In this Essay, I challenge the conventional corporate law wisdom that unhappy mutual fund investors paying high fees don’t need litigation or regulation to protect their interests because they should simply exit a fund and reinvest elsewhere. The exit solution, advanced by Professors John Morley and Quinn Curtis in Taking Exit Rights Seriously provided an elegantly simply solution to the problem of unhappy indirect investors (e.g., mutual fund investors) given that they are often low-dollar, low-incentive, rationally-apathetic investors facing enormous information asymmetries and collective action problems. According to their view, competition produced by exit, or the threat of exit, is the key to mitigating high fees in the mutual fund market.
But what if some mutual fund investors are stuck and exit is, for them, an empty option? Such is the case for citizen shareholders who are the fastest growing group of new securities investors: those who enter the securities market through self-directed, defined contribution retirement plans such as a 401(k)—and who invest heavily in mutual funds and other securities. Drawing upon more recent scholarship by Ian Ayres and Quinn Curtis, Beyond Diversification, showing the continuing problem of high mutual fund fees, I examine the implications of hindered exit for citizen shareholders. Investing through defined contribution plans (i) adds investment costs; (ii) distorts competitive forces through limited exit options, conflicts of interests and share classes; (iii) fractures oversight liability; and (iv) introduces unique switching costs. These differences create a competitive disadvantage for retirement investors who are relatively locked-in with diluted exit rights.
Thus, for citizen shareholders, exit and competition are not the hoped-for panacea. This Essay redirects corporate law scholarship’s attention to these unsophisticated, passive, and apathetic, but also socially and financially important, investors. Elusive exit suggests the need to reexamine regulatory and litigation strategies to better serve citizen shareholders.