FERC is usually known around Washington as an agency with a super-boring docket - it oversees power rate regulation, with specialties in hydro, pipelines, and natural gas, and also polices interstate electricity sales. It is famous for clogging the docket of the DC Circuit, and very often losing there. And for true governance afficiandoes, it is a purportedly independent agency that is part of the Department of Energy. Which is like making the SEC a unit of the Department of the Treasury. Is it independent? Politically accountable? It all brings to mind the vagaries of the PCAOB case, which we looked at here.
So the news that the post-Enron powers given to the agency to supervise energy trading are being used for huge fines and lots of investigations - and also occasioning serious pushback from the finance industry - is pretty interesting. Here are some reasons to fear FERC:
- Like the Fed, but unlike the SEC, it is self-funding, and so insulated from "starvation from the Hill"-style supervision.
- Like the SEC, but less like the Fed, it's quite a lawyered up agency - and the ability to get a former GC of the FBI to serve as deputy there is a serious notice of intent (though it is one of those GCs who has spent the entirety of their career in government service, which makes it only shocking, instead of totally implausible).
- Its statutory powers means it can seek real fines like the $435 million it wants from Barclay's for manipulating California energy sales. Peter Henning discusses how that's not chicken feed, at least given everything else that Barclay's has going on, here.
The SEC’s impasse over money market mutual fund reform may provide a test of some of the Financial Stability Oversight Council’s powers under Dodd-Frank. The FSOC has met to consider how to regulate the systemic risk posed by mutual funds. The FSOC, chaired by Treasury Secretary Geithner, has two options to try to jumpstart reform of a critical market that froze during the Panic of 2008.
Option 1: Declare Certain Large Funds as Systemically Significant
The first and more drastic action would be for the FSOC to use its powers to designate larger money market mutual funds as systemically significant under Section 113 of Dodd-Frank. This, in turn, would allow the Federal Reserve to regulate those institutions. Even the threat of losing power might be enough to spur the SEC to act (or convince Commissioner Aguilar to change his mind).
Wholesale designation of money-market mutual funds as per se systemically significant is not an option. When Dodd-Frank was passed, I heard some scholars talk about how Section 113 might be interpreted to allow for designation of an entire category of financial institution. That is not how the FSOC interpreted the statute when it promulgated regulations governing its process for designating non-banks as systemically significant. The FSOC Final Rules set a three stage procedure for determining when individual firms are systemically significant. At the first stage, the FSOC will only consider if a nonbank is systemically significant if it has $50 billion in total consolidated assets and meets one of five other quantitative thresholds (which range from notional value of credit default swaps in which the nonbank is the reference entity to a leverage ratio).
These thresholds – and the firm-by-firm approach generally – restrict the scope of the FSOC’s power considerably. An individual money market mutual fund would have to be both large enough and pose systemic concerns on its own to trigger a systemic designation. It is unclear whether designating only the largest money market funds – even if designation is actually accomplished – would achieve enough in terms of reducing the systemic threat of runs on money market funds as a class.
Indeed, the collective systemic risk of money market mutual funds would not allow the FSOC to act with respect to the entire industry. The too-big-to-fail concern may have overshadowed other problems like “too-correlated-to-fail” and the problems of herd behavior affecting financial firms. Many small non-banks can pose just as great dangers in terms of liquidity and solvency crises as one behemoth. But herd behavior does not elicit the same kind of visceral reaction as “bigness.”
Thus far, FSOC has not used its Section 113 power. (A number of large banks were automatically deemed systemically important under Dodd-Frank by virtue of their size. In July, FSOC designated several financial market utilities (think clearing companies) as systemically significant under Section 804 of Dodd-Frank.) However, the FSOC's latest minutes indicate that the council is proceeding to the third and final stage with respect to a number of non-bank financial companies.
Option 2: Issue Recommendations
Alternatively, FSOC could issue an official but a recommendation to the SEC. Dodd-Frank gave the FSOC the power to issue recommendations to financial regulatory agencies “to apply new or heightened standards and safeguards for financial activities or practices that could create or increase risks of significant liquidity, credit, or other problems spreading” among bank holding companies, nonbanks, and financial markets. (Dodd-Frank Section 112(a)(2)(K)); see also Section 120).
Personally, I have been skeptical about how much punch this recommendation power packs. Dodd-Frank provides that the agency "shall impose the standards recommended" but can also decline to follow the recommendation. (Dodd-Frank Section 120 (c)(2)). It is less clear what happens if the receiving agency does not "determine" that it will not follow the recommendation, but is instead deadlocked.
At conferences, my colleagues at other schools have been more exuberant about the ability of recommendations to shape agency behavior. The money market mutual fund case will provide a test. Would an FSOC recommendation carry enough policy heft, moral suasion, political cover, and potential for embarrassment to cause the SEC (including Commissioner Aguilar) to change course?
(A recommendation from the FSOC might also help the SEC with the cost-benefit hurdle in the DC Circuit).
Both options carry considerable risk for the FSOC. What happens is the FSOC begins either the systemic designation or recommendation process and fails to get enough votes in the council? What would happen if the FSOC tries the systemic designation route, but suffers a loss in the appeals process in Federal court? The recommendation path also poses dangers for the council: what would happen if the SEC declines the recommendation?
The first time for anything means considerable risk. However the FSOC acts, it will set a political and reputational -- if not a legal -- precedent. At the same time, not acting sets a mighty precedent too.
Unless you're Canadian. Foreign proposals by an American company to buy the Canadian Home Depot, for heavens sake, to say nothing of the dangerously Australian bid for a potash company a couple years ago have been scotched by regulators for not being in Canada's "national interest." Here's how those regulators make that assessment:
In reaching a decision, judgments will be made both in measuring the effects of a proposal in relation to the relevant individual factors of assessment and in measuring the aggregate net effect after offsetting the negative effects, if any, against the positive ones. An investment will be determined to be of net benefit when the aggregate net effect is positive, regardless of its extent.
Okay, then! It's the sort of cost benefit analysis that the DC Circuit is so thrilled about - and clear, I think we can all agree, as a bell. Basically, the Canadian approach to foreign acquisitions is one rejected by the US, which assesses foreign acquisitions only for whether they threaten "national security" or would obtain "critical infrastructure." But American regulators do not assess whether the country's "economic security" would be affected by a purchase, as Canadians do, despite musings by Congress to that effect - I've written about it here.
Somewhere between the United States and Canada is China's approach to foreign acquisitions, which is some combination of antitrust review and whatever seems to be bothering the Chinese at the time. It has cost Coca-Cola a soft drink bottler, and like all of these government okays, is maddeningly imprecise. But at least it isn't explicitly directed at the "national interest," which can look quite protectionist.
American lawyers generally advise their clients considering an acquisition of a classically American company to check with the Hill, as well as to moot it with regulators. The need for this sort of lobbying is even more apparent overseas - though you wouldn't necessarily realize it with a standard M&A syllabus.
The rule requires extractors to submit a report listing payments to foreign governments, which seems consistent with Dodd-Frank and, as a disclosure rule, hardly unreasonable. Nonetheless, the Chamber of Commerce is suing, and the SEC has had no love from the D.C. Circuit with regard to its rules. You can see the complaint here, the rule here, and a PR page here. CorpCounsel has a smidgen of analysis here. Notable about this particular suit:
- The C of C has found the most joy lately from its arguments that the SEC has failed to do an adequate cost-benefit analysis supporting its rules. That is in this case, but it isn't front and center. To be sure, the Chamber is noting some of the usual stuff, making hay out of the fact that there was a dissent at the Commission, and talking about the efficiency requirement on the agency that worked so well in killing the proxy acess rule. But here it is relying on a different provision of the commission's governing legislation, one providing that the comission “shall not adopt any such rule or regulation which would impose a burden on competition not necessary or appropriate in furtherance of the purposes of this title.” 15 U.S.C. § 78w(a)(2).
- Also new is a pretty bonkers sounding First Amendment complaint arguing that this compels specch by businesses. How that differs from any of the other disclosure requirements imposed by the SEC is not clear.
It is quite a literary one. Neil Barofsky has a book where he talks about how he and the Treasury Secretary had it in for one another. As the Huffington Post wrap has it - edited for family friendliness - one meeting got so shouty that Barofsky thought Geither would "throttle" him:
"I said that I thought our capacity as a nation to deal with what could be a continuing financial crisis was being undermined by a loss of faith in government," Barofsky writes. "Then I said that the current loss of government credibility could be traced to Treasury's mishandling of TARP."
"Geithner got dramatic," Barofsky writes: "'Neil, you think I don't hear those criticisms? I hear them. And each one, they cut me,' he said, pausing and then making an emphatic cutting motion with one hand as he said 'like a knife.'"
"'No one has ever made the banks disclose the type of s--- that I made them disclose after the stress tests. No one! And now you're saying that I haven't been f---ing transparent?'"
But if you can't persuade them when you're in the government, at least you can make it look bad when they're out of it.
Only a month prior to the international meeting, Geithner had been shooting for a 6% capital ratio and putting pressure on Bair to concede.
He had "lobbied me intensely on lower numbers for the Basel III calibration, knowing full well that our healthy banks will be just fine with a high numbers, but of course Citi and BofA will get killed," Bair wrote in a memo after an Aug. 6 meeting with Geithner, which is cited in the book. "Why do we keep making banking policy to accommodate weak institutions? Keep hoping our relationship will improve, but this was a new low."
Ultimately, Bair sees the entire episode as a power play by Geithner. She argues he was trying to blow up the meeting between international regulators so that the issue would be kicked higher to the Group of 20 finance ministers who were set to meet in November. If the G-20 took over negotiations, Geithner would be leading the U.S., not Bernanke.
About this charge, Felix Salmon is pretty skeptical, and despite his apparent sensitivity to cutting criticism, Geithner can probably live with having his biggest enemies in the book-writing, rather than regulatory, business. One can only imagine what Elizabeth Warren's memoir will look like - and one may have to, if she becomes a senator.
- The suit is really about the financial crisis - nothing orthagonal about it. It alleges that Bear Stearns (now JPM) systematically failed to inspect the quality of the mortgages it put into its mortgage related products (RMBS), which it then sold on to investors.
- Parts of the complaint read like a political document: consider "Faced with the promise of immediate, short-term profits and no long-term risks, originators began to increase their volume of home loans without regard to prospective borrowers’ creditworthiness – including their ability to repay the loan." Is this true? Germaine to JPMorgan?
- Or try "In fact, numerous originators who were top contributors to Defendants’ RMBS were on the Comptroller of the Currency’s “Worst Ten” mortgage originators in the “Worst Ten” metropolitan areas due to their loans’ high rate of foreclosures during the period 2005 to 2007." Seems like a newsy factoid more than a bit of data for the complaint. I'd be interested in knowing if this was different for JPM than anyone else, proportions, etc.
- The complaint spends a great deal of time (paragraphs 33-69 of an 85 paragraph complaint) arguing that the due diligence the bank made into its RMBS was insufficient, and that tells you something about a presumable defense to Martin Act fraud claims.
- Something new: part of the complaint relies on the fact that JPM sued and settled with mortgage originators, but failed to share the settlement proceeds with RMBS investors.
- The Martin Act is a fraud statute, and it used to be used to go after penny ante mountebanks. Elliot Spitzer, however, turned the act into a cudgel that could be used against Wall Street, aided by the fact that the Martin Act doesn't require intent or reliance, as federal fraud statutes do, even for crimes (which is amazing, and would raise visions of due process challenges to convictions in my head). The NYCtApp: the Act “includes all deceitful practices contrary to the plain rules of common honesty and all acts tending to deceive or mislead the public.” That means you only need to show that a material misstatement or omission occured (the link is to a handy memo from Dechert).
- The suits is a civil one, which means that the statute allows the AG to sue those "engaged in, is engaged or about to engage in any of the transactions heretofore referred to as and declared to be fraudulent practices."
The takeover of AIG was fraught with problems, and has birthed a Takings Clause suit that shouldn't be taken lightly. But once taken over, there was plenty of concern that AIG would be run like a Soviet factory. That concern now appears to have been misplaced, and I'm looking forward to apologies from those convinced we were on the road to insurance serfdom, or, at the very least, the relocation of all of the company's investments to the states of Ohio and Virginia by 2012.
Instead with AIG, what we saw was that the government, like any investor laying down an uncomfortably large bet, looked to maximize its returns and get out quickly. Governments - the largest investors, given pensions plans and the like - almost always do plain old risk-adjusted return maximization almost all the time, and it looks to me like the stake-taking during the financial crisis had been no exception to the rule.
Sure, you can wonder about the auto companies. I wonder about the Chevy Volt. But let's not kid ourselves. The 1% of the time that politics may have affected the way the government ran our bailouts should not obscure the 99% of the time it played it straight down the middle. That doesn't mean we should be psyched about bailouts. But it does introduce a little bit of realism about one of the alleged downsides.
One of the main concerns in the literature on regulatory capture and the "revolving door" has been that regulators will go easy on regulated firms in order to curry favor and win private sector employment. A new study of SEC lawyers involved in enforcement actions provides evidence for the opposite conclusion: more aggressive SEC lawyers are more likely to find plum opportunities when they leave for the private sector. Here is the abstract for DeHaan et al.:
We provide empirical evidence on the consequences of the “revolving door” phenomenon at the SEC. If future job opportunities make SEC lawyers exert more enforcement effort to showcase their expertise, then the revolving door phenomenon will promote more aggressive regulatory activity (the “human capital” hypothesis). In contrast, SEC lawyers can relax enforcement efforts in order to curry favor with prospective employers in the private sector (the “rent seeking” hypothesis”). We collect data on the career paths of 336 SEC lawyers that span 284 SEC enforcement actions against fraudulent financial reporting over the period 1990-2007. We find evidence consistent with the human capital hypothesis. Specifically, the intensity of enforcement efforts, proxied by the fraction of losses collected as damages, the likelihood of criminal proceedings and the likelihood of naming the CEO as a defendant, are higher when the SEC lawyer leaves to join law firms that defend clients charged by the SEC. Our evidence is thus inconsistent with popular concerns that revolving doors undermine the SEC’s enforcement efforts.
The study has attracted some high profile press too.
This work provides good reason to avoid the more simpler version of capture theory and return to some of the more nuanced work on the subtler ways regulators can be captured.
I've evinced skepticism about Judge Rakoff's decision to reject the SEC's $200 odd million settlement with Citi. But other legal scholars differ - a group of 19, all of whom are substantially smarter than me, have just filed a brief in support of the district court ruling. Jim Hamilton's blog has the details. Basically, they're against the thing that appeared to bother the judge:
There's some nice observations here, and maybe they are worth unpacking. First, was the fine a "modest sanction?" Maybe, but the usual judgement here is whether it would be unreasonable for the agency to conclude that it fit the circumstances. That's a tough standard to meet, although it certainly wasn't a huge fine, especially when you try to wrap your mind around the awesome churn and turnover that is Citi.
What about the settlement without the admission of wrongdoing or statement of facts? Most cases are settled without admissions of either of these things, after all, and so the question is whether cases that are settled by the government should be treated differently.
I generally prefer to not think of the government as engaged in a mission that private parties are not also engaged in - treating it as a radically different enterprise than a service provider like McKinsey or a goods provider like Apple can take you down the wrong kinds of roads (it makes it far too easy to dismiss the government as a useless rent-seeking foundry of incompetence, for one thing). But of course, in some ways the government is different, and the brief makes good arguments on this score, arguments that may appeal to you.
- The SEC is the monopoly power on capital markets enforcement, and maybe it should, as our agent in that field, be forced to explain its most important enforcement actions to us. Without such an explanation, we will be unable to assess whether it is using the powers we have given it in the way we want.
- The SEC is asking the court to use its special powers to provide ongoing oversight of Citi, without explaining to the court what Citi did to deserve such scrutiny, and a court shouldn't be expected to take extraordinary actions without knowing something about the facts underlying the request for such actions.
Me, I still would rather have the SEC mostly subject to the same sorts of rules as private litigants (who also request ongoing court supervision by the courts from time to time, and make decisions to settle lawsuits without shareholder gainsaying), but I think the brief gets to the crux of the issue behind the inclination to look more closely into the black box of enforcement deals. It will be interesting to see if the Second Circuit responds.
The constitional challenge has been filed by a Texas bank, alleging, a C. Boyden Gray suggested might be the way to go - that Dodd-Frank violates the nondelegation doctrine. That doctrine has only had, rather famously, one good year and 200 bad ones (the Supreme Court invoked it twice in 1935, just before the "switch in time that saved 9"). And the bank will have all sorts of standing problems getting to the merits. But still, these days, big signature legislation might be a bit more constitutionally suspect than you thought. The complaint is here.
That is the title of the new Executive Order issued by the president; Cass Sunstein says it has "a simple goal: to promote exports, growth, and job creation by eliminating unnecessary regulatory differences across nations." The EO would direct agencies to see if they can lessen regulatory burdens by doing things the same way their foreign counterparts do - so if the EU thinks it's organic, it can be labelled as such in the US. It all sounds less like world government and more like a slighter effort to use coordination to outsource some government functions, like coming up with standard hazardous chemical labels. But if you ask me, the promise of things like this is rooted in the success of international financial harmonization, and in a commitment, which I don't think is legally necessary, to view our international trade obligations as encouraging a search for this sort of harmonization.
When I don't have my business regulation hat on, sometimes the research turns to straight up public law, as, for example, it did in an empirical project done with David Law, in which we found that "Liberal justices are generally more likely than conservative justices to cite legislative history [and] the decline in the overall use of legislative history since the mid-1980s reflects a rightward shift in the ideological composition of the court."
Anyway, Robert Barnes of the Washington Post wrote about the article in his latest column on the difficulties the Supreme Court has in discerning what Congress wants. Which, perhaps for selfish reasons, I thought was a good read!
This is going to be the least substantial post in this forum by far, but ....
One strange thing about the statute, as Gaston de los Reyes has pointed out to me, is the part of it where Congress directs the SEC to add language to its regulations ... and basically provides the language! Why not just make that part of the statute? And that's just one of the admittedly somewhat arid administrative law mysteries provided by the move. Does the SEC have to take comment on its amendment to the regulations? Probably, though it isn't clear what purpose the comment would serve. Could a court view the language lifted from the statute as arbitrary if the SEC doesn't explain why it is using it? You can think up more of these all day. Anyway, have a look at Section 401(a) of the Act (and section 201 is somewhat similar):
The Commission shall by rule or regulation add a class of securities to the securities exempted pursuant to this section in accordance with the following terms and conditions:
(A) The aggregate offering amount of all securities offered and sold within the prior 12-month period in reliance on the exemption added in accordance with this paragraph shall not exceed $50,000,000.
(B) The securities may be offered and sold publicly.
(C) The securities shall not be restricted securities within the meaning of the Federal securities laws and the regulations promulgated thereunder.
(D) The civil liability provision in section 12(a)(2) shall apply to any person offering or selling such securities.
There are other parts of the section, to be sure, where the SEC has some discretion. But I suspect that Congress expects to see these exact words in the CFR soon, which seems like unnecessary agency commandeering, though there's nothing illegal about it.
The SEC and CFTC are exempting, after a strong push from energy companies, firms that do less than $7 billion in derivatives trades per year from complying with the qualified dealers rules coming once Dodd-Frank is implemented:
On Wednesday, the Securities and Exchange Commission and theCommodity Futures Trading Commission are expected to approve a rule that would exempt broad swaths of energy companies, hedge funds and banks from oversight. Firms would not face scrutiny if they annually arrange less than $8 billion worth of swaps, the derivative contracts tied to interest rates and commodities like oil and gas.
The threshold is a not-insignificant sum. By one limited set of regulatory data, 85 percent of companies would not be subject to oversight. After five years, the threshold would reset to $3 billion; it is the same amount suggested by a group of energy companies in a February 2011 letter, according to regulatory records.
- Implementation and rulewriting are the critical bits of Dodd-Frank, &c, &c.
- I think that the derivatives program in the statute marks a paradigm shift in how we are supposed to regulate capital markets. From a "level playing field" model that you see in the securities markets that is designed to promote capital formation through competition to a "safe and sound" model which subordinates that paradigm to considerations of avoiding systemic risk. A move from securities regulation to financial supervision in other words.