Cornucopia

Bannergate, Materiality, and Reasonableness

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This post is sure to be the final stake for Bannergate. I’m going to compare it to securities law.

Reactions to Bannergate have varied. A common apologetic stance is that there is no objective harm done. Any reasonable or objective reader would or should have caught on to the hoax. Claims of harm must be based on unreasonableness.

This argument is familiar to the securities lawyer. Similar arguments play out in securities briefs every day. A company makes a statement that turns out to be false, and number of shareholders file suit. In order to prevail, the shareholders must show that the false statement was material. If it’s not material — i.e., if it doesn’t really matter — then there is no liability. As a result, a good deal of litigation focuses on whether a false statement is material. There are known carve-outs. Obvious puffery (“our company is great”) is not material. Forward looking statements (“we hope to do X”) is often not material.

Banner apologists sometimes invoke similar reasoning, suggesting that objective readers knew or should have known that Banner was fake.

The materiality standard has been criticized. Recently, my friend and co-author Dave Hoffman wrote a great article on the topic. Dave’s argument (hopelessly condensed into a few sentences) is that the materiality standard as applied by courts is too demanding on shareholders. Shareholders are expected to act like pure economic profit-maximizing machines; any deviation makes their decisions look unreasonable and subjects their claims to dismissal. Dave severely criticizes what he sees as a de facto rule requiring that shareholders act as profit-maximizing robots or risk losing the protection of securities laws. His argument is, in effect, that irrational people — or not-perfectly-rational people — deserve protection too.

Our approach to Bannergate may depend on our view regarding this very question. Do irrational people deserve protection too? Yes, there were many indicators that should probably have raised suspicions for our rational, objective, “reasonable man” blog reader. But others, like Julie, seem to feel strongly that irrational people deserve protection too.

I find Julie’s position sympathetic, and not only because it corresponds to a vision of securities law that I like. I think Julie is right to demand protection for irrational people, precisely because there is so much about our relationship with God that is, at its core, irrational. Our faith depends on still small voices, burnings in the bosom, talks or prayers or thoughts that somehow confirms to us that God exists, that He loves us, that the church is true and correct, that families can be together forever. Testimonies rise and fall based on the silliest of little things. Take a look at Julie’s conversion thread. Julie’s own testimony comes in part from Owen Meany. A dozen conversion stories in the comments are no more objectively rational. And yet they are real. Is it equally possible that someone’s testimony is, however rationally, linked to the bloggernacle? I don’t base my own testimony on the bloggernacle. But my own entirely subjective foundations are not really much more rational or objective than simply basing it all on a blog.

Testimonies rise and fall based on small and often irrational factors. Those factors might — and apparently for some commenter, do — include blogs. This means that our responsibilty goes beyond merely protecting rational or objective blog readers. The less-than-perfectly-rational blog reader deserves protection too.

29 comments for “Bannergate, Materiality, and Reasonableness”

  1. THIS IS THE WORST POST EVER! SECURITIES LAW HAS ABSOLUTELY NOTHING TO DO WITH THIS! HAS ANYONE SEEN THAT DARN ARMADILLO? I KNOW IT’S AROUND HERE SOMEWHERE!

  4. EdwardE: Securities law is by definition about stuffed shirts. That is why all of the cool, hip law nerds do contract law and the UCC — especially the articles on secured transactions, commericial paper, and payment systems. It is so much sexier…

  5. Great post, Kaimi, but it doesn’t change the fact that Steve, Brian, Christian, Naomi and DKL are terrible, terrible, terrible, terrible, terrible people who are beyond redemption and are going to go straight to HELL!!!!!!!!

    Aaron B

    P.S. And Rosalynde too. :)

  9. “THIS IS THE WORST POST EVER!”

    Is no one going to take umbridge at this comment? Surely there have been worse posts than this at T&S. The floor is open for nominations…

  10. BTW, Kaimi: A very, very condesed reply to Dave’s argument is that I think he is wrong because otherwise we are in the position of making securities offerors into insurers for people who make poor investment decisions. If folks want insurance against stupid investment decisions they should: (1) diversify their portfolio or (2) buy insurance, rather than suing companies who failed to anticipate that some investors would be dumb.

  11. I’d like to make a suggestion,

    Owens comment should have read, “THIS IS THE WORST POST, not dealing with cheese, EVER!”

    Sorry Kaimi

    i like cheese

  12. Nate, for your comment to be germane to the topic at hand there must be equivalents to (1) diversifying one’s testimony portfolio and (2) buying testimony insurance. Absent such tie-ins it constitutes a threadjack.

  14. Kaimi,

    Your definition of rational is not the one actually used by economists, is it? It’s more like the one lawyers who don’t do economics use when they are talking about economists. :)

    I am fine with taking steps to legally eliminate options that only a moron would take. On the other hand, I am guessing I would not be impressed with arguments that what we really need in securities law is _more_ opportunities to sue firms if their stock price falls. Or that it is a good idea to make the firm culpable for, not just you being a moron, but the fact that they can’t prove you aren’t a moron. This sounds like a jobs program for lawyers.

    Also, I looked at the abstract but not the article. Why does a different preference for risk matter to this issue of the law? The economic definition of rationality allows for different risk preferences. In fact, risk aversion is present in most rational actor models and certainly it is in any model with stocks. Is there something about the lawyer definition that makes this different? I am just curious if you know the argument off hand.

  17. Frank,

    That is the kind of response I woud expect from the bannergate “short-seller.” Naturally, I agree with Finance Ministry of Malaysia; short-sellers should be caned. :)

  18. Frank,

    The big problem is that plaintiffs have to show that the statement is material. This devolves into a lot of name-calling about whether an objective or reasonable person would think it is material, etc.

    As Dave points out,

    (1) the statute isn’t written in a way to protect just the objective investor. It’s supposed to protect us all.
    (2) investors are, like everyone, known to have certain biases. (see Kahnemann & Tversky, etc).
    (3) our corporate law model assumes a passive investor who lets fiduciaries do their duty; our securities law model seems to require a Nancy Drew who goes sleuthing into statements; those aren’t consistent. If corporate law has figured out that investors are just glorified eggplants, then why hasn’t securities law caught on too?

  19. Kaimi,

    I took a brief look at the article. As best I can tell from my perusal, it looks to me like Dave is confusing differences in risk aversion with differences in rationality. Frankly, I’m surprised that lawyers are allowed to go around making wild claims about how women and minorities are less rational. I thought you guys were too hung up on PC to do that.

    But regardless, risk aversion is a straightforward implication of diminishing returns. The documented literature on differences in risk aversion across genders and races does not tell us anything about rationality. It just documents another example of the fact that people, genders, and races differ. And I am not at all clear how that difference informs us about a person’s ability to understand that someone is snowing them in stock fraud with material vs. non-material statements.

  20. Karl,

    In addition to believing that some stocks go down (for reasons besides fraud), I also should admit right now that I hold the horrible opinion that half of all children are below average.

  21. Frank, be careful, you don’t want to be one of those people who sympathizes with the following:

    Just as a healthy forest needs vultures and worms that feed on death and decay, the financial markets need what are known in the business as short sellers.

  22. Nate, for your comment to be germane to the topic at hand there must be equivalents to (1) diversifying one’s testimony portfolio and (2) buying testimony insurance. Absent such tie-ins it constitutes a threadjack.

    Hey, should someone with a fiduciary duty to you be able to count on you being dumb?

  24. Surely there have been worse posts than this at T&S. The floor is open for nominations…

    I nominate anything to do with law, and cheese.

    I heart Gordon Smith posts

  25. Doesn’t your whole post hinge on the idea that BoH believers did so irrationally? I’ve met stranger mormons than the invented characters over there, and I’m not sure I would be irrational to believe that they exist. Of course, that’s subjective, and not objective. But I’ll bet most people have at least one active member of their congregation that’s at least as crazy as any fictitious person at BoH.

    Moreover, my limited involvment in the securities world tells me that the “rationality” component of a securities fraud claim as interpreted by judges looks less like a reasonable man analysis and more like an unclean hands (or “we’re not to let you purposefully look the other way and then complain about it later”) analysis. And I think that the materiality component is also a pretty low burden–most cases simply ask if it would it have made a difference in the overall investment decision? Accordingly, I think if this analogy is made as a standard for the so-called “gullible” for BoH, you could make the argument that almost no reader has been irrational as they don’t have unclean hands and that almost all of them would have made different decisions about their “blogging decision” had they known the truth, thus making it material. I’m willing to defer to those who do more securities work than I do (or blogging for that matter), however.

  26. If those of you out there who post and read on the Times and Seasons website, would spend even half that amount of time reading and studying the scriptures, we would all be better because of it.

    Aren’t there some of you out there on this who spend a couple of hours every day reading this? How are you doing on your progress towards reading the Book of Mormon by end of the year as President Hinkley has asked us to do? maybe you should reconsider how you are spending your time.

    This so-called “web log” is about the closest thing I have seen to scripture mixed with the philosophies of (wo)men.

  27. NW,

    You know, blogging is just a drop in the bucket, time-wise, compared with all the time I spend at online gambling and porn sites. And buying illegal drugs.

    When I really want to get a kick, though, I go to the websites of people I’ve never met, and I speculate about their scripture reading habits.

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