Calls to dismantle the legal framework that was developed in response to the financial crisis have begun to multiply and gain momentum. Pursuant to a Trump Administration executive order, the Treasury Department has released a series of reports that undertakes a comprehensive review of existing financial regulations. And in Congress, the proposed Financial CHOICE Act sets forth a roadmap for replacing the Dodd-Frank Act in full. Some of that roadmap was enacted earlier this year with the passage of the Economic Growth, Regulatory Relief, and Consumer Protection Act.
The recent wave of reforms is as much about a change in … Read more
Where jurisdictions differ in how they regulate an activity, migration allows private parties to choose between regulatory regimes. In the context of financial regulation, scholars assert that harmonization of regulation across jurisdictions is necessary to prevent institutions from opting into the laxest regulatory regime through relocation. This assertion relies on two assumptions: (1) financial institutions indeed move in response to burdensome regulations, and (2) unilateral regulation is insufficient to achieve regulatory objectives with respect to offshore institutions. My recent project provides the first empirical evidence supporting that financial institutions relocate activities in response to derivatives regulation. Charges that unilateral … Read more
From the New Deal until the 1970s, banks were on a tight leash. Regulators controlled the rate of interest they could pay on deposits. Banks could not underwrite or deal in corporate securities. With some exceptions, they could not expand geographically.
These restrictions were gradually eliminated beginning in the 1970s. Simultaneously, banking grew riskier. From the end of World War II to 1970, bank failures were virtually nonexistent. From that time on, the U.S. experienced waves of bank distress culminating in the financial crisis of 2007-09.
It is tempting to conclude that the deregulation caused the instability. I believe, however, … Read more
The financial crisis of 2007-09 caused the Great Recession, the most severe global economic downturn since the Great Depression. The financial crisis began with the collapse of the subprime mortgage market in the U.S. and spread to financial markets around the world. Similarly, the disastrous financial events of the Great Depression began with the Great Crash on Wall Street in October 1929 and spread throughout the U.S. and Europe during the early 1930s.
Congress responded to the Great Depression by passing the Glass-Steagall Banking Act of 1933. Two of Glass-Steagall’s key provisions – Sections 20 and 32 – separated … Read more
In their lively disagreement about the role of deregulation in contributing to the 2007-2009 financial crisis, professors Arthur Wilmarth and Paul Mahoney inadvertently illuminate why the processes through which finance is regulated are so ill-suited to that purpose. Finance is dynamic. Today’s financial system bears only a coarse resemblance to the financial system of the 1950s. Tomorrow, the system will evolve yet further and in ways we may not be able to imagine today. In contrast, the legal regime is designed to stagnate. Frictions make statutes and regulations difficult to change, even when market changes have already altered the substantive … Read more
In this age of firebrand political rhetoric and sniping from the right and the left, Wall Street has taken more than its fair share of criticism. One of the most significantly misplaced criticisms, however, derives from a gross misunderstanding of how the invisible hand of the market works and how certain mechanisms improve the health of firms and the market overall, delivering value for a broad swath of stakeholders—managers, investors, and employees alike.
In his 1965 “Mergers and the Market for Corporate Control,” Henry Manne describes how market competition helps regulate the behavior of managers. Managers that pursue objectives counter … Read more
In the aftermath of the 2007—2009 financial crisis, policymakers around the globe responded to calls for greater transparency in the financial system by adopting new rules and institutions that required more and better information disclosure by financial institutions. For example, the Dodd-Frank Act required the Federal Reserve Board to publish the results of periodic stress tests administered to the largest financial institutions. In spite of the recent flurry of regulations, the jury is still out on whether they enhance the stability and development of the financial system.
The lack of consensus is largely based on conflicting predictions from the theoretical … Read more
As we approach the 10-year anniversary of the failure of Lehman Brothers, the news is again awash in a debate about whether policymakers could have saved the investment bank. That the issue remains so deeply contested reflects how fundamentally flawed the current legal regime is. Although embodying ideas that are sensible in the abstract, the regime makes the authority to act contingent on facts that policy makers cannot readily discern during periods of systemic distress. Making matters worse, subsequent events, including other actions by those same policy makers, can further skew the critical facts on which legal authority rests. This … Read more
The 10th anniversary of the harrowing financial events of September 2008 is nearly upon us. The anniversary will undoubtedly be marked by various retrospectives analyzing those events. For a longer-term perspective, though, it may be helpful to consider another anniversary that will be observed in September 2018: the near failure of Long-Term Capital Management, L.P. and its fund, Long-Term Capital Portfolio, L.P. (collectively “LTCM”) 20 years ago. LTCM was the largest hedge fund operating in the United States and its brush with death provided a preview of some of the forces that would contribute to the near collapse of the … Read more
Pay disparity between executives and employees has been criticized as evidence of corporate greed. It can also create perceptions of unfairness and dissatisfaction among employees, weakening their commitment and performance. To provide more information about pay disparity, the U.S. Congress enacted Section 953 (b) of Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which requires all publicly listed firms to disclose a Pay Ratio comparing annual CEO compensation with median annual employee compensation, excluding the CEO. Proponents of Section 953 (b) assert that the information helps investors understand and evaluate CEO compensation within a specific firm. However, critics … Read more
Despite the central role of government regulation in academic inquiry and policy evaluation, there is no universally accepted way to measure how changes in regulatory complexity and intensity affect private industry at different times. This lack of a standard methodological approach to measuring regulatory burdens on companies has limited the extent to which researchers can generalize and compare results of studies that consider particular regulations, industries, or time periods. There is a strong need for a standard approach that is theoretically and empirically grounded and difficult to manipulate.
In Measuring Regulation, Miao Ben Zhang and I develop a novel … Read more
Clawback provisions authorize firms to recoup compensation from executives upon the occurrence of financial restatements or executive misbehavior. The first clawback provision in U.S. federal law was Section 304 of the Sarbanes-Oxley Act of 2002 (SOX 304). SOX 304 requires CEOs and CFOs to return any earned incentive compensation following a financial restatement due to misconduct and puts the burden of enforcement on the Securities and Exchange Commission (SEC). After SOX 304, Section 954 of the Dodd-Frank Wall Street Reform and Consumer Protection Act introduced clawback rules in 2010 requiring firms to adopt and enforce clawback provisions themselves. While Section … Read more
Does paying employees for blowing the whistle on corporate crime to regulators discourage internal reporting and undermine corporate governance? The answer is not as simple as it might seem. My research shows that, as the amount of reward increases, the probability of internal reporting rises at ﬁrst but then falls.
The question has been discussed in countries that have introduced or contemplated the introduction of legislation to reward whistleblowers but has not yet been fully analyzed. One of the overlooked obstacles is that the standard of proof for external whistleblowing cases is higher than for cases of internal reporting, and … Read more
On May 30, the Federal Reserve Board proposed revisions (the “Proposal”) to the regulations implementing section 13 of the Bank Holding Company Act (referred to as the “Volcker Rule”) and asked questions on potential additional changes. Below are our preliminary takeaways on select issues. We anticipate providing a comprehensive summary of the Proposal in the future, covering the issues below in more detail and additional issues raised by the Proposal. A redline showing proposed changes to the regulatory text is available here.
- Compliance Tailored by Size: The Proposal would establish three tiers of banking entities, based on
… Read more
The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “Act”), which became law on May 24, contains the first major package of revisions to the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The Act leaves the architecture and core features of Dodd-Frank intact but significantly recalibrates applicability thresholds. While the changes mandated by the Act are significant, it also places significant discretion for further changes in the hands of the Federal Reserve Board.
Both the House of Representatives and the Senate passed the Act on bipartisan votes. The Chairman of the House Financial Services … Read more
In response to the 2008 financial crisis, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) was enacted on July 21, 2010 to overhaul the U.S. financial regulatory system. Dodd-Frank contains 390 rulemaking requirements, of which 274 (70.3 percent) were satisfied as of July 2016. Although implementation has been slow, Dodd-Frank has wrought many changes in the financial system. One of the most visible is the increased levels of capital at bank holding companies (BHCs).
The common equity tier 1 ratio of the 31 large and interconnected BHCs decreased from 7.07 percent in the fourth quarter of 2005 … Read more
In 2011, the Securities and Exchange Commission (SEC) introduced a Whistleblower (WB) program as part of the Dodd-Frank Act to protect investors through greater deterrence of securities law violations and more effective enforcement. The program offers financial incentives to provide original information that leads to a successful enforcement action. SEC officials have called the program a “game changer,” improving their ability to detect illegal conduct and speed investigations with fewer resources. Since the program’s introduction, the SEC has received over 18,000 tips, with the highest number coming in three categories: corporate disclosures and financials (financial reporting fraud); Ponzi schemes … Read more
Early 2018 will likely see the most significant progress on reforming the Dodd-Frank Act (“DFA”) since its passage in 2010 thanks to four key efforts: the Financial CHOICE Act and activity in the House Financial Services Committee, an appropriations effort, President Trump’s executive actions, and bipartisan legislation in the Senate.
The Reform Efforts
Last June, the Financial CHOICE Act (H.R. 10) passed the House of Representatives by a party line vote of 233–186. This moved the bill to the Senate, where it would have required 60 votes for passage. At that time, the Senate had 52 Republicans and … Read more
In recent years, there has been an increase in the number of firms opting to either forgo the public equity market or exit the market in favor of private financing. Increasingly, financing for private firms comes from private funds, such as private equity, venture capital, and hedge funds. In 2015, private funds owned stakes in over 7,500 firms and had over $4 trillion in capital under management. This amounts to a significant portion of the overall economy relative to the total U.S. market capitalization of $25 trillion.
As the privately-held sector of the economy grows, the financial … Read more