Wednesday, December 30, 2020
BLPB readers, I hope that everyone is enjoying the holiday season and the semester break! I also want to get an early start on wishing everyone a HAPPY NEW YEAR!!!
Before we leave 2020, I wanted to share that if you missed Bank Supervision: Past, Present, and Future, a stellar virtual conference hosted by the Federal Reserve Board of Governors, Harvard Law School, and the Wharton School on December 11, you can still access the conference materials here. There's lots of great stuff, including four literature reviews (below) that banking law profs researching in this area are certain to find helpful. Enjoy! And a big shout-out to the hosts for such a successful event!
Literature Review on Economics: Beverly Hirtle, Banking Supervision: The Perspective from Economics
Literature Review on Law: Julie Andersen Hill, Bank Supervision: A Legal Scholarship Review
Literature Review on History: Sean H. Vanatta, Histories of Bank Supervision
Sunday, December 27, 2020
In my previous post on the "Study on Directors' Duties and Sustainable Corporate Governance" ("Study on Directors' Duties") that Ernst & Young prepared for the European Commission (Commission), I focused on the transformative power of corporate governance. I said that stakeholder capitalism would have a practical value if supported by corporate governance rules based on appropriate standards such as the ones provided by the Sustainable Development Goals (SDGs).
Some of my pointers for the Commission were the creation of a regulatory framework that enables the representation and protection of stakeholders, the representation of “stakewatchers,” that is, non-governmental organizations and other pressure groups through the attribution of voting and veto rights and their members’ nomination to the management board (similar to German co-determination). I also suggested expanding directors' fiduciary duties to include the protection of stakeholders’ interests, accountability of corporate managers, consultation rights, and additional disclosure requirements.
In my last guest post in this series dedicated to the Study on Directors’ Duties, I ask the following questions. Do investors have a moral duty to internalize externalities such as climate change and income inequality, for example? Do firm ownership and investor commitment matter? Should investors’ money be “moral” money?
In their study Corporate Purpose in Public and Private Firms, Claudine Gartenberg and George Serafeim utilize Rebecca Henderson’s and Eric Van den Steen’s definition of corporate purpose, that is, “a concrete goal or objective for the firm that reaches beyond profit maximization.” In their paper, Gartenberg and Serafeim analyzed data from approximately 1.5 million employees across 1,108 established public and private companies in the US. In their words:
[W]e find that employee beliefs about their firm’s purpose is weaker in public companies. This difference is most pronounced within the salaried middle and hourly ranks, rather than senior executives. Among private firms, purpose is lower in private equity owned firms. Among public companies, purpose is lower for firms with high hedge fund ownership and higher for firms with long-term investors. We interpret our findings as evidence that higher owner commitment is associated with a stronger sense of purpose among employees within the firm.
With institutional investors on the rise, these findings are important because they redirect our attention from the board of directors’ short-termism discussion to shareholders' nature, composition, ownership, and long-term commitment. When it comes to owner commitment, Gartenberg and Serafeim say:
Owner commitment could lead to a stronger sense of purpose for multiple reasons. First, to the extent that commitment translates to an ability to think about the long-term and avoid short-term pressures, this would enable a firm to focus on its purpose rather than on solely short-term performance metrics. Second, committed owners may invest to gain and evaluate more soft information about firms, which in turn may allow managers to invest in productive but hard to verify projects that otherwise would not be approved by less committed owners (e.g., Grossman and Hart, 1986). Third, committed owners might mitigate free rider problems inside the firm, allowing employees to make firm-specific investments with greater confidence that they will not be subject to holdup by firm principals (Alchian and Demsetz 1972; Williamson 1985), which in turn could enhance the sense of purpose inside the organization. A similar argument could hold for customers, suppliers, and other stakeholders, who could see a strong sense of corporate purpose from owner commitment as a credible signal that enables the development of trust or ‘relational contracts’ (Gibbons and Henderson 2012; Gartenberg et al. 2019).
Gertenberg’s and Serafeim’s paper also discloses other findings. They found that firms are more likely to hire outside CEOs when less committed investors control the firms. Additionally, those firms are more likely to pay higher executive compensation levels, particularly relative to what they pay employees. Those firms also engage more frequently in mergers and acquisitions and other corporate restructuring processes. A simple explanation for this would be that such firms have higher agency costs since their ownership is more dispersed.
If we understand the company’s ownership structure, we know the purpose of the company. Therefore, there must be an underlying mechanism to better understand the company’s ownership structure because it will help us understand the company's purpose better.
Besides, Gertenberg’s and Serafeim’s findings spell out that financial performance and corporate ownership positively impact corporate culture, employees' satisfaction, and employee work meaningfulness. Putting it differently, the corporate culture, employees' satisfaction, and employee work meaningfulness can be standards for evaluating the impact of corporate ownership, governance, and leadership.
Now that the focus is on investors, what can they do to change corporate behavior and consequently impact stakeholders like employees? They can be actively engaged through proxy voting. In their paper Shareholder Value(s): Index Fund ESG Activism and the New Millennial Corporate Governance, Barzuza, Curtis, and Webber explain that index funds often are considered ineffective stewards. The authors also explain how index funds have claimed an active role by challenging management and voting against directors to promote board diversity and sustainability.
Still, institutional investors manage their companies’ portfolios depending on the market, which is heavily impacted by systemic shocks we know will eventually occur. The Covid-19 pandemic has shown us how volatile markets are and our current economic model is.
Corporate laws of most European Union (EU) countries determine that the board of directors must act in the company's interest (e.g., Unternehmensinteresse in Germany, l'intérêt social in France, interesse sociale in Italy, etc.). Defining what the interest of the company is has shown to be a rather tricky endeavor. Gelter explains that, in all cases, one side of the debate claims that the company's interest is different from the interest of shareholders. In the US, the purpose of the company is commingled with the idea of shareholder wealth maximization.
To overcome the tension between prioritizing shareholders' wealth maximization and corporate purpose that considers shareholders' and stakeholders' interests, the Commission should take into account the following dimensions in developing policies in corporate law and corporate governance.
- Investors’ ownership and their impact on intangibles like employees’ satisfaction and employee work meaningfulness.
- Governance structure and how it relates to the company’s ownership structure.
- Governance structure and how it integrates stakeholders’ interests in the decision-making process.
- Board diversity and recruitment.
- Institutional investors’ financial resilience.
Finally, investors should demand CEOs and boards of directors show how they are changing the game and moving the needle toward a more sustainable and resilient conception of the corporation. Why? Because ownership matters and commitment too.
December 27, 2020 in Agency, Business Associations, Comparative Law, Corporate Governance, Corporations, CSR, Financial Markets, Law and Economics, M&A, Private Equity, Shareholders | Permalink | Comments (0)
Sunday, December 20, 2020
In my first post on the "Study on Directors' Duties and Sustainable Corporate Governance" ("Study on Directors' Duties") prepared by Ernst & Young for the European Commission, I said that corporate boards are free to apply a purposive approach to profit generation. I added that:
[a]pplying such a purposive approach will depend on moral leadership, CEOs' and corporate boards' long-term vision, clear measurement of the companies' interests and communication of those interests to shareholders, and rethinking executive compensation to encourage board members to take on other priorities than shareholder value maximization. Corporate governance has a significant transformative role to play in this context.
This week, I focus on corporate governance’s enabling power. Therefore, “T” is for transformative corporate governance. Market-led developments can and do precede and inspire legal rules. Corporate governance rules are not an exception in this regard. To illustrate these rules’ transformative potential, I dwell on the ongoing debate around stakeholder capitalism.
First question. What is stakeholder capitalism? In a recent debate with Lucian Bebchuk about the topic, Alex Edmans explained that “stakeholder capitalism seeks to create shareholder welfare only through creating stakeholder welfare.” The definition suggests that the way to create value for both shareholders and stakeholders alike is by increasing the size of the pie.
In his book, Strategic Management: A Stakeholder Approach, R. Edward Freeman defines “stakeholder” as “any group or individual who can affect or is affected by the achievement of the organisation’s objectives.” (1984: p. 46). The Study on Directors’ Duties is concerned with the negative impact of corporate short-termism on stakeholders such as the environment, the society, the economy, and the extent to which corporate short-termism may impair the protection of human rights and the attainment of the sustainable development goals (SDGs). I am not going to discuss whether there is a causal link between short-termism and sustainability. In my previous post, I say that we need to take a step back to determine short-termism and whether it is as harmful as it sounds. Instead, I am interested in finding an answer to the following question. Has stakeholder capitalism practical value?
Edmans points out that “in a world of uncertainty, stakeholder capitalism is practically more useful.” It is more challenging to put a tag on various things in a world of uncertainty, and the market misvalues intangibles. Therefore, in this context, stakeholder capitalism would be a better decisional tool that improves shareholder value and profitability and shareholders' welfare.
Still, how do we measure CEO’s and directors’ accountability toward shareholders and the corporation for the choices they make? Can CEOs and directors be blamed for not caring about social causes? Is stakeholder capitalism, or as Lucian Bebchuk calls it “stakeholderism,” the right way to force managers to make the right decisions for the shareholders and the corporation?
While Edmans stays firmly behind stakeholder capitalism because he considers it has practical value in increasing shareholder wealth while increasing shareholders’ welfare, Bebchuk maintains that “stakeholderism” is “illusory” and costly both for shareholders and stakeholders. Clearly, they disagree.
However, both Edmans and Bebchuk agree on this – we need a normative framework that goes beyond private ordering and prevents companies from subjecting stakeholders to externalities such as climate change, inequality, poverty, and other adverse economic effects.
Corporate managers respond to incentives such as executive compensation, financial reporting, and shareholders' ownership. The challenge is to understand what type of corporate governance rules are more likely to nudge CEOs and managers to value other interests than shareholder wealth maximization. Would a set of principles suffice, or do we need a regulatory framework?
Freeman's definition of a stakeholder is telling because it allows us to think of corporations and governments as stakeholders for sustainable development. I am also inspired by the distinction that Yves Fassin makes in his article The Stakeholder Model Refined, between stakeholders (e.g., consumers), stakewatchers (e.g., non-governmental organizations) and stakekeepers (e.g., regulators). I suggest that the way to ensure stakeholder capitalism’s practical value is to create corporate governance rules based on appropriate standards. The SDGs afford the propriety of those standards.
Within this regulatory setting, corporate governance will fulfill its transformative potential by enabling, for example, the representation and protection of stakeholders, the representation of “stakewatchers” through the attribution of voting and veto rights and nomination to the management board (similar to German co-determination by which stakeholders like employees are appointed to the supervisory board). Corporate governance will show its transformative potential by enabling the expansion of directors' fiduciary duties to include the protection of stakeholders’ interests, accountability of corporate managers, consultation rights, and additional disclosure requirements.
The authors Onyeka K. Osuji and Ugochi C. Amajuoyi contributed an interesting piece, titled Sustainable Consumption, Consumer Protection and Sustainable Development: Unbundling Institutional Septet for Developing Economies to the book Corporate Social Responsibility in Developing and Emerging Markets: Institutions, Actors and Sustainable Development. The book was edited by Onyeka K. Osuji, Franklin N. Ngwu, and Dima Jamali. The piece addresses the stakeholder model from the emerging economies perspective. It goes to show how interconnected we are.
Friday, December 18, 2020
If you read the title, you’ll see that I’m only going to ask questions. I have no answers, insights, or predictions until the President-elect announces more cabinet picks. After President Trump won the election in 2016, I posed eleven questions and then gave some preliminary commentary based on his cabinet picks two months later. Here are my initial questions based on what I’m interested in -- compliance, corporate governance, human rights, and ESG. I recognize that everyone will have their own list:
- How will the Administration view disclosures? Will Dodd-Frank conflict minerals disclosures stay in place, regardless of the effectiveness on reducing violence in the Democratic Republic of Congo? Will the US add mandatory human rights due diligence and disclosures like the EU??
- Building on Question 1, will we see more stringent requirements for ESG disclosures? Will the US follow the EU model for financial services firms, which goes into effect in March 2021? With ESG accounting for 1 in 3 dollars of assets under management, will the Biden Administration look at ESG investing more favorably than the Trump DOL? How robust will climate and ESG disclosure get? We already know that disclosure of climate risks and greenhouse gases will be a priority. For more on some of the SEC commissioners’ views, see here.
- President-elect Biden has named what is shaping up to be the most diverse cabinet in history. What will this mean for the Trump administration’s Executive Order on diversity training and federal contractors? How will a Biden EEOC function and what will the priorities be?
- Building on Question 3, now that California and the NASDAQ have implemented rules and proposals on board diversity, will there be diversity mandates in other sectors of the federal government, perhaps for federal contractors? Is this the year that the Improving Corporate Governance Through Diversity Act passes? Will this embolden more states to put forth similar requirements?
- What will a Biden SEC look like? Will the SEC human capital disclosure requirements become more precise? Will we see more aggressive enforcement of large institutions and insider trading? Will there be more controls placed on proxy advisory firms? Is SEC Chair too small of a job for Preet Bharara?
- We had some of the highest Foreign Corrupt Practices Act fines on record under Trump’s Department of Justice. Will that ramp up under a new DOJ, especially as there may have been compliance failures and more bribery because of a world-wide recession and COVID? It’s more likely that sophisticated companies will be prepared because of the revamp of compliance programs based on the June 2020 DOJ Guidance on Evaluation of Corporate Compliance Programs and the second edition of the joint SEC/DOJ Resource Guide to the US Foreign Corrupt Practices Act. (ok- that was an insight).
- How will the Biden Administration promote human rights, particularly as it relates to business? Congress has already taken some action related to exports tied to the use of Uighur forced labor in China. Will the incoming government be even more aggressive? I discussed some potential opportunities for legislation related to human rights abuses abroad in my last post about the Nestle v Doe case in front of the Supreme Court. One area that could use some help is the pretty anemic Obama-era US National Action Plan on Responsible Business Conduct.
- What will a Biden Department of Labor prioritize? Will consumer protection advocates convince Biden to delay or dismantle the ERISA fiduciary rule? Will the 2020 joint employer rule stay in place? Will OSHA get the funding it needs to go after employers who aren’t safeguarding employees with COVID? Will unions have more power? Will we enter a more worker-friendly era?
- What will happen to whistleblowers? I served as a member of the Department of Labor’s Whistleblower Protection Advisory Committee for a few years under the Obama administration. Our committee had management, labor, academic, and other ad hoc members and we were tasked at looking at 22 laws enforced by OSHA, including Sarbanes-Oxley retaliation rules. We received notice that our services were no longer needed after the President’s inauguration in 2017. Hopefully, the Biden Administration will reconstitute it. In the meantime, the SEC awarded record amounts under the Dodd-Frank whistleblower program in 2020 and has just reformed the program to streamline it and get money to whistleblowers more quickly.
- What will President-elect Biden accomplish if the Democrats do not control the Congress?
There you have it. What questions would you have added? Comment below or email me at firstname.lastname@example.org.
December 18, 2020 in Compliance, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Financial Markets, Human Rights, International Business, Legislation, Marcia Narine Weldon, Securities Regulation, Shareholders, White Collar Crime | Permalink | Comments (2)
Sunday, December 13, 2020
This is my second post in a series of blog posts on the "Study on Directors' Duties and Sustainable Corporate Governance ("Study on Directors' Duties") prepared by Ernst & Young for the European Commission.
In 2015, the world gathered at the United Nations Sustainable Development Summit for the adoption of the Post-2015 development agenda. That Summit was convened as a high-level plenary meeting of the United Nations General Assembly. At this meeting, Resolution A/70/L.1, Transforming our World: The 2030 Agenda for Sustainable Development, was adopted by the General Assembly. In 2016, the Paris Agreement was signed. In my last post, I called both the United Nations 2030 Agenda and the Paris Agreement trendsetters because they kicked-off a global discussion on sustainable development at so many levels, including at the financial level.
During the 2015 United Nations Sustainable Development Summit, I recall that the Civil Society representatives called for a UN resolution on sustainable capital markets to tackle the absence of concrete actions regarding global financial sustainability following the 2008 Great Recession.
At the end of 2016, the European Commission (Commission) created the High-Level Expert Group on Sustainable Finance (HLEG). In early 2018, the HLEG published its report. Shortly after, in 2018, the European Union (EU) published the Action Plan: Financing Sustainable Growth (EU's Action Plan) based on the HLEG’s report. I want to focus for a bit on Action 10 of the EU's Action Plan: Fostering Sustainable Corporate Governance and Attenuating Short-Termism in Capital Markets. Action 10 sets forth the following:
1.To promote corporate governance that is more conducive to sustainable investments, by Q2 2019, the Commission will carry out analytical and consultative work with relevant stakeholders to assess: (i) the possible need to require corporate boards to develop and disclose a sustainability strategy, including appropriate due diligence throughout the supply chain, and measurable sustainability targets; and (ii) the possible need to clarify the rules according to which directors are expected to act in the company's long-term interest.
2.The Commission invites the ESAs to collect evidence of undue short-term pressure from capital markets on corporations and consider, if necessary, further steps based on such evidence by Q1 2019. More specifically, the Commission invites ESMA to collect information on undue short-termism in capital markets, including: (i) portfolio turnover and equity holding periods by asset managers; (ii) whether there are any practices in capital markets that generate undue short-term pressure in the real economy.
Under the EU's Action Plan, in 2019, the Commission called the three European Supervisory Authorities (ESAs) to collect evidence of undue short-term pressure from the financial sector on corporations. These supervisory authorities include the European Banking Authority (EBA), the European Securities and Markets Authority (ESMA), and the European Insurance and Occupational Pension Authority (EIOPA). The reports from EBA, ESMA, and EIOPA reviewed the relevant financial literature and identified potential short-term pressures on corporations.
In 2019, the European Commission Directorate-General Justice and Consumers organized a conference on "Sustainable Corporate Governance" that reunited policy-makers to discuss policy developments on corporate governance within Action 10 of the EU's Action Plan.
The Study on Directors' Duties builds on Action 10. As it reads in the Study:
[T]he need for urgent action to attenuate short-termism and promote sustainable corporate governance is clearly identified in the Action Plan on Financing Sustainable Growth, 137 put forward by the European Commission in 2018. The Action Plan recognises that, despite the efforts made by several European companies, pressures from capital markets lead company directors and executives to fail to consider long-term sustainability risks and opportunities and be overly focused on short-term financial performance. Action 10 of the Action Plan is therefore aimed at "fostering sustainable corporate governance and attenuating short-termism in capital markets." The present study implements Action 10, together with other studies aimed at investigating complementary aspects of short-termism,138 which shows European Commission's commitment to explore this complex problem from different angles and find an integrated response.
Before moving forward, it is pressing to define short-termism. In this context, obtaining empirical evidence to infer causation is important for policy advice. When it comes to defining short-termism, in a recent Policy Workshop on Directors' Duties and Sustainable Corporate Governance, Zach Sautner defined short-termism as a reflection of actions (e.g., investment, payouts) that focus on short-term gains at the expense of the long-term value of the corporation. The concept of short-termism encompasses a certain form of value destruction, an undue focus on short-term earnings or stock price, and a notion of market inefficiency. Suppose a CEO favors short-term earnings or makes decisions (e.g., buybacks) to the detriment of the corporation's long-term value. Then, if the market is efficient, it should signal that something is not right.
Still, I cannot avoid asking: is short-termism the right problem that needs fixing? The discussion around short-termism is puzzling because there is a vehement academic debate whether there even exists short-termism or whether it is as harmful as it sounds. For example, in their paper, Long-Term Bias, Michal Barzuza & Eric Talley explain how corporate managers can become hostages of long-term bias, which can be as damaging for investors as short-termism.
If short-termism and its effects are as negative as they sound, what kind of incentives do managers have to overcome it? Corporate managers act based on incentives such as executive compensation, financial reporting, and shareholders' ownership. Is this bad news for those who firmly stand behind stakeholders who can be undoubtedly impacted by the corporation's performance?
The bottom line is this. We need a clearer perspective on short-termism. Suppose one says that excessive payouts are not the problem. They are the symptom. However, even this bold statement needs to be taken with a grain of salt. It is difficult to assess if payouts (e.g., dividends, buybacks) are excessive if we do not know if there is a short-termism problem.
Wednesday, December 9, 2020
In doing my weekly SSRN search, I was absolutely delighted to see Professor Ron Berndsen’s Five Fundamental Questions on Central Counterparties (here) (note: these institutions are sometimes also referred to as CCPs or clearinghouses). Berndsen has produced an extensive and invaluable review of the “booming literature on CCPs, of which about 60% is published in the last five years.” As he notes, this area “can be considered as the most important niche of financial economics.”
Berndsen organizes the review through “asking five fundamental questions about CCPs.” Table 6 on p.30 (copied below) provides these questions and shortened answers.
I am grateful to Berndsen for writing this article, proposing future research topics based on his extensive review of the literature, and providing a comprehensive bibliography (even if it has increased my "to read" list!). An abstract of the article is below:
Central counterparties (CCPs) are designed to reduce aggregate counterparty credit risk and function as market infrastructures for capital markets in securities and derivatives. Although CCPs, also known as clearing houses, exist for well over a century, they have gained prominence since they became the main international public policy response to the Lehman crisis of making over-the-counter derivative transactions safer. This G20's response to the Lehman crisis of making central clearing mandatory for standardized over-the-counter derivative transactions has been translated into law, Dodd-Frank for the US and EMIR for the EU. However, CCPs remain to some extent controversial with adversaries claiming that they potentially increase systemic risk and proponents viewing them as systemic risk reducing when properly designed and maintained. In this article I review the booming literature on CCPs, of which about 60% is published in the last five years, by asking five fundamental questions about CCPs. The aim is to construct a broad, academically substantiated, synthesis about CCPs and to propose directions for future research in what can be considered as the most important niche of financial economics.
Wednesday, November 18, 2020
Yesterday, the Financial Stability Board (FSB) released a report: Holistic Review of the March Market Turmoil (Report). It contains lots of really interesting information and is well worth a read (for a quick overview, there’s an Executive Summary and a two minute YouTube video of Randal K. Quarles, FSB Chair and a Governor of the Federal Reserve System, discussing the Report).
I thought its emphasis on the increasingly central role of market liquidity to financial market resilience particularly important. Today, both the traditional, highly regulated banking system and the market-based credit system provide credit to the economy. These systems are interconnected and roughly equivalent in size. Although the market-based credit system – non-bank financial intermediation (NBFI) – looks, smells, and acts like banking, it is not similarly regulated nor does it have access to deposit insurance or the Federal Reserve’s lender of last resort liquidity facility. Nevertheless, in the financial crisis of 2007-09 and this past March, the Federal Reserve provided extraordinary liquidity and other support to the NBFI to promote financial stability and address bank-like runs.
On p.2, the Report notes that “The need to intervene in such a substantial way has meant that central banks had to take on material financial risk. This could lead to moral hazard issues in the future, to the extent that markets do not fully internalise their own liquidity risk in anticipation of future central bank interventions in times of stress.” The Report explains on p.33 just how extensive this recent central bank support was: “Overall, these measures lead to a US$7 trillion increase in G7 central bank assets in just eight months (Graph 5.1). In contrast, G7 central bank assets only rose by about US$3 trillion in the year following the collapse of Lehman Brothers in 2008.”
The market-based credit system underprices liquidity risk. Measures must be taken to address this significant issue. As I wrote in The Federal Reserve As Last Resort (footnotes removed from quote):
Liquidity is not free. Liquidity risk is one of the fundamental risks in financial markets. All else being equal, liquid financial assets are less risky than illiquid ones and, therefore, worth more. Financial investors generally expect to receive a "liquidity premium" for illiquid financial assets. In the past, however, both economic and financial theories have sometimes treated liquidity as costless. And international financial institutions have long mismanaged and mispriced liquidity risk. Not surprisingly, liquidity assistance emerged as one of the most sought-after remedies provided by the Federal Reserve and central banks around the world during the financial crisis.
On p.50, the Report states that “Taken together, the measures introduced [by central banks] essentially removed risk from investors and transferred it to the balance sheet of central banks and hence of the public sector as a whole.” I’m excited for the FSB’s upcoming “work programme” on NBFI (see p.3 of the Report for details), and hope that in the future, investors will be required to retain more of their contracted for risk and that the resilience of this sector greatly improves.
Friday, October 23, 2020
It’s hard to believe that the US will have an election in less than two weeks. Three years ago, a month after President Trump took office, I posted about CEOs commenting on his executive order barring people from certain countries from entering the United States. Some branded the executive order a “Muslim travel ban” and others questioned whether the CEOs should have entered into the political fray at all. Some opined that speaking out on these issues detracted from the CEOs’ mission of maximizing shareholder value. But I saw it as a business decision - - these CEOs, particularly in the tech sector, depended on the skills and expertise of foreign workers.
That was 2017. In 2018, Larry Fink, CEO of BlackRock, told the largest companies in the world that “to prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society…Without a sense of purpose, no company, either public or private, can achieve its full potential. It will ultimately lose the license to operate from key stakeholders.” Fink’s annual letter to CEOs carries weight; BlackRock had almost six trillion dollars in assets under management in 2018, and when Fink talks, Wall Street listens. Perhaps emboldened by the BlackRock letter, one year later, 181 CEOs signed on to the Business Roundtable's Statement on the Purpose of a Corporation, which “modernized” its position on the shareholder maximization norm. The BRT CEOs promised to invest in employees, deal ethically and fairly with suppliers, and embrace sustainable business practices. Many observers, however, believed that the Business Roundtable statement was all talk and no action. To see how some of the signatories have done on their commitments as of last week, see here.
Then came 2020, a year like no other. The United States is now facing a global pandemic, mass unemployment, a climate change crisis, social unrest, and of course an election. During the Summer of 2020, several CEOs made public statements on behalf of themselves and their companies about racial unrest, with some going as far as to proclaim, “Black Lives Matter.” I questioned these motives in a post I called “"Wokewashing and the Board." While I admired companies that made a sincere public statement about racial justice and had a real commitment to look inward, I was skeptical about firms that merely made statements for publicity points. I wondered, in that post, about companies rushing to implement diversity training, retain consultants, and appoint board members to either curry favor with the public or avoid the shareholder derivative suits facing Oracle, Facebook, and Qualcomm. How well had they thought it out? Meanwhile, I noted that my colleagues who have conducted diversity training and employee engagement projects for years were so busy that they were farming out work to each other. Now the phones aren’t ringing as much, and when they are ringing, it’s often to cancel or postpone training.
Why? Last month, President Trump issued the Executive Order on Combatting Race and Sex Stereotyping. As the President explained:
today . . . many people are pushing a different vision of America that is grounded in hierarchies based on collective social and political identities rather than in the inherent and equal dignity of every person as an individual. This ideology is rooted in the pernicious and false belief that America is an irredeemably racist and sexist country; that some people, simply on account of their race or sex, are oppressors; and that racial and sexual identities are more important than our common status as human beings and Americans ... Therefore, it shall be the policy of the United States not to promote race or sex stereotyping or scapegoating in the Federal workforce or in the Uniformed Services, and not to allow grant funds to be used for these purposes. In addition, Federal contractors will not be permitted to inculcate such views in their employees.
The Order then provides a hotline process for employees to raise concerns about their training. Whether you agree with the statements in the Order or not -- and I recommend that you read it -- it had a huge and immediate effect. The federal government is the largest procurer of goods and services in the world. This Order applies to federal contractors and subcontractors. Some of those same companies have mandates from state law to actually conduct training on sexual harassment. Often companies need to show proof of policies and training to mount an affirmative defense to discrimination claims. More important, while reasonable people can disagree about the types and content of diversity training, there is no doubt that employees often need training on how to deal with each other respectfully in the workplace. (For a thought-provoking take on a board’s duty to monitor diversity training by co-blogger Stefan Padfield, click here.)
Perhaps because of the federal government’s buying power, the U.S. Chamber of Commerce felt compelled to act. On October 15th, the Chamber and 150 organizations wrote a letter to the President stating:
As currently written, we believe the E.O. will create confusion and uncertainty, lead to non-meritorious investigations, and hinder the ability of employers to implement critical programs to promote diversity and combat discrimination in the workplace. We urge you to withdraw the Executive Order and work with the business and nonprofit communities on an approach that would support appropriate workplace training programs ... there is a great deal of subjectivity around how certain content would be perceived by different individuals. For example, the definition of “divisive concepts” creates many gray areas and will likely result in multiple different interpretations. Because the ultimate threat of debarment is a possible consequence, we have heard from some companies that they are suspending all D&I training. This outcome is contrary to the E.O.’s stated purpose, but an understandable reaction given companies’ lack of clear guidance. Thus, the E.O. is already having a broadly chilling effect on legitimate and valuable D&I training companies use to foster inclusive workplaces, help with talent recruitment, and remain competitive in a country with a wide range of different cultures. … Such an approach effectively creates two sets of rules, one for those companies that do business with the government and another for those that do not. Federal contractors should be left to manage their workforces and workplaces with a minimum amount of interference so long as they are compliant with the law.
It’s rare for the Chamber to make such a statement, but it was bold and appropriate. Many of the Business Roundtable signatories are also members of the U.S. Chamber, and on the same day, the BRT issued its own statement committing to programs to advance racial equity and justice. BRT Chair and WalMart CEO Doug McMillon observed, “the racial inequities that exist for many Black Americans and people of color are real and deeply rooted . . These longstanding systemic challenges have too often prevented access to the benefits of economic growth and mobility for too many, and a broad and diverse group of Americans is demanding change. It is our employees, customers and communities who are calling for change, and we are listening – and most importantly – we are taking action.” Now that's a stakeholder maximization statement if I ever heard one.
Those who thought that some CEOs went too far in protesting the Muslim ban, may be even more shocked by the BRT’s statements about the police. The BRT also has a subcommittee to address racial justice issues and noted that “For Business Roundtable CEOs, this agenda is an important step in addressing barriers to equity and justice . . . This summer we took on the urgent need for policing reform. We called on Congress to adopt higher federal standards for policing, to track whether police departments and officers have histories of misconduct, and to adopt measures to hold abusive officers accountable. Now, with announcement of this broader agenda, CEOs are supporting policies and undertaking initiatives to address several other systems that contribute to large and growing disparities.”
Now that stakeholders have seen so many of these social statements, they have asked for more. Last week, a group of executives from the Leadership Now Project issued a statement supporting free and fair elections. However, as Bennett Freeman, former Calvert executive and Clinton cabinet member noted, no Fortune 500 CEOs have signed on to that statement. Yesterday, the Interfaith Center on Corporate Responsibility (ICCR) sent a letter to 200 CEOs, including some members of the BRT asking for their support. ICCR asked that they endorse:
- Active support for free and fair elections
- A call for a thorough and complete counting of all ballots
- A call for all states to ensure a fair election
- A condemnation of any tactics that could be construed as voter intimidation
- Assurance that, should the incumbent Administration lose the election, there will be a peaceful transfer of power
- Ensure that lobbying activities and political donations support the above
Is this a pipe dream? Do CEOs really want to stick their necks out in a tacit criticism of the current president’s equivocal statements about his post-election plans? Now that JPMorgan Chase CEO Jamie Dimon has spoken about the importance of respect for the democratic process and the peaceful transfer of power, perhaps more executives will make public statements. But should they? On the one hand, the markets need stability. Perhaps Dimon was actually really focused on shareholder maximization after all. Nonetheless, Freeman and others have called for a Twitter campaign to urge more CEOs to speak out. My next post will be up on the Friday after the election and I’ll report back about the success of the hashtag activism effort. In the meantime, stay tuned and stay safe.
October 23, 2020 in Contracts, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Employment Law, Ethics, Financial Markets, Human Rights, Legislation, Management, Marcia Narine Weldon, Nonprofits, Stefan J. Padfield | Permalink | Comments (1)
Wednesday, October 7, 2020
Securities Financing and Derivatives Markets Interconnections and Potentials for Greater Transactional Efficiencies
I just did a quick read through ISDA’s new whitepaper, Collaboration and Standardization Opportunities in Derivatives and SFT Markets. “SFT” stands for securities financing transactions. I encourage anyone studying these markets to at least review its Executive Summary. As it states “This paper explains and illustrates how and why two large, important and interconnected markets – derivatives and securities financing transactions (SFTs) – could collaborate to achieve greater standardization and improved efficiency.” (p. 3)
It's divided into two parts: 1) an overview of the relevant markets (repo, stock loan, and derivatives), their interconnectedness, and possibilities for and benefits of greater transactional efficiencies, and 2) a proposal for implementing these objectives.
Much of the paper focuses on market interconnections, which strongly argue for the possibility of improved transactional efficiencies. I kept thinking about interconnections from a systemic risk/financial stability perspective, and how (if at all) promoting greater transactional efficiencies (which, at least at first glance, seems like a good idea) might impact such considerations.
I encourage more of us in the banking and financial institutions area to give additional thought to systemic risk and financial stability issues related to securities lending, including due to its interconnections with derivatives markets. For example, while there has been much written about AIG’s CDS problems in the 2007-08 financial crisis, comparatively little work has addressed the securities lending issues it had (for example, see Securities Lending and the Untold Story in the Collapse of AIG). Nevertheless, “Participants in the SFT and derivatives markets have traditionally overlapped. Banks (including investment banks, commercial banks and central banks), prime brokers, funds (including hedge funds, pension funds and sovereign wealth funds) and market infrastructures (such as clearing houses) are among the biggest players in both the derivatives and SFT markets.” (p. 12)
Well, once I finish my article on NCWOL claims for clearinghouse shareholders for the upcoming BLPB Virtual Symposium, maybe I’ll turn my attention to clearinghouses and securities lending. I’d also love to see more work in this area by BLPB readers, and if you’ve an article related to these topics, please do send it my way!
Wednesday, September 9, 2020
Just today, Professor Christopher Odinet posted Predatory Fintech and the Politics of Banking (forthcoming, Iowa Law Review) to SSRN (here). It's already been downloaded over 100 times, and I can't wait to read it! Here's the Abstract:
With American families living on the financial edge and seeking out high cost loans even before COVID-19, the term financial technology or “fintech” has been used like an incantation aimed at remedying everything that’s wrong with America’s financial system. Scholars and supporters from both the public and private sector proclaim that innovations in financial technology will “bank the unbanked” and open new channels to affordable credit. This exuberance for all things tech in finance has led to a quiet yet aggressive deregulatory agenda, including, as of late, a federal assault via rulemaking on the ability of states to police the cost and privilege of extending credit within their borders. This deregulation and the ethos behind it have made space for growth in high cost, predatory lending that reaches across state lines via websites and smart phones and that is aggressively targeting cash-strapped families. These loans are made using a business model whereby funds are funneled through a group of lightly regulated banks in a way designed to take advantage of federal preemption. Fintech companies rent out and profit from the special legal status of these bank partners, which in turn keeps the bank’s involvement in the shadows. Stripping down fintech’s predatory practices and showing them for what they really are, this Article situates fintech in the context of this country’s longstanding dual banking wars, both between states and the federal government and between consumer advocates and banking regulators. And it points the way forward for scholars and regulators willing to shake off fintech’s hypnotic effect. This means, in the short term, using existing regulatory tools to curtail the dangerous lending identified here, including by taking a more expansive view of what it means for a bank to operate safely and soundly under the law. In the long term, it means having a more comprehensive and national discussion about how we regulate household credit in the digital age, specifically through the convening of a Twenty-First Century Commission on Consumer Finance. The Article explains how and why the time is ripe to do both. As the current pandemic wipes out wages and decimates savings, leaving desperate families turning to predatory fintech finance ever more, the need for reform has never been greater.
Saturday, September 5, 2020
I think that the GCs at Big Pharma have hacked into my Zoom account. First, some background. Earlier this week, I asked my students in UM’s Lawyering in a Pandemic course to imagine that they were the compliance officers or GCs at the drug companies involved in Operation Warp Speed, the public-private partnership formed to find a vaccine for COVID-19 in months, rather than years. I asked the students what they would do if they thought that the scientists were cutting corners to meet the government’s deadlines. Some indicated that they would report it internally and then externally, if necessary.
I hated to burst their bubbles, but I explained that the current administration hasn’t been too welcoming to whistleblowers. I had served on a non-partisan, multi-stakeholder Department of Labor Whistleblower Protection Advisory Committee when President Trump came into office, which was disbanded shortly thereafter. For over a year after that, I received calls from concerned scientists asking where they could lodge complaints. With that background, I wanted my students to think about how company executives could reasonably would report on cutting corners to the government that was requiring the “warp speed” results in the first place. We didn’t even get into the potential ethical issues related to lawyers as whistleblowers.
Well the good news is that Pfizer, Moderna, Johnson & Johnson, GlaxoSmithKline, and Sanofi announced on Friday that they have signed a pledge to make sure that they won’t jeopardize public safety by ignoring protocols. Apparently, the FDA may be planning its own statement to reassure the public. I look forward to seeing the statements when they’re released, but these companies have been working on these drugs for months. Better late than never, but why issue this statement now? Perhaps the lawyers and compliance officers – the gatekeepers – were doing their jobs and protecting the shareholders and the stakeholders. Maybe the scientists stood their ground. We will never know how or why the companies made this decision, but I’m glad they did. The companies hadn’t announced this safety pledge yet when I had my class and at the time, almost none of the students said they would get the vaccine. Maybe the pledge will change their minds.
Although the drug companies seem to be doing the right thing, I have other questions about Kodak. During the same class, I had asked my students to imagine that they were the GC, compliance officer, or board member at Kodak. Of course, some of my students probably didn’t even know what Kodak is because they take pictures with their phones. They don’t remember Kodak for film and cameras and absolutely no one knows Kodak as a pharmaceutical company. Perhaps that’s why everyone was stunned when Kodak announced a $765 million federal loan to start producing drug ingredients, especially because it’s so far outside the scope of its business. After all, the company makes chemicals for film development and manufacturing but not for life saving drugs. Kodak has struggled over the past few years because it missed the boat on digital cameras and has significant debt, filing for bankruptcy in 2012. It even dabbled in cryptocurrency for a few months in 2018. Not the first choice to help develop a vaccine.
To be charitable, Kodak did own a pharmaceutical company for a few years in the 80’s. But its most recent 10-K states that “Kodak is a global technology company focused on print and advanced materials and chemicals. Kodak provides industry-leading hardware, software, consumables and services primarily to customers in commercial print, packaging, publishing, manufacturing and entertainment.”
The Kodak deal became even more newsworthy because the company issued 1.75 million in stock and options to the CEO and other grants to company insiders and board members before the public announcement of the federal loan. The CEO had only had the job for a year. I haven’t seen any news reports of insiders complaining or refusing the grants. In fact, the day after the announcement of the loan, a Kodak board member made a $116 million dollar donation to charity he founded. Understandably, the news of the deal caused Kodak’s shares to soar. Insiders profited, and the SEC started asking questions after looking at records of the stock trades.
Alas, the deal is on hold as the SEC investigates. The White House’s own trade advisor has said that this may be “one of the dumbest decisions by executives in corporate history.” I’m not sure about that, but there actually may be nothing to see here. Some believe that there was a snafu with the timing of the announcement and that the nuances of Reg FD may get Kodak off the hook .I wonder though, what the gatekeepers were doing? Did the GC, compliance officer, or any board member ask the obvious questions? “Why are we doing something so far outside of our core competency?” They didn’t even get the digital camera thing right and that is Kodak’s core competency. Did anyone ask “should we really be issuing options and grants right before the announcement? Isn’t this loan material, nonpublic information and shouldn’t we wait to trade?”
I’ll keep watching the Kodak saga and will report back. In coming posts, I’ll write about other compliance and corporate governance mishaps. In the meantime, stay safe and please wear your masks.
September 5, 2020 in Compensation, Compliance, Corporate Governance, Corporate Personality, Corporations, Current Affairs, Ethics, Financial Markets, Lawyering, Management, Marcia Narine Weldon, Securities Regulation, Shareholders, Technology | Permalink | Comments (0)
Wednesday, August 19, 2020
As I shared last week (here), many of us who study banking law and regulation are watching the path of Lacewell v. Office of the Comptroller of the Currency (OCC), a case about the OCC’s power to grant federal fintech charters to nondepository institutions, that is in the Second Circuit Court of Appeals. We've been treated to dueling banking law prof amicus curiae briefs (additional amicus briefs were also filed). In this week’s post, I’ll highlight the brief written by Professor David Zaring at the Wharton School. Download Zaring_Brief
Zaring has previously written about OCC chartering practices (here). He argues that “the OCC has the authority to issue special purpose national bank charters for financial technology (fintech) companies pursuant to the National Bank Act and 12 C.F.R. §5.20(e)(1).” Hence, the District Court’s judgement should be reversed.
First, as Zaring notes, the core issue here really is: “what is banking?” He argues that the “the business of banking” is “susceptible to more than one meaning,” and that receipt of deposits is not an essential aspect of what it is to be a bank. The plain text of 12 C.F.R. §5.20(e)(1) “allow[s] national banks to obtain an SPNB [special purpose national bank] charter so long as they conduct at least one of three enumerated functions-(1) receive deposits, (2) pay checks, or (3) lend money.” Second, the OCC has a history of taking a cautious, “reasoned approach to charters,” and it “is not trying to hide an elephant in a mousehole or expand the definition of the ‘business of banking’ out of all recognition…” Indeed, Zaring asserts, “the agency’s past practice with special charters illustrates its caution.” Third, it’s costly and unwise to require online fintech firms “to tailor their businesses by state borders,” because of the U.S.’s dual banking system. “Few industries benefit more from regulation at the national level than industries that exist on the internet.” Fourth, the lack of a federal fintech charter is costly to the U.S. in terms of “investment in financial technology,” and international competitiveness in this arena. Finally, the OCC’s “chartering decisions are reviewable,” and, “if appropriate,” the “Court should clarify” this.
Zaring does an excellent job of explaining why the OCC has the authority to grant federal fintech charters to nondepository institutions, and I encourage BLPB readers to review his brief. As I previously noted, the answer to what might seem to be a technical banking law question of interest to few (and perhaps uninteresting to most) will have tremendous practical ramifications.
Stay tuned for Part III! I’ll plan to update BLPB readers when the Second Circuit Court of Appeals issues its decision.
Friday, August 14, 2020
As an academic and consultant on environmental, social, and governance (ESG) matters, I’ve used a lot of loaded terms -- greenwashing, where companies tout an environmentally friendly record but act otherwise; pinkwashing, where companies commoditize breast cancer awareness or LGBTQ issues; and bluewashing, where companies rally around UN corporate social responsibility initiatives such as the UN Global Compact.
In light of recent events, I’ve added a new term to my arsenal—wokewashing. Wokewashing occurs when a company attempts to show solidarity with certain causes in order to gain public favor. Wokewashing isn’t a new term. It’s been around for years, but it gained more mainstream traction last year when Unilever’s CEO warned that companies were eroding public trust and industry credibility, stating:
Woke-washing is beginning to infect our industry. It’s polluting purpose. It’s putting in peril the very thing which offers us the opportunity to help tackle many of the world’s issues. What’s more, it threatens to further destroy trust in our industry, when it’s already in short supply… There are too many examples of brands undermining purposeful marketing by launching campaigns which aren’t backing up what their brand says with what their brand does. Purpose-led brand communications is not just a matter of ‘make them cry, make them buy’. It’s about action in the world.
The Black Lives Matter and anti-racism movements have brought wokewashing front and center again. My colleague Stefan Padfield has written about the need for heightened scrutiny of politicized decisions and corporate responses to the BLM movement here, here, and here, and Ann Lipton has added to the discussion here. How does a board decide what to do when faced with pressure from stakeholders? How much is too much and how little is too little?
The students in my summer Regulatory Compliance, Corporate Governance, and Sustainability course were torn when they acted as board members deciding whether to make a public statement on Black Lives Matter and the murder of George Floyd. As fiduciaries of a consumer goods company, the “board members” felt that they had to say “something,” but in the days before class they had seen the explosion of current and former employees exposing companies with strong social justice messaging by pointing to hypocrisy in their treatment of employees and stakeholders. They had witnessed the controversy over changing the name of the Redskins based on pressure from FedEx and other sponsors (and not the Native Americans and others who had asked for the change for years). They had heard about the name change of popular syrup, Aunt Jemima. I intentionally didn’t force my students to draft a statement. They merely had to decide whether to speak at all, and this was difficult when looking at the external realities. Most of the students voted to make some sort of statement even as every day on social media, another “woke” company had to defend itself in the court of public opinion. Others, like Nike, have received praise for taking a strong stand in the face of public pressure long before it was cool and profitable to be “woke.”
Now it’s time for companies to defend themselves in actual court (assuming plaintiffs can get past various procedural hurdles). Notwithstanding Facebook and Oracle’s Delaware forum selection bylaws, the same lawyers who filed the shareholder derivative action against Google after its extraordinary sexual harassment settlement have filed shareholder derivative suits in California against Facebook, Oracle, and Qualcomm. Among other things, these suits generally allege breach of the Caremark duty, false statements in proxy materials purporting to have a commitment to diversity, breach of fiduciary duty relating to a diverse slate of candidates for board positions, and unjust enrichment. Plaintiffs have labeled these cases civil rights suits, targeting Facebook for allowing hate speech and discriminatory advertising, Qualcomm for underpaying women and minorities by $400 million, and Oracle for having no Black board members or executives. Oracle also faces a separate class action lawsuit based on unequal pay and gender.
Why these companies? According to the complaints, “[i]f Oracle simply disclosed that it does not want any Black individuals on its Board, it would be racist but honest…” and “[a]t Facebook, apparently Zuckerberg wants Blacks to be seen but not heard.” Counsel Bottini explained, “when you actually go back and look at these proxy statements and what they’ve filed with the SEC, they’re actually lying to shareholders.”
I’m not going to discuss the merits of these cases. Instead, for great analysis, please see here written by attorneys at my old law firm Cleary Gottlieb. I’ll do some actual legal analysis during my CLE presentation at the University of Tennessee Transactions conference on October 16th.
Instead, I’m going to make this a little more personal. I’m used to being the only Black person and definitely the only Black woman in the room. It’s happened in school, at work, on academic panels, and in organizations. When I testified before Congress on a provision of Dodd-Frank, a Black Congressman who grilled me mercilessly during my testimony came up to me afterwards to tell me how rare it was to see a Black woman testify about anything, much less corporate issues. He expressed his pride. For these reasons, as a Black woman in the corporate world, I’m conflicted about these lawsuits. Do corporations need to do more? Absolutely. Is litigation the right mechanism? I don’t know.
What will actually change? Whether or not these cases ever get past motions to dismiss, the defendant companies are likely to take some action. They will add the obligatory Black board members and executives. They will donate to various “woke” causes. They will hire diversity consultants. Indeed, many of my colleagues who have done diversity, equity, and inclusion work for years are busier than they have ever been with speaking gigs and training engagements. But what will actually change in the long term for Black employees, consumers, suppliers, and communities?
When a person is hired or appointed as the “token,” especially after a lawsuit, colleagues often believe that the person is under or unqualified. The new hire or appointee starts under a cloud of suspicion and sometimes resentment. Many eventually resign or get pushed out. Ironically, I personally know several diversity officers who have left their positions with prestigious companies because they were hired as window dressing. Although I don’t know Morgan Stanley’s first Chief Diversity Officer, Marilyn Booker, her story is familiar to me, and she has now filed suit against her own company alleging racial bias.
So I’ll keep an eye on what these defendants and other companies do. Actions speak louder than words. I don’t think that shareholder derivative suits are necessarily the answer, but at least they may prompt more companies to have meaningful conversations that go beyond hashtag activism.
August 14, 2020 in Ann Lipton, Compliance, Consulting, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Delaware, Financial Markets, Management, Marcia Narine Weldon, Shareholders, Stefan J. Padfield | Permalink | Comments (0)
Thursday, August 13, 2020
Those of us who study banking law and regulation know it’s an absolutely exciting area! That’s particularly true at the moment. Not only are we watching the path of Lacewell v. Office of the Comptroller of the Currency (OCC), a case about the OCC’s power to grant federal fintech charters to nondepository institutions, currently in the Second Circuit Court of Appeals, but we’ve also been treated to dueling banking law prof amicus curiae briefs (additional amicus briefs were also filed). In this week’s post, I’ll highlight the brief led by Lev Menand, Saule Omarova, Morgan Ricks, Joe Sommer, and Art Wilmarth, and signed by thirty-three banking law scholars (here).
The professors begin by stating their interest: “ensuring that banking agencies stay within their statutory mandates and work in the public interest.” They term the OCC’s proposal to charter nondepository fintech firms “a dangerous power grab premised on the novel claim that banking is just another word for lending.” In a nutshell, the scholars argue that “the OCC does not have the power to charter entities that are not in the deposit – that is, money creation – business.” It’s actually illegal – as the brief notes – for “unregulated entities to receive deposits.” “Bank deposits constitute the bulk of our nation’s money supply, and it is for this reason that banks are subject to strict federal oversight…Creating deposit dollars is a delegated sovereign privilege – an extremely sensitive activity that justifies federal chartering, regulation, and supervision.” The OCC’s very name is linked to the nation’s currency system!
As the brief explains, if the OCC were to be able to grant federal fintech charters to nondepository institutions, this would result in a significant expansion of its regulatory authority. It would also impact the governance of the Federal Reserve, and expand access to Fed master accounts and discount window lending. Additionally, as banks are exempt from the coverage of the federal securities laws and investment company laws, it would impact the coverage of these laws, and it would even create “an alternative, OCC-controlled system of business organization available to a huge range of companies.”
Indeed, the answer to what might seem to be a technical banking law question of interest to few (and perhaps boring to most) will have tremendous ramifications. The professors do an excellent job of explaining the implications of the OCC having the authority to grant federal fintech charters, and I encourage BLPB readers to review their brief.
Stay tuned for Part II, next Wednesday!! I’ll be highlighting Professor David Zaring’s Amicus Curiae Brief supporting the OCC’s position.
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.