New governance in the teeth of human frailty: Lessons from financial regulation

Wisconsin Law Review

Volumn 2010, Issue 2, 2010, Pages 441-487

  Cristie, Ford ^a  

^a UNIVERSITY OF BRITISH COLUMBIA   (Canada)

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EID: 78650809164     PISSN: 0043650X     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Conference Paper

References (214)

1. With apologies to Jody Freeman and Daniel Färber, this variety of modularity is not the same as their positive account of modular environmental regulation in which regulatory components can be assembled and reassembled in different arrangements depending on circumstance. See generally Jody Freeman & Daniel A. Färber, Modular Environmental Regulation, 54 DUKE L.J. 795 (2005).
2. The GFC is broadly global in scope. Focusing only on the United States, it can be dated from the first effects of the subprime mortgage crisis in the United States in 2006-07, through the collapse of global credit markets in fall 2008, which saw the failure of major investment banks in the United States and brought about an industry bailout and economic stimulus package of unprecedented size, and into the present day. For a timeline of the core of the crisis, from September 2008 to September 2009, see A Year of Financial Turmoil, N.Y. TIMES, Sept. 11, 2009, http://www.nytimes. com/interactive/2009/09/11/business/economy/ 20090911-FINANCIALCRISIS-TIMEL INE.html?ref=businessspecial4.
3. HERBERT A. SIMON, MODELS OF MAN: SOCIAL AND RATIONAL 204-05 (1957) (explaining that "satisficing" means settling for an adequate, but not optimal solution).
4. Kimberly Krawiec, Cosmetic Compliance and the Failure of Negotiated Governance, 81 WASH. U. L.Q. 487 (2003).
5. See generally FRANK KNIGHT, RISK, UNCERTAINTY AND PROFIT (1921).
6. See, e.g., LAW AND NEW GOVERNANCE IN THE EU AND US (Grâinne de Burca & Joanne Scott eds., 2006);
7. Orly Lobel, The Renew Deal: The Fall of Regulation and the Rise of Governance in Contemporary Legal Thought, 89 MINN. L. REV. 342 (2004).
8. See generally Michael C. Dorf & Charles F. Sabel, A Constitution of Democratic Experimentalism, 98 COLUM. L. REV. 267 (1998);
9. James S. Liebman & Charles F. Sabel, A Public Laboratory Dewey Barely Imagined: The Emerging Model of School Governance and Legal Reform, 28 N.Y.U. REV. L. & Soc. CHANGE 183 (2004);
10. Charles F. Sabel & William H. Simon, Destabilization Rights: How Public Law Litigation Succeeds, 117 HARV. L. REV. 1015 (2004).
11. Sturm's work informs and is informed by the experimentalist approach, but see Susan Sturm, Second Generation Employment Discrimination: A Structural Approach, 101 COLUM. L. REV. 458, 555 n.353 (2001).
12. See Eric Orts, Reflexive Environmental Law, 89 Nw. U. L. REV. 1227 (1995);
13. Gunther Teubner, Substantive and Reflexive Elements in Modern Law, 17 LAW & SOC'Y REV. 239 (1983).
14. But see Bradley C. Karkkainen, "New Governance" in Legal Thought and in the World: Some Splitting as Antidote to Overzealous Lumping, 89 MINN. L. REV. 471 (2004).
15. See IAN AYRES & JOHN BRAITHWAITE, RESPONSIVE REGULATION (1992);
16. John Braithwaite, Enforced Self-Regulation: A New Strategy for Corporate Crime Control, 80 MICH. L. REV. 1466 (1981).
17. See Linda Senden, Soft Law, Self-Regulation and Co-Regulation in European Law: Where Do They Meet?, 9.1 ELECTRONIC J. COMP. L. 1 (2005), available at http://www.ejcl.org/91/abs91-3.html.
18. See Cary Coglianese & David Lazer, Management-Based Regulation: Prescribing Private Management to Achieve Public Goals, 37 LAW & SOC'Y REV. 691 (2003).
19. JOHN C. COFFEE JR., GATEKEEPERS: THE PROFESSIONS AND CORPORATE GOVERNANCE (2006).
20. Whether regulators ought to rely on "best practices" or "good practices" is a matter of debate among securities regulators. See Cristie L. Ford, New Governance, Compliance, and Principles-Based Securities Regulation, 45 AM. BUS. L.J. 1, 43 n.144 (2008) [hereinafter Ford, New Governance, Compliance].
21. On Deweyan pragmatism and experimentalism, see, e.g., Brandon L. Garrett & James S. Liebman, Experimentalist Equal Protection, 22 YALE L. & POL'Y REV. 261 (2004).
22. See, e.g., Sabel & Simon, supra note 7.
23. See Dorf & Sabel, supra note 7, at 446-52 (arguing that experimentalist rights are "the only kind of rights that we actually have").
24. See discussion infra Part II.C.
25. See generally Brandon L. Garrett, Structural Reform Prosecution, 93 VA. L. REV. 853, 855-56 (2007);
26. Benjamin M. Greenblum, Note, What Happens to a Prosecution Deferred? Judicial Oversight of Corporate Deferred Prosecution Agreements, 105 COLUM. L. REV. 1863 (2005);
27. Jennifer O'Hare, The Use of the Corporate Monitor in SEC Enforcement Actions, 1 BROOK. J. CORP. FIN. & COM. L. 89 (2006);
28. Leonard Orland, The Transformation of Corporate Criminal Law, 1 BROOK. J. CORP. FIN. & COM. L. 45 (2006).
29. Cristie Ford & David Hess, Can Corporate Monitorships Improve Corporate Compliance?, 34 J. CORP. L. 679, 680 (2009).
30. On AIG, see Peter Lattman, The US's Fly on the Wall at AIG, WALL ST. J., Mar. 27, 2009, at C1 (noting that a monitor was in place at AIG before and during the financial crisis, but was not charged with investigating matters directly related to the financial crisis, such as the use of credit default swaps).
31. See, e.g., Garrett, supranote 19, at 869-74.
32. See generally Cristie L. Ford, Toward a New Model for Securities Law Enforcement, 57 ADMIN. L. REV. 757 (2005) [hereinafter Ford, Toward a New Model] (discussing the civil "reform undertaking" process at the United States Securities and Exchange Commission). Miriam Baer has since challenged this view at a descriptive level, arguing that whatever else they may be, reform undertakings and deferred prosecution agreements are not and can never be an example of new governance.
33. See generally Miriam Baer, Governing Corporate Compliance, 50 B.C. L. REV. 949 (2009).
34. Ford, Toward a New Model, supra note 22, at 802-10.
35. Id. at 808.
36. Id. at 802.
37. Krawiec, supra note 4.
38. Ford, Toward a New Model, supranote 22, at 810-14.
39. Id. at 814-17.
40. Our study and its findings are described in Ford & Hess, supra note 20. The discussion of monitorships contained here draws on that work.
41. Id. at 695-96.
42. Id. at 730.
43. Id. at 728.
44. Id. at 697.
45. See id. at 728-29.
46. See Paul J. DiMaggio & Walter W. Powell, The Iron Cage Revisited: Institutional Isomorphism and Collective Rationality in Organizational Fields, 48 AM. Soc. REV. 147, 151-52 (1983) (describing mimetic isomorphism as a process through which organizations copy each other to draw on the legitimacy established by the prior example, and not due to its fitness to the new environment).
47. Jayne W. Barnard, Corporate Therapeutics at the Securities and Exchange Commission, 2008 COLUM. BUS. L. REV. 793, 816-20 (2008) (describing the settlement negotiating process). Barnard shares many of our concerns regarding the effectiveness of monitorships, the monitor selection process, and the capacity of lawyers in general and SEC (or, for us, criminal and civil) Enforcement staffers in particular to craft monitorships with the potential to achieve meaningful structural change. Id. at 837-38. Barnard also agrees that the SEC should be managing the data coming from monitorships more effectively, and making better use of monitors' final reports. Id. at 837-39. Her views differ from ours in other respects, including her confidence in mainstream corporate law mechanisms (e.g., the presence of independent directors) to discipline firms. Id. at 837-38. She concludes that monitorships and other "therapeutics" should be used sparingly because their usefulness has not been demonstrated. Id. at 838.
48. Ford & Hess, supra note 20, at 713.
49. Id.
50. Id. at 714.
51. GARY E. EDWARDS & ROBERT REID, CHALLENGES FACING CORPORATE ETHICS AND COMPLIANCE PROGRAMS: A RESEARCH REPORT FROM ETHOS INTERNATIONAL 10-11 (2007), available at http://www.ethosinternational.net/files/689-file-PDF- EthosResearchReport2007.pdf (reporting the results of a survey of legally trained chief compliance officers versus those from a management background).
52. See Ford & Hess, supra note 20, at 715-19.
53. Id. at 716.
54. Id. at 716-17.
55. Id. at 717-18.
56. Id. at 718.
57. See id. at 724-26, 736-37.
58. Id. at 726. Civil-side regulators more commonly pass monitors' reports onto their compliance or examinations departments, which may use the reports as blueprints for subsequent compliance examinations and audits; prosecutors' offices lack the institutional structure to do this. Id.
59. Id. at 725.
60. Id. at 736.
61. Id.
62. Id. at 725.
63. The familiar example here is the European Union's Open Method of Coordination, a functional and ongoing process that has attracted positive attention from new governance scholars. See, e.g., GRÁINNE DE BURCA & JONATHAN ZEITLIN, CENTRE FOR EUROPEAN POL'Y STUDS., CEPS POLICY BRIEF No. 31, CONSTITUTIONALISING THE OPEN METHOD OF COORDINATION: WHAT SHOULD THE CONVENTION PROPOSE? (2003), available at http://www.ceps.eu/system/files/book/1010.pdf. The seeds of the FSA's principles-based approach were also sewn in response to the need to amalgamate regimes across preexisting regulatory entities. FIN. SERVS. Aura., CONSULTATION PAPER NO. 8, DESIGNING THE FSA HANDBOOK OF RULES AND GUIDANCE 4-6 (1998), available at http://www.fsa.gov.uk/pubs/cp/CP08.pdf. In the interest of maintaining continuity and a "good standard of regulation during the transitional period," the FSA was launched in 1997, but did not have its own statutory source of regulatory power until December 2001.
64. See Financial Services and Markets Act [FSMA], 2000, cl. 8, §§ 2(2)-(3) (Eng.); Howard Davies, Chairman, Fin. Servs. Auth., Speech at the FSA Launch Conference (Oct. 28, 1997), available at http://www..fsa.gov.uk/Pages/ Library/ Communication/Speeches/1997/SP02.shtml. The FSMA replaced much of the previous legislation, including the Financial Services Act of 1986, the Banking Act of 1987, and the Insurance Companies Act of 1982 under which banks, insurance companies and other financial services firms had been authorized and supervised. In its early days the FSA did not see itself as a principles-based regulator, so much as a risk-based, outcome-oriented, cost-effective, consultative, and management-based one.
65. See, e.g., FIN. SERVS. Aura., ANNUAL REPORTS 11 (2002-03), available at http://www.fsa. gov.uk/pubs/annual/ar02-03/ar02?03.pdf;
66. FIN. SERVS. Aura., FINANCIAL SERVICES AUTHORITY: AN OUTLINE 31-33 (1997), available at http://www.fsa.gov.uk/pubs/policy/launch.pdf. The principles-based turn came later. The frequency of use of the term "more principles-based" had increased by orders of magnitude by late 2006 or early 2007.
67. See, e.g., Press Release, Fin. Servs. Auth., FSA Business Plan Focuses on More Principles-Based Regulation (Feb. 6, 2007), http://www.fsa.gov.uk/pages/ Library/Communication/PR/2007/019.shtml.
68. BASEL COMM. ON BANKING SUPERVISION, BANK FOR INT'L SETTLEMENTS, INTERNATIONAL CONVERGENCE OF CAPITAL MEASUREMENT AND CAPITAL STANDARDS: A REVISED FRAMEWORK (2004), available at http://www.bis.Org/publ/B.C.bs107.pdf [hereinafter 2004 BASEL II ACCORDS].
69. Ford, New Governance, Compliance, supra note 14, at 5-6. The term "principles-based regulation" is the dominant one in securities regulation, likely for path-dependent reasons stemming from post-Enron worries about whether U.S. GAAP rules were too rules-based. However, some scholars would argue that new governance methods transcend the rules-versus-principles debate. See Kathleen G. Noonan et al., Legal Accountability in the Service-Based Welfare State: Lessons from Child Welfare Reform, 34 LAW & Soc. INQUIRY 523, 536-37, 554-56 (2009) (arguing that new governance, or "experimentalist, " practice resolves "the rules/standard antimony" debate through a "simultaneous emphasis on articulation and flexibility"). These scholars argue, by contrast, that an experimentalist regime actually transcends the rulesversus-principles debate. Despite differences in terminology and emphasis, the fully articulated version of what I call principles-based regulation is not actually in tension with what Noonan et al. would describe. They find it most useful to frame the phenomenon as a pragmatic, practical method that bypasses an unproductive theoretical conversation. I find it most useful to describe essentially the same phenomenon by focusing on principles-based regulation as a first-order decision that reflects an appreciation of the relative capacities of legislative drafters, regulators, and industry actors. Nevertheless, my version of principles-based regulation calls for careful attention to implementation mechanisms that pull detailed industry knowledge into the articulation of those principles, in a way that is strongly similar to what Noonan et al. describe.
70. I am not alone in describing principles-based regulation as requiring more than principles-based drafting. See also Julia Black, Forms and Paradoxes of PrinciplesBased Regulation 12 (Law, Soc'y & Econ. Working Papers, 13/2008, 2008), available at http://www.scribd.com/doc/14726527/Forms-and- Paradoxes-of-Principles-Based-Regulation-by-Julia-Black [hereinafter Black, Forms and Paradoxes] (distinguishing "formal PBR," meaning principles in the rule books; "substantive PBR," which has some of the operational elements of PBR but not principles on the rule books; "full PBR," exhibiting both principles in the rule books and a principles-based operational approach; and "polycentric PBR," which is full PBR with the additional element of incorporating third parties into the regulatory process).
71. See, e.g., FIN. SERVS. AUTH., PRINCIPLES-BASED REGULATION: FOCUSING ON THE OUTCOMES THAT MATTER 4, 6-7, 9, 12 (2007), available at http://www.fsa. gov.uk/pubs/other/principles.pdf.
72. In actual practice, there is no necessary disconnect between outcomeoriented regulation and a third approach that some scholars call management-based regulation. See Coglianese & Lazer, supra note 12, at 692, 694. There are differences between the two concepts in terms of at what stage of firm conduct the regulator intervenes, but both place responsibility for detailed decision-making with industry actors, and give those actors the flexibility to design mechanisms that work for them based on their greater knowledge about their own businesses.
73. JULIA BLACK, RULES AND REGULATORS 30-37 (1997);
74. STANLEY FISH, IS THERE A TEXT IN THIS CLASS: THE AUTHORITY OF INTERPRETIVE COMMUNITIES 354-57 (1980);
75. Julia Black, Talking About Regulation, PUB. L. 77, 77 (1998);
76. Sol Picciotto, Constructing Compliance: Game Playing, Tax Law, and the Regulatory Sate, 29 LAW & POL'Y 11 (2007).
77. On best practices and critical success factors in principles-based regulation see, e.g., Julia Black et al., Making a Success of Principles-Based Regulation, 1 LAW & FIN. MKTS. REV. 191 (2007).
78. Don Langevoort makes the thought-provoking argument that this kind of collaborative regulation is more likely to be successful in small and socially interconnected sectors. Donald C. Langevoort, The SEC, Retail Investors, and the Institutionalization of the Securities Markets, 95 VA. L. REV. 1025 (2009). Retail-heavy markets like the American one may have to rely more heavily on ex post enforcement, despite its disadvantages. Id.
79. See 2004 BASEL II ACCORDS, supra note 53.
80. Id.
81. Id.
82. Alternative Net Capital Requirements for Broker-Dealers that Are Part of Consolidated Supervised Entities, Exchange Act Release No. 34-49830, 69 Fed. Reg. 34,428 (June 21, 2004), available at http://www.sec.gov/rules/final/34- 49830.pdf. The text of the rule acknowledges that a "broker-dealer's deductions for market and credit risk probably will be lower under the alternative method of computing net capital than under the standard net capital rule." Id. To be eligible to use the alternative method of computing net capital, the broker-dealer had to maintain tentative net capital (meaning net capital before deducting securities haircuts and charges on inventory) of at least $1 billion and net capital of at least $500 million. Id. It also had to have in place comprehensive internal risk management procedures that addressed market, credit, liquidity, legal, and operational risk at the firm, and to observe certain disclosure requirements vis-à-vis the SEC. Id. The ultimate holding company of those brokerdealers-which were global financial institutions operating in the shadow banking sector-also had to consent to certain disclosure and risk assessment protocols, to permit the SEC to examine it and its affiliates, and monthly to compute capital requirements and risk in accordance with Basel standards. Id. The Program was terminated in September 2008. Press Release, SEC, Chairman Cox Announces End of Consolidated Supervised Entities Program (Sept. 26, 2008), http://www.sec.gov/news/press/2008/2008-230. htm.
83. SEC, OFFICE OF INSPECTOR GEN., OFFICE OF AUDITS, REPORT NO. 446-A, SEC's OVERSIGHT OF BEAR STEARNS AND RELATED ENTITIES: THE CONSOLIDATED SUPERVISED ENTITY PROGRAM 81 (2008), available at http://www.sec.gov/about/oig/audit/2008/ 446-a.pdf [hereinafter, CSE REPORT]. That the CSE Program was voluntary was reportedly a function of the fact that no U.S. agency had regulatory authority over certain investment bank holding companies. Id.
84. See Stephen Labaton & Timothy L. O'Brien, Financiers Plan to Put Controls on Derivatives, N.Y. TIMES, Jan. 7, 1999, at C1 (discussing the move towards self-regulation in derivative markets, prior to the GFC);
85. Testimony Concerning Turmoil in U.S. Credit Markets: Recent Actions Regarding Government Sponsored Entities, Investment Banks and Other Financial Institutions Before S. Comm. on Banking, Housing, & Urban Affairs (2008) (statement of SEC Chairman Christopher Cox), available at http://www.sec.gov/ news/testimony/2008/ts092308cc.htm (recognizing a lack of regulatory oversight in the market for CDSs and other derivative products).
86. They differ in their attributes, but most over-the-counter (OTC) derivative contracts are at least documented under standard forms, known as Masters, created by the International Swaps and Derivatives Association, Inc. See International Swap and Derivatives Association, Inc., http://www.isda.org (last visited Mar. 19, 2010). The United States Department of the Treasury recently presented a bill to Congress that would significantly augment private standardization initiatives. See Press Release, U.S. Dep't of the Treasury, Administration's Regulatory Reform Agenda Reaches New Milestone: Final Piece of Legislation Language Delivered to Capitol Hill (Aug. 11, 2009), http://www.ustreas.gov/press/releases/tg261.htm. The Treasury's bill would allow bank regulators to establish margin and capital requirements for banks entering into derivatives contracts; would require standardized OTC derivatives contracts to be cleared by a derivatives clearing organization regulated by the Commodity Futures Trading Commission or the SEC; and would require banks to have their standardized contracts centrally cleared and traded over regulated exchanges. Id. Dealers, also, would no longer be able to directly trade standardized derivatives contracts among themselves, but would be required to use an exchange or equivalent trading platform. Id.
87. See, e.g., John C. Coffee & Hillary A. Sale, Redesigning the SEC: Does the Treasury Have a Better Idea?, 95 VA. L. REV. 707, 777-78 (2009).
88. Stephen Labaton, Agency's '04 Rule Let Banks Pile Up New Debt, and Risk, N.Y. TIMES, Oct. 2, 2008, at A1.
89. George Soros, The Worst Market Crisis in 60 Years, FIN. TIMES, Jan. 23, 2008, at 9.
90. See, e.g., Les Christie, Mortgage Fraud Still Soaring, CNN. COM, Aug. 26, 2008, http://money.cnn.com/2008/08/25/real-estate/soaring-mortgage-fraud/index. htm;
91. Roger Lowenstein, Triple-A Failure, N.Y. TIMES MAG., Apr. 27, 2008, at MM36.
92. For a discussion of the future of the "efficient-markets hypothesis" see Efficiency and Beyond, ECONOMIST, July 18, 2009.
93. See, e.g., Joe Nocera, Risk Mismanagement, N.Y. TIMES MAG., Jan. 4, 2009, at MM24 (describing oversimplification of the VAR model in banking practice);
94. Felix Salmon, A Formula for Disaster, WIRED MAG., Mar. 2009, at 74 (describing oversimplification of Li's gaussian cupola in banking practice).
95. Ben S. Bernanke, Remarks at the Sandridge Lecture, Virginia Association of Economics (Mar. 10, 2005), available at http://www.federalreserve.gov/ boarddocs/speeches/2005/200503102/ (referring to a global "saving glut").
96. Lucian A. Bebchuk & Holger Spamann, Regulating Banters' Pay, 98 GEO. L.J. (forthcoming 2010), available at http://papers.ssra.com/so13/papers.cfm? abstracted=1410072;
97. see also Michael Lewis, The End, CONDE NAST PORTFOLIO, Dec.-Jan. 2008-09, at 114 (blaming Wall Street excesses on the decision to take investment banks public).
98. David Brooks, Op.-Ed., Greed and Stupidity, N.Y. TIMES, Apr. 3, 2009, at A29 (contrasting two theories explaining decision-making failures at financial institutions). Precisely why financial institutions managed risk so poorly is an important question, the answer to which is also multi-factorial and variable from one firm to another.
99. This may be the least of it. As Martin Wolf has pointed out, "an enormous part of what banks did in the early part of this decade-the off-balance-sheet vehicles, the derivatives and the 'shadow banking system' itself-was to find a way round regulation." Martin Wolf, Comment, Reform of Regulation has to Start by Altering Incentives, FIN. TIMES, June 23, 2009, at 11.
100. See JONATHAN GOLIN, COVERED BONDS: BEYOND PFANDBRIEFE INNOVATIONS, INVESTMENT AND STRUCTURED ALTERNATIVES 323 (2006) (indicating the lack of legislation in the American market for covered bonds, which produces products which lack the standardization and comparability of their European counterparts). Recent legislative initiatives have seen an interest in standardizing certain OTC derivative products, in an effort to mitigate systemic risk,
101. see, e.g., "Over-the-Counter Derivatives" Before the S. Subcomm. on Sees., Ins., and Inv. (June 22, 2009), available at http://www.federalreserve.gov/newsevents/testimony/white20090622a.htm (statement of Patricia White, Associate Director, Division of Research Statistics).
102. Black, Forms and Paradoxes, supra note 55, at 7-12.
103. CSE REPORT, supra note 65, at 49.
104. Id.
105. Id. at 49-50.
106. Id. at 37-41. The SEC's failures in oversight do not appear to be limited to the CSE program. That agency's review of its failure to detect and prevent Bernard Madoff s fraud also records that Mr. Madoff s funds were overseen by inexperienced or unsuitably skilled staff who conducted inadequate examinations, failed to verify information, and failed to respond to "red flags." SEC, OFFICE OF INVESTIGATIONS, REPORT NO. OIG-509, INVESTIGATION OF FAILURE OF THE SEC TO UNCOVER BERNARD MADOFF'S PONZI SCHEME - PUBLIC VERSION 23, 29, 31, 144 (Aug. 31, 2009), available at http://www.sec.gov/spotlight/ secpostmadoffreforms.htm. Investigations were also delayed, questions were left unresolved, and SEC offices failed to communicate with each other. Id. The SEC's post-Madoff reforms include many of the initiatives recommended here, such as conducting surprise exams, recruiting staff with specialized experience, improving staff training, and seeking more resources. SEC, The Securities and Exchange Commission Post-Madoff Reforms (Dec. 7, 2009), http://www.sec.gov/ spotlight/secpostmadoffreforms.htm.
107. FIN. SERVS. Aura., INTERNAL AUDIT DIVISION, THE SUPERVISION OF NORTHERN ROCK: A LESSONS LEARNED REVIEW 7, 108-21 (2008), available at http://www.fsa.gov.uk.pubs/other/nr-report.pdf.
108. Id. at 13-59.
109. Id. at 5. But see Norma Cohen & Chris Giles, Northern Rock Risk Revealed in 2004, FIN. TIMES, May 30, 2009, at 1, available at http://www.ft.com/cms/s/0/4cc9637a-4c8a-11de-a6c5-00144feabdc0.html? nclick-check=1 (reporting that the FSA had conducted "war games" in 2004 that identified the systemic risk that Northern Rock posed).
110. Hector Sants, Chief Executive, Financial Services Authority, Speech at the FSA Annual Public Meeting (July 24, 2008), http://www.fsa.gov.uk/pages/ Library/Communication/Speeches/2008/0724-hs.shtml.
111. See FIN. SERVS. AUTH., THE TURNER REVIEW: A REGULATORY RESPONSE TO THE GLOBAL BANKING CRISIS 45-49 (2009), available at http://www.fsa.gov. uk/pubs/other/turner-review.pdf [hereinafter TURNER REVIEW] (criticizing the FSA for adopting "laissez faire" mentality); Labaton, supra note 69 (noting that "[t]he commission's decision effectively to outsource its oversight to the firms themselves fit squarely in the broader Washington culture of the last eight years under President Bush").
112. CSE REPORT, supra note 65, at 81-82 (Chairman Cox's comments justifying CSE program on the basis that it was voluntary and the SEC did not have a mandate to regulate CSEs otherwise).
113. See Labaton & O'Brien, supra note 66.
114. See generally Simon & Sabel, supra note 7. The concept of destabilization rights is borrowed from Unger. See, e.g., ROBERTO UNGER, FALSE NECESSITY 1-8, 530-32 (1987). I am not suggesting that new governance envisions a world as plastic as Unger does. See infra notes 134-136 and accompanying text.
115. See generally Dorf & Sabel, supra note 7.
116. See, e.g., Ian Bell & Petrina Dawson, Synthetic Securitization: Use of Derivative Technology for Credit Transfer, 12 DUKE J. COMP. & INT'L L. 541 (2002);
117. Michael Durrer, Asset-Backed Commercial Paper Conduits, 1 N.C. BANKING INST. 119 (1997). Not incidentally, conduits also allowed banks to move debt off their balance sheets and to maintain less capital on hand for purposes of Basel II and the CSE Program. Other significant difficulties with the incentive structures around structured finance, including the fact that through CDSs one could effectively buy more protection than one had risk exposure, are beyond this Article's scope.
118. See Bernanke, supra note 74 (discussing the global "saving glut" and its effect on the U.S. current account deficit); Lewis, supra note 75 (discussing the subprime mortgage crisis).
119. TURNER REVIEW, supra note 88, at 49.
120. Id. at 109.
121. Id. at 49.
122. ADOLF A. BERLE & GARDINER C. MEANS, THE MODERN CORPORATION AND PRIVATE PROPERTY 8-9 (1932).
123. The term is not a new one. For a prescient analysis of the systemic risk associated with widespread use of over-the-counter derivatives, see Mary L. Schapiro, Comm'r, SEC, Remarks at the Eighth Annual Symposium for the Foundation for Research in International Banking and Finance: The Derivatives Revolution and the World Financial System (Oct. 14, 1993), available at http://www.sec.gov/news/speech/1993/101493schapiro.pdf [hereinafter Schapiro Remarks].
124. See generally Henry T.C. Hu & Bernard Black, Equity and Debt Decoupling and Empty Voting II: Importance and Extensions, 156 U. PA. L. REV. 625 (2008) [hereinafter Hu & Black, Equity and Debt Decoupling];
125. Henry T.C. Hu & Bernard Black, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership, 79 S. CAL. L. REV. 811-908 (2006) [hereinafter Hu & Black, The New Vote Buying]. In September 2009, Professor Hu was appointed the first Director of the SEC's newly established Division of Risk, Strategy, and Financial Innovation. Press Release, SEC, SEC Announces New Division of Risk, Strategy, & Financial Innovation (Sept. 16, 2009), http://www.sec.gov/news/press/2009/2009-199.htm.
126. Hu & Black, The New Vote Buying, supra note 100, at 851-52.
127. Id. at 823.
128. Id. at 825.
129. Id. at 832-35.
130. Id. at 825-26.
131. 106. Id. at 836-42, 850-63.
132. See generally Hu & Black, Equity and Debt Decoupling, supra note 100.
133. Cf., e.g., PATRICIA J. WILLIAMS, THE ALCHEMY OF RACE AND RIGHTS 146-49 (1991).
134. Steven L. Schwarcz, Regulating Complexity in Financial Markets, 87 WASH. L. REV. (forthcoming 2010) (manuscript at 2-3, on file with author), available at http://ssrn.com/abstract=1240863.
135. Id. at 7-11.
136. Id. at 11-25.
137. Id. at 25-32.
138. Id. at 7-11.
139. Id. at 25-31.
140. This would include, for example, meaningful protections for corporate whistleblowers. See generally Orly Lobel, Citizenship, Organizational Citizenship, and the Laws of Overlapping Obligations, 2009 CAL. L. REV. 433.
141. TURNER REVIEW, supra note 88.
142. This notwithstanding premature and ultimately inaccurate reports by credible UK media sources that principles-based regulation would be abandoned. See Peter Thai Larsen & Jennifer Hughes, Sants Takes a Fresh View of Regulator's Principles, FIN. TIMES, Mar. 13, 2009, at 17.
143. Just as fundamental, but best put in the category of regulatory gaps rather than regulatory approaches, was failure in the oversight of systemic risk. See TURNER REVIEW, supra note 88, at 52-53.
144. E.g., Dorf & Sabei, supra note 7; Noonan et al., supra note 54.
145. See, e.g., Ronald J. Gilson et al., Contracting for Innovation: Vertical Disintegration andInterfirm Collaboration, 109 COLUM. L. REV. 431 (2008);
146. Katharina Pistor, Global Network Finance: Organizational Hedging in Times of Uncertainty (Columbia Law & Economics, Working Paper No. 339, Oct. 14, 2008), available at http://ssrn.com/abstract=1284606.
147. Joanne Scott & Susan Sturm, Courts as Catalysts: Re-Thinking the Judicial Role in New Governance, 13 COLUM. J. EUR. L. 565 (2007); Sturm, supra note 8.
148. See, e.g., Gilson et al., supra note 120.
149. See Michiyo Nakamoto & David Wighton, Citigroup Chief Stays Bullish on Buy-Outs, FIN. TIMES, July 9, 2007, at 1, available at http://www.ft.com/cms/ s/0/80e2987a-2e50-11dc-821c-0000779fd2ac.html (statement of Charles Prince, Citigroup CEO) ("As long as the music is playing you need to get up and dance.").
150. Cf. Robert K. Vischer, Subsidiarity as a Principle of Governance: Beyond Devolution, 35 IND. L. REV. 103 (2001) (arguing that the conservative political spin the principle sometimes assumes misconstrues the public-minded Catholic social theory from which the principle arises).
151. See, e.g., William H. Simon, Solving Problems vs. Claiming Rights: The Pragmatist Challenge to Legal Liberalism, 46 WM. & MARY L. REV. 127, 181-82 (2004).
152. See, e.g., Black et al., Making a Success, supra note 59, at 201;
153. Cristie L. Ford, Principles-Based Securities Regulation in the Wake of the Global Financial Crisis, 55 MCGILL L.J. (forthcoming 2010), available at http://www.ssrn.com/abstract=1516734.
154. Black et al., Making a Success, supra note 59, at 202.
155. See generally id. (discussing U.K. Treat Customers Fairly rules, which require registrants to demonstrate that they are in fact treating customers fairly at every stage).
156. Jennifer Hughes, FSA Admits Catalogue of Failures, FIN. TIMES, Mar. 27, 2008, at 3. The fact that quantitative analysis has been abused, misapplied, and overgeneralized in the past does not mean that banks will not use it in the future. Despite its theoretical limitations and the recent example of real-life catastrophe, quantitative analysis continues to have substantial predictive value, and it will continue to be a central tool for financial industry actors.
157. See supra notes 64-69 and accompanying text. The FSA implemented a "supervisory enhancement program" in response to the failure of Northern Rock. See Hector Sants, Fin. Servs. Auth., The FSA's Supervisory Enhancement Programme, in Response to the Internal Audit Report on Supervision of Northern Rock, High Level Summary (Mar. 26, 2008), available at http://www.fsa.gov.uk/pubs/other/enhancement.pdf. It has announced plans to enhance its supervisory teams (meaning more staff, better training, a mandatory minimum number of staff per high-impact institution, and closer contact between senior staff and the biggest firms).
158. Id. at 2. It also plans to improve the quality of its staff, hiring risk specialists to support frontline supervision teams by focusing on the complex models used by banks to gauge financial risk.
159. Id. at 3.
160. See also TURNER REVIEW, supra note 88, at 88 (describing the FSA's new approach as "intensive supervision"). Lord Turner describes intensive supervision as entailing much greater resources devoted to the supervision of high impact firms, more intense focus on business strategies and system-wide risks, more focus on technical competence of FSA supervisors, more focus on the details of bank accounting, and greater willingness to reach judgments about the overall risks that firms are running.
161. Id.
162. See Ford & Hess, supra note 20, at 726 (discussing civil side regulators passing monitors' reports onto compliance for use as blueprints). That said, even within the civil regulatory context, there is a clear distinction between regulated entities and public companies in terms of follow-up and oversight. Broker-dealer firms and other regulated entities operate in a highly regulated environment and are required to be in contact with their regulators through a number of prescribed mechanisms. Nothing similar is required of public companies as a condition of listing, and most people would probably agree that nothing similar should be required.
163. See, e.g., Bell & Dawson, supra note 93, at 561 (suggesting that synthetic securitization "is the second great leap forward in the road to a totally disintermediated financial world").
164. Contra UNGER, FALSE NECESSITY, supra note 91, at 530 (" Destabilization rights protect the citizen's interest in breaking open the large-scale organizations or the extended areas of social practice that remain closed to the destabilizing effects of ordinary conflict and thereby sustain insulated hierarchies of power and advantage.");
165. ROBERTO MANGABEIRA UNGER, SOCIAL THEORY: ITS SITUATION AND ITS TASK 210 (1987) ("The paramount condition of material progress [once poverty is overcome] becomes the plasticity of social life: the relative ease with which people can subject their forms of production and exchange, of machine design and work organization, to the logic of problem-solving.").
166. See, e.g., Noonan et al., supra note 54; Sabel & Simon, supra note 7; Scott & Sturm, supra note 121.
167. Edward Rubin, The Myth of Accountability and the Anti-Administrative Impulse, 103 MICH. L. REV. 2073, 2131-34 (2005) (arguing for open-ended formulations where the regulator "knows the result it is trying to achieve but does not know the means for achieving it, when circumstances are likely to change in ways that the [regulator] cannot predict, or when the [regulator] does not even know the precise result that she desires").
168. Gilson et al., supranote 120.
169. See Sturm, supra note 8 (identifying such problems of subtle resistance, and a solution based on building in responsive architecture rather than perpetuating plasticity).
170. Unger actually proposes four fundamentally restructured categories of rights: immunity rights, which protect the individual from the state, organizations, and other individuals; destabilization rights, which make it possible to dismantle institutions and practices that create social hierarchy and division; market rights, which constitute claims to social capital and replace conventional property rights; and solidarity rights, which are "the legal entitlements of communal life." UNGER, supra note 133, at 50838.
171. For Unger, the traditional property right was an unhelpful formative context that impeded societal plasticity. Unger would disaggregate private property rights and transfer control over major productive assets to a "rotating capital fund," which would disaggregate property rights down through tiers: (1) an ultimate social fund controlled by government, leasing capital to (2) autonomous investment funds operating in different sectors, which then (3) auction or ration resources to competitive teams of producers for stipulated periods of time. UNGER, FALSE NECESSITY, supra note 91, at 491-501. Welfare rights guarantees to citizens would protect them from the vagaries of markets, which would also allow innovators (capital-takers) to be even more innovative and to take larger risks.
172. See also ROBERTO MANGABEIRA UNGER, DEMOCRACY REALIZED: THE PROGRESSIVE ALTERNATIVE 273-75 (1987).
173. See, e.g., Matthew C. Jennejohn, Collaboration, Innovation, and Contract Design, 14 STAN. J.L. BUS. & FIN. 83, 86-87 & nn. 12-14 (2008);
174. Charles Sabel, Ungovemed Production, in CONVERGENCE AND PERSISTENCE IN CORPORATE GOVERNANCE 310 (Jeffrey N. Gordon & Mark J. Roe eds., 2004).
175. See, e.g., Lisa T. Alexander, Stakeholder Participation in New Governance: Lessons From Chicago's Public Housing Reform Experiment, 16 GEO. J. ON POVERTY L. & POL'Y 117, 127-28, 180-84 (2009);
176. Douglas NeJaime, When New Governance Fails, 70 OHIO ST. L.J. 323 (2009) (making essentially this recommendation albeit in different contexts).
177. For example, one post-GFC innovation in securitization is based on "life settlements." Jenny Anderson, New Exotic Investments Emerging on Wall street, N.Y. TIMES, Sept. 5, 2009, at A1.
178. On the other hand, prophylactic rules can impose considerable costs due to international regulatory arbitrage. The obvious response, which is international harmonization, remans elusive. I am grateful to Eric Pan for this observation.
179. See generally William S. Laufer, Corporate Liability, Risk Shining, and the Paradox of Compliance, 52 VAND. L. REV. 1343 (1999).
180. See, e.g., Sushil Bikhchandani et al., A Theory of Fads, Fashion, Custom, and Cultural Change as Informational Cascades, 100 J. POL. ECON. 992 (1992);
181. J.H. Davis, Group Decision and Social Interaction: A Theory of Social Decision Schemes, 80 PSYCHOL. REV. 97 (1973). "Risky shift" is part of a broader phenomenon of group polarization, referred to as "choice shift" in more recent academic work, though in this case the narrower term "risky shift" applies.
182. See Nakamoto & Wighton, supra note 123 (statement of Charles Prince) ("As long as the music is playing, you've got to get up and dance.").
183. Coffee & Sale, supra note 68, at 742, 782 (claiming that Basel II criteria generated a "very sophisticated tool that was beyond the capacity of the SEC's largely legal staff to administer effectively" and that simple, suboptimal might be capable of implementation while "a more optimal rule (in terms of its theoretical design) may not be").
184. See, e.g., Scott & Sturm, supra note 121, at 567. Strong safeguards for participation rights, being fundamental to the new governance deliberative process, need to be distinguished from providing guarantees to particular substantive outcomes, like the "right of return" proposed in Alexander, supra note 141. There is an analogous debate in new governance scholarship about the degree of "hard law" background measures needed (or assumed to exist) to safeguard participatory rights or address power disparities.
185. See, e.g., Amy Cohen, Negotiation, Meet New Governance: Interests, Skills, and Selves, 33 LAW & Soc. INQUIRY 503, 543 n.47 (2008). Even assuming that capital requirements and other prudential measures are fundamental to financial markets' operation, a range of reasonable opinion could exist as to the optimal degree of flexibility for what I still maintain need to be prophylactic standards around them.
186. Andrea Beltratti & Rene Stulz, Why Did Some Banks Perform Better During the Credit Crisis?: A Cross Country Study of the Impact of Governance and Regulation (Fisher College of Business, Working Paper No. 2009-03-012, 2009), available at http://papers.ssrn.com/so13/papers.cfm?abstract-id=1433502 (finding that banks in countries with stricter capital requirement regulations and with more independent supervisors performed better in the July 2007 to December 2008 period).
187. See, e.g., Kevin G. Lynch, Clerk of the Privy Council, Secretary to the Cabinet and Head of the Public Service to the Hertie School of Governance, Remarks in Berlin, Germany: Public Policy Making in a Crisis: A Canadian Perspective (May 7, 2009).
188. Id.
189. But see Lev Ratnovski & Rocco Huang, Why Are Canadian Banks More Resilient? (IMF Working Paper No. WP/09/152, 2009), available at https://www.imf.org/extemal/pubs/ft/wp/2009/wp09152.pdf (identifying the "key determinant" of Canadian banks' success as having a larger base of insured retail depositors). Other factors include steadier housing prices, a more unified regulatory structure, and the fact that mortgage lenders in Canada tend to hold the mortgages they extend.
190. See Lynch, supra note 150; Ratnovski & Huang, supra, at 16-18;
191. Fareed Zakaria, Worthwhile Canadian Initiative, NEWSWEEK, Feb. 16, 2009, at 31.
192. See supra note 67 and accompanying text.
193. Jeffrey M. Lipshaw, The Epistemology of the Financial Crisis: Complexity, Causation, Law, and Judgment (Suffolk Univ. Law Sch., Legal Studies Research Paper No. 09-30, 2009), available at http://papers.ssrn.com/so13/papers. cfm?abstract-id=1421837.
194. The term derives from American constitutional law theory, and is controversial in that context. Miranda v. Arizona, 384 U.S. 436 (1966) (holding that certain warnings must be given before a suspect's statement made during custodial interrogation could be admitted in evidence). The case invited legislative action to protect the constitutional right against coerced self-incrimination, but stated that any legislative alternative must be "at least as effective in appraising accused persons of their right of silence and in assuring a continuous opportunity to exercise it."
195. Id. at 467.
196. The Miranda warning requirement was upheld in Dickerson v. United Sates, but its prophylactic nature was severely narrowed and the warning requirement was constitutionalized. 530 U.S. 428 (2000).
197. For a new governance perspective on prophylactic rules, see Dorf & Sabel, supra note 7, at 452-59.
198. In Dickerson, arguments about costs and workability for law enforcement personnel were made successfully in support of upholding the Miranda warning requirements, notwithstanding the "undeniabl[e] instances in which the exclusionary rule of Miranda imposes costs on the truth-seeking function of a trial, by depriving the trier of fact of 'what concededly is relevant evidence.'" Brief for the United States, at I, Dickerson v. United States,
199. Dickerson, 530 U.S. at 442.
200. William H. Simon, Optimization and its Discontents in Regulatory Design: Bank Regulation as an Example 3 (Columbia Pub. Law, Research Paper No. 10-224, 2010), available at http://ssrn.com/abstract=1533446 (noting that "some of the most prominent pre-crisis regulatory initiatives, especially those associated with 'Basel II' . . . have a strong 'new governance' and reliability flavor").
201. See generally id.
202. Id. at 3, 22-23.
203. Id. at 4-6, 20-23.
204. Id. at 15-20.
205. Id. at 20-21.
206. Id. at 6-12, 22-28.
207. Id. at 24-26.
208. Id. at 26-28.
209. See, e.g., Jenny Anderson & Landon Thomas Jr., Goldman Sachs Rakes in Profit in Credit Crisis, N.Y. TIMES, NOV. 19, 2007, at A1.
210. Michael Lewis, Wall Street on the Tundra, VANITY FAIR, Apr. 2009, at 140, available at http://www.vanityfair.com/politics/features/2009/04/iceland200904.
211. LINDA MCDOWELL, CAPITAL CULTURE: GENDER AT WORK IN THE CITY (1997);
212. Paola Sapienza et al., Gender Differences in Financial Risk Aversion and Career Choices are Affected by Testosterone, 106 PROC. NAT'L ACAD. SCI. 15268 (2009), available at http://www.pnas.org/content/106/36/15268.full.pdf+html?sid= a5f6e12c-e595-4b48-b407-c1cbb78db59b.
213. Edward J. Balleisen & Marc Eisner, The Promise and Pitfalls of CoRegulation: How Governments Can Draw on Private Governance for Public Purpose, in NEW PERSPECTIVES ON REGULATION 127 (David Moss & John Cisternino eds., 2009) (describing the other prerequisites to effective co-regulation to be the relevance of flexibility in regulatory detail; the existence of sufficient bureaucratic capacity and autonomy on the part of nongovernmental regulators; the degree of transparency in the regulatory process; and the seriousness of accountability).
214. For an example that assesses American institutions along these lines, see Jeffrey J. Rachlinski & Cynthia R. Farina, Cognitive Psychology and Optimal Government Design, 87 CORNELL L. REV. 549 (2002).