Peter Henning has a nice overview of recent claims made against the SEC's growing inclination to take fraud cases before its handful of agency-judges (ALJs), instead of to court. Why should that be okay?
From a policy perspective, there's reason to worry. I did some litigation before an administrative tribunal, and it's not that different from in court litigation, with the exception of evidence admissability and objections. But it could be really quite different. Hearsay is in theory fine, there's no requirement that you be able to present evidence in person, and the judge works for the agency that is suing you. It's fair to say that defendants get less process from an ALJ than they would from a federal judge.
But not that much less. ALJs are required to hold hearings, permit the introduction of rebuttal evidence, the statute that governs them makes what they do ("formal adjudication" in the verbiage of administrative law) pretty similar to a trial.
That matters for the equities, as does the almost absolute discretion that agencies have to prosecute in the way they see fit. The SEC can drop claims, send scoldy letters, use ALJs, take you to court, or refer you to the criminal lawyers at DOJ with the recommendation that imprisonment could be sought. Because we wouldn't want judges second guessing the decisions to, say, emphasize insider trading prosecutions over accounting fraud claims, we leave those policy calls to the agency.
Which then begs the question: why now with the constitutional case against the ALJ, a thing that has existed since the end of WWII?
Well, the SEC hasn't used its ALJs for high profile cases very often, at least until recently. But the claims against the turn to administrative tribunals aren't getting a lot of love, and I predict that will continue to happen. Judge Lewis Kaplan, who isn't afraid to savage a government case alleging financial wrongdoing, concluded that he didn't have the power to judge whether an ALJ proceeding violated due process or equal protection standards, given that other, similar cases had been brought in court. The SEC recently ignored a declaratory relief case filed by an S&P executive when it brought an administrative complaint against her.
Some well-heeled defendants may have been emboldened to bring these cases by the Free Enterprise Fund decision in the Supreme Court, which constrained the number levels of tenured officials that could separate the president from policymakers. But administrative adjudication is simply too resource intensive and carefully done to be rendered illegal because of its insulation. The alternative would be to replace ALJs with political hacks, and no one wants that. So I'm not predicting a lot of luck for the defendants in these cases.
The government’s response to the financial crisis was dramatic, enormous, and unprecedented, and nothing about it has been overseen by the courts. In our federal system, the courts are supposed to put the policies of presidents and congresses to the test of judicial review, to evaluate decisions by the executive to sanction individuals for wrongdoing, and to resolve disputes between private parties. But during and after the financial crisis, there has been almost none of that sort of judicial review of government, few sanctions on the private sector for conduct during the crisis, especially criminal ones, for the courts to scrutinize, and a private dispute process that, while increasingly active, has resulted in settlements, rather than trials or verdicts. This Article tells the story of the marginal role of courts in the financial crisis, evaluates the costs of that role, and provides suggestions to ensure a real, if not all-encompassing, judicial role during the next economic emergency.
Do give it a download, and let me know what you think. And thanks in advance for supporting us around here - we do like downloads!
Yesterday, MetLife filed a complaint in the DDC protesting its designation as systemically important, which carries with it increased capital requirements and possibly burdensome oversight by the Fed. Most systemically important financial institutions (or SIFIs), are banks, used to burdesome capital requirements and oversight by the Fed. An insurance company is used to neither, hence the umbrage from MetLife.
The lawyer is Eugene Scalia, so the complaint is naturally well-written and thoughtful. I'm withholding judgment on the various statutory arguments posed, and on which it appears MetLife believes to have its best shot - they posit things like only financial companies can be designated as SIFIs, and financial companies must do 85% of their financial business in the US under the language of the statute, and MetLife, with its foreign insurance operations, does not do so. That sort of statutory flyspecking doesn't usually work in financial regulation, but maybe this time it's different.
But two of the firm's longer shots are worth considering. First, there is an effort to require the FSOC to do a cost benefit analysis in its SIFI designations, which it has steadfastly resisted so far. MetLife argues that the committee arbitrarily "did not address MetLife’s evidence of substantial market and company-specific costs, and did not even opine on whether designating MetLife was, on balance, for good or for ill." It is by no means clear that these considerations must be taken into account from the statute, but there are those who believe that some sort of weighing is something that every agency must do. This sort of argument worked when the DC Circuit had fewer Obama appointees on it.
MetLife is also arguing that it has been deprived of due process by the designation. It was "repeatedly was denied access to the full record on which FSOC’s action was based,"and anyway, "FSOC never identified the thresholds that result in SIFI designation or the manner in which the various statutory and regulatory factors regarding designation are balanced against one another in FSOC’s analysis," not least because of "the extraordinary design in the Dodd-Frank Act of FSOC itself, which identifies individual companies for designation, establishes the standards that govern the designation decision, and then sits in judgment of its own recommendations."
MetLife is right about the way that FSOC works, although the so-called "combination of functions" problems, whereby agencies both prosecute and adjudicate regulatory violations, has never been a big problem in administrative law. It especially has never been a problem in banking regulation, where the deal is that banks give up due process rights - they can be failed at any moment by the FDIC, based on an only somewhat clearly articulated CAMELS standard - in exchange for cheap, federal insured funding by small depositors, and the possibility of a bailout if things get really bad. MetLife doesn't get the cheap funding, but it does, as its SIFI designation suggests, get the benefit of being too big to fail, and therefore the likely recipient of a bailout. Should the fact that insurers only get a part of the benefit of the bargain of being a financial institution mean that they should get more process rights than banks? in some ways, that is what MetLife's constitutional claim posits.
The Times reports:
The billionaire investor, who managed to fend off a criminal insider trading investigation of himself, if not of his former hedge fund, is looking for a former prosecutor and several agents from the Federal Bureau of Investigation to join his new $10 billion investment firm, Point72 Asset Management, said several people briefed on the matter, who spoke on the condition of anonymity.
Look, one of the reasons to feel good about the revolving door is that it salts financial institutions with people who expect law compliance. So maybe that explains this development, and we should celebrate Cohen's search for g-men. Or maybe it is, as the Times reports, that he was heartened by the insider trading ruling of the Second Circuit requiring the trader to know both that he was trading on inside information and that the information was obtained in exchange for a benefit, and just wants to grow the enterprise on a number of different fronts.
I'm not sure he should be too heartened by that ruling. It only may free one of his convicted lieutenants, and certainly wouldn't do anything about Matthew Martoma, who both paid for and traded on information provided by a pharma insider.
One dodgy thing that is being included in the currently debated spending bill is a substantive provision repealing a much-hated-by-banks law requiring them to do most of their derivatives trading though an entity that is not covered by deposit insurance. It's a rule that sounds pretty logical - why subsidize derivatives trading with deposit insurance, and isn't it risky to do otherwise? And why do we have to address this in a government budget bill anyway?
But it is also one of uncertain policy origins. Blanche Lincoln thought the swaps pushout rule would resonate with voters when she pushed it, and maybe community banks, which don't do a ton of this stuff, would like to make life hard for the big banks that do. Elizabeth Warren is incensed that it might be repealed, so maybe her constituents would be for it. But the Fed doesn't think it does bank safety much good.
Here's Dave Weigel on the politics, which look good for the banks (Warren's concerns aside, Democrats aren't whipping for the pushout rule reversal to be defeated). Here's DealBook on the sausage-making (the statutory language was drafted by Citigroup, which has always seemed like the most tone-deaf bank to me, rather than the most politically puissant).
My view is that financial regulation, which is just about protecting banks from themselves/macroeconomic shocks, with a soupcon of rent-seeking, is a mixture of easy rules and hard ones. Activity restrictions, like the Volcker Rule, or anti-branching laws, are easy. Capital rules, at least the current ones, are hard, and require a team of examiners to look over the daily positions of the banks, and so on. Admati's capital rule recommendation - banks must hold 4 times more capital than they do now, and there will be no risk-weighting - is an effort to make that easy again.
And organizational rules - create a bank holding company, make this sub do this thing, and that sub do that thing - are also easy.
Note that currently, it's the left and community banks that like the easy rules, and it's the right and the big banks that prefer to do things the hard, sophisticated way. That doesn't mean that complex rules are weak ones - I can't judge the onerousness of our tax laws, but some of them are super-complicated responses to super-sophisticated behavior, and maybe that makes more sense than giving up and charging everyone a VAT. But that's the way I see financial regulation right now.
And yes, I don't know why part of Dodd-Frank should be repealed as a condition of passing a spending bill. But I admire the ability of the lobbyists to get in there and at it.
One last thing - it's risky to be the bank named as the drafter of a bill taking away some of your regulator's regulatory powers. We'll have to see if Citi starts paying a extra-large number of fines in the next year, or if it really did do this with the tacit approval of its supervisors.
The Basel committee enforces through peer pressure, rather than through resort to a formal dispute settlement process, and the peer pressure is increasingly institutionalized through IMF-like reviews of the implementation of Basel commitments. The US just had its review, and Basel just released the report.
The big problem with the US embrace of global rules has come through its treatment of securitizations. Perhaps most notably:
a number of divergences were identified that for some US core banks lead to materially lower securitisation RWA [risk-weighted assets, the stuff against which you have to hold capital] outcomes than the Basel standard. These differences are mainly related to the prohibition on the use of ratings in the US rules. Pursuant to the Dodd-Frank Act, the US rules cannot include provisions related to the Basel framework’s Ratings-Based Approach (RBA) for securitisations, so the rules provide alternative treatments.
The US is not Basel compliant because its regulators are explicitly not permitted to use a tool - credit ratings - that Basel requires. It looks like the committee may fix this not by forcing credit ratings down America's throat, but by coming up with some equivalence standard, which tells you that when Congress speaks clearly, global regulatory harmonizers must listen. Another admission of note:
In carrying out this review, the Committee's assessment team held discussions with senior officials and technical staff of the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation. The team also met with a select group of US banks.
This meet with regulated industry thing is one of the features of peer regulatory review, and it presumably gives industry yet another opportunity to make a case for its preferred version of regulation. But then, it is also a feature of international regulation, where the cross-border parties may sometimes also play roles as representatives of the domestically regulated.
This not at all silly list reveals the following:
- #1 William Dudley – President and CEO, Federal Reserve Bank of New York
Category: Government and Regulatory
- #1 Preet Bharara – US Attorney, Southern District of New York
Category: Government and Regulatory
- #3 Sophie Delaunay – Executive Director, Doctors Without Borders
Category: Non-Governmental Organization
- #4 Anonymous Whistleblower – Whistleblower, Securities and Exchange Commission
Category: Whistleblowing and Media
- #5 Glenn Murphy – CEO and Chairman, Gap Inc.
Category: Business Leadership
- #6 Eric Holder – Attorney General (outgoing), United States Government
Category: Government and Regulatory
- #7 José Ugaz – Chair, Transparency International
Category: Non-Governmental Organization
- #8 Pope Francis – Pope, Catholic Church
Category: Thought Leadership
- #9 Ma Jun – Director, Institute of Public and Environmental Affairs (IPE)
Category: Design and Sustainability
- #10 Larry Merlo – President and CEO, CVS Health
Category: Business Leadership
- #11 Carmen Segarra – Former Regulator, Federal Reserve Bank of New York
Category: Whistleblowers and Media
Dudley is the regulator who has called for bankers to act more ethically. I guess Bharara stands for the proposition that insider trading is the most unethical kind of business conduct, to the exclusion of all other such forms. Anonymous Whistleblower at 4! It proves you can make lots of money by being ethical! And Carmen Segarra, the Fed examiner, rounding out the top 11 - it suggests that business ethics are in question, finance would appear not to be the answer. Via.
We write about the revolving door here, and elsewhere, and we're not as worried about it as some. So what to make of Goldman's hiring of Fed bank supervisors? The critical problem here is that one hire may have brought (or obtained) Fed information to his new job at Goldman. Since the bank supervisor relationship is supposed to be pretty confidential - why would a bank let you examine their books if you're going to talk about their positions to their competitors? - this is a big deal. And also because of the ethics rules that generally require you to stay off of matters you worked on in the government.
Here's what happened:
Rohit Bansal, the 29-year-old former New York Fed regulator, was one such hire. At the time he left the Fed, Mr. Bansal was the “central point of contact” for certain banks.
Seizing upon Mr. Bansal’s expertise, Goldman assigned him to the part of the investment bank that advises other financial institutions based in the United States. That assignment presented Mr. Bansal with an ethical quandary: He might have to advise some of the same banks he once regulated.
Before starting at Goldman, Mr. Bansal sought to clarify whether New York Fed policy prevented him from helping those banks, according to a person briefed on the matter. Initially, he presented Goldman with a notice from the New York Fed, which indicated that he might have to steer clear of certain assignments for one client, the midsize bank in New York. (While the person briefed on the matter provided the name of the bank, The Times decided to withhold the name because the bank was not aware of the leak at the time.)
The New York Fed’s guidance was apparently somewhat ambiguous. And Mr. Bansal later assured Goldman colleagues that he could work behind the scenes for that banking client, the person briefed on the matter said, so long as he did not interact with the bank’s employees.
Mr. Bansal’s lawyer, Sean Casey at Kobre & Kim, declined to comment.
And then Goldman found him using some data that had to come from the Fed. Some thoughts:
- Our former supervisor has himself a very fancy lawyer
- When enforcement officials go through the revolving door, there's little reason to believe they have been encouraged to go easy on the industry they plan to join. Why not keep that guy where he is, and hire away the tormentor? Bank supervision, which is more collaborative, could be different.
- But note that what former bureaucrats are selling is, partly, expertise - particularly, the expertise about what current bureaucrats will do. The question is whether there is anything wrong with paying for this sort of expertise.
Which means a redo of the argument. We'll outsource, via Corporate Counsel, to Cooley:
The D.C. Circuit court of Appeals has granted the petitions of the SEC and Amnesty International for panel rehearing (and the motion of Amnesty to file a supplemental brief) in connection with the conflict minerals case,National Association of Manufacturers, Inc. v. SEC. (The Court also ordered that the petitions filed for rehearing en banc be deferred pending disposition of the petitions for panel rehearing.)
[In prior litigation, the D.C. Circuit,] "specifically citing the NAM conflict minerals case, ... indicated that “[t]o the extent that other cases in this circuit may be read as holding to the contrary and limiting Zauderer to cases in which the government points to an interest in correcting deception, we now overrule them.”
Zauderer applies a lenient standard of review to requirements of disclosure of purely factual information. Looks good for the SEC.
Over at DealBook, I've got a take on MetLife's claim that it will be suing over its designation as a systemically important financial institution. A taste:
Congress gave the government 10 factors to take into account when making a too-big-to-fail designation. This sort of multiple-factor test all but requires regulators to balance values that have different degrees of quantifiability. Some can be counted, like the amount of leverage and off-balance sheet exposure. But others like “the nature, scope, size, scale, concentration, interconnectedness and mix of the activities of the company” have so many moving parts, some of them difficult to quantify, that expressing them mathematically may not be worth the effort. The government has also been given the leeway to consider “any other risk-related factors” that it deems appropriate, a standard that encourages judges to defer to regulators.
Do give it a look!
Eugene Scalia, of the family Scalia, has been the scourge of the SEC with his until recently effective insistence on a cost-benefit analysis to justify the imposition of new major rules on the capital markets. Now he's working for MetLife, the insurance company recently designated as a SIFI (which stands for "dangerously big bank-like institution"), and I guess the argument will be that the designation was arbitrary and capricious, and so inconsistent with the federal standards for administrative procedure, which probably, in Scalia's view, require a quantitative cost-benefit analysis done with meticulous care. Some thoughts:
- Courts often stay out of financial stability inquiries, but, then, they used to defer to the SEC's capital markets expertise, until Eugene Scalia came along. Perhaps Scalia can do something in this really nascent field of disputing SIFI designations. Still, uphill battle.
- If the FSOC somehow lost this case, it could always go global, and ask the Financial Stability Board to designate Met Life as a G-SIFI, which would give foreign regulators the right to persecute the firm's foreign operations, and maybe super-persecute it, if the American regulators could do nothing to control its SIFIness.
- The basic idea, by the way, which is hardly ludicrous, is that insurance companies aren't subject to bank runs, even if they are really big, and that only one of them failed, or was even at risk, during the last financial crisis. Since Met Life isn't in the business of writing unhedged credit default swaps (which is what AIG did, bolstered by its AAA rating and huge balance sheet), why should it have to hold bank-like levels of capital? There's more to that story, but I assume that is part of the story that MetLife will be telling.
HT: Matt Levine
Geoffrey Graber, who is heading up a mortgage fraud task force for DOJ, is motivated by Glengarry Glen Ross, and the results have evinced an ouch from the banking community:
The surge of settlements engineered by Graber in the past year has helped neutralize some of that criticism and rehabilitate a key piece of Holder’s legacy. Still, the settlements have been controversial. Critics such as Roy Smith, a professor at New York University’s Stern School of Business, say prosecutors were driven by “political fever” to extract massive penalties from Wall Street.
“They have to deliver something, so they come up with this,” said Smith, a former Goldman Sachs Group Inc. (GS) partner. “The fact that it’s unfair never really gets considered. The banks have no choice but to hunker down and accept it.”
A bracing corollary to those capture stories, though notice that it's the enforcement officials who win headlines for big settlements, and the bank examiners who are subject to the expose about go along get along.
Steven Davidoff Solomon and I opine on a recent opinion dismissing cases brought by Fannie and Freddie shareholders against the government in DealBook. A taste:
In one Washington court, Maurice R. Greenberg, the former chief executive and major shareholder of A.I.G., is suing the United States government, contending that the tough terms imposed in return for the insurance company’s bailout were unconstitutionally austere.
In another closely watched case in a different Washington court, the shareholders of Fannie Mae and Freddie Mac, led by hedge funds Perry Capital and the Fairholme Fund, lost a similar kind of claim.
Parsing what the United States District Court did in the Fannie and Freddie litigation offers a window into the ways in which the government’s conduct during that crisis might finally be evaluated.
There are three main points to the decision. For one, the court held that the government’s seizure of Fannie’s and Freddie’s profits did not violate the Administrative Procedure Act’s prohibition on “arbitrary and capricious” conduct. It also found that the Housing and Economic Recovery Act barred shareholders of Fannie and Freddie from bringing breach of fiduciary duty suits against the boards of the companies and that the government’s seizure of profits was not an unconstitutional “taking.”
This American Life has a banking supervision story (!) that turns on secret recordings made by a former employee of the New York Fed, Carmen Segarra, and it's pretty good, because it shows how regulators basically do a lot of their regulating of banks through meetings, with no action items after. That's weird, and it's instructive to see how intertwined banking and supervision are. There's a killer meeting after a meeting with Goldman Sachs where Fed employees talk about what happened, and - though we don't know what was left on the cutting room floor - the modesty of the regulatory options being considered is fascinating. Nothing about fines, stopping certain sorts of deals, stern letters, or anything else. The talk is self-congratulation (for having that meeting with Goldman) and "let's not get too judgmental, here, guys."
The takeaway of the story, which is blessedly not an example of the "me mad, banksters bad!" genre, is that this kind of regulation isn't very effective. It clearly hasn't prevented banks from being insanely profitable until recently, in a way that you'd think would get competed away in open markets.
But here's the case for banking regulation:
- Imagine what it would be like if Alcoa and GE had EPA officials on site, occasionally telling them to shut down a product line. That's what bank regulators do, and, more broadly, did with things like the Volcker Rule (with congressional help).
- Since the financial crisis (and that's the time that's relevant here), regulation has made banking less profitable, not more, share prices are down, so are headcounts, etc.
- Regardless of how it looks, regulators that essentially never lose on a regulatory decision - that includes bank supervisors, but also broad swaths of agencies like Justice and DoD - don't experience themselves as cowed by industry. Kind of the opposite, actually. So what you really worry about is the familiarity leading to complacency, not fear. Regulators can fine any bank any number they like. If they want someone fired, they could demand it without repercussion.
The fact that TAL pulled off this story, given that it was centered around an employee who lasted at the Fed for 7 months before being fired, who made secret recordings of her meetings with colleagues (who does that?), who mysteriously and obviously wrongly alleged during her time at the Fed that Goldman Sachs did not have a conflict of interest policy, whose subsequent litigation has gone nowhere, and whose settlement demand was for $7 million (so that's one million per month of working as a bank examiner, I guess), is impressive. But that's the former government defense lawyer in me, your mileage may vary.
Morover, even skeptical I was persuaded that maybe the Fed could do with a more ambitious no-holds-barred discussion among its regulators, at the very least.
Enforcement cases, where the enforcers have total discretion about what to do, don't often motivate dissents from one of those enforcers, but one did recently before the SEC, in a case where a CPA CFO misstated earnings, and agreed to a Rule 102(e) suspension, or, if you like, a "wrist slap." Commissioner Aguillar thought that the CPA role was crucial.
Accountants—especially CPAs—serve as gatekeepers in our securities markets. They play an important role in maintaining investor confidence and fostering fair and efficient markets. When they serve as officers of public companies, they take on an even greater responsibility by virtue of holding a position of public trust.
Aguillar appears to be worried that CPAs are getting pled down into relatively innocent offenses even when there is strong evidence of intentional fraud.
I am concerned that this case is emblematic of a broader trend at the Commission where fraud charges—particularly non-scienter fraud charges—are warranted, but instead are downgraded to books and records and internal control charges. This practice often results in individuals who willingly engaged in fraudulent misconduct retaining their ability to appear and practice before the Commission.
So there you go, a commissioner who is particularly insistent on holding the accounting profession to high standards, and thinks the SEC is too willing to plead down everything. As an empirical matter, it is difficult to know whether the SEC is indeed guilty of Aguillar's charge (though he is, presumably, an expert on the matter). It's hard to know how much conduct is going unprosecuted, and for settleed cases, whether stiffer charges would have been likely to stick.