June 03, 2015
Did The Fed Fail To Save Lehman Brothers Because It Legally Couldn't?
Posted by David Zaring

My soon to be colleague Peter Conti-Brown and Brookings author (and future Glom guest) Philip Wallach are debating whether the Fed had the power to bail out Lehman Brothers in the middle of the financial crisis.  The Fed's lawyers said, after the fact, that no, they didn't have the legal power to bail out Lehman.  Peter says yes they did, Philip says no, and I'm with Peter on this one - the discretion that the Fed had to open up its discount window to anyone was massive.  In fact, I'm not even sure that Dodd-Frank, which added some language to the section, really reduced Fed discretion much at all.  It's a pretty interesting debate, though, and goes to how much you believe the law constrains financial regulators.

Here's Peter:

as I discuss at much greater length in my forthcoming book, The Power and Independence of the Federal Reserve, the idea that 13(3) presented any kind of a statutory barrier is pure spin. There’s no obvious hook for judicial review (and no independent mechanism for enforcement), and the authority given is completely broad. Wallach calls this authority “vague” and “ambiguous,” but I don’t see it: broad discretion is not vague for being broad. In relevant part, the statute as of 2008 provided that “in unusual and exigent circumstances,” five members of the Fed’s Board of Governors could lend money through the relevant Federal Reserve Bank to any “individual, partnership, or corporation” so long as the loan is “secured to the satisfaction of the Federal reserve bank.” Before making the loan, though, the relevant Reserve Bank has to “obtain evidence” that the individual, partnership, or corporation in question “is unable to secure adequate credit accommodations from other banking institutions.”

In other words, so long as the Reserve Bank was “satisfied” by the security offered and there is “evidence”—some, any, of undefined quality—the loan could occur. 

Here's Philip:

I (and most observers) read the “satisfaction” requirement as meaning that the Fed can only lend against what it genuinely believes to be sound collateral—i.e., it must act as a (central) bank, and not as a stand-in fiscal authority. The Fed’s assessment of Lehman Brothers as deeply insolvent at the time of the crisis meant that it did not have the legal power to lend. Years later, we have some indication that this assessment may have been flawed, but I don’t take the evidence uncovered as anything like dispositive. As I note in the book, the Fed’s defenders make a strong substantive case that the Fed was right to see Lehman as beyond helping as AIG (rescued days later) was not.

And the debate will be going on over at the Yale J on Reg for the rest of the week.  Do give it a look.

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May 20, 2015
Ben Lawsky's Departure As New York's Financial Services Supervisor
Posted by David Zaring

Lawsky had a tough reputation, and was probably the most challenging state corporate regulator since Spitzer (the Times: " a polarizing four-year tenure that shook up the sleepy world of financial regulation in New York").  And I can say that I knew him when - we were in the same unit at DOJ.  But really, I'm awfully impressed that 1. he is leaving to start his own firm, continuing the craze for boutiques that has animated investment bankers, and now, perhaps their former regulators?  And 2. this excellent front page from the Village Voice.

Apparently, the new firm will specialize in digital security.  Congratulations, Ben!

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May 11, 2015
Ending the (New York) Fed
Posted by David Zaring

There's a proposal out there, with support from various surprising corners of the political spectrum, to get rid of the NY Fed's place on the FOMC, on account of it being too close to Wall Street, big banks, and so on.  I wrote about it for DealBook - do check it out.  A taste:

I have my doubts about any legislation that threatens the central bank’s independence, but would evaluate it by looking to three of my pet axioms of financial regulation.

The first is that procedural reorganizations almost never matter – an axiom that counsels indifference about the change. The second is that the New York Fed has always been special – an axiom that cuts the other way. And the third, given that Congress comprises legislators who need to be re-elected, is to consider the short-term as well as the long-term functions of the change.

When I apply these axioms, I conclude that the New York Fed should not lose its vote. The short-term benefits are unclear, making the change look like a symbolic effort to shift the long-term focus of the Fed away from Wall Street. But Wall Street is important, and deserves its focus. There’s no reason to believe that the New York Fed will do a better or different job on Wall Street if it loses its automatic vote.

Do let me know what you think, either in the comments or otherwise.....

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April 02, 2015
The Dutch Banker's Oath
Posted by David Zaring

How can we persuade bankers to follow the law?  Other regulators looks to a familiar calculus inspired by Holmes' "bad man."  You write regulations that are clear enough, and threatening enough, to induce obedience by someone who, left to their own devices, would do the things the law is meant to prohibit.  So you provide for treble damages for illegal combinations in restraint of trade, you beef up enforcement where detection is difficult, and so on.

But banking regulation is increasingly talking less about clear laws, more about broad principles, and also about "ethical banking."  The New York Fed President has brought the ethics question up, as has the Comptroller of the Currency.  And check out, via Justin Fox, this new oath that every Dutch banker must take:

I swear within the boundaries of the position that I hold in the banking sector

  • that I will perform my duties with integrity and care;
  • that I will carefully balance all the interests involved in the enterprise, namely those of customers, shareholders, employees and the society in which the bank operates;
  • that in this balancing, I will put the interests of the customer first;
  • that I will behave in accordance with the laws, regulations and codes of conduct that apply to me;
  • that I will keep the secrets entrusted to me;
  • that  I will make no misuse of my banking knowledge;
  • that I will be open and transparent, and am aware of my responsibility to society;
  • that I will endeavor to maintain and promote confidence in the banking system.

So truly help me God.

I'm unaware of other regulatory schemes do this sort of thing, though lawyers certainly have codes of conduct, and I suppose that accountants do as well.  What is it supposed to do?  Three possibilities:

  • Regulators think that ethical bankers are likely to be the traditional "boring bankers" who took less risks - and believe that talking to them about ethics and requiring oaths will induce this sort of weltanschauung.
  • Regulators don't know what to do to make banking safe, and so are delegating the safe banking question to the industry, at least in part, by lecturing them about ethics, and hoping that they'll devise practices in this light that will make banking safer
  • This is an effort, by regulators and bankers, to rehabilitate the reputation of the industry by proclaiming ethics commitments.

If you have views about the new role of ethics in banking regulation, let me know in the comments.

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April 01, 2015
Oral History of Drexel Burnham Lambert
Posted by David Zaring

They didn't even get Milken or some of the other most august alumni of the firm to participate (Ken Moelis, though!), and it's still a really great read.

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March 24, 2015
Big Foreign Banks Get Rejected By American Regulators
Posted by David Zaring

One of the things you now have to do if you're a bank with over $50 billion in American assets is to file a resolution plan, or living will, with the authorities - this basically states how you are going to dispose of the company if it becomes insolvent.  After passing all the big American banks through an annual set of stress tests, the regulators have turned their attention abroad:

In their review of the resolution plans from BNP Paribas, HSBC Holdings plc, and The Royal Bank of Scotland Group plc, the agencies noted some improvements from the original plans. However, the agencies have jointly identified specific shortcomings with the 2014 resolution plans that will need to be addressed in the 2015 submissions.

It's annoying enough to be told by some foreign regulator that you aren't sufficiently prepared for a disaster, given that you're home regulator is telling you that you are.  But it must be especially annoying if you are a state-owned bank, which RBS is, to the tune of 66% of its outstanding shares. That's almost a foreign relations issue.  And given that the resolution of international banks like these is one of the most difficult issues facing bank regulators - there has been a failed effort to create a framework going on since Lehman Brothers failed so chaotically - it must be grating to be told to revise the plan:

The agencies will require that the annual plans submitted by these three institutions on or before December 31, 2015, demonstrate that the firms are making significant progress to address all the shortcomings identified in the letters, and are taking actions to improve their resolvability under the U.S. bankruptcy code.  These actions include:

  • Amending the financial contracts entered into by U.S. affiliates to provide for a stay of certain early termination rights of external counterparties triggered by insolvency proceedings to the extent those rights are not addressed by the International Swaps and Derivatives Association 2014 Resolution Stay Protocol;
  • Ensuring the continuity of shared services that support critical operations and core business lines throughout the resolution process; and
  • Demonstrating operational capabilities for resolution preparedness, such as the ability to produce reliable information in a timely manner.

Those are actual requirements!  The first one anyway.  The other two could be goalposts that just get moved further away next time.  Anyway, one question in the brave new world of international banking supervision is whether supervision is a tool that home banks are using for competitive advantage against foreign banks.  It will be interesting to see whether this sort of charge is leveled at this sort of action.

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March 05, 2015
Happy Stress Test Day!
Posted by David Zaring

The 31 banks subject to stress tests - to see how their positions would hold up if the economy hypothetically tanked - all passed, good news for them, and especially for Citi, which failed the last one, and vowed not to do so again.  More here, featuring a picture of former law professor/current Fed board member Dan Tarullo, who supervised the test.  And if you're thinking of investing in banks, the Times has a chart of the percentage of money-like assets in the banks' total assets mix.  If you are risk averse, you want to invest in Deutsche Bank or Discover.  But I think leverage is the most powerful force in the world, so hello, Goldman Sachs and Morgan Stanley!



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February 19, 2015
Gary Osen, Scourge of Banks
Posted by David Zaring

Here's an interesting profile of the guy who is going after banks that held money eventually used in terrorist activities by clients - a potentially long list of defendants, if he can make the legal theory stick.  He came up with that theory, by the way, by noodling it out with one of his law school professors.  HT: Matt Levine

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February 09, 2015
Suicide By Cop, Filed By A Decent Firm?
Posted by David Zaring

I'll outsource the content to Matt Levine's new email, but you just don't see briefs filed by financial businesses against their regulators like the one Powhatan Capital filed against FERC, abetted by one of Philadelphia's good law firms.

There are sections headed "Dr. Chen’s Trades Were Not 'Wash-like' Or 'Wash-type' -- Whatever The Heck That Means," "The Staff’s Stubborn Reliance On The Unpublished, Non-Precedential Amanat Case Is Just Lame," and "Uttering the Phrase 'Enron' Or 'Death Star' Does Not Magically Transform The Staff’s Investigation." It's like an angry trader's dream of what a legal brief might look like ("This is America"!)

It's really quite amusing - check it out.

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January 30, 2015
The Ethical Slide, Train Tickets, and Helping the Next Generation of Corporate Leaders to Choose Differently
Posted by Josephine Sandler Nelson

It has been a pleasure to guest-blog for the last two weeks here at the Glom. (Previous posts available here: one, two, three, four, five, six, seven, eight, and nine.) This final post will introduce the book that Lynn Stout and I propose writing to give better direction to business people in search of ethical outcomes and to support the teaching of ethics in business schools.

Sometimes bad ethical behavior is simply the result of making obviously poor decisions. Consider the very human case of Jonathan Burrows, the former managing director at Blackrock Assets group. Burrows’s two mansions outside London were worth over $6 million U.S., but he ducked paying a little over $22 U.S. in train fare each way to the City for five years. Perhaps Burrows had calculated that being fined would be less expensive than the inconvenience of complying with the train fare rules. Unluckily, the size of his $67,200 U.S total repayment caught the eye of Britain’s Financial Conduct Authority, which banned Burrows from the country’s financial industry for life. That’s how we know about his story.

But how do small bad ethical choices snowball into large-scale frauds? How do we go from dishonesty about a $22 train ticket to a $22 trillion loss in the financial crisis? We know that, once they cross their thresholds for misconduct, individuals find it easier and easier to justify misconduct that adds up and can become more serious. And we know that there is a problem with the incentive structure within organizations that allows larger crises to happen. How do we reach the next generation of corporate leaders to help them make different decisions?

Business schools still largely fail to teach about ethics and legal duties. In fact, research finds “a negative relationship between the resources schools possess and the presence of a required ethics course.” Moreover, psychological studies demonstrate that the teaching of economics without a strong ethical component contributes to a “culture of greed.” Too often business-school cases, especially about entrepreneurs, venerate the individual who bends or breaks the rules for competitive advantage as long as the profit and loss numbers work out. And we fail to talk enough about the positive aspects of being ethical in the workplace. The situation is so bad that Luigi Zingales of the University of Chicago asks point-blank if business schools incubate criminals.

New business-school accreditation guidelines adopted in April 2013 will put specific pressure on schools to describe how they address business ethics. Because business schools are accredited in staggered five-year cycles, every business school that is a member of the international accreditation agency will have to adopt ethics in its curriculum sometime over the next few years.

We hope that the work outlined in my blogposts, discussed at greater length in my articles, and laid out in our proposed book will be at the forefront of this trend to discuss business ethics and the law. We welcome those reading this blog to be a part of the development of this curriculum for our next generation of business leaders.

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January 26, 2015
The Silenced Connecticut Sex-Abuse Case
Posted by Josephine Sandler Nelson

My previous blogposts (one, two, three, four, and five) introduced why conspiracy prosecutions should be used to reach wrongdoing by agents within an organization. The 2012 prosecution of Monsignor Lynn for twelve years of transferring predator priests from parish to parish at the command and for the benefit of the Archdiocese of Philadelphia was defeated by the intracorporate conspiracy doctrine. Moreover, this was not the first time that the Roman Catholic Church had used the doctrine to help its bureaucrats escape liability for suppressing sex abuse cases.

In 1997, employees of the Roman Catholic Church in Connecticut were alleged—very much like Lynn—to have covered up the sexual misconduct of a priest, enabling him to continue to abuse children entrusted to the Church’s care by virtue of his office. When sued for civil conspiracy by the victims, the employees’ defense was that they were acting in the best interest of the corporation.

The Connecticut court found that the test for whether an agent is acting within the scope of his duties “is not the wrongful nature of the conspirators’ action but whether the wrongful conduct was performed within the scope of the conspirators’ official duties.” If the wrongful conduct was performed within the scope of the conspirators’ official duties, the effect of applying the intracorporate conspiracy doctrine is to find that there was no conspiracy. Because covering up the priest’s sex abuse was in the best interest of the corporate organization, the court found that the employees were all acting on behalf of the corporation. The court never reached the issue of whether the employees’ actions rose to the level of a civil conspiracy. Under the intracorporate conspiracy doctrine, it was a tautology that no conspiracy could be possible.

This case is interesting not only because it documents the way that the intracorporate conspiracy doctrine protects enterprises from inquiry into conspiracies, but also because of the subsequent history of its allegations. The full extent of the Bridgeport Diocese’s wrongdoings—if current public knowledge is indeed complete—only came to light in December 2009, twelve years after the 1997 case. It took twelve years, the combined resources of four major newspapers, an act displaying public condemnation of the Roman Catholic Church by members of the state legislature, and finally a decision by the U.S. Supreme Court to release the documents that could have become the basis of the intracorporate conspiracy claim in 1997. There is still no conspiracy suit or any criminal charge against the Diocese. Additional details about the case are available in my article The Intracorporate Conspiracy Trap. The article will be published soon in the Cardozo Law Review, and it is available in draft form here.

Astonishingly, none of the extensive news coverage about the sexual abuse cases in Bridgeport over those additional twelve years has connected these facts to the original 1997 case defeated by application of the intracorporate conspiracy doctrine. If the intracorporate conspiracy doctrine had not provided immunity, the case might have revealed the Diocese’s pattern of wrongdoing long beforehand and in a much more efficient way.

My next blogpost reveals additional dangers from the spread of the intracorporate conspiracy doctrine: frustration with the intracorporate conspiracy doctrine has started to distort other areas of law.

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January 21, 2015
Where are the Prosecutions for Corporate Conspiracy?
Posted by Josephine Sandler Nelson

My first and second blogposts introduced why conspiracy prosecutions are particularly important for reaching the coordinated actions of individuals when the elements of wrong-doing may be delegated among members of the group.

So where are the prosecutions for corporate conspiracy??? The Racketeer Influenced and Corrupt Organizations Act of 1970 (“RICO”, 18 U.S.C.A. §§ 1961 et seq.), no longer applies to most business organizations and their employees. In fact, business organizations working together with outside agents can form new protected “enterprises.

What’s going on here? In this area and many other parts of the law, we are witnessing the power of the intracorporate conspiracy doctrine. This doctrine provides immunity to an enterprise and its agents from conspiracy prosecution, based on the legal fiction that an enterprise and its agents are a single actor incapable of the meeting of two minds to form a conspiracy. According to the most recent American Law Reports survey, the doctrine “applies to corporations generally, including religious corporations and municipal corporations and other governmental bodies. The doctrine applies to all levels of corporate employees, including a corporation’s officers and directors and owners who are individuals.” Moreover, it now extends from antitrust throughout tort and criminal law.

What is the practical effect of this doctrine? The intracorporate conspiracy doctrine has distorted agency law and inappropriately handicaps the ability of tort and criminal law to regulate the behavior of organizations and their agents. Obedience to a principal (up to a point) should be rewarded in agency law. But the law should not immunize an agent who acts in the best interest of her employer to commit wrongdoing. Not only does the intracorporate conspiracy doctrine immunize such wrongdoing, but the more closely that an employer orders and supervises the employee’s illegal acts, the more the employer is protected from prosecution as well.

My next blogpost illustrates how the intracorporate conspiracy doctrine operates to defeat prosecutions for coordinated wrongdoing by agents within an organization. Let’s examine the case of Monsignor Lynn.

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January 20, 2015
Litigating The Financial Crisis, By Moi
Posted by David Zaring

I've written a paper on the judicial history of the financial crisis, and it's now out in the Virginia Law Review, and up on SSRN.  Here's the abstract:

The government’s response to the financial crisis was dramatic, enormous, and unprecedented, and nothing about it has been overseen by the courts. In our federal system, the courts are supposed to put the policies of presidents and congresses to the test of judicial review, to evaluate decisions by the executive to sanction individuals for wrongdoing, and to resolve disputes between private parties. But during and after the financial crisis, there has been almost none of that sort of judicial review of government, few sanctions on the private sector for conduct during the crisis, especially criminal ones, for the courts to scrutinize, and a private dispute process that, while increasingly active, has resulted in settlements, rather than trials or verdicts. This Article tells the story of the marginal role of courts in the financial crisis, evaluates the costs of that role, and provides suggestions to ensure a real, if not all-encompassing, judicial role during the next economic emergency.

Do give it a download, and let me know what you think.  And thanks in advance for supporting us around here - we do like downloads!

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J.P. Morgan’s Witness and the Holes in Corporate Criminal Law
Posted by Josephine Sandler Nelson

It is a pleasure to be guest-blogging here at The Glom for the next two weeks. My name is Josephine Nelson, and I am an advisor for the Center for Entrepreneurial Studies at Stanford’s business school. Coming from a business school, I focus on practical applications at the intersection of corporate law and criminal law. I am interested in how legal rules affect ethical decisions within business organizations. Many thanks to Dave Zaring, Gordon Smith, and the other members of The Glom for allowing me to share some work that I have been doing. For easy reading, my posts will deliberately be short and cumulative.

In this blogpost, I raise the question of what is broken in our system of rules and enforcement that allows employees within business organizations to escape prosecution for ethical misconduct.

Public frustration with the ability of white-collar criminals to escape prosecution has been boiling over. Judge Rakoff of the S.D.N.Y. penned an unusual public op-ed in which he objected that “not a single high-level executive has been successfully prosecuted in connection with the recent financial crisis.” Professor Garett’s new book documents that, between 2001 and 2012, the U.S. Department of Justice (DOJ) failed to charge any individuals at all for crimes in sixty-five percent of the 255 cases it prosecuted.

Meanwhile, the typical debate over why white-collar criminals are treated so differently than other criminal suspects misses an important dimension to this problem. Yes, the law should provide more support for whistle-blowers. Yes, we should put more resources towards regulation. But also, white-collar defense counsel makes an excellent point that there were no convictions of bankers in the financial crisis for good reason: Prosecutors have been under public pressure to bring cases against executives, but those executives must have individually committed crimes that rise to the level of a triable case.

And why don’t the actions of executives at Bank of America, Citigroup, and J.P. Morgan meet the definition of triable crimes? Let’s look at Alayne Fleischmann’s experience at J.P. Morgan. Fleischmann is the so-called “$9 Billion Witness,” the woman whose testimony was so incriminating that J.P. Morgan paid one of the largest fines in U.S. history to keep her from talking. Fleischmann, a former quality-control officer, describes a process of intimidation to approve poor-quality loans within the bank that included an “edict against e-mails, the sabotaging of the diligence process,… bullying, [and] written warnings that were ignored.” At one point, the pressure from superiors became so ridiculous that a diligence officer caved to a sales executive to approve a batch of loans while shaking his head “no” even while saying yes.

None of those actions in the workplace sounds good, but are they triable crimes??? The selling of mislabeled securities is a crime, but notice how many steps a single person would have to take to reach that standard. Could a prosecutor prove that a single manager had mislabeled those securities, bundled them together, and resold them? Management at the bank delegated onto other people elements of what would have to be proven for a crime to have taken place. So, although cumulatively a crime took place, it may be true that no single executive at the bank committed a triable crime.

How should the incentives have been different? My next blogpost will suggest the return of a traditional solution to penalizing coordinated crimes: conspiracy prosecutions for the financial crisis.

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January 14, 2015
MetLife Sues Over Its Systemically Important Designation
Posted by David Zaring

Yesterday, MetLife filed a complaint in the DDC protesting its designation as systemically important, which carries with it increased capital requirements and possibly burdensome oversight by the Fed.  Most systemically important financial institutions (or SIFIs), are banks, used to burdesome capital requirements and oversight by the Fed.  An insurance company is used to neither, hence the umbrage from MetLife.  

The lawyer is Eugene Scalia, so the complaint is naturally well-written and thoughtful.  I'm withholding judgment on the various statutory arguments posed, and on which it appears MetLife believes to have its best shot - they posit things like only financial companies can be designated as SIFIs, and financial companies must do 85% of their financial business in the US under the language of the statute, and MetLife, with its foreign insurance operations, does not do so.  That sort of statutory flyspecking doesn't usually work in financial regulation, but maybe this time it's different.

But two of the firm's longer shots are worth considering.  First, there is an effort to require the FSOC to do a cost benefit analysis in its SIFI designations, which it has steadfastly resisted so far.  MetLife argues that the committee arbitrarily "did not address MetLife’s evidence of substantial market and company-specific costs, and did not even opine on whether designating MetLife was, on balance, for good or for ill."  It is by no means clear that these considerations must be taken into account from the statute, but there are those who believe that some sort of weighing is something that every agency must do.  This sort of argument worked when the DC Circuit had fewer Obama appointees on it.

MetLife is also arguing that it has been deprived of due process by the designation.  It was "repeatedly was denied access to the full record on which FSOC’s action was based,"and anyway, "FSOC never identified the thresholds that result in SIFI designation or the manner in which the various statutory and regulatory factors regarding designation are balanced against one another in FSOC’s analysis," not least because of "the extraordinary design in the Dodd-Frank Act of FSOC itself, which identifies individual companies for designation, establishes the standards that govern the designation decision, and then sits in judgment of its own recommendations."

MetLife is right about the way that FSOC works, although the so-called "combination of functions" problems, whereby agencies both prosecute and adjudicate regulatory violations, has never been a big problem in administrative law.  It especially has never been a problem in banking regulation, where the deal is that banks give up due process rights - they can be failed at any moment by the FDIC, based on an only somewhat clearly articulated CAMELS standard - in exchange for cheap, federal insured funding by small depositors, and the possibility of a bailout if things get really bad.  MetLife doesn't get the cheap funding, but it does, as its SIFI designation suggests, get the benefit of being too big to fail, and therefore the likely recipient of a bailout.  Should the fact that insurers only get a part of the benefit of the bargain of being a financial institution mean that they should get more process rights than banks?  in some ways, that is what MetLife's constitutional claim posits.


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