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Why Financial Regulation Keeps Falling Short

Modern finance is fast moving, extremely complex, and contributes to pervasive unknowns. Yet the processes governing how finance is regulated are typically slow, highly deliberative, and often reflect deeply ingrained and incredibly optimistic assumptions about our ability to understand the financial system and the potential impact of regulatory intervention. In our new paper, “Why Financial Regulation Keeps Falling Short,” we identify the key drivers of this fundamental mismatch between finance and financial regulation, demonstrate how this mismatch contributes to undesirable policy outcomes, and lay the conceptual foundations for understanding how the processes governing the creation of financial regulations … Read more

SEC Chair Clayton on Proposed Amendments to Volcker Rule and Disclosure Items

Volcker Rule

Today, the Commission joined the Federal Reserve, OCC, FDIC and CFTC in proposing additional amendments to the implementing regulations under section 13 of the Bank Holding Company Act, commonly known as the “Volcker Rule.”[1]  The proposed amendments, which principally relate to the “covered funds” provisions of the Volcker Rule, represent the next step in the Agencies’ efforts to better tailor and clarify the implementing regulations while furthering the Volcker Rule’s important statutory objectives.[2]

Joint Agency Rulemaking and the Commission’s Three Part Mission

The Commission’s three part mission is to protect investors, maintain fair, orderly, and efficient

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Davis Polk Discusses FSOC’s Shift to an Activities-Based Approach

The Financial Stability Oversight Council’s (FSOC) recently revised guidelines (the 2019 Guidelines)[1] on how it will identify and address financial stability risks are a major shift from the guidelines it issued in the immediate aftermath of the Financial Crisis (the 2012 Guidelines).  The 2019 Guidelines draw upon lessons learned from FSOC’s ultimately fruitless attempts to designate nonbank financial companies as systematically important.  Instead, building on one of the original purposes of the Dodd-Frank Act,[2] which was then emphasized in one of the Treasury Reports, the 2019 Guidelines focus on identifying and regulating systemically important … Read more

Sullivan & Cromwell Discusses FSOC Changes to Nonbank SIFI-Designation Guidance

On December 4, 2019, the Financial Stability Oversight Council (the “Council”) voted unanimously to finalize amendments to its interpretive guidance (the “Final Guidance”) on designating nonbank financial companies as “systemically important financial institutions” (“SIFIs”).[1] The Final Guidance, which will replace the Council’s interpretive guidance on SIFI designations issued in April 2012 (the “Prior Guidance”),[2] implements an “activities-based” approach to identifying and addressing potential risks to financial stability, and is intended to enhance the “analytical rigor and transparency” of the Council’s process for designating SIFIs.

The Final Guidance, which adopts the … Read more

Too Many to Fail: Against Community Bank Deregulation

If there was one thing most people could agree on after the 2008 financial crisis, it was that “too-big-to-fail” banks were to blame for the market crash. This shared understanding was accompanied by a corollary: Small banks were not the problem. These so-called community banks were perceived to be innocent bystanders, overrun by market turmoil caused by much larger financial institutions.

Community banks have long been sympathetic figures in financial regulatory circles. Generally speaking, the term refers to banks with less than $10 billion in assets that focus on traditional financial products. Reasoning that such firms pose little risk, policymakers … Read more

The Effects of Mandatory Disclosure Rules on Hedge Fund Governance

In a new paper, I add to the debate over hedge fund regulation by introducing empirical evidence that hedge fund registration requirements reduce misreporting. Using three alternating changes in hedge fund regulation, my study finds consistent evidence that registration reduces hedge funds’ misreporting — and provides evidence on why this regulatory regime is effective. In particular, my analysis suggests that the disclosure requirements led funds to make changes in their internal governance, such as hiring or switching the fund’s auditor, and that these changes induced funds to report their financial performance more accurately.

It was initially unclear whether regulation would … Read more

Spinning the CEO Pay Ratio Disclosure

The growing compensation gap between CEOs and rank-and-file employees has generated considerable debate about potential adverse consequences at both the firm and societal levels. Despite interest in the topic, assessing vertical pay disparity has been difficult due to the lack of public disclosure about employee compensation.

While companies have long reported top-executive pay, transparency on employee compensation was recently enhanced when the SEC adopted the CEO Pay Ratio Rule requiring most reporting companies to provide new disclosures of the median employee’s pay and a ratio comparing the CEO’s compensation with this value.[1] For example, if the CEO and median … Read more

Calculating SEC Whistleblower Awards: A Theoretical Approach

On October 23, the Securities and Exchange Commission is scheduled to vote on whether to adopt proposed amendments to the rules governing its whistleblower bounty program.  The most controversial proposed amendments are to Rule 21F-6, which governs the way the SEC calculates the amount of an award. In a recent paper, available here, I analyze the wisdom of the proposed amendments to Rule 21F-6.  My take: They are wise, but incomplete.

Under the Dodd-Frank Act, SEC whistleblowers are entitled to between 10 and 30 percent of the money collected by the SEC in an enforcement action that the whistleblower’s … Read more

Gibson Dunn Discusses Volcker Rule Revisions

Since it was enacted in July 2010, the Dodd-Frank Act’s Volcker Rule has challenged banks and their regulators alike.  This is particularly the case with respect to its restrictions on proprietary trading.  It has been one thing for former Federal Reserve Chairman Volcker to state that “you know it when you see it,” quite another to formulate a regulation that accurately defines proprietary trading and implements a broad statutory directive across complex business operations.

On August 20, 2019, the Office of the Comptroller of the Currency and the Board of Directors of the Federal Deposit Insurance Corporation, Director Gruenberg dissenting, … Read more

Sullivan & Cromwell Discusses Amendments to Volcker Rule Regulations

On July 9, 2019, the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Office of the Comptroller of the Currency (the “OCC”), the Federal Deposit Insurance Corporation (the “FDIC”), the Securities and Exchange Commission (the “SEC”) and the Commodity Futures Trading Commission (the “CFTC” and collectively, the “Agencies”) released final rules adopting their previously proposed amendments to the regulations implementing Section 13 of the Bank Holding Company Act of 1956 (the “BHC Act”),[1] known as the “Volcker Rule.”

The amendments modify the implementing regulations in a manner consistent with Sections 203 and 204 of the … Read more

The Future of Financial Institution Resolution

One of the principal lessons learned from the 2007-2009 financial crisis was the need for new legal regimes to facilitate the rapid and orderly resolution of systemically important financial institutions without a government bailout.  In the final part of a six-part article that has just been published, I trace the development of these new legal regimes.[1]  The United States was itself a first mover in this regard with the enactment in 2010 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).[2]

The Dodd-Frank Act contains two provisions of singular importance to the resolution of … Read more

Emergency Guarantee Authority: The Pros and Cons

Today, we present a debate among preeminent scholars about Columbia Law School Professor Kathryn Judge’s proposal for an emergency guarantee authority that could help contain the fallout from another financial crisis. The first piece is Professor Judge’s summary of her proposal. It is followed by responses from Professor Morgan Ricks at Vanderbilt Law School, Graham Steele at Stanford University’s Graduate School of Business, and Professor Stephen G. Cecchetti at the Brandeis International Business School and Kermit L. Schoenholtz at New York University’s Leonard N. Stern School of Business.… Read more

Guarantor of Last Resort: Is There a Better Alternative?

Larry Summers, who was one of President Obama’s key economic advisors when the Dodd-Frank Act of 2010 was enacted, recently decried what he called “excessive populism” in portions of that legislation. This might seem surprising; Dodd-Frank’s technocracy-on-steroids approach (848 pages! 390 separate rulemaking requirements!) might seem like the antithesis of bust-up-the-banks populism. “My administration is the only thing between you and the pitchforks,” President Obama once famously told the nation’s leading bankers.

But Summers was referring to several specific Dodd-Frank provisions that curtailed the federal government’s financial rescue powers. During the financial crisis of 2007-2008, the Federal Reserve, the … Read more

Emergency Guarantee Authority: A FEMA for Finance

“[I]t is a question of when, not if, a large-scale attack succeeds.” DTCC and Oliver Wyman, Large-scale Cyber-attacks on the Financial System, March 2018.

“The government cannot credibly commit to a no-bailout policy.” Kathryn Judge, “Guarantor of Last Resort,” 97 Texas Law Review, forthcoming.

Modern financial systems are inherently vulnerable. The conversion of savings into investment—a basic function of finance—involves substantial risk. Creditors often demand liquid, short-term, low-risk assets; and borrowers typically wish to finance projects that take time to generate their uncertain returns. Intermediaries that bridge this gap—transforming liquidity, maturity and credit between their

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The Impact of Banking Regulation on Voluntary Disclosures

Firms disclose a variety of information to the public, some because they are required to do so by law or regulations, and others voluntarily because they want, for example, to signal their creditworthiness to potential investors. The level and effectiveness of financial institutions’ regulatory oversight have been widely debated since the onset of the financial crisis of 2007-2009. Financial and banking regulators have responded by increasing regulatory requirements and oversight, and by mandating greater disclosure of information. However, these actions do not necessarily improve the information environment of firms if they discourage voluntary disclosures of other types of information. In Read more

Securities Disclosure As Soundbite: The Case of CEO Pay Ratios

Since 2018, U.S. public companies have had to calculate and report a new, unconventional statistic—a CEO pay ratio—which links CEO pay to the pay of rank-and-file workers. Based on a last-minute addition to the Dodd-Frank Act of 2010, the disclosure requirement generated significant controversy during the lengthy SEC rulemaking process. Companies and their executive compensation consultants spent years and considerable resources preparing to comply with the rule. Once the pay ratio figures started arriving in 2018, they captured public imagination in ways that the typically long and technical corporate disclosure documents never do. The sizeable pay gaps highlighted by the … Read more

Sullivan & Cromwell Discusses Resolution-Planning Guidance for U.S. Global Systemically Important Banks

On December 20, 2018, the Federal Reserve and the Federal Deposit Insurance Corporation (together, the “Agencies”) issued final guidance (the “Final Guidance”)[1] with respect to future resolution plan submissions under Title I of the Dodd-Frank Act by the eight U.S. Global Systemically Important Banks (U.S. G‑SIBs), including the plan submissions that are due July 1, 2019.[2]  The Final Guidance adopts, and addresses comments provided in response to, the proposed resolution planning guidance the Agencies issued for comment on June 29, 2018 (the “Proposed Guidance”).[3]  Like the Proposed Guidance and the foundational guidance issued by the Agencies in … Read more

Why Dismantling Nonbank SIFI Regulation Is a Serious Mistake

The unnerving events of fall 2008 removed all doubt that investment banks and other nonbank financial firms can propagate systemic risk and endanger the world’s financial system.  In response, Congress instituted a robust system for regulating systemic risk posed by nonbanks.  The Dodd-Frank Act created two approaches to nonbank systemic risk regulation.  The first, known as entity-based regulation, authorized the new Financial Stability Oversight Council (FSOC) to designate individual nonbank financial firms as systemically important financial institutions (SIFIs) for heightened regulation and oversight by the Federal Reserve.  The second, dubbed activities-based regulation, gave FSOC the power to make … Read more

Transparency and the (E)valuation of Asset-Backed Securities

In 2011, the commission appointed by Congress to investigate the causes of the financial crisis concluded that “a combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis” (The Financial Crisis Inquiry Report, 2011, p. xix).  In particular, the opacity of asset-backed securities (ABS) greatly inhibited the ability of investors and regulators to fully understand the risks held by institutions that owned these products.  As part of the post-financial crisis effort to reform the securitization process, the Dodd-Frank Act directed the SEC to “require issuers of asset-backed securities, … Read more

The Unwise and Illegal Deregulation of Prudential Financial

On October 18, federal regulators released the largest U.S. insurance group, Prudential Financial, Inc., from enhanced government oversight.  Prudential had been the last remaining systemically important financial institution (SIFI)—a designation Congress created in the Dodd-Frank Act for nonbank financial companies that could threaten U.S. financial stability.  Prudential’s deregulation fulfills a years-long effort by Dodd-Frank critics to weaken a crucial post-crisis regulatory reform.

In my new essay, “The Last SIFI: The Unwise and Illegal Deregulation of Prudential Financial, Inc.,” I contend that overturning Prudential’s “systemically important” status was not only misguided, it was also against the law.  By illegally … Read more