Washington and Lee Law Review, Vol. 51, No. 3 (Summer 1994), pp. 879-924


Before the late 1980s, traditional contract law played virtually no role in private litigation under section 10(b) of the Securities Exchange Act of 1934 and rule 10b-5. The reason was perceived incompatibility. The 1934 Act is regulation intended to supersede “the philosophy of caveat emptor,” whereas traditional contract law promotes bargaining free of regulation. In the late 1980s, however, the tide turned. Since that time, private rule 10b-5 litigation has become riddled with the vocabulary of traditional contract jurisprudence – the statute of frauds, merger clauses, attorneys' fees clauses, choice of law clauses, releases, and the formation of an agreement. Thus, today lower federal courts often derail rule 10b-5 actions in reliance on the same contract devices that earlier case law rejected as inimical to investor interests.

Why does rule 10b-5 jurisprudence now embrace the contract law it previously rejected?

Part I contrasts the federal securities laws with the approach of law-and-economics. The two diverge sharply, and to merge them carries a price. The law-and-economics approach teaches that to maximize efficiency one must maximize freedom of contract. Hence that approach champions the use of traditional contract devices such as the statute of frauds, merger clauses, and attorneys' fees clauses. These devices often derail rule 10b-5 actions, thereby benefiting defendants and the status quo. This in turn contributes to the creation of the very caveat emptor world that the federal securities laws were intended to overcome.

Parts II, III, and IV apply Musick and Rodriguez to the statute of frauds, merger clauses, and attorneys' fees clauses in private rule 10b-5 litigation. Rule 10b-5 case law accepting these devices relies on efficiency rationales and disregards both the statutory text on the one hand and the realities of securities transactions on the other.

Part V examines the cumulative consequences of derailing rule 10b-5 actions through the use of contract devices. The actions most at risk are those involving transfers of close corporation stock, private placements, and customer-broker disputes. These actions perform essential regulatory functions, and their derailment jeopardizes those functions.