Banking and Finance Law Commons^™

A Legal Theory Of Finance, Katharina Pistor

Faculty Scholarship

This paper develops the building blocks for a legal theory of finance. LTF holds that financial markets are legally constructed and as such occupy an essentially hybrid place between state and market, public and private. At the same time, financial markets exhibit dynamics that frequently put them in direct tension with commitments enshrined in law or contracts. This is the case especially in times of financial crisis when the full enforcement of legal commitments would result in the self-destruction of the financial system. This law-finance paradox tends to be resolved by suspending the full force of law where the survival …

Idiosyncratic Risk During Economic Downturns: Implications For The Use Of Event Studies In Securities Litigation, Edward G. Fox, Merritt B. Fox, Ronald J. Gilson

Faculty Scholarship

We reported in a recent paper that during the 2008-09 financial crisis, for the average firm, idiosyncratic risk, as measured by variance, increased by five-fold. This finding is important for securities litigation because idiosyncratic risk plays a central role in event study methodology. Event studies are commonly used in securities litigation to determine materiality and loss causation. Many bits of news affect an issuer’s share price at the time of a corporate disclosure that is the subject of litigation. Because of this, even if an issuer’s market–adjusted price changes at the time of the disclosure, one cannot determine with certainty …

Legislation With Endogenous Preferences, Aviad Heifetz, Ella Segev, Eric L. Talley

Faculty Scholarship

It has long been recognized that individuals' preferences adapt to the social, economic and legal environment in which they take part, in addition to reacting to incentives and constraints given these preferences. Therefore, the design of such incentives via legislation or regulation should better take into account also its own effect on preferences, in order to avoid endogenous preference adaptation curtailing the designer's aims. Furthermore, the endogeneity of preferences poses a dilemma to the social planner whether to maximize welfare having in mind the original preferences of individuals, or rather the preferences that emerge endogenously with the intervention mechanism. This …

Assessing Transnational Private Regulation Of The Otc Derivatives Market: Isda, The Bba, And The Future Of Financial Reform, Gabriel Rauterberg, Andrew Verstein

Faculty Scholarship

For the last twenty years, the dominant narrative of the over-the-counter derivatives market has been one of absent regulation, deregulation, and regulatory conflict, predictably resulting in disaster. This Article challenges this narrative, arguing that the global derivatives market has been subject to pervasive and harmonized regulation by what should be recognized as transnational private regulators. Recognizing the reality of widespread transnational private regulation of derivatives has significant implications, which this Article explores. Appreciating the actual regulatory status quo is essential if policymakers are to correctly diagnose problems, avoid past regulatory errors, and plan effective remedies. There are also advantages to …

Revisiting Sovereign Bankruptcy, Lee C. Buchheit, Anna Gelpern, Mitu Gulati, Ugo Panizza, Beatrice Weder Di Mauro, Jeromin Zettelmeyer

Faculty Scholarship

Sovereign debt crises occur regularly and often violently. Yet there is no legally and politically recognized procedure for restructuring the debt of bankrupt sovereigns. Procedures of this type have been periodically debated, but so far been rejected, for two main reasons. First, countries have been reluctant to give up power to supranational rules or institutions, and creditors and debtors have felt that there were sufficient instruments for addressing debt crises at hoc. Second, fears that making debt easier to restructure would raise the costs and reduce the amounts of sovereign borrowing in many countries. This was perceived to be against …

Securitization, Structured Finance, And Covered Bonds, Steven L. Schwarcz

Faculty Scholarship

No abstract provided.

The Wonder-Clause, Anna Gelpern, Mitu Gulati

Faculty Scholarship

The Greek debt crisis prompted EU officials to embark on a radical reconstruction of the European sovereign debt markets. Prominently featured in this reconstruction was a set of contract provisions called Collective Action Clauses, or CACs. CACs are supposed to help governments and private creditors to renegotiate unsustainable debt contracts, and obviate the need for EU bailouts. But European sovereign debt contacts were already amenable to restructuring; adding CACs could make it harder. Why, then, promote CACs at all, and cast them in such a central role in the market reform initiative? Using interviews with participants in the initiative and …

Strengthening Financial Reporting: An Essay On Expanding The Auditor’S Opinion Letter, James D. Cox

Faculty Scholarship

Users of financial statements, foremost of which are investors, have a voracious appetite for information that better enables them to assess the financial position and performance of the reporting firm. Even though financial statements purport to address their needs, because the statements, which are prepared by the firm’s managers, conceal a range of managerial estimates, assumptions, judgments, and choices, investors are deprived of the most fundamental kernel of information they seek, namely the overall quality of the financial reports themselves. In this Article, the author sets forth several modest steps that would enhance the overall quality of financial reporting by …

Regulating Shadows: Financial Regulation And Responsibility Failure, Steven L. Schwarcz

Faculty Scholarship

In the modern financial architecture, financial services and products increasingly are provided outside of the traditional banking system—and thus without the need for bank intermediation between capital markets and the users of funds. Most corporate financing, for example, no longer is dependent on bank loans but raised through special-purpose entities, money-market mutual funds, securities lenders, hedge funds, and investment banks. This shift, referred to as “disintermediation” and described as creating a “shadow banking” system, is so radically transforming finance that regulatory scholars need to rethink their assumptions. Two of the fundamental market failures underlying shadow banking—information failure and agency failure—were …

Restructuring A Sovereign Debtor’S Contingent Liabilities, Mitu Gulati, Lee C. Buchheit

Faculty Scholarship

How should the contingent liabilities of a sovereign be treated in a general restructuring of the debts of that sovereign? This question has played only a minor role in past sovereign debt restructurings because the size of such contingent liabilities has in most cases been small. In recent years, however, slathering government guarantees on third party debt has become the tool of choice for many countries in their efforts to quell an incipient panic in their financial markets. Some of those sovereigns are now, or may soon be, in the position of needing to restructure their debts. Ignoring large contingent …

Collective Action Clauses For The Eurozone, Michael Bradley, Mitu Gulati

Faculty Scholarship

One of the primary policy initiatives instituted in response to the Eurozone sovereign debt crisis is a requirement that all Eurozone sovereign bonds issued after January 1 2013 include provisions referred to as Collective Action Clauses or CACs. These CACs allow for a super-majority of creditors to impose restructuring terms on minority holdouts. This article assesses the likely effect of this proposal on the borrowing costs of sovereign debtors. Contrary to much of the literature, we find that the presence of CACs leads to a lower cost of capital, especially for below-investment grade bonds

The Attorney-Client Privilege – Selective Compulsion, Selective Waiver And Selective Disclosure: Is Bank Regulation Exceptional?, Bruce A. Green

Faculty Scholarship

This essay examines three ways in which bank regulation has spawned significant exceptions to the ordinary judicial and administrative understanding of the attorney-client privilege. First, federal banking agencies assert that they have the legal authority selectively to compel banks and other financial institutions they supervise to disclose attorney-client privileged information. Second, when banks disclose privileged material to bank regulators, even if voluntarily, banks retain the privilege with respect to third parties pursuant to specific federal statutory authority. Third, under agency policy, once bank regulators obtain privileged information from a bank, whether through compulsion or voluntarily, the regulators reserve the right …

Don’T ‘Screw Joe The Plummer’: The Sausage-Making Of Financial Reform, Kimberly D. Krawiec

Faculty Scholarship

This Article examines agency-level activity during the preproposal rulemaking phase—a time period about which little is known despite its importance to policy outcomes—through an analysis of federal agency activity in connection with section 619 of the Dodd–Frank Act, popularly known as the Volcker Rule. By capitalizing on transparency efforts specific to Dodd–Frank, I am able to access information on agency contacts whose disclosure is not required by the Administrative Procedure Act and, therefore, not typically available to researchers.

I analyze the roughly 8,000 public comment letters received by the Financial Stability Oversight Council in advance of its study regarding Volcker …

The Emperor's New Loans: A Cautionary Tale From The Subprime Era, David J. Reiss

Faculty Scholarship

No abstract provided.

Dirt Lawyers And Dirty Remics: A Debate, David J. Reiss, Bradley T. Borden, Joshua Stein

Faculty Scholarship

No abstract provided.

Trouble With Regulating Microfinance, Anita Bernstein

Faculty Scholarship

No abstract provided.

Revolution In Manipulation Law: The New Cftc Rules And The Urgent Need For Economic And Empirical Analyses, Rosa M. Abrantes-Metz, Gabriel Rauterberg, Andrew Verstein

Faculty Scholarship

Three major banks have now admitted that their employees manipulated worldwide interest rates through the London Interbank Offered Rate (Libor), the most widely used interest rate index. Libor is the interest rate term for trillions of dollars of swaps and loans, and its manipulation may have been used to extract billions of dollars. These allegations come just as commodities manipulation law has been dramatically reformed and the Commodity Futures Trading Commission (CFTC) given vast new regulatory powers. This Article provides the first extended, scholarly analysis of the CFTC’s new anti-manipulation rules. We consider the difficulty the rules address: Commodities manipulation …

Index Theory: The Law, Promise And Failure Of Financial Indices, Gabriel Rauterberg, Andrew Verstein

Faculty Scholarship

Financial indices, like the S&P 500 or the Consumer Price Index, have become a ubiquitous feature of our financial markets. One index, the London InterBank Offered Rate ("Libor"), may be the world's most important number, an interest rate benchmark upon which hundreds of trillions of dollars depend. Yet, almost every day new revelations emerge that Libor was tampered with during the height of the financial crisis by one or many of the world's most prominent banks, with billions of dollars potentially misappropriated. This index disruption has attracted tremendous interest from regulators, private litigants, and market observers. Despite their importance, however, …

Towards A Legal Theory Of Finance, Katharina Pistor

Faculty Scholarship

This paper develops the building blocks for a legal theory of finance. LTF holds that financial markets are legally constructed and as such occupy an essentially hybrid place between state and market, public and private. At the same time, financial markets exhibit dynamics that frequently put them in direct tension with commitments enshrined in law or contracts. This is the case especially in times of financial crises when the full enforcement of legal commitments would result in the self-destruction of the financial system. This law-finance paradox tends to be resolved by suspending the full force of law where the survival …

Economics Of Bankruptcy – Introduction, Edward R. Morrison

Faculty Scholarship

This essay surveys important contributions to the economics of bankruptcy. It is an introductory chapter for a forthcoming volume (from Edward Elgar Press) that compiles the work of legal scholars as well as economists working in the field of corporate finance. The essay begins with the foundational theories of Baird, Jackson, and Rea and then collects scholarly work extending, testing, or revising those theories. At various points I identify questions that merit further study, particularly empirical testing.

Mapping The Future Of Insider Trading Law: Of Boundaries, Gaps, And Strategies, John C. Coffee Jr.

Faculty Scholarship

The current law on insider trading is remarkably unrationalized because it contains gaps and loopholes the size of the Washington Square Arch. For example, if a thief breaks into your office, opens your files, learns material nonpublic information, and trades on that information, he has not breached a fiduciary duty and is presumably exempt from insider trading liability. But drawing a line that can convict only the fiduciary and not the thief seems morally incoherent. Nor is it doctrinally necessary.

The basic methodology handed down by the Supreme Court in SEC v. Dirks and United States v. O'Hagan dictates (i) …

How Markets Work: The Lawyer’S Version, Mitu Gulati, W. Mark C. Weidemaier

Faculty Scholarship

In this article, we combine two sources of data to shed light on the nature of transactional legal work. The first consists of stories about contracts that circulate widely among elite transactional lawyers. Surprisingly, the stories portray lawyers as ineffective market actors who are uninterested in designing superior contracts, who follow rather than lead industry standards, and who depend on governments and other outside actors to spur innovation and correct mistakes. We juxtapose these stories against a dataset of sovereign bond contracts produced by these same lawyers. While the stories suggest that lawyers do not compete or design innovative contracts, …

The Problem Of Holdout Creditors In Eurozone Sovereign Debt Restructuring, Mitu Gulati, Lee C. Buchheit, Ignacio Tirado

Faculty Scholarship

The Eurozone official sector has declared that the belated restructuring of Greek bonds held by private sector creditors in 2012 was a “unique and exceptional” event, never, ever to be repeated in any other Eurozone country. Maybe so. But if this assurance proves in time to be as fragile as the official sector’s prior pronouncements on the subject of “private sector involvement” in Eurozone sovereign debt problems, any future Eurozone debt restructuring will be surely plagued by the problem of non-participating creditors --- holdouts. Indeed, it is the undisguised fear of holdouts and the prospect of a messy, Argentine-style debt …

Ring-Fencing, Steven L. Schwarcz

Faculty Scholarship

“Ring-fencing” is often touted as a regulatory solution to problems in banking, finance, public utilities, and insurance. However, both the precise meaning of ring-fencing, as well as the nature of the problems that ring-fencing regulation purports to solve, are ill defined. This article examines the functions and conceptual foundations of ring-fencing. In a regulatory context, the term can best be understood as legally deconstructing a firm in order to more optimally reallocate and reduce risk. So utilized, ring-fencing can help to protect public-benefit activities performed by private-sector firms, as well as to mitigate systemic risk and the too-big-to-fail problem inherent …

The Role Of The Imf In Future Sovereign Debt Restructurings: Report Of The Annenberg House Expert Group, Douglas G. Baird, Nicole Bollen, Lee C. Buchheit, Mitu Gulati, Anne O. Krueger, Fridrik Mar Balursson, Robert K. Rasmussen, David A. Skeel Jr., Sergei Storchak, Jeromin Settelmeyer

Faculty Scholarship

A meeting of international finance and insolvency experts was held on November 2, 2013 at the Annenberg House in Santa Monica, California. The meeting was co-hosted by the USC Law School and the Annenberg Retreat at Sunnylands. The goal was to solicit the views of experts on the implications of the IMF’s April 26, 2013 paper captioned “Sovereign Debt Restructuring -- Recent Developments and Implications for the Fund’s Legal and Policy Framework”. The April 26 paper may signal a shift in IMF policies in the area of sovereign debt workouts. Although the Expert Group discussed a number of the ideas …

Lawyers In The Shadows: The Transactional Lawyer In A World Of Shadow Banking, Steven L. Schwarcz

Faculty Scholarship

This article examines how the role of transactional lawyers should change in the new world of shadow banking. Although transactional lawyers should consider the potential systemic consequences of their client's actions, their actions should be tempered by their primary duties to the client and by their responsibilities to the l,egal system more broadly.

Fee Effects, Kathryn Judge

Faculty Scholarship

Intermediaries are a pervasive feature of modern economies. This article draws attention to an under-theorized cost arising from the use of specialized intermediaries – a systematic shift in the mix of transactions consummated. The interests of intermediaries are imperfectly aligned with the parties to a transaction. Intermediaries seek to maximize their fees, a transaction cost from the perspective of the parties. Numerous factors, including the requirement that a transaction create value in excess of the associated fees to proceed and an intermediary’s interest in maintaining a good reputation, constrain an intermediary’s tendency to use its influence in a self-serving manner. …

Agency Capitalism: Further Implications Of Equity Intermediation, Ronald J. Gilson, Jeffrey N. Gordon

Faculty Scholarship

This chapter continues our examination of the corporate law and governance implications of the fundamental shift in ownership structure of U.S. public corporations from the Berle-Means pattern of widely distributed shareholders to one of Agency Capitalism – the reconcentration of ownership in intermediary institutional investors as record holders for their beneficial owners. A Berle-Means ownership distribution provided the foundation for the agency cost orientation of modern corporate law and governance – the goal was to bridge the gap between the interests of managers and shareholders that dispersed shareholders could not do for themselves. The equity intermediation of the last 30 …

Interbank Discipline, Kathryn Judge

Faculty Scholarship

As banking has evolved over the last three decades, banks have become increasingly interconnected. This Article draws attention to an effect of this development that has important policy ramifications yet remains largely unexamined – a dramatic rise in interbank discipline. The Article demonstrates that today's large, complex banks have financial incentives to monitor risk taking at other banks, They also have the infrastructure, competence, and information required to be fairly effective monitors and mechanisms through which they can respond when a bank changes its risk profile. Interbank discipline thus affects bank risk taking, discouraging banks from taking some types of …

A More Realistic Approach To Directors' Duties, Michelle M. Harner

Faculty Scholarship

Expectations for what fiduciary duties can achieve in the corporate context are unrealistic. This segment of the law—and the alleged deficiencies therein—are blamed for corporate scandals, securities fraud, failed business plans, and even a company's insolvency. Risk is, however, inherent in business, and human beings are flawed. Fiduciary duty law cannot change these basic facts. To the extent we think it can, we will continue to be disappointed and frustrated. This essay considers recasting (and to a greater extent codifying) directors’ duties in a positive frame to help foster better director oversight. It does not suggest that codifying greater clarity …