Wednesday, October 13, 2021
For BLPB readers interested in financial market infrastructures (FMIs), there’s something new and exciting to put on your fall reading list! Don’t wait too long. Comments on the new CPMI-IOSCO Consultative report: Application of the Principles for Financial Market Infrastructures to stablecoin arrangements are due by December 1, 2021.
At the request of the G7, G20, and FSB, the standard setting bodies have produced a “report [that] provides guidance on the application of the Principles for financial market infrastructures (PFMI) to systematically important stablecoin arrangements (SAs), including the entities integral to such arrangements.”
The Executive Summary notes that: “Notwithstanding the fact that the transfer function of SAs is considered an FMI function for the purpose of applying the PFMI, SAs may present some notable and novel features as compared with existing FMIs. These notable features relate to: (i) the potential use of settlement assets that are neither central bank money nor commercial bank money and carry additional financial risk; (ii) the interdependencies between multiple SA functions; (iii) the degree of decentralisation of operations and/or governance; and (iv) a potentially large-scale deployment of emerging technologies such as distributed ledger technology (DLT).”
The report’s guidance is summarized in Table 1 (p. 5-6) and there are nine questions for consultation (p.7).
Once I’ve thought more about the report, I might return to it in a future post. Policymakers are increasingly focused on the regulation of stablecoins and other cryptocurrencies. The topic’s importance is sure only to increase.
Wednesday, September 29, 2021
I had a chance to read Chapter 7 on Clearinghouses [CCPs] in a recent report by the Task Force on Financial Stability and look forward to reading more of the report soon. It’s a short chapter with a lot of excellent information. I particularly appreciated its focus on the issue of clearinghouse ownership (too often left out of clearinghouse discussions), incentive misalignments, and tensions between shareholders and clearing members when CCPs are for-profit, public companies. There is an especially helpful discussion on externalities in the current clearing ecosystem and a summary table of them accompanied by related recommendations (p.99). I agreed with several of the chapter's recommendations (starting on p.96) and with the statement that “Pervasive reforms of derivatives markets following 2008 are, in effect, unfinished business; the systemic risk of CCPs has been exacerbated and left unaddressed” (p.96).
On p.94, the report mentions that clearing members “complained when, in December 2017, the CBOE and CME listed bitcoin contracts (which have extremely high volatility and which many members were not authorized to transact) and then commingled the contracts with the default fund for other instruments.” I think the complaints are understandable and pointed out this issue in a previous post (here).
I did have feedback about a few items in the chapter and will share two points:
First, on p.93, the report states “Were a CCP to fail, something that has not yet occurred, the disruption to the financial system could be enormous.” It’s certainly true that a failed, significant CCP would likely cause enormous disruptions in financial markets. However, as I note in my 2016 report for the Volcker Alliance (p.52), CCPs have failed in other countries and some have argued that certain CCPs in the U.S. risked failure in the October 1987 crash.
Second, I’d like to see a lot more discussion of recommendation #3 (p.97):
“Make sure that systemically important CCPs outside the United States have access to a lender of last resort who can provide dollar funding. This might be provided through a foreign central bank that is willing and able to lend and has access to a Fed swap line. If such funding is not available, and conditioned on a Fed finding that a non-U.S. CCP is adequately supervised, the Fed should consider extending access to the discount window to systemic non-U.S. CCPs. (Currently access is restricted to FSOC-designated systemically important financial market utilities.) It is in the United States’ interest to prevent the failure of systemic CCPs around the world. If a properly supervised entity needs access to dollar funding, and satisfactory information sharing is in place to limit risk, discount window access would strengthen the system.”
In The Federal Reserve's Use of International Swap Lines, I noted that from my perspective, certain provisions in Dodd-Frank appeared to anticipate the possibility of Fed swap lines with CCPs outside the U.S. (p.648). The risk of potentially having to provide emergency euro funding to clearinghouses outside the Eurozone has been an important aspect of the longstanding tensions between the U.K. and the E.U. surrounding clearing (a few stories on this are here, here, and here). The E.U. has argued that because of this financial stability risk, such clearing should be relocated to the Eurozone. Hence, the issue of a major central bank having to provide emergency funding to a foreign clearinghouse is a highly significant concern and merits extensive discussion.
Friday, September 24, 2021
I'm so excited to present later this morning at the University of Tennessee College of Law Connecting the Threads Conference today at 10:45 EST. Here's the abstract from my presentation. In future posts, I will dive more deeply into some of these issues. These aren't the only ethical traps, of course, but there's only so many things you can talk about in a 45-minute slot.
All lawyers strive to be ethical, but they don’t always know what they don’t know, and this ignorance can lead to ethical lapses or violations. This presentation will discuss ethical pitfalls related to conflicts of interest with individual and organizational clients; investing with clients; dealing with unsophisticated clients and opposing counsel; competence and new technologies; the ever-changing social media landscape; confidentiality; privilege issues for in-house counsel; and cross-border issues. Although any of the topics listed above could constitute an entire CLE session, this program will provide a high-level overview and review of the ethical issues that business lawyers face.
Specifically, this interactive session will discuss issues related to ABA Model Rules 1.5 (fees), 1.6 (confidentiality), 1.7 (conflicts of interest), 1.8 (prohibited transactions with a client), 1.10 (imputed conflicts of interest), 1.13 (organizational clients), 4.3 (dealing with an unrepresented person), 7.1 (communications about a lawyer’s services), 8.3 (reporting professional misconduct); and 8.4 (dishonesty, fraud, deceit).
Discussion topics will include:
- Do lawyers have an ethical duty to take care of their wellbeing? Can a person with a substance use disorder or major mental health issue ethically represent their client? When can and should an impaired lawyer withdraw? When should a lawyer report a colleague?
- What ethical obligations arise when serving on a nonprofit board of directors? Can a board member draft organizational documents or advise the organization? What potential conflicts of interest can occur?
- What level of technology competence does an attorney need? What level of competence do attorneys need to advise on technology or emerging legal issues such as SPACs and cryptocurrencies? Is attending a CLE or law school course enough?
- What duties do lawyers have to educate themselves and advise clients on controversial issues such as business and human rights or ESG? Is every business lawyer now an ESG lawyer?
- What ethical rules apply when an in-house lawyer plays both a legal role and a business role in the same matter or organization? When can a lawyer representing a company provide legal advice to an employee?
- With remote investigations, due diligence, hearings, and mediations here to stay, how have professional duties changed in the virtual world? What guidance can we get from ABA Formal Opinion 498 issued in March 2021? How do you protect confidential information and also supervise others remotely?
- What social media practices run afoul of ethical rules and why? How have things changed with the explosion of lawyers on Instagram and TikTok?
- What can and should a lawyer do when dealing with a businessperson on the other side of the deal who is not represented by counsel or who is represented by unsophisticated counsel?
- When should lawyers barter with or take an equity stake in a client? How does a lawyer properly disclose potential conflicts?
- What are potential gaps in attorney-client privilege protection when dealing with cross-border issues?
If you need some ethics CLE, please join in me and my co-bloggers, who will be discussing their scholarship. In case Joan Heminway's post from yesterday wasn't enough to entice you...
Professor Anderson’s topic is “Insider Trading in Response to Expressive Trading”, based upon his upcoming article for Transactions. He will also address the need for business lawyers to understand the rise in social-media-driven trading (SMD trading) and options available to issuers and their insiders when their stock is targeted by expressive traders.
Professor Baker’s topic is “Paying for Energy Peaks: Learning from Texas' February 2021 Power Crisis.” Professor Baker will provide an overview of the regulation of Texas’ electric power system and the severe outages in February 2021, explaining why Texas is on the forefront of challenges that will grow more prominent as the world transitions to cleaner energy. Next, it explains competing electric power business models and their regulation, including why many had long viewed Texas’ approach as commendable, and why the revealed problems will only grow more pressing. It concludes by suggesting benefits and challenges of these competing approaches and their accompanying regulation.
Professor Heminway’s topic is “Choice of Entity: The Fiscal Sponsorship Alternative to Nonprofit Incorporation.” Professor Heminway will discuss how for many small business projects that qualify for federal income tax treatment under Section 501(a) of the U.S. Internal Revenue Code of 1986, as amended, the time and expense of organizing, qualifying, and maintaining a tax-exempt nonprofit corporation may be daunting (or even prohibitive). Yet there would be advantages to entity formation and federal tax qualification that are not available (or not easily available) to unincorporated business projects. Professor Heminway addresses this conundrum by positing a third option—fiscal sponsorship—and articulating its contextual advantages.
Professor Moll’s topic is “An Empirical Analysis of Shareholder Oppression Disputes.” This panel will discuss how the doctrine of shareholder oppression protects minority shareholders in closely held corporations from the improper exercise of majority control, what factors motivate a court to find oppression liability, and what factors motivate a court to reject an oppression claim. Professor Moll will also examine how “oppression” has evolved from a statutory ground for involuntary dissolution to a statutory ground for a wide variety of relief.
Professor Murray’s topic is “Enforcing Benefit Corporation Reporting.” Professor Murray will begin his discussion by focusing on the increasing number of states that have included express punishments in their benefit corporation statutes for reporting failures. Part I summarizes and compares the statutory provisions adopted by various states regarding benefit reporting enforcement. Part II shares original compliance data for states with enforcement provisions and compares their rates to the states in the previous benefit reporting studies. Finally, Part III discusses the substance of the benefit reports and provides law and governance suggestions for improving social benefit.
All of this and more from the comfort of your own home. Hope to see you on Zoom today and next year in person at the beautiful UT campus.
September 24, 2021 in Colleen Baker, Compliance, Conferences, Contracts, Corporate Governance, Corporate Personality, Corporations, CSR, Current Affairs, Delaware, Ethics, Financial Markets, Haskell Murray, Human Rights, International Business, Joan Heminway, John Anderson, Law Reviews, Law School, Lawyering, Legislation, Litigation, M&A, Management, Marcia Narine Weldon, Nonprofits, Research/Scholarhip, Securities Regulation, Shareholders, Social Enterprise, Teaching, Unincorporated Entities, White Collar Crime | Permalink | Comments (0)
Wednesday, September 1, 2021
Last spring, I blogged about a University of Colorado Law School Symposium honoring Professor Art Wilmarth (here). Professor Jeremy C. Kress recently posted his symposium-related piece, Who's Looking Out For The Banks? It addresses an important bank governance issue that thus far has received too little attention. Here's its abstract:
When the Gramm-Leach-Bliley Act authorized financial conglomeration in 1999, Professor Arthur Wilmarth, Jr. presciently predicted that diversified financial holding companies would try to exploit their bank subsidiaries by transferring government subsidies to their nonbank affiliates. To prevent financial conglomerates from taking advantage of their insured depository subsidiaries in this way, policymakers instructed a bank’s board of directors to act in the best interests of the bank, rather than the bank’s holding company. This symposium Article, written in honor of Professor Wilmarth’s retirement, contends that this legal safeguard ignores a critical conflict of interest: the vast majority of large-bank directors also serve as board members of their parent holding companies. These dual directors are therefore poorly situated to exercise the independent judgment necessary to protect a bank from exploitation by its nonbank affiliates. This Article proposes to strengthen bank governance — and better insulate banks from their nonbank affiliates — by mandating that some of a bank’s directors must be unaffiliated with its holding company. As long as banks are permitted to affiliate with nonbanks, this reform is essential to ensure that someone is looking out for the well-being of insured depository institutions.
Friday, August 6, 2021
In January of 2020, The Bharara Task Force on Insider Trading released its report recommending that Congress adopt sweeping reforms of our insider trading enforcement regime. And it appears there is at least some momentum building to act on this recommendation. In April of 2021, the House of Representatives passed the Promoting Transparent Standards for Corporate Insiders Act, and in May of 2021, the House passed the Insider Trading Prohibition Act. I have expressed some concerns about these bills (see, e.g., here and here). But, as I argue in my book, Insider Trading: Law, Ethics, and Reform, I am in complete agreement with the claim that our current insider trading regime is broken and needs to be reformed.
We should not, however, rush to adopt a new insider trading regime without first thoughtfully considering what constitutes insider trading; why it is wrong; who is harmed by it; and the nature and extent of the harm. The answers to these questions have been subject to endless academic debate, but are crucial for determining whether insider trading should be regulated civilly and/or criminally (or not at all), as well as for determining the nature and magnitude of any sanctions to be imposed.
Historically, insider trading regimes around the globe can be grouped (roughly) into four categories (listed from the least to most restrictive): (a) laissez-faire regimes, which permit all trading on information asymmetries, so long as there is no affirmative fraud (actual misrepresentations or concealment); (b) fiduciary-fraud regimes, which recognize a duty to disclose or abstain from trading, but only for those who share a recognized duty of trust and confidence (with either the counterparty to the trade, or with the source of the information, or both); (c) equal-access regimes, which preclude trading by those who have acquired information advantages by virtue of their privileged access to sources that are structurally closed to other market participants (regardless of whether such trading violates a duty of trust and confidence); and (d) parity-of-information regimes, which strive to prohibit all trading on material nonpublic information (regardless of the source).
The following scenario illustrates conduct that would expose the trader to liability under a parity-of-information regime, but not under an equal access, fiduciary-fraud, or laissez-faire regime. As you read through the fact pattern, ask yourself: (1) Is this trading wrong? (2) Who (if anyone) is harmed by it? (3) What is the nature and extent of the harm? (4) Should this trading be regulated (civilly or criminally)? (Please share any answers/thoughts in the comments below!):
A high-school janitor is traveling home from work late at night on a public bus. She looks down and sees a trampled piece of paper. She picks up the paper and reads it. It appears to be someone’s notes from a meeting—though there is nothing to identify the paper’s owner/author. The paper reads as follows:
Meet at HQ of XYZ Corp at 3PM on Jan. 3 to finalize the merger with BIG Corp. Merger to be announced to public on Jan 10. Note: the announcement of merger will send shares of XYZ through the roof, so everyone must maintain strict confidentiality.
The janitor looks up and sees the bus is totally empty. There is no chance of finding the person who dropped the paper. It is January 4. The janitor opens an online brokerage account when she gets home and buys as many shares of XYZ Corp as she can afford. She makes huge profits when the merger is announced on January 10.
If you do not think the janitor has done anything wrong or harmful in this scenario, then you will probably not favor the parity-of-information model for insider trading regulation—which would render this conduct illegal. You will likely favor some version of one of the other insider-trading models instead. My next post will offer a scenario to test our intuitions about the equal-access model (the second-most restrictive regime).
The hope is that walking through these scenarios will help bring some clarity to our shared understanding of when trading on material nonpublic information is wrong and harmful—and (given our answer to this question) the nature and extent to which it should be regulated.
Friday, July 23, 2021
Professor Martin Edwards (Belmont University College of Law) and I are excited to moderate a discussion group titled, “A Very Online Economy: Meme Trading, Bitcoin, and the Crisis of Trust and Value(s)—How Should the Law Respond,” at the 2022 American Association of Law Schools Annual Meeting. The discussion group is scheduled to take place (virtually) on Friday, January 7, 2022. We welcome responses to the call for participation (here). Here’s the description:
Emergent forces emanating from social and financial technologies are challenging many underlying assumptions about the workings of markets, the nature of firms, and our social relationship with our economic institutions. The 21st century economy and financial architecture are built on faith and trust in centralized institutions. Perhaps it is not surprising that in 2008, a time where that faith and trust waned, a different architecture called “blockchain” emerged. It promised “trustless” exchange, verifiable intermediation, and “decentralization” of value transfer.
In 2021, the financial architecture and its institutions suffered a broadside from socialmedia-fueled “meme” and “expressive” traders. It may not be a coincidence that many of these traders reached adulthood around 2008, when the crisis called into question whether that real money, those real securities, or that real, fundamental value were really real at all. People are engaging with questions about social values in an increasingly uneasy way. There is a flux not only in the substantive values, but also with what set of institutions people should trust to produce, disseminate, and enforce values.
One question is what role business corporations might play in this moment, which is being worked out most prominently through discussions about environmental and social governance (ESG). Social and financial technologies may be rewriting longstanding assumptions about social and economic institutions. Blockchains challenge our assumptions about the need for centralization, trust, and institutions, while meme or expressive trading and ESG challenge our assumptions about economic value, market processes, and social values.
It promises to be a great discussion!
Saturday, June 26, 2021
The AALS Section on Financial Institutions and Consumer Financial Services invites submissions of no more than five pages for its session at the 2022 annual meeting of the AALS. Next year’s annual meeting will be held virtually from January 5-9, 2022, with the date and time of the Section’s session yet to be announced. The submission can be the abstract and/or introduction from a longer paper, and it should relate to the following session description:
Climate Finance and Banking Regulation: Beyond Disclosure?
In the United States, banking regulation has been slower than other forms of financial regulation (and slower than its European counterparts) to address climate-related financial risks. This panel explores the proper role of banking regulation in addressing the physical and transition risks from climate change. Possible measures include: standardized, mandatory climate risk disclosures by banks; supervisory assessments of climate-related financial risk; capital and liquidity regulation; climate risk scenario tests; determination of the appropriate role of banks in mitigating climate risk; financial stability oversight of climate risk; and action (through the Community Reinvestment Act and otherwise) to deter harms to disadvantaged communities and communities of color from climate change.
Please email your anonymized materials by Friday, July 16, 2021, to Joe Graham, firstname.lastname@example.org. Please also indicate, in addition to the proposal submission of up to five pages: (a) whether you are tenured, pre-tenure, or other; (b) whether you are in your first five years as a law professor (including any years spent as a fellow or visiting assistant professor); (c) how far along the full article is and when you expect to complete the discussion draft; and (d) optionally, how you would contribute to diverse perspectives in our field or on the panel.
The Section will announce the author(s) selected to present by no later than early September, 2021.
On behalf of the Section on Financial Institutions and Consumer Financial Protection
Chair: Patricia A. McCoy (Boston College)
Chair-Elect: Paolo Saguato (George Mason University)
Executive Committee Members:
Hilary Allen (American University)
Abbye Atkinson (University of California, Berkeley)
Felix Chang (University of Cincinnati)
Gina-Gail S. Fletcher (Duke University)
Pamela Foohey (Indiana University)
Kathryn Judge (Columbia University)
Michael Malloy (University of the Pacific)
Christopher Odinet (University of Iowa)
Jennifer Taub (Western New England University)
Rory Van Loo (Boston University)
David Zaring (The Wharton School)
Friend of the BLPB, Professor Sagi Peari, recently shared the great news about the publication of his second book with Oxford University Press, International Negotiable Instruments (w/Professor Benjamin Geva). A huge congratulations to the profs on this impressive accomplishment on such an important topic! Here's the book abstract:
For centuries, negotiable instruments have played a vital role in the smooth operation of domestic and international commerce. The payment mechanisms have been subject to rapid technological progress and law has needed to adapt and respond to ensure that the legal framework remains relevant and effective. This book provides a comprehensive and thorough analysis of the question of applicable law to negotiable instruments. Specifically, the authors challenge the conventional view according to which the fundamentals of negotiable instruments law are excluded from the scope and insights of general contract and property law doctrines and as such not subject to the general conflict of laws rules governing them. The authors make concrete suggestions for reform and contemplate on the nature of the conflict of laws rules that can also be applied in the digital age of communication.
Wednesday, June 16, 2021
Lev Menand, Academic Fellow and Lecturer in Law at Columbia Law School, has recently published Why Supervise Banks? The Foundations of the American Monetary Settlement, 74 Vanderbilt Law Review 951 (2021). Menand has actually worked in the Federal Reserve Bank of New York's Bank Supervision Group. I'm excited to read this article as banking law scholars are increasingly focused on the area of bank supervision and I've no doubt it makes a significant contribution to the literature. Here's the article's abstract:
Administrative agencies are generally designed to operate at arm’s length, making rules and adjudicating cases. But the banking agencies are different: they are designed to supervise. They work cooperatively with banks and their remedial powers are so extensive they rarely use them. Oversight proceeds through informal, confidential dialogue.
Today, supervision is under threat: banks oppose it, the banking agencies restrict it, and scholars misconstrue it. Recently, the critique has turned legal. Supervision’s skeptics draw on a uniform, flattened view of administrative law to argue that supervision is inconsistent with norms of due process and transparency. These arguments erode the intellectual and political foundations of supervision. They also obscure its distinguished past and deny its continued necessity.
This Article rescues supervision and recovers its historical pedigree. It argues that our current understanding of supervision is both historically and conceptually blinkered. Understanding supervision requires understanding the theory of banking motivating it and revealing the broader institutional order that depends on it. This Article terms that order the “American Monetary Settlement” (“AMS”). The AMS is designed to solve an extremely difficult governance problem—creating an elastic money supply. It uses specially chartered banks to create money and supervisors to act as outsourcers, overseeing the managers who operate banks.
Supervision is now under increasing pressure due to fundamental changes in the political economy of finance. Beginning in the 1950s, the government started to allow nonbanks to expand the money supply, devaluing the banking franchise. Then, the government weakened the link between supervision and money creation by permitting banks to engage in unrelated business activities. This transformation undermined the normative foundations of supervisory governance, fueling today’s desupervisory movement. Desupervision, in turn, cedes public power to private actors and risks endemic economic instability.
Wednesday, June 9, 2021
On June 3rd, the United States Court of Appeals for the Second Circuit (Court) decided Lacewell v. Office of the Comptroller of the Currency (here). I’d previously blogged about the “Dueling Law Professor Amicus Curiae Briefs” (here and here, see Appendix A of the Opinion for a listing of these briefs) in this heavily watched federal fintech charter case about whether the Office of the Comptroller of the Currency (OCC) has the authority to issue special-purpose national bank (SPNB) charters for fintech firms “engaged in the ‘business of banking,’ including those that do not accept deposits.” I promised to update BLPB readers when the Court rendered its decision.
In a nutshell, the Court reversed the district court's amended judgement and remanded “with instructions to enter a judgement of dismissal without prejudice.” The Court explained that DFS [the New York State Department of Financial Services, of which plaintiff Lacewell is Superintendent] lacked “standing because it failed to allege that the OCC’s decision caused it to suffer an actual or imminent injury in fact and...that DFS’s claims are constitutionally unripe for substantially the same reason.” Given these considerations, the Court stated that it did not have the jurisdiction to “address the district court’s holding, on the merits, that the ‘business of banking’ under the NBA [National Bank Act] unambiguously requires the receipt of deposits, nor whether that holding warrants setting aside Section 5.20(e)(1)(i) [OCC regulation permitting issuance of SPNB charters] nationwide with respect to non-depository fintechs applying for SPNB charters.” It added that “we express no view on the district court’s determinations regarding these issues.”
Of course, what constitutes the business of banking – whether deposit taking is required by the NBA to be a chartered bank – is the critical issue. Stay tuned! In the meantime, law firm analyses are available (for example, here and here) for readers interested in a more extensive discussion of this decision!
Wednesday, June 2, 2021
I thought I'd essentially copy the idea behind co-blogger Joshua Fershee's post from yesterday (thanks, Josh!) and share with readers that my new short article, Clearinghouse Shareholders and "No Creditor Worse Off Than in Liquidation" Claims is now available! Similarly, my article is a combination of a prior post and my presentation at the fourth annual Business Law Prof Blog Symposium. Here's its abstract:
Clearinghouses are the centerpiece of global policymakers’ 2009
framework of reforms in the over-the-counter derivative markets in
response to the 2007–08 financial crisis. Dodd-Frank’s Title VII
implemented these reforms in the U.S. More than ten years have now
passed since the establishment of this framework. Yet much work
continues on outstanding issues surrounding the recovery and
resolution of a distressed or insolvent clearinghouse. This Article
examines one of these issues: the possibility of clearinghouse
shareholders raising no creditor worse off than in liquidation claims
in resolution. It argues that such claims are nonsensical and should
be unavailable to clearinghouse shareholders. This would decrease
moral hazard in and promote the rationalization of the global
clearing ecosystem for derivatives.
I also want to encourage BLPB readers to review the perceptive commentary by Professor Thomas E. Plank on my article (here). Finally, I'd like to thank the Transactions law review student editors for their excellent work!
Wednesday, May 26, 2021
If you missed this past Monday's Regulating Megabanks: A Conference in Honor of Art Wilmarth, don't worry, it was recorded! I'll keep BLPB readers posted about when the recorded webinar is available online [now available -see link at bottom of post!]. In the meantime, Professor Wilmarth has just posted a new working paper, Wirecard and Greensill Scandals Confirm Dangers of Mixing Banking and Commerce, to keep you busy until then! Here's the abstract:
The pandemic crisis has accelerated the entry of financial technology (“fintech”) firms into the banking industry. Some of the new fintech banks are owned or controlled by commercial enterprises. Affiliations between commercial firms and fintech banks raise fresh concerns about the dangers of mixing banking and commerce. Recent scandals surrounding the failures of Wirecard and Greensill Capital (Greensill) reveal the potential magnitude of those perils.
The Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC) have encouraged commercial enterprises to acquire fintech banks. The FDIC has authorized commercial firms to acquire FDIC-insured industrial banks in reliance on a controversial loophole in the Bank Holding Company Act (BHC Act). The OCC is seeking to charter nondepository fintech national banks, which commercial firms could own under a separate exemption in the BHC Act. The FDIC’s and OCC’s initiatives undermine – and could potentially destroy – the BHC Act’s longstanding policy of separating banking and commerce.
The disasters at Wirecard and Greensill demonstrate the importance of maintaining a strict separation between banking and commerce. Regulators in Germany and other countries allowed banks controlled by Wirecard and Greensill to engage in risky and abusive transactions that benefited their parent companies and other related parties, including commercial firms connected to their major investors. Wirecard Bank provided financial support to its parent company and CEO, and it also made fraudulent transfers of funds to insiders and their controlled entities. Greensill Bank made preferential and unsound loans that benefited its parent company and leading investors. Greensill Bank securitized many of its reckless loans, and Greensill Capital sold the resulting asset-backed securities as “safe” and “liquid” investments to misinformed investors.
Regulators failed to take timely enforcement actions against Wirecard and Greensill because they did not exercise consolidated supervisory authority over the complex international structures created by both firms. In addition, Wirecard and Greensill built extensive networks of influence that produced significant political favors and regulatory forbearance in Germany and the U.K. The collapse of Wirecard and Greensill embarrassed government agencies and inflicted massive losses on investors, creditors, and other stakeholders.
The failures of Wirecard and Greensill provide clear warnings about the dangers of allowing fintechs to offer banking services while evading prudential regulatory requirements and supervisory standards that apply to traditional banks and their corporate owners. Regulators and policymakers should not allow fintechs’ claims of “innovation” to serve as a rationale for regulatory arbitrage and as camouflage for fraud. Both disasters show that high-tech firms engaged in banking and commercial activities are likely to create the same unacceptable hazards as previous banking-and-commercial conglomerates, including toxic conflicts of interest, reckless lending, dangerous concentrations of economic power and political influence, supervisory blind spots, and systemic threats to economic and financial stability.
Revised as of 5/28/2021: the recorded webinar of Regulating Megabanks a Conference in Honor of Art Wilmarth is now available on Youtube.
Wednesday, May 19, 2021
Dear BLPB readers:
Here's an event you won't want to miss! Check out the phenomenal speaker lineup!
Regulating Megabanks: A Conference in Honor of Arthur Wilmarth
May 24 @ 8:50 am - 5:30 pm
The public may access the webinar at the following link: https://cu.law/lawreview
Wednesday, May 5, 2021
Last week, I blogged about my new article, The Federal Reserve As Collateral's Last Resort, in the Notre Dame Law Review. I mentioned that this shorter work is a first step in a larger normative project on central bank collateral frameworks. As I progress with this research, I'm adding new articles to my reading list for this new article. Peter Conti-Brown, Yair Listokin, & Nicholas R. Parrillo recently posted their new work, Towards An Administrative Law of Central Banking, published in the Yale Journal on Regulation. It immediately made the list! Here's the Abstract:
A world in turmoil caused by COVID-19 has revealed again what has long been true: the Federal Reserve is arguably the most powerful administrative agency in government, but neither administrative-law scholars nor the Fed itself treat it that way. In this Article, we present the first effort to map the contours of what administrative law should mean for the Fed, with particular attention to the processes the Fed should follow in determining and announcing legal interpretations and major policy changes. First, we synthesize literature from administrative law and social science to show the advantages that an agency like the Fed can glean from greater openness and transparency in its interpretations of law and in its long-term policymaking processes. These advantages fall into two categories: (1) sending more credible signals of future action and thereby shaping the behavior of regulated parties and other constituents, and (2) increasing the diversity of incoming information on which to base decisions, thereby improving their factual and predictive accuracy. Second, we apply this framework to two key areas—monetary policy and emergency lending—to show how the Fed can improve its policy signaling and input diversity in the areas of its authority that are most expansive. The result is a positive account of what the Fed already does as an administrative agency and a normative account of what it should do in order to preserve necessary policy flexibility without sacrificing the public demands for policy clarity and rigor.
Wednesday, April 28, 2021
I’m delighted to share with BLPB readers that my new Essay, The Federal Reserve As Collateral’s Last Resort, 96 Notre Dame L. Rev. 1381 (2021) is now available (here). Its focus is central bank collateral frameworks, a critical and timely topic that has thus far received scant attention from legal scholars. I recently blogged about Professor Skinner’s Central Bank Activism. Regardless of one’s perspective on this issue, it’s crucial to realize that a central bank’s collateral framework is the mechanism that promotes or limits such activism. The institutional features of these frameworks are a combination of legislation and central bank policy, with the latter arguably being the most important influence on the Fed’s framework.
As the first paragraph of my Essay explains “Central bank money or liquidity is at the heart of modern economies. It is issued against collateral designated as eligible by, and on terms defined by, central bank collateral frameworks…what is often underappreciated is that the ultimate practical difference between an illiquid and insolvent firm is whether a firm has assets a central bank, such as the Federal Reserve, will accept as collateral for lending or for purchase, and at what valuation. What ultimately constitutes “good” or central bank “eligible” collateral, how best to assess its value, and whose perspective on these questions matters most are critical issues at the heart of central bank collateral frameworks.” (footnotes in Essay omitted throughout this post).
In the financial crisis of 2007-09, the Fed rescued both Bear Stearns and American International Group, but not Lehman Brothers. Fed officials explained that Lehman did not have collateral sufficient to secure its lending assistance. Some economists have disagreed with this assessment. Yet regardless of who is right about this issue, “the respective histories of these firms attest to the centrality of collateral and central bank collateral frameworks in modern credit markets.”
Central bank collateral frameworks also impact “the production, liquidity and pricing of assets that markets use as collateral…[and] market discipline and enable indirect bailouts of firms and governments.” In other words, central bank collateral frameworks can potentially incentivize the production of junk assets.
Much of my research has focused on clearinghouses. If the Fed were to provide funding assistance under Dodd-Frank’s Title VIII to a distressed, designated clearinghouse, an important consideration would be the collateral securing such funding. The loan might be “fully collateralized,” but the type of collateral actually securing the loan and its valuation would bear upon whether the assistance amounted to emergency liquidity provision or a bailout. As I note in The Federal Reserve As Last Resort, it's curious that while Dodd-Frank added collateral related provisions to the Fed's longstanding Section 13(3) emergency authority, it included no such provisions with the Fed's new liquidity authority in Title VIII for designated financial market utilities such as clearinghouses.
As the importance of the shadow banking system has increased, so too has the role of collateral in financial markets. The Fed provided extensive assistance to the shadow banking system in the financial crisis of 2007-09 and in the ongoing COVID-19 pandemic. Although economists and legal scholars have written about the shadow banking system and the Fed’s emergency liquidity facilities, there has been little focus on central bank collateral frameworks. More work is needed in this area. Manmohan Singh’s Collateral Markets and Financial Plumbing and Kjell G. Nyborg’s Collateral Frameworks: The Open Secret of Central Banks are important (and some of the only) contributions in this general area.
In sum, my Essay is meant to be a “first step in a broader normative project analyzing the proper balance between legislation and central bank policy—between architecture and implementation—in shaping the Federal Reserve’s collateral framework to best promote market discipline and to minimize credit allocation. Its modest aim is twofold. First, it provides the first analysis of central bank collateral frameworks in the legal scholarship. Second, it analyzes the equilibrium between legislation and central bank policy in the Federal Reserve’s collateral framework in the context of its section 13(3) emergency liquidity authority, lending authority for designated financial market utilities, and swap lines with foreign central banks, and general implications of these arrangements.”
My article, The Federal Reserve’s Use of International Swap Lines, was the first law review piece to analyze the Fed’s central bank swap lines. It started with the following quote from an article by John Dizard in the Financial Times: “Always define every issue as just a technical problem.” Central bank swap lines are anything but a mere technical issue. Similarly, BLPB readers should understand that the collateral framework of the Fed and other central banks is much more than just a technical central banking problem. It is a topic that should be of interest to all.
Finally, I’d like to thank NYU School of Law's Classical Liberal Institute and the Notre Dame Law Review for the opportunity to participate in their workshop on The Public Valuation of Private Assets (additional articles here). And I’d also like to thank Zachary Pohlman, Editor-in-Chief, Lauren Hanna, Symposium Editor, and all of the other members of the Notre Dame Law Review who edited my Essay for their superb work!
Wednesday, March 24, 2021
I always learn a ton in reading Professor Julie Andersen Hill's banking articles. A TON! Hence, I'm excited to see that she recently posted her new piece, Cannabis Banking: What Marijuana Can Learn from Hemp (forthcoming 2021, Boston University Law Review). This is her second article on cannabis banking, the first being an excellent symposium piece, Banks, Marijuana, and Federalism. As both houses of Congress have recently reintroduced the SAFE Banking Act, these articles couldn't be more timely. Here's the abstract for Cannabis Banking:
Marijuana-related businesses have banking problems. Many banks explain that because marijuana is illegal under federal law, they will not serve the industry. Even when marijuana-related businesses can open bank accounts, they still have trouble accepting credit cards and getting loans. Some hope to fix marijuana’s banking problems with changes to federal law. Proposals range from broad reforms removing marijuana from the list of controlled substances to narrower legislation prohibiting banking regulators from punishing banks that serve the marijuana industry. But would these proposals solve marijuana’s banking problems?
In 2018, Congress legalized another variant of the Cannabis plant species—hemp. Prior to legalization, hemp-related businesses, like marijuana-related businesses, struggled with banking. Some hoped legalization would solve hemp’s banking problems. It did not. By analyzing the hemp banking experience, this Article provides three insights. First, legalization does not necessarily lead to inexpensive, widespread banking services. Second, regulatory uncertainty hampers access to banking services. When banks were unsure what state and federal law required of hemp businesses and were unclear about bank regulators’ compliance expectations for hemp-related accounts, they were less likely to serve the hemp industry. Regulatory structures that allow banks to easily identify who can operate cannabis businesses and verify whether the business is compliant with the law are more conducive to banking. Finally, even with clear law and favorable regulatory structures, the emerging cannabis industry still presents credit, market, and other risks that make some banks hesitant to lend.
Wednesday, March 3, 2021
I recently had the good fortune to hear Professor Jonathan R. Macey speak about his insightful and timely new article, Fair Credit Markets: Using Household Balance Sheets to Promote Consumer Welfare (forthcoming, Texas Law Review). I wanted to highlight it to readers and share the Abstract:
Access to credit can provide a path out of poverty. Improvidently granted, however, credit also can lead to financial ruin for the borrower. Strangely, the various regulatory approaches to consumer lending do not effectively distinguish between these two effects of the lending process. This Article develops a framework, based on the household balance sheet, that distinguishes between lending that is welfare enhancing for the borrower and lending that is potentially (indeed likely) ruinous, and argues that the two types of lending should be regulated in vastly different ways.
From a balance sheet perspective, various kinds of personal loans impact borrowers in vastly different ways. Specifically, there is a difference among loans based on whether the loan proceeds are being used: (a) to make an investment (where the borrower hopes to earn a spread between the cost of the borrowing and the returns on the investment); (b) to fund capital expenditures (homes, cars, etc.); or (c) to fund current consumption (medical care, food, etc.). From a balance sheet perspective, this third type of lending is distinct. Such loans reduce wealth and are correlated with significant physical and mental health problems. In contrast, loans used to acquire capital assets (i.e. houses) are positively correlated with such socioeconomic indicators.
Payday loans are the paradigmatic example of the use of credit to fund current consumption. Loans to fund current consumption reduce the wealth of the borrower because they create a liability on the “personal balance sheet” of the borrower, without creating any corresponding asset. The general category of loans to fund current consumption includes both loans used to fund unforeseen contingencies like emergency medical care or emergency car repairs, and those used to make routine purchases. Consistent with the stated justification for creating these lending facilities, which is to serve households and communities, the emergency lending facilities of the U.S. Federal Reserve should be made accessible to individuals facing emergency liquidity needs.
Loans that are taken out for current consumption but are not used for emergencies also should be afforded special regulatory treatment. Lenders who make non-emergency loans for current consumption should owe fiduciary duties to their borrowers. Compliance with such duties would require not only much greater disclosure than is currently required. It also would impose a duty of suitability on lenders, which would require lenders to provide borrowers with the loan most appropriate for their needs, among other protections discussed here. These heightened duties also should be extended to borrowers when they take out a loan that increases the debt on a borrower’s balance sheet by more than 25 percent.
Wednesday, February 24, 2021
Truth be told, I don't know a whole lot about SPACs. HOWEVER, I've been encountering this topic frequently these days, whether I'm following clearing and settlement news such as Ex-Cosmo editor teams up with ice hockey owner in Spac deal or doing my daily glance at the FT and reading about Why London should resist the Spac craze. Wanting to be more in the know, I've just added Michael Klausner, Michael Ohlrogge & Emily Ruan's "A Sober Look at SPACs" to my reading list. Here's the abstract:
A Special Purpose Acquisition Company (“SPAC”) is a publicly listed firm with a two-year lifespan during which it is expected to find a private company with which to merge and thereby bring public. SPACs have been touted as a cheaper way to go public than an IPO. This paper analyzes the structure of SPACs and the costs built into their structure. We find that costs built into the SPAC structure are subtle, opaque, and far higher than has been previously recognized. Although SPACs raise $10 per share from investors in their IPOs, by the time the median SPAC merges with a target, it holds just $6.67 in cash for each outstanding share. We find, first, that for a large majority of SPACs, post-merger share prices fall, and second, that these price drops are highly correlated with the extent of dilution, or cash shortfall, in a SPAC. This implies that SPAC investors are bearing the cost of the dilution built into the SPAC structure, and in effect subsidizing the companies they bring public. We question whether this is a sustainable situation. We nonetheless propose regulatory measures that would eliminate preferences SPACs enjoy and make them more transparent, and we suggest alternative means by which companies can go public that retain the benefits of SPACs without the costs.
Wednesday, February 17, 2021
In August 2020, Citibank, as administrative agent for a syndicated loan to Revlon, Inc., accidently wired nearly $900 million to lenders. It had intended to send a $7.8 million interest payment. Some of the lenders refused to return the money. Not surprisingly, Citibank was not happy about this. Yesterday, U.S. District Judge Jesse M. Furman issued a ruling denying Citibank's attempt to recoup the funds. As it turns out, under NY law, keeping money wired by mistake generally amounts to conversion or unjust enrichment. However, under the discharge-for-value defense, “The recipient is allowed to keep the funds if they discharge a valid debt, the recipient made no misrepresentations to induce the payment, and the recipient did not have notice of the mistake.”
Wednesday, February 10, 2021
Co-blogger Joan Heminway predicted that GameStop Will Be 2021's Great Gift To Business Law Professors. Totally agree. I think it’s also a great gift to those of us who research financial market infrastructure, particularly clearing and settlement. This episode has highlighted the importance of clearinghouses. In the past, I’ve written several posts on clearinghouses (for example, here, here, here). In preparing to speak on this topic during the UT Law roundtable last week, I came across several great articles about the role of clearinghouses and margin calls in the Robinhood/GameStop story. I share a few of these below with readers.
Keep in mind that the DTCC’s clearinghouse, the National Securities Clearing Corporation (NSCC), was designated in 2012 by the Financial Oversight Stability Council (FSOC) as one of eight designated financial market utilities under Dodd-Frank's Title VIII. These designated FMUs are single points of failure in financial markets. I've written extensively about Title VIII, beginning with The Federal Reserve as Last Resort.
Jeff John Robert’s Fortune article: The real story behind Robinhood’s decision to restrict GameStop trading – and that 4 a.m. call to put up $3 billion.
Telis Demos’ WSJ article: Why Did Robinhood Ground GameStop? Look at Clearing
Stephen G. Cecchetti & Kim Schoenholtz’s blog post, GameStop: Some Preliminary Lessons
Robinhood’s post on “What Happened this Week”