I think they're doomed, but opponents of the 25 year old tradition of SEC administrative proceedings have had a good couple of days. Distressed Debt Diva (or whatever the right sobriquet is) Lynn Tilton has convinced the Second Circuit to hear her claim that appearing before an ALJ would be unconstitutional, which, if the court ruled in her favor, would create a circuit split with the 7th Circuit.
Also, the Wall Street Journal made much of a colloquy before Judge Richard Berman, who is one of the few judges who has ruled that ALJ proceedings are unconstitutional. He wanted to know more about the farcical decision by the SEC to send one of its ALJs a letter inviting him to tell them whether he was biased against defendants. He quite properly refused to answer, and they promptly reassigned him to another case. "You'll want to come up with a good explanation why," Judge Berman approximately told the agency.
I can't claim to understand what the SEC was doing with that missive to its ALJ, though it's always worth observing that ALJs work for the commissioners (much to their displeasure, ordinarily), and it isn't totally obvious that it is wrong to send a missive to an employee asking him to explain himself. But, oddly, adjudicative subordinates have a great deal of independence, to the point where I think we could consider them to be comparable to those most independent of regulators, bank supervisors. We wouldn't expect Janet Yellin to bother filing an affadavit explaining her thinking on interest rates if President Obama instructed her to do so, and there's no question that he is her boss.
The Wall Street Journal reports that the White House is considering our colleague for the SEC. Bainbridge thinks she'd be an excellent choice, and so do we. I won't gush, but Lisa has it all - she would be perfect for the agency.
I wrote in DealBook about SEC ALJs. Here's a taste:
I read every decision issued by the S.E.C.’s administrative law judges from the enactment of Dodd-Frank in 2010 to March of this year. Graded toughly – on whether the S.E.C. received everything it wanted from the case – the agency’s rate of success is high, but not unblemished.
In those decisions where at least one of the defendants was represented by counsel, the agency received everything it asked for only 70 percent of the time; that is not too different from the “rule of thumb” rate for victories by any federal agency in a federal court.
Of course, there is not getting everything the agency asks for, and there is losing the case. It is true that S.E.C. administrative law judges are willing to reduce the penalties sought by the agency’s enforcement division, either by reducing the amount of money that the defendant must pay to the S.E.C. or by reducing the length of their bar from practicing in their industry.
But in my sample, the agency rarely lost cases that it pursued to the point at which an administrative law judge would issue a decision. I identified only six of the first 359 decisions issued since Dodd-Frank was enacted that rejected the arguments of the enforcement division wholesale.
I wrote a paper on the SEC's ALJs, which I think are plenty independent and not at all unconstitutional. They cite federal judges and write sentences with the same degree of difficulty, and though the SEC usually wins before them, there are plenty of reasons for that.
It's forthcoming in the Texas Law Review, and here's the abstract. Do give it a look and let me know if you have any thoughts.
The Dodd-Frank Wall Street Reform Act allowed the Securities & Exchange Commission to bring almost any claim that it can file in federal court to its own Administrative Law Judges. The agency has since taken up this power against a panoply of alleged insider traders and other perpetrators of securities fraud. Many targets of SEC ALJ enforcement actions have sued on equal protection, due process, and separation of powers grounds, seeking to require the agency to sue them in court, if at all.
This article evaluates the SEC’s new ALJ policy both qualitatively and quantitatively, offering an in-depth perspective on how formal adjudication – the term for the sort of adjudication over which ALJs preside – works today. It argues that the suits challenging the SEC’s ALJ routing are without merit; agencies have almost absolute discretion as to who and how they prosecute, and administrative proceedings, which have a long history, do not threaten the Constitution. The controversy illuminates instead dueling traditions in the increasingly intertwined doctrines of corporate and administrative law; the corporate bar expects its judges to do equity, agencies, and their adjudicators, are more inclined to privilege procedural regularity.
In what I think is the first appellate decision on the issue, the Seventh Circuit held that timing problems prevented courts from entertaining collateral attacks on SEC administrative proceedings. It means that defendants have to raise their constitutional claims before the ALJs, and then the SEC itself on appeal, before they can get into court on appeal from that.
These timing issues have always looked really problematic for the plaintiffs. Essentially, they have been arguing that they think the SEC is about to open an administrative case against them, and that a court should tell the SEC that it can't do that, because administrative cases are unconstitutional. Usually, claiming that you think the government is about to do something isn't a very good reason to sue the government. Why not wait and see? You'll save the court's time and keep it from issuing an advisory opinion.
Put that way, it's not surprising that a CEO anticipating administrative proceedings against her was told to make her constitutional arguments to the agency, if the agency does, in fact, file papers against her, before trying to get the courts involved.
On the other hand, the case that has ginned up these suits, Free Enterprise Fund v. PCAOB, let a couple of accountants make their constitutional claims against PCAOB before it had lifted a finger against them. So the Seventh Circuit basically said "we don't think the Court meant to get rid of the doctrines of standing, finality, and exhaustion in that case," which is sort of hand waving, but probably true.
Anyway, it increases the likelihood that we will soon get an initial decision from an SEC ALJ ruling whether SEC ALJs are unconstitutional. I'm very much looking forward to that. You can find a gloss on the opinion here, and a link to the actual opinion at the end of the gloss.
I'm enjoying Philip's guest blogging with us. I think I particularly like this part of his last post:
If it sounds condescending to suggest that the government barely even thought about legitimacy issues during the last crisis, perhaps it is fitting that I end with an obligatory presentation of Wallach’s Law, which is that everything is more amateurish than you think, even after accounting for Wallach’s Law. Everything: financial crisis responding and post-response analysis are no exceptions.
At the end of my review of his book, I said:
one of the reasons I like thinking about the financial crisis, and like reading books like Wallach’s about it, is because it was an enormous almost-disaster that was averted for thousands of different, interlocking reasons. The government’s response to it was both wise, unreflective, tremendously unfair, and highly successful, and a million other things as well.
We may never sort out what exactly happened, and we'll certainly never know whether it was the best possible approach, or three removed from best, or 17, or whatever. Given so many inputs, what can we say about the legal output?
I think we can say a few things. First, that the law mattered, and provided constraints, even when it shouldn't have or was just used as an excuse (ahem, Lehman Bros.). Second, one of the ways it mattered is because it cabined the government's thinking of precisely how it could get creative. We can't save a bank through X, so let's push through a merger to save it that way. We may never want the government too cabined in the middle of a crisis, but there is room to impose constraints afterwards, too. So if you're inclined, for whatever reason, to look at the world through "law only" glasses, I think you can gain some useful perspectives on what happened during that hectic period six years ago.
Though, as we found out today, they're still litigating it all!
My colleague Peter Conti-Brown is interested in Philip Wallach's legal history of the financial crisis, as am I. He's got a post up on it over at the Yale J. on Reg. blog, and go give it a look. They've debated, over there, whether the Fed had the authority to rescue Lehman Brothers; it rather famously claimed that it did not, only to give AIG a massive bailout a couple of days later:
One of the features of Philip’s stint here was a debate we had on the Fed’s claim that it lacked the legal authority to save Lehman Brothers. I say that’s a post-hoc invention; Philip thinks it’s not, or at least,not so obvious. What do we learn from this fascinating exchange?
I still think those inside the Fed—whether at the Board of Governors or the Federal Reserve Bank of New York—had the authority to do whatever they wanted with Lehman. And given the political maelstrom they faced, I’m not sure I would have done a thing differently than they did. My critique of their legal analysis is not a critique of their crisis decision-making. But the legal arguments are distracting from the bigger question, about the appropriate levels of discretion that a central bank should have in using its lender of last resort authority. What the debate with Philip has shown me is that, even if I’m not wrong—and, well, I’m not—the law is something of an omnipresence in the way the government faced the financial crisis. That omnipresence may even have brooded from time to time.
Over at the New Rambler Review (which I'm really enjoying), I've got a review of Philip Wallach's legal history of the financial crisis. The kick-off offers a riff on the crisis:
The government’s response to the financial crisis was an example of messy policymaking that occasioned a happy ending, although not everyone sees it that way. Some are unsure about the ending – they have decried the very modest meting out of punishment that followed the recovery of the economy. Others are unsure that the policymaking was messy – they are likely to think of the government’s response to the financial crisis as an inevitable manifestation of executive preeminence as the doer of last resort, institutionally capable of acting when courts and legislatures cannot.
But I will take a stable economy over a few prison sentences, especially when it is possible that you can’t have both at the same time. And you won’t convince me that the things government officials did during the crisis – last minute deals, concluded late at night and paired with creative reimaginings of underused statutes and regular resorts to Congress for more legislation – was the mark of the smooth progress of an imperial presidency.
Go over there and read the whole thing!
My colleague Peter Conti-Brown has an op-ed in the Times today regarding the Fed's crazy regional bank system. A taste:
Congress should let the Board of Governors appoint and remove the 12 Reserve Bank presidents, as they may do with other employees of the board. The 12 regional Feds would then become branch offices of our central bank, continuing to do research and data analysis, while leaving policy making to Washington.
This plan has several benefits. First, the next time the Fed makes an egregious mistake — like failing to predict the meltdown of the housing market — we would know for certain whom to hold accountable. Second, it would allow the Fed to modernize the distribution of the 12 Reserve Banks. There is strong evidence that the cities for the 12 banks were chosen as much for politics as economics. In 2015, do we really need two regional Feds (Kansas City and St. Louis) in Missouri, but only one (San Francisco) west of Texas?
Everything Peter writes about the Fed is worth reading, and this is no exception. Give it a look here.
I was looking at Dan Scwarcz's lastest paper on Shadow Insurance, which is a thing:
Shadow insurance – defined as life insurers’ reinsurance of policies with captive insurers that are not “authorized” reinsurers and do not maintain a rating from a private rating agency – creates important risks to policyholders, the insurance industry, and potentially even the broader financial system. Although the standard state regulatory safeguards help mitigate some of these risks, they leave other hazards of shadow insurance largely unchecked. Even granting that shadow insurance likely helps reduce the cost of insurance associated with the excessive conservatism of some state reserving rules, the practice ultimately undermines insurance markets by impeding accurate risk assessments and tradeoffs by policyholders, regulators, and other market participants.
Of course, there may be a real world reason for this - shadow institutions are in theory nimbly entering markets that heavily regulated incumbents can't serve well. This is the regulation is bad story of the growth of shadow finance.
Over at DealBook, I have a piece up on the state of cost-benefit analysis at the SEC. Inadequacies in the CBA were how the SEC used to lose all its rulemakings in the D.C. Circuit; its latest rulemaking on clawbacks sets the stage for how seriously the agency takes cost-benefit analysis now, and how much it believes that analysis should be quantified. A taste:
Throughout the cost-benefit analysis, the agency warns that it is “often difficult to separate the costs and benefits,” and that various effects of the rule are “difficult to predict.”
I suspect the agency thinks it doesn’t need to blow the court of appeals away with some numbers to survive, though of course the S.E.C. can do more cost-benefit analysis in the final rule. It does, however, believe that a lengthy consideration of the costs and benefits of a rule should be part and parcel of any proposal.
For those who think that cost-benefit analysis slows the pace of regulation, this may not be good news. Economists might wish that numbers were being appended to the discussion.
But I am happy enough to see rules without numbers. Justifying rules only with regard to their costs and benefits is pretty routine. As routines develop, it may become difficult for regulators and judges to consider new sorts of costs, and unforeseen benefits contained, for example, by the simple expression of what the rule favors and what it discourages.
Go give it a look!
Banco Santander's American sub is in trouble. Big trouble with the government. Supervisors think it is undercapitalized, doesn't adequately keep track of its money, and is led badly. The Wall Street Journal put the story about their concerns on A1.
So, what's next? A takeover? A fine? A lawsuit?
The Federal Reserve issued a stinging lecture to Spanish bank Banco Santander SA,faulting the lender’s U.S. unit for failing to meet regulators’ standards on a range of basic business operations.
Oh. A lecture. Well that doesn't...
The Fed didn’t fine the bank but reserved the right to do so later and required the bank to write a series of remedial plans.
So a warning or whatever...
the Fed had already scolded Santander for paying an unauthorized dividend earlier in 2014 without the Fed’s required permission.
[Santander CEO] Ms. Botín spoke for 15 minutes by phone with [Fed Governor] Mr. Tarullo on Nov. 10.
She met with him again in Washington on Dec. 10, when they talked privately for an hour
Oh, and meetings. Still, there have been resignations and promises to change the whole governance structure of the company. So these talking-tos must have been absolutely hair-raising. For drama, you really can beat bank supervision, amiright?
The rule, authorized by Dodd-Frank, would permit companies to claw back compensation from executives if things go south. Or, more specifically, the rule will "require national securities exchanges and national securities associations to establish listing standards that would require each issuer to implement and disclose a policy providing for the recovery of erroneously paid incentive-based compensation." Clawbacks would happen when, well: "the trigger for the recovery of excess incentive-based compensation would be when the issuer is required to prepare an accounting restatement as the result of a material error that affects a financial reporting measure based on which executive officers received incentive-based compensation."
The rule had the usual two dissenters, independent statements by each of the commissioners. The SEC is a divided agency. But I'm interested in how the staff hope to close the deal, assuming that the rule will be litigated.
First, even though this is a proposed rule, the agency is already responding to plenty of comments from prior concept releases, &c. Second, 50 of the 198 pages of the rule are devoted to the cost benefit analysis that so stymied the SEC when the DC Circuit had a majority of Republican judges. But the analysis isn't heavy on quantitative cost-benefit, but rather an assessment of the implications on a variety of affected components in the agency. I think the agency thinks it doesn't need to blow the court of appeals away with some numbers to survive, though of course the agency can do more cost-benefit analysis in the final rule.
My article on the administrative law and practice of the FOMC is available on SSRN, and has come out as part of a great symposium in Law and Contemporary Problems, with articles by Jim Cox, John Coates, Kate Judge, and many other people smarter than me. Do give the paper a download, and let me know what you think. Here's the abstract:
The Federal Open Market Committee (FOMC), which controls the supply of money in the United States, may be the country’s most important agency. But there has been no effort to come to grips with its administrative law; this article seeks to redress that gap. The principal claim is that the FOMC’s legally protected discretion, combined with the imperatives of bureaucratic organization in an institution whose raison d’etre is stability, has turned the agency into one governed by internally developed tradition in lieu of externally imposed constraints. The article evaluates how the agency makes decisions through a content analysis of FOMC meeting transcripts during the period when Alan Greenspan served as its chair, and reviews the minimal legal constraints on its decisionmaking doctrinally.
In addition to being your one stop shop for the legal constraints on the FOMC, the paper was an opportunity to do a fun content analysis on Greenspan era transcripts, and to see whether any simple measures correlated with changes in the federal funds rate. In honor of Jay Wexler's Supreme Court study, I even checked to see if [LAUGHTER] made a difference in interest rates. No! It does not! But more people may show up for meetings where the interest rate is going to change, tiny effect, but maybe something for obsessive hedge fund types. Anyway, give it a look.
The AIG suit is over, and the shareholder who was zeroed out by the government won a judgment without damages. These kinds of moral victories are cropping up against the government: a Georgia judge just ruled that the SEC's ALJ program was unconstitutional, but easily fixed. The Free Enterprise Fund held that PCAOB was illegal, but not in any way that would undo what it had achieved. And now AIG. A right without a remedy isn't supposed to be a right at all, but it is true that this is incremental discipline of the government for business regulation excesses. That won't make any of these plaintiffs happy, however.