There's talk in the Senate of imposing new rulemaking restrictions on the SEC, and over at DealBook, I take a look:
The legislation would require more math and permit less flexibility by those regulators. But it would also limit Congress’s own ability to require the government to embrace good governance values like “transparency” and “honesty,” if the S.E.C.’s most recent rule-making is any guide.
The senators have suggested that they would impose cost-benefit analysis requirements on America’s financial regulators. No important rule could be passed without establishing that the dollar impositions on the financial industry would not be outweighed by the dollar benefits created by the rule.
The S.E.C. has, because of a series of adverse court decisions, grudgingly embraced a version of this sort of cost-benefit analysis in its rule-making proposals.
Now you can take a look too!
Daniel Gallagher has announced that he will be joining Patomak Partners, a company that is going to do the same thing that Promontory and PWC does - accumulate regulators who can get banks and broker-dealers out of regulatory trouble, partly by relying on the expertise and contacts of their principals, who tend to have run the agencies regulating the banks. It's a huge growth industry in banking regulation, sometimes dubbed shadow regulation, and a controversial one, because revolving door etc. I, however, am all in favor of the revolving door, and see nothing particularly wrong with this one.
However! Patomak is new and young and small, but what it represents is the politicization of these sorts of firms. Promontory invented the genre, and it was started by Democrats, but it reads as relatively non partisan. A review of the masthead of Patomak reveals a litany of Republican former political appointees at the SEC and CFTC, starting with the president and CEO, Gallagher, and Paul Atkins, probably the most aggressively conservative SEC commissioners ever, surely at a cost to their standing with the agency staff.
It makes you wonder what the play is. Trent Lott successfully created a Republican K Street, annoyed at the liberal dominance of lobbying firms, and thinking that the existence of a parallel more conservative DC ecosystem would benefit his party. Those firms do fine, I think, but being able to seriously negotiate with enforcement officials usually requires a vaguely non-partisan hue; that's one reason why law firm white collar practices generally don't sort into liberal and conservative. I'm not sure that a right wing financial regulation consultancy makes a ton of sense from a business perspective. So maybe you think this is like a think tank - a place where politicians hang out and make a little money before accepting their next appointment. Except that the next appointment for SEC and CFTC commissioners, other than chair, never usually happens. Instead, they go to law firms or academia, and become wise old people of capital markets regulation.
I suspect that the assumption is that even independent agency work is getting increasingly politicized, and so the next time there's a Republican presidency, the SEC and CFTC appointees are going to listen to Patomak, and aren't going to listen to anyone else. That will make for some feast and famine years for the business, and isn't an entirely appetizing prospect for regulation in general. It's also a big bet by Atkins and Gallagher, et al, on President Trump, or whoever. But maybe they were having a hard time getting hired by less partisan firms.
If you missed it, Lucian Bebchuk and Robert Jackson are in the Times today decrying the budget bill's one year prohibition on the SEC's issuance of political spending disclosure requirements rules. That's pretty micro-managey, and you can't imagine the legislature getting so involved in the details of banking regulation. Bebchuk and Jackson are, as proponents of regulation here, displeased:
The rider also undermines the standing of the S.E.C. It reflects a judgment that the commission and its staff, which have served the investing public well for generations, cannot be trusted to reach an appropriate decision about whether and how to develop rules in this area. Legislators should not tie the hands of independent and expert regulators and prevent them from doing their job.
And the rider undermines the critical premises on which the Supreme Court has relied in its Citizens United decision. In this consequential decision, the court reasoned that “the procedures of corporate democracy” would ensure that political spending by public companies does not depart from shareholder interests. Without disclosure to investors, however, such procedures cannot be expected to limit or prevent such departures.
Under a Carolene Products theory, this would be the sort of case that could call for judicial involvement; it involves legislators legislating for opacity about who gives to their own campaigns - a self interested effort that undermines the democratic process.
Via Corp Counsel, I enjoyed this talk by outgoing SEC Commissioner Luis Aguilar on "(Hopefully) Helpful Tips for New Commissioners." Indeed, some of the people associated with this site might find it particularly interesting. Aguilar makes being a commissioner sound a little like being a judge. There's a staff of five, four counsels, and one confidential assistant, and you spend all your time talking to them, so they have to be good. I also found these quotes - quotes from which Aguilar took inspiration - to be somewhat dark and foreboding:
“You have enemies? Good. That means you’ve stood up for something, sometime in your life.” — Sir Winston Churchill
“The difference between a successful person and others is not a lack of strength, not a lack of knowledge, but rather a lack of will.” — Vince Lombardi
If you set out to be liked, you would be prepared to compromise on anything at any time, and you would achieve nothing.” — Margaret Thatcher
I would have thought that being a commissioner would be much more like being the deputy secretary of an agency than a judge, but perhaps for nonstop meetings with a dizzying array of underlings, it's the chair or nothing.
The conflict between the SEC and Congress over its investigation of a tip from a committee staffer on Medicaid reimbursement regulations has resulted in an opinion requiring the House and the staffer to respond to an agency subpoena. Matt Levine has the opinion and a review of it (meh, he says), here. Here's a wrap.
I'm not sure I agree with the opinion. On the one hand, Congress could not have more clearly waived sovereign immunity for insider trading in the STOCK Act, which applied that doctrine explicitly to itself. On the other hand, the Speech and Debate Clause is meant to prevent the executive branch (for which read the SEC, although it less in the sway of the executive than is, say, the Department of Justice) from intimidating the legislative one when it is legislating, and there's lots of good precedent applying the protections enjoyed by members of Congress to their staffers, and applying them to investigations as well as prosecutions. The tip in question in this case went from a staffer to a lobbyist, and I can't think of a more legislative thing to do than to have those conversations - indeed, the court acknowledges that Congress was legislating at the time.
It could be that there is no good reason to protect insider tipping by staffers, but that's not clear to me, at least under the facts of this case. Staffers are going to want to talk to lobbyists about how to get things done, and that could easily involve discussions about what Congress is likely to do next, and that could easily be seen as market moving information. It would make it hard to legislate if staffers had to worry about these conversations.
So maybe Congress is standing up for its staffers as a true matter of principle. I don't quite follow the political economy here, though. If Congress is upset about this, I'm surprised the agency is willing to take it to litigation, but maybe they take the STOCK Act especially seriously over there.
With this terse order by the D.C. Circuit, it is official, the SEC's conflict minerals rule is unconstitutional ... but only to the extent that it requires public issuers who did make use of conflict minerals to state on their disclosures that their products have “not been found to be ‘DRC conflict free.’”
The idea is that this was forcing firms to declare that they had blood on their hands, and I find it all pretty unconvincing. The SEC can require firms to make disclosures in particular ways, it can require firms to make climate change disclosures, and it can tell them to identify, say, risk factors of participating in a securities offering that make the issuer look bad. This is all forced speech, and a disclosure based agency couldn't function if it couldn't require disclosures, including uncomfortable disclosures, permitting an inference that the issuer is incompetent, naive, whatever, and that the speaker would rather not say.
There may be a line that can be drawn - the SEC can require firms to say uncomfortable things, but it can't require them to say an exact set of words that make them look bad. I guess that would be a rule, but it wouldn't be much of a rule.
For example, consider the conflict minerals rule itself, which is both unconstitutional and very much in effect. Although companies do not have to attest that the products they make are not DRC-conflict free, they do have to do everything else: investigate their supply chains, describe their investigation, and report on the results of that investigation, including whether it revealed that they make products involving conflict minerals.
Anyway, Congress hasn't lost its taste for conflict minerals, and bills have been introduced in the House and Senate to add to the SEC's policing in this area. That's something that will not overjoy those in the agency who never thought of it as the tip of the spear in the spreading of human rights values.
The final rule is 686 pages long, which Corp Counsel describes, reasonably, as "humongous." I'm generally fine with lengthy statues, and have no problem being opposed to arguments like "they wrote the Constitution on an index card and last year's budget on a pallet of A4, and look which one is better!"
But still, that's quite a long release for a rule that shouldn't be all that technical. I think I'll wait for some law firm memos before I dive in.
Rep. Scott Garrett has introduced a bill that would make administrative proceedings optional for all defendants, and also change the standard of proof for them. It would basically kill things for SEC ALJs, and the enforcement division's new policy of directing cases their way (with one caveat that I bring up below). The bill's introduction suggests that not everyone is happy with the agency's attempt to hold onto its discretion to bring enforcement actions administratively or judicially by lengthening the time for proceedings to eight months (from four), and permitting a smidgen of discovery.
Check out the language of the bill:
“(a) Termination Of Administrative Proceeding.—In the case of any person who is a party to a proceeding brought by the Commission under a securities law, to which section 554 of title 5, United States Code, applies, and against whom an order imposing a cease and desist order and a penalty may be issued at the conclusion of the proceeding, that person may, not later than 20 days after receiving notice of such proceeding, and at that person’s discretion, require the Commission to terminate the proceeding.
“(b) Civil Action Authorized.—If a person requires the Commission to terminate a proceeding pursuant to subsection (a), the Commission may bring a civil action against that person for the same remedy that might be imposed.
“(c) Standard Of Proof In Administrative Proceeding.—Notwithstanding any other provision of law, in the case of a proceeding brought by the Commission under a securities law, to which section 554 of title 5, United States Code, applies, a legal or equitable remedy may be imposed on the person against whom the proceeding was brought only on a showing by the Commission of clear and convincing evidence that the person has violated the relevant provision of law.”.
I've never heard of another place where a defendant has the discretion to insist that an enforcement action against her be dismissed - not move for it, just send notice that the defendant will be dismissing the action. And I've never heard of this clear and convincing stuff before - the argument has been that the SEC has advantages before ALJs, but not particularly because of the burden of proof. In one way, the bill would make the defendant's decision a bit more difficult. On the one hand, she can have court whenever she wants, but on the other, administratively, she gets the benefit of a clear and convincing standard, more demanding (in theory) than a preponderance of the evidence standard. Decisions, decisions.
Our own Lisa Fairfax has been nominated to fill an opening on the Securities and Exchange Commission. Congratulations, Lisa! Well done, President Obama! Now Senate, do your part.
See the story here.
I blogged a little more about the SEC and its ALJs at the Harvard Corporate Governance Forum. Do check it out!
Mike Norton, Rohit Deshpande, and Bhayva Mohan, all affilated with HBS, think that it would affect purchasing choices, likely more than if it were simply published in an investor disclosure statement. Indeed, they're running a field experiment at an online retailer to see if it would. It would be difficult to require an energy saver style label on every good by regulation, but perhaps retailers will respond to consumer tastes? Here are some preliminary surveys:
The Volcker Rule’s covered fund provisions have not received the attention they deserve. Like the more well-studied proprietary trading rule, the covered funds rule restricts bank investments in the name of limiting their risk-taking and mitigating their contribution to systemic risk. As with proprietary trading, legislators and regulators faced a decision with covered funds on how to define those bank activities that would be off-limits. However, unlike with prop trading, Congress, and federal regulators subsequently, chose to define the scope of the covered funds rule largely by reference to an existing statute.
In a recent short article just published in The Capital Markets Law Journal (an earlier ssrn draft is available here), I examine this decision by Congress and federal regulators. In crafting the statutory provision and the final rule respectively, Congress and federal regulators chose to apply the covered funds rule to bank investments in entities that would otherwise be investment companies but for the exemptions in Sections 3(c)(1) and 3(c)(7) of the Investment Company Act. This importation from the Investment Company Act – in what I call a trans-statutory cross reference – has profound consequences.
A first cut
Using Investment Company Act exemptions to set the scope of the covered funds rule has advantages. The Investment Company Act exemptions set boundaries that have already been defined by regulators and market expectations. These particular trans-statutory cross references work to circumscribe bank investments in, and sponsorships of, a wide range of entities. Congress appears to have concluded that private equity and hedge fund investments posed inordinate risks for banks and the government safety net. Since those two types of funds typically use those two Investment Company Act exemptions, the trans-statutory cross references seem to accomplish Congress’s intended purposes. A range of other entities also use these two exemptions, but the five federal regulators that promulgated the final rule ultimately carved many of those entities out. Still, many non-real-estate-related securitization vehicles would be covered by the rule.
On the other hand, prohibiting banks from investing in particular exempted funds does not necessarily mean that banks will move their money to safer locales. Many real estate securitizations, for example, are not covered by the rule. Banks could move capital to other exempted funds or even restructure existing investments to fall under other Investment Company Act exemptions not covered by Volcker. More on this in a moment.
When securities law serves banking law purposes
Stepping back from its immediate market consequences: the trans-statutory cross references at the heart of the covered funds rule highlights the ways in which the Investment Company Act, in particular, and securities regulation, more broadly, can and cannot regulate effectively the systemic risk posed by banks and other financial institutions. In other words, the tools of securities relation are in some ways aligned and in some ways mismatched with the purposes of prudential regulation. The trans-statutory cross references exacerbate Volcker’s problems of under- and over-inclusiveness in limiting the risk-taking of banks. The portions of the Investment Company Act most useful for systemic risk are its restrictions on leverage, which are somewhat unique in the pantheon of securities laws and function most similarly to banking rules.
Trans-statutory cross references can delegate power from one agency to another
Volcker’s trans-statutory cross references have not only policy but also political implications. By using a securities law to define the scope of a banking law, the covered funds rule effectively transfers critical policymaking functions from one group of agencies (banking regulators) to another (the SEC). This has potentially profound implications given the differing statutory missions, cultures, and personnel of those agencies. Securities regulators also face different interest groups and have different institutional pressure points compared to their banking counterparts.
How the SEC will wield this power to define the scope of a banking law remains to be seen. Some commentators have doubts as to the SEC’s interest and ability to pursue systemic risk regulation alongside its traditional investor protection role. The covered funds rule will provide one test of the SEC’s resolve. Banking industry interest will likely now focus on other Investment Company Act exemptions. SEC decisions to narrow or expand other Investment Company Act exemptions – particularly Section 3(c)(5) or Rule 3-a-7 – now have cascading consequences by virtue of Volcker’s covered fund provisions. After Volcker, banks and other parties in securitization markets may seek to structure securitizations to rely on one of these other exemptions. Efforts to narrow these exemptions will likely meet strong opposition from banks and the securitization industry. In considering whether to narrow or enlarge these exemptions, the SEC must now consider not only whether investors in collective investment funds are protected. It must also consider the effects on bank risk-taking and systemic risk.
A larger lesson
The political dynamics outlined in my paper point to lessons for policymakers considering using trans-statutory cross references in the future. Trans-statutory references may take power from one regulatory body and give it to another. In the case of the covered fund rules, power over prudential rules was, perhaps unintentionally, delegated to a securities regulator. This works well if the statutory drafters trust the agency from whom power was taken less or trust the agency to whom power was given more. It works if the concern is to check potentially overzealous pursuit of policy objectives by the traditional regulator or to remedy potential shirking by a captured body. However, trans-statutory cross references may fail if the newly empowered regulator works at cross purposes to the statute it now has authority over. Trans-statutory cross references reflect a lesson that is old but one that bears repeating nonetheless: technical drafting decisions can have outsized and unintended political consequences, particularly with respect to the most important question of all – who decides policy going forward.
Cross-posted at Columbia's Blue Sky Blog.
I think they're doomed, but opponents of the 25 year old tradition of SEC administrative proceedings have had a good couple of days. Distressed Debt Diva (or whatever the right sobriquet is) Lynn Tilton has convinced the Second Circuit to hear her claim that appearing before an ALJ would be unconstitutional, which, if the court ruled in her favor, would create a circuit split with the 7th Circuit.
Also, the Wall Street Journal made much of a colloquy before Judge Richard Berman, who is one of the few judges who has ruled that ALJ proceedings are unconstitutional. He wanted to know more about the farcical decision by the SEC to send one of its ALJs a letter inviting him to tell them whether he was biased against defendants. He quite properly refused to answer, and they promptly reassigned him to another case. "You'll want to come up with a good explanation why," Judge Berman approximately told the agency.
I can't claim to understand what the SEC was doing with that missive to its ALJ, though it's always worth observing that ALJs work for the commissioners (much to their displeasure, ordinarily), and it isn't totally obvious that it is wrong to send a missive to an employee asking him to explain himself. But, oddly, adjudicative subordinates have a great deal of independence, to the point where I think we could consider them to be comparable to those most independent of regulators, bank supervisors. We wouldn't expect Janet Yellin to bother filing an affadavit explaining her thinking on interest rates if President Obama instructed her to do so, and there's no question that he is her boss.
The Wall Street Journal reports that the White House is considering our colleague for the SEC. Bainbridge thinks she'd be an excellent choice, and so do we. I won't gush, but Lisa has it all - she would be perfect for the agency.
I wrote in DealBook about SEC ALJs. Here's a taste:
I read every decision issued by the S.E.C.’s administrative law judges from the enactment of Dodd-Frank in 2010 to March of this year. Graded toughly – on whether the S.E.C. received everything it wanted from the case – the agency’s rate of success is high, but not unblemished.
In those decisions where at least one of the defendants was represented by counsel, the agency received everything it asked for only 70 percent of the time; that is not too different from the “rule of thumb” rate for victories by any federal agency in a federal court.
Of course, there is not getting everything the agency asks for, and there is losing the case. It is true that S.E.C. administrative law judges are willing to reduce the penalties sought by the agency’s enforcement division, either by reducing the amount of money that the defendant must pay to the S.E.C. or by reducing the length of their bar from practicing in their industry.
But in my sample, the agency rarely lost cases that it pursued to the point at which an administrative law judge would issue a decision. I identified only six of the first 359 decisions issued since Dodd-Frank was enacted that rejected the arguments of the enforcement division wholesale.