September 29, 2014
You Should Listen To The Goldman New York Fed Story
Posted by David Zaring

This American Life has a banking supervision story (!) that turns on secret recordings made by a former employee of the New York Fed, Carmen Segarra, and it's pretty good, because it shows how regulators basically do a lot of their regulating of banks through meetings, with no action items after.  That's weird, and it's instructive to see how intertwined banking and supervision are.  There's a killer meeting after a meeting with Goldman Sachs where Fed employees talk about what happened, and - though we don't know what was left on the cutting room floor - the modesty of the regulatory options being considered is fascinating.  Nothing about fines, stopping certain sorts of deals, stern letters, or anything else.  The talk is self-congratulation (for having that meeting with Goldman) and "let's not get too judgmental, here, guys."

The takeaway of the story, which is blessedly not an example of the "me mad, banksters bad!" genre, is that this kind of regulation isn't very effective.  It clearly hasn't prevented banks from being insanely profitable until recently, in a way that you'd think would get competed away in open markets.

But here's the case for banking regulation:

  • Imagine what it would be like if Alcoa and GE had EPA officials on site, occasionally telling them to shut down a product line.  That's what bank regulators do, and, more broadly, did with things like the Volcker Rule (with congressional help).
  • Since the financial crisis (and that's the time that's relevant here), regulation has made banking less profitable, not more, share prices are down, so are headcounts, etc.
  • Regardless of how it looks, regulators that essentially never lose on a regulatory decision - that includes bank supervisors, but also broad swaths of agencies like Justice and DoD - don't experience themselves as cowed by industry.  Kind of the opposite, actually.  So what you really worry about is the familiarity leading to complacency, not fear.  Regulators can fine any bank any number they like.  If they want someone fired, they could demand it without repercussion.  

The fact that TAL pulled off this story, given that it was centered around an employee who lasted at the Fed for 7 months before being fired, who made secret recordings of her meetings with colleagues (who does that?), who mysteriously and obviously wrongly alleged during her time at the Fed that Goldman Sachs did not have a conflict of interest policy, whose subsequent litigation has gone nowhere, and whose settlement demand was for $7 million (so that's one million per month of working as a bank examiner, I guess), is impressive.  But that's the former government defense lawyer in me, your mileage may vary.

Morover, even skeptical I was persuaded that maybe the Fed could do with a more ambitious no-holds-barred discussion among its regulators, at the very least.

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September 23, 2014
What Happened to the FOMC's Lawyers?
Posted by David Zaring

Philadelphia's own Charles Plosser, an economics professor, and Richard Fisher, an investor, have retired from their perches atop Fed regional banks, meaning that the Federal Open Market Committee has lost two of its hawks.  Dan Tarullo has stayed, which means that there is a law professor on that most essential of government committees still.  But it used to be that the Fed was run by lawyers, and they have disappeared.  Plosser and Fisher's retirement offers the opportunity to reflect on a fascinating chart:

 

The transformation of the FOMC into a redoubt of the economics profession makes it just about the only such place in the federal government that has such a role.

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September 11, 2014
Capital Adequacy News
Posted by David Zaring

The Basel Committee is doing a lot of Basel III capital accord implementation this week.  Page 10 of this report makes it look like the largest banks hold slightly less capital than smaller banks, which is the opposite of what you would want (smaller banks hold more variable capital though).  And this report suggests that the effort to have banks deal with a hypothetical effort to adopt the new capital rules was messy.  Not to worry, though!  As is the case with all Basel documents, bland positivity about the success of the regulatory effort is the tone of the day.

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September 09, 2014
The Modest New Super-Global Trend In Bank Regulation
Posted by David Zaring

One of the reason that bank capital regulation became an international affair was to ensure a regulatory "level playing field," which would be paired with market access to the US and UK.  That is, as long as the rest of the world complied with the Anglo-American vision of capital requirements, access to London and New York would be assured.

But as former law professor and current Fed Board member Daniel Tarullo will testify to Congress today, as those global (call them "BCBS") rules have become more elaborate and comprehensive, some countries have elected to depart from them - only upwards, not downwards.  Switzerland is trying to use very, very heightened capital requirements to shrink its universal banks into asset managers.  And now the United States is enacting global rules with its own pluses.  For example, the liquidity coverage ratio, which requires banks to keep a certain percentage of their assets in cash-like instruments,

is based on a liquidity standard agreed to by the BCBS but is more stringent than the BCBS standard in several areas, including the range of assets that qualify as high-quality liquid assets and the assumed rate of outflows for certain kinds of funding. In addition, the rule's transition period is shorter than that in the BCBS standard.

The Fed is also imposing an extra capital requirement on the largest American banks:

This enhanced supplementary leverage ratio, which will be effective in January 2018, requires U.S. GSIBs [very large banks] to maintain a tier 1 capital buffer of at least 2 percent above the minimum Basel III supplementary leverage ratio of 3 percent, for a total of 5 percent, to avoid restrictions on capital distributions and discretionary bonus payments 

And another such requirement based on the amount of risk-based capital

will strengthen the BCBS framework in two important respects. First, the surcharge levels for U.S. GSIBs will be higher than the levels required by the BCBS, noticeably so for some firms. Second, the surcharge formula will directly take into account each U.S. GSIB's reliance on short-term wholesale funding. 

I think of the global efforts in financial regulation as being notable precisely because they created, incredibly informally, some reasonably specific and consistently observed rules that comprise most of the policy action around big bank safety and soundness.  The little new trend towards harmonization plus is a bit comparable to the trade law decision to create the WTO for global rules, but to permit regional compacts like NAFTA and the EU to create even freer trade mini-zones.  Some find this multi-speed approach to be inefficient and, ultimately, costly to the effort to create a consistent global program.  We'll see if the Basel plus approach rachets up bank regulation, or just disunifies it.

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August 20, 2014
Trying To Understand New York State's Regulation Of Business
Posted by David Zaring

You'd think that the state that's home to the center of American business would take a Delaware-style light touch approach to overseeing it.  But instead, the New York paradigm is to take ambitious politiicans, blend with broadly worded supervisory or anti-fraud statutes like the Martin Act, and come up with stuff that, to my ears, sounds almost every time like it is off-base, at least in the details.  So:

  • Eliot Spitzer pursued research analysts for the sin of sending cynical emails even though they issued buy recommendations, despite that fact that analysts never issue negative recommendations, and if cynical emails are a crime, law professors are the most guilty people in the world.
  • I still don't understand what Maurice Greenberg, risk worrier par excellence, did wrong when he was running AIG.  I do know that after he was forced out by Spitzer, the firm went credit default swap crazy.
  • Maybe there's something to the "you didn't tell your investors that you changed the way you did risk management for your mortgage program" prosecutions, but you'll note that it is not exactly the same thing as "you misrepresented the price and/or quality of the mortgage products you sold" prosecutions, which the state has not pursued.
  • Eric Schneiderman's idea that high frequency trading is "insider trading 2.0" is almost self-evidently false, as it is trading done by outsiders.
  • Federal regulators wouldn't touch Ben Lawsky's mighty serious claims that HSBC or BNP Paribas were basically enabling terrorist financing.
  • And now Lawsky is going after consultants for having the temerity to share a report criticizing the bank that hired them to review its own anti-money laundering practices with the bank, who pushed back on some, but not all of the conclusions.

The easiest way to understand this is to assume that AGs don't get to be governor (and bank supervisors don't get to be AGs) unless people wear handcuffs, and this is all a Rudy Giuliani approach to white collar wrongdoing by a few people who would like to have Rudy Giuliani's career arc.

But another way to look at it is through the dictum that the life of the law is experience, not logic.  The details are awfully unconvincing.  But these New York officials have also been arguing:

  • Having analysts recommending IPO purchases working for the banks structuring the IPO is dodgy.
  • HFT is front-running, and that's dodgy.
  • This new vogue for bank consulting is dodgy, particularly if it's just supposed to be a way for former bank regulators to pitch current bank regulators on leniency.
  • If we can't understand securitization gobbledegook, we can at least force you to employ a burdensome risk management process to have some faith that you, yourself, understand it.
  • And I'm not saying I understand the obsession with terrorism financing or what the head of AIG did wrong.

Their approach is the kind of approach that would put a top banker in jail, or at least on the docket, for the fact that banks presided over a securitization bubble in the run-up to the crisis.  It's the "we don't like it, it's fishy, don't overthink it, you're going to pay for it, and you'll do so publicly" approach.  It's kind of reminiscent of the saints and sinners theory of Delaware corporate governance.  And it's my pet theory defending, a little, what otherwise looks like a lot of posturing.

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August 17, 2014
After the Deal: Fannie, Freddie and the Financial Crisis Aftermath, by Davidoff Solomon and Zaring
Posted by David Zaring

Steve Davidoff Solomon and I have put together a paper on the litigation between the government and the preferred shareholders of Fannie Mae and Freddie Mac.  Do give it a look and let us know what you think.  Here's the abstract:

The dramatic events of the financial crisis led the government to respond with a new form of regulation. Regulation by deal bent the rule of law to rescue financial institutions through transactions and forced investments; it may have helped to save the economy, but it failed to observe a laundry list of basic principles of corporate and administrative law. We examine the aftermath of this kind of regulation through the lens of the current litigation between shareholders and the government over the future of Fannie Mae and Freddie Mac. We conclude that while regulation by deal has a place in the government’s financial crisis toolkit, there must come a time when the law again takes firm hold. The shareholders of Fannie Mae and Freddie Mac, who have sought damages from the government because its decision to eliminate dividends paid by the institutions, should be entitled to review of their claims for entire fairness under the Administrative Procedure Act – a solution that blends corporate law and administrative law. Our approach will discipline the government’s use of regulation by deal in future economic crises, and provide some ground rules for its exercise at the end of this one – without providing activist investors, whom we contend are becoming increasingly important players in regulation, with an unwarranted windfall.

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August 09, 2014
Disruptive Legal Technologies: Benefit Corporations and the Crowdfunding of Firms
Posted by Eric Orts

Two recent developments in the law and practice of business include:  (1) the advent of benefit corporations (and kindred organizational forms) and (2) the application of crowdfunding practices to capital-raising for start-ups.  My thesis here is that these two innovations will become disruptive legal technologies.  In other words, benefit corporations and capital crowdfunding will change the landscape of business organization substantially.

A disruptive technology is one that changes the foundational context of business.  Think of the internet and the rise of Amazon, Google, etc.   Or consider the invention of laptops and the rise of Microsoft and the fall of the old IBM.  Automobiles displace horses, and telephones make the telegraph obsolete.  The Harvard economist Joseph Schumpeter coined a phrase for the phenomenon:  “creative destruction.”

Technologies can be further divided into two types:  physical technologies (e.g., new scientific inventions or mechanical innovations) and social technologies (such as law and accounting).   See Business Persons, p. 1 (citing Richard R. Nelson, Technology, Institutions, and Economic Growth (2005), pp. 153–65, 195–209).  The legal innovations of benefit corporations and capital crowdfunding count as major changes in social technologies.  (Perhaps the biggest legal technological invention remains the corporation itself.)

1.  Benefit corporations began as a nonprofit idea, hatched in my hometown of Philadelphia (actually Berwyn, Pennsylvania, but I’ll claim it as close enough).  A nonprofit organization called B Lab began to offer an independent brand to business firms (somewhat confusingly not limited to corporations) that agree to adopt a “social purpose” as well as the usual self-seeking goal of profit-making.  In addition, a “Certified B Corporation” must meet a transparency requirement of regular reporting on its “social” as well as financial progress.  Other similar efforts include the advent of “low-profit” limited liability companies or L3Cs, which attempt to combine nonprofit/social and profit objectives.  In my theory of business, I label these kind of firms “hybrid social enterprises.”  Business Persons, pp. 206-15.

A significant change occurred in the last few years with the passage of legislation that gave teeth to the benefit corporation idea.  Previously, the nonprofit label for a B Corp required a firm to declare adherence to a corporate constituency statute or to adopt a similar constituency by-law or other governing provision which signaled that a firm’s sense of its business objective extended beyond shareholders or other equity-owners alone.  (One of my first academic articles addressed the topic at an earlier stage.  See “Beyond Shareholders:  Interpreting Corporate Constituency Statutes.”  I also gave a recent video interview on the topic here.)  Beginning in 2010, a number of U.S. states passed formal statutes authorizing benefit corporations.  One recent count finds that twenty-seven states have now passed similar statutes.  California has allowed for an option of all corporations to “opt in” to a “flexible purpose corporation” statute which combines features of benefit corporations and constituency statutes.  Most notably, Delaware – the center of gravity of U.S. incorporations – adopted a benefit corporation statute in the summer of 2013. According to Alicia Plerhoples, fifty-five corporations opted in to the Delaware benefit corporation form within six months.  Better known companies that have chosen to operate as benefit corporations include Method Products in Delaware and Patagonia in California.

2. Crowdfunding firms.  Crowdfunding along the lines of Kickstarter and Indiegogo campaigns for the creation of new products have become commonplace.  And the amounts of capital raised have sometimes been eye-popping.  An article in Forbes relates the recent case of a robotics company raising $1.4 million in three weeks for a new project.  Nonprofit funding for the microfinance of small business ventures in developing countries seems also to be successful.  Kiva is probably the best known example.  (Disclosure:  my family has been an investor in various Kiva projects, and I’ve been surprised and encouraged by the fact that no loans have so far defaulted!)

However, a truly disruptive change in the capital funding of enterprises – perhaps including hybrid social enterprises – may be signaled by the Jumpstart Our Business Start-ups (JOBS) Act passed in 2012. Although it is limited at the moment in terms of the range of investors that may be tapped for crowdfunding (including a $1 million capital limit and sophisticated/wealthy investors requirement), a successful initial run may result in amendments that may begin to change the face of capital fundraising for firms.  Judging from some recent books at least, crowdfunding for new ventures seems to have arrived.  See Kevin Lawton and Dan Marom’s The Crowdfunding Revolution (2012) and Gary Spirer’s Crowdfunding:  The Next Big Thing (2013).

What if easier capital crowdfunding combined with benefit corporation structures?  Is it possible to imagine the construction of new securities markets that would raise capital for benefit corporations -- outside of traditional Wall Street markets where the norm of “shareholder value maximization” rules?  There are some reasons for doubt:  securities regulations change slowly (with the financial status quo more than willing to lobby against disruptive changes) and hopes for “do-good” business models may run into trouble if consumer markets don’t support them strongly.  But it’s at least possible to imagine a different world of business emerging with the energy and commitment of a generation of entrepreneurs who might care about more in their lives than making themselves rich.  Benefit corporations fueled by capital crowdfunding might lead a revolution:  or, less provocatively, may at least challenge traditional business models that for too long have assumed a narrow economic model of profit-maximizing self-interest.  James Surowiecki, in his recent column in The New Yorker, captures a more modest possibility:  “The rise of B corps is a reminder that the idea that corporations should be only lean, mean, profit-maximizing machines isn’t dictated by the inherent nature of capitalism, let alone by human nature.  As individuals, we try to make our work not just profitable but also meaningful. It may be time for more companies to do the same.”

So a combination of hybrid social enterprises and capital crowdfunding doesn’t need to displace all of the traditional modes of doing business to change the world.  If a significant number of entrepreneurs, employees, investors, and customers lock-in to these new social technologies, then they will indeed become “disruptive.”

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August 07, 2014
New Directions in Corporate Disclosure: Politics, Environment, and Religion
Posted by Eric Orts

Corporate disclosure, especially in securities regulation, has been a standard regulatory strategy since the New Deal. Brandeisian “sunlight” has been endorsed widely as a cure for nefarious inside dealings. An impressive apparatus of regulatory disclosure has emerged, including annual and quarterly reports enshrined in Forms 10K and 10Q. Other less comprehensive disclosures are also required: for initial public offerings and various debt issuances, as well as for unexpected events that require an update of available information in the market (Form 8K).

For the most part, corporate disclosure has focused on financial information: for the good and sufficient reason that it is designed to protect investors – especially investors who are relatively small players in large public trading markets. Some doubts have been raised about the effectiveness of this kind of disclosure and, indeed, the effectiveness of mandatory disclosure in general. A recent book by Omri Ben-Shahar and Carl Scheider, More Than You Wanted to Know: The Failure of Mandated Disclosure, advances a wide-ranging attack on all mandatory disclosure. (I think that their attack goes too far: I’ll be coming out with a short review of the book for Penn Law’s RegBlog called “Defending Disclosure”).   Assuming, though, that much financial disclosure makes sense, what about expanding it to include other activities of business firms?

Consider three types of nonfinancial information that might usefully be disclosed: information about a business firm’s activities with respect to politics, the natural environment, and religion.

1. Politics. One good candidate for enhanced corporate disclosure concerns business activities in politics. Lobbying laws require various disclosures, and various campaign finance laws do too. It is possible to obscure actual political spending through the complexity of corporate organization. (For a nice graphic of the Koch brothers’ labyrinth assembled by the Center for Responsive Politics, see here.) Good reporters can ferret out this information – but they need to get access to it in the first place. My colleague Bill Laufer has been an academic leader in an effort to encourage public corporations to disclose political spending voluntarily, with Wharton’s Zicklin Center for Business Ethics Research teaming up with the nonpartisan Center for Political Accountability to rank companies with respect to their transparency about corporate political spending. The rankings have been done for three years now, and there are indications of increased business participation.  Recently, even this voluntary effort has been attacked by business groups such as the U.S. Chamber of Commerce for being “anti-business.” See letter from U.S. Chamber of Commerce quoted here.  Jonathan Macey of Yale Law School has also objected to the rankings in an article in the Wall Street Journal, arguing that the purpose of political disclosure is somehow part of “a continuing war against corporate America.” These objections, however, seem overblown and misplaced. What is so wrong about asking for disclosure about the political spending of business firms? One can Google individuals to see their record of supporting Presidential and Congressional candidates via the Federal Election Commission’s website, yet large businesses should be exempt? Political spending by corporations and other business should be disclosed in virtue of democratic ideals of transparency in the political process. Media, non-profit groups, political parties, and other citizens may then use the resulting information in political debates and election campaigns. Also, it seems reasonable for shareholders to expect to have access to this kind of information.

In Business Persons, I’ve gone further to argue (in chapter 7) that both majority and dissenting opinions in Citizens United appear to support mandatory disclosure as a good compromise strategy for regulation. One can still debate the merits of closer control of corporate spending in politics (and I believe that though business corporations indeed have “rights” to political speech these rights do not necessarily extend to unlimited spending directed toward political campaigns). It seems to me hard to dispute that principles of political democracy – and the transparency of the process – support a law of mandatory disclosure of corporate spending in politics.

2. Natural environment. Increasingly, many large companies are also issuing voluntary reports regarding their environmental performance (and often adding in other “social impact” elements). Annual reports issued under the International Standards Organization (the ISO 14000 series), the Global Reporting Initiative, and the Carbon Disclosure Project are examples. The Environmental Protection Agency (EPA) has also established a mandatory program for greenhouse gas emissions reporting, which is tailored to different industrial sectors. One can argue about whether these kinds of disclosures are sufficiently useful to justify their expense, but my own view is that they help to encourage business firms to take environmental concerns seriously. Many firms use this reporting to enhance their internal efficiency (often leading to financial bottom-line gains). As important, however, is the engagement of firms to consider environmental issues – and encouraging them to act as “part of the solution” rather than simply as a generating part of the problem.

One caveat that is relevant to all nonfinancial disclosure regimes:   The scope of firms required to disclose should be considered.  I do not believe that the case is convincing that only public reporting companies under the securities laws should be included.  (For one influential argument to the contrary, see Cynthia A. Williams, “The Securities and Exchange Commission and Corporate Social Transparency,”  112 Harvard Law Review 1197 (1999)).  Instead, it makes to sense for different agencies appropriate to the particular issue at hand to regulate:  the Federal Election Commission for political disclosures and the EPA for environmental disclosures.

3. Religion? In the wake of the Hobby Lobby case, some have called for greater disclosure about a firm’s values on this score both with respect to employment and investors. See, e.g., Joan Heminway’s piece here. Stephen Bainbridge has also called attention to this question here.  Probably it makes sense to consider disclosure as a partial solution, though the idea of mandatory government disclosure of religious characteristics makes me nervous on “separation of church and state” grounds. It might be better to “wait” (as Frank Partnoy advises us often to do in his recent book) and see how the Hobby Lobby line of cases develops. My guess is that some tensions will become apparent that may result in keeping Hobby Lobby limited to the context of close and usually small corporations (though Hobby Lobby itself is an exception, having more than 10,000 employees).
 
But a rule of disclosure might not be the best approach with respect to religion and firms. Better in this context perhaps to bite the bullet and ascertain when for various legal purposes a business firm “crosses the line” from a private organization (with rights of self-organization and self-determination with respect to many internal business practices) to a public-facing organization (with duties to treat public customers, employees, and business partners in a non-discriminatory manner). These issues are not easy. As I suggest in Business Persons (chapter 3), a central problem in business theory concerns “the public/private distinction” which I conceive as involving “two faces of the business enterprise.” Here, the religious preferences of private owners require balancing with the public role undertaken when holding out one’s shingle in public markets. Drawing legal lines isn’t always easy, but often it’s necessary.  And disclosures alone will not always be sufficient.

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August 05, 2014
The Banco Espirto Santo Bailout
Posted by David Zaring

Portugal took the kind of quick action on its second largest bank that is completely by the book.  What can we learn about the current reality of bank bailouts from it?

  • Even medium sized banks are global: BES was doomed not by its Portuguese operations, but by its Angolan unit.  This sort of thing has driven supervisors to set up global regimes - the idea that their domestically safe and sound bank is in trouble internationally, but they don't know it - or that its foreign counterparties are, and they don't know that.
  • The government created a good bank and a bad bank, meaning that BES stakeholders now have one bank with depositors and branches, and another with dodgy loans in Angola.  This is a way of giving everyone - creditors, shareholders, employees - a haircut, but, since the Portuguese government is loaning BES $4.5 billion, it is hard to say this isn't also a lender of last resort bailout.  Still, a textbook approach.
  • This sort of ring-fencing, on a much larger scale, is one of the ways that some regulators would like to practice bank safety.  A British bank would have its British assets segregated from its overseas ones, and so on.  That obviously creates internal inefficiencies in the bank, but there you go.
  • What Portugal did was to "resolve" BES.  You can perhaps see why some think that one of the failures of the post financial crisis reforms is the failure to, so far, come up with a cross-border resolution scheme.  The British couldn't do this with Barclays, or couldn't without agreement by the Americans, and who knows if, when the chips are down, that would be forthcoming?

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July 18, 2014
The College of Supervisors Considered
Posted by David Zaring

Over at DealBook, I've got something on the financial regulatory reform that Europeans, in particular, love.  Give it a look.  And let me know if you agree with this bit:

Can a supervisory college work in lieu of a vibrant global resolution authority regime? The problem with these colleges is not that they are implausible, but that they have not really been tried in a crisis. The best-known supervisory college outside of the European Union was created in 1987 to monitor the Luxembourg-based, but international, Bank of Credit and Commerce International. Rumors of widespread fraud in the management of the bank were plentiful, but the collegiate approach did not mean that these problems were nipped in the bud. Although coordinated supervision led regulators to close many of bank’s branches at once after the bank’s accountant resigned and its insolvency became obvious, it is not clear whether Bank of Credit and Commerce International is a college success story or cautionary tale.

There are other reasons to worry about relying on colleges. The collegiate approach is meant to encourage communication more than action. Colleges operate as peers, convened by the home banking regulator, without the sort of hierarchy of decision-making and direction that leads to coordinated action.

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June 19, 2014
Sovereignty Mismatch And The New Administrative Law
Posted by David Zaring

I've been on a bit of an international and administrative law kick these days, but as always, the case study is financial regulation.  If you're interested in Sovereignty Mismatch And The New Administrative Law, available from the Washington University Law Review and here, you know what to do.  Here's the abstract:

In the United States, making international policymaking work with domestic administrative law poses one of the thorniest of modern legal problems — the problem of sovereignty mismatch. Purely domestic regulation, which is a bureaucratic exercise of sovereignty, cannot solve the most challenging issues that regulators now face, and so agencies have started cooperating with their foreign counterparts, which is a negotiated form of sovereignty. But the way they cooperate threatens to undermine all of the values that domestic administrative law, especially its American variant, stands for. International and domestic regulation differ in almost every important way: procedural requirements, substantive remits, method of legitimation, and even in basic policy goals. Even worse, the delegation of power away from the United States is something that our constitutional, international, and administrative law traditions all look upon with great suspicion. The resulting effort to merge international and domestic regulatory styles has been uneven at best. As the globalization of policymaking is the likely future of environmental, business conduct, and consumer protection regulation — and the new paradigm-setting present of financial regulation — the sovereignty mismatch problem must be addressed; this Article shows how Congress can do so.

Comments and concerns welcome.

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June 05, 2014
The Second Circuit Reverses Judge Rakoff On The SEC
Posted by David Zaring

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.

 

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May 29, 2014
Harvard Grads as Bubble Predictors
Posted by Erik Gerding

Here is an old saw: the best way to predict bubbles is to look at the industry to which Harvard MBA grads are flocking.  I used this as a laugh line when I spoke to David’s students at Wharton in October.  Now Matt O’Brien at the Washington Post Wonkblog extends the analysis to Crimson undergrads.

O’Brien’s article is the latest salvo in the analysis of what makes “Organization Kids” flock to finance.   Kevin Roose’s Young Money made a splash when it was published earlier this year.  Academics looking to understand students should consider delving into what makes students who enter finance and law with more than a dismissive lament of “kids these days.”  Indeed, the modern university seems designed specifically to create organization kids.  Think of how the bizarre gatekeeping rituals of college admissions filter down to create an achievement junky culture that begins in middle school if not earlier.  Students and parents seek to anticipate the divinations of middle aged oracles who themselves attempt to divine meaning from personal statements and lists of extracurriculars.

The Harvard MBA Indicator is a fun parlor game.  But it also suggests that in trying to understand deep questions such as why bubbles begin and how financial institutions operate, we might look at a broader set of disciplines than just economics.   Some very interesting legal scholarship on bubbles, financial markets (think Stuart Banner’s history) and financial institutions (Annelise Rile’s sociological studies of Japanese firms) serves as examples of the possibilities.  If academics lament their students being organization kids, they should have a little self-awareness and step outside their own institutional comfort zone.

Permalink | Finance| Financial Institutions| Law & Society| Law Schools/Lawyering| Legal Scholarship | Comments (0) | TrackBack (0) | Bookmark

Regulator Rotation and Peer Review
Posted by Erik Gerding

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.

Permalink | Administrative Law| Financial Institutions | Comments (0) | TrackBack (0) | Bookmark

May 28, 2014
RIP IRB & DIY Cap Reqs
Posted by Erik Gerding

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.

Permalink | Administrative Law| Financial Crisis| Financial Institutions | Comments (0) | TrackBack (0) | Bookmark

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