UNIVERSITY CASEBOOK SERIES®

FINANCIAL

REGULATION:

LAW AND POLICY

SECOND EDITION

MICHAEL S. BARR *J°an and Sanford Weill Dean of Public Policy herald R. Ford School of Public Policy

Roy F. and -Jean Humphrey Proffitt Professor of Law University of Michigan Law School

HOWELL E. JACKSON •James S. Reid, Jr.. Professor of Law Harvard Law School

MARGARET E. TAHYAR Offner Davis Polk & Wardwell LLP n oruce W. Nichols Lecturer in Law Harvard Law School

'FOUNDATION PRESS

TABLE OF CONTENTS

PART I. INTRODUCTION TO FINANCIAL REGULATION l 1.1. FINANCE TODAY 3

I. INTRODUCTION 3 II. THE FUNCTIONS OK FINANCE (I

A. The Role of the Financial System 6 B. Financial Intermediation 9

III. FINANCIAL SERVICES IN THE UNITED STATES 11 A. Overview 11 B. Insured Depository Institutions 14 C. Insurance Companies 16 D. Securities Firms 17 E. Consumer Finance 18 F. Financial Conglomerates 2Ü G. Payment Systems 21 H. Asset Managers 21 I. Derivatives 24 J. Shadow Banking 25

1. Securitization 26 2. Fannie Mae and Freddie Mac 28 3. Money Market Mutual Funds 29 4. Wholesale Funding 29

K. Evolution of the Financial System 31

1.2. THE HISTORY OF U.S. FINANCIAL REGULATION: A THEMATIC OVERVIEW 33 I. INTRODUCTION 34 II. THE FIRST AND SECOND BANKS OK THE UNITED STATES (1790-1863) 34

A. The First Bank of the United States 34 B. The Second Bank of the United States 36 C. Jackson's War Against the Second Bank 37 D. The Free Banking Era 38

III. THE RISE OK NATIONAL BANKS (1863-1914) 39 A. Uniform National Currency 40 B. The Dual Banking System 40 C. Unit Banks and Correspondent Banking 41 D. Interbank Deposits in the Reserve Structure 42

IV. THE CREATION OK THE FEDERAL RESERVE SYSTEM (1907-1933) 44 A. The Panic of 1907 44 B. Functions of the Federal Reserve System 47 C. The Early Eederal Reserve System 48

V. THE NEW DEAL AND ITS LEGACY (1933- 1960s) 49 A. Enhancing Transparency in Securities Markets and Separating

Banking from Securities 50 1. The Securities Act of 1933 and the Exchange Act of 193 1 50 2. The Banking Act of 1933 51

B. Stabilizing the Banking System Through Deposit Insurance 51 VI. A TREND TOWARDS DEREGULATION (1970s-2000s) 53

A. Deregulation of Depository Institutions 54 B. Loosening of Geographic Restrictions 55 C. Re-Regulation of Banks and Thrifts 56 D. The Erosion of the Glass-Steagall Act 57 E. Securitization and the New Models of Intermediation 58 F. The Commodity Futures Modernization Act 59

xvi FINANCIAL REGULATION: LAW AND POLICY

VII. THK FINANCIAL CRISIS AND ITS AFTERMATH 59 A. The Financial Crisis 59 B. The Dodd-Frank Act 64 C. Contending Visions of the Financial Crisis 65 D. Changed Political Climate 72

1.3. REGULATORY FRAMEWORKS 75 I. INTRODUCTION 75 II. THK MULTIPLE GOALS OF FINANCIAL REGULATION 76

A. Protection of Public Claimants 76 1. Collective Solution to Transaction Costs That Impede Self-Help 76 2. Absolute Protection of Terms of Investment 76

B. Klimination of Externalities from the Failure of Intermediaries 77 1. The Internalization of Social Losses 77 2. Systemic Costs of Failures 77

C. Other Considerations 77 1. Redistrihutivo Policies and Other Equitable Norms 78 2. Adjunct to Law Enforcement 78 3. Political Economy 78

III. THE STRUCTURE OF FINANCIAL REGULATION 79 A. Alternative Approaches 79 B. Principal Regulatory Agencies 82 C. Organizational Design After the Dodd-Frank Act 91

[V. THE INTERNATIONAL FINANCIAL ARCHITECTURE : 97 A. The Building Blocks 97 B. Reform After the Financial Crisis 104

1.4. THE REGULATORY PERIMETER 107 I. INTRODUCTION 107 II. SETTING JURISDICTIONAL BOUNDARIES 108

A. The Texas Attorney General's Letter 108 B. Koch v. First Union Corp 110 C. United States v. Horn 113 I). Morrison v. National Australia Bank 116

III. THE CLASSIFICATION PROBLEM 120 A. Formal Versus Functional Definitions 120 B. Classification Choices Under the Dodd-Frank Act 120

IV. OVERLAPPING REGULATORY PERIMETERS 128 A. The Regulation of Usuary 128 B. Marquette and Responses to It 132

1. Legal Developments 132 2. Developments in Credit Card Markets 1 35

1.5. A TOUR OF FINANCIAL STATEMENTS 137 I. INTRODUCTION 127 II. AN INTRODUCTION TO FINANCIAL STATEMENTS 138

A. The Balance Sheet 139 1. Assets 129 2. Liabilities (including Debt) 141 2. Equity 141 4. Elaborations 112

B. Income Statement 142 C. Financial Ratios 144

1. Liquidity Ill 2. Solvency 1 15 2. Profitability 145

TABLE: OF CONTENTS xvii

III. FINANCIAL STATEMENTS OF FINANCIAL INSTITUTIONS 146 A. Depository Institutions 146

1. Savings Bank 148 2. Commercial Bank 151

B. Insurance Companies 153 C. Mutual Funds 154 I). Broker-Dealers 157 E. Alternative Lenders 158 F. Financial Ratio Summary 161

IV. CONCLUDING THOUGHTS 161

PART II. INSURED DEPOSITORY INSTITUTIONS 163 2.1. THE IMPACT OF CHARTER CHOICE 165

I. THE BANK CHARTEH 165 II. DIFFERENT CHARTER TYPES 171

A. National Bank vs. State Bank 173 B. Thrifts and Savings and Loan Associations 175 C. Credit Unions 176 D. Industrial Loan Companies 177

III. COMPETITIVE EQUALITY—FEDERAL AND STATE LAW 179 IV. BANKING THE MARIJUANA SECTOR 182 V. FINTECH 184 VI. WHAT IS A BANK? 188

2.2. ACTIVITIES RESTRICTIONS AND THE BUSINESS OF BANKING 189 I. INTRODUCTION 189

A. The Business of Banking 189 B. Incidental Powers 192

II. CORE BANKING POWERS 198 A. Discounting—Credit Exchange 199 B. Government and Corporate Debt 199 C. Making Loans 200 D. Trust Fiduciary Powers and Financial Advice 201 E. Repo and Securities Lending 201 F. Payments Processing 201 G. Guarantees and Letters of Credit 202 H. Derivatives and Commodities 202 I. Mutual Funds 204 J. Commercial Paper 207 K. Mortgage Securitization 208 L. Brokerage 213 M. Equity Investments 214 N. Insurance 214 O. State Bank Powers 216

III. NARROW BANKING REPRISED SINCE THE FINANCIAL CRISIS 216

2.3. PORTFOLIO DIVERSIFICATION AND AFFILIATE TRANSACTIONS 219 I. INTRODUCTION 219 II. LENDING AND COUNTERPARTY LIMITS 220 HI. CREDIT CONCENTRATIONS AND SOCIAL GOALS IN LENDING 224 IV. TRANSACTIONS WITH AFFILIATES 229

A. Section 23A 233 B. Section 23B 234 C. Waivers 234

V. LOANS TO INSIDERS 236

xviii FINANCIAL REGULATION: LAW AND POLICY

2.4. DEPOSIT INSURANCE 239 I. INTRODUCTION 239 II. THK ROLK OF DEPOSITS IN THE FINANCIAL SYSTEM 240

A. The Definition of Deposit 240 B. The Bank Balance Sheet Revisited 243 C. Causes of Bank Runs 245 I). The Role of Deposit Insurance 246 E. Reserve Requirements 247

III. FEDERAL DEPOSIT INSURANCE 248 A. Historical Context 248 B. The Deposit Insurance Fund 250 C. Funding 250

1. The Assessment Base 251 2. Assessment Rates 252 3. Premium Payments and the Reserve Ratio 253

IV. DEPOSIT INSURANCE AND MORAL HAZARD 253 A. The Problem of Moral Hazard 254 B. Deposit Insurance Design Features 255 C. The Problem of Implicit Guarantees 256

1, Uninsured Deposits 256 2. Problems with Wholesale Funding 257

V. OTHER GOVERNMENT GUARANTEE PROGRAMS 258 A. Securities Investor Protection Corporation 258 B. Pension Benefit Guaranty Corporation 259 C. State Insurance Guarantee Funds 260

VI. INTERNATIONAL PERSPECTIVES 262 A. The Spread of Deposit Insurance 262 B. Cross-Border Deposit Taking: Who Pays? 263

2.5. CAPITAL REGULATION: AN INTRODUCTION 265 I. WHAT IS CAPITAL? 265

A. The Definition of Capital 265 B. The Fall and Rise of Capital Levels 267 C. U.S. Capital Requirements in the Basel I Era 278 D. Basic Leverage and Simple Risk-Based Capital Requirements 280

II. PROMPT CORRECTIVE ACTION 284 2.6. CAPITAL REGULATION: PRE-FINANCIAL CRISIS TO BASEL II 291

I. INTRODUCTION 291 II. BASEL 1 AND ITS SHORTCOMINGS 291 III. BASEL II OVERVIEW 296 IV. CAPITAL REGULATION AND THE FINANCIAL CRISIS 306

2.7. CAPITAL REGULATION: BASEL III AND BEYOND 313 I. INTRODUCTION 313 II. U.S. RESPONSE TO THE FINANCIAL CRISIS 314

A. Stress Testing and Capital Planning 314 B. Collins Amendment 320

III. BASEL 2.5 321 IV. BASEL III 321

A. Capital Requirements 322 1. Minimum Regulatory Capital Ratios 324 2. Capital Conservation Buffer 325 3. Countercyclical Buffer 325 4. G-SIB Surcharge 326 5. Supplementary Leverage Ratio 326

TABLE OF CONTENTS XIX

B. Liquidity Requirements 327 1. Liquidity Coverage Ratio 327 2. Net Stable Funding Ratio 329

V. CRITIQUES OF AND ALTERNATIVES TO BASEL III 329 VI. CAPITAL AND LIQUIDITY LEVELS TODAY 338

PART HI. INSURANCE 341 3.1. INTRODUCTION TO INSURANCE REGULATION 343

I. INTRODUCTION 343 II. AN OVERVIEW OF INSURANCE REOULATION 344

A. Sector Structure 344 B. A Brief History of U.S. Insurance Regulation 346

1. Colonial Times Through the Civil War: 1776-1865 346 2. Post-Civil War Developments: 1865-1944 347 3. The McCarran-Ferguson Act 351 4. Mutualization and Demutualization 354

C. The NAIC and State Insurance Regulation 355 D. Insurance Regulation Under the Dodd-Frank Act 357

III. DEFINING INSURANCE 367 A. The Regulatory Perimeter 367 B. Insurance vs. Other Financial Products 370

3.2. THE PROTECTION OF CONSUMERS IN INSURANCE REGULATION 375 I. INTRODUCTION 375 II. THE INTERPRETATION OF INSURANCE CONTRACTS 375

A. Contra Preferentem 376 B. The Insurable Interest Doctrine 379 0. Supervisory Oversight of Policy Terms 382

III. THE REGULATION OK AUTOMOBILE RATES 384 A. Overview of State Approaches 384 B. Illustrative Cases: Massachusetts and California 386

IV. THE REGULATION OF RISK CLASSIFICATIONS 390 A. The Function of Risk Classifications 390 B, Anti-Discrimination Norms in State Laws 393

1. Gender Classifications 393 2. Cross-State Variation Today 397

V. RESTRAINTS ON COLLABORATION IN RATE-SETTING 399 3.3. THE ROLE OF FEDERAL GOVERNMENT IN INSURANCE REGULATION 405

I. INTRODUCTION 405 II. FEDERAL ENGAGEMENT IN INSURANCE REGULATION 405

A. The Federal Reserve Board and Insurance Regulation 406 B. Coordinating Capital Requirements 408 C. Federal Coordination Regarding Reinsurance 4 13

1. Credit for Reinsurance 413 2. Covered Agreements 415

III. NONTRADITIONAL AREAS OK FEDERAI. DOMINANCE 417 A. Social Insurance: Social Security and Medicare 417 B. The Policies Underlying Social Insurance 421 C. ERISA and Employee Benefit Plans 423

1. ERISA's Preemption Provision 421 2. Fiduciary Duties Under ERISA 428

D. The Affordable Care Act of 2010 431 1. National Federation of Independent Business c. Sebelius 432 2. King v. Bunnell 133

xx FINANCIAL REGULATION: LAW AND POLICY

PART iv. SECURITIES FIRMS AND CAPITAL MARKETS 437 4.1. INTRODUCTION TO THE REGULATION OF SECURITIES FIRMS 439

I. OVERVIEW 439 II. A BRIEF HISTORY OK SECURITIES RKOULATION 440

A. Early Regulation and State Blue Sky Laws 412 B. Securities Regulation and the New Deal 443

1. The Securities Act of 1 933: Oversight of Public Offerings 444 2. The Securities Exchange Act of 1934: Regulation of Exchange's 445 3. The 1938 Amendments and the Creation of the NASI) 446

C. Further Refinements of the Modern Era 447 1. Realignment of Federal-State Authority Over Broker-Dealers 449 2. The Emergence of FINRA 449

a. The National Association of Securities Dealers 449 h. NYSE Regulation 150 c. Consolidation into FINRA 150

III. OVERVIEW OK THE SECURITIES SECTOR TODAY 451 A. Sector Participants and Lines of Business 451

1. Broker-Dealers 451 2. Investment Advisers 452

B. State-Federal Allocations of Authority and Self-Regulatory Organizations 453

IV. THE REGULATORY PERIMETER 457 A. What is a Security? 457 B. Broker-Dealers and Investment Advisers 461 C. Application of U.S. Requirements to Foreign Entities 467

V. CONSOLIDATE» OVERSIGHT OK MAJOR SECURITIES FIRMS 469 A. Leading Up to the Financial Crisis 469 B. Under the Dodd-Frank Act 472

4.2. SECURITIES FIRMS AND THE RETAIL INVESTOR 473 I. INTRODUCTION 473 II. DEFINING THE DUTIES OE BROKER-DEALERS 473

A. Early Cases 474 B. The Advisory Relationship 479 C. Broker-Dealers as Market-Makers 488

II I. BROKER-DEALERS VERSUS INVESTMENT ADVISERS 492 A. Illustrating the Differences 492 B. Harmonization of Fiduciary Duties 496

IV. THE RISE OE SECURITIES ARBITRATION 501 4.3. SECURITIES FIRMS IN CORPORATE TRANSACTIONS 507

I. INTRODUCTION 507 II. THE ROLE OE THE UNDERWRITER ,507

A. Due Diligence Under the Securities Act. of 1933 508 B. Deceptive Underwriters and Other Forms of Manipulation 513 C. Penny Stocks Versus Emerging Growth Companies 517

1. Penny Stock Rules 517 2. The .Jumpstart Our Business Startups Act. of 2012 518

D. The Duty to Supervise 519 HI. CONFLICTS OE INTEREST WITH CORPORATE CLIENTS .525

A. El Paso and Information Barriers 505 B. ABACUS Litigation 529

IV. THE EFFICIENT MARKETS HYPOTHESIS 5:51 4.4. EXCHANGES AND TRADING 535

I. INTRODUCTION 535

TABLE OF CONTENTS xxi

II. EXCHANGES AND OTHER TRADING MARKETS 535 A. Ending Fixed Commissions on the NYSE 535 B. The Rise of the National Market System 539 C. The Definition of Exchange 543

III. DUTIES OF BROKER-DEALERS IN TRADING MARKETS 546 A. Duties with Respect to Limit Orders 546 B. Payment for Order Flow and Best Execution 550 C. Demutualization and Decimilization 555

IV. CHALLENGES IN TRADING MARKETS TODAY 557

PART v. CONSUMER PROTECTION AND THE CFPB 565 5.1. THE CONSUMER FINANCIAL PROTECTION BUREAU 567

I. INTRODUCTION 567 II. HISTORY OF CONSUMER FINANCIAL PROTECTION 568

A. State Usury Laws 569 B. Federal Consumer Protection Laws 570

III. COMPARING THE NEOCLASSICAL AND BEHAVIORAL VIEWS OF CONSUMER PROTECTION 571 A. The Neoclassical View of Consumer Protection 571 B. The Behavioral View of Consumer Protection 572

IV. EARLY CALLS FOR A CONSUMER PROTECTION AGENCY 574 V. THE CONSUMER FINANCIAL PROTECTION BUREAU 581

A. Structure and Powers of the CFPB 581 1. Structure of the CFPB 582 2. Rulemaking Authority 584 3. Supervision Authority 588 4. Enforcement Authority 590 5. Exclusions from the CFPB's Authority 592

B. Balance of Federal and State Authority After the Dodd-Frank Act 594

C. Ongoing Policy Debates 594 5.2. MORTGAGES 599

I. INTRODUCTION 599 II. MORTGAGE BASICS 600

A. Mortgage Overview 600 B. Dodd-Frank Act Mortgage Reforms 601

III. MORTGAGE LENDING 603 A. Abilitv-to-Repay Requirements 603

1. Background 603 2. Ability-to-Repay 606 3. Qualified Mortgages 607 4. Qualified Residential Mortgages and Risk Retention 608

B. Integrated Disclosure 610 C. Home Ownership and Equity Protection Act 612 D. Yield Spread Premiums 614

IV. FEDERAL PREEMPTION AND STATE MORTGAGE REGULATION 618 A. Preemption Before the Dodd-Frank Act 618 B. Preemption After the Dodd-Frank Act 621

5.3. CONSUMER FINANCIAL PRODUCTS AND SERVICES 625 I, INTRODUCTION 625 II. STUDENT LOANS 626

A. Student Loan Delinquencies and Defaults 627 B. Discharge in Bankruptcy 629 C. Student Loan Servicing 630

xxii FINANCIAL REGULATION: LAW AND POLICY

III. AUTO LOANS 635 A. Types of Auto Loans 635 B. Criticism of Auto Lending Practices 636 C. Supervision and Enforcement 638

IV. CREDIT CARDS 639 A. The Need for Consumer Protection 640 B. The CARD Act of 2009 640

V. PAYDAY LOANS 643 VI. DEPOSIT AND TRANSACTION SERVICES 646

A. Prepaid Accounts 646 B. Overdraft Protection 647

VII. 1)RBT COU.F.CTION AND CREDIT REPORTING 649 A. Debt Collection 649 B. Credit Reporting 650

VIII. FINANCIAL PRIVACY 651 5.4. COMPARING CONSUMER PROTECTION MODELS ACROSS SECTORS 653

I. INTRODUCTION 653 II. DISCLOSURE 654 III. BKHAVIORAI.LY INFORMED FINANCIAL REGULATION 664 IV. DUTIES 667 V. PRODUCT REGULATION 674 VI. SUBSIDY AND TAX 677

PART vi. FINANCIAL CONGLOMERATES 683 6.1. REGUI.ATION OE HOLDING COMPANIES 685

I. INTRODUCTION 685 II. TYPICAL HOLDING COMPANY STRUCTURES 686 III. THE BANK HOLDING COMPANY ACT 688

A. Company Under the BHCA 689 B. That Which We Call a Bank 690 C. Control and Controlling Influence 691

IV. ACTIVITIES OF BANK HOI.DING COMPANIES: CLOSELY RELATED TO BANKING 693 V. THE GLASS-STKAGALL ACT 696 VI. SEPARATION OE INSURANCE AND BANKING ACTIVITIES 698 VII. ACTIVITIES OF FINANCIAL HOLDING COMPANIES 699

A. Becoming an FHC 700 B. Activities That are Financial in Nature 700 C. Merchant Banking 701

VIII. SAVINGS AND LOAN HOLDING COMPANIES 702 IX. THE VOLCKKR RULE 704

A. Policy Behind the Volcker Rule 704 B. Application to Banking Entities 705 C. Proprietary Trading 706 D. Covered Funds 707

X. THE SEPARATION OF BANKING AND COMMERCE 709 6.2. REGULATION OF BANK MARKET STRUCTURE AND CONSOLIDATION 713

I. INTRODUCTION 713 II. UNIT, BRANCH, AND CHAIN BANKING 7H III. DEVELOPMENT OK BANK ANTITRUST 713

A. The Bank Holding Company and Bank Merger Acts 716 B. The Dual System of Bank M&A Antitrust Review 718

1. Traditional Antitrust Review 719 2. Bank Antitrust Review 730

TABLE OF CONTENTS xxiii

C. Tying 724 IV. RIEGLR-NEAL AND THK ERA OF CONSOLIDATION 726

A. Consequences of the Riegle-Neal Act 726 B. Deposit Caps 728

V. FINANCIAL CRISIS CONSOLIDATION, DODD-FRANK, AND CONTEMPORARY BANK M&A 728

A. Limits on Consolidation Under Dodd-Frank 729 B. Contemporary Bank M&A Considerations 722

VI. CONTEMPORARY MARKET STRUCTURE 734 6.3. REGULATING SYSTEMIC RISK 737

I. INTRODUCTION 727 II. WHAT IS SYSTEMIC RISK? 738

A. Channels of Transmitting Systemic Risks to the Broader Economy 729

B. Regulatory Mechanism for Addressing Systemic Risks 742 1. Pure Ex Ante Interventions 742 2. Ex Post Interventions 743 3. Ex Ante Interventions to Facilitate Ex Post Interventions 745

III. DESIGNATION SYSTEMICALI.Y IMPORTANT INSTITUTIONS 745 A. Global Designations of Systemic Importance 746 B. Designations of Systemic Importance in the United States 747

IV. MITIGATING SYSTEMIC RISK IN THE U.S. BANKING SECTOR 756 A. BHCs with Assets Under $10 Billion 757 B. BHCs with $10-50 Billion in Assets 757 C. BHCs with $50-250 Billion in Assets 758 D. BHCs with Over $250 Billion in Assets 758 E. G-SIBs 758

V. BREAKING UP THE BANKS 760 A. Hard Breakup and the Post-Financial Crisis Debate 760 B. Breakup Options Under the Dodd-Frank Act 764 C. Soft Breakup 765 D. Structural Alternatives 766

6.4. FOREIGN BANKS IN THE UNITED STATES AND U.S. BANKS ABROAD 769 I. INTRODUCTION 769 II. FOREIGN BANKS IN THE UNITED STATES 770

A. Overview 770 B. Forms of Entry 772 C. The Branch and the Separate Entity Doctrine 773 D. National Treatment and the International Banking Act 779 E. The BCCI Scandal and Congressional Reaction 782 F. Foreign Banks and the Financial Crisis 785 G. The Intermediate Holding Company Requirement 786

III. U.S. BANKS ABROAD 795 A. Overview 795 B. Legal Forms for International Activities 796 C. The Decline in Correspondent Banking 797

PART vii. PAYMENT SYSTEMS 799

7.1. INTRODUCTION TO PAYMENT SYSTEMS 801 I. INTRODUCTION 802 II. TRACING THE HISTORY OF PAYMENT SYSTEMS 804 III. TRADITIONAL RETAIL PAYMENT SYSTEMS 807

XXIV FINANCIAL REGULATION: LAW AND POLICY

A. Mechanics 808 1. Cash 808 2. Checks 809 3. Credit Cards 809

B. Legal Frameworks 812 1. Cash 812 2. Checks 812

a. Insufficient Funds 813 b. Forgery 813 c. Unauthorized Issuance 813

3. Credit Cards 814 4. Debit Cards 815

C. Emerging Issues 817 1. Data Breaches 817 2. Merchant Restraints 817 3. Data Portability 818

IV. RETAIL INTERBANK FUNDS TRANSFER 820 A. Overview of the ACH System 820 B. Legal and Regulatory Frameworks 821

V. INNOVATIONS IN PAYMENT SYSTEMS 823 A. New Technologies Running on Old Rails? Digital Wallets 823 B. The Regulatory Fight Over Digital Wallet Technologies 825 C. Faster Payments Task Force 826

VI. THE UNBANKED AND UNDERBANKED : 826 A. Prepaid Cards 827 B. Money Transmitters 828 C. Mobile Phone Financial Services 830

7.2. EXAMINING CRITICAL ISSUES IN PAYMENT SYSTEMS 833 I. INTRODUCTION 833 II. RESPONDING TO INNOVATION: BITCOIN AND BEYOND 834

A. Bitcoin 834 B. Ripple 836 C. Ethereum and Other Blockchain-Based Systems 836 D. The Value of Decentralized Payment Systems 837 E. Approaches to Regulation 840

III. REGULATING PAYMENT CARD INTERCHANGE FEES 842 A. Who Bears the Cost of Card Transactions? 842 B. Antitrust Litigation 845 C. The Durbin Amendment 848 D. Who Ends Up Paying? 850

IV. MANAGING RISK IN WHOLESALE INTERBANK CLEARING AND SETTLEMENT 852 A. Fedwire and CHIPS 853 B. Managing Risk 853 C. CLS Bank 855 1). Title VI II of the Dodd-Frank Act 856

V. PREVENTING ILLICIT USE OE PAYMENT SYSTEMS 858 A. Anti-Money Laundering and Related Laws 858 B. Issues in Compliance 859

PART viii. CORPORATE GOVERNANCE, SUPERVISION, AND ENFORCEMENT 865

8.1. CORPORATE GOVERNANCE 867 I. INTRODUCTION 867

TABLE: OF CONTENTS XXV

II. THE SPECIAL NATURE OF FINANCIAL INSTITUTION CORPORATE: GOVERNANCE: ....868 A. Post-Financial Crisis Critique 869 B. Dodd-Frank Act Changes 870

III. THE: EVOLUTION OF CORPORATE GOVERNANCE 871 A. FDIC—Liability for Bank Failure 871 B. OCC—Heightened Standards for Large National Banks 874 C. Federal Reserve—Board Effectiveness 876

IV. EXTENDING DUTIES BEYOND DIRECTORS 884 A. Dual-Liability of Shareholders 884 B. Gatekeeper Liability 884

1. Lawyers 885 2. Consultants 886

V. MODIFYING INCENTIVES THROUGH COMPENSATION 887 A. The Situation Before the Financial Crisis 888 B. Changes After the Financial Crisis 889 C. Different Approach Taken in Europe 894

8.2. SUPERVISION AND ENFORCEMENT 897 I. INTRODUCTION 897 II. BASIC BUILDING BLOCKS OF SUPERVISION AND ENFORCEMENT 898

A. Reporting, Examination, and Supervision by Federal Banking Regulators 899

B. SEC and FINRA Examinations 903 C. The Public Enforcement Arsenal 905

III. ENFORCEMENT POLICY AND TRENDS 905 A. SEC and FINRA Enforcement Actions 905

1. SEC Enforcement 906 2. FINRA Enforcement 908

B. Enforcement Activities of Federal Banking Regulators 910 1. Federal Reserve Board Enforcement Policy and Trends 911 2. OCC Enforcement Policy and Trends 911 3. FDIC Enforcement Policy and Trends 912

C. Enforcement Activities of State Regulators 914 D. Aggregating Enforcement Activity 916 E. The Outer Limits of Bank Regulatory Enforcement 916

1. Powers with Respect to Institutions and IAPs 917 2. Using FIRREA to Pursue Civil Liability 919

F. Foreign Enforcement Levels Contrasted 920 IV. RECURRING ISSUES IN ENFORCEMENT POLICIES 922

A. Public Versus Private Enforcement 922 B. Confidential Supervisory Information Versus Disclosure 924 C. Large Firms Versus Small Firms 925 I). Corporate Versus Individual Sanctions 926 E. Settlements Without Admission of Wrongdoing 928

PART EX. LENDER OF LAST RESORT AND RESOLUTION 933 9.1. LENDER OF LAST RESORT 935

I. INTRODUCTION 935 II. HISTORY 936

A. The Bank of England 936 B. The United States Without a Lender of Last Resort 938 C. Today's Federal Reserve 939

III. TRADITIONAL LENDER OF LAST RESORT 939 A. Open Market Operations 941 B. The Discount Window 942

xxvi FINANCIAL REGULATION: LAW AND POLICY

C. The Problem of Stigma and the Early Financial Crisis 944 IV. FEDERAL RESERVE EMERGENCY LENDING: SECTION 13(3) 947

A. The History of Section 13(3) 948 B. Aftermath and Reform 951 C. The Lender of Last Resort Debate 953

1. Central Bank Independence 953 2. Criticisms of the Federal Reserve 955 3. The Future of Lender of Last Resort 957

V. THE FEDERAL RESERVE AS THE INTERNATIONAL LENDER OF LAST RESORT? 959 9.2. TRADITIONAL TOOLKIT FOR BANK FAILURES 961

I. INTRODUCTION 961 II. HISTORICAL PERSPECTIVE 962 III. THE EVOLUTION OF RESOLUTION TRANSACTIONS 965 IV. PURCHASE AND ASSUMPTIONS 966 V. TURMOIL AND INNOVATION IN THE 1980s 968 VI. OPEN BANK ASSISTANCE AND THE TOO BIG TO FAIL PROBLEM 970 VII. BRIDGE BANKS 971 VIII. LEGAL REFORMS AND THE LEAST COST REQUIREMENT 973 IX. THE FDIC'S BANK RESOLUTION AUTHORITY 977

A. Initiation of Resolution Proceedings 977 B. The Claims Process 978 C. FDIC Super-Powers 979

X. THE FINANCIAL CRISIS AND THE SYSTEMIC RISK EXCEPTION". 983 9.3. AFTER THE CRISIS: FROM ORDERLY LIQUIDATION TO BAIL-IN 985

I. INTRODUCTION 985 II. LESSONS LEARNED FROM THE FINANCIAL CRISIS 986

A. The Spread of Contagion from Lehman Brothers's Bankruptcy 987 B. Expansion of the Regulatory Toolkit 989 C. The EU Experience 990

III. THE ORDERLY LIQUIDATION AUTHORITY 991 A. The Bridge Financial Company 992 B. The Orderly Liquidation Authority Receivership 995 C. Living Wills 996

IV. SINGLE POINT OK ENTRY 999 V. TOTAL LOSS-ABSORBING CAPACITY 1001 VI. ONGOING POLICY DEBATES AND PROPOSALS FOR REFORM 1004

A. Moral Hazard and Bailouts 1004 B. Bankruptcy Reform and Chapter 14 1007 C. EU Bank Resolution and Recovery Directive 1008 D. Derivatives and Cross-Defaults 1009

PART x. MUTUAL FUNDS AND OTHER INVESTMENT VEHICLES 1011 10.1. INTRODUCTION TO ASSET MANAGEMENT AND ITS REGULATION 1013

I. INTRODUCTION TO ASSET MANAGEMENT 101:5 II. BACKGROUND ON THE INVESTMENT COMPANY ACT OF 1940 1017

A. Historical Overview 1017 1. The Origin of Investment Companies 1018 2. Abuses Preceding the Reforms of 1940 1019

a. Misleading Disclosure 1020 b. Self- Dealing 1020 c. Capital Structure 1020 d. Misappropriation of Funds 102]

TABLE OF CONTENTS xxvii

3. Passage of the Investment Company Act of 1940 1022 a. Registration 1022 b. Disclosure 1023 c. Regulation of Activities and Operations 1023 d. Shareholder Powers 1025 e. Independent Directors 1025 f. Interaction with the Investment Advisers Act 1025 g. SEO's Power to Grant Exemption 1020 h. Legal Developments Since the 1940s 1026

B. Regulatory Perimeters 1027 III. Is ASSET MANAGEMENT SYSTEMICALI.Y IMPORTANT? 1032 IV. INSTITUTIONAL INVESTORS IN CORPORATE GOVERNANCE 1039

10.2. MUTUAL FUNDS: FIDUCIARY DUTIES AND STRUCTURAL RESTRAINTS.... 1043 I. INTRODUCTION 1043 II. AN OVERVIEW OP INVESTMENT COMPANIES TODAY 1043

A. The Growth of Investment Companies and Principal Types 1043 B. Plan Sponsors and Mutual Fund Complexes 1045

III. THE CENTRALITY OK FUND DIRECTORS 1048 A. Brokerage Allocation 1048 B. Section 36(b) and the Gartenberg Test 1053 C. Director Independence 1060

IV. STRUCTURAL RESTRAINTS UNDER THE INVESTMENT COMPANY ACT OF 1940 1065 A. Net Asset Value and Fair Valuation 1066 B. Limits on Leverage and Complex Capital Structures 1068 C. Developments in the Market for Exchange-Traded Funds 1070

10.3. MUTUAL FUNDS: DISCLOSURE AND ITS LIMITATIONS 1073 I. INTRODUCTION 1073 II. AN OVERVIEW OF MUTUAL FUND DISCLOSURES 1074

A. Annotated Illustrations of Performance and Fee Disclosures 1075 1. Performance Disclosures 1075 2. Disclosures of Fees and Expenses 1077

B. The Role of Third-Party Analysis 1079 C. Fund-of-Fund Disclosures Versus Wrap Accounts 1080

III. Two CASE STUDIES 1083 A. Quantitative Measures of Financial Risk 1083 B. Target Date Funds 1087

IV. THE LIMITS OF DISCLOSURE 1091 A. Academic Studies on Investor Decision-Making 1092 B. Testing the Efficacy of Disclosure 1094

10.4. THE REGULATION OF RETIREMENT SAVINGS 1099 I. INTRODUCTION TO THE REGULATION OF RETIREMENT SAVINGS 1099 II. HISTORICAL OVERVIEW 1101

A. The Studebaker Incident 1102 B. ERISA: Key Features 1102 C. The Regulatory Perimeter: The ERISA Agencies 1105

III. DEFINED CONTRIBUTION PI.ANS AND THE CHALLENGES OP PARTICIPANT DIRECTED INVESTING 1105 A. Applying ERISA Fiduciary Duties to Defined Contribution

Plans 1108 1. The Duty to Monitor 1109 2. Ongoing Fiduciary Litigation Over Excessive Fees 1111 3. ESOPs and the Duty to Diversify 1113

B. Nudging and 401(k)s 1117 1. Default Savings Rates 1118

xxviii FINANCIAL REGULATION: LAW AND POLICY

2. Distribution Options and Annuitization 1120 3. Nudging Bank to Defined Benefit Plans 1121

IV. INTERNATIONAL COMPARISONS 1121 A. Switzerland 1121 B. Sweden 1122

V. REACHING WORKERS WITHOUT EMPLOYER PLANS 1122 A. The Rise and Fall of myRA 1122 B. State-Run Auto-Enrolment IRAs 1123

10.5. THE REGULATION OF HEDGE FUNDS AND OTHER PRIVATE FUNDS 1125 I. INTRODUCTION 1125 II. OVERVIEW OF PRIVATE FUNDS POST-DODD-FRANK ACT 1126 III. SIGNATURE EVENTS IN THE RISK OF HEIKIE FUNDS 1127

A. The Collapse of Long-Term Capital Management 1127 B. Regulatory Responses Post Long-Term Capital Management 1132

1. Adviser Regulation and Goldstein v. SEC 1132 2. Sector Best Practices 1136

C. The Madoff Scandal and Feeder Fund Litigation 1136 1. Excerpts from the Report of the SEC Inspector General 1136 2. Anwar v. Fairfield Greenwich 1141

IV. THE REGULATION OF ALTERNATIVE FUNDS AFTER THE DODD-FRANK ACT 1147 A. Key Dodd-Frank Act Changes 1147 B. Provisional Assessments of Impact 1148 C. The Retailization of Hedge Funds 1149 D. EU Regulation Contrasted 1150

PART xi. DERIVATIVES AND RATE MARKETS 1153 11.1. OVERVIEW OF DERIVATIVES 1155

I. INTRODUCTION 1155 H. WHAT ARE DERIVATIVES AND WHO USES THEM? 1156

A. Overview of Derivative Contract Types 1156 1. Forwards 1156 2. Futures 1157 3. Options 1159 4. Swaps 1160

a. Interest Kate Swaps 1160 b. Foreign Exchange Swaps 1161 c. Commodity Swaps 1162 d. Credit Default Swaps 1162

B. Volume of Derivatives Contracts 1164 C. Debate Over the Value of Derivatives 1165

HI. HISTORY OF U.S. DERIVATIVES REGULATION: CRISIS AND REFORM 116« A. History of Derivatives Regulation 1166 B. The Fight Over OTC Derivatives Regulation 1168 C. The Pre-Financial Crisis OTC Derivatives Infrastructure 1172

IV. OTC DERIVATIVES AND THE FINANCIAL CRISIS 1171 A. The Role of Derivatives in the Financial Crisis 1171 B. Summary of Derivatives Regulation in the Dodd-Frank Act 1175

1. Overview of Dodd-Frank Act, Derivatives Reforms 11 75 2. -Jurisdiction Over Derivatives Markets Post-Dodd-Frank Act. 1177

C. A Coordinated International Response 1179 11.2. DERIVATIVES: MARKET INFRASTRUCTURE 1181

I. INTRODUCTION 1182 11. MITIGATING CREDIT RISK: MARGIN AND CLEARING 1182

A. Initial and Variation Margin 1183

TABLE OF CONTENTS xxix

1. Initial Margin 1183 2. Variation Margin 1183

B. Use of Margin for Swaps Before the Dodd-Frank Act 1184 C. The Dodd-Frank Act's Margin Requirements for Uncleared

Swaps 1184 D. Central Clearing 1186

1. What Does it Mean to (Tear a Derivative? 1186 2. How Do Clearinghouses Mitigate Systemic Risk? 1187

a. Initial and Variation Margin for Cleared Swaps 1188 b. Clearinghouse Guaranty Fund and Assessments 1 188 c. Regulation and Governance of Derivatives Clearinghouses .... 1 189 d. Multilateral Netting 1191 e. Portability 1192

3. Mandatory (Tearing of Swaps 1193 a. The History of (Tearing 1193 h. The Dodd-Frank Act's Mandatory (Tearing Requirement 1193 c. Kxeeptions and Exemptions to Mandatory (Tearing 1194 d. Criticisms of the Mandatory (Tearing Requirement 1194

E. International Implementation 1195 III. DEVELOPING A TRANSPARENT MARKETPLACE 1198

A. Goals of Transparency 1198 B. Pre-Trade Transparency: Mandatory Exchange Trading 1199

1. Designated Contract Markets 1200 2. Swap Execution Facilities 1200 3. Made Available to Trade 1201

C. Post-Trade Transparency: Trade Reporting 1202 1. Providing the Regulators with Swap Data 1203 2. Providing the Market with Swap Data 1203 3. Block Trades 1203 4. International Implementation 1204

11.3. DERIVATIVES: BUSINESS CONDUCT AND MARKET INTEGRITY 1207 I. INTRODUCTION 1208 II. REGULATING THE KEY PARTICIPANTS 1209

A. Swap Dealers and Security-Based Swap Dealers 1209 B. Major Swap Participants and Major Security-Based Swap

Participants 1211 C. Regulatory Obligations of Key Market Participants 1211

1. Fair Dealing 1212 2. Swap Trading Relationship Documentation and Confirmations ... 1213 3. Portfolio Reconciliation and Dispute Resolution 1213 4. Capital Requirements 1213 5. Risk Management, Portfolio Compression, and Conflicts Rules.... 121 1 6. Risk Exposure and Chief Compliance Officer Reports 1215

D. Post-Dodd-Frank Act ISDA Protocols 1215 E. Position Limits 1216

III. MARKET INTEGRITY 1217 A. London Interbank Offered Rate Manipulation 1218

1. Background 1218 2. LIBOR Misconduct 1219 3. Reform 1221

B. Foreign Exchange Rate-Rigging 1222 1. Background 1222 2. Alleged Manipulation 1223 3. Private Litigation 1225 4. Reform 1225

0. The Beginnings of Enforcement Under Title VII 1228

XXX FINANCIAL REGULATION: LAW AND POLICY

IV. THE EXTRATERRITORIAL REACH OF TITLE VII 1229 A. Why is Cross-Border Regulation Needed? 1229 B. Cross-Border Application of Title VII 1230

1. The CFTC's Cross-Border Approach 1230 2. The SEC's Cross-Border Approach 1233

C. Substituted Compliance 1233

PART xii. SHADOW BANKING 1235 12.1. SECURITIZATION 1237

I. INTRODUCTION 1237 II. SECURITIZATION'S RISE 1237

A. The Growth of Securitization 1237 B. Benefits and Logic 1240 C. Legal Problems 1243

III. EMERGING PROBLEMS 1244 A. Fragmentation of Functions 1244

1. Yield Spread Premiums 1244 2. Multiple Gatekeepers 1245 3. Credit Rating Agencies 1246 4. Troubled Mortgage Litigation 1248 5. Eminent Domain Proposals 1253

B. The Critique of Originate-to-Distribute 1255 IV. KEY CHANGES IN THE DODD-FRANK ACT 1257

A. Risk Retention Reforms 1257 B. Loan-Level Disclosure Reforms 1259 C. Consumer Protection Reforms 1261 D. Credit Rating Agency Reforms 1263

V. TRENDS IN SECURITIZATION AFTER THE DODD-FKANK ACT 1266 12.2. MORTGAGE MARKETS AND THE GOVERNMENT-SPONSORED

ENTERPRISES 1269 I. INTRODUCTION 1269 II. HISTORY OF THE U.S. MORTGAGE MARKET 1272

A. The GSEs from the 1930s through the Financial Crisis 1272 B. The GSEs and the U.S. Mortgage Market 1276

III. CRITICISMS OF THE GSEs 1277 A. Too Big To Fail Subsidy 1277 B. Investment Portfolios and Other Prudential Concerns 1279 C. Affordable Housing Goals 1283

IV. THE GSES IN CRISIS: THE HOUSING AND ECONOMIC RECOVERY ACT AND GOVERNMENT CONSERVATORSHIP 1287

V. THE FUTURE OF THE GSES: PROPOSALS FOR REFORM 1291 A. Conceptual Frameworks 1291 B. Legislative Proposals 1295

VI. COMPARATIVE APPROACHES TO HOUSING FINANCE 1297 12.3. MONEY MARKET FUNDS 1301

I. INTRODUCTION 1301 II. THE EMERGENCE OF MONEY MARKET MUTUAL FUNDS 1302

A. Historical Context 1302 B. The Introduction of Rule 2a-7 1303 C. Early Reactions 1304

1. Oregon Attorney General's Letter 1304 2. Other Perspectives 1300

III. THE GROWTH AND REFINEMENT OF MONEY MARKET MUTUAL FUNDS 1308

TABLE OF CONTENTS XXXI

A. Overview of Industry Growth: 1980 to 2008 1308 B. Evolution of SEC Oversight 1310 C. Dealing with Investment Losses 1313 D. Lehman Brothers's Failure and Its Consequences 1314

IV. MONKY MARKET MUTUAL FUNDS INTHK FINANCIAL CRISIS AND BEYOND 1315 A. Policy Debates Over Reform 1315

1. Floating the NAV 131(5 2. Imposing Liquidity Fees 131(5 3. Allowing Redemption Gates 131(5 4. Requiring a Loss-Absorption Capacity 131 (5 5. Differentiating Between Types of Money Market Mutual Funds 1317

B. SEC Proposals and FSOC Interactions 1317 C. The 2014 Final Rule 1321 D. Developments After the Reforms 1323

12.4. SHORT-TERM WHOLESALE FUNDING 1325 I. INTRODUCTION 1.32(5

A. Overview of Short-Term Wholesale Financing 132(5 B. Mechanics of a Run 1327 C. The Financial Crisis 1328

II. SECURITIES FINANCING TRANSACTIONS 1329 A. Repurchase Agreements 1330

1. Repo Basics 1330 2. Bilateral Repo 1332 3. Tri-Party Repo 1332 4. General Collateral Finance Repo 1335

B. Securities Lending Transactions 133(5 1. Transaction Basics 1337 2. Securities Lending During the Financial Crisis 1338 3. Post-Financial Crisis Landscape and Reform 1339

III. COMMERCIAL PAPER, PRIME BROKERAGE AND DERIVATIVES 1310 A. Commercial Paper 1340

1. Basics of Commercial Paper 1340 2. Asset-Backed Commercial Paper Conduits 1341 3. Commercial Paper in the Financial Crisis 1342 4. Aftermath and Reforms 1343

B. Prime Brokerage 1344 1. Basics of Prime Brokerage 1344 2. Rehypothecation 1344 3. Prime Brokerage and the Financial Crisis 1315 4. Prime Brokerage Reforms 134(5

C. Derivatives 1347 1. Loss of Derivatives Collateral 1347 2. Derivatives Runs as a Source of Contagion 1347 3. Accelerating Margin (Tills 1348 4. Derivatives Reforms 1348

IV. ASSESSING THE REGULATORY RESPONSE 1348 A. Summary of Reforms Affecting Wholesale Funding Risk 1348 B. Data Collection 1350 C. Mandatory Haircuts 1350 I). Title VIII of the Dodd-Frank Act 1351 L. Critiquing the Current Approach to Wholesale Funding 1352

GLOSSARY 1355

JNDKX 1361