In the wake of Sarbanes-Oxley, Henry Butler and I wrote a book called the Sarbanes-Oxley Debacle. We closed on this hopeful note:
An understanding of [the Act’s] high costs and minimal benefits, and of the forces that produced this misguided legislation, may help to prevent a regulatory debacle in the future. We make specific recommendations for any future regulation of the capital markets that are suggested by the SOX experience, including optional provisions, periodic review and sunset provisions, and regulation whose scope is more carefully designed and focused. SOX should teach us to respond to fraud in a more measured way, with regulation that works with, rather than against, markets.
Unfortunately, the Dodd-Frank 2,315 page monstrosity taught me an important life lesson about optimism. “Measured” is not the word I would use to describe it. I recently reviewed some of the worst features:
- Corporate governance provisions, including shareholder voting on executive compensation, "clawbacks" on compensation paid to innocent executives, authorization for SEC proxy access rules, and restrictions on broker voting that will make shareholder elections more costly without doing anything to ensure that executives will catch the risks they missed last time around.
- The hedge funds that did catch those risks and that largely avoided the meltdown will be subject to new registration and disclosure requirements.
- The law imposes new fiduciary duties on securities sellers. The Supreme Court in Jones v. Harris recently punted on trying to fix a fiduciary duty provision Congress imposed on investment advisors 40 years ago (watch for my forthcoming article on Jones, which I plan to post soon). Now we can have another 40 years of litigation trying to figure out this new set of duties.
- The bill gets praise for its “Volcker rule” restricting banks’ proprietary trading. Yet the law allows banks to risk their money by trading in what they call customer accounts. So now the trading just shifts to a setting in which it will exacerbate conflicts between customers and banks.
- The law requires end-users of derivatives to post collateral – a little provision that the International Swaps and Derivatives Association famously estimated will cost the economy up to a trillion dollars will reducing the beneficial use of derivatives. At the same time it will do little to prevent another financial crisis.
- Last but certainly not least, the bill will certainly not end regulatory uncertainty in the markets. A Davis-Polk memo paints an exciting picture an exciting picture of the future under Dodd-Frank, in which it notes that “market participants will need to make strategic decisions in an environment of regulatory uncertainty” and that “regulators and market participants will be dealing with the bill’s consequences, both intended and unintended, for many years to come.” Among other things, the memo says to expect 243 rulemakings and 67 studies required by the law; persistent ambiguities “that will require consultation with the staffs of the various agencies involved;” and the need to adjust the regulation to changes in market behavior as well as to the technical fix bill promised by Chairman Frank.
But all is not bad. Dodd-Frank did do one good thing by fixing one of the worst hangovers from the SOX debacle: it exempted small-cap companies from SOX’s heinous internal controls attestation requirement. Maybe the next financial law, after the next financial meltdown, will fix some of Dodd-Frank. I am no longer optimistic enough to expect more.
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