Securities Law Prof Blog

Editor: Eric C. Chaffee
Univ. of Toledo College of Law

Wednesday, February 13, 2013

SEC Approves 2013 PCAOB Budget

The SEC approved the 2013 budget of the Public Company Accounting Oversight Board (PCAOB) and the related annual accounting support fee as required by the Sarbanes-Oxley Act of 2002.  The PCAOB budget totals $245.6 million and will be funded primarily by the collection of an accounting support fee totaling $234 million.

Highlights of the PCAOB’s Proposed 2013 Budget and Accounting Support Fee

A proposed 2013 budget of $245.6 million

A proposed 2013 accounting support fee totaling $234 million allocated as follows:
$207.5 million to be assessed on issuers
$26.5 million to be assessed on broker-dealers

The PCAOB’s 2013 budget represents an increase of approximately 8 percent over its 2012 budget of $227.7 million. The increase is primarily attributable to an increase in the PCAOB’s audit inspections program, including additional staff to:

Perform inspections of audits of SEC-registered broker-dealers (a class of audits overseen by the PCAOB as a result of the Dodd-Frank Act).

Perform international inspections.

Implement planned improvements to the PCAOB’s inspections program, including the reporting and processes for assessing quality control remediation efforts.

The 2013 budget will be funded mostly by the 2013 accounting support fee of $234 million, which is approximately 9 percent higher than the 2012 accounting support fee of $215 million.

February 13, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Massachusetts Securities Division Calls on SEC to Study Use of PDAAs by Investment Advisers

Massachusetts Securities Division filed a letter with the SEC, requesting the SEC to address what the Division  calls a "key investor protection issue:" investment advisers including mandatory pre-dispute arbitration provisions in the advisory contracts (PDAAs).  It urges the SEC to use its authority under Dodd-Frank section 921 to commence a study of investment advisers requiring pre-dispute arbitration, "a practice that appears to be inconsistent with the fiduciary duty that advisers owe their customers."

The Division recently sent 710 state-registered Massachusetts advisers surveys that requested specific information about arbitration.  Responses were voluntary, and the response rate was 50%.  Nearly half of the advisers who responded to the survey reported that they include a PDAA in their advisory contract.

There has never been a study of how many investment advisers require PDAAs, what forum those advisers requiring PDAAs use for resolving the disputes, and what the outcomes are in those disputes.  An SEC study of this issue would provide important information for addressing the question of whether customers of advisory clients receive fairer outcomes in court or in arbitration.  Without information, we can only speculate.

The Securities Division letter to the SEC and the survey results are posted on its website.

February 13, 2013 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Tuesday, February 12, 2013

Senate Banking Committee Schedules Hearing on Wall St. Reform

The Senate Committee on Banking, Housing and Urban Affairs will hold a hearing on Feb. 14, 2013 on Wall Street Reform: Oversight of Financial Stability and Consumer and Investor Protections.  Here is the list of witnesses:

•Honorable Mary J. Miller
Under Secretary for Domestic Finance
U. S. Department of the Treasury
•The Honorable Daniel K. Tarullo
Board of Governors of the Federal Reserve System
•The Honorable Martin J. Gruenberg
Acting Chairman
Federal Deposit Insurance Corporation
•The Honorable Thomas J. Curry
Comptroller of the Currency
Office of the Comptroller of the Currency
•The Honorable Richard Cordray
Consumer Financial Protection Bureau
•The Honorable Elisse B. Walter
U.S. Securities and Exchange Commission
•Honorable Gary Gensler
U.S. Commodity Futures Trading Commission


February 12, 2013 in News Stories | Permalink | Comments (0) | TrackBack (0)

POGO Reports on SEC's Revolving Door

The Project on Government Oversight (POGO) is a nonpartisan independent watchdog that investigates waste, fraud and abuse throughout the federal government, according to its website.  It recently released its second study on the "revolving door" at the SEC, Dangerous Liaisons: Revolving Door at SEC Creates Risk of Regulatory Capture.  Whether or not you agree with the premise of the report, it is worth reading.  In addition, POGO performed a public service by obtaining from the SEC, through FOIA requests, disclosure statements filed by former SEC employees from 2001 through 2010, which are searchable online through its SEC Revolving Door Database.

The Report also contains a number of sensible recommendations, including

  • let the public see where federal employees go after they leave the government, and disclose their ethics agreements
  • extend the cooling off periods for employees who enter and leave the agency
  • give the public more information about agency actions
  • give the SEC the resources it needs
  • other players should do their part.

February 12, 2013 in News Stories, SEC Action | Permalink | Comments (0) | TrackBack (0)

SEC Feb. 13 Meeting Takes Up PCAOB Budget

The SEC will hold an Open Meeting on February 13, 2013, where it will consider whether to approve the 2013 budget of the Public Company Accounting Oversight Board and will consider the related annual accounting support fee for the Board under Section 109 of the Sarbanes-Oxley Act of 2002.

February 12, 2013 in SEC Action | Permalink | Comments (0) | TrackBack (0)

Monday, February 11, 2013

Fraud Scheme Targets Foreign Investors with Lure of U.S. Citizenship

On Feb. 8 the SEC announced charges and an asset freeze against Anshoo R. Sethi, an Illinois resident,  charging him with defrauding foreign investors seeking profitable returns and a legal path to U.S. residency through a federal visa program.   According to the SEC, Sethi created A Chicago Convention Center (ACCC) and Intercontinental Regional Center Trust of Chicago (IRCTC) and fraudulently sold more than $145 million in securities and collected $11 million in administrative fees from more than 250 investors primarily from China. Sethi duped investors into believing that by purchasing interests in ACCC, they would be financing construction of the “World’s First Zero Carbon Emission Platinum LEED certified” hotel and conference center near Chicago’s O’Hare Airport. Investors were misled to believe their investments were simultaneously enhancing their prospects for U.S. citizenship through the EB-5 Immigrant Investor Pilot Program, which provides foreign investors an avenue to U.S. residency by investing in domestic projects that will create or preserve a minimum number of jobs for U.S. workers.

According to the SEC’s complaint, the EB-5 program enables foreign investors to possibly qualify for a green card if they invest $1 million (or $500,000 in a “Targeted Employment Area” with a high unemployment rate) in a project that creates or preserves at least 10 jobs for U.S. workers, excluding the investor and his or her immediate family. Sethi and his companies used the lure of a pathway to U.S. citizenship to convince investors to wire a minimum of $500,000 apiece plus a $41,500 “administrative fee” to U.S. bank accounts. These administrative fees are separate from the investment capital that the EB-5 program requires to be deployed into a job-creating enterprise. More than $11 million in administrative fees were collected with the claim that they were fully refundable to investors if their visa applications are rejected. Sethi and his companies have instead been spending those funds.

In addition to the temporary restraining order and asset freeze granted by the court, the SEC’s complaint seeks permanent injunctions and other monetary relief.

February 11, 2013 in Film, SEC Action | Permalink | Comments (0) | TrackBack (0)

Einhorn Raises Issue of Interpeting SEC's Unbundling Rule

As Securities Law Prof Blog readers probably know, David Einhorn through his hedge fund, Greenlight Capital, is a significant SH in Apple.  Einhorn is dissatisfied because he says that Apple has $137 Billion in cash ($145 per share) on its balance sheet and has “an obligation to examine all options to create and unlock additional value” for its SHs. Einhorn advocates that Apple unlock shareholder value by distributing to existing SHs a perpetual,  high-yield preferred stock that would enable SHs to own and trade separately the preferred shares and the existing common shares.

Apple's annual SH meeting is scheduled for Feb. 27.  On the agenda is a management proposal  to amend the certificate of incorporation in several ways (Proposal 2), including eliminating the power of the BOD to issue preferred shares without SH approval.  Specifically,

the amendment of the Company’s Restated Articles of Incorporation would (i) eliminate certain language relating to the term of office of directors in order to facilitate the adoption of majority voting for the election of directors, (ii) eliminate “blank check” preferred stock, (iii) establish a par value for the Company’s common stock of $0.00001 per share and (iv) make other conforming changes.

Greenlight opposes this amendment because it would “hinder [Apple’s] ability to unlock value for shareholders.” It recently sent a letter to SHs, urging them to vote against Proposal 2 because it is “value destructive” and “impedes the boards’ flexibility.”  CALPERS is also soliciting Apple SHs, urging them to support Apple management on Proposal 2 as enhancing SH rights. In a Feb. 7 statement, Apple stated that the company is actively discussing other ways about returning additional cash to SHs and that it will thoroughly evaluate the Greenlight proposal.  Regarding Proposal 2, Apple stated that:

As a part of our efforts to further enhance corporate governance and serve our shareholders’ best interests, Proposal #2 in our proxy includes some recommended changes to our articles of incorporation. These changes were recommended independently of Greenlight’s proposal and would not preclude Apple from adopting their concept. Contrary to Greenlight’s statements, adoption of Proposal #2 would not prevent the issuance of preferred stock. Currently, Apple’s articles of incorporation provide for the issuance of “blank check” preferred stock by the Board of Directors without shareholder approval. If Proposal #2 is adopted, our shareholders would have the right to approve the issuance of preferred stock. As such, Proposal #2 has the support of many of our shareholders.

 Greenlight has also filed suit in S.D.N.Y. asserting that Proposal 2 violates the SEC’s proxy rules because it contains three amendments to the Certificate of Incorporation, contrary to SEC rules that do not permit the bundling of separate matters presented for SH vote (Rule 14a-4(a)(3), Rule 14a-4(b)(1)).  It seeks a preliminary injunction against the shareholder vote.  The Court has scheduled a Feb. 22 oral argument on the application for a preliminary injunction.



February 11, 2013 in Judicial Opinions, News Stories | Permalink | Comments (0) | TrackBack (0)

Friday, February 8, 2013

FINRA Gives Up Advocating for SRO Responsibilities over Investment Advisers

I missed the story when it appeared, but I ran into Reuters' Suzanne Barlyn at Brooklyn Law School's Conference on the Importance of Compliance today, and she filled me in on the news that FINRA CEO Rick Ketchum has backed away from advocating that FINRA take on SRO responsibilities for investment advisers.  In an interview Ketchum said there was "no sign it can convince lawmakers in Washington to support a change in the way the advisers are regulated anytime soon."  He warns that investors continue to be at risk because the SEC does not have the resources to examine investment advisers on a regular basis. 

So what's the solution?  My understanding is that investment advisers sensibly would prefer one regulator over two and thus resist the idea of any SRO.  Will the SEC be given the resources to expand its examination program over investment advisers?

Reuters, Exclusive: Watchdog backs off over financial adviser regulation

February 8, 2013 in News Stories, Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Oral Argument in SEC v. Citigroup

William Alper, a Manhattan attorney, attended the oral argument today in SEC v. Citigroup at the request of the Securities Law Prof Blog and filed the following report.  He cautions that it is difficult to convey accurately the Q&A, but I think you'll agree that he has done a darn good job in capturing the essence.  He notes that although the oral argument was scheduled for only 29 minutes, it went on much longer than that.  The judges asked many questions and were obviously engaged.

Securities and Exchange Commission v Citigroup Global Markets Inc.
Oral Argument
February 8, 2013
United States Court of Appeals
For the Second Circuit

Judges: Rosemary S. Pooler, Raymond J. Lohier, Jr., Susan L. Carney

 The courtroom was so overcrowded that additional seating was set up in the ante room where more than 50 people watched on closed circuit TV.  SEC v Citigroup was first on the calendar and once the argument was concluded nearly everyone inside or outside the courtroom left.

SEC’s Argument

Counsel for SEC began by arguing that the District Court (Judge Rakoff) had adopted an inappropriate “bright line” rule.  Question was asked whether the District Court had said held the parties had provided insufficient information to warrant approval of the settlement/injunction but that the SEC contended the information provided was sufficient.  Counsel answered that the information provided was sufficient.  Asked by a judge what information was available to Judge Rakoff, SEC counsel referred to the Complaint, the settlement agreement negotiated by counsel at arms’ length, that it contained no ambiguity and that it did not require excess resources to enforce.

Asked by a judge whether the allegations in the Complaint were sufficient to support approval of the settlement, SEC counsel argued that they were.  He was then asked whether more information had been available to the Court which approved settlement in the Bank of America case, counsel agreed, but noted that Bank of America had agreed to submission of a statement of facts without admitting to any of them and had given the District Court additional evidence.

One of the judges noted that Judge Rakoff had not been satisfied with the answers supplied by the parties to his 9 questions.  SEC counsel agreed, but noted that many of Judge Rakoff’s questions were policy questions and that Judge Rakoff had complained, in refusing to approve the settlement, that he’d been provided no facts established by trial or by admission.

A judge asked whether Judge Rakoff should not have asked for more facts and SEC counsel said that under the law, it wouldn’t have been necessary for approval of the settlement.

A judge asked whether the District Court was entitled in deciding whether to approve the settlement to look at the complaint in Stoker.  SEC counsel replied that it was beyond the legitimate scope of the District Court’s review of the settlement.  That SEC refused to bring additional charges in light of Stoker was permissible, because SEC, as a government agency, has discretion and the District Court is not entitle to go beyond that.  The District Court’s power to review the settlement is limited to the injunctive relief, e.g., to determine whether there were ambiguous terms in the settlement.

Q: How could the District Court assess whether third parties would be harmed by the settlement with only the Complaint to go on? Could it ask 3d parties to submit facts?

A: That could happen in, e.g., a Title VII case, where the potential for harm to 3d parties is much more apparent, but not here.

Q: Why was an injunction necessary at all, in light of the fact the SEC almost never takes action to enforce them?

A: The possibility of enforcement proceedings is “useful” and has collateral effect as, for example, in SEC v. Cioffi, (EDNY(?)).

Citigroup’s Argument

Judge Rakoff asked for admissions from Citigroup that could be used for collateral estoppel purposes.

Q: What if the district court asked for facts “short of admissions”?

A: The District Court had ample “evidence” from the complaint, the SEC’s 28 page response to the District Court’s 9 questions and Citi’s 20 page response to them.  All of the questions were fully answered. WARNING: Corporations won’t settle if findings that could be used for collateral estoppel purposes were made or required.  2d Circuit precedent states that the District Court shouldn’t second guess the agency and defendant.

Q: Didn’t the District Court say it could not exercise its judgment and couldn’t make a judgment?

A: District Court said that either trial or admissions [to establish facts] were required.

Q: What if the District Court required something more than it was given, but short of admissions, should the Court of Appeals remand?

A: Many more words with colorful analogies but, “No.”

Q: Didn’t Harvy Pitt say the SEC could meet the District Court’s requirements?

A: The law doesn’t require admissions by settling party to settle or for District Court to approve settlement.

Q: The “admissions” argument is a “red herring” because the District Court didn’t and couldn’t demand them.

Pro Bono Counsel's Argument

Basic disagreement among the parties is what the District Court actually required of the parties: Appellants argue he required admissions or a trial to establish facts.  That’s just not so.

Q: District Court’s Order, p. 4, states that the court hadn’t been given proven or admitted facts.  Doesn’t that require admissions or trial to establish facts?

A: District Court didn’t require an admission of liability, but rather facts that could be the basis for proof of liability.  The “proof” could be documents, deposition testimony.

Q: So the Court’s ruling requires proof from the parties?

A: None was required, but there’s no rule that the District Court can’t ask, and Citi did provide evidence in support of it’s application to the Court for a stay, stating that courts can require evidentiary submissions. The District Court also had admissions from the 2 criminal cases.

Q: Did the acquittal in Stoker support the settlement in this case?

A: Yes, it would have, but it occurred after the District Court had already made its decision in this case.  It might be sufficient now [on remand].

Q: You agree that the District Court can’t require an admission of liability?

A: Yes.

Q: Would it be inappropriate to ask for facts necessary to establish liability?

A: It isn’t necessary to determine liability and the District Court’s questions and the answers did not.

Q: Did the Bank of America settlement establish facts estopping B of A?

A: No.

Q: But Bank of America settlement led to the filing of many lawsuits based on the facts of that case?

A: Yes, but without collateral estoppel/factual findings that could be used in subsequent cases.

Q: Why is an Article III judge entitled to determine what’s necessary in the public interest instead of the relevant agency?

Rule 23, and the fact that the settlement incorporated an injunction subject to judicial enforcement.

Q: SEC acknowledged a gap between total damage caused by the alleged acts and the amount Citigroup agreed to pay.

A: This case is different from Stoker: No criminal charges, not allegations of Citi’s scienter.

Q: Why isn’t it the SEC’s responsibility to determine the strength of its own cases, as other agencies and prosecutors do?

A: The SEC can, it is entitled to deference, but the District Court is not required to approve automatically what the SEC has agreed to.  It has its own standards to apply and uphold.

Q: SEC/Citi argue that many facts were given to the court.

A: No evidence, e.g., deposition testimony, was submitted.

Q: It isn’t sufficient for the agency to state important facts, the District Court may require sworn testimony, affidavits?

A: The submissions were “lawyer talk”, not “proof” or “evidence”.

Q: In light of the results in Stoker, does the District Court now have sufficient information?

A: Yes.

Counsel (Wing): The statement at the end of the District Court’s opinion was a “rhetorical flourish”.

Q: After Stoker, what is there left for the District Court to do on remand?

A: Stoker resolves Judge Rakoff’s questions and shows why the District Court was properly concerned.

Q: It showed the weakness of the SEC’s case?

A: Yes, but now the District Court has that information to us in doing its job.

SEC’s Rebuttal

Rule 23 is very different from this case because District Courts have a fiduciary responsibility to protect others, not, as here, where there’s an agency entitled to deference.

Q: What relief should we give, reverse and approve the settlement?

A: Yes.

Q: In light of Stoker, should we direct approval of the settlement on remand or just give the District Court the opportunity to take Stoker into account?

A: Yes, and perhaps give the parties a chance to back out of the settlement.

Citi’s Rebuttal

Q: Can’t we remand with an opportunity for the parties to appeal immediately if they wish?

A: Stoker is not a case to which Citi was a party – it can’t be the basis for fact finding in this case.


February 8, 2013 in Judicial Opinions, News Stories, SEC Action | Permalink | Comments (0) | TrackBack (0)

Wednesday, February 6, 2013

SEC Posts Q&A About Broker-Dealer Exemption in JOBS Act

Tuesday, February 5, 2013

DOJ Sues S&P Alleging Fraudulent Credit Ratings

As was predicted yesterday, the U.S. Department of Justice filed a complaint against Standard & Poor's Financial Services and its parent company McGraw-Hill Companies, alleging civil fraud in connection with S&P credit ratings issued from 2004-2007 for residential mortgaged backed securities (RMBS) and collateralized debt obligations (CDOs).  The suit is brought under the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA) and seeks recovery of civil money penalties for mail and wire fraud affecting federally insured financial institutions and financial institution fraud.  The complaint alleges that S&P falsely represented that its credit ratings of RMBS and CDO tranches were "objective, independent, uninfluenced by any conflicts of interest that might comprominse S&P's analytic judgment, and reflected S&P's true current opinion regarding the credit risks the rated RMBS and CDO tranches posed to investors."  The government seeks an unspecified amount of damages, which, according to the Wall St. Journal, could be as high as $5 billion.  WSJ, U.S. May Seek $5 Billion From S&P .

February 5, 2013 in News Stories | Permalink | Comments (0) | TrackBack (0)

Monday, February 4, 2013

FINRA Seeks Comments on Proposed Rule on Markups and Commissions

FINRA Requests Comment on Proposed FINRA Rules Governing Markups, Commissions and Fees in Regulatory Notice 13-07.  This is part the process to develop a new, consolidated rulebook (the Consolidated FINRA Rulebook).

FINRA is proposing several changes to the proposed rules. These changes include, among other things, amendments to: (1) retain the 5% markup policy in NASD IM-2440-1 (Mark-Up Policy); (2) revise certain of the relevant factors used to determine the reasonableness of markups and commissions; (3) eliminate the requirement to provide commission schedules for equity securities transactions to retail customers; and (4) extend the proposed markup rules to transactions in certain government securities. 

The text of the proposed rules is here.  Deadline for comments is April 1, 2013.

February 4, 2013 in Other Regulatory Action | Permalink | Comments (0) | TrackBack (0)

Government Plans to Sue S&P Alleging Fraudulent Ratings

The financial press is reporting that the U.S. Department of Justice, as well as state officials, plan to file civil fraud charges against Standard & Poor's Ratings Service, charging that the firm fraudulently rated mortgage bonds.  This would be the first government suit against a ratings firm related to the financial crisis.  The company issued a statement stating that any suit would be "entirely without factual or legal merit."

Settlement discussions reportedly broke down because the government was talking about a settlement figure around $1 billion, a somewhat higher figure that the parent company's profits for last year.

NYTimes, Dealbook, U.S. and States Prepare to Sue S.&P. Over Mortgage Ratings

WSJ, U.S. and States Prepare to Sue S.&P. Over Mortgage Ratings

February 4, 2013 in News Stories | Permalink | Comments (0) | TrackBack (0)

Sunday, February 3, 2013

Grundfest on Reg FD and Netflix

Regulation FD in the Age of Facebook and Twitter: Should the SEC Sue Netflix?, by Joseph Grundfest,
Stanford University Law School, was recently posted on SSRN.  Here is the abstract:

The Staff of the Securities and Exchange Commission has announced its intention to recommend to the Commission that enforcement proceedings alleging a violation of Regulation FD be instituted against Netflix, Inc. and its CEO, Reed Hastings, because of a posting on Mr. Hastings’ personal Facebook page. Mr. Hastings’ webpage had more than 200,00 followers, including reporters who covered the posting in the traditional press. The posting was also the subject of a tweet by TechCrunch, which has approximately 2.5 million followers on Twitter.

This article is in the form of an amicus Wells Submission suggesting that the Commission would, for nine distinct reasons, be prudent not to initiate an action on the facts of the Netflix posting. In particular, the public record suggests that the posting did not contain material information, was not a selective disclosure, and because of its spread through social media constituted a “broad non-exclusionary distribution” that did not violate Regulation FD. A prosecution would also diverge dramatically from all prior Regulation FD enforcement proceedings, and would violate the Commission’s prior representations not to “second guess” good faith efforts to comply with Regulation FD. In addition, the posting is not inconsistent with the Commission’s 2008 Guidance on the Use of Company Webpages - - guidance that is seriously outdated because of the emergence of social media.

The enforcement action on the facts of the Netflix posting would, moreover, raise serious constitutional questions. Regulation FD is a restraint on truthful speech and, as applied on the facts of a Netflix prosecution, would involve discrimination against social media and in favor of more traditional media channels. There is also doubt that Regulation FD would pass muster as a restraint on commercial speech, particularly in light of the Supreme Court’s recent decision in Sorrell and the Second Circuit’s decision in Caronia. A loss on constitutional grounds would also call into question a large panoply of Commission regulations that act as restraints on truthful speech, including, without limitation, quiet period restrictions and restriction on communications with analysts.

Further, the issuance of the Wells Notice has already chilled the use of social media as a form of corporate communication absent the filing of a Form 8-K with the Commission. It also constitutes a questionable allocation of scarce Commission resources and raises questions that should be addressed through rulemaking and not through prosecution. The submission closes with suggestion for a reformulated Regulation FD that should be better able to pass constitutional muster and that would embrace social media technology rather than confront it.


February 3, 2013 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Heminway on Definition of Security Post- JOBS Act

What is a Security in the Crowdfunding Era?, by Joan MacLeod Heminway, University of Tennessee College of Law, was recently posted on SSRN.  Here is the abstract:

With the advent of the crowdfunding era, financial interests in business enterprises may look less like investment instruments commonly known as common stock or debentures, and more like loans, gambling bets, rights to consumable products or services or charitable or other nonprofit donations. A closer look at innovations in interests, instruments and offerings in the crowdfunding era preceding the enactment of the Jumpstart Our Business Startups Act (JOBS Act) offers a basis for comparisons and contrasts that raises questions about the categorization of instruments regulated as securities. These and other questions are important to a rethinking of the structure of financial and financially related regulation in and outside the realm of U.S. securities law.

Specifically, innovations in financial interests and instruments that immediately preceded the JOBS Act raise a number of important questions about regulatory authority and interpretation. How do we classify the instruments that represent complex or hybrid financial interests in business enterprises? What area of regulation should apply to them? Why? What do the answers to those questions tell us, if anything, about the current (and possible future) structure and function of domestic and international financial regulation? This essay preliminarily explores the features of certain financial instruments in an effort to begin to answer these questions by focusing on what a security — a statutory and regulatory category including specific financial instruments — is and should be under federal securities law.

February 3, 2013 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)

Bainbridge on Reforming LIBOR

Reforming LIBOR: Wheatley versus the Alternatives, by Stephen M. Bainbridge, University of California, Los Angeles (UCLA) - School of Law, was recently posted on SSRN.  Here is the abstract:

The London Interbank Offered Rate (LIBOR) is the trimmed average interest rate for interbank loans by a panel of leading London banks. LIBOR is the most widely used benchmark rate. An estimated $350 trillion in financial products are based on the LIBOR rate.

In late June 2012, a major scandal broke when Barclays PLC — one of the panel banks whose rates went into calculating LIBOR — agreed to pay $453 million in fines to UK and US regulators to settle allegations that Barclays had attempted to manipulate the LIBOR rate. The probe by multiple national regulators around the world quickly spread to include several other global banks.

In response, the United Kingdom’s Chancellor of the Exchequer charged a commission led by Martin Wheatley with conducting an independent review of the setting and usage of LIBOR. In September 2012, Wheatley released a report proposing a comprehensive 10-point reform plan. In October, the UK Government announced that it accepted “the recommendations of Martin Wheatley’s independent review of LIBOR in full.”

Even though Wheatley’s recommendations likely will have been implemented by the time this article appears in print, they are still deserving of analysis. First, changes and amendments may be necessary to further improve the process, perhaps including some of those suggested in this Article. Second, while LIBOR is one of the most important benchmark rates, it is not the only such rate. Some of these other benchmarks are already under scrutiny. Assessing the merits of various LIBOR reforms therefore may be helpful as regulators evaluate whether these other benchmark rates require similar reform.

In light of LIBOR’s systemic importance as a global interest rate benchmark and the compelling evidence of rate manipulation by panel banks, reforming LIBOR was both a political and economic incentive. This Article explores a number of alternatives that were available to the UK government.

The Article concludes that leaving the problem to market forces had failed and, moreover, was politically unfeasible. Switching to a government-supplied alternative benchmark was both impractical and unwise as a policy matter, as was installing a government agency as a replacement for BBA as the LIBOR administrator. Although vesting the LIBOR administrator with sufficiently strong intellectual property rights to ensure an adequate stream of licensing fees to provide adequate incentives for the administrator and panel banks is an important part of a reform package, but — contrary to what some commentators have suggested — is not viable as a stand-alone reform.

In contrast to the alternatives, the Wheatley Review provides a comprehensive reform package that has proven politically attractive and seems likely to significantly enhance LIBOR’s credibility and attractiveness as a interest rate benchmark. To be sure, the Wheatley regime is not perfect. To the contrary, this Article suggests a number of ways in which it can be expanded and improved. Over all, however, the analysis of the Wheatley Review herein strongly suggests that it will prove a viable starting point as a blueprint for reforming LIBOR and other interest rate benchmarks.

February 3, 2013 in Law Review Articles | Permalink | Comments (0) | TrackBack (0)