Wednesday, July 22, 2020
An abstract for Ethics of Legal Astuteness: Barring Class Actions Through Arbitration Clauses, written with Daniel T. Ostas and published in the Southern California Interdisciplinary Law Journal is below, and the article is here.
Recent Supreme Court cases empower firms to effectively bar class
action lawsuits through mandatory arbitration clauses included in
consumer adhesion and employment contracts. This article reviews
these legal changes and argues for economic self-restraint among
both corporate executives and corporate lawyers who advise them.
Arbitration has many virtues as it promises to reduce transaction costs
and to streamline economic exchange. Yet, the ethics of implementing
a legal strategy often requires self-restraint when one is in a position
of power, and always requires respect for due process when issues of
human health, safety, and dignity are in play.
An abstract for Banking on the Cloud, written with David Fratto and Lee Reiners, and published in Transactions: The Tennessee Journal of Business Law is below, and the article is here.
Cloud computing is fast becoming a ubiquitous part of today’s
economy for both businesses and individuals. Banks and financial
institutions are no exception. While it has many benefits, cloud
computing also has costs and introduces risks. Significant cloud
providers are single points of failure and, as such, are an important
new source of systemic risk in financial markets. Given this reality,
this article argues that such institutions should be considered critical
infrastructures and designated as systemically important financial
market utilities under Dodd-Frank’s Title VIII
Wednesday, July 8, 2020
Yesterday, Randal K. Quarles, the Vice Chair of the Board of Governors of the Federal Reserve System and Chair of the Financial Stability Board (FSB), gave a speech at the Exchequer Club entitled “Global in Life and Orderly in Death: Post-Crisis Reforms and the Too-Big-to-Fail Question” (here). As he notes, the catchy first part of this title harkens back to the 2010 words of Mervyn King, then Governor of the Bank of England, who stated that “most large complex financial institutions are global—at least in life if not in death.” Quarles asserts that “In this pithy sentence, he [King] summed up the challenge policymakers faced.”
The context of Quarles’ speech is the FSB’s recent consultation report: Evaluation of the effects of too-big-to-fail reforms (here). Two major challenges post-crisis banking reforms sought to address were: 1) the market’s assumption that big banks would not be allowed to fail, and the moral hazard this created, and 2) the absence of effective resolution frameworks for global banks, which lead to bank rescues. There’s lots of good news here, including that prior to the current crisis, globally systemically important bank capital ratios had doubled since 2011 to 14%. As a result of this and other reforms, such banks have fared much better in the current crisis, and “[t]his has allowed the banking system to absorb rather than amplify the current macroeconomic shock.” Good news indeed!
At the same time, the challenges of the current crisis are not over. The International Monetary Fund projects that the global economy will contract by 4.9% in 2020 (a steeper decline than with the 2007-08 financial crisis). And Quarles notes that “The corporate sector entered the crisis with high levels of debt and has necessarily borrowed more during the event. And many households are facing bleak employment prospects. The next phase will inevitably involve an increase in non-performing loans and provisions as demand falls and some borrowers fail.”
Corporate and consumer bankruptcies are almost certain to increase as a result of the current crisis. Should a wave of such bankruptcies materialize, this could lead not only to a broader financial crisis, but also to the overwhelming of bankruptcy courts, including a need for additional bankruptcy judges (here). In the U.K., banks have been told to “rethink handling of crisis debt” (here), and the need for related, effective dispute resolution systems has also been noted.
Once again, the necessity of effective resolution frameworks is likely to be front and center in banking regulation. However, this time, it is likely to be a need for effective dispute resolution frameworks so that banks can speedily deal with consumer and corporate bankruptcies to promote economic recovery.
Wednesday, July 1, 2020
Yesterday, the Bank for International Settlements (BIS), whose ownership consists of 62 central banks, released its Annual Economic Report (here). It’s a treasure trove of information for banking and financial market regulation types (like me!) and includes a plethora of informative data and graphs. It’s divided into three main parts: 1) A global sudden stop, 2) A monetary lifeline: central banks’ crisis response, and 3) Central banks and payments in the digital era. Definitely well worth reading!
Sunday, June 21, 2020
On p. 17 of Rules for Principles and Principles for Rules: Tools for Crafting Sound Financial Regulation (here), Heath P. Tarbert, the Chairman and Chief Executive of the Commodity Futures Trading Commission, provides a useful table that he notes “is intended to be a helpful reference point for regulators confronted with finding the appropriate balance between principles and rules.” I found myself thinking of how helpful a table like this – and the article in general – would have been when I was teaching courses focused on the regulation of financial markets!
I highly recommend this very readable work to BLPB readers, especially to those teaching in the area of regulation. In fact, I’d likely make this article assigned reading if I were teaching a course on financial regulation this fall. It does an excellent job of providing an overview of the strengths and weaknesses of principles-based versus rules-based approaches to regulation and discussing hybrid possibilities. It also examines four categories of factors that suggest taking one approach over the other (summarized in the p.17 table), and applies these factors to several areas (automated trading, position limits, cross-border regulations, and digital assets).
Sunday, June 7, 2020
In doing a routine SSRN search, I’m always thrilled to see an exciting new banking article! At the top of my “to read list” for this week is Michael Salib & Christina Parajon Skinner’s, Executive Override of Central Banks: A Comparison of the Legal Frameworks in the United States and the United Kingdom (here). For a quick read, the authors have a post on the CLS Blue Sky Blog (here). The article's abstract is here:
This Article examines executive branch powers to “override” the decisions of an independent central bank. It focuses in particular on the power and authority of a nation’s executive branch to direct its central bank, thereby circumscribing canonical central bank independence. To investigate this issue, this Article compares two types of executive over- rides: those found in the United States, exercised by the U.S. Treasury (Treasury) over the U.S. Federal Reserve (the Fed), and those in the United Kingdom, exercised by Her Majesty’s Treasury (HM Treasury) over the Bank of England (the Bank). This Article finds that in the former, the power is informal and subject to minimal formal oversight, whereas in the latter, there are legal powers of executive override within an established and transparent legal framework.
This Article is the first piece of scholarship to undertake comparative analysis of the legal powers of executive override over these two leading central banks. The comparison is indeed striking—it juxtaposes the express, but limited, legal powers of HM Treasury to direct the Bank of England with the ad hoc and informal conventions of Treasury or presidential control of the Federal Reserve. The comparative analysis begs a paradoxical question in the conception of central bank independence: could a narrowly tailored set of override powers that authorize a treasury, with oversight from the legislature, to direct a central bank in exigent circumstances yield a sturdier form of central bank independence than a system which establishes few or limited legal mechanisms of executive override? Ultimately, this analysis prompts renewed examination of the way in which the law structures the Fed’s independence vis-a`-vis the Treasury and the President, informed by lessons from the U.K. design.
Sunday, May 31, 2020
This past week, I had occasion to return to the Financial Stability Board’s (FSB) recent Consultative document, Guidance on financial resources to support CCP resolution and on the treatment of CCP equity in resolution (Guidance), which I wrote a brief post about several weeks ago (here). In doing so, I spent more time thinking about the possibility of clearinghouse shareholders raising “no creditor worse off than in liquidation” (NCWOL) claims in a resolution scenario. I’m struggling with this idea. Shareholders are not creditors. I’ve decided to research this issue more and plan to write a short article. Stay tuned.
The Guidance notes the principle:
that in resolution CCP [clearinghouse] equity should absorb losses first, that CCP equity should be fully loss-absorbing, and that resolution authorities should have powers to write down (fully or partially) CCP equity.
It also notes that:
actions in resolution that expose CCP equity to larger default or non-default losses than in liquidation under the applicable insolvency regime could, based on the relevant counterfactual, enable equity holders to raise NCWOL claims. This may be inconsistent with the other Key Attributes principle that equity should be fully loss absorbing in resolution. This may also raise moral hazard concerns by allowing equity holders to maintain their equity interest in a CCP post resolution while participants are made to bear losses.
Most clearinghouses – for example ICE Clear Credit, a clearinghouse for CDS, and CME Clearing, a clearinghouse within CME Group – are now part of publicly traded global exchange group structures. Historically, clearinghouses were owned by their users/participants. Post Dodd-Frank, some clearinghouses, including the two just noted, have been designated as systemically significant financial market utilities (here).
Over a long period of time, clearinghouses have proven themselves to be robust risk management institutions. However, they can and have failed. Clearinghouses can experience losses due to the default of a clearing member(s), due to non-clearing member default issues (for example, cybersecurity problems, investment or custody losses, operational problems etc.), or due to a combination of both default and non-default issues.
Clearinghouses have rulebooks (contractual arrangements between the clearinghouse and clearing members/participants) that delineate how losses will be handled in the event that a clearing member were to default. Typically, clearinghouse default waterfalls in rulebooks direct that if the defaulting member’s performance bond (initial margin) does not cover its obligations, then a limited amount of funds contributed by the clearinghouse itself would be used to cover losses, and then any remaining losses would be covered by a common default fund which all clearing members are required to contribute to. Were the default fund to be exhausted, rulebooks generally permit clearinghouses to make an additional “cash call” to members. Were losses then still outstanding, the clearinghouse would initiate a recovery process.
Clearing members have called for clearinghouses to put additional capital at risk in this default waterfall structure (here) and to be required to hold additional capital. There is an obvious tension/conflict of interest between clearing members of a publicly traded clearinghouse being largely responsible for default losses and the clearinghouses's shareholders benefiting from the clearinghouse’s profits and managing its risk. Of course, if clearinghouses were owned by their users as they were historically, this conflict of interest would not exist. An alternative to the remutualization of clearinghouses would be for the clearinghouse to be responsible for any default losses that exceeded the defaulting member’s initial margin. From my perspective, this would make a lot more sense. I'm unaware of other examples in which the customers (clearing members) of a publicly traded institution, rather than its shareholders, are responsible for losses created by other customers.
Were a systemically important clearinghouse to become distressed, a resolution authority (RA) could step in – perhaps prior to the completion of the clearinghouse’s recovery process – to ensure the continuity of the clearinghouse’s operations and financial market stability. Systemically important clearinghouses are too critical to fail. Were the RA to take actions resulting in the shareholders experiencing larger losses than they would “in liquidation under the applicable insolvency regime,” there is a concern that such action by the RA could “enable equity holders to raise NCWOL claims.” I would think that this concern would largely disappear if the odd situation of having customers paying for the losses of other customers at a publicly traded institution did not exist or if clearinghouses were owned by their users.
At least for now, in my pre-NCWOL claims by clearinghouse shareholders article world, it’s unclear to me why given that shareholders are not creditors that shareholders would (or should) be able to make credible “NCWOL” claims as shareholders in resolution. I understand that a RA could step in before a clearinghouse recovery process were complete and that shareholders might lose more than they would were the rulebook procedures followed. I also understand that clearinghouse rulebooks generally require clearing members – rather than shareholders – to absorb the majority of the losses from the default of a clearing member. But at the end of the day, shareholders are simply not creditors. Perhaps if it were clear ex-ante that clearinghouse shareholders would be unable to make NCWOL claims in a clearinghouse resolution, it might help to rationalize the incentive conflicts in the clearinghouse area. If clearinghouse shareholders want to make “no shareholder worse off than in liquidation” claims, then the case should be made for that.
Sunday, May 10, 2020
Last Monday, the Financial Stability Board (FSB) released the consultative document, Guidance on financial resources to support CCP resolution and on the treatment of CCP equity in resolution (here). As readers know, I’ve written several times about clearinghouses, the central feature of the G20’s reforms to the over-the-counter derivative markets following the 2007-08 crises, implemented in the US in Dodd-Frank’s Title VII (for example, here and here).
The Guidance’s title is a succinct encapsulation of its two-part focus. In the first part, it uses a five-step process to evaluate the adequacy of a CPP’s resources and available tools to support its resolution (were that to prove necessary). These steps include:
Step 1: identifying hypothetical default and non-default loss scenarios (and a combination of them) that may lead to resolution;
Step 2: conducting a qualitative and quantitative evaluation of existing resources and tools available in resolution;
Step 3: assessing potential resolution costs;
Step 4: comparing existing resources and tools to resolution costs and identifying any gaps; and
Step 5: evaluating the availability, costs and benefits of potential means of addressing any identified gaps.
In the second part, the Guidance focuses on how to treat CCP equity in resolution. A resolution of a CCP would be distinct from a “wind down” of the CCP. Readers might ask why one would have to think about such a thing – equity will likely get wiped out, right? Not necessarily. Today, most CCPs are shareholder-owned, but the CCP users/customers (clearing members) are mostly on the hook for any losses resulting from a user’s default. As I’ve written about in Incomplete Clearinghouse Mandates (here), this creates a foundational incentive problem because the shareholders benefit from the CCP’s profits, but the users are primarily responsible for any default losses.
As the Guidance notes, in theory, CCPs could experience losses due to user defaults, non-default issues, or a combination of both. How CCPs owned by shareholders will allocate losses between themselves and users in a “combination” scenario is completely unclear (allocation of non-default losses is also unclear in many cases) and should be addressed as I’ve noted before (here). Should the combination scenario arise, I think loss allocation will prove to be an intractable problem.
In reading the second part of the Guidance, one realizes how complicated and legally fraught the question of CCP equity could be in a resolution given the status quo. Towards the end of the second part, the Guidance states that:
Based on the analysis undertaken in accordance with the previous sections, the relevant home authorities should address the challenges relating to CCP equity fully bearing losses in resolution. This may include, where possible, that home authorities having the relevant powers and authority require that CCPs modify their capital structures, rules or other governance documents in a manner that subordinates shareholders to other creditors or sets out the point at which equity absorbs losses in legally enforceable terms. This may also include identifying or proposing potential changes to laws, regulations or powers of the relevant supervisory, oversight or resolution authorities that would enable achieving the resolution objectives or limit the potential for NCWOL claims.
In the short term, the last sentence of this quote likely offers a more feasible approach to handling CCP equity than what I think would be a more sensible approach: addressing the ownership structure of these institutions. This would almost certainly be much more difficult to implement in practice, but it’s ultimately a simpler, more sensible long-term solution for addressing CCP equity in resolution and for addressing loss allocation under a combination scenario. Until we fix this foundational issue of ownership, we shouldn’t be surprised if the path of a distressed, systemically significant clearinghouse ultimately resembles that of the government‐backed mortgage lenders whose fate more than 11.5 years after entering government conservatorship still remains uncertain. Let’s not repeat this history!
Wednesday, April 15, 2020
The National Center for Public Policy Research has posted an open letter to Blackrock CEO Larry Fink that should be of interest to readers of this blog. I provide some excerpts below. The full letter can be found here.
Dear Mr. Fink,
This economic crisis makes it more important than ever that companies like BlackRock focus on helping our nation’s economy recover. BlackRock and others must not add additional hurdles to recovery by supporting unnecessary and harmful environmental, social, and governance (ESG) shareholder proposals.
…. we are especially concerned that your support for some ESG shareholder proposals and investor initiatives brings political interests into decisions that should be guided by shareholder interests…. when a company’s values become politicized, the interests of the diverse group of shareholders and customers are overshadowed by the narrow interests of activist groups pushing a political agenda.
…. ESG proposals will add an extra-regulatory cost .... This may harm everyday Americans who are invested in these companies through pension funds and retirement plans. While this won’t affect folks in your income bracket, this may be the difference between affording medication, being able to retire, or supporting a family member’s education for many Americans.
There is a financial risk to this tack as well. The Wall Street Journal recently reported that “[p]erformance of BlackRock’s own iShares range of ESG funds shows that ESG is no guarantee of gold-plated returns. Its two oldest in the U.S., set up in 2005 and 2006 and now tracking the MSCI USA ESG Select index and the MSCI KLD 400 Social index, have both lagged behind iShares’ S&P 500 fund.”
And while publicly traded companies operate under a legal fiduciary duty to their investors, this is also a moral imperative. Free market capitalism has lifted more people out of poverty than any economic system in world history. That’s because, at its simplest level, capitalism operates under the basic rule that all exchanges are voluntary. Therefore, to achieve wealth and create growth in a capitalist system, one must appeal to the self-interest of others….
Thursday, April 9, 2020
Congressional securities trading has attracted a good bit of attention after controversial trades by Senators Burr and Loeffler. The scrutiny has even drawn more attention to another surprisingly well-timed trade by Senator Burr.
In his essay, Shill takes up the issue from a policy perspective, looking at how we ought to regulate Congressional Securities Trading. He draws from ordinary securities regulation and suggest pulling over the trading plan approach and short-swing profit prohibition we use for corporate executives. This approach should help manage ordinary securities transactions by members of Congress and their staff. He also advocates for limiting Congressional investing to U.S. index funds and treasuries. This would reduce the incentive to favor one market participant over another.
The proposed reforms would be a substantial improvement over the status quo. We should not have legislators with significant financial incentives to favor one company over another when making law and setting policy. We should also not subsidize public service by tolerating Congressional trading on Congressional information.
Of course, we'll still face some implementation challenges. When and how would we require newly-elected and currently-serving officials to liquidate existing portfolios? What kinds of exceptions would we make for private-company investments where no ready, liquid market exists? These implementation challenges strike me as mild compared to the benefits.
And Congressional adoption of the proposal would certainly yield substantial benefits. Although difficult to quantify, two broad benefits seem clear. First, adopting the proposal would generally increase confidence in government's integrity. As we're seeing with the pandemic, public trust in public officials can shift how society responds in times of collective crisis.
Allowing federal officials to trade securities generates real harm, confusion, and suspicion. Consider the hubbub over Trump's indirect ownership of a tiny stake in drug-maker Sanofi. Some have seized on the small, indirect interest to contend that he now hypes a particular drug for personal gain. A public-trust-focused regime limiting all elected officials to only broad index funds and U.S. Treasuries would likely cut down on the fear that officials recommend particular things to the public because of their economic interests. To be clear, it strikes me as extremely unlikely that the President now hypes the drug because of his minuscule ownership stake. The much likelier explanation is simply disordered magical thinking.
Many politicians have been targeted by similar attacks. This particular type of ill-informed charge has also been leveled at Senator Elizabeth Warren. One deeply misleading headline claimed she "invested in private prisons" before going on to explain that she owned a Vanguard index fund. It would be better to remove this line of attack entirely by sharply limiting the ways public officials invest.
Limiting Congressional ownership would also advance another vital national interest by increasing confidence in American securities markets. Our ability to attract capital and move it from investors to the real economy depends on confidence in the system. If investors fear that Congressional insiders have a leg up, they may not be as likely to participate in our markets.
As Congress considers how to regulate on these issues in the future, it should pay close attention to Shill's recommendations.
Sunday, March 29, 2020
In a December 2018 post (here), I noted that “although esoteric, such issues as who has access to an account at the Fed are critical social policy choices with real world implications that merit broad-based public debate.”
This past week, a federal district court judge granted the Federal Reserve Bank of New York’s (FRBNY) motion to dismiss The Narrow Bank’s (TNB) complaint in TNB USA Inc. v. Federal Reserve Bank of New York (USDC SDNY) (here). In light of this recent opinion, I wanted to reiterate my invitation to BLPB readers to think about seemingly technical, arcane issues such as who gets an account at the Fed – a master account is essentially a bank account at a regional Federal Reserve Bank enabling access to the Federal Reserve Payments System – and how such decisions should be made. The importance of this critical policy issue is only set to increase. A few months ago, the Federal Reserve announced plans to develop FedNow Service (here).
TNB is a financial institution with an innovative business model. Professor Peter-Conti Brown has written about it (here). It’s model is essentially this: open an account at the Federal Reserve, deposit customer funds (financial institution customers), receive interest on the funds deposited at the Fed’s Interest on Excess Reserves Rate (“IOER rate”), keep a slice of the gains, and pay out the remainder to customers. The Federal Reserve is a risk-free counterparty, but it is not limited to paying the risk-free interest rate. So, TNB has a really clever business model. TNB’s Chairman & CEO, James McAndrews spent 28 years working in the Federal Reserve System (19 at the FRBNY). Its Board members also includes two highly respected finance professors: Gary Gorton at Yale University and Darrell Duffie at Stanford University.
TNB received a “temporary Certificate of Authority” from the Connecticut Department of Banking, contingent on several things, including “that the FRBNY would open a master account for TNB.” As the opinion explains, the FRBNY has not actually denied TNB’s application for a master account…though at least 18 months have passed since TNB applied for it! However, as the opinion notes, “the FRBNY’s delay is not TNB’s cause of action.” Hence, United States District Judge Andrew L. Carter, Jr. granted the FRBNY’s motion to dismiss, writing that “TNB lacks standing to pursue its claim, which is also constitutionally and prudentially unripe.”
The decision strikes me as technically correct, and it will be interesting to see TNB’s strategy from here. I’m not taking a position on whether TNB should/should not have a master account without additional research and thought. However, what I am taking a position on is the importance of greater public debate about the underlying policy questions surrounding who does/doesn’t get an account at the Fed.
In Regulating the Invisible: The Case of Over-the-Counter Derivatives (here), I noted that ICE US Trust LLC, an uninsured NY trust company clearing credit default swaps – controversial financial instruments that had just played a huge role in the financial crisis of 2007-08 – had been granted membership in the Federal Reserve System in 2009 (here). ICE Trust was essentially the predecessor of ICE Clear Credit, which essentially has the monopoly on CDS clearing today. Dodd-Frank’s Title VIII explicitly provides the Federal Reserve with the ability to provide accounts and services to clearinghouses designated as systemically important under that title. But prior to Dodd-Frank, I think that granting ICE Trust membership in the Federal Reserve System was a questionable decision.
The Fed obviously has its hands full at the moment with much more urgent issues. In the future, however, it should provide additional clarity about the granting of master accounts and the general timing of such decisions.
Sunday, February 16, 2020
What’s the #1 new release in Banking Law on Amazon? I’m glad you asked! It’s Professor David Zaring’s first book, The Globalized Governance of Finance (Cambridge University Press). In 2008, Zaring joined Wharton's Legal Studies and Business Ethics Department as an assistant professor. At the time, I was a PhD student in the Department and also focused on banking law. So, it was really exciting for me to have a banking law scholar join us and I’m thrilled to now have a chance to highlight his new book. My copy is on its way from Amazon, so for now, I’ll share Zaring’s description of his book and my own thoughts with BLPB readers soon!
The book pulls together work I’ve done on the regulatory networks – the Basel Committee, IOSCO, IAIS, e.g., – that have become the global taste for harmonizing financial regulation. I think the regimes, and their relative bindingness (especially Basel), are interesting in their own right, and they are also an interesting way of doing global governance, where the sine qua non is often thought to be a treaty enforced by a tribunal, a la the World Trade Organization.
But in finance, you see neither of those things, and still robust oversight that American regulators, regardless of administration, seem to embrace. Even as the Trump administration has pushed for changes in trade law, Randal Quarles of the Fed has been installed as chair of the Financial Stability Board, the network of networks that keeps everything moving. The Obama administration tried to get a Basel-like process into its trade deals, and issued an executive order encouraging agencies to harmonize regulations.
Moreover, since the financial crisis, regulators have doubled down on these networks, adding political oversight from the G-20, a middle manager in the FSB, and standardizing notice and comment rulemaking at the network level. That, I think, makes the whole scheme look increasingly like a cross-border bureaucracy. After all, American agencies make policy through notice and comment rulemaking overseen by career regulators overseen by political leaders. So too Basel, IOSCO, IAIS, and the other networks.
Friday, January 24, 2020
On January 17, I headed to the University of Florida’s Warrington College of Business to be a discussant at the Huber Hurst Seminar. A great event! On the same day, Randal K. Quarles, the Vice Chair for Supervision (a position created by Dodd-Frank) and Governor of the Federal Reserve System gave a speech, Spontaneity and Order: Transparency, Accountability, and Fairness in Bank Supervision, at the 2020 American Bar Association Banking Committee Meeting. Legal scholars have focused scant attention on bank supervision in the past, but this is starting to change. It can be a challenging area to work in as Wharton Assistant Professor Peter Conti-Brown explains in The curse of confidential supervisory information. Indeed, confidential supervisory information is protected from disclosure with criminal penalties.
Bank regulation (which has received a bit more attention) and bank supervision, though linked concepts, are distinct. Supervision “implements the regulatory framework.” An important tension exists in banking supervision. In his speech, Quarles explains that “We have a public interest in a confidential, tailored, rapid-acting and closely informed system of bank supervision. And we have a public interest in all governmental processes being fair, predictable, efficient, and accountable. How do we square this circle?” It’s an important question. Quarles terms it “a complex and consequential issue that, for decades now, has received far too little attention from practitioners, academics, policymakers and the public.”
Quarles’ speech makes several suggestions regarding “some obvious and immediate ways that supervision can become more transparent, efficient, and effective.” To improve transparency, he makes three proposals: 1) “create a word-searchable database on the Board’s website with the historical interpretations by the Board and its staff of all significant rules,” 2) “putting significant supervisory guidance out for public comment,” and 3) “submitting significant supervisory guidance to Congress for purposes of the Congressional Review Act.”
All three proposals strike me as reasonable. What would be the drawback of the Board making interpretations of significant rules transparent and easily accessible? Regulatory guidance, as opposed to rules, is not legally binding. Yet in reality, there may be no difference in practice. I’d welcome both additional public comment on significant supervisory guidance and review by Congress. However, it’s also critical that a variety of stakeholders, especially academics, policymakers, and the public, actively participate in these processes.
Tuesday, December 24, 2019
Happy holidays! Billions of people around the world are celebrating Christmas or Hanukah right now. Perhaps you’re even reading this post on a brand new Apple Ipad, a Microsoft Surface, or a Dell Computer. Maybe you found this post via a Google search. If you use a product manufactured by any of those companies or drive a Tesla, then this post is for you. Last week, a nonprofit organization filed the first lawsuit against the world’s biggest tech companies alleging that they are complicit in child trafficking and deaths in the cobalt mines of the Democratic Republic of Congo. Dodd-Frank §1502 and the upcoming EU Conflict Minerals Regulation, which goes into effect in 2021, both require companies to disclose the efforts they have made to track and trace "conflict minerals" -- tin, tungsten, tantalum, and gold from the DRC and surrounding countries. DRC is one of the poorest nations in the world per capita but has an estimated $25 trillion in mineral reserves (including 65% of the world's cobalt). Armed militia use rape and violence as a weapon of war in part so that they control the mineral wealth. The EU and US regulators believe that consumers might make different purchasing decisions if they knew whether companies source their minerals ethically. The EU legislation, notably, does not limit the geography to the DRC, but instead focuses on conflict zones around the world.
If you’ve read my posts before, then you know that I have written repeatedly about the DRC and conflict minerals. After visiting DRC for a research trip in 2011, I wrote a law review article and co-filed an amicus brief during the §1502 litigation arguing that the law would not help people on the ground. I have also blogged here about legislation to end the rule, here about the EU's version of the rule, and here about the differences between the EU and US rule. Because of the law and pressure from activists and socially-responsible investors, companies, including the defendants, have filed disclosures, joined voluntary task forces to clean up supply chains, and responded to shareholder proposals regarding conflict minerals for years. I will have more on those initiatives in my next post. Interestingly, cobalt, the subject of the new litigation, is not a “conflict mineral” under either the U.S. or E.U. regulation, although, based on the rationale behind enacting Dodd-Frank §1502, perhaps it should have been. Nonetheless, in all of my research, I never came across any legislative history or materials discussing why cobalt was excluded.
The litigation makes some startling claims, but having been to the DRC, I’m not surprised. I’ve seen children who should have been in school, but could not afford to attend, digging for minerals with shovels and panning for gold in rivers. Although I was not allowed in the mines during my visit because of a massacre in the village the night before, I could still see child laborers on the side of the road mining. If you think mining is dangerous here in the U.S., imagine what it’s like in a poor country with a corrupt government dependent on income from multinationals.
The seventy-nine page class action Complaint was filed filed in federal court in the District of Columbia on behalf of thirteen children claiming: (1) a violation of the Trafficking Victims Protection Reauthorization Act of 2008; (2) unjust enrichment; (3) negligent supervision; and (4) intentional infliction of emotional distress. I’ve listed some excerpts from the Complaint below (hyperlinks added):
Defendants Apple, Alphabet, Dell, Microsoft, and Tesla are knowingly benefiting from and providing substantial support to this “artisanal” mining system in the DRC. Defendants know and have known for a significant period of time the reality that DRC’s cobalt mining sector is dependent upon children, with males performing the most hazardous work in the primitive cobalt mines, including tunnel digging. These boys are working under stone age conditions for paltry wages and at immense personal risk to provide cobalt that is essential to the so-called “high tech” sector, dominated by Defendants and other companies. For the avoidance of doubt, every smartphone, tablet, laptop, electric vehicle, or other device containing a lithium-ion rechargeable battery requires cobalt in order to recharge. Put simply, the hundreds of billions of dollars generated by the Defendants each year would not be possible without cobalt mined in the DRC….
Plaintiffs herein are representative of the child cobalt miners, some as young as six years of age, who work in exceedingly harsh, hazardous, and toxic conditions that are on the extreme end of “the worst forms of child labor” prohibited by ILO Convention No. 182. Some of the child miners are also trafficked. Plaintiffs and the other child miners producing cobalt for Defendants Apple, Alphabet, Dell, Microsoft, and Tesla typically earn 2-3 U.S. dollars per day and, remarkably, in many cases even less than that, as they perform backbreaking and hazardous work that will likely kill or maim them. Based on indisputable research, cobalt mined in the DRC is listed on the U.S. Department of Labor’s International Labor Affairs Bureau’s List of Goods Produced with Forced and Child Labor.
When I mentioned above that I wasn’t surprised about the allegations, I mean that I wasn’t surprised that the injuries and deaths occur based on what I saw during my visit to DRC. I am surprised that companies that must perform due diligence in their supply chains for conflict minerals don’t perform the same kind of due diligence in the cobalt mines. But maybe I shouldn't be surprised at all, given how many companies have stated that they cannot be sure of the origins of their minerals. In my next post, I will discuss what the companies say they are doing, what they are actually doing, and how the market has reacted to the litigation. What I do know for sure is that the Apple store at the mall nearest to me was so crowded that people could not get in. The mall also has a Tesla showroom and people were gearing up for test drives. Does that mean that consumers are not aware of the allegations? Or does that mean that they don’t care? I’ll discuss that in the next post as well.
Wishing you all a happy and healthy holiday season.
December 24, 2019 in Compliance, Corporate Personality, Corporations, CSR, Current Affairs, Ethics, Financial Markets, Human Rights, Litigation, Marcia Narine Weldon, Securities Regulation, Shareholders | Permalink | Comments (0)
Tuesday, October 29, 2019
“Big banks do not usually gang up to demand more financial regulation, least of all with asset managers in tow.” That’s the first sentence of Gillian Tett’s recent piece, Banks are right to say that clearing houses are ripe for reform, in the Financial Times (here – subscription required). Her title and lead sentence are spot on. That should be worrisome to all. Tett’s piece centers on a white paper, A Path Forward for CCP Resilience, Recovery, and Resolution (here), released on October 24, 2019, by nine financial institutions (Allianz Global Investors, BlackRock, Citi, Goldman Sachs, Societe Generale, JPMorgan Chase & Co., State Street, T.RowePrice, and Vanguard). Tett states: “the current status quo around clearing houses is worrying.” As BLPB readers know, I agree.
The white paper calls for “enhanced risk management standards and aligning incentives through requirements for meaningful CCP [clearinghouse] own capital for covering both default and non-default losses and recapitalization resources.” (p.1) It highlights the incentive misalignment present in many clearinghouses given their publicly-traded, shareholder ownership status: “Although CCP shareholders take 100% of the returns a CCP earns from clearing revenues, they bear only a small portion of the losses the CCP incurs as a result of a default.” (p.10) Many of its recommendations are not new, but some are. These include: a clearing member voting mechanism in recovery; ex-ante provision of financial resources for resolution; and, the possibility of “long-term debt that could be bailed in for recapitalization.” (p.1)
While I generally agree with the white paper’s recommendations, I don’t think they go far enough. As I’ve posted before on clearinghouses (here, here, here, here) and will do so in the future, I’ll just highlight a few things. First, while increasing clearinghouse capital is a step in the right direction towards better incentive alignment, it’s only a start. The ownership structure itself of these institutions needs to be addressed. If clearinghouses were owned by their members – as they were historically – the incentive misalignment between members and owners would largely diminish. However, as I’ve noted in Incomplete Clearinghouse Mandates (here), even if clearinghouses are all member-owned, this doesn’t solve the problem of who ultimately holds the extreme tail risk of these institutions. In a previous post (here), I pointed out parallels between clearinghouses and the residential mortgage giants, Fannie Mae and Freddie Mac, whose exit from government ownership is still pending more than a decade after the financial crisis. Let’s not go down the same route in the clearinghouse space.
Second, the white paper argues that clearinghouses should generally be responsible for non-default losses. I agree. However, as I’ve noted before, both types of losses could occur in close proximity. Hence, it could be very difficult in practice to separate them out to allocate any losses in the case of investor-owned clearinghouses. Finally, as I write about in forthcoming research, clearinghouses are self-regulatory organizations (SROs). Presumably, they would be acting in a regulatory capacity in a recovery scenario as it is arguably the analog to government action in a resolution scenario. Exchanges, as SROs, are generally entitled to regulatory immunity for actions taken in a regulatory capacity (for more on exchange immunity, see here). At the same time, the recovery of an investor-owned, distressed clearinghouse is also inherently a commercial endeavor. It is fundamentally about the survival of the clearinghouse, and potentially the exchange group structure itself. So, it could be very difficult in practice to separate regulatory from commercial action for purposes of regulatory immunity. Given this consideration, investor-owned clearinghouses could have less incentive to be circumspect about recovery decisions that might adversely impact members.
Tett refers to a “trenchant letter” from the Systemic Risk Council to the Financial Stability Board “demanding action” on clearinghouses. Paul Tucker, who chairs the Council, is the former Deputy Governor of the Bank of England. In closing, I recommend that readers interested in understanding more about the centrality of clearinghouses in financial markets read a 2014 speech by Tucker: Are Clearing Houses the New Central Banks? If the answer to Tucker's question is yes, that says it all!
Saturday, September 7, 2019
Have you ever wanted to learn the basics about blockchain? Do you think it's all hype and a passing fad? Whatever your view, take a look at my new article, Beyond Bitcoin: Leveraging Blockchain to Benefit Business and Society, co-authored with Rachel Epstein, counsel at Hedera Hashgraph. I became interested in blockchain a year ago because I immediately saw potential use cases in supply chain, compliance, and corporate governance. I met Rachel at a Humanitarian Blockchain Summit and although I had already started the article, her practical experience in the field added balance, perspective, and nuance.
The abstract is below:
Although many people equate blockchain with bitcoin, cryptocurrency, and smart contracts, the technology also has the potential to transform the way companies look at governance and enterprise risk management, and to assist governments and businesses in mitigating human rights impacts. This Article will discuss how state and non-state actors use the technology outside of the realm of cryptocurrency. Part I will provide an overview of blockchain technology. Part II will briefly describe how public and private actors use blockchain today to track food, address land grabs, protect refugee identity rights, combat bribery and corruption, eliminate voter fraud, and facilitate financial transactions for those without access to banks. Part III will discuss key corporate governance, compliance, and social responsibility initiatives that currently utilize blockchain or are exploring the possibilities for shareholder communications, internal audit, and cyber security. Part IV will delve into the business and human rights landscape and examine how blockchain can facilitate compliance. Specifically, we will focus on one of the more promising uses of distributed ledger technology -- eliminating barriers to transparency in the human rights arena thereby satisfying various mandatory disclosure regimes and shareholder requests. Part V will pose questions that board members should ask when considering adopting the technology and will recommend that governments, rating agencies, sustainable stock exchanges, and institutional investors provide incentives for companies to invest in the technology, when appropriate. Given the increasing widespread use of the technology by both state and non-state actors and the potential disruptive capabilities, we conclude that firms that do not explore blockchain’s impact risk obsolescence or increased regulation.
Things change so quickly in this space. Some of the information in the article is already outdated and some of the initiatives have expanded. To keep up, you may want to subscribe to newsletters such as Hunton, Andrews, Kurth's Blockchain Legal Resource. For more general information on blockchain, see my post from last year, where I list some of the videos that I watched to become literate on the topic. For additional resources, see here and here.
If you are interested specifically in government use cases, consider joining the Government Blockchain Association. On September 14th and 15th, the GBA is holding its Fall 2019 Symposium, “The Future of Money, Governance and the Law,” in Arlington, Virginia. Speakers will include a chief economist from the World Bank and banking, political, legal, regulatory, defense, intelligence, and law enforcement professionals from around the world. This event is sponsored by the George Mason University Schar School of Policy and Government, Criminal Investigations and Network Analysis (CINA) Center, and the Government Blockchain Association (GBA). Organizers expect over 300 government, industry and academic leaders on the Arlington Campus of George Mason University, either in person or virtually. To find out more about the event go to: http://bit.ly/FoMGL-914.
Blockchain is complex and it's easy to get overwhelmed. It's not the answer to everything, but I will continue my focus on the compliance, governance, and human rights implications, particularly for Dodd-Frank and EU conflict minerals due diligence and disclosure. As lawyers, judges, and law students, we need to educate ourselves so that we can provide solid advice to legislators and business people who can easily make things worse by, for example, drafting laws that do not make sense and developing smart contracts with so many loopholes that they cause jurisdictional and enforcement nightmares.
Notwithstanding the controversy surrounding blockchain, I'm particularly proud of this article and would not have been able to do it without my co-author, Rachel, my fantastic research assistants Jordan Suarez, Natalia Jaramillo, and Lauren Miller from the University of Miami School of Law, and the student editors at the Tennessee Journal of Business Law. If you have questions or please post them below or reach out to me at firstname.lastname@example.org.
September 7, 2019 in Compliance, Conferences, Contracts, Corporate Governance, Corporations, CSR, Current Affairs, Financial Markets, Human Rights, Law Reviews, Lawyering, Legislation, Marcia Narine Weldon, Securities Regulation, Shareholders, Technology | Permalink | Comments (0)
Friday, May 10, 2019
Join me in Miami, June 26-28.
June 26-28, 2019
Managing Compliance Across Borders is a program for world-wide compliance, risk and audit professionals to discuss current developments and hot topics (e.g. cybersecurity, data protection, privacy, data analytics, regulation, FCPA and more) affecting compliance practice in the U.S., Canada, Europe, and Latin America. Learn more
See a Snapshot: Who Will Be There?
Learn More: Visit the website for updated speaker information, schedule and topic details.
This program is designed and presented in collaboration with our partner in Switzerland
May 10, 2019 in Compliance, Conferences, Corporate Governance, Corporations, CSR, Current Affairs, Ethics, Financial Markets, International Business, Law Firms, Law School, Marcia Narine Weldon, White Collar Crime | Permalink | Comments (0)
Thursday, November 29, 2018
I’d like to thank the Business Law Prof Blog for the opportunity to be a guest blogger! In this first post, I build on a subject of previous posts (here, here, and here): Theranos, a now defunct Silicon Valley health-care start-up.
I rely heavily on the Financial Times to follow developments in one of my main research areas: financial market clearing and settlement (I’ll plan to report next week on the upcoming December 4th meeting of the Market Risk Advisory Committee, sponsored by CFTC Commissioner Rostin Behnam). The FT recently announced that Wall Street Journal investigative reporter John Carreyrou’s book, Bad Blood: Secrets and Lies in a Silicon Valley Startup, had been named the FT/McKinsey Business Book of the Year 2018. Having immensely enjoyed reading past winners, I wasted no time in ensuring that Amazon Prime speedily delivered it to my doorstep.
Bad Blood is a riveting tale of Theranos’ spectacular rise and fall, and well-worth the reader’s time. A fun fact is that a pathologist blogger, Adam Clapper (founder of the former Pathology Blawg), tipped Carreyrou onto the Theranos story (Chapter 19). Additionally, in the months after Bad Blood’s publication, its founder and CEO, Elizabeth A. Holmes, and former COO, Ramesh “Sunny” Balwani, were charged by the Justice Department with wire fraud.
I know little about the health-care industry. Yet in reading Bad Blood, I was struck by links to and concerns shared with the financial industry (an area about which I know more). Below, I make a few observations and invite reader comments on their importance in these and other industries.
Post-financial crisis, rock-bottom interest rates acted as a “key ingredient” to a new Silicon Valley boom (p.82). Similarly, these low rates have also been a key ingredient for the many years of increasing stock market prices post-financial crisis. Indeed, recent equity market declines made at least a temporary rebound yesterday after comments by Federal Reserve Chairman Jerome Powell at the Economic Club of New York.
The increasing expansion of private markets enables companies such as Theranos to “avoid the close scrutiny” (p.178) to which public companies are subject (nevertheless, Theranos and Holmes settled fraud charges with the SEC). Given current regulatory structures, it also risks severely limiting retail investment opportunities. And it adversely impacts financial journalists’ access to information!
When I teach Banking and Financial Institutions Law, the term “regulation-induced innovation” tends to amuse students. The Theranos tale demonstrates, however, that such practices aren’t a laughing matter. For example, its business strategies appeared to include: maneuvering in regulatory “gray zones” between the FDA and Centers for Medicare and Medicaid Services (p.88), exploiting “gap[s] spawned by outdated statutes” (p.125), and “operat[in]g in a regulatory no-man’s-land” (p.260). Such practices can be troublesome enough in financial markets. However, in Theranos’ case, the stakes (patient health) were much higher.
Finally, who doesn’t love a good story? Carreyrou, a two-time Pulitzer Prize-winning journalist, is an expert storyteller. His portrayal of Holmes suggests that she too profoundly understood the power of stories, and that she had a bewitching talent for telling them. Clearly, untruthful, non-fictional narratives are generally unethical and, depending upon the context, might also be illegal. However, taking a cue from Holmes on the importance of stories and honing one's ability to tell them could assist financial market policymakers. Indeed, several years ago, the FT’s Gillian Tett wrote an opinion piece entitled, “Central bank chiefs need to master the art of storytelling.” Enhanced storytelling capabilities could also assist academics researching financial market regulation. For both, the ability to compellingly communicate with the public about issues in financial markets and their broad-based importance is critical. Even so, constructing a fascinating narrative about clearing and settlement along the lines of Bad Blood would be no small feat!
Sunday, September 16, 2018
I knew it would be impossible. There was no way to relay my excitement about the potential of blockchain technology in a concise way to lawyers and law students last Friday at the Connecting the Threads symposium at the University of Tennessee School of Law. I didn't discuss cryptocurrency or Bitcoin other than to say that I wasn't planning to discuss it. Still, there wasn't nearly enough time for me to discuss all of the potential use cases. I did try to make it clear that it's not a fad if IBM has 1500 people working on it, BITA has hundreds of logistics and freight companies signed up to explore possibilities, and the World Bank, OECD, and United Nations have studies and pilot programs devoted to it. As a former supply chain person, compliance officer, and chief privacy officer, I'm giddy with excitement about everything related to distributed ledger technology other than cryptocurrency. You can see why when you read my law review article in a few months in Transactions.
I've watched over 100 YouTube videos (many of them crappy) and read dozens of articles. I go to Meetups and actually understand what the coders and developers are saying (most of the time). A few students and practitioners asked me how I learned about DLT/blockchain. First, see here, here, here, and here for my prior posts listing resources and making the case for learning the basics of the technology. What I list below adds to what I've posted in the past.
Here are some of the podcasts I listen to (there are others, of course):
1) The Decrypting Crypto Podcast
2) Block that Chain
3) Block and Roll
4) Blockchain Innovation
Here are some of the videos that I watched (that I haven't already linked to in past posts):
There are dozens more, but this should be enough to get you started. Remember, none of these videos or podcasts will get you rich from cryptocurrency. But they will help you become competent to know whether you can advise clients on these issues.
September 16, 2018 in Compliance, Corporate Governance, Corporations, CSR, Current Affairs, Financial Markets, Human Rights, Law Firms, Law Reviews, Law School, Lawyering, Marcia Narine Weldon | Permalink | Comments (1)
Thursday, August 16, 2018
On Tuesday, Elizabeth Warren penned an article in The Wall Street Journal entitled Companies Shouldn’t Be Accountable Only to Shareholders: My new bill would require corporations to answer to employees and other stakeholders as well.
The article announced and promoted her Accountable Capitalism Act. With Republicans in control of Congress and the White House, Warren’s bill almost certainly doesn’t stand a chance of passing in the short-term.
Yet, because the bill draws on benefit corporation governance, a main scholarly interest of mine, and because it may foreshadow moves by a Democrat-controlled Congress in the future, I decided to read the 28-page bill and report here briefly.
Portions of the bill summarized:
- As has been widely reported, the bill only applies to companies with more than $1 billion in revenue.
- The bill seeks to establish an “Office of United States Corporations” within the Department of Commerce, which will review, grant, and rescind charters for the large companies covered by the bill.
- The bill takes language from benefit corporation law and requires that U.S. Corporations must have a purpose to serve a “general public benefit” – “a material positive impact on society resulting from the business and operations of a United States corporation, when taken as a whole.” This purpose is in addition to any purpose in the company’s state filing.
- The governance requirements are a mix of the Model Benefit Corporation Legislation and Delaware version of benefit corporation law – requiring both that directors balance the “pecuniary interests of shareholders” with the "best interests of persons that are materially affected by the conduct of the United States corporation” (drawn from Delaware) and that directors consider a litany of stakeholders in their decisions (including shareholders, employees, customers, community, local and global environment - drawn from the Model). Only shareholders with 2%+ of the shares can sue derivatively.
- Employees must elect 40%+ of the board of directors.
- 75%+ of shareholders and 75%+ of directors must approve political spending of over $10,000 on a single candidate.
My brief thoughts:
- This is a lot of press for benefit corporations.
- The press may not be good for benefit corporation proponents who have been largely able to pitch to both sides of the political aisle in their state bills. B Lab co-founder Jay Coen Gilbert has already written an article trying to promote what he sees as the bipartisan nature of benefit corporations: Elizabeth Warren, Republicans, CEOs & BlackRock's Fink Unite Around 'Accountable Capitalism'
- I have noted in my scholarly work how the state benefit corporation laws fail to align the purported “general public benefit” corporate purpose with effective accountability mechanisms. This bill, however, takes one step toward aligning company purpose and accountability by requiring that employees elect 40%+ of the board. Of course, that still leaves out many other stakeholders that directors are supposed to consider, and shareholders are still the only stakeholders with the ability to sue derivatively. A better solution is to have stakeholder representatives who elect the entire board and also possess, collectively, the right to sue derivatively. This stakeholder representative framework, articulated in my 2017 American Business Law Journal article, has the benefit of keeping the board united on a common goal – instead of fighting on behalf of the single stakeholder group who elected them – while also being held to account by representatives of all major stakeholder groups, collectively.
- Suggesting that benefit corporation law become mandatory will likely not be popular among many conservatives. See, e.g., this early response in the National Review: Elizabeth Warren’s Batty Plan to Nationalize . . . Everything. Currently, a fair response to conservative critics of state benefit corporation laws is "if businesses do not like the benefit corporation framework, they can just choose to be a traditional corporation." This bill attempts to remove that choice for large companies.
(My co-blogger Joshua Fershee may be horrified to learn that the bill purports to apply not only to corporations, but also to LLCs, even though they use the term "U.S. Corporations" throughout).
Tuesday, January 9, 2018
The new semester is upon us, and AALS (as it tends to) ran right into the new semester. Joan Heminway provided a nice overview of some of her activities, including her recognition as an outstanding mentor by the Section on Business Associations, and it was a pleasure to see her recognized for her tireless and consistent efforts to make all of us better. Congratulations, Joan, and thank you!
I, too, had a busy conference, with most of it condensed to Friday and Saturday. (As a side note, it was pretty great to run along the water in 55-65 degree weather. As much as I love New York and appreciate San Francisco and DC, I'd be quite content with AALS moving between San Diego and New Orleans.) I spoke on a panel with my co-bloggers, as Joan noted, about shareholder proposals, and I spoke on a panel about the green economy and sustainability, which was also fun. It's nice when I am able to spend some time with a focus on my two main areas of research.
As to our panel on shareholder proposals, I thought I'd share a few of my thoughts. First, as I have explained in the past, I am not anti-activist investor, even though I often think their proposals are wrong headed. I think shareholder (and hedge fund) activist can add value, even when they are wrong, as long as directors continue to exercise their judgment and lead the firm appropriately.
Second, although I tend to have a bias for staying the course and leaving many laws and regulations alone, I am open to some changes for shareholder proposals. The value of the current system (especially one that has been in place for some time) is that everyone knows the rules, which means there is some level of efficiency for all the players.
That said, the threshold for shareholder proposals has been in places since the 1950s. The Financial Choice Act looks to move the proxy threshold from $2,000 and one-year holdings to a 1%/three-year hurdle. That is a pretty big move. Updating the $2,000 threshold from 1960 would mean raising the threshold to around $16,000, so a move to what can be millions may be too much. But $16,000 (basically updating for inflation), would make some sense to me, too. Anyway, just a few simple thoughts to start the year. Hope your classes are starting well.