• 29 April 2009

On eBay and Big Boy Letters

Edwin D. Eshmoili - J.D. Candidate, Cornell Law School

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Each day, hundreds of eBay members log on to the auction website and, with limited information and much risk, bid on items being sold “as is.” When consumers purchase an item “as is,” they agree to buy the item in whatever condition it is in—regardless of whether it is actually operational or otherwise worthless.1 Nearly all “as is” items on eBay have some sort of malfunction or blemish.  Indeed, the “as is” label acts as a precaution to potential purchasers, warning them that the item comes with no guarantees. To prevent bidders from assuming the worst, sellers of “as is” items will very often include brief details on the condition of the item or the nature of the defect.  Such information is typically vague and incomplete. Nevertheless, eBayers continue to buy and sell “as is” items and the system largely works.

Now imagine if the sale of securities were to operate in the same fashion. That is, suppose securities were sold on an “as is” basis where purchasers were afforded little information and no recourse. Should this be allowed? Prevailing policies and case law dictate that it should, so long as the purchaser is a sophisticated investor bargaining in a face-to-face transaction.

In fact, such securities transactions have been occurring with increasing frequency in recent years with the advent of big boy letters.  Big boy letters are agreements between parties to a securities transaction where one party, typically the seller, has material, nonpublic information that it does not want to disclose, but both parties want to complete the transaction and preclude any claims based on the nondisclosure of the nonpublic information.  The party with superior information will ask for a big boy letter precisely because of this claim waiver clause, in an effort to protect itself from Rule 10b-5 liability.  By signing a big boy letter, the signatory agrees not to rely on the any of the counterparty’s nondisclosures and to waive all claims against the counterparty arising out of the nondisclosure.  The signatory also acknowledges that it is financially sophisticated and that it realizes the effect of the waiver and elects to proceed with the transaction, essentially stating, “I am a big boy.”

At first glance, it appears the eBay bidder has a distinct advantage over the signatory of a big boy letter.  At least the eBayer receives some information, no matter how vague and incomplete, whereas the big boy signatory seems left in the dark.  Crucially, though, this is not so.  Just as the “as is” tag acts a warning to the bidder, so, too, does a big boy letter.

Suppose that Seller and Buyer, both sophisticated parties, initiate a discussion for the sale of securities.  At the very outset, Seller alerts Buyer that the latter will need to sign a big boy letter to carry out any such sale.  Immediately, Buyer realizes several key points.  That Seller is asking for a big boy letter notifies Buyer that Seller has nonpublic information and that such information is material to the sale.  If neither of these were true, there would be no need for a big boy letter in the first place.  Moreover, that Seller is looking to trade the securities, combined with the fact that Seller has material, nonpublic information, signals to Buyer that the information that Seller has must be adverse.  If the nonpublic information was indeed positive, Seller would surely hold the securities until the good news materialized, so that Seller could reap the benefits.

Consequently, the disparity between the two parties is not as great as it first seems.  Buyer receives a strong, albeit somewhat noisy, signal about the material, nonpublic information—similar to the vague and incomplete information delivered to the eBay bidder.  This quasi-disclosure, coupled with the sophistication of the parties, discharges any duty to disclose that Seller may have, while still complying with Rule 10b-5 jurisprudence.

Ultimately, the sophisticated party who buys securities with a big boy letter is in a better position than the eBayer who buys items “as is.”  The former can investigate the public issuer of the securities to gain more information and can negotiate for more favorable contractual terms.  Short of visiting the seller and inspecting the item in question, a near-impossibility with eBay auctions, an eBay bidder has no choice but to proceed on whatever information it is given at whatever price the market has set on whatever terms the seller has offered.

Regardless, this does not answer the normative question posed at the outset.  Should big boy letters be allowed in the first place?  We are in the midst of an economic crisis caused, in great part, by a series of risky maneuvers where too few considered the dangers or the overall effects of their actions.  The sophisticated parties referred to here—institutional investors such as investment banks and insurance companies—infamously made numerous such missteps.  Are we to allow them to trade securities with one another in a system rigged by information asymmetries where buyers have no recourse?

Yet, for the same reason that the market for “as is” items on eBay operates smoothly, the market for securities traded with a big boy letter operates smoothly as well, and it will continue to do so.  On eBay, the decision to bid on an item or not2 and the final auction price3 of an item are both appreciably influenced by a seller’s feedback rating—essentially its reputation.  The feedback mechanism “reduce[s] opportunistic behaviors by screening participants and monitoring transactions,” acting as a proxy for trustworthiness.4  The market for “as is” items functions properly because, like any other market on eBay, the transaction is generally between honest participants who are incented not to cheat or mislead in order to generate positive feedback (or at least to avoid negative feedback).5

It is interesting to note that, despite the prevalence of big boy letters and their officially unresolved legal status, there has only been one private law suit concerning them.  The circumstances surrounding big boy letters reveal an explanation for this phenomenon.  Big boy letters are contracts between sophisticated parties who are repeat players in the financial markets negotiating face-to-face.  As such, these parties must act with integrity to protect their brand and reputation.  Therefore, the signatory may not be able to afford the reputational costs of going back on its word by suing the counterparty, just as the counterparty may not be able to afford the reputational costs of fraudulent or misleading behavior.  The paucity of cases on big boy letters seems to indicate that they do indeed implement this sort of market discipline.  In the financial industry, trust and reputation are arguably a firm’s most valuable assets.

To be sure, buyers certainly face risk when purchasing securities with a big boy letter.  At the same time, all securities transactions are inherently risky, even when both parties have perfect information.  Buyers realize these risks and do not undertake big boy transactions lightly.  Furthermore, the sophisticated party’s knowledge, experience, bargaining power, and competent counsel all mitigate the risks involved.  In the end, it is not the role of the SEC or the government to regulate the substance of a trade or to prevent bad or risky investments.  This does not mean that the SEC ought to ignore big boy letters altogether.  In my note, Big Boy Letters: Trading on Inside Information, I identify three areas of concern regarding big boy letters and propose rules and policies that the SEC ought to consider.  However, in this instance, the calculated judgments of sophisticated parties bargaining at arm’s length and with ready access to counsel ought to be left alone.dingbat



Copyright © 2009 Cornell Law Review.

Edwin D. Eshmoili is a J.D. Candidate at Cornell Law School. He received his B.S. from Binghamton University in 2006.

I am indebted to Osamu Watanabe for inspiring me to write on this topic. I am grateful to Joshua C. Teitelbaum and Jonah Fecteau for their insights and guidance. I appreciate my colleagues on the Cornell Law Review for all their assistance. Most of all, I thank my family and friends for their love and support.

This Editorial is based on the following Student Note: Edwin D. Eshmoili, Big Boy Letters: Trading on Inside Information, 94 CORNELL L. REV. 133 (2008). Click Here for the Full Student Note

  1. In fact, the very first item ever sold on eBay, at the time known as AuctionWeb, was a broken laser pointer. It sold for $14.83.
  2. José J. Canals-Cerdá, The Value of a Good Reputation Online: An Application to Art Auctions 21 (working paper, April 1, 2008), available at http://ssrn.com/abstract=1123599.
  3. Luís Cabral & Ali Hortaçsu, The Dynamics of Seller Reputation: Evidence from eBay 2 (NYU Stern School of Business Research Paper Series, No. 2451/26094, March 2006), available at http://ssrn.com/abstract=1282525.
  4. David Masclet & Thierry Pénard, Is the eBay Feedback System Really Efficient? An Experimental Study 2 (Center for Research in Economics and Management, WP 2008-03, January 2008), available at http://ssrn.com/abstract=1123599.
  5. Id. at 3.


  • I have never heard of or seen a big boy letter and you didn’t present an example of one or any language that might be in one but I appreciate learning of their existence and have formed an idea what they look like. I believe them to be ultimately irrelevant (I am not clear what you think of them) just like another form for a buyer to sign off on at a real estate closing that no one has time or interest to read. Big boy letter or not, a free market expects buyers or sellers of a security or real estate to be big boys when they buy or sell and no seller can escape their liability for positive fraud. When the Big boy becomes standard practice (and i expect it will) and it will not be a signal to any buyer, just a CYA device.

    Posted by richeethepinhead, 05.07.09 

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