The comment period just ended, and the Times has a piece on how active individual banks have been in filing their thoughts (with pictures of your favorite Davis Polk banking law celebrities, if you like that sort of thing).  Ordinarily, banks leave these sorts of things to the banking associations.  The WSJ has a piece summarizing the comments, and you can get your own taste here (SEC), here (CFTC), and here (Fed).  Perhaps most encouragingly, Kim Krawiec, already something of an expert on this sort of commenting, is on the case.  It certainly shows how financial lawyers may need to master some of the intricacies of participating in administrative rulemaking.

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The SEC is a resource constrained agency that clearly misses much wrongdoing.  But by going after hedge funds with its insider trading powers, and now by investigating private equity, I think you can also tell a story of an agency that is increasingly unwilling to let some areas of the capital markets go as "buyer beware, big boys play here" alternatives to the heavily regulated public listings.  Dodd-Frank made the SEC more of a player in derivatives regulation, and with money market funds too.  

To be sure, there are still some dark pool markets out there.  But instead of picking its battles, it looks to me like the agency is trying to be comprehensive in its oversight.  As for the latest development, the SEC's investigation concerns the way that private equity firms value their hard-to-value assets, which may be being oversold to investors.  It sounds like a Rule 10b-5 matter:

One focus of the inquiry is how private equity firms value their investments and report performance. Unlike the valuing of publicly traded stocks, valuing private equity investments — largely in private companies that are not listed on an exchange — can be a thorny and subjective process.

The S.E.C.’s concern, say people familiar with the government inquiry, is that some private equity funds might overstate the value of their portfolios to attract investors for future funds.

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In the midst of repeated appeals to the merits of jail time as a post-financial crisis government strategy comes word of a new kind of reckoning.  The CEO of the Royal Bank of Scotland, who disastrously pushed his bank to go really big in the runup to the financial crisis, and received a knighthood for his efforts, is now getting stripped of it:

The British government announced Tuesday that Frederick A. Goodwin, the former chief executive of the Royal Bank of Scotland, now nationalized, would be stripped of his knighthood.

A couple of weeks ago, the country’s prime minister,David Cameron, said that he supported a review of Mr. Goodwin’s knighthood, which Mr. Goodwin received in 2004 for his service to the British banking industry.

That honor now looks woefully out of place. The bank, based in Edinburgh, is 82 percent owned by British taxpayers after receiving a multibillion-dollar bailout in 2008. Mr. Goodwin, who gained the nickname Fred the Shred for his cost-saving efforts, left the bank after the government took control of it in 2008.

Perhaps most amusingly, the stripping puts Mr. Goodwin among some pretty select company.

The removal of his knighthood places Mr. Goodwin alongside other notable individuals. Robert G. Mugabe, the president of Zimbabwe, lost his honorary knighthood in 2008 because of violence ahead of a presidential runoff. Jean Else, who helped transform a failing British school, lost her damehood last year for ignoring some standards and promoting her twin sister.

Given the track record of previous financial crises, I expected a lot more jail time in exchange for the bailouts, but perhaps the bailouts put governments in a "doing business with" rather than "being really angry at" place vis a vis the large banks.  From an American perspective, that relationship would be different from the one that developed after the S&L crisis of the 1990s.  But perhaps Britain is showing the way with regard to imposing sanctions, but not resorting to the criminal code.  If only the United States permitted titles.

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The debate about the legality of Richard Cordray’s appointment to head the Consumer Financial Protection Bureau is just one of many brewing power battles.  Another, and the one I am writing about today, is the Office of the Comptroller of the Currency’s preemption ruling.

The OCC has absorbed the Office of Thrift Supervision and, thus, has dramatically increased the number of institutions subject to its enforcement, supervisory and rule-writing authority, which translates into more and louder voices crying for preemption of state lending laws.  The OCC already is a poster child for regulatory capture because of its 2004 blanket preemption rule shielding national banks from state laws that were aimed at curtailing costly, unaffordable loans, and deceptive lending practices. It was in response to the OCC preemption rule (and a similar one by OTS) that the Dodd-Frank Wall Street Reform and Consumer Protection Act included provisions aimed at limiting preemption.

Dodd-Frank restricts OCC preemption to situations in which a state consumer financial law: (1) discriminates against national banks in favor of banks chartered in the state; (2) “prevents or significantly interferes with the exercise by the national bank of its power;” or (3) conflicts with federal laws that expressly preempt state laws. Dodd-Frank also requires that any preemption determinations be made case-by-case, based on substantial evidence, and on the record. http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_public_laws&docid=f:publ203.111.

As many of you know, on July 21, 2011, the OCC revised its preemption provisions as required under Dodd-Frank. http://www.occ.treas.gov/news-issuances/news-releases/2011/nr-occ-2011-97.html.  Many features of the new OCC rule were in accord with Dodd-Frank’s mandates, but the process that the OCC employed in issuing the rule did not follow the requirements set out in Dodd-Frank.  

The OCC did not look at individual state consumer financial laws to determine whether they were preempted on the grounds that they “prevent[ed] or significantly interfere[d]” with national banks’ exercise of their power. The OCC’s position is that the process for issuing preemption rulings is only for prospective rules and that the agency had no obligation to review existing rules.  As a result, the OCC kept intact a list of preempted state laws that it had assembled under its former and broader preemption standard.  The effect boils down to continued field preemption of state consumer financial laws.

So, why should we expect a battle ahead?  When the OCC issued its proposed rule, both the Department of the Treasury—of which the OCC is an arm—and the National Association of Attorneys General opposed the proposed rule.  The OCC did not yield.  Bets are that Obama’s nominee for Comptroller of the Currency, Thomas Curry, won’t yield either. 

Whether Treasury and the CFPB, with Cordray in the driver’s seat, will try to win Curry over is hard to say.  The CFPB has its own preemption battle to contend with as consumer advocates protest its interim rule on the Alternative Mortgage Transaction Parity Act, which preempts state laws that restrict nonbank lenders from making loans with balloon payments and other “nontraditional” features. http://www.nationalmortgagenews.com/nmn_features/criticize-cfpb-preemption-1028266-1.html.

The field of play will be the courts where state Attorneys General will likely try to enforce laws that are subject to earlier OCC preemption rules. It will take years for courts to determine the legality of the OCC’s process and its 2011 rule.  While the courts sort out these issues, neither lenders nor consumers will know exactly which laws matter.

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The Canadian Supreme Court just held that creating a single Canadian securities law would be unconstitutional.  Unconstitutional!  Those guys haven't mastered the American Court's approach to legal legitmacy, which I interpret to be "tough in symbolic cases, deferential in substantive ones."  Under the Court's rule, Canada will never be able to federalize its securities law, unless, that is, the court can be overruled under the constitutional scheme, or the constitution is amendable.  Check out this language, summarized by Kevin LaCroix:

The “field of activity” that the Act “would sweep into the federal sphere simply cannot be described as a matter that is truly national in importance.” The basic nature of securities regulation “remains primarily focused on local concerns of protecting investors and ensuring fairness of the markets through regulation of the participants.”  

Sounds both incorrect and an unwise substantive judgment about the securities industry to me.  But it suggests that they take their federalism extremely seriously up there in Canada.  HT: CorpCounsel.

Meanwhile American trade lawyers are worried that the proposed combination of USTR and Commerce will not work well.  I would suggest that they needn't spend a lot of time thinking about it.  Combining agencies means dispossessing a congressional sub/committee of oversight responsibilities, and it isn't as if it can never happen - we have a Department of Homeland Security, after all - but it makes such consolidations much more difficult than mere logic would suggest.  USTR and Commerce do not generate a ton campaign contributions from regulated industry, but they aren't politically meaningless, either.

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The CFTC, the most on track agency in Dodd Frank implementation, just issued its new segregation of customer accounts rule, or, as I like to call it, the MF Global Rule.  It just issued a Volcker Rule, too, but the MF Global rule was passed in the time between October 31, the firm's bankruptcy, and today, with breaks for Christmas, Thanksgiving, and assorted other federal holidays.  By American standards, that's really flying. 

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This is the fourth installment of a series of previews of the papers being presented at the AALS Financial Institutions & Consumer Financial Services Section meeting this Sunday from 9 am to 10:45 am at the Marriott Wardman Park.

Stavros Gadinis (U.C. Berkeley) has authored the fourth paper that will be presented on Sunday. His work, From Independence to Politics in Banking Regulation (forthcoming in the Duke Law Journal) provides a very insightful empirical study of how lawmakers are responding to the financial crisis. Surprisingly, Gadinis finds across a number of countries, lawmakers are moving away from giving responsibility for bank regulations to independent agencies. Instead, lawmakers are increasingly assigning responsibility to officials subordinate to elected politicians or to politicians themselves.

Here is his abstract:

U.S. financial regulation traditionally relied on independent agencies, such as the Federal Reserve and the FDIC. In the last two decades, countries around the world followed the U.S. example by strengthening the independence of their financial regulators, encouraged by recommendations from international organizations such as the Basel Committee and the IMF. Yet, reforms introduced following the 2007-2008 financial crisis abandon the conventional paradigm of agency independence and allocate authority to officials under the direct control of elected politicians, such as the Secretary of the Treasury. This paper studies reforms in 10 key jurisdictions for international banking. It shows that politicians gained new powers with three distinct features. First, politicians have new authority not only to handle emergencies, but also to oversee banks’ financial condition during regular times of smooth business operation. Second, politicians exercise these powers directly, rather than by delegation to a regulatory bureaucracy. Third, while reforms did not dismantle independent regulators, they require them to work under the leadership of politicians in new systemic oversight arrangements. Whenever reformers established new regulatory bodies or mechanisms, they placed politicians at the helm.

Gadinis’s paper promises to launch a fleet of subsequent scholarship. Beyond the normative/ policy question of whether this shift away from independence is a good development, are interesting questions that would drill down into the data. I would find it surprising that elected officials would assume all these new powers without building in mechanisms to hedge the risk of being blamed for the next crisis.

At the same time, Gadinis is writing at a particularly fertile juncture of financial regulation and administrative law. Some of the influential recent administrative law scholarship in this area has argued that traditional hallmarks to measure agency independence and traditional mechanisms to safeguard that independence need to be rethought, at least in the U.S. context. For example, Lisa Schulz Bressman & Robert Thompson have looked at the nuanced ways in which the President can exercise influence over agencies.   Rachel Barkow has laid out other ways in which agencies can be insulated from capture beyond the traditional mechanisms (which, include taking away the President’s power to fire an agency head and exempting agency regulations from Executive Office cost-benefit review). So we need to pay much more attention to texture and nuance in defining agency independence and serving its underlying goals. Of course, the coding in a comparative empirical study cannot take into account all the differences in institutional environments among numerous countries.

Gadinis’s paper is sure to spark a lively scholarly conversation. Shruti Rana (Maryland) will serve as discussant and be first to engage.

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It would appear that yearly quotas are being met:

• Perhaps most intererestingly, the Basel Committee sent out for comment "a set of requirements for banks to disclose the composition of their regulatory capital," which might be of real interest to investors, shorts, and competitors.
• Much less tough, the Basel Committee, worried that arbs are forcing the prices of certain regulatorily required forms of credit protection sky hight, said that "the Committee is clarifying that supervisors will consider the cost of credit protection that has not yet been recognised in earnings when assessing whether credit protection purchased should be recognised for purposes of regulatory capital, including whether a bank meets the Basel standards for significant credit risk transference."
• And Basel put out a third set of questions and answers on Basel III.
• The Joint Forum (Basel plus supes of insurers and investment banks) asked for comment on its paper on "Principles For The Supervision of Financial Conglomerates.

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David Smyth at the Cady Bar The Door blog has a pretty plausible take as to what prompted DOJ to indict Rajat Gupta well after the SEC's civil case against him had collapsed.  Here's some of the relevant analysis:

I think the delay in the criminal case against Gupta is explainable if one assumes two things are true:  First, that a criminal prosecutor would much rather go to trial in a case like this with incriminating taped conversations than without.  It makes sense; proving a case beyond a reasonable doubt is no easy trick.  Insider trading cases can be very hard to prove, and one can imagine that the prosecutors in the Southern District of New York would want to have the best evidence possible before walking onto that big stage.

The second key assumption is that prosecutors made a final run at trying to get Rajaratnam to flip on Gupta just before Rajaratnam was sentenced.  It’s hard to know if this is true, but Rajaratnam did recently submit to a wide-ranging interview with Newsweek magazine in which he revealed that prosecutors had asked again for his cooperation against Gupta....

To me, one of the interesting questions in this involves the lobbying of the prosecuting agency, DOJ, by the investigating agency, the SEC, to commit to a criminal case.  Once the SEC had lost on the administrative proceedings (which it may have begun because DOJ was unwilling to indict), it may have presented DOJ with something of an ultimatum.  We'll never know.  

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Much of the interesting action in post-financial crisis regulation is occuring on the international level, through the FSB and its network affiliates.  Now comes news that the SEC's international strategy is going to be coordinated by someone from academia, namely Eric Pan, from Cardozo Law School.  Eric will join the SEC's office of international affairs, "where he will oversee the development of international regulatory policy," as the press release puts it.

“I am pleased to welcome Eric to the Office of International Affairs. In serving as an academic fellow this past year, Eric quickly established himself as a senior leader,” said Ethiopis Tafara, Director of the SEC’s Office of International Affairs. “Eric has tremendous intellectual skills and a remarkable ability to identify solutions to seemingly intractable issues in the regulation of cross-border activities.”

As for professors, Eric joins commissioner Troy Paredes, ex Wash U, at the agency.  Somewhat rare to see an academic in a financial diplomacy job.  Accordingly, we're wishing Eric the best over here at the Glom.

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For a North Carolina law review symposium, Dain Donelson and I took a look at the question: did lax regulation cause the financial crisis?  Of course, that's a hard question to answer, but at least we could look at how institutions that shifted in and out of the vilified and shuttered Office of Thrift Supervision did during the crisis, and consider what light was shed on the lax regulation thesis there.  It's up on SSRN, do give it a look and tell us what you think:

We evaluate evidence reflecting the stability of our multi-regulator, charter-competitive system of financial regulation during the financial crisis in this symposium essay. Specifically, we compare thrifts to banks, charter-switchers to other thrifts and banks, and bailout recipients to non-bailout recipients to discover if any of these institutions did poorly when compared to their peers during the financial crisis. First, we compare publicly traded thrifts to publicly traded banks during 2008--the critical year of the crisis--and find that thrifts fared only marginally worse than banks, if at all, during that year. This result modestly suggests that the multi-regulator regime, however illogical, did not concentrate instability in a particular industry subject to a weak regulator. Second, to evaluate the impact of competition for charters, we compare thrift and bank performance to those institutions that chose to switch regulators immediately before and during the financial crisis. We find no significant differences in returns among either institutions that converted their federal bank charters to federal thrift charters, or institutions that converted federal thrift charters to bank charters, although our samples of these institutions are small. Third, we examine the bailout propensity of these charter-switchers. Our results suggest that although institutions switching to thrift charters were big enough to receive bailout money from the government, they did not. Conversely, we find that institutions switching away from thrift charters received more bailout money than their size would suggest. Our final finding may suggest some (possibly misplaced) dissatisfaction with the performance of the federal thrift regulator among federal government officials, which may have contributed to the decision to eliminate it in the Dodd-Frank Financial Reform Act passed in the wake of the crisis.

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We've been pro-DF over here, and this correspondent has told you that the real action in curbing bank excesses would come from Basel, to which DF punted many of the hardest issues.  And at this moment, we're looking pretty prescient.  With the most dangerous banks posting sharply lower earnings, and blaming it on regulation, with regulators telling the banks that they need to raise more capital, and that it won't hurt the economy if they do, we may be much closer to that holy grail of smaller, less profitable banks than any of the hand-wringers or libertarians thought possible.

Here's Daniel Drezner on it:

it's not terribly surprising that global regulators will say that they're right and the banks are wrong.  One would expect that the interest group power of Wall Street, however, would have the upper hand.  What is surprising, as the Wall Street Journal's Sara Schaefer Munoz notes, is thatthe banks seem to be losing their battle with regulators:

The tug-of-war between banks and regulators over post-crisis financial rules has so far moved in the watchdogs' favor with banks largely failing to upend the tougher proposals in the U.S. and Europe....

Even before Monday's report, regulators didn't seem responsive to the industry's arguments. In the U.S., lawmakers have already determined that the country's big banks must hold more capital, but haven't yet specified how much.

The Dodd-Frank financial overhaul law, enacted more than a year ago, mandated many new restrictions on banks but left it to regulatory agencies to write the rules. Wall Street and the financial industry have spent millions of dollars lobbying to shape the rules, with little success so far.

They lost in their efforts to block new limits on the fees they can charge merchants when consumers use debit cards. Regulators are expected to vote Tuesday to issue a proposed "Volcker Rule," a part of the Dodd-Frank law designed to curtail trading activities at bank. Now they appear likely to fail in their efforts to block or water down a rule requiring them to hold extra capital.

In 2010, securities and investment firms spent a record $101.6 million on lobbying, up from $92.3 million in 2009, according to the Center for Responsive Politics. Through early October 2011, the firms had shelled out $49.5 million.

There are plenty of ways in which large banks can continue to fight the suggested rules, particularly on the implementation side.  Still, this is not how open economy politics traditionally works.  Traditionally, bank preferences are communicated to national governments, which then get expressed in BIS/Basle Committee meetings.  This certainly happened in the actual Basel III negotiations.   This kind of back and forth, in which regulators appear to trump the arguments of the financial sector, is highly unusual

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Here, via Felix Salmon, is a useful breakdown of the impending Volcker Rule.  Seems to be pushing the idea of closely scrutinizing short term trades, and a "we know it when we see it" vision of what proprietary trading looks like.

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Not completely crazy.  The opinion strikes pretty hard at the power of the industry regulator though, because it prevents FINRA from using the court system to enforce its decisions - a critical power enjoyed by every overseer.  The court doesn't identify a workaround either.  So how you feel about the case will depend on how you feel about textualism, where a plausible case can be made that the court is onto something vs. context, which matters when a court deprives a regulator of a power it has been happily relying on for over four decades. 

On the one hand, FINRA has the power to levy "fines," under the Exchange Act.  And you'd think that the power to levy a fine includes the power to enforce such a levy.  Moreover, if you sign a contract, the idea is that you can go to court if the other party fails to perform, and the securities industry essentially has contracted with FINRA to police its bad actors, which it does, inter alia, with fines, and which the bad actor in this case refused to pay.  

To be traditional about it, the administrative law question presented in the FINRA case is whether the statute is ambiguous on that go-to-court question, and whether, even if so, FINRA, a private entity, is entitled to Chevron deference in interpreting a law that permits it to fine members to permit it to go to court to enforce those fines.

FINRA lost the case because the ability to go to court is something that is a big enough regulatory deal that it is usually spelled out in the statute explicitly.  The Exchange Act, for example, has language that permits the SEC to sue explicitly.  It doesn't have that language for FINRA, and the court didn't just rely on negative inference, but less plausibly on other limitations on judicial review in the Exchange Act.  

The court also concluded that FINRA's own rule permiting it to go to court (state court, problematically, given that the exclusive jurisdiction of the Exchange Act lies in federal court), was illegally promulgated without comment (so it ducked the Chevron issue).

This isn't textualy impossible, but it makes FINRA impossible.  You also wouldn't want to set up a regulatory scheme that can't be enforced.  And that is what the Court has done - I'm not sure that FINRA can bring a fine action to the SEC, and then to federal court, don't really know how that would work, and the court didn't suggest any answers.  FINRA must be able to enforce its fines.

What will happen?  I can't imagine it won't go en banc, it is a conservative panel in a pretty liberal appellate court.  Fixing this might require congressional legislation, though the SEC could pass a rule authorizing FINRA to sue (that would be a tricky delegation of an important power).

Anyway, those are my preliminary thoughts on a pretty important case.

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Jamie Dimon thinks it is, and I still don't understand why (maybe it's because of the way it treats Fannie bonds?).  But this Times Room for Debate gives you something of an overview, featuring the usual suspects (Peter Wallison, Steve Bartlett, Simon Johnson).  Basel is the place where the most onerous financial regulation will happen, and it is the only place where you might ever get something like the emerging Swiss, and maybe British, requirement that banks hold 20% equity against their other assets, which some finance professors here think is interesting (they also wouldn't bother to risk-weight it - also interesting).  Here's how the Times sets the scene:

Jamie Dimon has been on the warpath this month against new international banking rules, saying their capital requirements are "anti-American." At a closed-door meeting of the Financial Stability Forum in Washington last week, he reportedly "launched a tirade" against the Basel III regulatory standards and against Mark Carney, the central banker of Canada who is seen as the successor to lead the forum.

On Sunday, Mr. Carney said publicly: "If some institutions feel pressure today, it is because they have done too little for too long, rather than because they are being asked to do too much, too soon."

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