December 11, 2014
Will The Swaps Pushout Rule Die In The Cromnibus?
Posted by David Zaring

One dodgy thing that is being included in the currently debated spending bill is a substantive provision repealing a much-hated-by-banks law requiring them to do most of their derivatives trading though an entity that is not covered by deposit insurance.  It's a rule that sounds pretty logical - why subsidize derivatives trading with deposit insurance, and isn't it risky to do otherwise?  And why do we have to address this in a government budget bill anyway?

But it is also one of uncertain policy origins.  Blanche Lincoln thought the swaps pushout rule would resonate with voters when she pushed it, and maybe community banks, which don't do a ton of this stuff, would like to make life hard for the big banks that do.  Elizabeth Warren is incensed that it might  be repealed, so maybe her constituents would be for it.  But the Fed doesn't think it does bank safety much good.

Here's Dave Weigel on the politics, which look good for the banks (Warren's concerns aside, Democrats aren't whipping for the pushout rule reversal to be defeated).  Here's DealBook on the sausage-making (the statutory language was drafted by Citigroup, which has always seemed like the most tone-deaf bank to me, rather than the most politically puissant).

My view is that financial regulation, which is just about protecting banks from themselves/macroeconomic shocks, with a soupcon of rent-seeking, is a mixture of easy rules and hard ones.  Activity restrictions, like the Volcker Rule, or anti-branching laws, are easy.  Capital rules, at least the current ones, are hard, and require a team of examiners to look over the daily positions of the banks, and so on. Admati's capital rule recommendation - banks must hold 4 times more capital than they do now, and there will be no risk-weighting - is an effort to make that easy again.

And organizational rules - create a bank holding company, make this sub do this thing, and that sub do that thing - are also easy.

Note that currently, it's the left and community banks that like the easy rules, and it's the right and the big banks that prefer to do things the hard, sophisticated way.  That doesn't mean that complex rules are weak ones - I can't judge the onerousness of our tax laws, but some of them are super-complicated responses to super-sophisticated behavior, and maybe that makes more sense than giving up and charging everyone a VAT.  But that's the way I see financial regulation right now.

And yes, I don't know why part of Dodd-Frank should be repealed as a condition of passing a spending bill.  But I admire the ability of the lobbyists to get in there and at it.

One last thing - it's risky to be the bank named as the drafter of a bill taking away some of your regulator's regulatory powers.  We'll have to see if Citi starts paying a extra-large number of fines in the next year, or if it really did do this with the tacit approval of its supervisors.

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December 08, 2014
The International Review Of The Quality Of American Financial Supervision
Posted by David Zaring

The Basel committee enforces through peer pressure, rather than through resort to a formal dispute settlement process, and the peer pressure is increasingly institutionalized through IMF-like reviews of the implementation of Basel commitments.  The US just had its review, and Basel just released the report.

The big problem with the US embrace of global rules has come through its treatment of securitizations.  Perhaps most notably:

a number of divergences were identified that for some US core banks lead to materially lower securitisation  RWA [risk-weighted assets, the stuff against which you have to hold capital] outcomes than the Basel standard. These differences are mainly related to the prohibition on the use of ratings in the US rules. Pursuant to the Dodd-Frank Act, the US rules cannot include provisions related to the Basel framework’s Ratings-Based Approach (RBA) for securitisations, so the rules provide alternative treatments.

The US is not Basel compliant because its regulators are explicitly not permitted to use a tool - credit ratings - that Basel requires.  It looks like the committee may fix this not by forcing credit ratings down America's throat, but by coming up with some equivalence standard, which tells you that when Congress speaks clearly, global regulatory harmonizers must listen.  Another admission of note:

In carrying out this review, the Committee's assessment team held discussions with senior officials and technical staff of the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation. The team also met with a select group of US banks.

This meet with regulated industry thing is one of the features of peer regulatory review, and it presumably gives industry yet another opportunity to make a case for its preferred version of regulation.  But then, it is also a feature of international regulation, where the cross-border parties may sometimes also play roles as representatives of the domestically regulated.

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The 11 Most Influential People In Business Ethics
Posted by David Zaring

This not at all silly list reveals the following:

  • #1 William Dudley – President and CEO, Federal Reserve Bank of New York
    Category: Government and Regulatory
  • #1 Preet Bharara – US Attorney, Southern District of New York
    Category: Government and Regulatory
  • #3 Sophie Delaunay – Executive Director, Doctors Without Borders
    Category: Non-Governmental Organization
  • #4 Anonymous Whistleblower – Whistleblower, Securities and Exchange Commission
    Category: Whistleblowing and Media
  • #5 Glenn Murphy – CEO and Chairman, Gap Inc.
    Category: Business Leadership
  • #6 Eric Holder – Attorney General (outgoing), United States Government
    Category: Government and Regulatory
  • #7 José Ugaz – Chair, Transparency International
    Category: Non-Governmental Organization
  • #8 Pope Francis – Pope, Catholic Church
    Category: Thought Leadership
  • #9 Ma Jun – Director, Institute of Public and Environmental Affairs (IPE)
    Category: Design and Sustainability
  • #10 Larry Merlo – President and CEO, CVS Health
    Category: Business Leadership
  • #11 Carmen Segarra – Former Regulator, Federal Reserve Bank of New York
    Category: Whistleblowers and Media

Dudley is the regulator who has called for bankers to act more ethically.  I guess Bharara stands for the proposition that insider trading is the most unethical kind of business conduct, to the exclusion of all other such forms.  Anonymous Whistleblower at 4!  It proves you can make lots of money by being ethical!  And Carmen Segarra, the Fed examiner, rounding out the top 11  - it suggests that business ethics are in question, finance would appear not to be the answer.  Via.

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December 05, 2014
CEO Health Disclosures: JPMorgan Edition
Posted by David Zaring

Not to pile on, but there's the slightly unsettling trned of CEOs talking, or not, about their health.  Surely material information a real investor would want to know about when deciding whether to buy or sell a stock in these days of the imperial CEO.  But deeply unprivate.  Anyway, here's Jamie Dimon's letter to the staff, in part, on the very good news that, after been stricken with throat cancer, he now appears to be free of it.

Subject: Sharing Some Good News
Dear Colleagues -

This past summer, I let you know that I had been diagnosed with throat cancer. Having concluded my full treatment regimen a few months ago, I wanted to give you an update on my health. This week I had the thorough round of tests and scans that are normally done three months following treatment, including a CAT scan and a PET scan. The good news is that the results came back completely clear, showing no evidence of cancer in my body. While the monitoring will continue for several years, the results are extremely positive and my prognosis remains excellent.

The stock is up 2% on the day.  It will be interesting to see whether this email makes its way into a securities filing.

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November 25, 2014
Does The Revolving Door Work Differently For Bank Supervisors
Posted by David Zaring

We write about the revolving door here, and elsewhere, and we're not as worried about it as some.  So what to make of Goldman's hiring of Fed bank supervisors?  The critical problem here is that one hire may have brought (or obtained) Fed information to his new job at Goldman.  Since the bank supervisor relationship is supposed to be pretty confidential - why would a bank let you examine their books if you're going to talk about their positions to their competitors? - this is a big deal.  And also because of the ethics rules that generally require you to stay off of matters you worked on in the government.

Here's what happened:

Rohit Bansal, the 29-year-old former New York Fed regulator, was one such hire. At the time he left the Fed, Mr. Bansal was the “central point of contact” for certain banks.

Seizing upon Mr. Bansal’s expertise, Goldman assigned him to the part of the investment bank that advises other financial institutions based in the United States. That assignment presented Mr. Bansal with an ethical quandary: He might have to advise some of the same banks he once regulated.

Before starting at Goldman, Mr. Bansal sought to clarify whether New York Fed policy prevented him from helping those banks, according to a person briefed on the matter. Initially, he presented Goldman with a notice from the New York Fed, which indicated that he might have to steer clear of certain assignments for one client, the midsize bank in New York. (While the person briefed on the matter provided the name of the bank, The Times decided to withhold the name because the bank was not aware of the leak at the time.)

The New York Fed’s guidance was apparently somewhat ambiguous. And Mr. Bansal later assured Goldman colleagues that he could work behind the scenes for that banking client, the person briefed on the matter said, so long as he did not interact with the bank’s employees.

Mr. Bansal’s lawyer, Sean Casey at Kobre & Kim, declined to comment.

And then Goldman found him using some data that had to come from the Fed.  Some thoughts:

  • Our former supervisor has himself a very fancy lawyer
  • When enforcement officials go through the revolving door, there's little reason to believe they have been encouraged to go easy on the industry they plan to join.  Why not keep that guy where he is, and hire away the tormentor?  Bank supervision, which is more collaborative, could be different.
  • But note that what former bureaucrats are selling is, partly, expertise - particularly, the expertise about what current bureaucrats will do.  The question is whether there is anything wrong with paying for this sort of expertise.

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November 17, 2014
Battling A SIFI Designation
Posted by David Zaring

Over at DealBook, I've got a take on MetLife's claim that it will be suing over its designation as a systemically important financial institution.  A taste:

Congress gave the government 10 factors to take into account when making a too-big-to-fail designation. This sort of multiple-factor test all but requires regulators to balance values that have different degrees of quantifiability. Some can be counted, like the amount of leverage and off-balance sheet exposure. But others like “the nature, scope, size, scale, concentration, interconnectedness and mix of the activities of the company” have so many moving parts, some of them difficult to quantify, that expressing them mathematically may not be worth the effort. The government has also been given the leeway to consider “any other risk-related factors” that it deems appropriate, a standard that encourages judges to defer to regulators.

Do give it a look!

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November 06, 2014
Can You Litigate Your Way Out Of A SIFI Designation?
Posted by David Zaring

Eugene Scalia, of the family Scalia, has been the scourge of the SEC with his until recently effective insistence on a cost-benefit analysis to justify the imposition of new major rules on the capital markets.  Now he's working for MetLife, the insurance company recently designated as a SIFI (which stands for "dangerously big bank-like institution"), and I guess the argument will be that the designation was arbitrary and capricious, and so inconsistent with the federal standards for administrative procedure, which probably, in Scalia's view, require a quantitative cost-benefit analysis done with meticulous care.  Some thoughts:

  • Courts often stay out of financial stability inquiries, but, then, they used to defer to the SEC's capital markets expertise, until Eugene Scalia came along.  Perhaps Scalia can do something in this really nascent field of disputing SIFI designations.  Still, uphill battle.
  • If the FSOC somehow lost this case, it could always go global, and ask the Financial Stability Board to designate Met Life as a G-SIFI, which would give foreign regulators the right to persecute the firm's foreign operations, and maybe super-persecute it, if the American regulators could do nothing to control its SIFIness.
  • The basic idea, by the way, which is hardly ludicrous, is that insurance companies aren't subject to bank runs, even if they are really big, and that only one of them failed, or was even at risk, during the last financial crisis.  Since Met Life isn't in the business of writing unhedged credit default swaps (which is what AIG did, bolstered by its AAA rating and huge balance sheet), why should it have to hold bank-like levels of capital?  There's more to that story, but I assume that is part of the story that MetLife will be telling.

HT: Matt Levine

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October 23, 2014
The Coming Global Prohibition On Securitization
Posted by David Zaring

Okay, the headline was made to draw in the reader.  Non-banks will be allowed to securitize to their heart's content, and banks will likely basically continue to do the same.  However, the Basel Committee orchestrated a meeting in Tianjin between central bankers (they do monetary policy) and bank supervisors (they do safety and soundness),and came up with, among other standards, an approach to the ability of banks to hold collateralized debt obligations, the sort of obligations that have been blamed for the financial crisis.

I will quote the report made from the meeting, though that's pretty dull and bureaucratic. However:

  • the freedom of banks to hold derivatives is being set in these informal international meetings among bureaucrats, a fact always worth repeating
  • the limits on bank holdings of securitized assets is being set through a negotiated, and global, process involving bank regulators and capital market regulators 
  • some people, the US very much not included, would see no reason to consult those who set monetary policy, or what the currency is worth, on the appropriate way to limit the power of banks to hold derivatives, or whether derivatives would fail to protect a bank in crisis times
  • the supervisors and central bankers met in Tianjin, which means that some of them hopefully took the world's fastest train from Beijing's airport to Beijing's port city.

It's all very global and committee of regulators oriented.  Anyway, here's the report on securitization assets held by banks:

The Committee also reviewed progress towards finalising revisions to the Basel framework's securitisation standard and agreed the remaining significant policy details that will be published by year-end. It also recognised work that is being conducted jointly by the Basel Committee and the International Organization of Securities Commissions (IOSCO) to review securitisation markets. The Committee looks forward to the development of criteria that could help identify - and assist the financial industry's development of - simple and transparent securitisation structures. In 2015, the Committee will consider how to incorporate the criteria, once finalised, into the securitisation capital framework.

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Turkish Banking Law Is All About Image
Posted by David Zaring

Turkey's largest Islamic bank believes that it has been targeted for destruction by the Turkish government, and, given the way things seem to go in that country, the level of conspiratorial innuendo is high.  But also high is the discretion of the government to act against banks and observers of same.  Banks generally did well in the financial crisis of 2008, if not so well before then.  Usually, supervision is done for safety and soundness.  But here's Euromoney's quote of one of the principles of Turkish banking law:

The 'protection of reputation’ article of Turkey’s banking law, introduced after the country’s devastating banking crisis of 2001, states "no real or legal person shall intentionally damage the reputation, prestige or assets of a bank or disseminate inaccurate news either using any means of communication". Convicted violators of the code face up to three years in prison.

That seems like almost untrammeled regulatory discretion to me, joined with severe penalties.  You could go after shorts, any sort of speaker, and probably the banks themselves, for soiling their own reputation.  Via Matt Levine.

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October 08, 2014
When They Tell You About Capture, Tell Them About Graber
Posted by David Zaring

Geoffrey Graber, who is heading up a mortgage fraud task force for DOJ, is motivated by Glengarry Glen Ross, and the results have evinced an ouch from the banking community:

The surge of settlements engineered by Graber in the past year has helped neutralize some of that criticism and rehabilitate a key piece of Holder’s legacy. Still, the settlements have been controversial. Critics such as Roy Smith, a professor at New York University’s Stern School of Business, say prosecutors were driven by “political fever” to extract massive penalties from Wall Street.

“They have to deliver something, so they come up with this,” said Smith, a former Goldman Sachs Group Inc. (GS) partner. “The fact that it’s unfair never really gets considered. The banks have no choice but to hunker down and accept it.”

A bracing corollary to those capture stories, though notice that it's the enforcement officials who win headlines for big settlements, and the bank examiners who are subject to the expose about go along get along.

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October 02, 2014
A Take In DealBook On The Fannie/Freddie Takings Case
Posted by David Zaring

Steven Davidoff Solomon and I opine on a recent opinion dismissing cases brought by Fannie and Freddie shareholders against the government in DealBook.  A taste:

In one Washington court, Maurice R. Greenberg, the former chief executive and major shareholder of A.I.G., is suing the United States government, contending that the tough terms imposed in return for the insurance company’s bailout were unconstitutionally austere.

In another closely watched case in a different Washington court, the shareholders of Fannie Mae and Freddie Mac, led by hedge funds Perry Capital and the Fairholme Fund, lost a similar kind of claim.

Parsing what the United States District Court did in the Fannie and Freddie litigation offers a window into the ways in which the government’s conduct during that crisis might finally be evaluated.

...

There are three main points to the decision. For one, the court held that the government’s seizure of Fannie’s and Freddie’s profits did not violate the Administrative Procedure Act’s prohibition on “arbitrary and capricious” conduct. It also found that the Housing and Economic Recovery Act barred shareholders of Fannie and Freddie from bringing breach of fiduciary duty suits against the boards of the companies and that the government’s seizure of profits was not an unconstitutional “taking.”

Go give it a look, won't you?

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October 01, 2014
The Five Pathways in Action
Posted by David Orozco

In this post, which follows our earlier discussion of legal strategy, we’ll offer examples of companies situated within each of the five pathways. As Robert and I mentioned in our article, most companies follow the compliance pathway. Such companies insource legal compliance through their in-house legal department, or they may choose to partner with an external compliance verification service. A firm such as ISN, for example, has built a business handling compliance issues for corporations and their subcontractors. According to the Society of Compliance and Corporate Ethics, compliance is a thriving industry due to the increased legal penalties and regulations that companies face in today’s heightened legal environment.

The avoidance pathway is less frequent, given the high stakes and liability attached to this type of strategy. General Motors may have engaged in avoidance if it misled regulators about its faulty ignition switches. Avoidance issues tend to be costly to deal with, given the loss of trust and enhanced penalties that arise from this behavior.

The more interesting and rare pathways involve prevention, value, and transformation. An interesting and controversial prevention legal strategy involves trademark policing, which, in its most egregious form, devolves into the unethical and legally dubious practice of trademark bullying. For example, Chik-fil-A employs an aggressive strategy that targets large and small companies alike and uses the threat of trademark litigation to prevent anyone from encroaching upon its trademarked brands and brand equity. Setting aside the overreaching and legally dubious aspects of this approach, some companies legitimately use a preventive legal strategy that involves cease and desist letters, litigation, and U.S. Patent and Trademark Office administrative oppositions to protect the value of their brands and advertising. The Chik-fil-A case serves as a useful reminder, however, that aggressive legal strategies may push the boundaries of ethical behavior, sound legal argument, and public opinion. 

Two recent examples illustrate how employing a legal strategy in the value pathway can generate positive and tangible financial returns. The first instance involves hedge funds investing in a corporate acquisition target and then filing suit in Delaware to challenge the valuation and seek an appraisal from the court. This legal strategy is referred to as appraisal arbitrage. Many of these cases either settle or result in substantially higher prices for the party seeking the appraisal.

Another value strategy that has been in the headlines recently involves tax inversions. Burger King’s recent decision to acquire Canada’s Tim Horton’s will yield business synergies, but it also exploits a legal maneuver allowed under current tax law permitting a company acquiring a foreign entity to reincorporate in the foreign jurisdiction. By reincorporating in Canada, Burger King will effectively lower its tax rate from 35% to 15%.

The last and rarest of legal strategies is transformation. This occurs when the top executives in a corporation integrate law as a core aspect of the firm’s business model to achieve sustainable competitive advantage. Few companies are able to achieve this strategic pathway, and it’s certainly not for everyone. One company that notoriously used law to achieve abnormally large market share and margins in the ticket processing industry was Ticketmaster. The ticket service provider used venue ticket licensing contracts that included several key provisions such as long term renewable exclusivity terms (up to 5 years), and more infamously, fee sharing provisions. Ticketmaster’s business model was, essentially, to take the bad rap for charging exorbitant convenience fees and sharing those fees with the venue, thus contractually locking them into a highly profitable and exclusive business system. It didn’t hurt that Ticketmaster’s pioneering CEO Fred Rosen was a Wall Street attorney turned impresario.

Another company that is showing signs of attempting to pursue a transformative legal strategy is Tesla Motors. Tesla’s recent announcement to offer open licensing terms for its battery and charging station patents illustrates a pioneering mentality that seeks to build a business ecosystem with other auto manufacturers. By doing so, Tesla has made a major legal bet that giving up patent exclusivity rights in the short term will yield long-term competitive advantage by helping to diffuse electric battery and recharging technology. The other legal strategy Tesla has pursued relates to its pioneering distribution model of direct sales to the consumer, bypassing the traditional dealership model established for conventional automobiles. To achieve this direct-to-customer model, Tesla has engaged state regulators to achieve exemptions from state dealership franchise laws. Tesla is clearly strategizing and innovating along many fronts that involve business, technology and law. It remains to be seen, however, whether these legal strategies will offer Tesla a long-term sustainable competitive advantage.

In our next and last post, we’ll discuss our experience teaching the five pathways of legal strategy to business students and how it has been a valuable resource in the classroom. 

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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 25, 2014
Mapping a successful corporate legal strategy
Posted by David Orozco

In our last post, we discussed our framework for legal strategy called the five pathways. Today, we’d like to address how companies navigate within these pathways to attain the best results. As we mentioned in our MIT Sloan article, there is no one-size-fits-all approach to developing a legal strategy. Companies and industries are simply too diverse for such a simplistic solution. Instead, what we find is that legal strategy often is dependent on internal and external variables, such as company size, corporate culture, regulation, pace of technological change and the company’s maturity stage.

That is not to say, however, that a large and mature company in a regulated industry cannot cross the divide from risk management to a value creation pathway. One well established transportation company recently engaged in a strategic and cross functional (legal and finance) assessment of freight contracts to evaluate which ones to renew, cancel or negotiate. The company, which was operating at full capacity, changed its legal strategy to optimize its operations for the near and medium terms. This type of strategic contract assessment clearly fits within the value pathway.

To cross the divide and move from a risk management pathway (avoidance, compliance, prevention) to a value-enabling pathway (value and transformation) we suggest that C-level executives must view the law as an important and enabling resource for achieving strategic goals. This perspective requires a strong working knowledge of law, or legal astuteness, and organizational commitments such as the deployment of resources and authority to develop and test legal strategy.

Our research suggests that successful legal strategies require a champion, or what we refer to as a chief legal strategist. This is someone who is authorized by top management and recognized across the organization as the point person for driving legal strategies. Sometimes that individual is the general counsel, such as Twitter’s former chief legal officer, Alexander Macgillivray, who once stated that fighting for free speech is more than a good idea, it is a competitive advantage for the company. We find, however, that an associate general counsel is more often able to devote time to legal strategy execution. These individuals often possess strong legal and business fluency, leadership capabilities and the ability to work dynamically in teams.   

For our next post, we'll offer more examples of companies operating within each pathway.

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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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