Professor Barry evaluates Professor Fleischer’s analytical framework developed in Regulatory Arbitrage, which addresses how actors respond generally...
Professors Knoll and Raff argue that Professor Fleischer's theory that transactional lawyers produce an optimal transactional structure by balancing Coasean transaction costs and regulatory costs...
Prof. Fleischer expounds a comprehensive theory of regulatory arbitrage—a type of gamesmanship in which parties exploit gaps between the economic substance of a deal and its regulatory treatment, restructuring the deal to avoid regulatory costs while maintaining the underlying economics. Although regulatory arbitrage observes the letter of the law, its consequences can be pernicious.
Prof. Fleischer first fleshes out a theoretical framework of regulatory arbitrage. He details the role of the lawyer in regulatory arbitrage, which involves spotting the gaps between the legal and economic structures and subsequently finding ways to structure deals to increase value. Next, he describes the conditions under which arbitrage occurs, which lead to different forms of arbitrage as well as considerations constraining arbitrage. According to the author, deal lawyers engineer regulatory costs as well as Coasean transaction costs, balancing the two against the shifting backdrop of legal, business, ethical, professional, and political concerns. With this background, Prof. Fleischer synthesizes the traditional transaction-cost economic literature on deal structuring with newer tax-planning literature to arrive at a comprehensive theory.
The Article next explores three implications of the theory. First, balancing regulatory costs against transaction costs can distort regulatory competition. When a new form is chosen because it reduces regulatory costs but increases transaction costs, it reduces economic efficiency and shifts the regulatory burden onto those who cannot engage in arbitrage. Second, such arbitrage makes many regulatory schemes, including much of securities and tax law, effectively optional for sophisticated clients. As a result, firms unable to engage in arbitrage, including many entrepreneurial firms and small business in general, bear a greater regulatory burden—a distribution that is inefficient and unjust. Finally, there is the political aspect of regulatory arbitrage: With the ever-increasing size of the modern administrative state, staffers and agency lawyers have gained more discretion in interpreting regulations, which allows them to draw regulatory lines on a deal-by-deal basis, subject to political pressures rather than the rule of law.
Prof. Fleischer does not claim to know what should be done about the problems of regulatory arbitrage. The difficulty in doing so is that, as he recognizes, the optimal amount of arbitrage is not zero. Not all regulations are well written, and not all serve the social welfare. Thus arbitrage may incentivize better drafting and create positive welfare effects. The author leaves the line-drawing between good and bad arbitrage to future scholars, but gives them a comprehensive theory of regulatory arbitrage to guide their efforts.
