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Lehman Brothers: How Good Policy Can Make Bad Law

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

A Retrospective on the Demise of Long-Term Capital Management

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

Why Firms Disclose a Supplemental CEO-to-Median Worker Pay Ratio

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

Measuring Regulation Based on Industry Response

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

The Consequences of Strong v. Weak Clawback Provisions

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

How External Whistleblower Rewards Affect Internal Reporting

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

SEC’s Jackson Calls for Curbing Executives’ Ability to Cash Out on Buybacks

Thank you so much, Neera [Tanden], for that very kind introduction. I’ve long admired all that you and everyone here at the Center for American Progress do to promote a progressive economic agenda. And I share your commitment to making sure our markets are safe and efficient—and fair for all Americans. So it’s a real honor to be with you here today.[1]

I also want to thank my friend Andy Green, who in addition to being Managing Director of Economic Policy here at CAP, has been a critical source of wisdom for me since my swearing in at the

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Cleary Gottlieb Discusses New Law Revising Dodd-Frank Act

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

Did Dodd-Frank Help Reduce Systemic Risk?

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.[1] 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

Whistleblower Provisions of Dodd-Frank Deter Aggressive Financial Reporting

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.[1] 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

K&L Gates Discusses the Dodd-Frank Reform Endgame

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

Financial Reporting Choices of Large Private Firms

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.[1] 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.[2] This amounts to a significant portion of the overall economy relative to the total U.S. market capitalization of $25 trillion.[3]

As the privately-held sector of the economy grows, the financial … Read more

Does Local Supervision Affect Banks’ Risk Taking?

An often-over-looked aspect of regulation is how agencies are organized. Regulatory agencies for many industries, including banking, pharmaceuticals, mining, and agriculture, rely on a mix of centralized decision-making and delegated monitoring. For instance, in the case of banking, federal agencies design regulations in Washington, D.C. but monitor banks at the local level by utilizing semi-autonomous field offices.

A major advantage of this dispersed presence is that it allows local examiners and supervisors to interact with regulated firms more frequently and to collect “soft information” about firms’ performance that is often imperfectly captured through accounting-based reporting measures. The approach may, however, … Read more

Too Big to Fail: Measures, Remedies, and Consequences for Efficiency and Stability

Bank failure was almost unthinkable in Europe long before “too big to fail” became a byword for U.S. regulatory policy on big banks. But the 2007−2009 global financial crisis, which for some countries grew to a full-blown crisis, made the unthinkable a real possibility.

U.S. and EU regulators were responsible for much of the increase in bank size and concentration over the previous three decades, and the crisis forced them not only to contemplate allowing banks to fail, but to plan for banks’ orderly demise. To that end, they have proposed and implemented remedies for the too-big-to-fail, or TBTF, problem. … Read more

Do Corporate Whistleblower Laws Deter Accounting Fraud?

Whistleblowers play a significant role in detecting corporate fraud. For example, recent high-profile financial frauds such as the Enron scandal and Bernard Madoff’s Ponzi scheme were brought to light by whistleblowers. To encourage more whistleblowers to come forward, the Securities and Exchange Commission (SEC) implemented in 2011 the Dodd-Frank whistleblower program, which provides enhanced protection and financial rewards to whistleblowers. According to the program’s 2016 annual report, the SEC received over 4,200 tips for the fiscal year 2016 and has awarded more than $111 million to 34 whistleblowers since the inception of this program.[1] In a recent paper, I … Read more

The Case Against Activity-Based Financial Regulation

An October 2017 Treasury Department report on the asset management and insurance industries includes an important—and fundamentally flawed—recommendation that could change the way U.S. regulators monitor risk in the financial system.  The Treasury report recommends that regulators focus on identifying and overseeing potentially risky financial activities rather than systemic firms like AIG, Lehman Brothers, and Bear Stearns.

This proposal, long favored by the insurance sector, would represent a sharp departure from U.S. and global regulators’ approach to systemic risk since the financial crisis.  When Congress created the Financial Stability Oversight Council as part of the Dodd-Frank Act, it gave the … Read more

Arnold & Porter Discusses SEC’s Pay Ratio Guidance

Item 402(u) of Regulation S-K was adopted in 2015 to implement the pay ratio disclosure provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and will require pay ratio disclosure with respect to the first fiscal year beginning on or after January 1, 2017 (i.e., such disclosure will be required during the 2018 proxy season)[1]. The required disclosures consist of the total compensation of the registrant’s principal executive officer, the median total compensation of the registrant’s employees other than its principal executive officer, and the ratio of the first of these amounts to the second.

One … Read more

Skadden Discusses Potential Impacts of the Financial CHOICE Act

On June 8, 2017, the House of Representatives passed, by a 233-186 vote (with all Democrats and one Republican voting against), the Financial CHOICE Act of 2017, a bill principally designed to reverse many features of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank). The House Financial Services Committee majority has provided both an executive summary and a comprehensive summary of the current bill. It is unclear at this time what action the U.S. Senate will take with regard to the bill in its current form.

While the vast majority of the bill relates to the … Read more

The Financial CHOICE Act of 2017: Will Collective Amnesia Triumph?

Notwithstanding decidedly hostile testimony last month from this humble columnist,[1] the U.S. House of Representatives will soon pass legislation (probably on a strict party-line basis) entitled, “The Financial CHOICE Act of 2017” (H.R. 10) (which acronym stands for “Creating Hope and Optimism for Investors, Corporations, and Entrepreneurs”).  Despite this cutesy and innocuous title, the CHOICE Act proposes dangerous and radical surgery that would gut those provisions of the Dodd-Frank Act that seek to prevent the failure of a single major bank from setting off a chain reaction that could bring down all interconnected banks.  Indeed, the Act reads as … Read more