The Fed board member finished off a speech on October 4 by laying into money market funds:
I would be remiss if I did not remind you of another, highly complementary area where reform is necessary: the money market fund sector. Money funds are among the most significant repo lenders to broker-dealer firms, and an important source of fire-sale risk comes from the fragility of the current money fund model. This fragility stems in part from their capital structures--the fact that they issue stable-value demandable liabilities with no capital buffer or other explicit loss-absorption capacity--which make them highly vulnerable to runs by their depositors. I welcome the work of the Securities and Exchange Commission on this front, particularly its focus on floating net asset values, and look forward to concrete action. Another source of fragility arises from money funds investing in repo loans collateralized by assets that they are unwilling or unable to hold if things go bad. This feature creates an incentive for them to withdraw repo financing from broker-dealers at the first sign of counterparty risk, even if the underlying collateral is in good shape.
For those reading between the lines, this "I care what the SEC is doing with MMFs" might be viewed as a threat, both to the industry and the agency. The Fed may be telling the SEC that it will step in, via the FSOC process, to regulate the funds as systemtically destabilizing (and therefore in need of SIFI designation), if the SEC doesn't sort them out itself. One thing is clear: Stein has no doubt that the funds are fraught with danger.
That's the rule that compares CEO pay to median worker pay - it is supposed to shame CEOs, but so was the rule requiring them to plain old disclose their own compensation, and look how that turned out.
Anyway, here's a nice overview from Matt Levine; I found it interesting how interested people are in this rule; the SEC said it would be regulating in this area (Dodd-Frank requires it), and:
In connection with rulemakings implementing the Dodd-Frank Act, we have sought comment from the public before the issuance of a proposing release. With respect to Section 953(b) of the Dodd-Frank Act, as of September 15, 2013, we have received approximately 22,860 comment letters and a petition with approximately 84,700 signatories.
If anything like those numbers comment on the agency's proposal, it will be pretty busy when it drafts the final rule's statement of basis and purpose. That statement must respond to "well-supposed arguments contained in public comments critical of the agency's proposed rule." A lot of comments means a long, long statement.
Over at Dealbook, Brandon Garrett and I take the temperature of the DPA. A taste:
These agreements are a form of regulation — except it is a single company or entity rather than an entire industry that is ordered to adopt structural reforms. Regulatory programs are supposed to receive consultation and careful judicial review, but deferred prosecution agreements usually do not.
The larger picture is similar. The deferred prosecution agreement has not been endorsed by Congress, or vetted by an agency. Moreover, the agreements – settling a case before it can be filed – are designed to avoid even the deferential judicial review that occurs if a company enters a plea deal before a judge.
Britain’s impending adoption of the agreements, on the other hand, exemplifies the cautious embrace offered by good administrative law.
Britain’s proposed program comes with a code governing its use, and a requirementthat a court conclude that the agreement is both “in the interests of justice” and “fair, reasonable, and proportionate.” Moreover, the proposal itself has been opened for comment from the public.
We wish deferred prosecution agreements had been similarly vetted in the United States. Instead, American prosecutors have used agreements in cases of great public importance without any meaningful oversight.
Do give the whole thing a look, and let us know what you think.
- While we wait for news that JPMorgan will pay $800 million + an admission of wrongdoing to settle the London Whale trade, it turns out that the SEC has entered into "no admit, no deny" settlements with a passel of short sellers. We'll see how much the agency's new quest for accountability meshes with the need to close cases.
- Sheila Bair came to Penn, and here's what she said about reforming financial regulation.
- More evidence that the New York financial supervisor and the national ones are carving out different regulatory perspectives: favored bank consultant Promontory is being investigated by the former, even as it is hired to pitch the latter for client forbearance.
- The $160 million paid by Merrill Lynch to settle its bias case is in some ways a landmark, and in other ways puts the whole fine culture on Wall Street in mysterious perspective. It's the largest such settlement ever, and yet a much larger ($550 million) settlement by Goldman Sachs in the wake of the Abacus case was thought to be a slap on the wrist. I eagerly wait an explanation of the transitive properties of settlement penalties.
- The international financial regulatory deals realize their enforcement through peer review and reports to the G20. Here's Basel's latest example, assessing the state of compliance with its capital accords. The US is assessed to be only semi-compliant with Basel II, and making progress on implementing Basel III. If you want to know the three elements of Basel III that the Basel Committee thinks are the important ones, then you can find out here; the table that comprises the bulk of the report focuses on only three elements. It reports on compliance with the G-SIB process (identifying and adding capital requirements to Global Systemically Important Banks), the Liquidity Coverage Ratio (requiring banks to keep a percentage of assets in cash or very short term debt), and the Leverage Ratio. The capital requirements are monitored through compliance with Basel II and what the committee calls 2.5.
If you didn't see it, the Wall Street Journal brings word, straight from Eric Holder's mouth, that yes, there will be some financial crisis cases brought. The AG said:
....anybody who's inflicted damage on our financial markets should not be of the belief that they are out of the woods because of the passage of time. If any individual or if any institution is banking on waiting things out, they have to think again.
The only thing is, the passage of time is beginning to hem in DOJ. The world went crazy in September, 2008 - five years ago next month. And the ordinary statute of limitations for federal cases is five years. What can we surmise from this?
- Some people really can start to breathe easier. Although the crisis became spellbinding with the collapses of Fannie, Freddie, AIG, and Lehman Brothers, the securitization markets had already pretty much ground to a halt by 2007. Bear Stearns had fallen. There are some statutes - criminal mail and wire fraud, for example - that, unless I'm missing something, cannot be invoked for matters that happened then.
- Those people do not include those who committed bank fraud, or fraud "affecting a federally insured financial institution." Under FIRREA, these defendants are covered by a ten year statute of limitations, lashings of time. FIRREA can get the government civil monetary penalties, but not criminal ones.
- So if Holder is planning some press conferences, he's likely doing so for criminal cases that would be associated with the events of the fall of 2008, or civil cases that have a much broader scope, but probably do not involve a hedge fund lying to a money market fund, or something that does not involve FDIC insurance.
It is because, to channel Nietzsche, the Fed "writes such good books." The good book-length rule* it wrote on Friday puts companies overseen by the Financial Stability Oversight Council (the Dodd-Frank committee of agencies, remember) on the hook for $440 million annually - to be paid to the Fed itself. Those are supervision fees, and the Fed is the FSOC's designated supervisor. Banks with over $50 billion in assets and nonbanks designated as important by the FSOC have to pay for that additional FSOC supervision, and the Fed has now told them how much it will cost.
The SEC, which is on the FSOC, can only be jealous. It's been after self-funding for forever. And the Fed doesn't even need this new stream of income. It already makes banks pay for supervision, and of course it also makes money on currency trades.
*Okay, the rule's not so long. A trim 31 pages, with the key decision being that the assessments are basically going to be apportioned by size, rather than by complexity, dangerousness, or some other criteria - a fact that has not pleased the American Bankers Association.
In DealBook, Steve Davidoff and I have a take on Perry Capital's interesting, and Ted Olson led, suit against the government after it changed the dividend payment rules for unextinguished but unresolved Fannie and Freddie shares that remained outstanding during the financial crisis. A taste:
[B]y 2012, Fannie and Freddie unexpectedly turned back into profitable firms. Seeking a way to keep the common and preferred stock worth nothing, the government changed the way the two paid their dividends in a fashion that meant all dividends went directly to Treasury – that any remaining common and preferred-stock holders would receive nothing.
Perry Capital has accumulated both common and preferred stock in the two entities before this change, and now wants those dividends to be paid to those shareholders once the government’s priority preferred stock has received its 10 percent. It argues that the government failed to justify the change in dividend payments.
Do give it a look. Let us know your thoughts, either over here or over there.
The SEC "failure to supervise" claim against Steven A. Cohen is an administrative one; it goes before an admnistrative law judge, insulated agency employees that preside over trial-type hearings (but can dispense with the rules of evidence, etc), appeal from which is made to the commission, and after that to the federal courts. Court review is likely to be most searching where the commission reverses the ALJ; and SEC ALJs in my view, have the most fun (or are tied for that honor with ITC ALJs who hear seriously big money disputes). Most ALJs work for the Social Security Administration, but a small number occupy specialized niches in other agencies (in the 90s, the SEC relied on all of three ALJs to do their administrative adjudications). These judges, because of a very strong veterans' preference, are very likely to have military backgrounds, which makes them in turn very likely to be men.
Will they rule in favor of the agency they work for? Here's John Carney on the early defense being put together by Cohen's lawyers:
First, they say Cohen didn't read the email. Like most of us, Cohen gets far too many emails to read them all. According to the paper, he gets roughly 1,000 emails each day. This is highly plausible for someone in Cohen's position. Let's call this the "Email is Broken" defense.
The second response is the "Hamptons Pool" defense. When the email was sent to Cohen, at 1:29 in the afternoon, Cohen was in the middle of a 19 minute telephone call with SAC's head of business development. A minute and a half after the conclusion of that phone call, at 1:37:46, Cohen got a call from a research trader, discussing something or other (no one is certain what). At 1:39:11, an order to sell shares of Dell in Cohen's personal account at SAC was placed.
And here's Matt Levine on the claim that Cohen should have realized he was being told to sell Dell stock based on inside information:
here’s the obvious paradox of “I was too busy not reading emails to not supervise.” ... [A] billionaire businessman who gets 1,000 emails a day can probably afford an employee to screen those emails and flag the most important ones for him. And Cohen did that. There was “a SAC employee whose duties included forwarding to Cohen trading-related information worthy of Cohen’s attention (the ‘Research Trader’).” And that employee forwarded the relevant Dell email to Cohen’s office and home email addresses. And then called to follow up. And talked to Cohen for 48 seconds. And then Cohen sold Dell. But: he never opened the email. Imagine the priority that he gave to emails that the Research Trader didn’t flag.
One the one hand, those prices are set by a commodity exchange, which, in theory, the firm would have to corner to set prices. And getting around a "you must deliver 3000 tons of aluminum to the market every day" rule by delivering it to other warehouses in Detroit that you own hardly seems like effective subterfuge. If anything, it is too dumb a regulatory compliance strategy to be possibly what the firm had in mind.
On the other hand, since GS bought the firm that stores 25% of the nation's aluminum, the market has changed. That is,
Before Goldman bought Metro International three years ago, warehouse customers used to wait an average of six weeks for their purchases to be located, retrieved by forklift and delivered to factories. But now that Goldman owns the company, the wait has grown more than 20-fold — to more than 16 months, according to industry records.
If lengthy delivery delays began the second that Goldman bought the firm, that's something. And if the idea is that creating delivery delays makes the future price of alumninum higher than the present price, there could be a reason to create those delays.
But in my view, the jury is still out. Maybe that's only because it is inherently pretty hard to write about these sorts of trades in a way that makes sense in New York Times levels of space. We'll see if the hearings are more revealing, as well as if the very busy CFTC has the resources to chase the story.
That mineral payments rule reversal is something worth thinking about, as it is the early days of the Dodd-Frank rulemaking, and no agency wants to be constantly reversed in its efforts to implement a healthy grant of authority. Nonetheless, outsourcing yields its own dividends. From Corp Counsel:
The SEC's loooong losing streak in major cases continues. Yesterday, Judge John Bates of the US District Court for DC vacated the SEC's resource extraction rules and remanded the case back to the SEC (just before he leaves for another job). This case was brought jointly by the Chamber and the American Petroleum Institute. Oxfam America had joined the SEC as a defendant to defend the rule.
Either the SEC will appeal or it will conduct new rulemaking which takes into account the Judge's twin concerns of public disclosure of individual payments to foreign governments and lack of an exemption for countries that have laws that bar disclosure of payment information. If the agency goes the rulemaking route, it may simply revise its existing rules or go through an entirely new rulemaking process (bear in mind the SEC has a new Chair and two new Commissioners coming in). Either way, the deadline of reporting payments starting October 1st is bound to be substantially delayed. The SEC can't simply drop the rulemaking since adopting a rule is mandated by Dodd-Frank.
This does not bode well for the future of the conflict minerals rules, since a similar case is pending before the same court with a decision expected soon (oral argument took place two days ago in that case, as noted in this article). Nor does it bode well for federal agencies in general trying to promulgate rules, even though the Chamber lost one of these "cost-benefit analysis" cases against the CFTC last week...
It's not, in my view, a very persuasive opinion, though it might make a smidgen of sense in a world where firms operating in countries that prohibit the public disclosure of payments made to governments have to choose between meeting their reporting requirements and continuing to operate their overseas plants.
The problem is that Dodd-Frank requires mineral extraction companies to file annual reports of payments made to these governments. The SEC, in its rule, concluded that requirement obviously meant that the reports would have to be disclosed to the world, not just to the agency. And if that isn't clear from the plain language of the statute, it is at the very least a reasonable reading of it. Is it crazy to conclude that the following language means that companies must disclose to investors their payments to governments? For that is what the opinion holds:
Under the heading “Disclosure,” and the subheading “Information required,” section 13(q) provides that “the Commission shall issue final rules that require each resource extraction issuer to include in an annual report of the resource extraction issuer information relating to any payment made” to a government for “the commercial development of oil, natural gas, or minerals.”
One of the early rules pased by the SEC under Dodd-Frank, and one of the first to go down. Commentary, and opinion. It wasn't even the DC Circuit that was to blame - this fell before a district court judge.
The new policy, however, will make pursuing the big fish draining. For the large cases, it will mean that there are only two possible outcomes: a civil trial with a verdict, or an admission of guilt by the defendant, which will lead to serious follow-on litigation.
It is particularly troubling given that the new S.E.C. chairwoman, Mary Jo White, has said she would like to prioritize securities fraud cases. Those cases are hard enough to win to begin with. They frequently involve large public companies that may balk rather than make an admission and face litigation from plaintiffs’ lawyers who did not discover and bring cases on their own before the S.E.C. action.
One can also assume that making the price of admissions high will make the price of fines correspondingly low.
Dodd-Frank is already under attack--and not just from the usual suspects like special interests, but also from globalization itself. Because of the international nature of today's financial markets, many of the objectives embraced in Dodd-Frank--from trading OTC derivatives on exchanges and centralized clearing to hiving off or limiting the activities of too-big-to-fail banks--require international cooperation to actually be effective. Without it, the United States can certainly try to unilaterally regulate the world. But chances are, go-it-alone strategies will just force still dangerous transactions offshore, or push some of our closest trading partners to retaliate against us, or just as damaging, ignore the US government when it asks for help pursuing its own objectives abroad.
And you know where to find the rest.