January 20, 2015
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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March 08, 2014
Destructive Coordination in Securities Contracts
Posted by Greg Shill

Image: Flickr

In my last post—also a shameless plug for my recent article, “Boilerplate Shock”—I argued that boilerplate terms governing securities could serve as a trigger that transforms an isolated credit event into the risk of a broader systemic failure. I’ll now briefly explain why I see this danger—which I call “boilerplate shock”—as a general problem in securities regulation, not just some quirky feature of Eurozone sovereign debt (the focus of the paper and post). Any market where securities are governed by uniform boilerplate terms is vulnerable to boilerplate shock.

The nature of this phenomenon—systemic risk—is of course familiar, but its source in contract language is a little unintuitive. How could private contracts unravel an entire securities market or the world economy?

Coordination around uniform standards. 

In the back of our mind most of us probably still conceive of contracting as an activity that occurs among two, or perhaps a few, individuals or firms. But when standard terms are used by virtually all actors within a given market, it’s worth considering the collective impact of those terms as a distinct phenomenon.

Coordination’s benefits are well known. Consider uniform traffic signals. But coordination can also compound the effects of bad individual decisions.

As Charles Whitehead has argued, widespread “destructive coordination” among banks during the precrisis days helped generate systemic risks. When the credit markets froze, for example, firms using the same risk management formulas reacted in the same way at the same time. This helped transform isolated events into systemic ones—e.g., Lehman, the canonical example of a failure that triggered a de facto coordinated panic.

A similar risk, I argue, is present where participants in a securities market rely on the same standardized contract terms. Whether they were intended to or not, these terms will often control what happens in the event of certain legal emergencies, like a country departing the euro or Lehman declaring bankruptcy.

For example, if an effort by Greece to pay its bonds in “new drachmas” is rejected because of Boilerplate Contract Terms A and B, the market will surely be concerned that Terms A and B also govern the bonds of similarly situated borrowers, like Spain, Italy, etc. You’ll see that the borrowing premium the “peripheral” euro countries (the uppermost five lines: Ireland, Italy, Greece (biggest spike), Portugal, Spain) paid versus richer euro countries (Germany, France, the Netherlands, the three lowest lines) zoomed higher as worry over a Greece exit gripped markets in late 2011/early 2012, and again (to a lesser extent) because of Cyprus exit talk in early 2013:

Eurozone Debt Chart 1-1-10 - 7-13-13

Bloomberg. Click to enlarge.

Moreover, this panic occurred against a backdrop of unduly rosy assumptions (namely, that a departing euro country could convert its bonds into a new currency and thereby avoid default, a likely contagion trigger). I argue that the uniformity of boilerplate across these bonds would intensify these problems significantly since it’s likely to result in a declaration of default.

To my mind, this demonstrates that boilerplate securities contracts, in the aggregate, can be systemically significant. “Boilerplate Shock” introduces this concept and offers a modest proposal to mitigate its dangers in the Eurozone.

Beyond the euro, what about the risks of boilerplate shock in general?

Boilerplate shock is probably an inherent and permanent risk in any securities market.

Securities contracts are quintessential candidates for boilerplate. They are used by sophisticated parties for repeat or similar transactions and are drafted quickly—sometimes in three and a half minutes. The (correct) assumption is that they are more efficient for the parties that use them.

I’d like to begin thinking about how contracts can be drafted with a view to systemic risk mitigation, or at least to avoid exacerbating existing risks. But I think this is a hard problem that lacks an off-the-shelf solution:

  • The risk is also an externality: it is severe because of its collective impact. The parties do not bear the primary risk that uniform contracts will result in a meltdown, and in the unlikely event a crash happens (1) no individual party will be to blame and (2) at least one party to the initial transaction (the initial purchaser of a bond, for example) will probably no longer hold the asset, because most systemically significant securities are actively traded on the secondary market.

But banning or discouraging boilerplate is not the answer:

  • The risk that a bunch of assets governed by the same terms will plummet in value is not only an externality. Risk allocation among parties might improve if scrutiny of existing securities boilerplate improves. The terms can evolve.

  • A requirement to craft unique, artisanal terms—disclosures, subordination provisions ("flip clauses"), choice of governing law—for each individual securities transaction would be criminally inefficient.

  • A requirement to craft unique contract terms might even be unjustified on risk-management terms alone, because it would increase drafting errors.

It's tricky to mitigate the risks of securities boilerplate.

Some options for places to start:

  1. Validation by third parties: perhaps issuers could use risk-rated contract templates. For example, see credit ratings…but see credit ratings.
  2. Culture: inculcate systemic risk mitigation as a professional norm among private sector lawyers? In principle, this could work. The number of lawyers who draft these contracts is pretty small. In practice, one could envision many complications.
  3. Insurance: encourage the development of derivatives to account for the possibility of boilerplate shock? Like some of the other solutions, this one presumes some agreement on what terms create the risk of boilerplate shock. It could also encourage new forms of moral hazard.
  4. Mandatory regulation: some public entity could be tasked with the mission of proactively identifying and combating the risk of boilerplate shock in contract practices. Arguably a natural choice given that the risk is an externality. Nevertheless, I’m a little skeptical. First of all, who would do it? A domestic regulator, like the SEC or CFTC, that might be dodged on jurisdictional grounds? An international institution, which is arguably more subject to capture? More generally, regulation seems like a heavy-handed first choice.

In sum, when standardized and aggregated, choices that determine legal risks—e.g., contract terms designating governing law, payment priority—can create the same hazards as choices about business risks. This suggests that contract terms should be taken seriously as possible sources of systemic risk alongside more familiar sources, like leverage and credit quality.

Securities contracts as a source of systemic risk—what do you think?

Permalink | Contracts| Economics| Europe| European Union| Fiduciary Law| Finance| Financial Crisis| Financial Institutions| Law & Economics| Rules & Standards| Securities | Comments (0) | TrackBack (0) | Bookmark

March 07, 2014
More Monies, More Problems
Posted by Greg Shill

Duck tales    








© Disney, “Duck Tales”

I expressed concern in my last post that uniform contract terms could destabilize securities markets in unexpected ways. In a recent paper, I dub this risk “Boilerplate Shock.” The paper uses boilerplate terms in Eurozone sovereign bonds as a case study, but I argue that any market in which a lot of securities are governed by uniform contract terms is vulnerable to boilerplate shock. In this post, I will focus on the Eurozone and my proposed solution to the risk of boilerplate shock there.

One major problem is that no one really knows how to deal with sovereign debt obligations denominated in a currency that still exists but is no longer used by the debtor. A partial breakup of the European Monetary Union would trigger some question marks in commercial law and private international law (among other things).

In the Eurozone sovereign lending market, bond contracts typically contain standardized language specifying:

(a)  choice of governing law (often foreign), and
(b)  currency of payment (euros).

The combined effect of these clauses, I argue, is to render any country that departs the euro more likely to default on its debt. Whatever the impact of the departure itself, a forced default would make things much worse for Europe and the world economy.

Leading scholars have concluded or strongly suggested that a sovereign that changes currencies can redenominate (convert) its bonds to its new currency even where the contract is governed by foreign law (e.g., Philip Wood (p. 177), Michael Gruson (p. 456), Arthur Nussbaum (pp. 353-59), Robert Hockett (passim)). As a descriptive matter, I believe this to be a mistaken interpretation of New York (and probably English) private international law and commercial law (see “Boilerplate Shock” pp. 47-67). But normatively, I agree: a sovereign should be able to redenominate its bonds under certain circumstances. Among other things, the alternative would make currency union breakups far more dangerous than they already are.

In brief:

  • The prevailing consensus underestimates the risk that a departing Eurozone member’s attempt to redenominate its sovereign bonds into a new currency will be ruled a default.

  • Since the bonds of other struggling euro countries are largely governed by the same boilerplate terms ((a) and (b) above), this misapprehension has the potential to be particularly damaging. In addition to surprising the market (which appears to incorporate this consensus), it is likely to spread beyond the immediate debtor to the bonds of similarly situated countries that have issued under the same terms.

  • Same for CDSs (which are likewise often governed by foreign law, usually New York).

  • Thus, given the widespread use of terms (a) and (b), a ruling that a departing country cannot pay its euro-denominated contracts in a new currency could cause the market to demand unsustainable premiums from other weak debtors.

  • This could cause Eurozone countries to lose market access. Greece is not TBTF in any sense, but some of its neighbors are—and are also too big for the EU (including the ECB) and IMF to bail out. Italy (the world’s 9th largest economy) and Spain (13th) come to mind.

Thus, if my commercial law/private international law analysis is right, these boilerplate contracts could end up playing quite a big role in the event of any euro breakup. 

To mitigate this risk of boilerplate shock, I suggest a new rule of contract interpretation. The proposal is detailed at pp. 67-71 of the article. I suggest commercially significant jurisdictions adopt it by statute. Here is a quick summary.

Any sovereign that:

  1. Belongs to an international monetary union, and
  2. Issues bonds in the currency of that monetary union subsequent to the adoption of this rule, and
  3. Leaves the monetary union and introduces its own currency,

shall retain the right to redenominate its bond obligations into its new currency, UNLESS the sovereign has affirmatively waived the right to redenominate its bonds.

You’ll notice this is a default rule—merely a presumption of the right to redenominate—not a mandatory rule. It is also prospective-only: it does not apply to existing issuances. It also does not protect sovereigns that issue in foreign currency (e.g., Argentina), only those that are monetary union members and issue in the common currency (e.g., France).

The reason for these limitations is to minimize unintended consequences and near-term disruption to the market, but also to embody the relatively modest objectives of the rule. It is an information-forcing default rule that is intended to facilitate better risk management by parties. It is not a “save the world” rule.

The challenge, as I’ll discuss in my next post on the paper, is not that redenomination would be ruled impermissible when it ought to be available (otherwise, that might suggest a mandatory “pro-redenomination” rule). It is that the likely effect of these boilerplate terms—to prohibit redenomination—was almost certainly not bargained for and is largely unknown to parties. This market failure has, in turn, created latent risks to the broader financial system and the existing legal tools are poorly suited to address them.

Permalink | Contracts| Economics| Europe| European Union| Financial Crisis| Law & Economics| Rules & Standards| Securities | Comments (0) | TrackBack (0) | Bookmark

July 24, 2012
Are NCAA Sanctions Too Good for Penn State?
Posted by Christine Hurt

Following Gordon's post yeseterday on the Penn State "nondeath penalty," I started thinking more about whether NCAA sanctions against Penn State are a good idea. 

Now, I don't mean whether the sanctions are too harsh or will have collateral effects on innocent Penn State programs, students and alumni.  Of course sanctions will have collateral effects, just as disclosure of the events at the heart of the sanctions did.  The decline in the reputation of Penn State hurts employees, students and alumni.  The financial penalty as well as lost revenue will result in a different academic budget that will affect the same groups.  These effects are not super great reasons not to punish an organization.  Many folks in our field think a lot about the merits of organizational sanctions, and the Penn State scenario is no different from the SEC levying fines against an investment bank or any other large firm that employees folks and has shareholders.

Here is why I'm concerned that NCAA sanctions aren't a great idea.  What Sandusky did and his colleagues covered up was categorically different and categorically worse than having a slush fund for players (SMU); letting agents pay a player (USC); letting students trade autographed jerseys for cash (Ohio State); or letting boosters lavish players with cash, prostitutes and entertainment (Miami).  All of those things are against the spirit of amateur sports, but they aren't things that require the devil to grow a new mouth for the accuseds to rot in.  Giving someone money isn't per se a horrible thing; giving someone money in the context of collegiate athletics is.  The heinous acts that occurred in and around the Penn State locker room are heinous in any context.

Let's picture this.  SMU was banned from playing for 1987 and hosting home games for 1988 and lost 55 scholarships over 4 years for "X."  Penn State was not banned from playing, was fined $60 million, banned from bowl games for 4 years and lost 40 scholarships over 4 years for "Y."  Does that mean that the NCAA thinks that "X" is worse than "Y"?  USC lost 30 scholarships over 3 years and was banned from bowl games for 2 years for "Z."  Does the NCAA think that "Z" is 3/4 or 2/3 as bad as "Y"?  Miami is still awaiting its sanction for allegations made in 2011 of "W."  What if Miami gets a harsher penalty than Penn State?  It has to get a harsher penalty than USC, and there's not a lot of real estate between USC's penalty and Penn State's penalty. 

Do we really want to put the bad acts of the Penn State officers on the same spectrum as recruiting violations and payouts to players?

I don't mourn the fallout at Penn State due to the NCAA sanctions, but I am concerned with the symbolism.

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October 02, 2007
Yay! The First D C Circuit Opinion of the Season!
Posted by David Zaring

The regulation-skeptical judges Henderson, Randolph, and Brown today claimed the first victim of the D.C. Circuit's new year, in a super-unthrilling case that at least included a reasonable standing ruling. 

Poor FERC.  That agency loses a lot in the court of appeals, and today in Southern California Edison v. FERC, it lost a case worth less than 20,000 dollars.  Why'd SCE bother suing for that kind of money?  The utility was miffed that FERC hadn't applied California law, which was the law of a service contract with the City of Corona, to its failure to invoice Corona for some higher than expected interconnection charges within a year.  In other words, SCE wanted to be reimbursed for the late-filed charges, and thought its delay in filing the charges was immaterial under California law.  FERC applied federal law in rejecting the reimbursement request, because, it noted, SCE eventually invoiced Corona for the charges on its FERC-filed rates.  And FERC-filed rates are federal documents.  Because "accepting FERC's choice of law argument would permit FERC to disregard a choice of law provision in any FERC-approved contract," the court ruled that FERC had to evaluate SCE's reimbursement claim under California law.

Thrillsville, right?  No one ever said government contracting rocked at all times.  In my view, the opinion is notable mostly for the nuts standing argument that FERC made.  FERC argued that because SCE had delayed invoicing Corona beyond the contractual term, it didn't have standing to sue; SCE's injury was not traceable to FERC's interpretation of the contract, in other words, but to SCE's delay in invoicing.  To me, that sounds like an effort to convert a merits defense (SCE billed too late to be paid) into a jurisdictional question.  It's the sort of argument that, if credited, would keep a variety of basic breach of contract claims - the bread and butter of the first year of law school - out of court.  And thankfully, the court rejected the claim, noting that "in reviewing the standing question, the court must be careful not to decide the questions on the merits."

Crazy standing argument, right?  But don't blame FERC.  Every government lawyer is contractually obligated to challenge the standing of the plaintiff in every DC Circuit case.  And they're only obligated to do so because that court gets seduced by standing so frequently.

The opinion may be found here.

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September 03, 2007
The Faltering Regulation of Sin
Posted by David Zaring

The always insightful Simon Lester observes that the latest sin case that the WTO may take up (we’ve already told you about Antiguan internet gaming) is the incipient American ban on clove cigarettes. Indonesia, where such cigarettes are both a staple, and, apparently, an export, thinks that banning cloves but not methols would constitute trade discrimination against foreign exporters.

And, in a recent decision that the Fifth Circuit called, ahem, “high stakes,” that court threw out the Secretary of the Interior’s effort to save the Indian gaming regulatory scheme held to be unconstitutional in the Seminole Tribe case. The Indian Gaming Regulatory Act required states to negotiate casino deals with Indian tribes under the management of a judge which, the Supreme Court held, violated the states' 11th amendment immunity from suit, in Seminole Tribe. The secretary then replaced the judicially managed negotiation with a negotiation process managed by Interior. But the 5th Circuit just concluded that the Act did not authorize the agency to substitute itself for a court: “Congress plainly left little remedial authority for the Secretary to exercise.  … The Secretary may not decide the state's good faith; may not require or name a mediator; and may not pull out of thin air the compact provisions that he is empowered to enforce. To infer from this limited authority that the Secretary was implicitly delegated the ability to promulgate a wholesale substitute for the judicial process amounts to logical alchemy.” I generally don’t bother predicting cert grants, but I could see the government trying to obtain one here, and if it did, law clerks might find a follow up to Seminole Tribe – and an effort by the government to get around the impact of that decision without going to Congress for more legislative authority – to be quite exciting.

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August 30, 2007
The Law of Tomato Season
Posted by David Zaring

New Yorkers love their greenmarket produce.  And rightly so this time of year, though the commitment to local gardens makes a March full of sauteed fiddlehead fern salads really dreary.  Maybe that's why Hunts Point Market dealers often bribe USDA inspectors to show up particularly quickly when a shipment of actually fresh vegetables comes in, or, sometimes, to rate produce as worse than it really is, so that buyers can purchase low, and resell high. 

In honor of tomato season, but unseasonably late in a schedule that usually features a summer off for the  court, the D C Circuit recently barred a veteran Hunts Point outfit from participating in the USDA's Hunts Point inspection scheme.  It agreed with the Department of Agriculture that one of the firm's vice presidents gave a USDA inspector fifty bucks every time he came for inspection, in exchange for which the inspector allegedly did what the firm wanted.

Fifty bucks ain't a lot of money.  Which is why I note with slight sadness the passing of Kleiman & Hochberg, Inc, traduced by an employee with a too-close relationship with a regulator, and condemned to dealing, from this point forward, in uninspected fruits and vegetables.  Could it possibly have been worth it to bribe the USDA on the penny ante level?  The opinion may be found here.

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August 15, 2007
What I’ve Been Reading in Regulation
Posted by David Zaring

The NRDC is having a good month, what with the injunction against the use of sonar by the navy in southern California (it may be bad for whales, and the appropriate environmental impact statement was not prepared, the court concluded), and the enjoining of exploratory drilling by Shell in Alaska (a, shall we say, not yet explored temporary order pending a mid-August hearing). Impact litigation against big institutions still thrives on the west coast.

I’m extraordinarily late to the party, but it’s worth noting. Career attorneys are resigning or publicly protesting the current Department of Justice leadership. The former actually has been happening for a while (and sometimes resignation is a hard-to-disaggregate mixture of annoyance and the temptations of early retirement). But the airing of grievances in newspapers is pretty novel. So, for that matter, is the willingness to cover it.  One of the first of the recent wave to quit was the long serving head of the department’s Office of Information and Privacy, who in this interview describes his supervisors as too young and too ineffective. Here, by the way, is the latest report on information disclosure by DOJ; it is relatively positive.

James Park’s Duke Law Journal article has a vision of the choice for SEC regulators between rules and principles:

“Rulemaking reflects the mentality that securities regulation is a technical enterprise that should be left to experts who have created a comprehensive, efficient, administrative scheme. Principles-based enforcement actions reflect the demand that regulators punish conduct violating principles reflecting public values. For the most part, the regulated prefer a predictable regulatory regime, which rulemaking provides, while the public prefers decisive responses, which can be provided by principles-based enforcement actions.”

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November 28, 2006
The FRAP & FRCP Enter the Electronic Age
Posted by Christine Hurt

Effective December 1, certain new amendments to the Federal Rules of Civil Procedure and Appellate Procedure will bow to the realities of the electronic age.  Amendments to the FRCP address electronic discovery.  Rule 32.1 of the FRAP will now allow attorneys in federal courts to cite to unpublished opinions as of December 1.  However, as Howard Bashman points out in this Law.com article, attorneys may only cite to unpublished opinions from cases decided January 1, 2007 or later.  Therefore, the unpublished opinions that were "unpublished" before January 1 will be relegated to the Island of Misfit Opinions for perpetuity.  For more on the history of 32.1, see this old post.

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May 05, 2006
Libertarians, Regulation of Public Space, and the YUCK factor
Posted by Christine Hurt

In case you've missed it, new Conspirator Ilya Somin and (old Conspirator) Eugene Volokh have been having some fun debating whether anyone can articulate a valid reason for prohibiting certain activities in places open to the public (like parks, streets, etc.), such as nudity, sexual activity, urination, and smoking.  And, "it's yucky" isn't a valid reason.  Although my sensibilities bristle at little at the thought, I have to admit that it is difficult to come up with a consistent, Constitutional theory for regulation beyond "I don't like it, and no thinking person would want that."  Check it out, and please, please come up with something!

The debate reminded me of some posts earlier on the Conspiracy between David Bernstein and Orin Kerr about whether it was necessary/appropriate/relevant to explore whether certain law schools were open to libertarian-minded students.  And why would schools not be open to libertarian views?  I'm not defending it, but for some reason I think most of us get to law school so rigid in our thinking that it's hard to have an open mind when someone says in class "Yes, I think people should be able to contract themselves into slavery" (someone in my Contracts class) or "There is no reason to prohibit public sexual acts."  So the speaker of those statements, which could provide for rich, intelligent exploration, becomes "the guy who said people should be able to contract themselves into slavery").  These statements seem to be arguing for a reality that has a big YUCK factor, and so others turn away.  I'm glad to see that the blogosphere can revel in these discussions.

But please, someone come up with a very persuasive reason to prohibit public nudity.  At least here in Wisconsin.

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June 30, 2005
What is Academic Cheating?
Posted by Christine Hurt

Inside Higher Ed. has a story about economics graduate students at UVa who may face permanent expulsion for cheating.  The cheating incident here was finding the answers to problems in their textbook that were available online and sharing them with one another.  The students did not alert the professor that the answers were available online.  At UVa, there is only one punishment for violating the Honor Code:  permanent expulsion.

I would like to know the more facts before I described this homework incident as "cheating."  What if the answers were in the back of the book, but the professor didn't know that they were.  On the first assignment, students handed in their answers, which they copied from the back of the book, or perhaps checked against the answers in the back of the book.  Is that cheating?  Was the website with the answers hosted by the publisher, so it looked more like a study guide, or was it hosted by an anonymous student who had figured out the answers or maybe secured a copy of the teacher's manual?  What did the syllabus say about study guides or Internet websites?  I think that to one generation, finding answers on a website has the same degree of difficulty as breaking into a teacher's office desk drawer, and therefore requires the same criminal mental state.  I would say that finding problem answers on the Internet has the same degree of difficulty as flipping to the back of the book.

I've had conversations like this with academics before, and usually the response is "they know it's cheating" or "everyone knows what cheating is."  I'm not sure that's true anymore.  When I was in junior high, using a calculator was cheating.  It's not anymore.  Having someone check your spelling before you turn in your senior theme used to be cheating, but using spellcheck is not. 

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June 26, 2005
Nutrition Facts and Financial Facts
Posted by Caroline Bradley

Food and financial services share one problem: that it is very difficult to set up any regulatory system which will allow consumers to understand and measure the risks they are undertaking in making decisions about what foods to eat and what financial products to buy. The Acting Comptroller of the Currency, Julie Williams, has been suggesting that, at least in the context of disclosures about credit card terms it would be a good idea if financial regulators could follow the same sort of approach to disclosure that the FDA uses to disclosure of information about food products:

Why should consumers today get more effective disclosure when they buy a bag of potato chips than when they make substantial financial commitments for financial products and services?

This idea is based in part  on what the UK's Financial Services Authority has been saying about consumer disclosures recently:

the OCC also took the unusual step several months ago of submitting a comment letter to the Federal Reserve Board on its Advance Notice of Proposed Rulemaking related to credit card disclosures, discussing both the development of the FDA’s “Nutrition Facts” label and the efforts of the Financial Services Authority (FSA) in the United Kingdom to develop revised disclosures for a variety of financial products.

Simplified disclosure of this sort works better for standardised products than for others. The Financial Services Authority publishes comparative tables which allow consumers to compare some of the basic terms on which some financial products are offered. But the FSA is also working on developing a system for risk ratings or risk warnings for managed investment products (referred to, for example in last week's paper on Wider Range Retail Investment Products ). I'm not convinced that this sort of simplified disclosure really works very well even for potato chips, but I do like the idea of thinking hard about improving disclosures for consumers of financial products.

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June 10, 2005
Posted by Christine Hurt

In doing some research on the differences between attorney malpractice and the much rarer broker malpractice, I've been looking at stockbroker websites.  I have this impression that those Sunday afternoon commercials for stockbrokers are fairly overt, promising implicitly that these firms will guide you through with expert advice that you can trust.  However, investors can't sue brokers for faulty advice or a faulty plan unless the plan is patently "unsuitable" based on the investor's proclaimed "suitability."  But, if a broker says that Enron is going to go sky high, and then it doesn't, that's too bad.  Brokers aren't guarantors; you knew the risks.  However, if you went to see an estate planning attorney and asked for a plan to save on estate taxes, and the plan ended up being stupid, you might have a malpractice case.  (Note:  broker malpractice case law is hard to find, given the securities arbitration scheme that leaves no precedential paper trial.  Aaaargh for me.)

Anyway, stockbroker websites are very interesting.  Even the "individual investor" pages really focus on the fact that your investing strategy is your investing strategy.  They will give you some tools and resources to create and implement that strategy, but it's yours.  For example, Merrill Lynch tells you "[f]rom establishing objectives to setting strategy, implementing the solutions and then regularly reviewing progress, your Financial Advisor can help as you implement your own strategies for success."  Charles Schwab tells you "[t]hat's why we give you greater control over everything from the investments you make to the accounts you open to the type of advice and service you desire."  Is this investor empowerment or liability avoidance?

I cannot imagine a law firm touting on its website that the firm will help individual plaintiffs or estate planning clients "implement your own strategies"?  (On the BakerBotts estate planning page, that firm declares, "A detailed working knowledge of the estate tax leads to the successful development, implementation, and defense of the most sophisticated and effective estate plans for our clients."  You don't have to develop and implement the plan, we'll do it for you.  What about a physician that advertised that his practice "gives you greater control over everything from the medications you take to the type of diagnosis and treatment you desire."

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May 05, 2005
Am I Pro-Regulation?
Posted by Christine Hurt

Last week, Vic at A Taxing Blog made this statement (in comparing my thoughts on regulatory entrepreneurs to Larry Ribstein's): 

My hunch is that Larry usually dislikes regulation, and Christine usually thinks more regulation is needed. Of course, both Larry and Christine would surely agree that it depends on the circumstances: regulation that protects inefficient government monopolies are bad; regulation that protects widows and orphans from the sharks at Enron is good.

This has caused me to do some soul-searching. I would not have described myself as a pro-regulation kind of person. On this blog, I often urge for additional regulation, but generally in areas that are already regulated. So, the additional regulation is needed to fix a flawed regulatory scheme. Does that make me pro-regulation? Anyway, to prove that I am not pro-regulation, I have found two great examples of regulations that should be abolished or nipped in the bud, as the case may be:

1. The Texas House of Representatives' regulation of the content of high school cheerleading; and

2. The prohibition by ordinance against my cat wandering free every once in awhile in the Village of Whitefish Bay, Wisconsin.

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December 09, 2004
Texas Bar Rules Referendum
Posted by Christine Hurt

Texas Bar Rules Referendum

Normally, Texas Disciplinary Rules of Professional Conduct, which apply to members of the Texas Bar, are considered and adopted by the Texas Supreme Court. End of story. However, the Texas Supreme Court has issued a referendum to the members of the Texas Bar on two proposed rule changes. The referendum ends on December 20. Being out of the Texas Bar loop for awhile, I can only imagine that these rules generated much controversy and comment to make the court withdraw their previous approval of these rules in lieu of the referendum.

The first rule change is to TDR 1.04, which previously allowed for a "forwarding fee" to be paid to a lawyer who merely referred a client to another lawyer without doing any substantive work for that client.

If the rule change passes, fees may only be divided if the client agrees to the division and the division must either reflect the true allocation of work among the two lawyers or must be accompanied by joint responsibility for the representation. In the court's order issuing the referendum, the court noted that currently Texas is the only jurisdiction whose rules allow for the payment of a pure referral fee.

The second rule change concerns lawyer advertising and has many facets. The two changes that I found interesting were (1) an attorney may not advertise a previously won dollar judgment unless the ad also discloses how much the client actually pocketed after attorney's fees and costs and (2) attorneys may not use actors in ads. I remember seeing an ad for the local plaintiff's attorney in Lubbock, Texas on the back of the phone book (one phone book -- residential, business, and yellow) with a picture of a lovely, blonde family of four only to see the same lovely family pose in an ad in Houston for a completely different service. Disillusionment is hard.

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