Corporate Governance

US v. Nacchio: The Death Knell for Special Treatment of Economic Analysis in Securities Cases?

By J. Robert Brown

For a time, it seemed as if economic analysis (often bad economic analysis) was the sin qua non of legal analysis in the corporate law area.  There were plenty of scholars who wanted to see corporate and securities law become entirely a matter of contract.  The best way to police inefficient management was not by strengthening shareholder rights but by allowing the market for corporate control to exact the appropriate punishment.  In other words, let the market resolve everything. 

Those days have come and gone.  Certainly, the idea that the market can be counted on to correctly regulate behavior had taken a beating in the current economic turmoil.  Some degree of economic analysis can be useful depending upon the circumstances but it is but one more source of analysis, and sometimes a meager one at that.

In this particular case, Judge Holmes held that the reputation of Daniel Fischel, a preeminent scholar in the law and economics movement, and his track record of testifying in other cases was not of itself sufficient to establish his methodology.  In other words, it was not enough to repeat the mantra of economic analysis and present someone experienced and well known.  In effect, Judge Holmes held that economic analysis would receive no particular deference and, instead, had to meet the same standards that all other experts had to meet.      

Judge McConnell took great umbrage at the exclusion of Daniel Fischel and the perceived slight to the law and economics movement.  As he stated:

• Even more so, the judge must have been influenced by his conclusion that, quite apart from methodology, the evidence excluded was irrelevant and would be confusing to the jury. In his explanation of his disqualification ruling, Judge Nottingham articulated a contempt for expert economic evidence that raises serious questions about any exercise of his discretion in this matter. He described Professor Fischel’s proposed testimony—without knowing anything more about it than was described in the cursory “written summary” required under Rule 16—as “a waste of time” that would “mislead the jury” by “inviting the jurors to abandon their own common sense and common experience and succumb to this expert’s credentials.” Id. at 3919, 3920. He said, among other things, that the jurors had no need of expert evidence in determining whether Mr. Nacchio had an “economic incentive to trade or not trade on inside information here,” App. 3917; that analysis of the defendant’s trading patterns was “essentially irrelevant,” id.; that economic analysis “is within the common knowledge of the jury,” id. at 3918; that an analysis of whether Mr. Nacchio’s sales could be explained on the basis of the “economics of diversification” is “a piece of elucidation we really don’t need here,” id.; and that a comparison of Mr. Nacchio’s trades to those of other CEOs or Qwest directors at the same time, who lacked Mr. Nacchio’s inside information, is “almost preposterous.” Id. at 3919. He opined that expert evidence is no more necessary in a complex securities matter than in “a simple negligence case.” Id. at 3841. These statements are in sharp conflict with the advisory committee note to Federal Rule of Evidence 702, which describes “the venerable practice of using expert testimony to educate the factfinder on general principles,” specifically mentioning as an example “how financial markets respond to corporate reports.”

Perhaps this is a final chapter in the era of excessive deference to economic analysis.  Perhaps it means that economic analysis will be treated like any other, admitted where it is supported by a reasonable methodology, not admitted where it does not.     

The primary materials on this case have been posted at the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on February 26, 2009 (boomark / email).