After the SEC settled with Citigroup over misreprsentations made about a toxic security it sold during the financial crisis for a centimillion dollar fine among other things, Judge Rakoff rejected the settlement for failing to contain "cold, hard, solid facts established either by admissions or trials." I've been pretty critical of the decision, which was always headed for reversal. Not that Judge Rakoff cares: his familiarity with the agency (he once was in it), his generally respected status as a judge, and rumblings of discontent by other courts asked to approve other settlements once he fired his shot across the SEC's bow has led to a change in approach by the agency; I talked about the new policy here.
The problem with the decision was twofold, according to the Court of Appeals, at least as I interpret it.
Problem 1: Doctrinally, a settlement decision is an exercise of enforcement discretion, and enforcement discretion is basically unreviewable because the alternative - making it reviewable - would thrust the courts into the heart of what the executive branch does. Because the SEC wanted continuing court supervision of Citigroup as a consequence of the settlement, Rakoff did, indeed, have something to do. But if the SEC had simply dismissed its suit in exchange for the payment of a fine, which is less onerous than a fine plus continuing supervision by a court, Rakoff would have had, literally, no role to play in the resolution of the case. So requiring cold, hard facts to be established as a condition of signing off on a deal was a radical increase in the oversight of the SEC by a court.
No surprise, then, that the Second Circuit said that "there is no basis in the law for the district court to require an adminision of liability as a condition for approving a settlement between the parties. The decision to require an admission of liability before entering into a consent decree rests squarely with the SEC."
Problem 2: Settlements are not about right and wrong, while admissions of guilt are. Settlements are about moving on. We don't expect private parties to establish whether management caused the bankruptcy or someone else did, whether that product really was dangerous, or was misused by consumers, or whatever. And these can be matters of great public import. So it was never clear why the government, even though, yes, it is a state actor, should be treated very differently.
No shock, then, that the Second Circuit has said that "consent decrees are primarily about pragmatism" and "normally compromises in which the parties give up something they might have won in litigation and waive their rights to litigation."
According to the appellate court, the right way to review consent decrees is for procedural clarity and, as far as the public interest is concerned, with Chevron deference to reasonable decisions by the agency. It's not totally clear what that deference means - the court faulted Rakoff for figuring out whether the public interest in the truth was served by the deal when he should have been deciding "whether the public interest would be disserved by entry of the consent decree." But there you go.
Anyway, I think this stuff is interesting, because it's a tool in the regulatory arsenal, and indeed, my first baby law professor article was on just that.
Or so you could conclude if you look at my latest in DealBook:
The Business Roundtable has protested that it “is all too rare that agencies ask whether the original problem a regulation was issued to address has been solved or could be addressed more cost-effectively.”
Congress has heard these complaints. Bills with bipartisan sponsorship that would create an independent commission to recommend the repeal of antiquated rules are proceeding through both the House of Representatives and Senate.
But this is a case where the cure is dubious and the disease exaggerated.
Two bright spots yesterday from the Office of the Comptroller of the Currency. First, the OCC announced a new policy of rotating examiners among banks. Second, this recommendation stemmed from a peer review of the OCC by international financial regulators. With multiple eyes, all bugs are shallower.
In Governor Tarullo’s closely watched speech on bank regulation (I already blogged on the idea of a sliding scale of regulation based on bank size), he also argued for ending the IRB approach to capital requirements. How does IRB translate into Plain(er) English: DIY capital requirements for big banks. Tarullo’s argument is based in part on obsolescence: all the increases to capital in Dodd-Frank and Basel III dwarfed the IRB component. But it is also based on the fact that DIY capital requirements was a spectacularly bad idea (something I wrote about back when). Big banks have built in incentives (courtesy of government guarantees, explicit and implicit) to lower their capital and increase their leverage. Tarullo’s coming to bury not praise this part of Basel II calls for revisiting some of Joe Norton’s prescient work critiquing that accord as a political economy product of lobbying by behemoth banks. If we take New Governance and its experimentalism seriously, it is vital that we look at experiments that failed.
I want to draw your attention to this, now out in the Cornell Law Review. As regular readers know, I do a great deal of research on the international regulatory networks that increasingly set the standards for financial and securities regulation. This paper is an effort to connect the shaky legitimacy of that sensible impulse to a stronger body of doctrine, and so it touches more on foreign relations and administrative law than on pure financial regulation - and it is co-authored with a foreign relations and international law expert, Jean Galbraith. You should download it. The abstract:
The United States increasingly relies on “soft law” and, in particular, on cooperation with foreign regulators to make domestic policy. The implementation of soft law at home is typically understood to depend on administrative law, as it is American agencies that implement the deals they conclude with their foreign counterparts. But that understanding has led courts and scholars to raise questions about whether soft law made abroad can possibly meet the doctrinal requirements of the domestic discipline. This Article proposes a new doctrinal understanding of soft law implementation. It argues that, properly understood, soft law implementation lies at the intersection of foreign relations law and administrative law. In light of the strong powers accorded to the executive under foreign relations law, this new understanding will strengthen the legitimacy and legality of soft law implementation and make it less subject to judicial challenge. Understanding that soft law is foreign relations law will further the domestic implementation of informal international agreements in areas as different as conflict diamonds, international financial regulation, and climate change.
Please don't hesitate to send along your comments, concerns, etc.....
Oops, says BofA, we messed up our capital calculations. We don't have as much money on hand for shocks or emergencies as we thought. Since that's the principal thing that banking regulators care about, you might wonder what happens to banks who do this. Perhaps it would be interesting to consider some alternatives, might offer a sense of what bank supervision does and doesn't involve these days.
- The Fed could prosecute BofA executives for fraud. Call that the securities regulator/white collar approach. One problem, fraud must be intentional, so this would have to be not an error, but at the very least some sort of reckless accounting. It punishes individuals in management who contributed to the fraud.
- The Fed/FDIC could revoke their license or pull the inspectors. This is the USDA approach. The problem is that it is too nuclear - both of those things would shut down a bank that is far too big to fail.
- The Fed could fine them. This is the money laundering approach, and those fines are often imposed not just for tolerating the laundering of money, but for having inadequate controls in place to prevent it. We may see a fine here, BofA is pretty much saying that it had inadequate controls in place by acknowledging that it did the calculations wrong to the tune of billions of dollars.
- Or the Fed could do what the Fed is, for now, doing. It is suspending any dividend increases by the bank until it submits an accurate account of the state of its capital reserves, and has that account approved by the agency as sufficient. This is a somewhat new thing in high level banking oversight - punish the shareholders, thereby encouraging them to monitor management. Does it work? It is perhaps a little untested, although suspending capital distributions has been a tool used by the FDIC on the sorts of distressed small banks that were its old stock in trade. Seeing that tool applied to Citi and now BofA, however, is a dfferent thing altogether. It will be interesting to see if this trend continues.
- "That one million hours a year devoted to resolution planning is 500 full-time employees"
- "There are 8,000 employees 'dedicated solely to building and maintaining an industry-leading Anti-Money Laundering (AML) program.' JPMorgan employs more AML compliance officers than the Treasury and the Fed combined."
- Stress testing required 500+ FTEs
- Compliance with Basel's new securitization rules has required 35,000 hours of work (at 2000 hours per year, that's only 17.5 FTEs, so you can see why they moved to hours there).
That's a lot of compliance, and indeed, at these rates, way more people do compliance for JPMorgan than, probably, do actual investment banking. Of course, maybe we want all of this given that the firm is far too big to fail, and maybe we want to make banking burdensome and unprofitable. If so, we are on our way!
The DC Circuit rather shockingly threw out the SEC's conflict minerals rule ONLY because it compelled publicly traded companies to speak about the issue in their securities filings, which it concluded violated the First Amendment. EDIT: This means that the parts of the rule that require reporting but not a statement that goods are "not DRC conflict free," might still be okay. Bainbridge has takes here and here, Jonathan Adler here, Matt Levine here.
But, you are thinking, the SEC compels companies to do a million things in their securities filings! Does the very existence of a disclosure regime violate the First Amendment? The court's novel theory was that it is okay to mandate disclosures that aim to prevent consumer deception (so the books of publicly traded companies could be opened to investors), but any other goal must have more than a rational basis to be sustainable.
It is a crazy theory. Warning labels, origin labels, nutrition labels, mandatory agricultural marketing schemes, they don't involve consumer deception, and they're okay. And maybe this reveals a lack of adoration for the First Amendment, but if Congress could prohibit companies from using conflict minerals, which it surely can, then requiring them instead to disclose the use is both less burdensome and possibly more efficient. Why would we want a legal system that does not permit disclosure regimes, thereby requiring command and control?
Some other observations:
- One judge wanted the court to wait for a ruling in a related case going en banc before the now democratically controlled circuit, and the two majority judges declined to do so because now the SEC and the petitioners could participate in the en banc. Unless the new Obama judges on the court cannot hear the en banc, this seems like a request for a quick reversal.
- Also interesting, the court didn't bullet proof the opinion. The SEC survived the adlaw challenges, and the very controversial cost-benefit analysis requirement the DC Circuit has started imposing, though that is likely to change very soon, on the agency. There is only one ground for reversal here: disclosure is unconstitutional.
- There is a difference between speech and conduct in the First Amendment, but the other big thing the SEC does in foreign policy is corrupt practices prosecutions (bribes paid to foreign government officials, that is). Could that be affected by the holding of this opinion, were it to stand? It sure isn't consumer protection.
- One of my many pet theories about why people care about constitutional law, though they often overdo it, is the sense that stare decisis is only sort of a good way to think about the subject. Conservative judges clearly love commercial speech, and have been using it to reverse some settled doctrines that have been in place for decades. I doubt a single securities lawyer thought that this was a plausible holding by the Court. Some smarter on the subject than I were clearly surprised. Let's see if it lasts.
The leverage rule agreed to internationally is 3%, and you should think of a it as an alternative minimum tax. Worried that banks might be able to game capital requirements, which require them to hold funds in reserve to deal with shocks, the world's regulators also decided to forbid, on pain of cutting dividends and executive compensation, large banks froms from taking positions that would mean that more than 3% of their assets are capital. American banking regulators are going further - they are disincentivizing bigness by requiring the 8 largest banks to comply with a 5% leverage ratio. Some thoughts:
- The giveback to industry is that this rule isn't effective until 2018. Only in financial regulation do you ever see such long-dated rules.
- American banks might have to add $68 billion in capital to comply with this requirement. Would you sue to avoid that kind of a charge? Of course you would! But the banks probably won't. The Fed just doesn't face the sort of Total Litigation regulatory contest that the SEC faces.
- Ditto, you'd think that such a big deal rule would require review by OIRA. Nope!
The answer is no, it won't kill monetary policy, but here's the way it might constrain the Fed, which relies on primary dealers (that is, big banks, who would now be subject to leverage requirements) to help it set the federal funds rate. This reliance has been cited as a reason to delay the leverage rule. Felix Salmon also thinks that's no reason to delay the imposition of the rule, but here's how the argument works, in his nicely straightforward words:
The way that the Fed conducts monetary policy is by instructing the traders at the New York Fed to buy and sell certain financial instruments so that a particular interest rate — the Fed funds rate — is very close to a certain target. Through a complex series of financial interlinkages, setting the Fed funds rate at a certain level then has a knock-on effect, and ultimately helps determine every interest rate in America, from the Treasury yield curve to the amount you pay for your credit card or your mortgage.
Those interlinkages are so complex that they’re impossible to model with any particular accuracy: all the Fed can do, really, is set the Fed funds rate and then see what happens to everything else. And directionally the causality is clear: if the Fed wants rates to rise, then it pushes the Fed funds rate upwards, and if it wants rates to fall, then it brings the Fed funds rate down. That doesn’t always work at the distant end of the yield curve, but it’s still most of what monetary policy can do.
Especially early on in the chain, a lot of the interlinkages take place at the level of big banks. And so it stands to reason that if you change the leverage requirements of big banks, that might change what happens to interest rates when you move the Fed funds rate.
Over at DealBook, I’ve got a piece on the analysis of FOMC transcripts – a cottage industry, now that the Bernanke era version of the committee has released its 2008 (that is, depth of the crisis) records. There’s lots of counting that can be done, including some, in honor of Jay Wexler’s Supreme Court study, on the number of times the FOMC broke into laughter. Easy enough to actually do for the Greenspan FOMC, and so I do it:
For what it is worth, the mood lightened as the chairman aged, although the F.O.M.C. certainly went through turbulent times during both the beginning and the end of Mr. Greenspan’s tenure. Meeting transcribers recorded laughter on a per-transcript-page basis increasing from an average of less than 20 percent from 1988 to 1992 to more than 20 percent from 2001 to 2006. In a few years, we will be able to make comparable statements about the F.O.M.C. when Ben S. Bernanke was the Fed chairman. Mr. Greenspan used wit far more than any other single Fed official (although he spoke far more at F.O.M.C. meetings than the others did) – laughter ensued after something he said 556 times over the course of his tenure.
Do give it a look.
Below you'll see the first of what I suspect will be many interesting posts from guest blogger Greg Shill. Do welcome him.
And here you'll see a neat graphic of the money that the big American banks are agreeing to pay to settle their financial crisis suits; the tl;dr is poor Bank of America! Here's USC's worthy effort to track all the settlements.
Greetings, Glommers! (and hello, Janet and Mario*!)
It’s an honor to join this extremely sharp and thoughtful community of corporate and commercial law scholars for the next two weeks. The Conglomerate has long been one of my favorite law blogs and it’s truly a privilege to walk among these folks for a time (if a bit daunting to follow not just them but Urska Velikonja and her excellent guest posts). Thanks to Gordon, David, and their Glom partners for inviting me to contribute.
By way of biographical introduction, I’m currently a Visiting Assistant Professor at the University of Denver Sturm College of Law, where I teach International Business Transactions and International Commercial Arbitration. Last year, I did a VAP at Hofstra Law School (and taught Bus Orgs and Contracts).
In the next few weeks, I’ll be exploring a number of issues related to law and global finance. I have a particular interest in currencies and monetary law, or the law governing monetary policy. Two of my current projects (on which more soon) address legal aspects of critical macroeconomic policy questions that have emerged since 2008: U.S. monetary policy and the Eurozone sovereign debt crisis.
Without further ado, I will take a page from Urska and kick off my residency here with a somewhat meta question: should scholars refrain from writing about legal issues in macroeconomics, specifically monetary policy?
One thinks of monetary policy decisions—whether or not to raise interest rates, purchase billions of dollars of securities on the secondary market ("quantitative easing"), devalue or change a currency—as fundamentally driven by political and economic factors, not law. And of course they are. But the law has a lot to say about them and their consequences, and legal scholarship has been pretty quiet on this.
Some concrete examples of the types of questions I’m talking about would be:
- Pursuant to its dual mandate (to maintain price stability and full employment), what kinds of measures can the Federal Reserve legally undertake for the purpose of promoting full employment? More generally, what are the Fed’s legal constraints?
- What recognition should American courts extend to an attempt by a departing Eurozone member state to redenominate its sovereign debt into a new currency?
When it comes to issues like these, it is probably even more true than usual that law defines the boundaries of policy. Legal constraints in the context of U.S. monetary policy appear fairly robust even in times of crisis. For example, policymakers themselves often cite law as a major constraint when speaking of the tools available to the Federal Reserve in combating unemployment and deflation post-2008. Leading economics commentators do too. Yet commentary on “Fed law” is grossly underdeveloped. With the exception of a handful of impressive works (e.g., by Colleen Baker and Peter Conti-Brown), legal academics have largely left commentary on the Fed and macroeconomics to the econ crowd.
A different sort of abstention characterizes legal scholarship on the euro crisis. Unlike the question of Fed power, there is a burgeoning literature on various “what-if” euro break-up scenarios. But this writing tends to focus on the impact on individual debtors and creditors, not on the cumulative impact on the global financial system. Again, the macro element is missing.
It is curious that so many legal scholars would voluntarily absent themselves from monetary policy debates. The subtext is that monetary policy questions are either normatively or descriptively beyond the realm of law. If that is scholars’ actual view, I think it is misguided. But maybe the silence is not as revealing as all that.
- One issue is sources. You will not find a lot of useful caselaw on the Fed’s mandate or the Federal Reserve Act of 1913, and the relevant statutes and regulations are not very illuminating. Further, it’s a secretive institution and that makes any research (legal or otherwise) on its inner workings challenging.
- Another issue is focus. Arguably the natural home of legal scholarship on domestic monetary issues, for example, should be administrative law. But the admin scholarly gestalt is not generally as econ-centric as, say, securities law. Meanwhile, securities scholars tend to focus on microeconomic issues like management-shareholder dynamics.
- A final possibility, at least in the international realm, is historical. After World War II, Bretton Woods established a legal framework intended to minimize the chance that monetary policy would again be used as a weapon of war. The Bretton Woods system collapsed over forty years ago, the giants of international monetary law (Frederick Mann, Arthur Nussbaum) wrote (and died) during the twentieth century, and now even some of the leading scholars who followed in their footsteps have passed away. At the same time, capital now flows freely across borders and global financial regulation has become less legalized in general. These factors plus the decline of exchange-rate regulations (most countries let their currencies float) may have undermined scholars’ interest in monetary law. But as the ongoing euro saga demonstrates, international monetary law and institutions remain as critical as ever.
These are some possible explanations for why legal scholars have largely neglected questions of monetary law, but I’m sure I’ve overlooked others. What do you think?
*Pictured are Janet Yellen and Mario Draghi, chiefs, respectively, of the Federal Reserve and the European Central Bank.
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What you'll hear from me, as a general matter, is a story about the increasing convergence on matters financial regulatory across borders. But this is not to say that this convergence will be a story of cosmopolitan triumphalism, sans bumps, disputes, and difficulties.
Take auditor rotation, which is the shorthand for "the government requires you to fire your auditor and hire a different one everyone so often, lest your auditor become captured, or you start speaking to it in a strange shorthand outsiders can't understand." It's something that will really make a difference to the lives of CFOs and their reports everywhere. It will also either disrupt the multi-billion dollar accounting business, or end competition in the sector. And the EU now requires it every 10 years or so, while the US has dropped its auditor rotation plans. You might even call the emerging approaches to auditor independence completely inconsistent with one another.
The interesting question will be whether the EU makes foreign listed companies rotate auditors if they solicit or somehow end up with a substantial number of European investors (the current answer appears to be no, but stay tuned). If it does that, it will be yet another example of the way that the EU makes regulatory policy for the rest of the world. HT: Corp Counsel
Better Markets is an advocacy group worried about the failure of the government to hold banks accountable for misdeeds that lead to the financial crisis. No problem there, I'm mystified by it myself, though there might be a normative case to be made for the policy, depending on how you feel about how the government treated Arthur Andersen and varous Enron executives during the last crisis.
But the group's suit against the government for violating separation of powers principles and FIRREA for settling with JPMorgan without filing the settlement with a court must have made the lawyers who filed the complaint a little nervous, in the "is this frivolous and will I get sanctioned?" kind of way.
Are you depriving courts of their Article III jurisdiction if you settle a case, instead of trying it to completion (and presumably then filing an appeal)? Owen Fiss thought so, in an article that I really love, but perhaps we should put the piece under the "seminal Yale thought experiment" rubric.
Settlement isn't exactly unprecedented in our federal system. Sometimes the government announces that it won't be defending a statute like DOMA in court, thereby depriving the judges of their Article III powers to assess the constitutionality of the law. Sometimes it changes policies when a powerful senator complains, thereby depriving Congress of its Article I right to reverse the executive branch's overreaching through legislation. And sometimes it enforces statutes - Title VII is an example - that deprive millions of potential plaintiffs of their right to file constitutional suits, in that case invoking the Equal Protection Clause. Sometimes, it also just settles cases before they go to trial, just like every other institution in America.
And yet somehow these dramatic examples of executive branch overreaching have never resulted in a colorable separation of powers claim. Indeed, separation of powers claims are almost never colorable; as a rule of thumb, they are step one towards losing a lawsuit, because they can be made about all cases, which is basically the same thing as saying they can be made about no cases. I'm generally not a fan of holding the government to particularly different standards than, say, Amnesty International, but even if you feel differently, you might do so because of the government's criminal powers, which the JPMorgan settlement doesn't involve.
The FIRREA count isn't a whit better, by the way. FIRREA authorizes the Attorney General to file suits against banks who violate the substantive principles of that banking statute. But just because a statute permits such litigation hardly means that it means that courts will be reviewing the AG's decisions as to whether to bring a case under it or not. THAT would be a separation of powers problem; courts would get to micromanage every decision whether to prosecute a case, supposedly one of the most core executive branch functions there is. Just ask Justice Scalia.
And don't even get me started on whether Better Markets has standing to sue over a settlement between the government and some other party that has nothing to do with Better Markets.