Blog
California’s Mini-CFPB
By: Jenny Eldred, RBFL Student Editor
The California Consumer Financial Protection Law went into effect January 1, 2021,[1] reorganizing the Department of Business Oversight into the newly created Department of Financial Protection and Innovation. The DFPI assumes the reserved powers carved out of the Dodd-Frank Act for state regulators to protect consumers against unfair, deceptive, or abusive acts and practices.[2] The new California statute expands the jurisdiction of the consumer watchdog to cover previously unregulated actors including debt collectors, rent-to-own contractors, consumer credit reporting agencies, credit repair agencies, and—most notably—fintech.[3]
However, the DFPI does not have authority over any “bank, bank holding company, trust company, savings and loan association, savings and loan holding company, credit union…when acting under the authority of a license, certificate, or charter under federal law or the laws of another state.”[4] The exclusion of federally-chartered banks and banks chartered in other states was inserted into the bill as a result of the lobbyist efforts of the California Bankers Association.[5] The CCFPL is also limited in scope by not applying to persons licensed under other California state laws not administered by the DFPI, which effectively narrows CCFPL’s regulatory scope to mostly small lenders and fintech[6]—a major claw-back in scope from the original bill.[7]
The year 2020 presented significant challenges for consumer protection that likely prompted the California legislature into action, ranging from the COVID-19 pandemic[8] to Donald Trump running for reelection after effectively gutting the federal Consumer Financial Protection Bureau.[9] The CCFPL’s language also points to the emergence of fintech as another impetus of its enactment.[10]
The DFPI now has the opportunity to supplement what the CFPB doesn’t do particularly well at the federal level—regulating fintech. Tasked with regulating all actors who offer a financial product to consumers (from many individual payday lenders to massive banks), the CFPB may be too consumed with its responsibilities to fully pursue oversight of fintech industry actors.[11] During its first month, the DFPI has already signed memorandums of understanding with five fintech companies to provide it with information, follow industry best practices, and disclose their fees.[12] These agreements may possibly be the first of their kind between fintechs and a state regulatory agency.[13] California’s DFPI is undoubtedly an entity to watch in the emerging area of fintech regulation.
[1]Antonio F. Dias, et al., California Passes Legislation to Create Mini-CFPB. Jones Day. (Oct. 2020), https://www.jonesday.com/en/insights/2020/10/california-passes-legislation-to-create-minicfpb [https://perma.cc/6MXY-WMSN].
[2]Cal. Fin. Code §§ 90012(a); 90009(c); 12 U.S.C. § 5531(a), (b).
[3]Department of Consumer Protection and Innovation, California Consumer Protection Law for Businesses (Feb. 5, 2021, 11:35 AM), https://dfpi.ca.gov/california-consumer-financial-protection-law/ccfpl-for-businesses/.
[4]See Cal. Fin. Code § 90002 as enacted by Assembly Bill No. 1864.
[5]Sen. Rules Com., Off. of Sen. Floor Analyses, 3d reading analysis of 2019 CA A.B. No. 1864 as amended Aug. 25, 2020.
[6]See Id.
[7]See Id.
[8]See Cal. Fin. Code § 90000 as enacted by Assembly Bill No. 1864.
[9]See Biden Taps Proponents of Stricter Wall Street Rules for His agency Review Teams During Transition. The Washington Post. (Nov. 11, 2020, 6:24 AM), https://www.washingtonpost.com/business/2020/11/10/biden-transition-wall-street-regulation.
[10]See Cal. Fin. Code § 90000 as enacted by Assembly Bill No. 1864.
[11]See Rory Van Loo, Technology Regulation by Default: Platfoms, Privacy, and the CFPB, 2 Geo. L.Tech. Rev. 531, 545 (2018).
[12]See Id.
[13]See Press Release, Department of Financial Protection and Innovation, The DFPI Signs MOUs Believed to be Among the Nation’s First with Earned Wage Access Companies (Jan. 27, 2021), available at https://dfpi.ca.gov/wp-content/uploads/sites/337/2021/01/DFPI-Press-Release_Earned-Wage-Access-MOUs.pdf.
A Historical Perspective on the Japanese Keiretsu
By: Sarah Klim, RBFL Student Editor
In the U.S., a corporation is made up of many different constituencies, often including its shareholders, managers, creditors, and employees. Most large companies are publicly-traded and widely-held. Large institutional investors, such as Vanguard and Fidelity, are also common. The majority of shareholders are typically not managers, although management may own some shares in the company. In turn, this can create costs associated with separating ownership and control.
In stark comparison to the U.S., the predominate shareholding structure in Japan has traditionally been the keiretsu, or families of companies that have invested in one another.[1] There are two predominant varieties of the keiretsu: horizontal and vertical. In the horizontal keiretsu, dozens of companies in different industries own shares in one another, with a major financial institution at the center. The Studies in Systems, Decisions and Control book series has provided an excellent diagram of this type of cross-ownership group (Figure 1, below).[2]
In the vertical keiretsu, large companies (often associated with the automotive industry) own shares in manufacturers, suppliers, and distributors.[3] The Studies in Systems, Decisions and Control book series has again provided an excellent diagram of the vertical keiretsu (Figure 2, below).[4]
Japan and the U.S. developed drastically different predominant ownership structures due to their distinct corporate histories. Prior to World War II, the Japanese economy was dominated by the zaibatsu, or “financial cliques” run by wealthy families who controlled massive business groups financed by major banks.[5] After the War, Occupation authorities enacted regulations in an effort to “democratize” Japan and dissolve the zaibatsu. Ultimately, these regulations were relaxed as the political and economic landscape shifted once again and the U.S. turned to Japan for supplies during the Korean War. The zaibatsu reestablished their cross-shareholdings, forming the modern keiretsu we see today.
Subsequently, Japan emerged from the destruction of World War II to rapidly become the world’s second-largest economic superpower (after the U.S.), in what was dubbed an “Economic Miracle.” Western observers credited this unprecedented transformation, at least in part, to the keiretsu, which allowed “individual companies to gain financial strength and connections necessary to undercut foreign and domestic rivals” and “gain market share rather than accumulate short-term profits, and … aggressively enter[] high-growth sectors with long-term potential.”[6] Unfortunately, Japan’s economy swelled into a bubble in the 1980s which ultimately burst in the 1990s, leading to a decades-long economic stagnation Japan’s press termed, “The Lost Decades.”
In an effort to counteract the downturn, Japan enacted significant economic and regulatory changes which stressed the viability of the keiretsu for the first time, including threatening the keiretsu’s close banking ties, globalizing the financial markets, and deregulating the Japanese securities markets.[7] Nevertheless, in 2003 researchers found “little evidence that economic and regulatory changes in the early 1990s influenced the Japanese inter-corporate network, and in particular keiretsu organization,” suggesting that economic efficiency and effectiveness incentives alone could not dismantle the keiretsu’s cross-held shares.[8]
The next major threat to the keiretsu came in the 2000s in the form of sweeping corporate governance reform. Critics of the keiretsu have long-argued that cross-shareholdings lead to “notoriously poor” corporate governance characterized by entrenched and underperforming management, excessive corporate loyalty bias (i.e., when faced with a problem, corporations may choose a familial choice over an economic or rational solution), and excessive group think that has occasionally led to scandal and fraud.[9] In particular, foreign and institutional investors have pressured companies to reduce or sell-off their cross-shareholdings. In light of these circumstances, both Japan’s revised Corporate Governance Code and Stewardship Code adopted a “comply or explain” based approach, mandating that companies either reduce cross-shareholdings, or explain their economic rationale for failing to do so.[10] The results have been dramatic — cross-held shares dropped to less than 10% of all holdings for the first time in 2017[11], and the Tokyo Stock Exchange speculates that this trend will continue.
In conclusion, the keiretsu are no longer the predominant ownership structure in Japan, and are on-track to disappearing altogether. Although the keiretsu have deep historical roots in Japanese corporate history (stemming from the pre-War zaibatsu), helped the country experience an “Economic Miracle” in the mid-to-late 20th century, and have several benefits, moves to reduce cross-shareholdings will likely accelerate due to continued corporate governance reform, increasing pressure by foreign and institutional investors, and the enhancement of disclosures in securities reports.[12]
[1] Ken Auletta, American Keiretsu, The New Yorker (Oct. 13, 1997), https://www.newyorker.com/magazine/1997/10/20/american-keiretsu.
[2] Peter Simon Sapaty, Real Network Processing Examples, in Holistic Analysis and Management of Distributed Social Systems 137, 138 (2018).
[3] James R. Lincoln, et al., Keiretsu Networks and Corporate Performance in Japan, 61 Am. Socio. Rev. 67, 68 (1996).
[4] Sapaty, supra note 2, at 139.
[5] David Flath, Shareholding in the Keiretsu, Japan's Financial Groups, 75 Rev. Econ. & Stat. 249,249 (1993).
[6] Robert J. Crawford, Reinterpreting the Japanese Economic Miracle, Harv. Bus. Rev. (Jan.–Feb. 1998), https://hbr.org/1998/01/reinterpreting-the-japanese-economic-miracle.
[7] J. McGuire & S. Dow, The Persistence and Implications of Japanese Keiretsu Organization, 34 J. Int’L. Bus. Stud. 374, 374 (2003).
[8] Id. at 384.
[9] See Ken Kobayashi, Effects of Japanese Financial Regulations and Keiretsu Style Groups on Japanese Corporate Governance, 43 Hastings Int'l & Comp. L. Rev. 339, 356 (2020).
[10] Tokyo Stock Exchange, Inc., TSE-Listed Companies White Paper on Corporate Governance 24-25 (2019).
[11] Shinya Oshino, Japan’s Cross-Held Shares Fall Below 10% of All Holdings, Nikkei Asia (July 16, 2017), https://asia.nikkei.com/Business/Japan-s-cross-held-shares-fall-below-10-of-all-holdings2.
[12] Tokyo Stock Exchange, Inc., supra note 10, at 35.
The SPAC Bubble
Special Purpose Acquisition Vehicles (a “SPAC” or “SPACs”) offer a valuable alternative to emerging companies considering going public via IPOs, especially amid times of crisis. A SPAC is essentially a shell company that exists for the sole purpose of raising capital through its own IPO, before acquiring (typically through reverse merger) the target company.[1] How, then, are SPACs different from investing directly into the target?
The simple answer, for the company, is that a SPAC greases the wheels. Because a SPAC can go public without identifying its target (if it even has one), it simplifies the IPO process.[2] Reducing required disclosures and scrutiny means SPACs provide a faster, cheaper route to market, and they provide access for those companies that might not otherwise qualify due to listing requirements.[3]
Of course, SPACs generate new risks. First, as with any acquisition, the acquirer (the SPAC) most likely overpaid for the target, by virtue of outbidding its competitors.[4] Buyers often recoup this loss due to the individualized reasons they chose to acquire the target, such as the unique synergies between the companies, but SPACs, which lack any operations, offer no possible operational synergies.[5] Moreover, the typical two-year time limit for SPACs incentivizes the founders to inflate the purchase price further, else collapse and allow their investments to languish for two, worthless years.[6]
Yet SPACs have grown in popularity exponentially since the advent of COVID-19.[7] Due to market volatility, venture capitalists began to stockpile cash, or “dry powder,” causing a sharp decline in operating company IPOs.[8] SPACs were the solution.[9] Market uncertainty has historically led to many downward swings in major sectors, and SPACs can offer refuge.[10] Because SPACs tend to go public well before disclosing their target, the target escapes the public eye—and thus volatility—which is a critical advantage when the typical IPO roadshow is more complicated than ever before.[11]
Despite the recent boom, SPACs had disappeared from common parlance for good reason. Recent, high profile success stories such as DraftKings Inc. and Nikola Corp. have excited the market, but, historically, most SPACs trade below their IPO prices..[12] Kevin Dowd explained how “the SPAC boom is also a reminder that financial markets are a free-flowing experiment in mass psychology.”[13] SPACs could merely be a craze, taking off as part of a far-reaching bandwagon effect.[14] Only time can tell for certain whether this widespread gambit will pay off for the parties involved, but, to the extent the SPACs can pursue opportunities while avoiding the current complications of a traditional IPO roadshow, discarding the strategy simply is not an option for many of the people and entities on the ground.[15]
[1] See Special Purpose Acquisition Company (SPAC), Corp. Fin. Inst., https://corporatefinanceinstitute.com/resources/knowledge/strategy/special-purpose-acquisition-company-spac/.
[2] See Julie Young, Special Purpose Acquisition Company (SPAC), Investopedia (Aug. 3, 2020), https://www.investopedia.com/terms/s/spac.asp.
[3] See Ramey Layne & Brenda Lenahan, Special Purpose Acquisition Companies: An Introduction, Harv. L. Sch. F. on Corp. Governance (July 6, 2018),
https://corpgov.law.harvard.edu/2018/07/06/special-purpose-acquisition-companies-an-introduction/;
Nate Nead, Advantages of a SPAC, Deal Capital Parnters, LLC, https://investmentbank.com/special-purpose-acquisition-company/ [hereinafter Advantages]; Nate Nead, NASDAQ Listing Requirements, Deal Capital Partners, LLC, https://investmentbank.com/nasdaq-listing-requirements/ [hereinafter NASDAQ].
[4] SPACs: The Most Ludicrous Bubble We'll Ever See... Why Not $IAC?, Yet Another Value Blog (July 22, 2020), https://yetanothervalueblog.com/2020/07/spacs-the-most-ludicrous-bubble-well-ever-see-why-not-iac.html [hereinafter Ludicrous].
[5] See id.; Young, supra note 2.
[6] See Ludicrous, supra note 4.
[7] See Q2 2020 PitchBook-NVCA Venture Monitor, at 9 (2020).
[8] See Cameron Stanfill, SPACs Resurface in a Volatile Market, PitchBook (May 5, 2020), https://files.pitchbook.com/website/files/pdf/PitchBook_Q2_2020_Analyst_Note_SPACs_Resurface_in_a_Volatile_Market.pdf; The Evolution of US VC During the COVID-19 Crisis, PitchBook Blog (Aug. 5, 2020), https://pitchbook.com/blog/webinar-the-evolution-of-us-vc-during-the-covid-19-crisis.
[9] See Dan Caplinger, What Are SPACs, and Why Are They Back?, The Motley Fool (Apr. 12, 2019), https://www.fool.com/investing/2019/04/12/what-are-spacs-and-why-are-they-back.aspx.
[10] See C. Derek Liu, Buying Distressed Tech Startups, Baker McKenzie (Apr. 2020), https://www.bakermckenzie.com/-/media/files/insight/publications/2020/05/buyingdistressedtechstartupseco48212.pdf.
[11] See Byrne Hobart, Why SPACs Are the New IPO, Marker (July 28, 2020), https://marker.medium.com/why-spacs-are-the-new-ipo-dcefe54b4bdd.
[12] See Ortencia Aliaj, et. al., Can SPACs Shake Off Their Bad Reputation?, Financial Times (Aug. 13, 2020), https://www.ft.com/content/6eb655a2-21f5-4313-b287-964a63dd88b3; Anmol Suratkal, 4 SPACs to Keep On Your Radar, Stock News (Aug. 26, 2020), https://stocknews.com/news/dkng-nkla-spce-rpay-4-spacs-to-keep-on-your-radar/.
[13] Kevin Dowd, 9 Big Things: 2020’s SPAC-tacular Keeps Getting Crazier, PitchBook (Oct. 11, 2020), https://pitchbook.com/news/articles/2020-spacs-keeps-getting-crazier [hereinafter SPAC-tacular].
[14] See SPAC-tacular, supra note 13.
[15] Kevin Dowd, 10 Big Things: Inside a $500M Bet on SPACs and Sports, PitchBook (Aug. 16, 2020) [hereinafter SPACs and Sports].
CFPB Wins in Suit Against Student Loan Servicer
By: Jason Ziegler, RBFL Student Editor
In the United States, student loan debt currently stands at an all-time high of approximately $1.5 trillion spread across 44 million borrowers. Student loans can be categorized as either federal or private. Unlike federal loans, which are subject to maximum fixed rates and have interest rates set by regulation, private loans are generally variable rates and do not have rates set by regulation. Prior to being named Navient Corporation, Sallie Mae was created by Congress to support secondary markets for student loans. Sallie Mae ended up becoming the largest lender and servicer of student loans in the United States.
On January 18, 2017, the Consumer Financial Protection Bureau (“CFPB”) sued Navient Corporation (“Navient”), Navient Solutions, Inc. and Pioneer Credit Recovery, Inc. for alleged predatory lending practices, claiming that it steered borrowers into forbearance rather than discussing income-driven repayment (“IDR”) plans. Navient filed a motion to dismiss CFPB’s claims on the grounds that CFPB lacks the authority to file lawxsuits against companies over alleged unfair practices, and that the agency's very structure interferes with the president’s powers under Article II of the U.S. Constitution. The U.S. District Judge dismissed Navient’s claims noting that several courts had already examined the constitutionality issue and that CFPB isn’t outside the bounds of the Constitution. Navient also argued that because the president is limited in his ability to cut funding to the CFPB, the executive powers are violated by the CFPB’s control over its own budget. The Court here found that Congress is the one that creates the budget, not the president. Also, because the CFPB is controlled by the Consumer Financial Protection Act, legislators can change the funding rule when they need to.
In the same year that CFPB filed their suit against Navient, the Attorney General for Pennsylvania filed a separate suit against Navient as well. This lawsuit accused Navient of violating Pennsylvania and federal consumer-protection laws. Like the case against CFPB, Navient filed a motion to dismiss this case claiming that this case was preempted by the Higher Education Act. On July 27, 2020, the Court of Appeals for the Third Circuit rejected Navient’s motion to dismiss the case. This outcome is significant because this could become a trend that is most favorable to states and consumers in which states are allowed to sue student loan servicers under state consumer protection laws. Also, this brings forth an important issue that a state could likely bring an action against a company while it is being sued by the CFPB, thus shutting down any “copycat” claims.
Matthew A. Martel et al., United States: A New Frontier: Massachusetts Steps Up Its Focus On Student Loan Servicers, MONDAQ (Sept. 17, 2020, 8:14 PM), https://www.mondaq.com/unitedsta tes/financial-services/855034/a-new-frontier-massachusetts-steps-up-its-focus-on-student-loan-servicers.
NERA Economic Consulting, United States: Student Loans And Student Loan Asset-Backed Securities: A Primer, MONDAQ (Sept. 17, 2020, 7:18 PM), https://www.mondaq.com/unite dstates/banking-finance/81108/student-loans-and-student-loan-asset-backed-securities-a-primer?signup=true.
Shearman & Sterling LLP, United States: District of New Jersey Upholds Securities Fraud Action Against Major Student Loan Servicer Based Upon Alleged Forbearance Scheme Harming Borrowers, MONDAQ (Sept. 17, 2020, 8:17 PM), https://www.mondaq.com/unitedstate s/securities/881100/district-of-new-jersey-upholds-securities-fraud-action-against-major-student-loan-servicer-based-upon-alleged-forbearance-scheme-harming-borrowers.
Kat Greene, CFPB Can Pursue Suit Over Navient’s Loan Servicing, LAW360 (Sept. 17, 2020, 11:13 PM), https://www-law360-com.ezproxy.bu.edu/articles/951681/cfpb-can-pursue-suit-over-navient-s-loan-servicing
Jillian Berman, Lawsuit against Navient can move forward, boosting efforts to regulate student-loan companies, MARKETWATCH (Sept. 17, 2020, 8:04 PM), https://www.marketwatch.com/story/lawsuit-against-navient-can-move-forward-boosting-efforts-to-regulate-student-loan-companies-11596013989.
Department of Labor Limits Consideration of ESG Factors in Pension Plan Investing
By: Katherine Pino, RBFL Student Editor
The Department of Labor recently fast-tracked a controversial rule that would make changes to the Employment Retirement Income Security Act of 1974 (ERISA) limiting plan fiduciaries’ ability to incorporate environmental, social, and governance (ESG) factors into their investment decisions. Proposed on June 23, 2020, the rule was finalized by the White House on October 30, 2020.
This new rule, named “Financial Factors in Selecting Plan Investments,” has been pushed through to finalization at an unusually fast pace. After proposing this rule, the DOL only allotted a 30-day public comment period. Rules like this are usually given a 60- to 180-day public comment period and take around eighteen months to become finalized. This rule was submitted for finalization to the White House in less than four and a half months, despite widespread opposition and complaints.
Under this new rule, employee pension plan fiduciaries will only be able to make investment decisions based solely on “financial considerations relevant to the risk-adjusted economic value” of the particular investment. While it is a long-standing position of the DOL to put the economic interests of pension plan participants before other considerations, this rule severely limits plan fiduciaries’ ability to consider financially material ESG factors into their investment decisions. It is the DOL’s opinion that “[i]t does not ineluctably follow from the fact that an investment promotes ESG factors. . . that the investment is a prudent choice for retirement or other investors.” The rule has cemented these guidelines into law, unusual in an area where DOL guidance tends to change with each administration.
Concern for sustainable investing and ESG among corporations and shareholders is at an all-time high. This sentiment is evident in the over 8,700 public comments that were submitted in response to this rule, over 94% in opposition to the changes. Prominent institutional investors such as BlackRock and Vanguard wrote lengthy comments opposing the rule and urged the DOL to reconsider. In their comment detailing the financial benefits of ESG investing, BlackRock “encourage[d] the DOL to engage with plan sponsors, investment managers, and index providers to understand how ERISA plans can . . . incorporate ESG factors to drive positive economic outcomes for plan participants.”
The language in this DOL regulation shows that the government does not place economic value on sustainable investing decisions. Instead, the rule forces plan fiduciaries to focus only on the traditional indicators of financial performance in an investment. Secretary of Labor Eugene Scalia, commenting on this new rule, stated that “[p]rivate employer-sponsored retirement plans are not vehicles for furthering social goals or policy objectives that are not in the financial interest of the plan.”
This thinking is at odds with proponents of ESG, who maintain that sustainable investing has inherent economic value. Market performance indicators show that ESG portfolios are often out-performing traditional portfolios. In 2019, a typical ESG portfolio outperformed the S&P index by 45%. Studies have found that investors who screened for ESG considerations could have avoided 90% of S&P 500 bankruptcies from 2005 to 2015. In addition, traditional financial indicators are no longer the only measurement of an investment’s success. In the fiscal year 2018, 68% of companies’ total value was attributed to intangible assets like brand reputation. Given the growing shift towards sustainability practices, a company’s intangible assets can be significantly bolstered by incorporating ESG considerations into their operations.
“Financial Factors in Selecting Plan Investments” displays the disconnect between the DOL and the movement of industry actors towards ESG investing. Rules like this, especially when they are codified into law and no longer serve only as a guideline, severely impact the ability of large investors like pension plans to consider ESG factors. This in turn could limit the effort to mainstream ESG considerations in investing and serve as a significant barrier for the industry’s movement towards sustainability.
Sources:
BofA Securities, 10 Reasons to Care About Environmental, Social, and Governance (ESG) Investing, https://www.wlrk.com/docs/BofA_ESG-10-reasons-you-should-care-about-ESG-Investing.pdf.
Comment, BlackRock, RE: Financial Factors in Selecting Plan Investments; 29 CFR Part 2550; RIN 1210-AB95 (July 30, 2020).
Financial Factors in Selecting Plan Investments, 85 Fed. Reg. 39113 (June 30, 2020) (to be codified at 29 C.F.R. pt. 2550).
Martin Lipton, DOL Proposes New Rules Regulating ESG Investments, Harvard Law School Forum on Corporate Governance (July 7, 2020), https://corpgov.law.harvard.edu/2020/07/ 07/dol- proposes-new-rules-regulating-esg-investments/.
Press Release, U.S. Dep’t of Lab., U.S Department of Labor Proposes New Investment Duties Rule (June 23, 2020).
Trump Labor Department’s Rule Discouraging ESG Investing in Retirement Plans is Finalized Over Swell of Objections, MarketWatch (Oct. 31, 2020).
Rethinking Dual-Class Voting Structures
By: Justin Brogan, RBFL Student Editor
Delaware law permits corporations to assign classes of stock differential voting rights.[1] For example, Class A stock at a given corporation could be assigned ten votes per share, while Class B stock could carry just one vote per share. Traditionally, this stock structure has been utilized by family-owned corporations to vest shareholder voting power in the hands of a few individuals, allowing the family to control the composition of the corporation’s board of directors.[2] Increasingly, however, dual-class voting structures have been utilized by technology companies, allowing the founders (who often boast technical expertise and unique vision) to retain managerial control over the company’s direction. Indeed, almost 50% of newly listed technology companies have gone public with dual-class status, joining well-known companies like Facebook and Alphabet (Google).[3]
Support for the dual-class voting structure is not universal. Some scholars argue that vesting so much voting power in the hands of a few manager-directors can entrench corporate directors, inflate executive compensation, and result in lower stock returns for shareholders.[4] Other scholars, however, suggest that banning dual-class stock status altogether would encourage many technology companies to remain private, thus preventing investors from reaping the financial benefits of these companies and stifling potential innovation.[5] The New York Stock Exchange (NYSE), NASDAQ, and the Securities and Exchange Commission (SEC) have addressed these competing concerns through informal commitments to limit the listing of dual-class voting stocks to companies who elect the dual-class voting structure at the time of the Initial Public Offering (IPO).[6]
These informal agreements, however, are not long-term solutions. Congress should consider passing legislation to allow corporations to not only elect dual-class stock status at the time of IPO, but also permit companies to utilize the dual-class stock structure through a charter resolution passed by a majority of shares voted at any time in the company’s lifecycle, subject to shareholder recertification or rejection after a predetermined number of years. This solution would afford corporations additional opportunities to raise capital, pursue alternative business models, or enter into new markets. Additionally, this approach would provide more security and flexibility to emerging companies – particularly those in the technology sector – while also providing shareholders protections not currently available to them.
The undeniable growth of these dual-class stock options in the technology sector suggests that both corporate directors and stockholders see the benefits. The current regulatory landscape provides unsatisfactorily informal protections for companies seeking to go public with dual-class stock status and forces companies to make an unnecessarily difficult decision at the time of IPO. Congress should codify a more flexible approach to allow companies to elect dual-class status, while also empowering shareholders to periodically recertify or reject dual-class status. If companies like Facebook and Google are any indication, shareholders are happy to vest trust in the technical expertise and vision of founder-directors so long as the company continues to perform well.
[1] Del. Code Ann. tit. 8, §151(a) (West 2020).
[2] WILLIAM T. ALLEN & REINIER KRAAKMAN, COMMENTARIES AND CASES ON THE LAW OF BUSINESS ORGANIZATION 199 (5th ed. 2016).
[3] Vijay Govindarajan et. al., Should Dual Class Shared be Banned?, HARV. BUS. REV. (Dec. 3, 2018), https://hbr.org/2018/12/should-dual-class-shares-be-banned.
[4] See, Paul A. Gompers, Joy Ishii, & Andrew Metrick, Extreme Governance: An Analysis of Dual Class Firms in the United States, 23 REV. FIN. STUDIES 1051, 1073 (2009); Ronald W. Masulis, Cong Wang & Fei Xie, Agency Problems in Dual-Class Companies, 64 J. FIN. 1697, 1706 (2009).
[5] Govindarajan, supra note 3.
[6] WILLIAM T. ALLEN & REINIER KRAAKMAN, supra note 2, at 201
Why the Majority Approach to Subrogation Between the Competing Interests of Insurers and Insureds in Settlements with Third-Party Tortfeasors is Unfair.
By: Dalton Battin, RBFL Student Editor
For years, a majority of courts have followed the “make-whole” subrogation approach between the competing interests of health insurers and insureds in settlements with third-party tortfeasors. However, this approach is not equitable and allows for inadequate policy limits on other forms of insurance. Now, you may be asking what this even means, so let me give an example. Let’s say, Sally is driving home from work late at night when her car is struck by Chad’s car. As a result, not only is Sally’s car totaled but she also suffered various severe injuries that required emergency surgery to save her life and will require various follow-up procedures. Fortunately, Sally has medical insurance that coverages the cost of her emergency procedures, which happen to exceed $500,000. Because Chad was not only speeding but driving while intoxicated it is obviously that he is liable for any damages that Sally has suffered. Unfortunately, however, Chad is judgment proof, meaning that he does not have any means to compensate Sally for her damages, and his auto insurance has a policy limit of $300,000 per accident, the bare minimum that is required by the state Chad lives in. Although Sally damages easily and undisputedly exceed over $1,000,000, as a result of the circumstances, she decides to settle any civil claims for liability that she has against Chad for $300,000, his policy limit.
Now, in a perfect world, Sally would collect enough money from Chad and his insurers to make her whole again, or in other words, enough money to fully compensate her for all of her damages, including any medical expenses as well as pain and suffering that resulted from the accident. In Sally’s case, it would require well over $1,000,000 to make her whole again. Once Sally has collected for her damages against Chad, her health insurer would have a subrogation right to the money that it expended for her medical expenses as a result of Chad’s wrongdoing, in other words, Sally’s insurer would have the right to be paid back for any medical expenses that it covered which Chad was actually liable for.
However, when the settlement is inadequate to fully compensate victim for their injuries and pay their medical expenses, as in Sally’s case, the courts have differed as to who should be compensated from the settlement first. Should the victim, who has suffered a life altering experience and more likely than not needs the settlement proceeds in order to sustain an adequate standard of living after the accident, or the victim’s health insurer, who only covered the medical expenses for which the tortfeasor is really liable. Most courts have held that the victim must be made-whole before the insurer has any right to subrogation, which means that the insurer, in a case like Sally’s, would not be able to recover any of the medical expenses that it expended. While this made be the equitable result vis-à-vis the victim and her health insurer, it is not the equitable result vis-à-vis the victim’s health insurer and the tortfeasor’s auto insurance.
Essentially, the make-whole again approach allows tortfeasors’ auto insurers to subsidize their inadequate policy limits through the victims’ health insurance policies. Now, you may be asking, why should you care? You should care for two main reasons. For one, following this approach results in higher health insurance premiums, which are already relatively high and leaves many Americans uninsured, whose cost should be passed onto drivers and auto insurance policies, not hundreds of thousands of people who may not drive a day in their lives. Further, allowing for these inadequate policy limits in certain lines of insurance on the strength of health insurance subsidizing them puts uninsured victims in an extremely vulnerable position, as the settlements would be not able to cover the medical expenses that an insured would owe to a hospital in which case they would receive absolutely not compensate for their other damages. Therefore, the make-whole approach is unfair and should be abandoned because it raises health insurance premiums for every American and often leaves the uninsured tort victim in a precarious predicament.
SOURCES:
- Kent Miller, Subrogation: Principles and Practice Pointers, Colo. Law. R., Jan. 1991, 11,11 ; § 222:5.Definition and Nature of Subrogation, 16 Couch on Ins. § 222:5.
Kenneth S. Abraham & Daniel Schwarcz, Insurance Law and Regulation, Cases and Materials (West Academic, 7th ed. 2020).
Andrea L. Parry, Subrogation in Pennsylvania-Competing Interests of Insurers and Insureds in Settlements with Third-Party Tortfeasors, 56 Temp. L.Q. 667, 669 (1983).
Todd L. Fulks, The "Made-Whole" Doctrine: Its Effect on Tennessee Tort Litigation and Insurance Subrogation Rights, 32 U. Mem. L. Rev. 87, 97 (2001).
Changes to the Volcker Rule and the Venture Capital Exception
By: Colby Trace, RBFL Student Editor
Everybody wants to blame the financial industry in times of financial crisis, and the flames only get fanned when banks need to be bailed out from what is viewed as their own risky behavior with taxpayer dollars, as was the case in the financial crisis of 2008. The Volcker Rule is a modern codification that reflects the idea that banks should not be gambling with their depositor’s money. The sentiment comes from a strong intuition; why should banks be allowed to seek upside for themselves via risky investments while their depositors or insurers take on the potential losses? This intuition is also embedded in the history of U.S. financial regulation. The Banking Act of 1933 was passed in the wake of the Great Depression and contained what came to be known as Glass-Steagall, a set of provisions that separated commercial banking from investment banking in an attempt to curb the amount of risk in the banking system. Over time, the teeth of these provisions were dulled, and they were eventually repealed in 1999.
Less than a decade after this repeal, another financial crisis was in full swing, and once again banking activity was scrutinized. Many viewed it as the primary driver of the economic collapse. In response to the crisis, the Dodd-Frank Wallstreet Reform and Consumer Protection Act was passed and contained a set of provisions that partially resurrected the ghost of Glass-Steagall, known as the Volcker Rule. The Volcker Rule essentially prevents banking entities from proprietary trading and from making large investments in or sponsoring “covered funds” such as private equity and hedge funds, with several enumerated exclusions. Once again, the idea is to prevent banks from taking on too much risk by not allowing them to engage in investment activities which are purely for their own benefit and which shift potential risk to their depositors or insurers.
While curbing risk sounds like a great idea in the abstract, in practice it is a balancing act. Banks are a vital source of capital, and they need some freedom to invest their funds to foster economic activity. The Fed recognizes this and in January 2020, proposed a set of changes to the Volcker Rule. The rule changes were finalized by five federal agencies on June 25, 2020 and included tweaks and additions to what can be excluded from the definition of a covered fund. Among these new exclusions are venture capital funds (VC funds).
Given the economic downturn caused by the ongoing pandemic, allowing banks to invest in VC funds looks like it may provide some stability to the capital pool and incentivize the funds to distribute capital where they otherwise wouldn’t have. Combined with the provisions that stop banks from guaranteeing VC funds’ investments, it looks like this new exception could foster private capital infusion at a time when it is very much needed. But, where does this leave the Volcker Rule with respect to its original purpose? At the time the changes were proposed, Chairman Jerome Powell acknowledged that the purpose of the Volcker Rule is still to stop banks from engaging in risky investment behavior with their taxpayer insured deposits and that this goal is an important one. Presumably, this is an important objective because allowing investment with insured funds is thought to be a source of systemic risk. Yet, at their heart, VC investments are inherently risky. Up to 30% fail completely. Even though banks are not allowed to insure the losses of the VC funds, any completely failed venture will still reflect as total loss of the bank’s portion of investment in that venture. The inclusion of VC funds in the new exclusions, then, may suggest attitudes about the risks of banks and their speculative investments are shifting.
Sources:
- Prohibitions and Restrictions on Proprietary Trading and Certain Interests in, and Relationships With, Hedge Funds and Private Equity Funds, 12 C.F.R. § 248, https://www.federalregister.gov/documents/2020/07/31/2020-15525/prohibitions-and-restrictions-on-proprietary-trading-and-certain-interests-in-and-relationships-with
- Jason Katz and Timothy Lavender, The Final Volcker Rule: Implications for Venture Capital, JD Supra, https://www.jdsupra.com/legalnews/the-final-volcker-rule-implications-for-45283/#:~:text=The%20Final%20Volcker%20Rule%20will,startups%2C%20thus%20encouraging%20capital%20formation.
- Chair Jerome H. Powell, Statement on Volcker Rule Covered Funds Proposal and Control Framework Final Rule 1, https://www.federalreserve.gov/aboutthefed/boardmeetings/files/powell-opening-statement- 20200130.pdf
- Investopedia, The Volcker Rule, https://www.investopedia.com/terms/v/volcker-rule.asp#:~:text=The%20Volcker%20Rule%20is%20a,funds%2C%20also%20called%20covered%20funds.
- Investopedia, The Glass Steagall Act, https://www.investopedia.com/terms/g/glass_ steagall_act.asp
- Deborah Gage, The Venture Capital Secret: 3 out of 4 Startups Fail, The Wall Street Journal, https://www.wsj.com/articles/SB10000872396390443720204578004980476429190#:~:text=The%20common%20rule%20of%20thumb,of%20venture%2Dbacked%20businesses%20fail.
Consumer Financial Protection Bureau? Recent Recission of Payday Lending Regulations Undermines Agency’s Statutory Purpose & Objectives
By: Tyler Winterich, RBFL Student Editor
The payday lending industry has a significant and controversial economic footprint. In 2018, consolidated payday loan volume across brick and mortar and online lenders was $29.2 billion. While more precise and recent industry data is challenging to identify, as of 2012, 12 million individuals are estimated to use payday loans. The significant nature of this industry and concerns about predatory practices led the Consumer Financial Protection Bureau (CFPB) to issue a payday lending rule in 2017.[1]
In July 2020, the CFPB issued a final rule revoking the 2017 rule’s mandatory underwriting requirements. Effective October 20, 2020, the rule, among other changes, revokes the ability-to-repay provision.[2] This provision required payday lenders to evaluate a borrower’s financial circumstances to ensure that they could meet minimal living expenses and repay the payday loan without re-borrowing. Ability-to-repay requirements are not foreign to the law and exist in other areas, including mortgage lending.
The CFPB’s rescission of these requirements raises the question of whether that decision aligns with the agency’s statutory purpose and objectives. Congress established the CFPB under the 2010 Dodd-Frank Act as part of the government’s response to the 2008 financial crisis.[3] In addition to filling in regulatory gaps, the CFPB serves a necessary purpose, according to supporters, to protect consumers from abusive and deceptive financial transactions which many consumers experienced during the financial crisis. These goals are reflected in the agency’s statutory purpose which includes “ensuring that all consumers have access to markets for consumer financial products and services and that markets for consumer financial products and services are fair, transparent, and competitive.”[4] Further, one of the agency’s objectives is to utilize its authority to ensure “consumers are protected from unfair, deceptive, or abusive acts and practices and from discrimination.”[5] While the CFPB’s authority has been challenged before, its authority remains intact even after the Supreme Court’s ruling this past June in Seila Law LLC v. CFPB held that the CFPB’s single-director structure is unconstitutional.[6]
Although the CFPB’s authority has been preserved, the recission of the 2017 mandatory underwriting provisions represents an unsettling shift in how the agency wields its authority. In 2017, the CFPB, based on its own research, viewed payday lending as a predatory industry that required additional regulation to protect economically vulnerable consumers.[7] The ability-to-repay requirements attempted to alleviate unequal bargaining power, stop “debt traps,” and demonstrated federal intervention into a mostly state-regulated industry with a history of evading state laws. In 2020, the CFPB aligns with the payday lending industry and views mandatory underwriting requirements as unnecessarily restricting lenders, reducing credit access, and unfairly underestimating consumers.[8] From this perspective, the combination of free market competition and information will ensure borrowers have access to credit at affordable prices.
Which version of the payday lending market will prevail is uncertain, especially because the 2017 rule never went into effect, but deregulated markets likely provide some insights. Payday lenders have demonstrated a willingness to evade remaining laws including state interest rate laws.[9] In addition, the CFPB’s own 2014 report and 2017 rulemaking process as well as multiple third-party organizations have documented significant consumer harm in deregulated payday lending markets, particularly for communities of color.[10] The economic disruptions resulting from COVID-19 likely only increase reliance on predatory credit sources like payday lending. The potential increase in consumer harm as a result of the CFPB’s recission of the 2017 rule seems irreconcilable with the agency’s statutory purpose and objectives.
[1] Payday, Vehicle Title, and Certain High-Cost Installment Loans, 82 Fed. Reg. 54,472 (proposed Nov. 17, 2017) (codified at 12 C.F.R. pt. 1041).
[2] Payday, Vehicle Title, and Certain High-Cost Installment Loans, 85 Fed. Reg. 44,382 (proposed Jul. 22, 2020) (codified at 12 C.F.R. pt. 1041).
[3] Creating the Consumer Bureau, ConsumerFinance.Gov, https://www.consumerfinance.gov/about-us/the-bureau/creatingthebureau/ [perma.cc/M5D8-4386] (last visited Oct. 21, 2020).
[4] 12 U.S.C. §5511(a) (2018).
[5] 12 U.S.C. §5511(b)(2) (2018).
[6] Seila Law LLC v. CFPB, 140 S. Ct. 2183, 2192 (2020).
[7] Payday, Vehicle Title, and Certain High-Cost Installment Loans, 82 Fed. Reg. at 54,875; Press Release, Bureau of Consumer Financial Protection, CFPB Finalizes Rule to Stop Payday Debt Traps (Oct. 5, 2017), https://www.consumerfinance.gov/about-us/newsroom/cfpb-finalizes-rule-stop-payday-debt-traps/ [perma.cc/A2XA-NYL3].
[8] Complaint, Cmty. Fin. Serv. Ass’n. of Am., Ltd. Vs. Consumer Financial Prot. Bureau, No. 1:18-cv-00295 (W.D. Tex. Apr. 9, 2018); Press Release, Bureau of Consumer Financial Protection, Consumer Financial Protection Bureau Issues Final Rule on Small Dollar Lending (July 7, 2020), https://www.consumerfinance.gov/about-us/newsroom/cfpb-issues-final-rule-small-dollar-lending/ [perma.cc/MD2M-CMY8].
[9] Rent-A-Bank Schemes and New Debt Traps: Assessing Efforts to Evade State Consumer Protections and Interest Rate Caps, Hearing Before the United States House Committee on Financial Services, 116th Cong. (2020) (testimony of Graciela Aponte-Diaz, Director of Federal Campaigns for the Center for Responsible Lending).
[10] See e.g., id.; Payday, Vehicle Title, and Certain High-Cost Installment Loans, 82 Fed. Reg. 54,472; Payday Loan Facts and the CFPB’s Impact, Pew Charitable Trusts (Jan. 14, 2016), https://www.pewtrusts.org/en/research-and-analysis/fact-sheets/2016/01/payday-loan-facts-and-the-cfpbs-impact [perma.cc/Z6QT-657T]; The Consumer Financial Prot. Bureau Office of Research, CFPB Data Point: Payday Lending (2014) https://files.consumerfinance.gov/f/201403_cfpb_report_payday-lending.pdf [perma.cc/45AA-QMA8].
Should Chapter 11 Small Businesses Be Eligible for PPP Loans?
By: Helen Park, RBFL Student Editor
In the wake of the COVID-19 pandemic crisis, the U.S. government established the Paycheck Protection Program (PPP), a $669-million business loan program, to help small businesses pay for urgent expenses, namely payroll, rent, interest, and utilities. These “loans” would be forgiven so long as they are used towards qualifying expenses (payroll, rent, interest, and utilities). Congress appointed and authorized the Small Business Administration (SBA) to administer the PPP loans, and the SBA used this congressional authority to exclude bankrupt businesses from being eligible to apply for PPP loans.
This spurred lawsuits across the country. Bankrupt businesses are suing the SBA and alleging that the SBA overstepped its authority by ignoring congressional intent, unlawfully implemented arbitrary and capricious rules, and/or unlawfully discriminated bankrupt businesses. The court holdings have been mixed across jurisdictions because different courts have different interpretations of relevant statutes, such as the CARES Act. It would be up to Congress to provide clearer legislative intent--either to give broad authority to the SBA or to require the SBA to accept applications from bankrupt small businesses.
Should bankrupt businesses be entitled to apply for PPP loans in the first place? The SBA says no for two reasons. Allegedly, bankrupt businesses are more likely to use the PPP loans for noncovered expenses. Loan amounts used for noncovered expenses cannot be forgiven and must be repaid, which leads to the SBA’s second reason for disqualifying debtors: bankrupt businesses also have high risk of not repaying any unforgiven amounts. Contrary to the SBA’s claim, bankruptcy experts say the PPP loans should be extended to Chapter 11 small businesses, because these businesses need the loans and can be relied upon to use the proceeds properly. To be in Chapter 11 proceedings means that a business declared bankruptcy and then placed itself under the bankruptcy court’s supervision to reorganize its operations, assets, and debts so that the business is better positioned to keep its operations alive and pay back the debts. The key is that the Chapter 11 businesses are under the supervision of the courts. Contrary to the SBA’s concerns, such oversight can ensure that the PPP loan proceeds are used properly--that is, toward the qualifying expense--and be forgiven.
What if a bankrupt business fails to meet the loan forgiveness requirements? A newly proposed bill seems to address the SBA’s second concern. On July 27, Senators Marco Rubio and Suzanne Collins proposed Continuing Small Business Recovery and Paycheck Protection Program Act, which, among other things, addressed this question of whether the PPP loans should be extended to bankrupt businesses. This bill has been welcomed by bankruptcy experts. Under this bill, any unforgiven loan amounts would be granted super-priority status in the Chapter 11 proceedings, meaning these loans will be paid back with the highest priority.
If passed, this bill could not only address the SBA’s concerns over bankrupt businesses’ fitness for PPP loans but also provide a little more clarification on the congressional intent behind the PPP. The language of this bill could be more explicit (for example, actually requiring the SBA to accept PPP loan applications from Chapter 11 businesses), but experts seem to be happy for now that this issue is being addressed by Congress. But it remains to be seen which solutions Congress may ultimately adopt in order to maximize the value of the PPP.