Gatekeeper Failure and Reform: The Challenge of Fashioning Relevant Reforms

John C. Coffee Jr., Columbia Law School


Securities markets have long employed "gatekeepers" – independent professions who pledge their reputational capital – to protect dispersed investors. This strategy of relying on reputational intermediaries to assess, verify and certify the corporate issuer's disclosures appears to have failed during the late 1990s, as accounting irregularities increased exponentially. Part I of this paper assesses the reasons for this failure, emphasizing both a shortfall in deterrence and the sudden shift from a cash-based to an equity-based system of executive compensation during the 1990s. Part II and III then survey the realistic regulatory options and the incomplete steps taken by the Sarbanes-Oxley Act. Breaking down these options into four categories – structural rules, prophylactic rules, procedural rules, and liability-enhancing rules – Part III concludes that simply increasing the threat of liability could cause the market for gatekeeping services to fail. Instead, it proposes a shift towards stricter liability standards coupled with a ceiling on gatekeeper liability set at a level adequate to deter misconduct, but not to compensate investors. Finally, Part III proposes that the role of a new gatekeeper needs to be recognized and formalized: namely, the attorney who prepares a disclosure document, who should, it argues, be forced to provide a functionally parallel certification with regard to this issuer's non-financial disclosures to the certification provided by the auditor with respect to financial disclosures. The feasibility and scope of such a certification requirement, along with its impact on the attorney's other obligations to its client, are explored in Part III.