressures. Apparently, the lack of an immediate market for hybrid business forms prevents the emergence of a new network of expertise and services. Without market opportunities, corporate lawyers are inclined to discourage legal reform and hence favour adhering to the traditional legal framework. The developments in Japan show that even if the legislature decides to abolish one of the existing business forms, corporate lawyers, captured by legal doctrine and other path dependence factors, tend to be slow in accepting legal innovations. It is therefore fair to say that common law systems are quicker to adapt their legal infrastructure to changing market circumstances and increased global competition.[71]

V.         Conclusion

It would be too simple and naive to suggest that the introduction of hybrid business forms alone would spur innovation and economic growth. But hybrid business forms can become an important tool in the legal infrastructure of the future. If public legislatures give maximum freedom in the choice of governance arrangements, these new business forms will allow corporate lawyers to provide legal services that better match the needs of the business community in its efforts to excel and innovate in the ever-changing global market place.

In the United States, state legislatures have embraced hybrid business forms to improve the legal infrastructure and business environment. Interest group pressures and the competitive incentives of not losing local filings to other states have moved legislatures into hasty action. The expansion of new business forms appears to be based on compelling logic: it allows firms easy access to a range of governance structures designed to provide limited liability, reduce complexity and limit transaction costs. Recently, public legislatures in other jurisdictions have also, inspired by the success of the LLC in the United States, introduced hybrid business forms. Generally, these business forms seek to facilitate the emergence of innovative contractual arrangements to efficiently structure the internal relationship between parties inside a wide range of firms as well as the relationship between these firms and their outsiders. Increased pressures of competition make it likely that similar reforms will, sooner or later, be introduced in other slow-reform countries.

Let us conclude with our broader point. One of the goals in this paper was to assess whether common law systems outperform their civil law counterparts in terms of legal innovation. To test this hypothesis, we have attempted to strengthen our understanding of the introduction and acceptance of new hybrid business forms in both common law and civil law jurisdictions. We have found that interest group pressures play a pivotal role in the success of hybrid business entities in both common law and civil law jurisdictions. Without these pressures, the chance of successfully introducing new business forms outside the established company law framework and doctrines decreases more significantly in civil law countries. The reason for this is that, in general, common law corporate lawyers appear to be more pro-active in terms of anticipating their clients’ needs. It is therefore fair to say that the common law systems tends to be more open to legal change and innovation.

1. Introduction

The concept of international competition law has gained common usage in the academic world and more in specific in the English literature on competition law. With the publication of books like International Competition Law[1] and Emerging Principles of International Competition Law,[2] a trend has been set in the development of a new discipline within competition law. The former work describes international competition law as an agreement that should be adopted within the WTO framework. At the end of the book, a possible model of a competition law agreement for the WTO regime is given. In doing so, the book indicates that international competition law is still de lege ferenda.[3] By using “emerging principles” in the title, the latter work seems to partly confirm this point of view. International competition law is emerging, but it is not yet a fully grown discipline within competition law due to the absence of any action within the WTO.[4]

This paper will question whether international competition law does not yet exist in today’s world or whether it is just an emerging discipline. This question will indirectly affect the presumption of whether a WTO agreement is necessary in order to speak about international competition law.[5] Indeed, it is necessary to investigate what is exactly meant by the word ‘international’. If this word refers to a discussion of norms that are the sources of public international law, international competition law may well be in the realm of the WTO or any other treaty.[6] If this word, to the contrary, refers to the subject dealt with, international competition law may well be that part of domestic competition law dealing with its territorial scope.[7]

The discussion on whether international competition law actually exists and what the content could be of this discipline, resembles the early discussions on the development of international criminal law as a discipline within criminal law.[8] As the content of international criminal law has gradually developed to a reasonably defined content, the analysis of what international competition law is or could be will draw on a parallel with international criminal law.[9] More in specific, this paper will have to investigate to what extent there have been similar developments in a competition law context as there have been in a criminal law context that have led to the discipline of international criminal law. For this purpose, the paper will introduce a categorization of Georg Schwarzenberger in relation to international criminal law.[10] Note, however, that it is not the purpose of this paper to give a detailed list of examples of competition law for each of the developments in competition law.

The paper will be structured as follows. Section 2 will introduce the categorization in international criminal law as has been conceptualized by Schwarzenberger in his article The Problem of an International Criminal Law.[11] This categorization reveals six different meanings of the concept international criminal law. Based on these six meanings, Section 3 will describe whether there have been parallel developments within competition law. Hence, this section will investigate into the international scope of domestic competition law, the international cooperation for the enforcement of domestic competition law, the internationally prescribed or authorized competition laws or the existence of international substantive competition law. In Section 4 will then theoretically frame the concept of international competition law as it exists today. As a conclusion, this paper will state international competition law exists. However, the existing international competition law has two rather than one dimension.

2. International Criminal Law and Its Six Meanings

International criminal law has gradually been recognized as a separate discipline within criminal law. At the formative stage of this discipline, it was far from clear what was meant by international criminal law. Schwarzenberger identified not less than six senses in which the term has been used.[12] International criminal law has been used to refer to a State’s domestic law laying down the spatial scope of its criminal law.[13] The term has also been used to indicate the instances in which a State is bound by international law to visit the sanctions of its domestic criminal law upon certain acts.[14] Slightly different with the previous understanding, international criminal law can be the internationally authorized domestic criminal law.[15] Substantive domestic criminal law has also been considered as international criminal law in so far as the offences are common to all civilized nations.[16] Bilateral and multilateral treaties relating to cooperation in criminal matters is another aspect of international criminal law.[17] Finally, international criminal law could be understood in a material sense, i.e. a body of international law proscribing the acts that strike the roots of international society.[18]

The categorization of Schwarzenberger is very detailed. Each different aspect has been presented as another understanding of the term international criminal law. A much broader categorization is possible by looking at the source of international criminal law. Schwarzenberger’s categorization reveals that there are mainly two different sources of international criminal law, domestic criminal law and public international law. International criminal law stemming from domestic law focuses on the international aspects of criminal law. If the sources of international criminal law public international law instruments are, the term emphasizes the criminal aspects of international law. The former encompasses the State’s laws laying down the spatial scope of its criminal law and the competence of its courts.[19] The latter involves internationally prescribed and internationally authorized criminal law. In these cases, a customary or treaty based rule obliges or empowers a state to enact a crime in its domestic criminal law, to punish offenders or to cooperate with other States in criminal matters.[20]

For the further analysis of the concept of international competition law, this paper will rely on the detailed categorization of international criminal law rather than on the one based on the sources of it. The detailed categorization allows drawing more precise conclusions as to the state of development of the concept of international competition law.

3. Six Meanings of International Competition Law?

3.1. The Territorial Scope of Domestic Competition Law

Kingman Brewster, researching on the relationship between national jurisdictional rules and public international law, formulated his view that “since there is no binding external authority to which the United States has submitted these questions, any limitation, in the last analysis, is self-imposed. In that sense, the decision to restrict jurisdiction is a matter of national policy, not sovereign power.”[21] The answer given by Brewster seems to be inspired by the fact that “international legal tribunals have not set a positive limitation upon the power of a state to regulate conduct abroad.”[22] This suggestion thus seems to be that this area of national jurisdiction is unregulated by public international law, or in other words that the States are free to exercise their powers and regulate in this area without any limitations of public international law.

This analysis leans very closely to the judgment of Permanent Court of International Justice (PCIJ) in the Lotus case (1927).[23] In this case, the PCIJ decided that neither a permissive rule nor a prohibitive rule exists within legislative jurisdiction. Public international law leaves the States with a wide measure of discretion, only limited by prohibitive rules in certain cases.[24] In other words, there is no general principle limiting the exercise of legislative jurisdiction by a State. The very existence of this discretion, the PCIJ argues, is the reason why a great variety on rules has been adopted without objections or complaints of other States. Moreover, the PCIJ noticed that States prepared conventions to minimize the effect of the discretion, which, according to Erik Nerep, implies that if there were prohibitions on jurisdiction such efforts would have no sense.[25]

Whether public international law really lets the field of legislative jurisdiction unregulated, has been the subject of vigorous debate among scholars.[26] Much of the debate started with the judgment of Judge Learned Hand in United States v. Aluminum Company of America Ltd, introducing the famous, or should we rather say the infamous, “effects doctrine.”[27] With this doctrine, Hand broke with the long established jurisdictional rule that jurisdiction was depended on the place where an action took place. Instead, he introduced effects as the basis for jurisdiction.

Judge Learned Hand perceived it for settled law[28] that “any state may impose liabilities, even upon persons not within its allegiance, for conduct outside its borders that has consequences within its borders which the state reprehends.”[29] In the next paragraph, Judge Leaned Hand further explained his view on unintentional consequences. As to these unintentional consequences, agreements that unintentionally produce mere repercussions or agreements that do not produce intended effects on the United States market, fall outside the scope of agreements for which a State may impose liabilities.[30] All these elements describe the effects doctrine formulated by Judge Learned Hand.

As states reacted against the use of the effects doctrine as a jurisdictional rule, other jurisdictional rules were developed in order to claim jurisdiction over anticompetitive behavior located the borders of the state but having effects within. Two alternatives have been developed, the theory of the economic unity of the enterprise,[31] also referred to as the attributive theory,[32] and the implementation theory.[33] Even though these theories are less controversial as they keep territorial links, they enable a state to take jurisdiction over nearly all anticompetitive behavior that not really occurs within their territory.

The theory of economic unity of the enterprise starts from the presumption that a parent company and its subsidiaries form one economic unity. This presumption allows imputing conduct of the subsidiary to the parent company.[34] Parent companies making the decision to engage in anticompetitive behavior with effects within the territory of a state in which they are not located could not be punished for the decision based on the territoriality principle. However, the courts and antitrust enforcement agencies decided that not to base the jurisdiction on the intellectual decision leading to the anticompetitive effects. Instead, they looked at the conduct of the subsidiaries. This conduct, being the implementation of the intellectual decision of the parent company, was the basis for jurisdiction. Via the unity of the enterprise, this conduct could be imputed to the parent company.[35]

Since the theory of the economic unity of the enterprise did not allow taking jurisdiction in the absence of a subsidiary, the competition authorities looked for another construction to overcome this problem. The EU Commission, more in specific, was confronted with this problem in the Wood Pulp case.[36] To establish jurisdiction, the Commission relied on the effects doctrine, but the European Court of Justice (ECJ) overturned it. The ECJ, instead, decided to make a distinction between the formation of a contract and the implementation thereof.[37] Basing jurisdiction on the place where the contract is formed, the ECJ concluded, would enable any company to evade the prohibitions of the competition law.[38] Therefore, the basis for jurisdiction should be the place where the contract is implemented. Competition authorities of other countries, among which Japan,[39] adopted this analysis.[40]

3.2. International Cooperation in Administering Domestic Competition Law Enforcement

Due to unclear borders put by public international law on legislative jurisdiction, the scope of application of domestic competition law expanded gradually. This did not only cause issues of extraterritorial application of competition law, but also of enforcement jurisdiction and concurrent jurisdiction. As it is not within the scope of the paper to discuss the former, the focus will be on enforcement jurisdiction and concurrent jurisdiction. The issue with enforcement jurisdiction is governed by the territoriality principle, hampering investigations and enforcement.[41] The issue with concurrent jurisdiction is the potentiality of being confronted with different legal frameworks, out of which political tensions can grow.[42]

In response to the growing problems related to the international application of domestic competition law, States recognized that it would be mutually advantageous to cooperate in fields of conflicts of competition law.[43] It would not only eliminate various jurisdictional issues, but also problems associated with the gathering of information. Focusing only on the binding bilateral instruments, three different types of agreements have been concluded. One type of agreements seeks to avoid and manage jurisdictional disputes between national competition enforcement authorities.[44] Another type of agreements relates to co-operation of competition law enforcement.[45] Still another type of agreements deals with technical co-operation.[46]

The early agreements aiming at avoidance and management of jurisdictional disputes mainly require from its contracting parties that they notify and consult each other whenever they engage in an investigation or adopt a competition policy that may affect the other’s laws, policies or national interests.[47] During these consultations, the parties agree to give due regard to each other’s sovereignty and to considerations of comity. Concretely, this kind of agreements aims at prevention of conflicts by talking through potential conflict issues, and so calling for restraint and moderation on the part of the competition law enforcement authorities.[48] This kind of comity is also known as traditional comity.[49]

The notions of sovereignty and comity did not immediately eradicate all the issues arising from concurrent and extraterritorial jurisdiction. These notions mitigated potential conflicts, but did not provide much assistance in cases without any conflict. Hence, a new generation of agreements started to pay attention to cooperation and coordination in cross-border enforcement efforts.[50] More specifically, these agreements deal with the assistance of locating and securing evidence and witnesses. Furthermore, this generation of agreements incorporates also the notion of positive comity,[51] meaning that each party can ask the other to enforce its competition laws against local conduct that adversely affects the other’s interest.[52] The notion of positive comity is part of most of the recent bilateral cooperation agreements, even though the words are not expressis verbis used.[53]

Geo-political changes and a gradually progressing liberalization caused a shift in many states in their stance towards competition law and policy. These changes brought about a proliferation of competition law throughout the world. In order to implement an effective competition law, many bilateral cooperation agreements incorporated the commitment to provide technical assistance related to the implementation of competition law and policy.[54] The technical assistance can take various forms, such as training sessions, lectures or the exchange of personnel.[55]

It is obvious that the raison d’être for these bilateral cooperation treaties, at least for the first two categories, is the territorial limitation of national sovereignty in cases of enforcement of the law. Without these international cooperation agreements between states, it would be relatively easy to defy the domestic competition laws of most states with relative impunity. Thus, the very purpose of this type of treaties is to strengthen and lengthen, on the basis of reciprocity, the arms of national justice. Hence, just as it is in the case of international criminal law, these treaties are not concerned with the substance of domestic competition law, but with the administrative question of foiling attempts to evade the due course of domestic competition law.[56]

3.3. Competition Law Common to All States

Different states can regulate certain behavior because of they share an identical view towards such a behavior. The general noxious character of the behavior is perceived by these states as enough ground to regulate and punish it.[57] Whereas it is probably not so difficult to find examples in field of criminal law, it will be much harder in the field of competition law. This has not only to do with the history of its proliferation, but also with the conceptualization of this field of law in each country.

The idea of adopting competition law grew almost parallel in the United States and in Europe, more in specific in Austria.[58] However, due to political events, further development of competition law ideas in Austria where blocked and it was not until the end of the Second World War that the basis for a competition law in Europe at the national and supra-national level.[59] Japan was forced to adopt a competition law around the same time.[60] It took another fifty years before the idea of adopting competition law really spread throughout the world. At present, nearly states have a competition law in place.[61] The historical absence of competition law in many states alone casts doubt on whether there is competition law common to all states.

The proliferation of competition law did not mean the adoption of uniform competition law throughout the world. The only issue on which most states agree within the field of competition laws is the regulation of the most egregious hard core cartels.[62] Other issues within competition law are marked with differences. To name a few, the United States approach towards the categorization of horizontal and vertical agreements infringing competition law is different than the European Union.[63] While the United States has a judicially developed per se rule and rule of reason, the European Union has a codified equivalent that substantially allows for different outcomes.[64]

The goals behind competition law have also implications on how infringements are judged. The economic efficiency goals determine much of the United States competition policy and so the interpretation of the competition law. Territorial division of the market will in this context be approached from an economic efficiency perspective. In other words, this agreement to divide the market is not necessarily an infringement.[65] In the European Union, on the contrary, the situation is different due to the important goal to realize an internal market. Any agreement that hampers this goal, will be regarded as illegal and agreements to territorially divide the market have the nature to hamper this goal. Therefore, these are treated as infringements of the European competition law.[66]

Further, the economic efficiency goal is represented by different economic schools of thought. These different economic schools are not necessarily consistent with each other.[67] Predatory pricing in a Harvard School context will be easily regarded as an infringement of competition law,[68] while in a Chicago School context the result will most likely be the opposite.[69] Game theory has come up with views due to which a predatory pricing strategy has most likely to be scrutinized closely in order to determine whether it is an infringement or not.[70] Hence, it locates itself in between the Harvard and Chicago School. The European Union has opted for the former,[71] while the United States for the latter.[72]

The many differences already existing between the United States and the European Union exponentially grow when all competition laws currently in place would be compared. This divergence of approaches to competition law issues only fortifies the conclusion drawn a little earlier. Competition law common to all states is as good as non-existent. This already reveals that states do not share the same principles in relation to competition law and policy and that these states do not consider it opportune to assimilate to a common standard. Whether this is the case, further study of activities at the international level have to be investigated.

3.4. Internationally Prescribed Domestic Competition Law

3.4.1. Soft Law Approaches

Public international law, either by treaty or by custom, can oblige a state to apply its domestic law to certain forms of behavior.[73] Given the absence of a competition law common to all states, revealing the willingness of states to adhere to sovereignty over their competition law, it is most likely that internationally prescribed competition law does not exist either. An obligation to apply its domestic competition law to certain forms of anti-competitive behavior, would most likely have the effect of creating a competition law common to all states. However, this does not necessarily mean that no initiatives have been taken to achieve this goal.

Indeed, several international initiatives have been undertaken to formulate a common language for some competition law issues. However, the instruments that came out of these initiatives have never superseded the stage of soft law. States are thus not obliged to implement any of the prescriptions made in these instruments. The prescriptions are mere recommendations or guidelines. There exists, among others, the OECD Recommendation Concerning Effective Action Against Hard-Core Cartels[74] and the UNCTAD Set of Multilaterally Agreed Principles and Rules for the Control of Restrictive Business Practices.[75] Both instruments, even though in different wordings, encourage states to adopt legislation aiming at effectively eliminating hard-core cartels or restrictive business practices respectively. Definitions of prohibited business behavior are provided in the respective instruments.[76]

3.4.2. Prescriptions within the WTO System

International competition law literature often investigates to what extent the WTO system regulates competition and more in specific on private anticompetitive behavior that impedes market access.[77] Due to the nature of the WTO as a public international law instrument, this is not self-evident. The subjects of the WTO system are states and the actions of their governments, not private companies and their business behavior. The consequence hereof is that the WTO can have only an indirect impact on anticompetitive behavior of private companies. Via an obligation for states, the WTO can have an influence on private anticompetitive behavior.[78]

Several types of WTO rules are relevant for competition. First, some WTO rules require states to address private anticompetitive behavior. These include both weak and general obligations and hard and sector-specific obligations.[79] Article IX of GATS exemplifies the former. This article requires states to enter into consultations in order to eliminate business practices of service suppliers that may restrain competition.[80] In relation to the latter, it is worth to refer to the telecommunications sector. The additional commitments to the Fourth Protocol to the GATS, the so-called Reference Paper,[81] stipulate that a state has to take appropriate measures to prevent major suppliers from engaging in or continuing anti-competitive behavior.[82]

Second, several WTO rules affect how states may regulate anticompetitive behavior.[83] The basic WTO non-discrimination principles of national treatment, most-favored-nation treatment, and transparency prevent states to make uncontrolled use of their competition laws.[84] Article III:4 of the GATT[85] and Article XVII of the GATS,[86] for example, may be used to argue that the application of a competition law is a violation of these respective WTO agreements because of giving benefits to domestic companies while denying them to foreign companies. The TRIPS agreement also imposes the requirement of national treatment on its member states in Article 3. Hence, the measures that member states can take within the framework of TRIPS, such as in relation to anti-competitive practices under licensing agreements.[87] The Antidumping Agreement, in combination with GATT, forces a competition law to expand its rules on price discrimination and predatory pricing to all forms of price discrimination and predatory pricing to allow them to incorporate various forms of sanctions.[88]

Third, WTO rules also control the governments’ encouragement of anticompetitive conduct.[89] Again, this kind of WTO rules does not aim at the practices of private companies. Not private conduct, but government conduct short of legal compulsion is envisaged by this kind of WTO rules. Via GATT Article XI:1, a control mechanism is set up to control a state’s involvement in import and export control and boycotts.[90] GATS seems to limit, via article XVI, the possibility of a state to limit the number of service suppliers in the market.[91]

3.5. Internationally Authorized Competition Law

Slightly different than in the previous case, public international law may not oblige states to act in a certain way, but rather empower them to act regarding certain anticompetitive behavior. In other words, this understanding of international competition law looks for rules that recognize the right of states to take action against certain anticompetitive behavior.[92] Parallel with our findings above, examples of this kind of rules may be found in the WTO agreements. Indeed, the TRIPS agreement authorizes states to take measures against anticompetitive behavior.

Article 8 TRIPS recognizes that national measures may be needed to prevent “the resort to practices that unreasonably restrain trade or adversely affect international technology transfer.”[93] Other articles further specify this Article 8 TRIPS. One of the most important articles for the purposes of this paper, is Article 40 TRIPS. This article allows states to prevent and regulate licensing practices and conditions that restrain competition. Examples of these licensing practices and conditions are exclusive grantback conditions, coercive package licensing or contract terms that prevent challenges to the validity of a patent.[94]

Even though the origin of this competition law provisions is international, the actual provisions are domestic law. The domestic law can differ from state to state, since TRIPS does not specify the content of the measures to be taken. On the contrary, TRIPS leaves a lot of discretion to the states. The discretion given to the states does not only relate to adopting measures or not, but also to the content. Hence, it is unlikely that uniform rules develop out of this practice of internationally authorizing domestic competition law.

3.4. International Competition Law in a Substantive Sense

These trans-border anticompetitive effects have been close to be regulated in the past by an agreement when in March 1948 the International Trade Organization (ITO) Charter was adopted in Havana.[95] The ITO Charter, also known as the Havana Charter,[96] contained provisions on restrictive business practices (Articles 46-56). In these ten articles, the Havana Charter did not only ask its Member States to take appropriate measures to prevent restraints of competition, limit market access or foster monopolistic control, but also set up a mechanism to deal with disputes between Member States in relation to these issues.[97]

When the US President finally decided in 1950 not to submit the Havana Charter to the Congress, the ITO died. Together with the ITO also the idea of establishing an international competition law did not disappear completely.[98] After the failed attempts to make the Havana Charter’s competition policy principles part of GATT, the ball was passed to the United Nations to try to draft a convention on restrictive business practices.[99] The first draft was completed in 1953 and presented to UN Economic and Social Council. With an international competition law agency and an internationally limited scope of substantive provisions, a step was set in the direction of a substantive international competition law. Out of a fear that smaller states would be passing judgments on US business practices, the United States withdrew its support.[100]

A private initiative working out a substantive competition law followed in the early 1990s.[101] A group of academics, the International Antitrust Code Working Group, also known as the Munich Group, published on 10 July 1993 the Draft International Antitrust Code (DAIC).[102] The DAIC was intended to be a model for a plurilateral agreement in the WTO. Besides guidelines for national legislation, the DAIC contained principles and minimum standards for the application of as well as a dispute settlement mechanism. The project was criticized for being too ambitious, as it included substantive law provisions.[103]

The discussions for an international competition agreement went on at the governmental level until the moment the agenda for the Doha Round had to be determined.[104] The general view that an international agreement under the WTO would be preferable was barely translated into the Doha Development Agenda.[105] WTO would only aim at instigating its member states to adopt provisions prohibiting hard-core cartels and to strive to reach an agreement on the core principles of domestic competition law, such as transparency, anti-discrimination, and due process. Further, the WTO also aimed at facilitating co-operation between competition authorities worldwide.[106]

Historical precedents have shown that a substantive international competition law is hard to attain. Therefore, the Doha Development Agenda tried to achieve a less ambitious agenda in relation to competition law. However, the further development of the Doha Development Agenda in Ministerial Conferences has shown that it is even difficult to reach an agreement on a minimalist approach.[107] Therefore, it is probably safe to conclude that a substantive international competition law on a world level may not be for the near future. This does not mean that on a regional level, like in the EU, such substantive internationalization attempts may be more successful.

4. The Case of International Competition Law Today

4.1. National Jurisdictional Rules as International Competition Law

States have engaged in applying their domestic competition law to competition law cases with a foreign element. Due to the foreign element involved, it could be said that a problem of Conflict of Laws presents itself. Conflict of Laws has evolved as a body of law to deal with legal problems resulting from situations containing foreign elements. At this stage, we need to incorporate a note of caution. Conflict of Laws has been developed as a system that incorporates any legal problem holding a foreign element. The continental equivalent of this Anglo-Saxon legal concept, private international law, deviates slightly. Private international law is said to cover only civil legal problems holding a foreign element. A subsection for public legal problems holding a foreign element is not included in private international law. Both legal systems have thus a different approach towards the present problem. Since competition law has a public law character, this distinction has to be made.

In the civil law systems, public law is not part of private international law. The reason for not conceiving public laws as a component of private international law is to be found in the maxim that courts of one nation do not apply the penal laws of another.[108] A national court determines only whether the lex fori is applicable or not. In other words, the courts determine whether they have subject matter jurisdiction. Since private international law does not include this as a subsection, new terminology has been developed for the purpose of covering this area of law. Under the influence of mainly civil law scholars, this field of competition law has been named ‘international competition law” or “international antitrust law.”[109]

Lawyers from civil law countries have created the concept of international competition law in the sense just described. The civil law origin may explain why this understanding of international competition law has not really rooted in common law countries. However, even in civil law countries, the use of international competition law is still peripheral. Rather than using the term international competition law, lawyers from civil law countries prefer to terminology of extraterritorial application of competition law or international dimensions of competition law.[110] Furthermore, French literature has made a distinct terminology for referring to this problem. Rather than calling this area international competition law (le droit international de la concurrence), they call this area the law of international competition (le droit de la concurrence internationale).[111]

Nevertheless, there is much to say for the use of international competition law. The jurisdictional rules determine the territorial scope of competition law. They specify the circumstances in which antitrust provisions that exist under domestic competition law will be applied to anticompetitive behavior involving a foreign element. Both the competition law aspect and the international element are represented by these jurisdictional rules. Therefore, pursuant to other fields of law, like criminal law or tax law, there is much to say for calling these jurisdictional rules international competition law.

4.2. Network Model as International Competition Law

By concluding the bilateral cooperation agreements, a new institutionalized model started to govern competition law. This new model has been termed the network model.[112] Instead of different states’ antitrust enforcement authorities that exist next to and separate from each other, the antitrust enforcement authorities find themselves in cooperative relationship with each other.[113] The bilateral cooperation agreements externalize this relationship.[114] However, one should not be blind for the cooperation between the antitrust enforcement authorities that are not included in the bilateral cooperation agreements. Since other antitrust enforcement authorities then the one mentioned in the agreements have no formal way of cooperating with each other, cooperation and coordination exists among the several intrastate competition enforcement authorities as well.[115] Some of the networks are managed through formal protocols, others are based on less formal contacts.[116] The result is that there is a domestic enforcement network transgressing borders, due to which the international competition law gets a “decentralized and less hierarchical outline than that political boundaries would otherwise indicate.”[117]

International competition law as a network model has no substantive content. Nevertheless, the network model can be termed international competition law for various reasons. First, the network model is a part of competition law. It enables competition law enforcement authorities to enforce their domestic competition law effectively to trans-border competition cases. Second, the network model is international. Indeed, the network model deals with competition law cases that have an international character. What is more, the network model is mainly based on international law instruments.

4.3. Principles and Guidelines as International Competition Law

The application of domestic competition law to trans-border competition law cases does not happen in an international legal vacuum. Indeed, the WTO agreements provide several restraints or guidelines on how domestic competition law should function in an international context.[118] The WTO agreements provide with the non-discrimination principles of national treatment, most-favored-nation treatment, and transparency a start of a check and balances on the international application of domestic competition law. Further, some WTO provisions guide states in the conceptualization of parts of their domestic competition law.

The principles and guidelines developed in the international trade framework affect domestic competition law, so establishing a link with this field of the law. The effect of the former constitutes restraints on states’ discretion in applying its domestic competition law, and is thus not substantive competition law. The link to competition law of the latter is established by allowing states to legislate in relation to certain anticompetitive behavior. This permission does in no way constitute substantive competition law. The substantive competition law has to be created by the respective WTO member states.

These principles and guidelines do not simply belong to domestic competition law. The source of these principles and guidelines is the WTO and its different agreements. Hence, a public international law instrument is the basis of these principles and guidelines. Further, these principles and guidelines specify states’ conduct in relation to competition law issues that are not limited to one state. In other words, a foreign element is always present in the competition law cases to which these principles and guidelines apply.

5. Conclusion

International competition law does exist today. This paper has found three different dimensions of international competition law. First, jurisdictional rules determining to which trans-border cases the domestic competition law will apply. Second, for an effective domestic enforcement, the enforcement authorities need to rely on networks with domestic enforcement authorities of other states, established in bilateral cooperation agreements. Third, to avoid excesses for the international business community, non-discrimination principles govern the use of domestic competition laws in trans-border cases.

Even though all these dimensions deal with a certain international aspect of competition law, none of them lays down rules of substantive competition law. They, complementary to each other, deal with the territorial scope of application of domestic competition law, the way this extraterritorial application of domestic competition law can be facilitated or the way to avoid discriminatory excesses by the extraterritorial application of domestic competition law. The link with competition prevents that international competition law becomes a misnomer.

Domestic competition law is in all three dimensions of international competition law important. Again, the prevalence of domestic does not mean that international competition law is a misnomer for this reason. The international aspect is present in each dimension, either in the form of trans-border anti-competitive conduct or in the form of an international legislative instrument.

Further, out of the three dimensions of international competition law, only one relates to the WTO. This paper has classified this form of international competition law as principles and guidelines. Any other form of WTO related international competition law does still not exist and is still merely a suggestion de lege ferenda.

Insider trading – the trading of publicly listed securities based on material, non-public information – has long been the source of controversy and debate amongst Anglo-American criminal law scholars. On the one hand, are those who regard the criminal sanction as being necessary and appropriate on the grounds that such transactions are (i) economically harmful (mainly because they undermine investor confidence in the integrity of the securities market and hence have a “chilling effect” on potential investors) and/or (ii) morally wrongful (in that they are unfair and violate a duty owed either to the shareholder from whom the stock is purchased or the source of the confidential information). Although there are alternatives to the criminal law, such as the imposition of some form of administrative sanction, a preference for criminal liability remains the dominant view of those jurisdictions in which the major capital markets are located.

On the other hand, however, are those legal scholars such as Henry Manne who subscribe to Nobel Prize winning economist Milton Friedman’s view that “what is needed is more insider trading and not less”, and have advocated the repeal of this kind of securities fraud statute.[1] Advocates of decriminalization suggest that insider trading is economically desirable because (i) such transactions make securities markets more efficient by causing market prices to reflect more complete and accurate information about the real value of securities, and (ii) that the benefits of such transactions are a legitimate form of executive compensation that enhances corporate decision-making and performance. Given the positive economic consequences of such transactions, proponents of insider trading regard it is as somewhat churlish to think of it as morally wrong.

This paper does not intend to offer an in-depth examination of this well-trodden debate. Rather, it will instead focus on critically evaluating a recent and original contribution to the discussion, namely Stuart Green’s book Lying, Cheating & Stealing: A Moral Theory of White-Collar Crime (Oxford University Press, 2006, hereinafter LCS). Specifically, this paper will address Green’s argument that insider trading is morally wrong and that this moral wrongfulness is best conceptualized as a form of cheating. From the outset, it is worth emphasizing that the scope of LCS is much broader than insider trading. The chapter on insider trading is brief and offered as an illustration of a more general argument rather than a fully developed contribution to discussion on securities fraud. The main focus of LCS is rather to investigate the moral foundations of those parts of the criminal law that regulate “white-collar crime”, e.g. fraud, false statements, obstruction of justice, perjury, extortion, blackmail, tax evasion, and insider trading. More specifically, Green explores the complex relationship that exists between white-collar criminal law and everyday moral norms. The central contention of LCS is that criminal law norms both as a matter of fact, do, and, as a matter of policy, should, closely track everyday moral norms, such as lying, cheating and stealing. Section 2 of this paper offers an overview of Green’s general argument and a discussion of its application to insider trading.

One of the stated aims of LCS is to provide practical guidance in determining the legitimate scope of the criminal law, particularly in so-called “hard cases”. Debates on insider trading are littered with examples of these hard cases, most obviously the “moral luck” cases (i.e. cases where the non-public information is obtained purely by chance) or the “dedicated broker cases” (where a resourceful broker receives non-public information via a “tip off” that she then confirms though her own skill and effort). Rather than assess Green’s theory based on its ability to satisfactorily resolve these formulaic insider trading cases (which anyway can be found in LCS), this paper will instead consider a recent, high profile Japanese case, namely the 2005 conviction of Yoshiaki Tsutsumi, former head of the Seibu corporation, and (at least according to Forbes magazine) the holder of the dubious distinction of being the “world’s richest man” for the period from 1987-1990.[2] Section 3 will introduce the main facts of the Tsutsumi case and the legislative framework in Japan.

The facts of the Tsutsumi case are a little unusual, at least compared with cases discussed in the English language literature on insider trading, and it will be suggested that it represents a “hard case”, albeit of a different kind to those mentioned above. As such, Section 4 of the paper will seek to ask whether Green’s framework can advance our understanding of the Tsutsumi case or whether the Tsutsumi case exposes difficulties in Green’s account of insider trading as cheating? The paper will not offer a comprehensive critique of LCS, but will instead focus one problem that can be usefully illustrated via of discussion of the Tsutsumi case.

Before proceeding to the substantive discussion, it is worth pausing to reflect on one possible objection to this paper, namely the choice of Japanese law and a Japanese case in the context of an evaluation of a book ostensibly focusing on Anglo-American law. Of relevance here is the general level at which Green himself frames his argument. He points out in the Introduction that the book’s focus on US and English law should be viewed as a “starting point” and that: “[t]he attempt is to find, to the extent possible, a more universal conception of these key white-collar crime offenses, or least to identify where different systems define them differently” (my emphasis).[3] As such, Green seems to invite research that focuses on white-collar crime in other jurisdictions. Having said that, the principle intention of this paper is not to advance our understanding of Japanese law, but to use the Tsutsumi case for an evaluation of Green’s argument that the everyday norm of cheating can help us identify what is morally wrong with insider trading.

2. STUART GREEN ON THE MORAL CONTENT OF WHITE COLLAR CRIME

2.1. Background to LCS

LCS is a comprehensive and thought provoking examination of the “moral foundations” of white-collar criminal law. The book is to be welcomed for various reasons, not least because it is the first time that one of the “major players” in contemporary Anglo-American criminal law theory has devoted significant attention to the issue of white-collar crime.[4] As such, it is not surprising that the book has been well received by academic commentators. Rather more unusual, however, is the attention of the mainstream media: LCS achieved the rare distinction for an academic criminal law text of a Wall Street Journal review.[5] In part, this reflects the timeliness of the book’s publication. In the wake of recent political and corporate scandals, public perceptions of crime are no longer exclusively dominated by images of an urban underclass but increasingly involve the illegal activities of corporate executives, managers and political elites. The collapse of Enron, for example, provided a compelling narrative of managerial greed and injurious loss that captivated global public attention and came to symbolize the problem of corporate crime in the United States. High profile white-collar crime cases have also occurred in many other countries, for example, the Livedoor securities fraud case in Japan, and the Lee Ming Tee case in Hong Kong. It is clear that LCS taps into the renewed global interest that currently surrounds white-collar crime and corporate wrongdoing, more generally.

2.2. Overview of the main arguments of LCS

2.2.1. Defining white-collar crime

The term “white-collar crime” was first used by Edwin Sutherland in his December 27^th 1939 presidential address to the American Sociological Association. Sutherland spoke of “crimes committed by a person of respectability and high social status in the course of his occupation”, and castigated social scientists and legislators for their neglect of the wrongs of the powerful. And yet, as Green points out, almost seventy years later there is still widespread disagreement and uncertainty among sociologists, criminologists, legal professionals, and legal scholars regarding the precise meaning of this often used concept. LCS begins with a brief overview of these definitional debates.[6]

Green suggests that the debate is framed by three questions: first, whether the term white-collar crime should be limited to crime only or should include non-legal forms of immoral behavior? (The definition of crime debate); second, whether it should be defined by reference to characteristics of defendants or the acts they commit? (The act or actors debate), and third, if the latter, what factors should determine which criminal acts quality? (The quality of the act debate). In answering each of these questions, Green defends (contra Sutherland) a legalistic approach arguing that white-collar crime should be limited to crimes as defined in the criminal law, excluding other kinds of illegality or wrongdoing. Green also rejects definitions that focus on offenders’ rather than offences as such an approach would clash with “deeply rooted equal protection type norms”.[7] He then considers existing act-centered definitions that seek to precisely delimit white-collar offences but he concludes that they are mostly unhelpful. This is because such definitions seek to provide an all-encompassing list of conditions that all white-collar crimes must satisfy. Green suggests that “we are bound to be disappointed” if we conceptualize white-collar crime in this way.[8]

Equally, Green does not believe that such an “evocative” and “indispensable” term should be abandoned (although he is little unclear as to why exactly other than the fact that most US law schools offer J.D. courses on white-collar crime). Instead, he proposes what he calls a “family-resemblance” approach in which white-collar offenses are “loosely defined” by an overlapping web of similarities (and differences). These similarities include (but are not limited) to the fact that such offences involve non-violent means; incorporeal, non-specific harms that may be difficult to identify and are often indistinguishable from harm caused by lawful conduct; they affect victims who it may be hard to identify; they can be committed by corporate entities as well as real persons; they are often not criminalized in general criminal code but special statutes; and they tend to involve well-resourced and highly motivated defendants. Although he never offers a definitive list of white-collar offenses, Green seems to be referring to fraud, false statements, obstruction of justice, perjury, extortion, blackmail, corruption, tax evasion, securities fraud, and various regulatory offenses. Green covers many issues in the short first chapter but his “family resemblance” approach represents an interesting contribution to the conceptual debate on white-collar crime.

2.2.2. Moral ambiguities of white-collar crime

According to Green, one of the most important characteristics (“family resemblances”) that distinguish white-collar offenses from other crimes is doubt as to the moral character of the criminalized conduct and a concomitant uncertainty as to whether the criminal law is appropriate in such cases. As Green puts it: “what is interesting and distinctive about white-collar crime . . . is that in a surprisingly large number of cases there is genuine doubt as to whether the defendant was alleged to have done was in fact morally wrong”. There is a “widely felt . . moral uncertainty that distinguishes it [white-collar crime] from that which governs more familiar core cases of crime”.[9] Green doesn’t offer any empirical evidence for his claims about public attitudes to white-collar offenders, but his point is clear: the image of crime that has traditionally dominated both public debate, as well as the criminological literature, is one of clear wrong doing involving manifestly harmful acts, such as murder, theft and rape (so-called “street crime”). That is to say, acts which are self-evidently worthy of moral condemnation. According to Green, understandings of white-collar crime, in contrast, are pervaded by various moral ambiguities. Debates on insider trading mentioned above provide an obvious illustration of this point: well-informed commentators cannot agree on whether such transactions should be prohibited or the reasons for doing so.

Green argues that this is problematic because there exits a broad consensus within the modern literature on criminal law that the imposition of punishment by the state is the existence of moral fault. Punishment without fault or, alternatively, punishment that is disproportionate to the quantity of fault is correctly regarded as inappropriate and unjust. A consequence of this is that establishing the existence and degree of moral fault is a necessary pre-condition for the application of the criminal sanction if the law is to retain its normative legitimacy, coherence and authority. According to Green, in the context of white-collar crime it is often difficult to identify in an analytically precise manner whether sufficient fault exists to justify criminalizing the conduct (as opposed to imposing alternative forms of legal liability or sanction) in the first place and, perhaps more frequently, what degree of fault exists and what punishment should be applied. Given the high stakes (i.e. the moral authority of the criminal law), Green contends that we need to develop a “more precise method for assessing the moral content of white collar offenses than we currently have”.[10] The main objective of LCS, therefore, is to develop such a framework.

2.2.3. Everyday norms and white-collar criminal law

Green begins this task by asking what it is that makes certain acts morally wrongful? Although he acknowledges the importance of harm, he draws upon the recent work of UK-based writers like John Gardner, Stephen Shute and Jeremy Horder to argue that “the concept of harm fails to capture all that is interesting or rationally significant, about the seriousness of various offenses; that we need to focus on the way in which harm is brought about; on how various criminal acts are wrongful.”[11] The central contention of LCS is that everyday moral norms, such as lying, cheating and stealing, provide the key to understanding this aspect of wrongfulness. Green suggests that “every civilized person” has some “rudimentary understanding” of what is morally wrong.[12] Moreover, legal definitions of white-collar criminal offenses (and presumably other types of offense as well) “closely track” these everyday judgments of common sense morality.[13] For Green, this is both a descriptive and a normative claim: bribery is (and should be) criminalized because it instantiates the moral wrong of disloyalty; fraud and perjury do (and should) be criminalized because they instantiate various moral norms against misleading and lying; and, as we shall examine in detail, insider trading is (and should be) criminalized because it instantiates the moral wrong of cheating.

Green’s method in developing this bold claim is, in Part II of LCS, to define certain everyday norms relevant to white-collar crime. The norms he discusses are cheating, stealing, coercion, exploitation, disloyalty, promise breaking, and disobedience. It is a somewhat arbitrary list, why for example is “covering up” not given a chapter, particularly given its obvious importance for obstruction of justice? Green characterizes Part II of LCS as an exercise in “descriptive moral theory” in which he attempts to identify the necessary elements of each of these everyday norms. Green’s approach is to regard such norms as conceptually distinct and “law-like” in their form, offering clear and mutually exclusive definitions of those norms that interest him. As such, Green might be criticized for failing to acknowledge the way that our everyday moral discourse employs concepts that do not always have common properties or clear boundaries (the so-called “fuzzy norms” problem). It is a curious feature of LCS that having adopted a “family resemblance” approach to defining white-collar crime, he persists with a conventional approach to everyday norms. Unfortunately, Green never explicitly addresses this point or offers justification for what is a crucial methodological decision. Presumably, however, he is aware that a “family resemblance” conception of everyday norms might complicate his efforts to overcome the moral ambiguities of white-collar crime and provide the criminal law with sound normative foundations.

In Part III, Green then seeks to establish the “doctrinal relevance” of everyday norms by examining US and English law on ten white-collar offences (perjury, fraud, false statements, obstruction of justice, bribery, extortion and blackmail, insider trading, tax evasion & regulatory offenses) and shows how fine-grained distinctions in the criminal law are “a reflection of equally fine grained distinctions in our moral thinking”.[14] A crucial feature of his argument is that distinct everyday norms stand in a one-on-one relation with legal norms, i.e. bribery instantiates disloyalty, insider-trading instantiates cheating etc. In many ways, however, Part III is the most interesting part of the book. Green possesses a deep knowledge of the relevant statutory framework and case law, as well as the good sense to draw upon recent high profile cases (such as the Bill Clinton, Martha Stewart & Scooter Libby cases) to add a bit of flavor to the narrative and to illustrate key points.

Throughout the book, Green defines the relationship between everyday and legal norms in subtly different ways, e.g. the criminal law “closely tracks” everyday norms[15]; the law is “thoroughly dependent on subtle everyday moral judgments”[16]; moral wrongfulness “shapes the contours” of legal doctrine[17]; and, legal norms are “consistent” with “deeply held moral intuitions”.[18] On occasion, Green goes even further and suggests that legal norms have an important influence over everyday norms: “ostensibly baffling everyday distinctions” can be traced to distinctions “that first appeared in the criminal law”.[19] However, this is an argument that is never fully developed. Although there may well be differences in each of these formulations, the basic point is clear: moral wrongfulness is a necessary condition for the imposition of the criminal sanction and that everyday morality provides the best source for these moral judgments.

The intimate connection between law and everyday morality is important for Green since it provides the criminal law with an important ground for legitimacy in morally pluralistic societies. According to Green, it is socially desirable that our legal doctrines correspond to distinct moral norms.[20] Although on various specific points the law may be in need of revision to more accurately and completely reflect everyday moral judgments, Green is, in general, fairly optimistic about the current state of the criminal law and its instantiation of everyday norms. In this light, he suggests that many of the above-mentioned concerns about the moral ambiguities of white-collar crime are largely misplaced and reflect a lack of understanding of the moral foundations of law. Close examination of this issue reveals that white-collar criminal law corresponds rather well to the claims of everyday morality and that greater public education on legal doctrines would result in these ambiguities dissolving away.

In order to highlight the distinctiveness of LCS it is worth briefly contrasting the argument with a number of possible alternative accounts of the actual and desirable moral structure of the criminal law. One competing account might argue that criminal offences needn’t be justified by reference to moral wrongs at all, but instead should focus on purely consequentialist concerns, most obviously harm prevention. According to this view, (one that in an Anglo-American context is usually associated with the liberal tradition and J.S. Mill, H. L. A. Hart & Joel Feinberg) democratic states are not entitled to enforce moral standards for their own sake (so-called “legal moralism”). With the exception of certain special cases where paternalistic legislation may be justified, the state should respect individual freedom, intervening only to prevent or punish the commission of tangible harms. Green insists that he is not a legal moralist and that he is not suggesting that the criminal law be used solely to enforce morality. Rather, he argues that “moral wrongfulness should be viewed along with harmfulness and culpability” as minimum necessary conditions for criminalizing certain conduct (emphasis in original).[21] As such, his account is different from legal moralists (i.e. in that he insists upon harm) and pure consequentialists) i.e. (in that he insists upon wrongfulness).

A third competing account might agree with Green that the creation of a criminal offense can only be justified as a means to prohibit a moral wrong, but once we have made the decision to prohibit a certain class of acts the precise legal definition of the offence is and should be influenced by the particular needs and values of the criminal justice system or other policy interests. This type of approach suggests either that it is desirable that law departs from everyday morality or, alternatively, that as a matter of fact it does do so. The kind of systemic needs and values that may justify this divergence between law and everyday norms might include the desire to reduce the number of false convictions or to minimize socially costly over-deterrence, for example. On Green’s account, such pragmatic considerations should be excluded on the grounds that they compromise the moral integrity of the criminal law.

Another view might suggest that as a matter of fact, such divergence between law and everyday norms is inevitable given the structural differences in the form of legal as opposed to moral reasoning. Whereas legal reasoning is deliberative, institutionalized and involves the considered deployment of formalistic rules and principles, moral reasoning is, informal, unsystematic, situational and involves intuitions, emotions and perceptions that are not easily formulated in a precise manner. From this perspective, Green could be accused of being insufficiently attentive to the way that everyday moral norms are transformed when they become part of the criminal law. Green seems to avoid this issue by treating everyday norms as “law-like” phenomena. His definitions of various everyday norms, for example, resemble statutory provisions and, on a critical view, the distinctive form and style of moral reasoning is obscured. Nevertheless, LCS represents a provocative and distinct position within academic debate in criminal law theory.

2.3. LCS on insider trading

It is in the context of the above general framework that Green introduces his discussion of insider trading. The basic US prohibition on insider trading, as formulated by the Securities Exchange Commission in 1943, and developed by the SEC and Federal Court decisions is that certain classes of trades involving individuals (paradigmatically but not limited to corporate insiders) who possess non-public information that bears materially on a given transaction must either disclose the information or abstain from trading.[22] As mentioned above, the so-called “disclose-or-abstain rule” is famously controversial, particularly (and not surprisingly) amongst those who think that such transactions improve market efficiency.

Green’s starting point is the suggestion that “the question whether insider trading is harmful” has been over-emphasized in the insider trading literature. This emphasis is unfortunate because the question of harm is “not the most important issue”, at least for lawyers.[23] According to Green, the more interesting question “is exactly why insider trading is morally wrongful”.[24] The leading answers to that question – at least in a Common Law context – are that insider trading is wrongful either because it is in some way unfair and that it involves a breach of a duty to either the shareholder from whom the security was purchased or sold (the classical view), or to the source of the information (so-called misappropriation theory).[25] Green criticizes these theories principally on the grounds that duty-based theories do a “poor job of reflecting our moral intuitions about what’s wrong with insider trading” and accounts based on fairness lack analytical precision.[26] The details of these arguments needn’t concern us here, although the basic claim is that existing theories don’t provide us with helpful guidance in borderline cases and that these theories don’t focus on “what matters” in such cases, namely the fact that the inside trader seems to exploit an unreasonable informational advantage enjoyed over other traders.[27] Green therefore attempts to develop an alternative framework that argues that insider trading is wrongful because it entails cheating.

Green’s discussion of cheating is interesting, not least because it is original. There seems to be little written on the subject either within the philosophical, sociological, economical or psychological literature, at least in the English language. Starting with a blank canvas, Green seeks to identify the formal elements that characterize cheating. He settles on just two: “in order for us to say that X has cheated, X must (1) violate a fair and fairly enforced rule, (2) with the intent to obtain an advantage over a party with whom she is in a cooperative, rule-bound relationship”.[28] It is interesting to note what Green excludes from this definition, namely deception. In doing so, Green takes a different approach to that found in English language dictionary definitions of cheating, all of which include some degree of covertness in their definitions.[29] Green seems to want to maintain a clear distinction between cheating, on the one hand, and lying, on the other, and such a distinction might be blurred by the inclusion of deception in his concept of cheating. To justify this decision he points to examples from everyday moral discourse, e.g. he offers an example of a driver using the emergency lane of a highway in order to circumvent traffic jam. Such an act is not deceptive – after all, everyone can see what happens – but Green says we would still label this cheating. Ergo, deception is not a necessary condition of cheating. This argument, based as it is on one example, is unpersuasive or, at least, inconclusive, and is a point we will return to later.

Having defined cheating-in-general, Green then applies the concept to insider trading and suggests that such trades are morally wrong because they involve cheating. This is because “the trader (i) violates the SEC rule that they must either disclose material non-public information or abstain from trading, and does so (ii) with the intent to obtain an advantage over a second party with whom she is in a cooperative, rule-governed relationship”.[30] According to this view, securities markets are a highly formalistic, rule-governed “game”. The rules are designed to give participants and potential participants confidence that the game is being played in a fair and even-handed way. In the case of insider trading, the trader gains an unfair advantage over the uninformed party with who she is dealing by exploiting information the other party had no way of knowing at the time the transaction was completed. The prohibition of such trades is a clear instantiation of the prohibition on cheating that exists in everyday life.

Green thinks a cheating approach does a better job than existing theories in describing what troubles people about insider trading. Most people seem to think there is something “unfair” about it, but the concept fairness in this context seems too imprecise to be of much analytical value. Green contends that his concept of cheating captures this sense of unfairness whilst at the same time providing clear criteria for deciding difficult cases. For example, cheating provides us with grounds for not criminalizing “lucky” traders or “skillful” traders, something that the alternative theories fail to provide. In the case of the “moral luck” cases, Green suggests that exploiting a piece of good fortune would not normally be considered cheating in everyday life, in contrast, to an action that intentionally created an advantageous situation. Consequently, he thinks there is nothing morally wrong with trading on a piece of confidential information that is acquired by chance. Equally, in the case of a diligent trader, Green suggests that in everyday life we would not normally label someone a cheat who exploits their naturally given or hard-earned talents to their own advantage. Applied to insider trading, Green suggests that informational inequality is not in itself a problem, what is problematic, however, is someone trading on information that is simply unavailable to the other party, irrespective of their skill as an investor or research efforts. Green offers an original and provocative account of insider trading that utilizes the everyday norm of cheating to identify what is morally wrongful about trading on non-public, material information. A detailed assessment of this approach will be offered after we have first introduced the facts of the Tsutsumi case and the relevant provisions of Japanese law.

3. THE YOSHIAKI TSUTSUMI INSIDER TRADING CASE

3.1.Background: Yoshiaki Tsutsumi & Seibu

Yoshikai Tsutsumi is a potent symbol of Japan’s remarkable post-war economic reconstruction and, more recent, economical woes. He transformed Seibu into one of the biggest corporations in Japan, becoming in the process the richest man in the world, through a combination of talent, charisma, political maneuvering and, as it turns out, a systematic disregard of the law. The original Seibu was a local railway operator founded in 1894 that fell under the control of Yoshiaki’s father, Yasujiro Tsutsumi in the mid-1940s. Tsutsumi was born in 1934, the youngest of three brothers. He joined Seibu immediately after graduation from Waseda University when he was appointed President of Kokudo Corporation, a key part of the Seibu Group (Kokudo was one of the major shareholders in Seibu). After the death of Yasujiro in 1964 there was an acrimonious battle between the sons for control of the business empire that Yoshiaki Tsutsumi ultimately won. Since 1973, when he became President of Seibu, Tsutsumi aggressively sought to expand the businesses by creating a vast chain of hotels, golf courses, ski resorts and shopping centers. At the height of the “Bubble” economy in the late 1980s, Seibu’s appreciation brought about by the rising value of real estate in Japan was estimated at thirteen trillion yen making Tsutsumi the world’s wealthiest individual with a personal fortune estimated at over US$20 billion. However, soon after the economic meltdown of the mid-1990s, Seibu’s value shrunk to one trillion yen leaving the company saddled with crippling debts and Tsutsumi’s personal wealth degraded to merely a few billion US$. Earlier this year, he faced the ultimate indignity of being removed from the Forbes billionaires list altogether. Famous for his fiery temper, womanizing, and autocratic management style, “urban myths” about Tsutsumi abound: for example, it was reported in the Japanese media that Seibu didn’t hold a board meeting for seven years from the late 1980s such was his absolute control over the company and his disregard for the niceties of corporate governance. When describing what he looked for in a potential executive, he is quoted as saying, “I don’t want a person with intelligence. I make all of the decisions myself”.

3.2.Facts of the Tsutsumi insider trading case

It is not difficult to see how Tsutsumi’s fall from grace was widely regarded in the Japanese media as marking the end of an era, specifically the passing of an antiquated business model. The events that led to his conviction can be traced back to April 2004 when Seibu’s long-alleged connections to organized crime became the subject of a police investigation that resulted in the subsequent prosecution and conviction of three Seibu executives. Tsutsumi stepped down as President of Seibu, a position he had held for over thirty years, to take “moral responsibility”, although he was not indicted. Seibu’s statutory required auditors resigned and new auditors were appointed. Moreover, Seibu found itself subject to a greater degree of public scrutiny than had previously been the case.

In June 2004 Tsutsumi conspired with Terumasa Koyanagi (the newly appointed Seibu President) to have Seibu submit falsified claims in Seibu’s statutorily required stock ownership reports. It seems Seibu had long engaged in the practice of concealing the true distribution of stock ownership. The reports submitted in 2004 declared inter alia that Kokudo owned 43.16% of Seibu stock when in fact they owned 64.83%. The apparent motive for doing this was to conceal the fact that Seibu was, and had been for decades, in violation of Tokyo Stock Exchange (hereinafter TSE) concentrated ownership rules that required more than ten persons to own at least 80% of the stock in any given corporation. The sanction for violating TSE rules on this point is de-listing. The concealing of this information had been facilitated by the use of “name-lending” in which stocks were nominally held in the name of one person (in this case, former Kokudo employees loyal to Tsutsumi) on behalf of another person who receives the dividend payments (in this case Kokudo who received all dividend payments) and controlled the right to transfer ownership. Now prohibited, name-lending was lawful, at that time, for certain categories of stock, including the Sebu stock in this case.

In August 2004, the newly appointed Seibu auditors discovered the full extent of Kokudo’s ownership of Seibu and threatened to disclose the information to the TSE or the Securities Exchange Commission. To head off a crisis, Tsutsumi promised to dilute Kokudo’s ownership to comply with TSE rules and avoid possible de-listing. He personally approached around twenty companies (many of whom were corporate clients of Seibu) and offered them Seibu stock explaining that he wished to promote “mutual stock ownership” and to deepen business ties. The Tokyo District Court subsequently found that these companies were unaware of either (i) the false statements or (ii) Tsutsumi’s true motive for off-loading the stock. Between September 9^th and 28^th 2004 in a series of block transactions Kokudo sold 18 million Seibu shares for 21.8 billion yen to ten companies. These transactions brought Seibu into compliance with the concentrated ownership rules (i.e. greater than 10 companies now owned more than 80% of the stock). However, a whistleblower (allegedly Tsutsumi’s brother or someone close to him) informed authorities of the summer’s events and this information was leaked to the news media. At a press conference on October 13^th 2004, Tsutsumi admitted concealing losses of Seibu and using “name lending” to violate TSE rules. The markets responded to this news and Seibu’s share price started to slide rapidly. On November 10^th 2004 they hit a record low of 414 yen per share in expectation of de-listing. Less than one month earlier (just prior to Tsutsumi’s press conference admitting wrongdoing) the price had been 1100 yen per share.

On November 16^th 2004, the TSE de-listed Seibu for submitting false financial reports and for the violation of ownership rules. Koyanagi was removed as President and new management was installed. On February 19^th 2005, Koyanagi was found dead in a hotel room after apparently committing suicide hours after being released by the Tokyo District Public Prosecutor. On March 3^rd 2005 Tsutsumi was arrested by police in Tokyo. After being detained for twenty days Tsutsumi, Seibu & Kokudo were indicted for (i) false reporting & (ii) insider trading. he was subsequently released on bail for 100 million yen. The trial started in Tokyo District Court on June 17^th and on Oct. 27^th, after sitting for only three sessions, the Court found all defendants guilty and sentenced Tsutsumi to 30 months in prison (suspended for four years) and a 5 million yen fine; Seibu to 200 million yen fine, and Kokudo to 150 million yen fine. In the meantime, Seibu’s interim management chose Cerberus a US investment firm to be the largest shareholders in the newly created entity, Seibu Holdings. Yuji and Seiji Tsutsumi (brothers – and bitter rivals – of Yoshiaki) had their bid to take control rejected. The era of the Tsutsumi family dominating Seibu had finally ended.

3.3. Legal framework: The Securities Exchange Law & the prohibition on insider trading

In the decades after the Meiji Restoration, capital markets in Japan were not important either as a means of capitalizing corporations or as an investment opportunity. Economic development was driven by zaibatsu, large family controlled business conglomerates that dominated the economy. Within this model, conglomerate affiliated banks provided the principle source of finance and not securities markets. A key aim of the US occupation was to “democratize” the economy (i.e. to dismantle the zaibatsu) and the construction of a US-style securities market-investment model represented the obvious means to achieve this objective. Under the directing hand of GHQ, therefore, the Japanese Diet enacted the Securities Exchange Law 1948 (hereinafter SEL) a law that is similar in content to the US Securities Act 1933 and the US Securities Exchange Act 1934. One similarity relates to the laws relating to insider trading: Article 157 of the SEL is very much like Rule 10b-5, the US prohibition on insider trading.

For various reasons, however, the criminal law provisions of the new securities law were, for much of the post-war period, never enforced. In part, this reflected the lack of normative force of the SEL as a whole in a Japanese context. On the one hand, government (notably the Ministry of Finance) was more concerned to coordinate the reconstruction of the economy and not act as a market regulator, and, on the other hand, corporations were happy to engage in long-term, stable cross-shareholding arrangements that meant there was limited liquidity in securities markets. Also of relevance, particularly in the immediate post-war period, was a significant change in the attitude of the US government. The Korean War and heightened tensions with China and the Soviet Union meant that preserving Japan as a bulwark against communism in Asia took priority over concerns about “democratizing” the economy. In 1952, soon after the end of the occupation (and with the tacit approval of the departing occupying power) a series of amendments to the SEL were introduced, notably the abolition of strict disclosure rules and the absorption of the independent Japanese Securities Exchange Commission into a bureau of the Ministry of Finance. The result was that there was only one prosecution for insider trading in Japan between 1948-1988 (the Shokusan Jutaku case in 1974. And although there is rarely any evidence offered, it is widely believed that, during those years, insider trading was rampant in Japan, variously described as “insider heaven” or a “rigged casino”.

In 1988, a significant series of amendments to the SEL were enacted, including a new prohibition on insider trading trading. The 1988 amendment to the insider trading rules has been widely interpreted as the result of US pressure and concerns in the Reagan Administration that “international insider trading” was becoming a serious problem. Although Article 166 is much more explicit in its prohibition of insider trading, it is not at all obvious that it criminalized anything that wasn’t already prohibited by Article 157. Although Article 157 has never been repealed, most Japanese commentators on the SEL now regard it as “dead law”. Article 166 of the amended SEL prohibits any: (i) Securities transaction involving shares in a publicly listed company; (ii) by (a) any party connected to that company (i.e. a so-called “corporate insider”) who is in possession of “material facts” about that company, or (b) Any other person (i.e. a “corporate outsider”) who learns the material facts from a corporate insider; (iii) prior to the material facts becoming public. The law defines “corporate insiders” broadly, so as to include any employee (part-time, full-time, or temporary); recently (“within one year”) retired employees; shareholders; anyone who has a business or legal relationship with the company; or government regulator. Equally, “material facts” are defined very broadly. The law enumerates various classes of fact that would fall within this category but various “catch-all” provisions – “any fact that may significantly effect the investment decisions of investors” – are also included. Finally, the law provides a precise definition of “becoming public”: publication of the material fact in two “media outlets” plus 12 hours, or the relevant government agency becoming aware of the material fact plus 12 hours.

The Tokyo District Court convicted Tsutsumi under Article 166 of the SEL. As recently retired President of Seibu (therefore as a “corporate insider”) he had, in his capacity as Chairman of Kokudo, sold Seibu stock to other parties with the non-public, material knowledge that the Seibu stock faced the possibility of being de-listed for falsifying stock ownership reports and violation of the liquidity rules (the “material fact”) prior to that information becoming public. The Tokyo District Court held that the purchasers were unaware of this fact and that had they been aware it would have significantly effected their decision to invest. Tsutsumi was sentenced to 30 months in prison (suspended for four years) and a 5 million yen fine.[31]

4. THE LIMITS OF A CHEATING APPROACH TO INSIDER TRADING: THE MORAL COMPLEXITY OF WHITE COLLAR CRIME

Although there are a number of criticisms that could be made against the LCS-cheating account of insider trading this section will focus one issue that can be developed via a discussion of the Tsutsumi case. In particular, it will be asked whether an everyday norm, in this case cheating, can completely describe the wrongfulness of a morally complex action such as insider trading. The intention of the discussion is not to reject out-of-hand Green’s characterization of insider trading as cheating but rather to (i) raise some doubts about the ability of a cheating-based approach to offer an exhaustive account of the wrongfulness associated with such transactions and (ii) explore the implications of such a failure for Green’s general argument about the moral content of white collar criminal law.

On Green’s account, the modern criminal justice system is an institutionalized system of morality. From this point of view, substantive criminal offenses should be consciously designed to encapsulate in their detailed specifications, the particular moral wrongs to be proscribed by law, thereby clearly advertising the limits of criminal liability. The criminal law should at least strive to communicate sound and comprehensible moral judgments to offenders, victims, and society at large. Green’s contention is that the best means for facilitating effective communication of law’s moral content is to build common sense moral distinctions and intuitions into the structural design of criminal offenses. As a normative ideal, this is a persuasive. Moreover, for many categories of offense (most obviously, “street crime”) it is relatively unproblematic for the law to reflect particular and distinct everyday norms. The problem with LCS, however, is that Green fails to acknowledge the limits of such an approach, i.e. that it may not always be possible for a particular everyday norm to encapsulate all that is morally significant about complex acts. Recourse to everyday norms, at least in the form proposed by Green, may have the paradoxical effect of excluding certain common sense intuitions as to what is morally problematic about the underlying conduct, something that may, in turn, damage the legitimacy of law. The desire to place the criminal law on firm normative foundations should not blind us to the moral complexities of certain classes of action.

The Tsutsumi case poses something of a dilemma: on the one hand, our intuitive sense is that his actions are wrongful, on the other hand, traditional theories of insider trading don’t seem to do a very good job of describing this wrongfulness. For example, breach-of-a-duty-to-shareholders only applies in cases where shares are being bought by corporate executives and not sold as in this case, and breach-of-a-duty-to-the-source of the information doesn’t seem to apply given that Tsutsumi’s own actions provided the material, non-public information (i.e.. how could he breach a duty to himself). One is left with vague notions of unfairness or the idea that Tsutsumi perpetrated a wrong because he caused harm or damaged market integrity. None of these accounts seem entirely satisfactory, at least as the basis for the imposition of criminal liability. This section will therefore begin by asking whether LCS-cheating provides a better characterization of Tsutsumi’s actions than these standard theories, and more specifically, whether LCS-cheating assists us in identifying what is morally wrongful in the Tsutsumi case.

LCS cheating involves two elements, namely (i) violation of a fair rule and (ii) advantage seeking. Taking the issue of advantage seeking, Green makes the following observation: “when X cheats, she seeks an advantage by violating a rule that Y is believed to be obeying. Typically, X and Y will be competing over a limited resource and X’s gain will be Y’s loss”.[32] A simple example would be a person pushing in at the front of a queue at the supermarket checkout. In such a case, X has broken the rule that says one should wait one’s turn in line, and has done so to Y’s disadvantage. The result is that X spends less time in line and Y spends more time waiting at the checkout, i.e. X has gained something (time) at Y’s expense. A feature of this account is that advantage seeking is only cheating (and hence wrongful) when it involves the violation of a “fair rule”. Green is a little unclear on what constitutes a fair rule, his only (unhelpful) comment being that such rules would need to be “just”.[33] But on a critical view this merely defers the question of wrongfulness to a consideration of the content of the “justness” or otherwise of the rule. The concept of cheating, by itself can never tell us whether something is wrongful or not. One would first need to consider the content of the rule and only then ascertain whether there has been a violation of the rule and advantage seeking. In the case of supermarket queues this is not perhaps an issue, but in the case of an inherently controversial rule such as the rule prohibiting insider trading this feature of his definition poses something of a problem. Cheating is presented as providing the answer to the question of why we need insider trading rules, but, on closer examination we are find that it can do not such thing.[34]

Moreover, the LCS-cheating concept of advantage seeking doesn’t obviously apply in the Tsutsumi case. In a “typical” case of insider trading one could reasonably conceive of the situation as one where the investors are “players” competing for a “limited resource” in a rule-governed “game-like” environment and that the “resource” the “players” compete over is economically valuable securities (i.e. securities that will maximize returns and minimize risks). One party, in violation of a rule prohibiting trades based on non-public knowledge seeks to gain something (either the security or the proceeds of the sale) at the direct expense of the other party. However, such a description does not seem to apply to the Tsutsumi case where the parties objectives cannot be conceived in this way. The companies that purchased Seibu stock from Kokudo were pursuing what they believed to be an economically desirable investment opportunity (and possibly a closer relationship with Seibu). In contrast, Tsutsumi’s motive was to bring the company into compliance with the TSE concentrated ownership rules and to remove the possibility of de-listing. Price was a consideration for Tsutsumi but only insofar as an artificially low price might have attracted the attention of regulators that something suspicious was occurring. Given that Seibu had been under recent criminal investigation this must have been a concern. Tsutstumi’s actions interfered with the decision making process of the trading partners, but to suggest (as Green would require) that both parties to the transaction were competing for the same resource and that Tsutsumi gained that resource at the expense of the trading partners doesn’t seem an appropriate description of the events in this case, if we accept – as the Court did – that the proceeds of the sale were not Tsutsumi’s principle concern. Rather, we would say the parties to the transaction were competing for different objectives that although related to one another were not directly connected.

This brings us to a related, more general point, namely that Tsutsumi’s purpose in concluding the transaction was to ensure Seibu complied with the TSE rules and not personal financial gain. Of course, Tsutsumi adopted illegal and dishonest means to achieve this goal of compliance. Moreover, by seeking to avoid the negative impact of Seibu being de-listed he was clearly engaging in an act designed to protect his personal fortune, which would have been (and subsequently was) significantly diminished as a result of Seibu’s de-listing. But is it appropriate to characterize a case where someone is seeking to bring themselves into compliance with the rules as advantage seeking and/or cheating?

An analogy with sport may be helpful on this issue. Imagine a professional cyclist who has been taking illegal performing enhancing drugs for a period of time. The cyclist becomes concerned that he may soon be caught as a result of a new testing regime and therefore decides to take an illegal pill that will remove all traces of the earlier drug use from his body. In everyday moral discourse, would we describe the act of taking such a pill as cheating? We would certainly characterize the earlier period of drug use as cheating, and it would fit within the LCS definition (rule violation and advantage-seeking at expense of others). But in the case of taking the pill, however, things are less clear. For a start, how does taking the pill involve gaining at the expense of others and what precisely is being gained? And although the cyclist may have avoided sanction by taking the pill, would it not be more precise to say that they sought to avoid disadvantage rather than to gain an advantage? We would, more usually, be inclined to describe such an action as bringing to an end a period of cheating or, perhaps more precisely, as one of attempting to cover up or conceal the earlier period of cheating. Either way, it would not, in itself, constitute an act of cheating. That is not to deny cheating occurred at the earlier stage, just to argue that two acts occurred – both of which may be immoral – but each of which possess a distinct character. Equally in the Tstusmi case, doesn’t it make more sense to characterize his, albeit illegal and morally dubious, act of insider trading as one of covering up or concealing wrongdoing rather than one of cheating?

Having raised some preliminary doubts about whether LCS-cheating can by itself either justify a ban on insider trading or provide a convincing characterization of the moral wrong in the Tsutsumi case, it might be helpful to consider some alternative everyday norms that play a role in our assessment of the wrongfulness of Tsutsumi’s actions. The aim of this exercise is not to identify replacements to LCS-cheating, rather it is to identify norms that plausibly describe an aspect of wrongfulness in the Tsutsumi case that is not encompassed by LCS-cheating. A possible implication of such an analysis, if successful, would be that one cannot reduce an analysis of what is wrong with insider trading to LCS-cheating,, and that Green’s attempt to do so, although well intended, merely serves to obscure the moral complexity of the underlying conduct. There are several alternative norms that are somehow connected to the Tsutsumi case, covering-up (which we have already alluded to), promise-breaking & loyalty, for example, all seem relevant to the facts of the case, and none of which are included in LCS-cheating. However, it may be more useful to pick a norm that has a more general relevance to “typical” insider trading cases, namely deception.

It will be recalled from the earlier discussion that Green excludes deception from his definition of cheating. This is motivated by a desire to maintain a clear distinction between different moral norms. But is the decision to exclude deception from cheating in this way appropriate given the centrality of deception to insider trading? Can any assessment of the wrongfulness of insider trading not incorporate consideration of the deception involved? If one considers the Tsutsumi case, for example, at the center of any evaluation of the wrongfulness or otherwise of his actions has to be the lie that he told the other parties to the transaction, namely that he was selling the Seibu shares to deepen corporate ties, when in reality he was seeking to dilute his ownership. Putting it bluntly, he deceived the other parties to the sale and they relied upon the lie and were induced to buy. Excluding this from an assessment of wrongfulness seems absurd. Presumably, Green would respond by arguing that Tsutsumi is not a typical insider trading case in that it (i) involved a face-to-face transaction negotiated between the parties in which (ii) one party made an obviously fraudulent misrepresentation that the other relied upon. This could be contrasted with an anonymous market-floor transaction more typical of securities deals in general and insider transactions in particular. In such a case, the only positive representation one party makes is the offer of a price to buy a certain number of shares, and even then it is mediated by a computer network or a trader on the market floor.

The Tsutsumi case is undoubtedly unusual in that it involved a face-to-face deal of this kind. However, the problem with this argument is that it misconstrues what is deceptive about Tsutsumi’s actions. On the facts of the Tsutsumi case, the deceit was, in part, the positive assertion that the purpose of the sale was to strengthen corporate ties. However, another way of describing the act of deception in this case would be say that the failure to disclose the true situation regarding the distribution of Seibu stock was also deceitful, given that the parties to the transaction had no independent means of discovering what for them would, presumably have been a crucial fact. This alternative description – that Tsutsumi perpetrated a deception by his failure to disclose – is important because (unlike the positive representation) it would appear to be a distinctive feature of all insider trading cases.

This is not the occasion for a discussion about the circumstances under which a person might reasonably be said to be under an obligation to disclose information. In ordinary life (as well as contract law), we would not normally censure someone for a failure to disclose information (in contrast to a misrepresentation or a misleading response). The classic example is the person who discovers a Picasso in the garage sale of a stranger and purchases it for $1 from the ignorant seller. However, it is wrong to conclude from cases such as this that we are never under a duty to disclose information. One can reasonably argue that in the context of the securities market “game” if you have no more right to material, non-public information than the person with whom you make an exchange (irrespective of whether you know who they are), and your using that information puts the other party at a disadvantage in making the exchange, then you wrong that person by using that information. Nothing should prevent people trading on informational advantage gained by talent, hard work and luck, but what shouldn’t be allowed is people trading on information which they have no more claim over than other players in the game. This is of course a large issue, but it places the question of deception and deceit at the centre of the debate, something that LCS cheating does not do.

Moreover, an advantage with a deception-based approach is that it connects the moral wrong of insider trading to the parties to the transaction and the fact that there is clear interference by one party with the autonomous choice of another. Deontological moral theories teach us that it is morally wrong to interfere with another persons autonomous decision making process and everyday morality would seem to require that we refrain from such interference. The LCS-cheating concept of advantage seeking does really capture this element of interference – the violation of the other’s autonomy – only the fact that one part gains at the expense of the other. At least in the context of the Tsutsumi case, interference seems to a more applicable description.

LCS cheating is undoubtedly a helpful and thought-provoking concept that makes an important contribution to the insider trading debate. However, Green is overly ambitious in claiming that by itself LCS cheating can capture all that is interesting and morally significant about the wrongfulness of such transactions or provide sufficient justification to ban such transactions. There are two aspects to this claim: firstly, the suggestion that Green’s definition of cheating fails to provide a compelling justification for prohibiting insider trading in the first place because of its assumption that such a rule is already in place, and secondly, based on the inadequacies that are revealed as a result of the application of LCS-cheating o the Tsutsumi case. The conclusion of the paper is that we need to exercise some caution before claiming that the wrongfulness of a morally complex offense like insider trading can be reduced to the violation of any one everyday norm, however sophisticated we are in attempting to define it.

The Transformation of International Comity by Professor Paul recounts the evolution of the comity doctrine from seventeenth century Europe through the United States (U.S.) Supreme Court interpretations in the eighteenth century to its current conception.[i] As the concern of the U.S. has changed so too has the notion of comity.[ii] Originating as a doctrine of deference to foreign sovereigns, it evolved into a doctrine of deference to private autonomy.[iii] Paul opines that the next incarnation of comity will be deference to the market.[iv] Not, however, in exactly the same sense as is currently owed to private parties but to the market as an independent entity with its own “autonomous will.” [v]

Paul does not believe the market is in any way autonomous.[vi] Instead, countries will rely on the market to “formulate and implement regulation.”[vii] The market thus operates within “the penumbra of state power.”[viii] He argues this explicitly in an earlier paper in order to abate concerns that E.U. internal market trade liberalization will lead to an environmental regulatory race-to-the-bottom.[ix] Paul considers comity which shows deference to the market as an opt-out which likely threatens this state-market regulatory interaction, raises the risk of regulatory arbitrage, and increases democratic deficit.[x] His concerns are not hypothetical; law and economics scholars have discussed regulatory opt-out or opt-in as a viable conflict of laws option.[xi] This paper will explore a few of these law and economics debates in relation to Paul’s concerns. I hope to show that Paul’s preference for a mandatory legal regime is really just another formulation of a social welfare maximizing system that can be achieved through market deference in a sector by sector approach.

Market deference seems to work better where the distinction between public and private law is stark. Paul believes the public-private market divide to be a fallacy in and of itself[xii], but assuming he is correct even if the public and private divide cannot be parsed out in its entirety, the threat that an individual contract will impugn the public-private regulatory relationship is minimal. Consistent with this U.S. courts have shown a clear preference for choice of law provisions and more broadly forum selection clauses.[xiii] Even where a contract creates externalities, contracting parties should theoretically bargain to a socially optimal outcome via the internalization of those costs.[xiv] From a conflict of laws perspective an efficient outcome may be obtained by opting-in or -out of one state’s mandatory law versus another’s.[xv] Comity performs the same function by allowing an opt-in or -out of certain mandatory rules in the international context.[xvi] While contracts seem like an easy case in support of private ordering, or more broadly market deference, the calculus appears to change when the notion of social welfare grows beyond the parties to the contract.[xvii]

U.S. corporate law in this respect is interesting. Although some scholars have characterized Delaware as a race-to-the-bottom, others see it as a reflection of the efficient market for law.[xviii] In either case, contract law in the form of a corporate charter is determinative of the governing law.[xix] In this way, it is an opt-in to mandatory rules or, from another perspective, an opt-out of the mandatory rules of the places where the corporation operates.[xx] This is the classic example of an opt-in -out market and, in terms of social welfare maximization, it is hard to see how Delaware’s efforts to get corporate charting is a less valid regulatory method than the public-private market intertwine which Paul describes in the case of E.U. internal market trade liberalization. In both examples legislatures respond to market concerns by implementing policies through markets.[xxi] Paul does not discuss corporate law, but if he believes the public market interaction in the E.U. will maintain social welfare[xxii] the implicitly the same principle should hold for Delaware. To this he may try to draw a distinction between the E.U. regulations and Delaware by noting that E.U. regulations were implemented on the consumer level and not the production level, so producers in any given market could not opt-out.[xxiii] There are two responses. First, the inability to opt-out is irrelevant if, as Paul claims, these programs are creating economic benefits for the market participants.[xxiv] Under such conditions parties may be operating in an efficient regulatory framework where opting-out would hurt their business.[xxv] In the alternative, even if the jurisdiction is less efficient, transaction costs associated with changing the regulatory regime may be too high.[xxvi] Second, although implemented at the consumer level producers could still limit their sales to certain markets where they have an existing advantage. Because they have preexisting experience, theses firms can operate at lower cost than competitors. So in reality, although also producing positive benefits, this kind of regulation could be an example of raising rivals costs.[xxvii]

In sum, the lack of an opt-out may be irrelevant, or at worst it may act as a trade restriction. This concern likely prompted the implementation of the E.U. Directive on Packaging and Packaging Waste, which provided minimum harmonized standards.[xxviii] Whether these same effects could have been remedied by an opt-out is beyond the scope of this paper. Important, however, is that what Paul categorizes as state-market interaction – the type of thing he believes comity and more generally opt-out provisions derogate – is summarily a type of social welfare maximization. The proponents of regulatory competition (what Paul would call deference to the “autonomous will” of the market) make the same claim.[xxix] Social welfare maximization for any regulatory system should thus be determinative of the worth of the system.[xxx]

An illustrative debate is found in the arguments which surrounded the movement for investor choice of securities regulation.[xxxi] Like the corporate law and E.U. waste management examples, the U.S. public securities regulator is densely intertwined with private firms and persons.[xxxii] The movement for investor choice, which ultimately failed, highlights the consideration that proponents of opt-in and mandatory systems considered during the debate to reform U.S. securities laws to look more like U.S. corporate law.[xxxiii] Ultimately, the debate turned on whether market competition for securities laws would produce the same amount or greater social benefit as mandatory regulation.[xxxiv]

The regulatory competition method, or what was called “competitive federalism”, would have increased individual state authority to formulate securities disclosure rules and abandon, or make optional, the current federal system.[xxxv] With respect to choice of law, the system would have worked in a manner similar to corporate law where the issuer could choose the regulatory regime through contract.[xxxvi] Also, similar to corporate law proponents cited reduced cost of capital as a major justification for investor choice.[xxxvii]

Opponents, however, came up with compelling arguments as to why the corporate law experience is not analogous to the securities law field. One such argument had to do explicitly with social welfare maximization. Namely, those individual securities issuers would always have incentive to disclose less than was socially optimal because the benefits to the issuer from higher disclosure do not necessarily align with those of the managers. [xxxviii] This problem is compounded by the fact that regulatory choice in the way proponents conceptualized it may not arise, rather jurisdictions may generate substantially similar regulations. [xxxix] Taking these arguments together in a worst case scenario, all significant choices could require a level of disclosure less than the socially optimal level.[xl] The issuer choice debate thus shows that a regulatory opt-in scheme needs a close accounting of social welfare in relation to the goals of the regulation in order to access its potential efficiency.

Notably, both opt-in and mandatory systems derive much of their benefit from being closed. Exceptions to the rules either derogate the will of the legislature as Paul claims in the case of comity, or affect the economic calculus in the case of market dereference.[xli] Comity at one point was used by courts in antitrust cases to cabin extraterritoriality within what they viewed as reasonable boundaries.[xlii] The move to a more narrow usage of comity as a tool in antitrust may reflect not only respect to the U.S. legislature, which specifically provides for extraterritorial jurisdiction, but also concern for the special economic nature of antitrust.[xliii] This kind of discretionary opt-out with the potential to undermine particular aspects of a regulatory system may be more threatening than an opt-in or -out of a total-package regulatory system.[xliv]

In conclusion, the contract and corporate law areas show that opt-in systems can be efficient. Moreover, as the consideration of corporate law shows, opt-in regimes are a form of a regulator backed market system of the kind Paul thinks will avoid a race-to-the-bottom and thus will not necessarily facilitate a diminution of social welfare. However, as was the case with issuer choice, close attention to social welfare maximization is necessary. From this I think it is a fair extrapolation to say that, sector by sector, a market approach to regulation can provide adequate or optimal social welfare. Consequently, the market deference which the U.S. Supreme Court shows in the form of comity is not as contrived as Paul implicates. That said, special attention needs to be paid to what kind of opt-out comity or another mechanism is offering. The consequences to social welfare are greater if such a mechanism allows derogations from a system of benefits and burdens designed for a specific outcome. Derogations in this sense could tip the welfare calculus away from a socially maximizing position.

1. Introduction.

In recent years the economics literature has been alive with discussion on the importance of the historical origins of legal systems to various economics outcomes.[i] Much of this has looked specifically at the relationship between “legal origins” and the ownership structure of corporations in different countries. Relying on the traditional comparative law distinctions between systems, the main writers in the field, La Porta, Lopez-de-Silanes, Shliefer and Vishny (“LLSV”) have put forth the argument that common law systems are more conducive to dispersed shareholdings than civil law systems, where concentrated ownership is the norm.[ii] Differences in the substantive laws relating to investor protection across legal origins are said to explain the difference.

Ownership structures matter to corporate governance, mainly in light of the differing agency problems which different structures present. For corporations with dispersed shareholders, the emphasis is on the relationship between shareholders and management, whereas in those with concentrated shareholdings problems may primarily arise between controlling and minority shareholders. A corollary of the legal origins literature is that legal history matters to corporate governance in part due to its influence on the structure of corporate ownership.

From the point of view of assessing the impact of the historical origins of legal systems on corporate governance, legal scholars such as Milhaupt and Pistor[iii] have criticized this “legal origins literature” for, among other things, viewing national legal systems as a form of “endowment” that evolved in the ancient past and has since remained a largely immutable characteristic of a given country’s economy. Also criticized has been the view that economic changes – such as changes in ownership structure – are largely caused by the nature of the legal system and not the other way around, i.e. that changes in the economy do not cause changes in the legal system.

This paper is concerned with a basic question that animates part of the debate – whether or not the historical origins of a legal system matters to modern day corporate governance. The aim here is not to provide a definitive answer to this question. The much more modest goal is to argue that the main problem with the legal origins literature is not so much the fact that it takes an endowment perspective per se, but that it treats the legal system as a whole as an endowment. This paper asks whether an approach that ignores the formal classification of the historical origins of legal systems and instead focuses on the historical roots of specific, relevant features of a country’s legal system can provide a more useful way of examining the question. In other words it looks at an approach which focuses on the individual “endowments” of a legal system as an alternative to the current one used in the legal origins literature, which treats the legal system itself as a form of endowment.

This paper proceeds as follows. Section one discusses the state of the literature in the field and why an approach which focuses on individual features of a legal system, rather than the system as a whole, as legal endowments may be a useful way of approaching the question. Section two discusses the historical sources of such legal endowments and why the economic literature’s reliance on the traditional comparative law taxonomy is problematic. Section three looks at which types of specific legal endowments have potential implications for corporate governance. Section four looks at the question of how legal endowments might evolve over time.

2. Systemic Legal Endowments.

The word “endowment” here is drawn from what Milhaupt and Pistor critically term the “endowment perspective” on the relationship between legal systems and economic development.[iv] The basic idea is that a country’s legal system, with all its specific features, is a type of endowment or inheritance that society has received from its past. As some legal systems are better suited towards promoting certain economic outcomes than others, the argument goes, the type of legal system a country is endowed with will be a determining factor in how countries develop economically.

This perspective traces its roots back to the work of Weber, who argued that the existence of a rational legal system was a necessary precondition to industrialization. In its most recent and prominent guise, however, it has been used by financial economists seeking to demonstrate the importance of legal origin to financial development. The main scholars in the field, LLSV, have argued that the historical origin of a country’s legal system is a determining factor, among other things, in the ownership structure of firms in that country.[v] Companies in countries which received an English legal origin are said to have more dispersed patterns of shareholdings as a result of general effects of the English system’s greater protection of private property rights against state interference. Companies in countries with a French legal origin, on the other hand, usually have more concentrated ownership due to the weaker protections afforded to private property rights by the French legal system.

Though extremely influential, this line of scholarship has been heavily criticized. Spamann, for example, has recently shown that the anti-directors rights index upon which most of these studies is based contains flaws that render many of the claims of the literature – including the claim that the common law provides better shareholder protection than the civil law – unsupportable.[vi] Of more direct interest to the subject of this paper, Milhaupt and Pistor have shown that the notion of legal development upon which the “legal origins” literature is based is problematic. As they note:

“Law is treated as if it were imposed from somewhere outside markets and economic activity – as a precondition to them…. – and then serves as a stable and unchanging foundation for economic life.”[vii]

Looking at a series of recent corporate governance scandals in different countries, they argue that legal systems should not be viewed as an immutable characteristic, but rather as part of a “rolling relationship” in which legal and economic change mutually interact with each other. Demand for legal change among affected constituents combined with the contestability of the law making process will determine whether or not changes in the legal system are possible.

This argument provides a refreshing counterbalance to the predominant view in the legal origins literature, which largely discounts the possibility that legal systems are capable of system-altering change. It does, however, leave open the question of the degree to which the historical origins of a country’s legal system might “matter” in today’s world. While the legal origins theory has rightly been criticized for relying on an overly strong form of path dependence[viii] to explain their theory and for ignoring the possibility of systemic legal change, at the same time few would dispute the fact that at some level, history must matter. The legal origins literature has simply failed to provide an adequate means of assessing how it does so.

The theory does, however, at least provide a useful point of departure from which to discuss the issue, hence this paper’s focus on the concept of “legal endowments”. The regrettably, but necessarily, broad definition of this term is that it is simply an element of a legal system that has been received from an earlier time. This definition leaves much unsaid. When exactly is that “earlier time”? What elements of a legal system are we talking about? How have these been “received”?

The original sin of the legal origins literature from the point of view of assessing the importance of the historical origin of a legal system to present outcomes is that it attempted to answer these questions by taking the traditional comparative law taxonomy of legal systems “off the shelf”. The answer to the first question for most countries was the time at which it received a European legal system. The answer to the second was left in the hands of the comparative law scholars, who divided the world’s legal system using criterion which may not have been entirely relevant to the issues being examined. The answer to the third question was mostly through the process of “transplantation” of legal systems from parents to recipients.

A more full understanding of the issue requires a closer inspection of these and related questions as they relate to specific countries. The working hypothesis here is that some elements of a legal system may usefully be viewed as “endowments” for the purposes of assessing the importance of legal history to contemporary economies. This has to be tempered by the acknowledgment that those endowments are not immutable, but are subject to change – some more so than others. It also must be noted that not all legal endowments “matter” for all purposes. In varying fields different elements of the legal system are going to play greater or lesser roles. Finally, in the temporal realm, it must be noted that not all endowments spring from the same time and place. The reception of a legal system from a European source in the 19^th or 20^th century may be the source of some such endowments, but it is not obvious that all elements of a legal system would have survived the trip from parent to recipient, nor is it clear that prior or subsequent legal development would be irrelevant.

3. Identifying the Source of a Legal Endowment.

A first problem which must be dealt with is identifying the source of an endowment. When and from where do the relevant features of a legal system come into existence? The legal origins literature identifies two possible historical sources for the distinguishing features of the French and English legal systems. The earliest explanation is rooted in the 12^th and 13^th centuries. At that time, according to this explanation, the French Crown adopted the centralized, inquisitorial system of the Roman Church in order to overcome the weak control of the government over the regions and extend the Crown’s control. At the same time in England, the Magna Carta was enshrining the rights of the nobles to due process against the demands of the Crown, setting the stage for the development of a more decentralized legal system there than would develop in France.[ix]

The second explanation, chronologically speaking, is rooted in the later revolutionary periods in England and France. The English judiciary was on the winning side of the Glorious Revolution in the late 17^th century and was thus able to gain a great deal of independence from the Crown. This in turn gave them greater freedom to protect private property rights and freedom of contract. The French judiciary, on the other hand, was on the side of the Ancien Régime during the French Revolution and were thereafter deprived of much of their independence and law-making powers.[x]

It is to be noted that neither of these explanations are geared specifically towards the general question of how the historical origins of a legal system could explain differences in current economic outcomes. Rather, they are geared specifically to the question of why the English legal system is more suited to protecting property and contractual rights than the French system is. This is due to the fact that it was only after the author’s earlier statistical regressions had demonstrated the alleged superiority of the English system to the French that they began to look for a historical explanation for why this was so.

This approach is fraught with problems when applied to a general theory such as the legal origins theory. The first and most obvious is that it only really explains differences in the English and French systems while largely overlooking the historical development of the German and Scandinavian systems which the theory also examines. The second problem is that as some scholars have noted these explanations suggest an extraordinarily strong form of path dependence.[xi] If political events from the 12^th to 18^th centuries could so affect the suitability of legal systems to protect property rights and freedom of contract, then why would political events in subsequent centuries not have similar influence on the legal system’s development?

A corollary of this is that the identified formative sources of each country’s distinctive legal systems are closely tied to formative political developments in their histories. These occurred largely outside of the legal system itself. In the vast majority of countries in the world today, however, the modern formal legal system was “transplanted” rather than developed over time as in France and England. It does not automatically follow that in transplanting the formalities of a legal system across borders, all of the institutional factors outside of the formal law which may have lent the system to treating private property rights in a certain way would come along. To put the question at its most extreme – do for example the drastically different economic performances of Singapore and Nicaragua trace their origins back to the 12^th and 13^th century political histories of their respective English and French legal parents? Or are subsequent developments more specific to those countries have greater explanatory value?

When viewed in this context, it becomes much less clear that the notion of “legal origin” as developed by the traditional comparative law scholarship is an appropriate tool by which to examine the issues. The traditional comparative law taxonomies developed by Zweigert and Kötz[xii] use a number of factors – the historical development of the system, the distinctive mode of legal thinking, distinctive legal institutions, sources of law and ideology – in determining how to categorize systems. While some of these factors could be relevant in determining the degree to which a legal system will provide better protection to property and contractual rights, it is not clear that these are the optimal criteria for doing so. Some of them are clearly irrelevant while others which may be relevant are not included.

For these reasons the focus on legal origin as a source of legal endowment seems particularly ill suited in this context for countries which received their legal systems via transplantation. All of the political and institutional developments which influenced the development of the French and English legal systems over the course of several centuries are assumed to have coalesced into the single moment at which those countries received their legal origin from their parent. All prior and subsequent developments specific to that country which may have made their respective judiciaries either more or less capable of protecting private property and contractual rights are excluded from consideration.

To be certain to the extent that one is only interested in learning how the traditional comparative law categorizations are correlated with differences in substantive laws and economic outcomes, the approach taken in the legal origins literature is not necessarily problematic. There is little doubt that the form of law matters and that the traditional distinctions among “legal origins” still have some substantive value and that some legal systems are better suited to certain contexts than others. Equally certain is that in transplant countries the type of system that is transplanted is important and will undoubtedly affect the course of subsequent legal development.

Such an approach will not, however, tell us very much about how the actual historical origin of a country’s legal system might matter today. It will only tell us how one element of that history matters and to this it is only capable of a simple “yes, it does” answer without much further elaboration. For this reason, this paper takes the position that for purposes of assessing the impact of legal history on economic outcomes such as ownership structure, it is necessary to examine the origins of a legal system not at the high level of abstraction that the concept of “legal origin” exhibits, but rather at the level of the individual features of a system which may have an influence. To begin a more thorough inquiry, we must move on to the next logical question, which is to ask what some of those features might be.

4. What Types of Legal Endowments “Matter”?

In this section we briefly consider which types of systemic legal endowments might matter to corporate governance via affects on the ownership structure of firms. The aim here isn’t to provide a comprehensive list of such features, but merely to illustrate the fact that legal scholarship has demonstrated that features beyond those discussed in the legal origins literature matter.

As noted earlier, one of the basic precepts of the legal origins literature is that the ability of a legal system to protect private property rights and freedom of contract are said to influence the types of ownership structure that firms in a given country will have. This hypothesis is by no means universally accepted. Many have argued that factors outside the legal system are responsible for the differences in economic outcomes rather than the legal system itself.[xiii] Others still have found that economic changes such as the move towards dispersed shareholdings have preceded rather than been caused by strengthened legal protections for investors.[xiv]

This paper takes no position on these specific issues, but merely notes that there is nothing in such criticisms that specifically preclude the possibility that certain aspects of a legal system might matter to ownership structure. Many of the arguments put forth on behalf of alternate causal explanations for the data produced by LLSV go mainly to the weight to be put on competing factors. Indeed there is compelling evidence that some such factors may better explain the observed differences, but this does not preclude the possibility and intuitive likelihood that elements of the legal system also matter. Likewise the question of reverse causality (the argument that legal change flows from economic change rather than vice versa) has largely focused on the role of substantive rules created legislatively or by court decisions rather than on general features of the system itself. As Coffee has noted, while the move towards dispersed ownership in the United States generally preceded the enactment of rules protecting shareholder rights, general features of the common law legal system contributed to an overall institutional environment that was conducive to this change.[xv]

For these reasons we may proceed on the premise that general features of a legal system can influence the structure of corporate ownership, with the proviso that the degree to which such features matter may differ widely from country to country and, when weighed against other variables outside the legal system, they may not be the most important. This leads to the question of which such features are worth examining with regard to the issue of ownership structure.

A number of such elements have been put forward. In the legal origins literature, the independence of the judiciary from other organs of state power is seen as an important one.[xvi] A more independent judiciary, the thinking goes, will be more willing and able to protect private property rights against state interference than one in which the judiciary is more subservient to state power. At first glance it is not clear how this factor would relate to corporate ownership structures, as there the main “hurdle” to the rise of dispersed ownership would be concerns related to expropriation by insiders and not the state. It is said, however, that the greater ability of the state to divert resources to favored ends may stunt the development of financial markets and in this way affect ownership structure.

A second element which the legal origins literature looks at is the “adaptability” of the legal system.[xvii] The basic notion here is that differences in sources of law will affect the economic efficiency of different systems which will in turn have implications for the structure of corporate ownership. This relies on Posner’s argument that the common law evolves efficiently as judges are able to respond to changing economic or social conditions on a case by case basis and weed out inefficient rules. Civil law systems will in contrast be less adaptive to changed conditions due to their reliance on statutory amendments as the main source of change to formal legal rules. Critics[xviii] have noted that in reality the differences in law making processes between the Common law and Civil law are exaggerated and that judges in Civil law countries do in effect “make law” while at the same time the ability of Common law judges to do so is not as great as it once was.

It is to be noted, again, that both of these factors are tightly connected to perceived differences between the English and French legal systems. This focus again largely stems from the literature’s conclusion that differences between these two specific legal systems were the most pronounced, a conclusion that was reached before an attempt to develop a theoretical model to explain their findings was made.

Legal scholars have been somewhat less constrained in their analysis and have suggested other features not solely related to the English/ French divide that may be useful. Milhaupt and Pistor have noted that the economics literature has been pre-occupied with the protective role of law in ordering economic affairs.[xix] They argue that an additional distinction needs to be drawn between systems that assign law a protective role in economic affairs and those which assign it a coordinative role. “Coordinative” here refers to the use of law not strictly as a means of protecting substantive rights but as a way of coordinating the activities of market participants towards some economic ends. The same authors also point to the relative centralization of the law making process as a factor.

Legal culture is another type of endowment which the current literature has largely neglected. This concept is capable of at least two meanings, one intrinsic to the legal system and the other extrinsic. The first is the culture and norms of the legal profession itself. How do lawyers, judges and prosecutors view their role in the system and its accepted boundaries? What input does this in turn have on the process of legal change? The second is the views of society as a whole towards the legal system. What do potential users of the system view its role as? What are the incentives and barriers to their using it?

As we are primarily interested here in elements intrinsic to the legal system itself it is the former that is of interest. Kagan has noted that, while it isn’t the main cause, the culture of American lawyers has played a “substantial contributory causal role” in creating the style of adversarial legalism that dominates the US system.[xx] As the ability of the law to affect economic outcomes will in part be a product of the way in which it is used by those who actually run the system, and how they influence the process of legal change, this is a significant factor to consider. Ahlering and Deakin have taken up this theme and noted that the evolution of legal cultures creates “ground rules” which affect the interpretation of laws by those inside the system and that this explains the channel through which legal origin affects the substance of contemporary labor regulations.[xxi]

This is by no means an exhaustive list of potentially significant factors. The purpose here has mainly been to demonstrate that there are a broad range of features of a legal system which may be relevant to economic outcomes. These features will vary from country to country, and are not coterminous with the features that the legal origins theory relies on to explain the facts. In the next section we briefly consider the question of how these features evolve over time.

5. Do Legal Endowments Change Over Time?

Finally we may consider the issue of changes to legal endowments over time. As noted above, one of the major criticisms with the legal origins literature has been a temporal one. The theory that has been developed to explain why legal origins matter is firmly rooted in historical narratives, yet the variables which LLSV tested represented a “snapshot” in time, only reflecting the situation at the time of writing. Rajan and Zingales[xxii] have pointed out that some of the economic outcomes looked at – namely financial market development – have changed significantly over the past century and that in 1913 French systems had better developed financial markets than English ones, the exact opposite of what the legal origins theory states should have been the case.. In the field of substantive law the Cambridge Law, Finance and Development Project[xxiii] has looked at how individual laws develop over time, from 1995 to 2005, and found that many of the differences in shareholder protection laws between civil law and common law systems have been sharply reduced in that time.

In terms of the general features of a legal system itself, there is little doubt that these are capable of change. History is replete with examples of legal systems experiencing such types of change – as indeed the historical examples of the evolution of the English and French systems are evidence. Yet the legal origins literature largely ignores this possibility and any implications to the theory which would flow there from by focusing solely on the notion of a “legal origin” that was received by most countries at some point in the 19^th or 20^th centuries, since which time it implicitly assumes no systemic changes occurred.

Though not related specifically to the question of how features of legal systems in general change, about a decade ago the corporate governance literature became quite interested in the barriers and incentives to legal and institutional changes affecting corporate governance. Roe and Bebchuck developed a path dependent theory on the development of corporate law rules and ownership structures.[xxiv] Ownership structures at one point in time, according to their theory, will affect subsequent choices both with regard to future ownership structures and to the rules that will be chosen to govern said structures. Efficiency concerns and incumbent interests will influence the subsequent path of development.

Articulating an opposing view of corporate ownership and legal development are Henry Hansmann and Reinier Krakkman, who suggest that systems of corporate governance around the world are converging on the American shareholder-primacy model.[xxv] They argue that factors such as the forces of competition and the rise of shareholder classes are enough to overcome any path dependent barriers to convergence on the American model.

Closely tied to this debate is the question of whether features of the legal system as a whole can also change under the pressure of similar forces. Milhaupt and Pistor[xxvi] note that major crises in corporate governance can foster such change in some circumstances when such crises disturb the make up of constituencies who create demand for legal rules. Aspects of the legal system such as its degree of centralization, its legal culture and so on may affect the degree to which the legal system is capable of changing to accommodate these changing demands. Likewise these demands may create forces which alter these features of the system as a whole.

The basic point here is that the individual endowments of a legal system are capable of change, a fact that has implications for the question of how legal history can affect a country’s system of corporate governance. If a legal system with certain endowments can be said to produce certain economic outcomes as a result, it stands to reason that changes to these endowments may likewise have led to different results.

6. Conclusion.

This paper has sought to re-examine the question of how the historical origin of a country’s legal system can affect the structure of corporate ownership. The problems outlined herein with the legal origins literature’s reliance on the traditional comparative law classifications of legal systems prevent the theory from telling us very much about how a country’s legal history can affect economic outcomes, despite that being one of the literature’s main purported aims. This paper suggests that a new approach to this specific question – one that looks not to such classifications but to the historical development of specific, relevant “endowments” of individual country’s legal systems – may provide a clearer picture of how legal development has affected corporate governance over time and today.