Wall Street Scandals: the Curative Effects of Law and Finance

This paper studies three scandals that embroiled U.S. financial markets during the past decade, including the Nasdaq market-makers' use only of odd-eighths quotes, the abuse of specialist power on the New York Stock Exchange, and the mutual fund scandal. We attempt to attribute the resolution of these situations to the curative effects of markets versus regulation. We argue that the intervention of the legal system through regulation and/or litigation is often necessary to help resolve the misalignment of incentives needed for markets to accomplish their goal of maximizing value. The paper suggests that there exists an important synergy between financial markets and law that is often overlooked.