Financial Services and Products
Nonbank Banks—An Issue in Need of a Policy
Carl Felsenfeld, 41(1): 99–123 (Nov. 1985)
Whether an institution meets the definition of "bank" under the Federal Bank Holding Company Act of 1956 may be one of the central controversies today among financial institutions, their regulators, and the country's legislators, as the financial services industry accelerates its evolution. The controversy has, however, been largely untouched by any serious discussion of what we as a society are trying to accomplish by including an institution within, or excluding it from, the coverage of the BHCA. Debates over inclusion and exclusion tend to suffer from want of direction absent some fundamental policy. The Article represents an attempt to find such a policy.
Regulating Financial Services in the United Kingdom—An American Perspective
Sam Scott Miller, 44(2): 323–64 (Feb. 1989)
The United Kingdom is presently installing the most comprehensive system of financial regulations since that adopted by the United States in the 1930s and 1940s. Coverage of the Financial Services Act compares to that of the Securities Act, the Securities Exchange Act, the Commodity Exchange Act, the Investment Company Act, and the Investment Advisers Act. This Article introduces the regulatory scheme to the U.S. lawyer and furnishes a general overview.
Financial Statement Fraud: The Boundaries of Liability Under the Federal Securities Laws
Richard C. Sauer, 57(3): 955 (May 2002)
Accurate information about public companies is fundamental to the operation of our capital markets. The recent spate of major accounting scandals, however, reminds us that the reported performance of public companies can be highly vulnerable to manipulation. The result is the squandering of billions in investor funds and the erosion of faith in the securities markets. This Article describes common approaches employed to misrepresent the operating results of public companies. Taking examples from recent SEC enforcement actions, it discusses a range of earnings management techniques and analyzes their status under present standards of legal liability, with particular emphasis on those areas of financial reporting in which standards are unclear or evolving.
Home Banking Services Agreement
Task Force on Home Banking Services Agreement, ABA Section of Business Law, 61(2):611—640 (February 2006)
Consumer PerspectiveÂ-Home Banking Agreements: Don't Bank on Them
Mark E. Budnitz, Donald F. Clifford, Michael Ferry, and Margot Saunders, 61(2):641—652 (February 2006)
Task Force Response to Consumer Perspective
Task Force on Home Banking Services Agreement, ABA Section of Business Law, 61(2):653—658(February 2006)
Initial Report of the Joint Task Force on Deposit Accounts Control Agreements
Joint Task Force on Deposit Account Control Agreements, ABA Section of Business Law, 61(2):745—796 (February 2006)
Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms
Henry T. C. Hu and Bernard Black, 61(3):1011–1070 (May 2006)
Most American publicly held corporations have a one-share, one-vote structure, in which voting power is proportional to economic ownership. This structure gives shareholders economic incentives to exercise their voting power well and helps to legitimate managers' exercise of authority over property the managers do not own. Berle-Means' "separation of ownership and control" suggests that shareholders face large collective action problems in overseeing managers. Even so, mechanisms rooted in the shareholder vote, including proxy fights and takeover bids, constrain managers from straying too far from the goal of shareholder wealth maximization.
In the past few years, the derivatives revolution, hedge fund growth, and other capital market developments have come to threaten this familiar pattern throughout the world. Both outside investors and corporate insiders can now readily decouple economic ownership of shares from voting rights to those shares. This decoupling—which we call "the new vote buying"—is often hidden from public view and is largely untouched by current law and regulation. Hedge funds, sophisticated and largely unfettered by legal rules or conflicts of interest, have been especially aggressive in decoupling. Sometimes they hold more votes than economic ownership, a pattern we call "empty voting." That is, they may have substantial voting power while having limited, zero, or even negative economic ownership. In the extreme situation of negative economic ownership, the empty voter has an incentive to vote in ways that reduce the company's share price. Sometimes hedge funds hold more economic ownership than votes, though often with "morphable" voting rights—the de facto ability to acquire the votes if needed. We call this "hidden (morphable) ownership" because under current disclosure rules, the economic ownership and (de facto) voting ownership are often not disclosed. Corporate insiders, too, can use new vote buying techniques.
This article analyzes the new vote buying and its corporate governance implications. We propose a taxonomy of the new vote buying that unpacks its functional elements. We discuss the implications of decoupling for control contests and other forms of shareholder oversight, and the circumstances in which decoupling could be beneficial or harmful to corporate governance. We also propose a near-term disclosure-based response and sketch longer-term regulatory possibilities. Our disclosure proposal would simplify and partially integrate five existing, inconsistent share-ownership disclosure regimes, and is worth considering independent of its value with respect to decoupling. In the longer term, other responses may be needed; we briefly discuss possible strategies focused on voting rights, voting architecture, and supply and demand forces in the markets on which the new vote buying relies.
Consumer Arbitration: If the FAA "Ain't Broke," Don't Fix It
Alan S. Kaplinsky and Mark J. Levin, 63(3): 907–920 (May 2008)
During 2007, Congress showed significant interest in mandatory pre–dispute consumer arbitration agreements. Some in Congress focused on whether to prohibit them altogether. This Article argues that such legislation is unnecessary because the current system of consumer arbitration works well and needs no fix. The authors review case law and empirical studies showing that the current system of checks and balances in the area of consumer arbitration law is sufficiently protective of consumers' rights. These protections emanate from: (1) the Federal Arbitration Act ("FAA") itself, (2) the careful drafting of arbitration agreements, (3) the use of third–party arbitration administrators, and (4) the rigorous enforcement of the FAA by state and federal courts.
Reforming the Regulation of Broker-Dealers and Investment Advisers
Arthur B. Laby, 65(2): 395–440 (February 2010)
A key component of financial regulatory reform is harmonizing the law governing broker-dealers and investment advisers. Historically, brokers charged commissions and were regulated under the Securities Exchange Act of 1934. Advisers charged asset-based fees and were subject to the Investment Advisers Act of 1940, which contains a special exclusion for brokers. In recent years, brokers have changed their compensation structure and many now market themselves as advisers, raising questions about whether they should be treated as such. The Obama Administration's 2009 white paper on regulatory reform and draft legislation call for a fiduciary duty to be imposed on brokers that provide advice. This Article explores the debate over regulating brokers and advisers, and makes four key claims. First, changes in brokers' compensation and marketing methods vitiate application of the broker-dealer exclusion and should subject brokers to the Advisers Act. Second, changes in the nature of brokerage, spurred by changes in technology, make the broker-dealer exclusion unsustainable and Congress should repeal it. The third claim is that imposing fiduciary duties on brokers is incompatible with their historical roles as dealers and underwriters. To resolve this tension, this Article suggests a compromise that enhances brokers' duties but does not hobble their ability to perform their traditional functions. Finally, regulating brokers as advisers would overburden the U.S. Securities and Exchange Commission. This Article offers alternatives to alleviate the strain.
Law of Private Placements (Non–Public Offerings) Not Entitled to Benefits of Safe Harbors—A Report
Committee on Federal Regulation of Securities, ABA Section of Business Law, 66(1): 85–124 (November 2010)
Fiduciary Society Unleashed: The Road Ahead for the Financial Sector
Edward J. Waitzer and Douglas Sarro, 69(4): 1081-1116 (August 2014)
Informational asymmetries, misaligned incentives and artificially elongated chains of intermediation have created a disconnect between the financial sector and the “real economy” that is detrimental to the public interest. Courts and regulators are increasingly intervening to break the cycle. We argue that fiduciary law offers a conceptual framework both for understanding and responding to this trend, and that the financial sector, rather than waiting for this trend to develop and reacting to new rules in a piecemeal way, should be proactive and try to shape the way in which this trend develops. We describe some elements of what such an approach might look like, and consider how regulators and political institutions can encourage financial institutions to adopt this approach, and in so doing support a broader transition to a more sustainable economy.
Massey Prize for Research in Law, Innovation, and Capital Markets Symposium—Foreword
70(2): 319-320 (Spring 2015)
Financial Innovation and Governance Mechanisms: The Evolution of Decoupling and Transparency
Henry T. C. Hu; 70(2): 347-406 (Spring 2015)
Financial innovation has fundamental implications for the key substantive and information-based mechanisms of corporate governance. “Decoupling” undermines classic understandings of the allocation of voting rights among shareholders (via, e.g., “empty voting”), the control rights of debtholders (via, e.g., “empty crediting” and “hidden interests”/ “hidden non-interests”), and of takeover practices (via, e.g., “morphable ownership” to avoid section 13(d) disclosure and to avoid triggering certain poison pills). Stock-based compensation, the monitoring of managerial performance, the market for corporate control, and other governance mechanisms dependent on a robust informational predicate and market efficiency are undermined by the transparency challenges posed by financial innovation. The basic approach to information that the SEC has always used—the “descriptive mode,” which relies on “intermediary depictions” of objective reality—is manifestly insufficient to capture highly complex objective realities, such as the realities of major banks heavily involved with derivatives. Ironically, the primary governmental response to such transparency challenges—a new system for public disclosure that became effective in 2013, the first since the establishment of the SEC—also creates difficulties. This new parallel public disclosure system, developed by bank regulators and applicable to major financial institutions, is not directed primarily at the familiar transparency ends of investor protection and market efficiency.
As starting points, this Article offers brief overviews of: (1) the analytical framework developed in 2006−2008 for “decoupling” and its calls for reform; and (2) the analytical framework developed in 2012−2014 reconceptualizing “information” in terms of three “modes” and addressing the two parallel disclosure universes.
As to decoupling, the Article proceeds to analyze some key post- 2008 developments (including the status of efforts at reform) and the road ahead. A detailed analysis is offered as to the landmark December 2012 TELUS opinion in the Supreme Court of British Columbia, involving perhaps the most complicated public example of decoupling to date. The Article discusses recent actions on the part of the Delaware judiciary and legislature, the European Union, and bankruptcy courts—and the pressing need for more action by the SEC. At the time the debt decoupling research was introduced, available evidence as to the phenomenon’s significance was limited. This Article helps address that gap.
As to information, the Article begins by outlining the calls for reform associated with the 2012−2014 analytical framework. With revolutionary advances in computer- and web-related technologies, regulators need no longer rely almost exclusively on the descriptive mode rooted in intermediary depictions. Regulators must also begin to systematically deploy the “transfer mode” rooted in “pure information” and the “hybrid mode” rooted in “moderately pure information.” The Article then shows some of the key ways that the new analytical framework can contribute to the SEC’s comprehensive and long-needed new initiative to address “disclosure effectiveness,” including in “depiction-difficult” contexts completely unrelated to financial innovation (e.g., pension disclosures and high technology companies). The Article concludes with a concise version of the analytical framework’s thesis that the new morphology of public information—consisting of two parallel regulatory universes with divergent ends and means—is unsustainable in the long run and involve certain matters that need statutory resolution. However, certain steps involving coordination among the SEC, the Federal Reserve, and others can be taken in the interim.
The Promise of Unfavorable Research: Ramifications of Regulations Separating Research and Investment Banking for IPO Issuers and Investors
Benjamin J. Catalano; 72(1): 31-60 (Winter 2016/2017)
The trend in Securities and Exchange Commission and Financial Industry Regulatory Authority rulemaking and enforcement to insulate research from investment banking influence has led to the removal of research analysts from the underwriting process with adverse consequences for new issuers and their investors. The approach conflicts with the congressional objective under the Jumpstart Our Business Startups (JOBS) Act to incorporate research fully in public offerings for emerging growth companies, which now comprise the vast majority of IPO issuers. Faced with these competing objectives, broker-dealers should have written policies and procedures that are carefully crafted to service their underwriting and investor clients appropriately and to take advantage of the JOBS Act privileges with respect to research.
Square Peg Meets Round Hole: Regulatory Responses to Challenges Created by Innovation in Banking
Jonice Gray Tucker, Daniel Stipano, Kari Hall, Brendan Clegg, and Anthony Carral, 75(4): 2491-2518 (Fall 2020)
During the past decade, an underlying tension between the financial sector’s embrace of innovative products and services and the regulatory framework that governs the industry surfaced—and that tension has since become even more acute during the COVID-19 pandemic. Facing pressure from customers’ twenty-first century expectations and competition from emerging fintechs, banks began implementing technological advances into their businesses even before disruptions to the U.S. financial system caused by the coronavirus placed a spotlight on the critical role those advances will play in banking’s future. This article highlights a number of areas of law where the governing framework erected during bygone eras has hindered the industry’s adoption of innovation and proven incompatible with the digital revolution that has changed the business of banking. This article also explores the successes and failures of a range of approaches adopted by the federal regulatory agencies responsible for the framework’s design, implementation and enforcement as they try to mitigate this tension. The degree to which these agencies embrace innovation in the industry, and use the tools at their disposal to encourage its continuation, will go a long way toward determining whether banks can weather this period of economic disruption, meet the changing needs of their customers, and fend off competition from industry upstarts.
The Treatment of Derivatives Under the SEC’s Net Capital Rule
Michael P. Jamroz, 76(1): 183-210 (Winter 2020-2021)
Every broker or dealer conducting a general securities business registered with the Securities and Exchange Commission (Commission) must comply with SEC Rule 15c3-1, the Net Capital Rule. The Net Capital Rule is designed to ensure that broker-dealers will have adequate liquid assets to meet their obligations to investors and liabilities to other creditors. The rule is complex and specifically addresses the liquidity, market, and counterparty credit risks associated with the proprietary positions of the broker-dealer.