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.
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.”
Permalink | Business Ethics| Business Organizations| Corporate Governance| Corporate Law| Delaware| Economics| Employees| Entrepreneurs| Entrepreneurship| Environment| Fiduciary Law| Finance| Financial Institutions| Investing| JOBS Act| Legal Theory| Organizational Theory| Securities| Social Entrepreneurship| Social Responsibility| Technology| Venture Capital | Comments (0) | TrackBack (0) | Bookmark
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.
Permalink | Business Ethics| Business Organizations| Corporate Governance| Corporate Law| Employees| Environment| Finance| Financial Institutions| Hobby Lobby| Legal Theory| Organizational Theory| Politics| Religion| Securities| Social Responsibility | Comments (0) | TrackBack (0) | Bookmark
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?
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.
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.
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.
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.
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.
A little over a week Governor Tarullo gave a fascinating speech that focused on creating different regulatory approaches for different sized banks. This is a must read for policymakers and scholars (and further evidence of the value of having at least one lawyer or expert in prudential regulation on the Federal Reserve Board). Tarullo advocates pushing further the approach in Dodd-Frank of having a sliding scale with different regulatory standards for different tiers of banks.
Several news outlets picked up on Tarullo’s call to reduce compliance costs for community banks. Tarullo’s welcome approach recognizes that not all banks pose the same amount or types of risk. It contrasts sharply with the views of folks like Tim Geithner, who in his Stress Test memoir, discounts reform proposals that targeted the “popular villain” of size (see pages 391-2). Oddly, Geithner’s memoir also makes the case that the government did not have enough “foam for the runway” when some of the jumboest jetliners started to plummet in the Panic of 2007-2008.
Still Geithner makes a point that serves as a mild corrective addendum for Tarullo’s sliding scale approach: many financial crises started with the risk-taking and failure of smaller institutions. Indeed, too-big-to-fail is but one problem. It should not completely overshadow the risks of herd behavior and too-correlated to fail. The collective actions of stampeding small institutions can generate big doses of systemic risk.
Tarullo’s speech implies that “macroprudential” regulation should only kick in for medium sized banks and ramp up further still for the behemoths. But the case for no macroprudential regulations for smaller firms depends on what we mean by “macroprudential.” One kind of macroprudential regulation focuses on correlated risks across financial institutions (what Claudio Borio labels the “cross-sectional” dimension). What does this mean concretely? Regulators need to worry when even small financial institutions collectively have too much risk exposure to the same types of losses (e.g. subprime residential mortgages, the Sunbelt, the energy sector, etc.). So even community banks need to come under the macroprudential umbrella.
The good news for community banks is that the monitoring cost of looking at correlated risks should (and likely has to) sit with regulators. No individual community bank would be able to assess the overlap between its risk portfolio and that of hundreds or thousands of competitors. Regulators, by contrast, are built to serve these information-gathering and coordination (or anti-coordination if you want to get technical) functions.
Regulators must also carry the burden of looking at how regulations can promote dangerous herd behavior by financial institutions and how this herd behavior can increase during bubble periods (the subject of Chapter 7 of my book). But that is a topic for another day.
Dan and Steven Schwarcz have an insightful new article, Regulating Systemic Risk in Insurance (forthcoming Univ. of Chicagao Law Review). The potential systemic risk in the insurance industry became front page news after AIG (see here for an essay questioning the AIG bailouts). It has continued to simmer; the Financial Stability Oversight Council designated both AIG and Prudential as non-bank SIFIs (systemically important financial institutions). One criticism of this desgination is that it may lead to bank-style regulations being imposed on these firms even though the risks they pose are different in kind from banks (e.g., insurance firms typically don't engage in maturity transformation).
So how might insurance firms pose systemic risk concerns? Schwarcz fils and per focus less on size and Too-big-to-fail, and more on risk correlations. This insight is welcome: the Beltway obsession with size has obscured other dangers, such as herd behavior and correlated risk exposures.
What should be done? Schwarcz and Schwarcz argue for a greater federal role in regulating insurance. Yet they chose to focus less on FSOC and more on an expansive role for one of Dodd-Frank's less well-known innovations, the Federal Insurance Office. Their abstract is after the jump...
Schwarz & Schwarcz abstract:
As exemplified by the dramatic failure of American International Group (AIG), insurance companies and their affiliates played a central role in the 2008 Global Financial Crisis. It is therefore not surprising that the Dodd-Frank Act – the United States’ primary legislative response to the crisis – contained an entire title dedicated to insurance regulation, which has traditionally been the responsibility of individual states. The most important of these insurance-focused reforms in Dodd-Frank empowered the Federal Reserve Bank to impose an additional layer of regulatory scrutiny on top of state insurance regulation for a small number of “systemically important” insurers, such as AIG. But in focusing on the risk that an individual insurer could become too big to fail, this Article argues that Dodd-Frank largely overlooked a second, and equally important, potential source of systemic risk in insurance: the prospect that correlations among individual insurance companies could contribute to or cause widespread financial instability. In fact, the Article argues that there are often substantial correlations among individual insurance companies with respect to both their interconnections with the larger financial system and their vulnerabilities to failure. As a result, the insurance industry as a whole can pose systemic risks that regulation should attempt to identify and manage. Traditional state-based insurance regulation, the Article contends, is poorly adapted at accomplishing this given the mismatch between state boundaries and systemic risks and states’ limited oversight of non-insurance financial markets. As such, the Article suggests enhancing the power of the Federal Insurance Office – a federal entity currently primarily charged with monitoring the insurance industry – to supplement or preempt state law when states have failed to satisfactorily address gaps or deficiencies in insurance regulation that could contribute to systemic risk.
A few weeks back (I am catching up on my blogging), the Economist featured a terrific essay on “A History of Finance in Five Crises.” The conclusion of the essay – “successive reforms have tended to insulate investors from risk” and “this pins risk on the public purse … [t]o solve this problem means putting risk back into the private sector” – resonates. However, the Economist makes a few surprising errors of omission in reaching this point.
First, many financial crises occurred without much of a state bailouts or safety net. The Economist starts its history with the Panic of 1792 in the United States. By that point England had already experienced a crisis in the late 1690s and the South Seas Bubble in 1720 and France had suffered through the searing Mississippi Bubble (I discuss all of these in Chapter 2 of my book). The Economist then hopscotches to the Panic of 1825. Roughly every ten years after that, Britain experienced another bubble and crash (also detailed in my book). It is less than clear how government safety nets triggered these crises.
These crises point to a second omission: each of these 19th Century British crises – the Panic of 1825, the Panic of 1837, the Crisis of 1847 (it is a mystery to me what causes some incidents to qualify as a “Panic” and others to be a “Crisis”), the Crisis of 1857, and the Overend Gurney Crisis of 1866 – was preceded by a liberalization of corporate law or an expansion of limited liability for corporate shareholders. Some scholars wax poetic about the “sine curve” of regulation without tracing that back in history. Well, British corporate law (see also Chapter 2 of my book) provides the caffeine for that coffee. This corporate law history has several important implications:
State intervention in financial markets takes other forms than deposit insurance and government bailouts. This intervention often occurs before crises. Indeed, I argue that booming markets and bubbles create strong incentives for interest groups to lobby for, and policymakers to provide, legal changes that further stimulate markets. What I call “regulatory stimulus” goes beyond “deregulation” and includes government subsidies or legal preferences (think bankruptcy exemptions for swaps) for particular markets. It also includes active government investments in markets (think all those state land and money giveaways to 19th Century railways).
Regulatory stimulus in the form of changes to corporate law has particularly powerful effects. The corporate form provides ideal for lobbying for regulatory favors: corporations solve collective action problems by centralizing decision-making and allow managers to lobby with “other people’s money.”
Moreover, as the Economist hints but doesn’t quite hammer home, limited liability can generate moral hazard, which becomes particularly vicious if risk-taking can be externalized onto financial markets and taxpayers.
The Economist’s third omission is the most amusing (at least to nerds like me). The magazine notes that after the Overend Gurney Crisis in 1866, “Britain then enjoyed 50 years of financial calm, a fact that some historians reckon was due to the prudence of a banking sector stripped of moral hazard.” Many economists reckon that these years of calm owe more to the Bank of England finally assuming the mantle of lender of last resort in a banking crisis. The intellectual godfather of this was none other than Walter Bagehot, the legendary editor of the Economist. Perhaps this failure to provide credit where it is due owes to some intellectual Oedipal issues at the journal?
The fourth omission in the essay is perhaps the most unforgivable. The Economist talks about the Great Crash of 1929 without mentioning the critique that the Federal Reserve failed to serve as lender-of-last-resort and pursued a destructive monetary policy at critical junctures. Indeed, these are state interventions that many economists advocate that central banks take in the face of a banking crisis. These state interventions also provide a government safety net that can create moral hazard.
Which leads to the most biting criticism of the Economist piece: letting the economy burn in the wake of a financial crisis is pure but risks being purely destructive. Rather than focusing on unravelling government safety nets for markets, we should be thinking about how to regulate financial firms given their inevitability.
We enjoyed a great lineup of speakers and cutting edge scholarship here in Boulder this past semester as part of CU’s Business Law Colloquium. The following papers make for excellent start-of-the-summer reading:
Dan Katz (Michigan State): Quantitative Legal Prediction – or – How I Learned to Stop Worrying and Start Preparing for the Data Driven Future of the Legal Services Industry: a provocative look at Big Data will help clients analyze everything from whether to bring or settle a lawsuit to how to hire legal counsel. Katz examines implications for legal education.
Rob Jackson (Columbia): Toward a Constitutional Review of the Poison Pill (with Lucian Bebchuk): Jackson and Bebchuk kicked a hornet’s nest with their argument that some state antitakeover statutes (and, by extension, poison pills under those statutes) may be preempted by the Williams Act. See here for the rapid fire response from Martin Lipton.
Brad Bernthal (Colorado): What the Advocate’s Playbook Reveals About FCC Institutional Tendencies in an Innovation Age: my co-teacher interviewed telecom lawyers to map out both their strategies for influencing the Federal Communications Commission and what these strategies mean for stifling innovation in that agency.
Kate Judge (Columbia): Intermediary Influence: Judge examines the mechanisms by which intermediaries – both financial and otherwise – engage in rent-seeking rather than lowering transaction costs for market participants. The paper helps explain everything from Tesla’s ongoing fight with the Great State of New Jersey to sell cars without relying on dealers to entrenchment by large financial conglomerates.
Lynn Stout (Cornell): Killing Conscience: The Unintended Behavioral Consequences of 'Pay For Performance': Stout argues that pay for performance compensation in companies undermines ethical behavior by framing choices in terms of monetary reward. This adds to the growing literature on compliance which ranges from Tom Tyler’s germinal work to Tung & Henderson, who argue for adapting pay for performance for regulators.
Steven Schwarcz (Duke): The Governance Structure of Shadow Banking: Rethinking Assumptions About Limited Liability: Schwarcz argues for imposing additional liability on the “owner-managers” of some shadow banking entities to dampen the moral hazard and excessive risk taking by these entities, which contributed to the financial crisis. This paper joins a chorus of other papers arguing to using shareholder or director & officer liability mechanisms to fight systemic risk. (See Hill & Painter; Admati, Conti-Brown, & Pfleiderer; and Armour & Gordon).
[I’ll inject myself editorially on this one paper: this is a provocative idea, but one that would make debt even cheaper relative to equity than it already is. This would encourage firms to ratchet up already high levels of leverage. I looked at the expansion of limited liability in Britain in the 18th Century in Chapter 2 of my book. The good news for Schwarcz’s proposal from this history: expansions of limited liability seem to have coincided and contributed to the booms in the cycle of financial crises in that country that occurred every 10 years in that country. The bad news: unlimited liability for shareholders does not seem to have staved off crises and likely contributed to the contagion in the Panic of 1825.]
The CU Business Law Colloquium also heard from Gordon Smith (BYU), Jim Cox (Duke), Sharon Matusik (Colorado – Business), Afra Afsharipour (UC Davis), Jesse Fried (Harvard), and Brian Broughman (Indiana). Their papers are not yet up on ssrn.
After the jump, is the program for the AALS Mid-year Meeting on Corporate and Financial Law in Washington, D.C. from June 7-9. If you register (site restricted) and attend, make sure to stay until the fireworks at the very last panel!
Saturday, June 7, 2014
4:00 - 8:00 p.m.
6:00 - 7:30 p.m.
Sunday, June 8, 2014
8:45 - 9:00 a.m.
Judith Areen, AALS Executive Director, Chief Executive Officer
Joan M. Heminway, Chair, Planning Committee for AALS Workshop on Blurring Boundaries in Financial and Corporate Law and The University of Tennessee College of Law
9:00 - 9:30 a.m.
Donald C. Langevoort, Georgetown University Law Center
9:30 a.m. - 12:00 p.m.
Sessions on Research
Recent appraisals of the state of legal education have raised questions about the value of legal scholarship. Yet, most law scholars believe that their work contributes meaningfully to important theoretical and policy-oriented discussions-including those involving financial and corporate law. What is the relevance and overall value of legal scholarship in financial and corporate law in an era of blurred and blurring boundaries? What methodologies, forms of scholarly output, and publication venues most effectively and efficiently reach the target audiences for financial and corporate law scholarship? This segment of the program focuses on these and other questions relating to research and writing in financial and corporate law as a matter of current and desired future practice.
Specifically, the segment features a two-part approach to questions involving research in the context of unclear substantive demarcations in financial and corporate law. The first part is a plenary panel discussion, and the second part is a series of small-group networking sessions. More detailed descriptions of each are set forth below.
9:30 -10:45 a.m.
Research Plenary Panel
Robert P. Bartlett, III, University of California, Berkeley School of Law
Jill E. Fisch, University of Pennsylvania Law School
Claire A. Hill, University of Minnesota Law School
The prevalence of economic analysis is one element that unites legal scholarship across the many areas of business law. Scholars in the various business law fields of endeavor (e.g., business associations, securities regulation, financial institutions, insurance) have used other disciplines and methodological approaches to a far lesser extent. Do we have the right mix of interdisciplinarity to most effectively respond to current challenges involving financial and corporate law? How, if at all, do traditional legal scholars re-tool to address any perceived need for interdisciplinary research that engages academic disciplines outside their areas of expertise (or areas of expertise in which their knowledge is superficial or outdated)?
This panel explores the capacity of a variety of methodologies and disciplines to enrich the study of financial and corporate law in an era of blurring substantive and regulatory boundaries. The panel also addresses cutting edge questions and controversies regarding blurring boundaries in particular research traditions. The panel comprises scholars who use different quantitative and qualitative analytical methods in their work. The panel is designed to allow these scholars to discuss techniques and tools they use and to yield valuable insights into questions that cut across financial and corporate law, such as the behavior of consumers, investors, financial institutions (and the individuals who work inside them), lawyers, and regulators.
10:45 - 11:00 a.m.
11:00 a.m. - 12:00 p.m.
Research Small Group /Networking Sessions
Michelle M. Harner, University of Maryland Francis King Carey School of Law
Christine Hurt, University of Illinois College of Law
Anne M. Tucker, Georgia State University College of Law
Others to be announced.
This part of the program is designed to offer participants the opportunity to share their thoughts on blurred lines in financial regulation research. Topics will vary from session to session but may include: how individual research approaches and methods have changed and are changing; how law academics keep up with emerging research approaches and methods-e.g., where research content is now found and how it is processed; whether (and, if so, how) individuals with different substantive law and research backgrounds "talk" to each other to help bridge gaps; and what optimal work product outcomes look like as substantive and regulatory lines continue to blur. Facilitators will report out the ideas from their sessions.
12:00 - 1:30 p.m.
Elizabeth Warren, U.S. Senator for Massachusetts (Invited)
1:45 - 5:00 p.m.
Associated legal and regulatory challenges and changes force us to reconsider our pedagogy and the business law curriculum in very fundamental ways. Structuring courses and choosing and employing effective teaching tools are, of course, part of the discussion. But teaching financial and corporate law in an era of blurring boundaries also engages larger issues, such as the role of different types of courses (e.g., clinics, practicums, externships, field placements, simulation courses) and pedagogies in teaching business law courses. Also important are pedagogical methods geared to develop the financial literacy, numeracy, and professional values that students concentrating in financial and corporate law should have when they graduate from law school. Finally, it seems that it would be beneficial to address the value for law students, if any, in joint degree (e.g., JD/MBA) and advanced degree (LLM, Masters in Law, Juris Masters, etc.) programs and the overall place and prominence of financial and corporate law in the current and future program of legal education in the United States. The program is designed to involve a significant amount of "show and tell," rather than predominantly focusing on traditional academic presentations.
1:45 - 3:00 p.m.
Teaching Plenary Panel
William A. Birdthistle, Chicago-Kent College of Law, Illinois Institute of Technology
James A. Fanto, Brooklyn Law School
Edward J. Janger, Brooklyn Law School
John Henry Schlegel, University at Buffalo Law School
David A. Westbrook, University at Buffalo Law School
This panel, populated with presenters culled from a call for proposals, explores the challenges and opportunities for legal educators in an era of blurring substantive and regulatory boundaries. A range of possible teaching methods and tools can assist in the task. But difficult questions exist as to how to best use these methods and tools in individual courses and across the curriculum-in and outside business law teaching. Course selection and curricular options (including those external to the standard Juris Doctor courses and curriculum) deserve important consideration at both the individual (student and faculty) and institutional levels. The panel is designed to allow academics specializing in financial and corporate law to discuss these and other issues relevant to educating business law students in light of blurring financial and corporate law boundaries.
3:00 - 3:15 p.m.
3:15 - 5:00 p.m.
Teaching Concurrent Sessions
This portion of the program features concurrent sessions on teaching led by law faculty chosen from a call for proposals. Each session has a different topical focus and is offered twice-once in each breakout period. Accordingly, each attendee has the opportunity to attend two sessions, each on a different topic. These sessions are designed to involve significant interaction between the selected discussion leader and the attendees.
3:15 - 3:45 p.m.
Consumer Protection Clinicas as a Site for Blurring Boundaries
Bryan L. Adamson, Seattle University School of Law
Teaching Banking Law
Mehrsa Baradaran, University of Georgia School of Law
A Multi-Disciplinary Approach to Real Estate Investment and Finance Law
Andrea Boyack, Washburn University School of Law
Teaching the Federal Reserve in Law School: Crossing Disciplines, Paradigms and Vantage Points
Timothy A. Canova, Nova Southeastern University, Shepard Broad Law Center
From the Balance Sheet to Beta: A Hands-On Approach to Teaching Accounting & Finance Concepts
Virginia Harper Ho, University of Kansas School of Law
3:45 - 4:15 p.m.
Repeat of Concurrent Session Presentations
4:15 - 5:00 p.m.
5:30 - 6:30 p.m.
Monday, June 9, 2014
9:00 - 10:15 a.m.
Complexity Plenary Panel
Henry T. Hu, The University of Texas School of Law
Kristin N. Johnson, Seton Hall University School of Law
Tom C.W. Lin, University of Florida Fredric G. Levin College of Law
Saule T. Omarova, University of North Carolina, School of Law
Modern financial markets, as well as the firms that operate within these markets, have become increasingly complex over the last several decades. This trend is attributable to various developments, including the accelerating sophistication of technology, the increasing size of firms, the more heterogeneous and sophisticated needs of users of financial services, and the inevitable desire of firms to seek out regulatory gaps. This ever-growing complexity creates a broad set of new challenges for law and regulation. For instance, complexity may confound the efforts of regulators to monitor financial markets for systemic risk or to erect rules to prevent or mitigate that risk. Similarly, it can frustrate the capacity of law to promote more informed consumer and investor protection tools such as disclosure or financial literacy education. Increasing complexity also raises new challenges about the optimal modes of regulation: according to some, it demands greater reliance on regulatory approaches such as self-governance or "new governance," while others argue that it may counter-intuitively necessitate simpler and blunter rules. Finally, market and firm complexity complicates the targets of regulation, which now consists not only of banks, insurers and broker-dealers, but also shadow banks, hedge funds, and participants in derivatives markets.
10:15 - 10:30 a.m.
10:30 a.m. - 12:00 p.m.
Modern Regulatory Approaches
Historically, scholars have studied law and regulation within a particular substantive area, such as banking, corporate, insurance, or securities regulation. However, modern regulatory approaches frequently require knowledge of multiple topics and raise challenges that cut across different areas of legal study. These two concurrent sessions will feature four approaches to understanding modern regulation, each led by a scholar whose work has been focused in the area.
Regulatory arbitrage and cost-benefit analysis are issues that cut across many areas of modern regulation. Many costly rules create incentives for parties to transact in ways that are economically equivalent, but lead to differential regulatory treatment. Both regulators and courts increasingly are required to, and do, use cost-benefit analysis to justify new regulation.
10:30 - 11:15 a.m.
Modern Regulatory Approaches Concurrent Session #1
Jordan M. Barry, University of San Diego School of Law (confirmed)
Modern Regulatory Approaches Concurrent Session #2
Yoon-Ho Alex Lee, University of Southern California Gould School of Law (confirmed)
11:15 a.m. - 12:00 p.m.
Modern Regulatory Approaches Concurrent Session #1
Adam J. Levitin, Georgetown University Law Center (confirmed)
Modern Regulatory Approaches Concurrent Session #2
Dana Brakman Reiser, Brooklyn Law School (confirmed)
12:00 - 1:30 p.m.
Daniel K. Tarullo, Governor, Board of Governors, Federal Reserve System, Washington, DC
1:30 - 3:00 p.m.
New Frontiers: Innovation, Competition and Collaboration in International Financial Markets
Wulf Kaal, University of St. Thomas School of Law
Eric J. Pan, Associate Director, Office of International Affairs, U.S. Securities and
Exchange Commission, Washington, DC
Roberta Romano, Yale Law School
Innovation and the mobility of capital have changed global financial markets in profound and consequential ways. Advances in technology and developments in the infrastructure of financial markets have engendered new levels of interconnectivity. The creation of new financial products, the increasing prominence of market participants such as private equity and hedge funds, and the birth of complex trading strategies (namely algorithmic and high-frequency trading); have permanently altered the landscape of financial markets. Operating in this new frontier, significant financial institutions face historically unparalleled vulnerabilities. The financial crisis of 2008 demonstrated the broad range of concerns that challenge government efforts to regulate financial markets.
Responding to the crisis, authorities propose a diverse array of regulatory reforms. For example, the U.S. Congress and regulators have adopted an aggressive and extraterritorial policy governing domestic and international over-the-counter derivatives, creating a Financial Stability Oversight Council and articulating formal processes to address the insolvency of an international financial market conglomerate. In addition, the highly debated and not-yet-finalized Volker Rule promises to reduce excessive risk taking by systemically important financial institutions and minimize the likelihood of future crises. Other countries' proposed solutions take a different tack, adopting Vickers- and Liikanen-style "ring-fencing" policies. The trend toward diversity in regulatory approaches overshadows central bankers' collaborative efforts to craft, implement and enforce the third round of Basel accords.
The debate over uniformity or diversity in regulation provides a forum for evaluating the merits of these various regulatory approaches and the domestic and international actors who inform the discussion. Questions arising from the debate explore the value of efforts to adopt uniform regulatory approaches; the contributions of international regulatory bodies and trade organizations such as the BIS, the G-20, and IOSCO; the benefits and shortcomings of microprudential policies governing banking institutions; and the limits that political accountability and legitimacy pose for each of the governments whose regulatory policies may heighten or mitigate the potential for future financial crises.
3:00 - 3:15 p.m.
3:15 - 4:45 p.m.
Political Dynamics Plenary Panel
Erik F. Gerding, University of Colorado School of Law
M. Todd Henderson, The University of Chicago, The Law School
Steven Ramirez, Loyola University Chicago School of Law
Hillary A. Sale, Washington University in St. Louis School of Law
Financial and corporate regulation no longer fits within the comfortable regulatory silos so familiar to scholars of previous decades. The efforts to design and implement new regulatory structures after the financial crisis are taking place in sometimes unfamiliar political cross-currents that reshape prior theories. This plenary panel will address the political dynamics of financial and corporate law in contexts framed by a series of important questions: Have financial and corporate law become more political (e.g. the Dodd-Frank Wall Street Reform and Consumer Protection Act and the Jumpstart Our Business Startups Act within 20 months of each other)? Have the roles of courts, legislators, the president, and independent agencies changed and what should those roles be, (with the Citizens United, Business Roundtable, and American Petroleum cases as recent relevant examples)? How has the blurred world of financial and corporate law changed? Who are the constituencies to be considered in evaluating these laws? For example, whose primacy should be our focus and is there new space for occupiers, crowds, and those pursuing social benefit enterprises? Does globalization stress our traditional reliance on state regulation and complicate our existing theories of political economy?