|(Illustration by Tomasz Wolenta)|
Resolving Securities Law Conflicts
In October 1987, the US received a nasty jolt into the modern era. From the close of trading on October 13, 1987, to the close of trading on October 19, 1987, the Dow Jones industrial average fell 769 points—31 percent—and the value of all US stocks decreased by nearly $1 trillion. The October 1987 crash and subsequent crises in the financial markets have led policy makers to devote considerable attention to modernizing the law governing clearance and settlement of securities transactions. Not only has the securities business changed dramatically in recent decades, it has also become a global business. So, questions about which country’s law applies have become more and more important.
The modernization effort has to take account of a major change in the way that investors hold securities. Years ago, investors who owned securities had physical possession of certificates. Today, however, they typically hold their securities through accounts with brokers or banks. The investors never see any certificates; they just see the statements from their banks or brokers. The volume of securities holding through this indirect system is enormous. It has been estimated that some $50 trillion of securities are held through intermediaries.
About ten years ago, US commercial law was revised to take account of these new practices. (I served as the Reporter, that is, principal drafter, for that project.) Some other countries also have modernized their laws, but many have not. The laws of different countries on securities held through intermediaries, therefore, vary considerably. That difference in substantive law poses a serious problem when coupled with traditional rules on conflict of laws.
For instance, suppose that Investor in the US holds securities through an account with a US broker or bank. Through that account, Investor holds securities issued by companies and countries around the world. Suppose that Investor wants to pledge that securities account, that is, use the account as collateral for a loan or other obligation. How do lawyers figure out which country’s law applies to the transaction?
Traditional conflict of laws rules suggest that the law governing a pledge is determined by the location of the thing that is pledged. As applied to our securities transaction, that means that the law governing the pledge of the account is determined not by the location of the broker or bank that maintains the account, but by the location of the issuers of all of the securities held through the account. If that traditional rule is applied, then the lawyers might have to look at the laws of dozens of different countries to decide what’s necessary to implement the pledge.
Lawyers around the globe who deal in such transactions have come to realize that the traditional conflict of laws rules just don’t work for modern transactions. Several years ago, a project on this problem began through a group in The Hague, Netherlands, that works on international treaties on conflict of laws for various subjects. Appointed by the US Department of State, I participated as a member of the US Delegation and as a member of the small Drafting Group for the project. In December 2002, the drafting work on the Hague Convention on Conflicts of Laws for Securities Held Through Intermediaries was completed at a meeting at The Hague. Now, we are working on getting the Convention ratified by the various countries. As part of that effort, I traveled to a conference in Beijing in the fall of 2003 and Tokyo last fall.
The basic principle of the Convention is that the law governing a pledge or other transfer of securities held through an intermediary should be the law of the country where the intermediary is located, regardless of the location of the issuers of the underlying securities. Though that basic principle is easy to articulate, the devil, as always, is in the details. In particular, it is no easy matter to specify where an intermediary is located, particularly when the activities of account maintenance may be dispersed throughout many offices located around the globe. Thus, the Convention says that the governing law is that chosen by the intermediary and account holder.
The approach taken in the Convention is common in domestic US law, but it has been regarded as novel in other parts of the world. Partly because of that novelty, it remains to be seen whether the Convention will be adopted widely. One can only hope that lawyers and policy makers around the world will have sufficient foresight to recognize the need for clarity in this area of the law before that need is driven home by the next financial crisis.
Professor James Rogers teaches commercial law and contracts. He has written articles and books on the history and future of commercial law.