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Dodd-Frank at Four

Dodd-Frank turns four today. Proponents marketed the law as the response to the financial crisis of 2007 to 2009, even though it included many unrelated items and left out many matters central to the crisis. It is not surprising that four years later, Dodd-Frank is still flawed. A recent poll conducted on behalf of Better Markets found that sixty percent of the respondents support "stricter federal regulation on the way banks and other financial institutions conduct their business." Only ten percent of survey respondents think the federal government is doing a good job regulating the financial industry using the powers it has already, so additional authority for the government is not the answer. A more effective approach would be to allow the markets to do what they do best--allocate resources to their most productive use and punish firms that are not delivering products and services that people want and need at prices they are willing to pay. Government regulations often impede these healthy market functions. An intense government regulatory regime, such as the one embodied in Dodd-Frank, comes with deep government relationships with large financial institutions and implicit or explicit guarantees that the government will be there to clean up those firms' meeses. Taxpayers bear the cost of this regulatory regime, but so do the consumers and Main Street companies that financial markets are supposed to serve.


By Olivia Davidson
Summer Intern, Manhattan Institute's Center for Legal Policy

Two weeks ago, supposed baseball fan Andrew Rector filed a defamation lawsuit against Major League Baseball, ESPN, commentators Dan Shulman and John Kruk, and the New York Yankees for $10 million. Rector, who was caught sleeping on camera during a Yankees-Red Sox game on April 13th, claims that the commentators "unleashed an avalanche of disparaging words" commenting on his weight and ability to sleep through a home run.

Defamation is not a crime, but a tort, and for a statement to qualify as slander (a defamatory statement that is spoken), the following elements must be proven, writes attorney Emily Doskow:


"Published" means that a third party heard or saw the statement...

A defamatory statement must be false -- otherwise it's not considered damaging. Even terribly mean or disparaging things are not defamatory if the shoe fits...

The statement must be "injurious". Those suing for defamation must show how their reputations were hurt by the false statement -- for example, the person lost work; was shunned by neighbors, friends, or family members; or was harassed by the press...

"Unprivileged": Lawmakers have decided that in [some] situations, which are considered "privileged," free speech is so important that the speakers should not be constrained by worries that they will be sued for defamation...

In Rector's case, the alleged slander is evidently published and unprivileged, though whether or not it was injurious and false remains to be determined by the Court. According to a NY Times article,

Mr. Rector maintains the announcers used words like 'fatty' and 'stupid' to describe him, but neither Mr. Shulman nor Mr. Kruk uttered such insults in the clip [of their commentary]. It is unclear whether they commented later in the game on Mr. Rector's lengthy nap, implying perhaps the falsehood lies in Rectors idiosyncratic and frequently grammatically incorrect complaint.

Undeniably, following the upload of the clip to Youtube by MLB, Rector was subject to public ridicule, being called 'Sleeping Beauty' by one Twitter user. Rector goes as far as to say he has "suffered substantial injury" to his "character and reputation," as well as "mental anguish, loss of future income and loss of earning capacity." Rector's mother supported his claims saying he had missed work because of the public scorn he had experienced and that "everyone made fun of him everywhere he went."'

Rector is also suing for intentional infliction of emotional distress which requires an intentional or reckless act, outrageous conduct, causation and sufferance of emotional distress by the plaintiff.

As Texans for Lawsuit Reform wrote, "Lampooning the lawsuit industry has become an industry unto itself." We'll have to see if Rector has what it takes to make it in this business and win his plea.

Fish-nancial Fraud

Now that the Supreme Court's flurry of opinions for the last term is out, we can start thinking ahead to the new term. The Court will consider a case based on a provision of the Sarbanes-Oxley Act, which was the legislative response to the Enron-era accounting scandals. The law is now being used to pursue fish destruction--a type of fraud that most certainly was not within Sarbanes-Oxley's intended reach.

Class-Actions & Market Integrity

The ruling in Erica P. John Fund v. Halliburton got lost among the other opinions released at the end of the Supreme Court's term. The case had already been to the Supreme Court once on a separate issue. This iteration presented the Court with the opportunity to fundamentally rethink its own role in generating securities class actions. Instead, the Court made only peripheral changes that slightly limit the leverage that class action attorneys have against a corporation after a drop in its stock price.


The Wall Street Journal reports that Michael Corbat, the CEO of Citigroup, has a singular focus--ensuring that his bank passes its next stress test. The bank's failure of its most recent stress test last spring was an unwelcome surprise. The Journal reports that its failure was rooted in the qualitative portion of the test. Mr. Corbat is thus focusing on "courting the Fed" with visits; "passing next year's stress test [is] his 'Mission No. 1.'" How sad that a bank manager's overriding objective is to cozy up to his regulators so that they give him their blessing. Doing so might not even keep the bank safe. What if the regulators' focus is misplaced? As much as we want to believe that regulators are omniscient and unbiased decision-makers, they have limited information and sometimes miss things or exercise imperfect judgment. The Fed made supervisory missteps with respect to entities like Citi in the lead-up to the last crisis, and that is not surprising. Regulators simply are not able to collect and process information as quickly and effectively as necessary to be outside risk managers for the big banks. Moreover, as John Cochrane observed in a recent article, "[a] system more ripe for capture and a revolving door would be hard to design." Our regulatory system should be designed to encourage bankers to pay close attention to the challenges and opportunities faced by their institutions, not to keep their eyes fixed on every move their regulators make. Bank executives with their heads in the regulatory clouds are likely to miss important happenings on the ground.

FINRA's Fines

The Wall Street Journal reports that the Financial Industry Regulatory Authority is reviewing its penalty guidelines to make sure they are appropriately severe. This review follows a speech by Securities and Exchange Commission member Kara Stein, in which she opined that FINRA penalties are "too often financially insignificant for the wrongdoers" and urged FINRA to make penalties high enough to be "impactful, and provide strong motivation for compliance." It is good that someone at the SEC is paying attention to FINRA, but a blanket suggestion to raise penalties may serve only to exacerbate problems that arise from FINRA's inadequate accountability structure.

Operation Choke Point's Back Door

Last week, payday lenders sued the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Board of Governors of the Federal Reserve System for allegedly dissuading banks from doing business with payday lenders. Plaintiffs argue that the bank regulators' efforts are part of the now infamous "Operation Choke Point," the Department of Justice's program to prevent fraudsters from gaining access to the banking system. Bank regulators, through these Choke Point initiatives, have effectively changed the regulatory landscape for banks and legitimate businesses without affording these entities an opportunity to weigh in.

The payday lenders contend that the banking regulators, urging banks to be mindful of reputation risk, have forced banks to sever their relationships with payday lenders. Rather than using notice-and-comment rulemaking, bank regulators have used informal methods to spur action, such as guidance documents and suggestions by bank examiners. Using guidance documents and other informal means to influence bank behavior, plaintiffs argue, runs afoul of the Administrative Procedure Act, because they are de facto mandates on banks that are implemented without public input. FDIC guidance, for example, identifies as higher-risk activities payday lending, magazine subscriptions, and pharmaceutical sales. Although these regulatory directives are about keeping banks away from bad actors, banks would rather cut ties with a legitimate customer than risk attention from their regulators. As the Department of Justice explained in a September 9, 2013 memo, it is up to legitimate businesses "through their own dealings with banks, [to] present sufficient information to the banks to convince them that their business model and lending operations are wholly legitimate." Such information campaigns likely will go unheeded by bankers following the not-so-subtle hints they are getting from their regulators.


Yesterday's decision in SEC v. Citigroup weakens the much needed judicial check on the Securities and Exchange Commission's enforcement program. The U.S. Court of Appeals for the Second Circuit told District Court Judge Jed Rakoff to stop being so skeptical when the SEC presents him with settled enforcement actions.

Bond v. U.S.
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Manhattan Institute Center for Legal Policy intern Meghan Herwig assisted in drafting this post.

Monday's Supreme Court decision in Bond v. United States, which we earlier profiled here, involved a case raising fundamental constitutional questions of federalism and separation of powers. Rather than grappling with these questions, the Court majority ruled on statutory grounds.

Case background
Carol Anne Bond, a Pennsylvania microbiologist, attempted to poison her husband after learning that he had impregnated her best friend. She was convicted of violating a U.S. federal statute enacted to implement the Convention on Chemical Weapons, a 1997 treaty intended to prevent the proliferation of chemical weapons. On appeal, Bond's lawyers argued that the law did not apply to Bond's conduct and second that even if it applied it was unconstitutional.

Key to Bond's constitutional claim was whether a treaty signed by the president and ratified by the Senate can expand Congress's legislative powers beyond those otherwise enumerated in the Constitution. A 1920 Court decision authored by Justice Holmes, Missouri v. Holland, had held that for a valid treaty "there can be no dispute about the validity of the statute under Article I, ยง 8, as a necessary and proper means to execute the powers of the Government" -- without further analysis or authority. A subsequent Court decision, Reid v. Covert, limited this holding such that a treaty obligation could not empower Congress to violate the Bill of Rights. More recent scholarship by Georgetown law professor Nicholas Quinn Rosenkranz has challenged Missouri v. Holland's holding in light of the constitution's text, history, and structure.

Decision
While the Supreme Court unanimously overturned Bond's conviction, Chief Justice Roberts's majority opinion, on behalf of six justices, avoided the constitutional question. Roberts reasoned that the Chemical Weapons Convention was not intended to cover minor, local poisoning incidents and determined that Congress could not have intended such a construction of the convention's implementing statute, which would upset the constitutional balance of power between Congress and the states. Roberts thus construed the law narrowly and concluded that the law could not apply to Bond's crime.

Justices Scalia, Thomas, and Alito each filed separate concurring opinions arguing that the case had to be decided on constitutional rather than statutory grounds. In their view the statute on its face clearly applied to any attempted use of a "toxic chemical" not used for a "peaceful purpose related to an industrial, agricultural, research, medical, or pharmaceutical activity." Justice Scalia's concurrence, joined by Justice Thomas, was particularly specific in its inquiry into the limits of the power given to the President and Senate to "make" treaties -- following significantly the line of argument of Professor Rosenkranz's article -- and called for Missouri v. Holland to be overturned.

SCOTUSblog's Amy Howe ably summarizes the decisions in more detail here.

Analysis
At Volokh, Jonathan Adler suggests that the concurring opinions may signal some discontent on the part of the more conservative justices with the Chief Justice's tendency to embrace strained statutory readings to avoid constitutional questions (the so-called doctrine of "constitutional avoidance"). His co-conspirator Ilya Somin reads the tea leaves and suggests that in a future case where the treaty issue is more explicit, the Court may be disposed to overturn Missouri v. Holland and limit the ability of a treaty to expand Congressional legislative authority, and offers further thoughts on the justices' various positions.

In its embrace of constitutional avoidance, the Court's decision is obviously reminiscent of the Chief Justice's lone opinion in NFIB v. Sebelius, in which he construed the individual mandate of the PPACA (Obamacare) to be an exercise of Congress's taxing power rather than its Commerce Clause power to uphold the law's core provision (though in that opinion, the Chief did observe that the mandate was clearly a penalty, and only reached the "tax" construction as an alternative functional ruling through which Congress could have reached the same end). The Bond decision also brings to mind Justice Ginsburg's opinion in Skilling v. U.S., which effectively rewrote the "honest services fraud" statute (construing the law's vague provision to apply only to bribes and kickbacks) to avoid deciding whether it was unconstitutionally vague.

The Bond and Skilling decisions may signal how the Court will rule in the upcoming Yates v. United States. Yates involves the prosecution of a commercial fisherman accused of violating the Sarbanes-Oxley financial reform law's prohibition on destroying, manipulating, or concealing any "record, document or tangible object" to hinder federal investigations -- in the context of throwing back fish that may have been smaller than the minimum size allowed by regulations. While a fish is certainly a "tangible object," the Sarbanes-Oxley law, passed in the wake of the Enron-era corporate scandals, was clearly contemplating document-shredding and similar destruction of corporate records such as that conducted by Enron's auditor, Arthur Andersen. It will be interesting to watch whether the justices in the Bond majority will continue the trend of narrowing criminal statutes beyond their clear terms when the government is applying a broad statutory provision in the criminal-law context.

Au Revoir Dollar
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The newspapers this week are full of stories of the impending settlement between French bank, BNP Paribas, and US authorities for BNP's alleged violations of US sanctions. The latest speculation on the settlement number is $10 billion. That hefty financial contribution to American coffers is just part of the anticipated settlement. According to the Wall Street Journal, the New York Department of Financial Services is also insisting that executives lose their jobs and the bank temporarily lose its dollar-clearing privileges. The transactions, at issue apparently fall under US law because they were denominated in dollars. As reported by France's Le Figaro, Bank of France governor Christian Noyer noted that the transactions at issue did not run afoul of French or European Union laws and regulations or United Nations rules. He also cautioned other banks in light of "evolving American jurisprudence".

Absent more details about the conduct at issue, it is difficult to assess the degree of wrongdoing and the proportionality of the contemplated settlement. If these were dollar-denominated transactions conducted by bank employees outside of the US in compliance with applicable foreign laws, should US regulators be pursuing this case at all? By using dollar denomination as a jurisdictional hook are financial regulators hastening the transition away from the dollar's reserve currency status, a trend that many believe is already underway? Rather than using the dollar and opening themselves up to unpredictable punishment at the hands of countless federal and state regulators, companies might choose to conduct their business in other currencies. American regulators and prosecutors should not hesitate to pursue illegal conduct, but focusing their attention on cases not reasonably within their regulatory jurisdiction could have the undesirable consequence of making the dollar a currency to be avoided.

 

 

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Isaac Gorodetski
Project Manager,
Center for Legal Policy at the
Manhattan Institute
igorodetski@manhattan-institute.org

Katherine Lazarski
Press Officer,
Manhattan Institute
klazarski@manhattan-institute.org

 

Published by the Manhattan Institute

The Manhattan Insitute's Center for Legal Policy.