My previous blogposts (one, two, three, four, five, six, seven, and eight) discussed the dangers of granting intracorporate conspiracy immunity to agents who commit coordinated wrongdoing within an organization. The last two blogposts (here and here) highlighted the harm that public and judicial frustration with this immunity inflicts on alternative doctrines.
In addition to exacerbating blind CEO turnover, substituting alternative doctrines for prosecuting intracorporate conspiracy affects an executive’s incentives under Director’s and Officer’s (D&O) liability insurance. This post builds on arguments that I have made about D&O insurance in articles here and here.
In traditional conspiracy prosecutions, the Model Penal Code (MPC) provides an affirmative defense for renunciation. The MPC’s standard protects the actor, who “after conspiring to commit a crime, thwarted the success of the conspiracy, under circumstances manifesting a complete and voluntary renunciation of his criminal purpose.” This means that the executive who renounces an intracorporate conspiracy faces no charges.
In contrast with conspiracy prosecutions, responsible corporate officer doctrine and its correlates fail to reward the executive who changes course to mitigate damages or to abandon further destructive behavior. Although the size of the damages may be smaller with lesser harm if the executive renounces an organization’s course of conduct, the executive’s personal career and reputation may still be destroyed by entry of a judgment. Modest whistle-blower protections are ineffectual.
Specifically, because of the way that indemnification and D&O insurance function, the entry of judgment has become an all-or-nothing standard: an employee’s right to indemnification hinges on whether the employee is found guilty of a crime or not. To receive indemnification under Delaware law, for example, an individual must have been “successful on the merits or otherwise in defense of any action, suit or proceeding.” Indemnification is repayment to the employee from the company; D&O insurance is a method that companies use to pass on the cost of indemnification and may contain different terms than indemnification itself.
Indemnification and D&O insurance are not a minor issues for executives. In fact, under many circumstances, employees have a right to indemnification from an organization even when the alleged conduct is criminal. Courts have acknowleged that “[i]ndemnification encourages corporate service by capable individuals by protecting their personal financial resources from depletion by the expenses they incur during an investigation or litigation that results by reason of that service.” And when hiring for an executive board, “Quality directors will not serve without D&O coverage.” Because of this pressure from executives, as many as ninety-nine percent of public U.S. companies carry D&O insurance.
So what does this standard mean for executives prosecuted under responsible corporate officer doctrine instead of for traditional conspiracy? Executives are incentivized either not to get caught, or to perpetrate a crime large enough that the monetary value of the wrongdoing outweighs the potential damage to the executive’s career. Because an executive’s right to indemnification hinges on whether he is found guilty of a crime or not, he has an enormous incentive to fight charges to the end instead of pleading to a lesser count. Thus, unless the executive has an affirmative defense to charges, like renunciation in traditional conspiracy law, there is no safety valve. Litigating responsible corporate officer doctrine cases creates a new volatile high-wire strategy. Moreover, as discussed in my last blogpost, responsible corporate officer doctrine imposes actual blind “respondeat superior” liability. Regardless of the merits, the executive may be penalized. So you can see the take-home message for executives: go ahead and help yourself to the largest possible slice pie on your way out the door.
I argue that in sending this message, and in many other ways, our current law on corporate crime is badly broken. My last blogpost for the Glom will introduce the book that Lynn Stout and I propose writing to give better direction to business people in search of ethical outcomes.
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My previous blogposts (one, two, three, four, five, six, and seven) discussed why conspiracy prosecutions were the best method to penalize coordinated wrongdoing by agents within an organization. Using alternative doctrines to impose liability on behavior that would otherwise be recognized as an intracorporate conspiracy results in flawed incentives and disproportionate awards.
The fundamental problem with substituting responsible corporate officer doctrine and control person liability for reforming the intracorporate conspiracy doctrine is that these alternative doctrines represent exactly what Professor Martin objects to: actual imposition of blind “respondeat superior” liability. For example, under these doctrines, “in most federal courts, it is not necessary to show that the corporate official being charged had a culpable state of mind.” Instead, the issue before the court is merely whether the officer had control and responsibility for the alleged actions. Accordingly, it is not a defense to control person liability that the officer did not “knowingly participate in or independently commit a violation of the Act.”
But simply penalizing the officer who is in the wrong place at the wrong time does little to define and encourage best practices. Moreover, with these and other explosive hazards for corporate service, it should be no surprise that top executives are demanding and receiving ever-increasing compensation for often short-term positions. Since 2009, the year that the NSP case establishing “control person” liability was settled, the discrepancy in pay between top management and the average worker has been growing dramatically. In 2013, the CEO of J.C. Penny Co., for example, was exposed for making 1,795 times what the average U.S. department store employee made. From 2009 to 2013, as measured across Standard & Poor’s 500 Index (S&P 500) of companies, “the average multiple of CEO compensation to that of rank-and-file workers” has risen to 204, an increase of twenty percent.
It is true that the financial crisis did reduce executive compensation packages before 2009, and that there has been a historical trend towards the growth of executives’ salaries as a multiple of average workers’ salaries. For example, “[es]timates by academics and trade-union groups put the number at 20-to-1 in the 1950s, rising to 42-to-1 in 1980 and 120-to-1 by 2000.” But the jump in executives’ salaries from 2009 has been extraordinary. The new emphasis on vicarious liability for individuals under the responsible corporate officer doctrine since that date must be considered part of executives’ demands for such high compensation in exchange for their risky positions.
The average duration of a CEO’s time in office has diminished as well. In 2000, the average tenure of a departing S&P 500 CEO in the U.S. was ten years. By 2010, it was down to eight years. In 2011, merely a year later, the average tenure of a Fortune 500 CEO was barely 4.6 years. In 2013, that former CEO of J.C. Penny Co. served for only eighteen months.
With an eighteen-month tenure, how much can the chief executive of a large company discover about the wrongdoing that his or her new company is committing? Furthermore, how much can that person design and institute good preventative measures to guide his or her subordinates to avoid that harm? A blindly revolving door for CEOs does not help those interested in effectively reducing the wrongdoing of agents within the corporation. Incentives without intracorporate conspiracy immunity would be different because they would reward the agent who abandons a conspiracy. (More about this argument here, here, here, and here.)
My next blogpost will examine how substituting alternative doctrines for prosecuting intracorporate conspiracy affects incentives under Director’s and Officer’s (D&O) liability insurance.
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My previous blogposts (one, two, three, four, five, and six) discussed why conspiracy prosecutions should be used to reach coordinated wrongdoing by agents within an organization. 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.
My Intracorporate Conspiracy Trap article argues that the intracorporate conspiracy doctrine is not properly based in agency law, and that it should most certainly not be applied throughout tort law and criminal law. As a result of the immunity granted by the doctrine, harmful behavior is ordered and performed without consequences, and the victims of the behavior suffer without appropriate remedy. My Corporate Conspiracy Vacuum article argues that public and judicial frustration with the lack of accountability for corporate conspiracy has now warped the doctrines around it.
Courts have used a wide variety of doctrines to hold agents of enterprises responsible for their actions that should have prosecuted as intracorporate conspiracy. Some of these doctrines include:
But the new applications of these alternative doctrines are producing distortions that make the doctrines less stable, less predictable, and less able to signal proper incentives to individuals within organizations.
An example of how piercing the corporate veil has been used to defeat intracorporate conspiracy immunity can be seen in the Morelia case. A previous blogpost discussed how the intracorporate conspiracy doctrine has defanged RICO prosecutions of agents and business entities. In Morelia, which was a civil RICO case, the federal district court, obviously outraged by defendants’ behavior in the case, explicitly permitted plaintiffs to pierce the corporate veil to avoid application of the intracorporate conspiracy doctrine. In a creative twist invented from whole cloth to link the two doctrines, the Morelia court overruled its magistrate judge’s recommendation to announce:
"Since the court has determined that plaintiffs have properly alleged that the corporate veil should be pierced, the individual defendants may be liable for corporate actions and any distinction created by the intra-corporate doctrine does not exist."
Regarding its test for piercing the corporate veil, the Morelia court further overruled its magistrate’s recommendation by focusing on plaintiffs’ arguments regarding undercapitalization, and its decision included only a single footnote about the disregard of corporate formalities.
The Morelia court is not alone in its frustration with the intracorporate conspiracy doctrine and in its attempt to link analysis under the intracorporate conspiracy doctrine with the stronger equitable tenets of piercing the corporate veil. More subtly, courts across the country have started to entangle the two doctrines’ requirements as intracorporate conspiracy immunity has become stronger and courts have increasingly had to rely on piercing the corporate veil as an ill-fitting alternative to permit conspiracy claims to proceed. Even large public companies should take note. No public company has ever been pierced, but a bankruptcy court recently reverse-pierced corporate veils of the Roman Catholic Church, which is far from a single-person “sham” corporation. My Corporate Conspiracy Vacuum article discusses additional examples and repercussions for incentives under each of these alternative doctrines.
My next blogpost will examine how frustration with intracorporate conspiracy immunity has led to volatility in responsible corporate officer doctrine and related control person liability. Ironically, executive immunity from conspiracy charges fuels counterproductive CEO turnover.
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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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My previous blogposts (one, two, three, and four) introduced why conspiracy prosecutions should be used to reach wrongdoing by agents within a business organization. The same legal analysis applies to religious organizations.
We should have been able to charge Monsignor Lynn and the Archdiocese of Philadelphia that directed his actions to hide the sexual abuse by priests with criminal conspiracy. Instead, Pennsylvania charged Lynn with two things: child endangerment and conspiracy with the priests.
As international news outlets later reported, Lynn could not be guilty of child endangerment because the state’s statute could not apply to an administrative church official who did not directly supervise children.
Lynn could not be guilty of conspiracy with the priests because he did not share their “particular criminal intent.” As the jury understood, Lynn was not trying to help a predator priest get from parish to parish so that “he can continue to enjoy what he likes to do.” Lynn was trying to protect the reputation of his employer, the Archdiocese—if the priests benefitted, that was a side issue.
So why didn’t the prosecution charge Lynn and the Archdiocese with conspiracy? It was the Archdiocese that directly coordinated and profited from Lynn’s actions. The intracorporate conspiracy doctrine, as discussed before, would bar that prosecution. In Pennsylvania, it is “well-settled that a corporation cannot conspire with its subsidiary, its agents, or its employees.”
Finally, considering other options, Lynn could not have been charged with possible crimes such as obstruction of justice. Lynn was too good: Lynn and the Archdiocese were so successful at covering up the sexual abuse and silencing victims, there was no ongoing investigation to obstruct. “Aiding and abetting” the Archdiocese’s cover-up of the sex abuse would have been difficult to pursue (see more here) and is not allowed under RICO in the Third Circuit.
My next blogpost will demonstrate that the Monsignor Lynn case was also part of a pattern by the Roman Catholic Church in America to use the intracorporate conspiracy doctrine to hide the coordinated wrongdoing of its agents to cover-up sexual abuse by priests. Fifteen years before prosecutors attempted to try Monsignor Lynn, the silenced Connecticut sex-abuse case showed the Church how effective this defense could be.
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My previous blogposts (one, two, and three) introduced the topic of how the intracorporate conspiracy doctrine prevents the prosecution of coordinated wrongdoing by individuals within organizations. This post illustrates the doctrine’s effect in the context of a specific organization—here a religious one: the Roman Catholic Archdiocese of Philadelphia and the systematic transfer of predator priests. This post is based on my article The Intracorporate Conspiracy Trap to be published soon in the Cardozo Law Review. The article is available in draft form here.
For twelve years, from 1992 to 2004, as Secretary for Clergy, Monsignor William Lynn’s job within the Philadelphia Archdiocese was to supervise priests, including the investigation of sex-abuse claims. In 1994, Monsignor Lynn compiled a list of thirty-five “predator” priests within the archdiocese. He compiled the list from secret church files containing hundreds of child sex-abuse complaints. On the stand, Lynn testified that he hoped that the list would help his superiors to address the growing sex-abuse crisis within the Archdiocese. But for twelve years Lynn merely re-assigned suspected priests, and he hid the abuse within the church. His superiors never acted on the list that Lynn gave them—in fact, they ordered all copies of the list destroyed—and Lynn never contacted outside authorities. As late as 2012, one of the “predator” priests on Lynn’s list was still serving in a parish.
All parties agree that Lynn’s actions in transferring priests who molested children allowed those priests to continue to abuse children, sheltered the priests from potential prosecution, and directly protected the Philadelphia Archdiocese’s reputation.
In fact, Lynn’s actions had been ordered by the archbishop on behalf of the Archdiocese. Lynn reported what he was doing to his superiors, who rewarded Lynn with twelve years of employment and a prominent position within the Archdiocese for doing his job as they saw it. Moreover, the archbishop himself inadvertently revealed the existence of the number thirty-five “predator” priests to the media, and he was the one who ordered all copies of the list to be shredded to keep it from being discovered in legal proceedings.
The instinct here is that this behavior—the transferring of predator priests to cover-up the sexual abuse of children—should have been illegal for Monsignor Lynn to pursue. But the Commonwealth could not prosecute Monsignor Lynn and the Archdiocese for conspiracy. Furthermore, immunity for Lynn’s behavior is now the rule in most state and federal jurisdictions around the country. As described in an earlier blogpost, the intracorporate conspiracy 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.
My next blogpost will further investigate why this behavior was not illegal under our current system, and how we should have tried Monsignor Lynn.
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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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In my previous blogpost, I granted the merit of defense counsel’s argument that the actions of discrete individual defendants—when the law is not permitted to consider the coordination of those actions—may not satisfy the elements of a prosecutable crime.
But what is the coordination of individuals for a wrongful common purpose? That’s a conspiracy. And, for exactly the reasons that defense counsel articulates, these types of crimes cannot be reached by other forms of prosecution. The U.S. Supreme Court has recognized that conspiracy is its own animal. “[C]ollective criminal agreement—partnership in crime—presents a greater potential threat to the public than individual delicts.” When we consider the degree of coordination necessary to create the financial crisis, we are not talking about a single-defendant mugging in a back alley—we are talking about at least the multi-defendant sophistication of a bank robbery.
Conspiracy prosecutions for the financial crisis have some other important features. First, the statute of limitations would run from the last action of a member of the group, not the first action as would be typical of other prosecutions. This means that many crimes from the financial crisis could still be prosecuted (answering Judge Rakoff’s concern). Second, until whistle-blower protections are improved to the point that employees with conscientious objections to processes can be heard, traditional conspiracy law provides an affirmative defense to individuals who renounce the group conspiracy. By contrast, the lesson Wall Street seems to have learned from the J.P. Morgan case is not to allow employees to put objections into writing. Third, counter to objections that conspiracy prosecutions may be too similar to vicarious liability, prosecutors would have to prove that each member of the conspiracy did share the same common intent to commit wrongdoing. The employee shaking his head “no” while saying yes would not be a willing participant, but many other bankers were freely motivated by profit at the expense of client interest to cooperate with a bank’s program.
My next blogpost will ask: where are the prosecutions for corporate conspiracy?
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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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Like Brett, I have been surprised not by the backlash against reform, but by how quickly it started and how it appeared on so many fronts. From the moment the statute was signed, a fight loomed on the Consumer Financial Protection bureau and on debit card interchange fees. Now there are fights against the Volcker Rule, credit retention in securitization, capital requirements (the Collins Amendment)...
What will financial reform look like next year at this time?
Many thanks to Brett McDonnell for pressing me on a few open questions my prior posts left him with. His comments have helped me to clarify in my own mind the problems I see with the Volcker Rule and the legislative process that gave rise to it.
In particular, I do not believe that a critique of responsibility-shifting delegations of the sort I have argued the Volcker Rule may represent depends on some notion of the optimal rule, though I can see why Brett might draw that inference from my prior posts (which suggests I need to work on the language some more as I write this paper). Instead, the inference to be drawn, I would argue, is about the optimal governmental body for making such decisions -- Congress versus regulatory agencies – and the trade-offs that we make among transparency, accountability, and efficient lawmaking. And this is especially worth emphasizing, given that we don’t know yet the final rule or how effective enforcement will be.
I do not contend that legislators are immune from interest group pressure or are more likely to enact substantively better laws. Brett is correct about the pressure for the legislature to “do something” – whether it makes any sense or not – in the wake of a financial crisis. Nor do I mean to suggest that the problem of interest group influence on the lawmaking process would conveniently vanish were Congress to legislate precisely rather than to delegate. In fact, as argued by some commentators, interest groups might wield even more influence when policy is made directly by Congress, rather than through delegations (because it would place more power in the hands of legislative committees and their leaders). Moreover, Congress should delegate substantive lawmaking to agencies under many circumstances, such as when it makes sense to harness agency expertise, when an agency can make policy more efficiently, or when uncertainty about the future renders ex post gap filling prudent.
But the legislature does offer an advantage in terms of policymaking: transparency and electoral accountability. Direct policymaking by Congress, for all its faults, renders legislators' actions more observable by voters, who then have an opportunity to hold them accountable for their choices. So the question of appropriate delegation is, to my mind, really a matter of degree, motivation, and trade-offs under the particular circumstances.
One particular irony here is that, though Brett disavows any SILR (Slightly Imaginary Larry Ribstein) leanings, I actually am a bit of an SILR, particularly when it comes to financial regulation. Like Brett, I am not a particular fan of the Volcker Rule. Though I remain concerned about bank risk-taking (indeed, financial institution risk-taking more broadly), I have doubts that the Volcker rule, even a better-designed one, is the right approach to address that concern. In short, I chose to study it, not because of any particular belief in the rule’s wisdom, but because I suspected – based on the congressional maneuvering that accompanied its passage and the importance of proprietary and fund activities to banks’ bottom line – that it would illustrate a point about whose voice gets heard on financial reform issues as the sausage is really getting made, so to speak.
But I’m not as confident that the benefits of vague laws given little effect by agency interpretations outweigh the costs. Aside from the false signal to voters (and, potentially, other governmental actors) about the state of financial regulation, these moves have other, potentially unintended, consequences. Let’s remember that even a Volcker rule that fails to substantially alter proprietary trading and fund investment activity will impose costs – banks have reorganized their activities to comply with the mechanics of the law and there will be ongoing compliance and oversight expenses.
There is really much more to say on this, but I’ve exhausted myself with this anniversary celebration and have probably exhausted you patient readers as well. So, I’m signing off now. Thanks for reading.
And, as I mentioned, my goal with these posts was to float some preliminary data and ideas for a work-in-progress. So, feel free to send comments my way.
So far, our posts have focused on individual rules and agencies. Can we make any sort of sensible overall assessment of the implementation of Dodd-Frank so far? It is still pretty early. Many of the rules have yet to be written or finalized. And there are already so many rules, written by so many agencies, that it is hard for any one person to get an overall picture. I certainly have not kept up enough to do that. Via Ann Graham, a good tool for trying to keep up is at the St. Louis Fed web site. Davis-Polk is usefully surveying the rules on the simple question of whether or not the agencies are completing the rules in a timely way (short answer: they have missed a fair number of deadlines but not too bad so far, but the biggest crunch is about to hit now).
The general mood seems to be that the rule-writing isn't going very well, either because of the sort of industry capture problem on which Kim has focused or because the sheer scale and scope of the task is just beyond the capability of the agencies. Some of the rules I have looked at do little more than re-formulate the guiding statutory language, adding little detail or precision. That, for instance, describes the rule on the quite important issue of defining the systematically important financial companies that will be subject to new regulation under Title I. But Mike Konczal at Rortybomb has an interesting interview with an anonymous but clearly well-informed lawyer who is relatively positive about the state of rulemaking so far. Who knows? I continue to believe that the heavy delegation to agencies was simply unavoidable given Congress's lack of expertise and the sheer scope of what needed to be done, but it may well turn out that the problems are too much for the agencies as well.
While I still have the mike, let me briefly lament the D.C. Circuit's vacating of the proxy access rule. I have my own reservations about the rule, in particular the SEC's failure to allow shareholders to opt out in any way they choose. Still, I think it's on balance a pretty sensible and defensible rule. The SEC's documents proposing and finalizing the rule are about extensive as I have ever seen from that agency, and they had voluminous comments from all sides to help guide them. The D.C. Circuit cherrypicks areas where it asserts the SEC didn't do enough. It will almost always be possible to do that with any agency rulemaking. Requiring that level of deliberation could well make the task of rule-writing for Dodd-Frank more daunting still. This opinion is little more than the judges ignoring the proper judicial rule of deference to an agency involved in notice-and-comment rulemaking and asserting their own naked political preferences. Talk about judicial activism.
As some of you know, I have been following and assessing (through the lens of change leadership literature) reform efforts at the Securities and Exchange Commission during the Obama administration. My former articles on this topic are available here and here. In last year's forum, I posted about the numerous studies mandated by Dodd-Frank. This post (as well as a short discussion group paper I have written for next week's SEALS conference) in some small way brings those two lines of thought together.
Section 967 of Dodd-Frank calls for the SEC to "hire an independent consultant of high caliber and with expertise in organizational restructuring and the operations of capital markets to examine the internal operations, structure, funding, and the need for comprehensive reform of the SEC, as well as the SEC’s relationship with and the reliance on self-regulatory organizations and other entities relevant to the regulation of securities and the protection of securities investors that are under the SEC’s oversight." The section goes on to prescribe the areas of study and require that the independent consultant render a report to SEC and the U.S. Congress “[n]ot later than the end of the 150-day period after being retained.” The SEC hired BCG--The Boston Consulting Group--to conduct the study. The resulting 256-page report (not including the cover page, table of contents, and glossary) was issued on March 10, 2011. To what effect? Were my tax dollars well spent on this legislative and regulatory exercise?
The SEC was reforming itself in ways consistent with the contents of the BCG report before the study was conducted. But the BCG report does add new ideas and actons to the mix. And the BCG report notes that without appropriate funding, Congress must cut back on the mandates for the agency's activities (a no-brainer, but perhaps a useful apolitical observation).
Bottom line? We should develop assessment rubrics and processes to evaluate the efficacy of congressionally mandated studies. Under Section 967(c) of Dodd-Frank, the SEC must report out to Congress on its progress in implementing the BCG report every six months for the two-year period following the report's issuance. That means the first report is to be made in September 2011. Without an assessment tool, Congress will be ill-equipped to handle that report. I fear that the conversation will lapse into political line-drawing, rather than focusing on regulatory efficiency and effectiveness. [sigh]
And who, in the end, will evaluate the quality of Congress's judgment in requiring the study and the implementation of its findings? Might the SEC have done just as well in continuing on the road to reform it had been on pre-Dodd-Frank? . . . .
In my last post, I discussed the public comment letters. Now, I want to talk about the agency meeting logs. As part of the new transparency efforts associated with Dodd-Frank implementation, the Federal Reserve, the CFTC, the SEC, and the FDIC began disclosing their contacts regarding Dodd-Frank shortly after the bill was signed into law last July. These logs give some insight into the work of statutory interpretation and implementation that goes on behind closed doors: who is meeting with the regulators that will ultimately determine the scope of the Volcker Rule? What interests do they represent? What are the topics on which they are meeting? What questions are being asked and answered and what sort of information is being conveyed?
Table 1 shows the federal agency meetings with financial institutions to discuss the Volcker Rule posted between July 26, 2010, and July 5, 2011. To save space in this post, I have included only the top 10 institutions individually, as well as the total number of financial institution meetings.
As you can see from Table 1, JP Morgan Chase, Morgan Stanley, and Goldman Sachs met with federal agencies most frequently on the Volcker Rule, with 27, 13, and 12 meetings, respectively. In total, 216 financial institutions met with federal regulators regarding the Volcker Rule during this time period.
Table 2 shows federal agency meetings to discuss the Volcker Rule with law firms representing financial institutions. In total, these law firms met with agencies 24 times during the relevant time period. Davis, Polk; Sullivan & Cromwell; and Debevoise met most frequently with federal regulators, with 8, 6, and 5 meetings each.
Table 3 shows financial industry trade associations, lobbyist, and policy advisor meetings with federal agencies to discuss the Volcker Rule – a total of 25. SIFMA (The Securities Industry and Financial Markets Association), the Financial Services Roundtable, and the Managed Funds Association met most frequently with federal agencies -- 8, 5, and 2 times, respectively.
Table 4 shows public interest group and research or advocacy organization meetings with federal agencies to discuss the Volcker Rule -- a total of 9 meetings, primarily with labor union representatives. Finally, Table 5 shows a total of 9 meetings by other persons and organizations: namely, Senators Merkley and Levin and their staffs, and Paul Volcker and his staff.
In sum, whereas financial industry representatives met with federal agencies on the Volcker Rule a total of 265 times, “public interest groups” -- by which I mean nothing more technical than an entity or group that might reasonably be expected to act as a counterweight to industry representatives in terms of the information provided and the types of interpretations pressed – met only 18 times, even if we include the Merkley, Levin, and Volcker meetings under the heading of “public interest group” meetings. This is roughly the same number of times that a single financial institution -- JP Morgan Chase – met with federal agencies on Volcker Rule interpretation and implementation, and a total meeting ratio of almost 15 to 1.
A few notes here. First, July 5, 2011 is our cut-off date for collecting meeting logs. But because different agencies have different lag times for updating their logs after meetings take place, there were agency meetings prior to July 5 that were not yet posted by that date.
Second, for these purposes, I have defined “financial institution” broadly to include not only commercial and investment banks, but also asset managers and investment advisors, as well as insurance companies. This does not mean that these different types of institutions raised identical concerns at every meeting. But, although the exact subject matter of the meetings differed according to the particular regulatory concern faced by each group, the important point for these purposes is that nearly all of the industry representatives to meet with federal agencies on Volcker were seeking clarifications on the rule’s application to their activities -- most often, a clarification that the Volcker Rule would not prohibit the activities in question.
Finally, I should emphasize that not all meetings are created equal. Many of the meetings in Table 1 are group meetings, often as part of an industry trade association meeting. For example, 27 separate financial institution representatives were listed in attendance at an April 7, 2011, SIFMA-SEC meeting with Chairman Schapiro.
Perhaps more tellingly, nearly all of the public interest group meetings in Table 4 are of this nature. For example, representatives of AFL-CIO, Laborer's International Union of America, AFSCME, and SEIU are logged for an October 13, 2010, SEC meeting with Kayla J. Gillan and Jim Burns. These are 4 of the 5 meetings by public interest groups with the SEC (Americans for Financial Reform met separately with the SEC on April 13, 2011). And all of the public interest group meetings with the CFTC on Volcker took place together, on March 16, 2011.
And the identity (or number) of agency representatives at certain meetings may signal something about the importance of the event. For example, the log for an August 3, 2010, CFTC meeting with SIFMA and ISDA at which the Volcker Rule was discussed (along with other Dodd-Frank provisions) lists 53 SEC and CFTC staff members in attendance. But Goldman Sachs CEO, Lloyd Blankfein, is logged as meeting alone with SEC Chairman Mary Shapiro (along with Chief of Staff Didem Nisanci, and Robert Cook, Director of Trading & Markets) on March 9, 2011. Mr. Blankfein met with Ms. Shapiro again on Oct. 8, 2010, at an SEC-Financial Services Roundtable meeting, at which Jamie Dimon of J.P. Morgan, Robert H. Benmosche (President and CEO of AIG), Richard K. Davis (President and CEO) of U.S. Bancorp, and other major financial institution CEOs are logged as being in attendance.
What to make of this data? For me, it suggests that those worried that Dodd-Frank left too many details to be filled in my regulators, giving industry a second chance to lobby for important exemptions and interpretations, were at least barking up the right tree. Federal agency contacts with industry representatives significantly outpace those of any potential countervailing voices in terms of both quantity and quality.
Does this prove that regulatory agencies are captured or not regulating in the public interest? No, of course not. But regulators are only human. They have limited time, expertise, personnel, and budgets. Although comment letters and meetings are not by any means the only source of information and persuasion to which regulators are subjected, the meeting logs (particularly when combined with the data on the public comment letters) paint a very one-sided picture of influence, information, and pressure – influence, information, and pressure that largely take place in the absence of meaningful public scrutiny.
In my next, and final, post, I’ll be back to address some of Brett McDonnell’s always-thoughtful comments, and will wrap up with some concluding thoughts.
I'm greatly enjoying Kim's series of posts on the rulemaking process for the Volcker Rule. She's gathered incredibly useful data. The basic story she tells, that the financial industry has dominated the rulemaking process and as a result been able to shape the rule in a more lenient direction, seems extremely plausible. But even accepting that story, I'm not sure she has yet fully made the case that the extent of delegation to agencies in the Act is the main culprit in a process that has hurt the public interest. To make that case, she needs to do two further, harder analyses: a counterfactual and a normative analysis of the optimal rule.
As for the counterfactual, suppose one believes that the resulting Volcker Rule has too many holes, and that the optimal rule would allow fewer forms of trading. Even so, one must still make the case that if Congress had been forced to draft a fuller rule (say, by a much stronger constitutional nondelegation doctrine that would have invalidated the current version of the Act) it would have drafted a tougher rule. Perhaps, but I doubt it. Yes, Congress faced some populist pressure when it wrote Dodd-Frank. But there was already strong public opposition to the Rule in Congress. Its opponents weren't shy. Almost all Republicans voted against the Act, and that didn't seem to harm them in the midterms a few months later. Is there good reason to believe Congress was ever willing to draft a Rule with more teeth than has emerged through rulemaking? In short, Congress is at least as subject to capture as the bureaucracy. There's a clear capture story here, but does the delegation angle really add that much?
As to the normative analysis of the optimal rule: though not (yet) explicit, Kim's posts have a clear tone of disapproval, suggesting that capture has led to a rule that does not adequately support the public interest. Perhaps. But imagine an argument from a Slightly Imaginary Larry Ribstein (SILR). SILR opposes most (all?) mandatory regulation, including the Volcker Rule. But SILR also recognizes that in the face of a financial crisis, there's strong public pressure to regulate. This pressure is ill-informed, and likely to lead to bad rules (think of that one-word comment letter--"Regulate"--that Kim mentions). What is Congress to do? Perhaps the public interest is best-served by passing a vaguely worded statute that seems to do a lot, satisfying the ignorant public, while trusting the agencies to pass rules which give the statute little effect. This is Kim's story, but with an opposing normative twist.
I'm no SILR. I'm much more inclined to like some regulations, and on the whole I tend to approve of Dodd-Frank. But I've never been a big fan of the Volcker Rule, or of the Glass-Steagall Act before it. Indeed, one of my first publications celebrated the end of Glass-Steagall. So in this instance, I find SILR's argument rather tempting.
Of course, Kim isn't done posting yet, and maybe by the end she will make the counterfactual and normative cases that I suggest she needs to consider. And even if not, she is still adding a lot to our understanding of the political dynamics of regulation for Dodd-Frank, even if the normative debate as to how to evaluate that politics remains open.