Monthly Archives: April 2016

Remember: the securities laws cover unicorns just like every other species!

The big news in Silicon Valley this week was the Wall Street Journal report that “unicorn” medical testing startup Theranos is being investigated by both the Department of Justice and the Securities and Exchange Commission.

This follows the recent visit by SEC Chair Mary Jo White to the Valley where she made clear that the SEC was focused on potential securities law issues related to highly valued startup companies. As I made clear in a book chapter I wrote for a collection edited by UCLA’s Steve Bainbridge, the securities laws prohibit fraud at both public and private companies.

When the pipeline to an IPO slowed for the tech sector in the wake of the dotcom crash many companies opted to stay private longer. When the credit crisis hit that problem deepened. But as the recovery took hold money flooded into certain sectors in the Valley and valuations of many companies soared, giving rise to the “unicorn” label – entities with more than a billion dollar valuation but still privately or closely held.

But just because a company has not yet engaged in a public offering of its shares does not mean the prohibitions agains securities fraud do not apply. They do, even where there is an exemption available that allows a company to limit the disclosure it provides investors. In fact, this is a regulatory framework I am explaining to my securities law students this week.

Don’t blame Bernie – of course the banks can be broken up

In a recent interview, a very confused New York Daily News reporter continually mixed up the Treasury Department and the Federal Reserve in the face of a very straightforward statement of presidential candidate Bernie Sanders that Congress can give the President power to impose changes on the structure of the financial system “under Dodd Frank.”

Well, the Treasury is an agency of the executive branch while the Federal Reserve is an independent hybrid public-private entity. The former is an extension of the power of the President while the latter has autonomy that limits, understandably, Presidential influence. Apparently in the minds of financial journalists the two entities can be conflated without consequence.

Sure enough Secretary Clinton jumped on the bandwagon and slyly and indirectly suggested on Morning Joe that Bernie Sanders does not “seem” to know enough about how the economy works to be qualified as president.

Now that we have cleared up the fact that it was the Daily News reporter who was confused not Sanders, let’s focus on the agency that a President does control, the Treasury. When Sanders said he wanted to use Dodd-Frank to break up the big banks one could consider that from two angles. First, does the current language of that law enable the federal government to break up the banks; and second, could Dodd-Frank be amended to give the federal government the power it needs to break up the banks. Since Sanders talked about going to Congress to empower the government to break up the banks it seems reasonable to conclude he means the latter, second method.* But he is taking the view that any such amendment would be consistent with Dodd-Frank, a necessary extension consistent with the spirit of what Congress intended to do.

I think he is right about that – Dodd Frank cannot be viewed in isolation or as a static statement by Congress. In fact, many aspects of the statute are clearly aimed at collecting information and monitoring the ongoing behavior of the financial system so that Congress can decide if further change to the financial system is necessary. This summary of the key features of Dodd-Frank authored by a major corporate law firm that advises banks makes clear the role of the statute in enabling Congress and the President to maintain ongoing live and dynamic oversight that could and should lead to further changes in banking structure.

One key feature of the Act? A Financial Stability Oversight Council (FSOC) which has several key roles including (according to that law firm): “identifying risks to U.S. financial stability that may arise from ongoing activities of large, interconnected financial companies as well as from outside the financial services marketplace, promoting market discipline by eliminating expectations of government bailouts, responding to emerging threats to financial stability.”

No wonder the authors of this report tell their banking clients in summation: “There will be much more to come once the studies mandated by the Dodd-Frank Act are completed. There also is every reason to believe that the rule-making process will be a long and winding road.”

In fact, in part, Dodd Frank did restructure the banks by implementing the so-called Volcker Rule which forbids proprietary trading by banking entities.

Recent controversies, post Dodd-Frank, suggest that such active oversight is warranted. JPMorgan, for example, had no idea that it was building up a huge bet on synthetic credit INSIDE the very part of the bank that was supposed to be reducing risk! The London Whale scandal would likely have led to a break up of the bank in a rational world and certainly should have led to the dismissal of its CEO. Arguably this was a form of proprietary trading and thus in violation of Dodd Frank (although the Volcker Rule provisions were not finally passed until after this particular scandal – just good luck?) Can anyone not believe that Sanders and the Minneapolis Fed President Neil Kashkari are raising alarms about a serious ongoing problem in the financial system?

Please note I am not taking a position here on whether all the banks should be broken up. I do think that the repeal of Glass Steagall did unleash serious problems and enabled a hidden bubble to build up inside large banks that blew up in 2007-08. For a full discussion of the normative debate about whether to break up the banks consider the comments expressed at a Brookings Institution conference by Kashkari of the Minneapolis Fed recently here.

*Given the opportunity to expand on his earlier comments to the Daily News on the Morning Joe program today (April 8) Senator Sanders confirmed that he intends to use both existing Dodd-Frank provisions and additional legislation. He pointed specifically to Section 121 of Dodd-Frank which allows the Federal Reserve with the backing of FSOC to impose structural changes on banks including restricting product offerings or terminating activities.