Dr. Spitzlove or: How I Learned to Stop Worrying and Love “Balkanization”

Abstract

Recently, the term “balkanization” has arisen in the context of securities regulation, in reference to the wave of activism by select state attorneys general in prosecuting cases of securities fraud. As certain theorists argue, the creation and enforcement of securities market reforms devised by individual states will destroy the integrity of a single, efficient national market system. In its place would arise a variegated patchwork of different regimes, as occurred on the Balkan peninsula at different points in history. The cacophony of many different and possibly conflicting sets of rules would impose great compliance costs and inject uncertainty into the securities market. The efficiency loss would be tremendous.

In recent years, state attorneys general have indeed become more assertive in policing the securities industry and have been employing a remedial toolkit that transcends traditional state measures. Eliot Spitzer, the Attorney General of New York, launched this era in his April 2002 settlement with Merrill Lynch & Co. The settlement imposed restrictions on the interactions between the firm’s investment banking and equity research divisions. It would be difficult, however, to argue that this settlement itself caused any “balkanizing” damage to the national market system, because the Securities and Exchange Commission (“SEC”) ratified the April settlement terms in the Global Settlement of December 2002. Yet does not this activism by state attorneys general nevertheless create vast possibilities for “balkanization,” by which inexpert state political entrepreneurs may wreck the uniform federal scheme with parochial reforms crafted only for their populist ring? Theorists who believe that “balkanization” presents a real and continuing threat advocate for congressional (legislative) preemption to avert it. The theoretical arguments behind “balkanization” seem plausible. Yet four years have passed since Spitzer’s initial settlement with Merrill. Not unlike killer bees from South America and the Y2K bug, “balkanization” has fallen grievously short of the hype. Thus, these political economy theories, which consider only the narrow political self-interest of state attorneys general, are at best incomplete. Because “balkanization” has not occurred, there must exist countervailing dynamics that weigh against a progressive “balkanizing” trend and toward stability and comity in the federal-state regulatory relationship. This Note proposes one such dynamic: State officials regulate securities in the shadow of administrative preemption by the SEC. Should a state attorney general take action deleterious to an efficient, integrated national securities market, the SEC can use its authority under Section 11A of the Securities Exchange Act of 1934 to promulgate a preemptive measure to void it. Academic literature has widely neglected this observation, likely because federal securities law contains “savings clauses” that appear to guard state prerogatives against any federal curtailment. This Note contends, however, that a state action serving to undermine an integrated, efficient national market actually conflicts with federal law, as stated by Congress and explicitly delegated to the SEC for further definition in Section 11A. A savings clause does not prevent “conflict” preemption, and hence, does not “save” efficiency-undermining state rules from invalidation by the SEC.