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.
Hester Peirce Archives
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.
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.
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.
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.
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.
Last week, the Public Company Accounting Oversight Board released its staff guidance on economic analysis in PCAOB standard setting. According to PCAOB Chairman James Doty, "[t]he Guidance should give those who are interested in the PCAOB's standard setting a better understanding of the analysis that staff plan to conduct to ensure effective and efficient rulemaking." The PCAOB guidance is an important departure from the historical reluctance of federal financial regulators to conduct economic analysis in connection with their rulemaking. In response to this aversion to pre-regulatory analysis, Abby McCloskey and I released a paper this week exploring the merits of a statutory requirement applicable to all the federal financial regulators.
Rather than something to be feared, economic analysis helps a regulator identify the problem it is trying to solve and think through potential solutions. Yes, it is a difficult, time-consuming, and costly exercise. It is true that there are hard to quantify benefits and costs, uncertainties, data gaps, and indirect effects. Despite these problems, most regulators are required by executive order to conduct economic analysis. Given the far-reaching effects that federal financial regulations have, the benefits of ascertaining what your rule will do before you adopt it outweigh the costs of doing a reasonable analysis. The PCAOB guidance embraces a form of analysis similar to that required under the executive orders. The other federal financial regulators should do the same. A clear, statutory requirement applicable to all of the financial regulators would ensure that thinking about whether and how regulations will work and what their likely consequences will be is not optional.
On Monday, the Financial Stability Oversight Council will hold an asset management conference with industry, academics, regulators, and a handpicked audience. The FSOC, which is made up primarily of the heads of the federal financial regulatory agencies, has the power to designate non-bank financial companies for regulation by the Federal Reserve. Monday's event will be the latest step in the FSOC's consideration of whether to designate one or more asset managers as systemically important. A report by the FSOC's sidekick--the Office of Financial Research--on the asset management industry looked as if it had been written without much consideration of the actual nature, purposes, or risks of the industry.
Center for Legal Policy at the