Lots of Financial Regulation Is Illegal

(Bloomberg Opinion) -- Everything is unconstitutional.

The Securities and Exchange Commission brings a lot of enforcement actions against a lot of people in its own internal courts. Employees of the SEC’s enforcement division decide to bring a case, and then they get approval from the SEC itself—the five Commissioners who formally run it—to bring the case, and then the case is heard by another employee of the SEC called an administrative law judge, and the ALJ decides the case, and then if they don’t like the ALJ’s ruling the parties can appeal to the SEC itself—the Commissioners again—for review. It’s kind of a weird structure, and for the past few years many of the people caught up in it—the people accused by the SEC of doing bad stuff—have complained that it is illegitimate.

I have, as far as I can remember, never really written about these complaints, because honestly they are the most boring thing I can think of. I mean! I like securities regulation, and law, and metaphysical hair-splitting about what it means for someone to have the power to do something, but even I, the natural audience for this stuff, find it appallingly dull. But I guess I have to mention that yesterday the U.S. Supreme Court ruled that the SEC’s ALJs are unconstitutional. They are, apparently, “Officers of the United States,” and so, under the Constitution, they can only be appointed by the president, a court, or “Heads of Department.” Because they were just hired as regular SEC employees, they are not good enough. This led the Supreme Court to reverse the SEC’s lifetime ban against Raymond Lucia, who “marketed a retirement savings strategy called ‘Buckets of Money,’” okay, which was found to be fraudulent by an SEC ALJ. 

It is not clear what else it means. Lucia is not the only person to have lost an SEC enforcement action in front of an unconstitutionally appointed ALJ: Do all of those cases have to be re-heard? And last year, realizing that the issue was serious (the Justice Department ended up siding with Lucia), the SEC decided to “ratify” the appointments of the ALJs. The theory was that the SEC itself—the Commissioners—is a “Head of Department” and so can constitutionally appoint the ALJs, so it appointed the ones who were already appointed. Is this valid? Who knows. “I don’t think the SEC gets much comfort that the ratification is definitely sufficient,” says a lawyer, and the Supreme Court punted on it in a footnote. So these are all questions that will no doubt be litigated in the future and that I will not care about because boy are they boring, I am sorry.

Meanwhile a New York federal court ruled yesterday that the Consumer Financial Protection Bureau—sometimes known as the Bureau of Consumer Financial Protection—is also unconstitutional. The CFPB had sued RD Legal Funding, LLC, which offers “cash advances to consumers waiting on payouts from settlement agreements or judgments entered in their favor,” arguing that those agreements were usurious loans. (We talked about that metaphysical hair-splitting—were they usurious loans or valid assignments?—last year.) RD tried to outflank the CFPB by arguing that the CFPB is unconstitutional, because it is an independent agency with only a single director who can’t be fired by the president without cause. There are lots of independent agencies—the SEC is one of them—and they “collectively constitute, in effect, a headless fourth branch of the U.S. Government,” a federal judge once wrote. But usually they are run by multiple commissioners, which—the theory goes—“reduces the risk of arbitrary decisionmaking and abuse of power.” The CFPB is arguably unique as an independent agency with a single director, and RD argued that it’s unconstitutional. A federal appellate court in Washington, D.C., had previously disagreed, but yesterday the New York district judge agreed (and threw out the CFPB’s case against RD, though not the parallel case brought by New York regulators).

So that will be appealed, and probably end up before the Supreme Court too eventually. And if I had to bet, I’d bet that the CFPB will lose, because it wants to lose. Mick Mulvaney, its acting director, spent much of his time in Congress trying to abolish the CFPB. (He now says “It’s not really appropriate for someone running the bureau to say the bureau shouldn’t exist,” which is not quite the same thing as saying that it should exist.) Standing up for a robust consumer financial protection agency that is independent of presidential authority does not seem like a priority for the current presidential (or CFPB) administration. 

The specific issues in these cases—who gets to appoint how many of whom—are very dull and technical. But their overall drift is significant; it amounts to a nibbling away at the theoretical underpinnings and practical operations of the regulatory state. Were Lucia’s “Buckets of Money” fraudulent? Was RD Legal Funding making illegal loans? Who cares, they reply: The real issue is executive-branch appointment procedure. The substance of large chunks of financial regulation and enforcement is on hold, while everyone figures out how to clean up the procedure. When you combine that with a government that is not all that keen on the substance of regulation and enforcement to begin with, you get a pretty clear sense of where regulation is heading. It’s probably a good time to start a payday lending company.

Elsewhere in the Supreme Court, here’s a decision about whether stock options count as “money remuneration” for the purposes of calculating railroad pensions, a question that we certainly aren’t going to talk about here; I just want to mention that four Justices signed on to a dissenting opinion by Justice Breyer saying this (citations omitted):

Moreover, what we view as money has changed over time. Cowrie shells once were such a medium but no longer are; our currency originally included gold coins and bullion, but, after 1934, gold could not be used as a medium of exchange; perhaps one day employees will be paid in Bitcoin or some other type of cryptocurrency.

So there you go, a Supreme Court endorsement of Bitcoin, congratulations everyone. 

Access Power.

Access Power, Inc., is a pico-cap U.S. public company that “offers Internet-based communications products and services in the United States and international markets,” according to Bloomberg. As of yesterday’s close, it had a stock price of $0.0004 and a market capitalization of about $98,000; it trades an average of about $13.26—thirteen dollars and twenty-six cents—worth of stock each day, though it had a big day last week when almost $400 worth of stock traded.

According to Access’s most recent quarterly filing with the Securities and Exchange Commission on Form 10-Q, Access Power is … wait … what:

The Corporation is for sale. I will sell Access-Power, Inc for $15,000,000.00 or $.06 per share.

Okay that’s a weird 10-Q, you don’t usually see them in the first person singular. Also that’s a 15,000 percent premium to the trading price; seems high. Tell me more.

All financial records from Access-Power, Inc. have been destroyed by previous management and are not available. It is very expensive to obtain audited reports of $0.

“We do not claim any assets so we do not need to prove anything,” says Access’s annual report on Form 10-K.

Umm. I say the “most recent” 10-Q, but that’s actually one of nine 10-Qs that Access Power had filed by 9:30 this morning. There were seven more yesterday, five the day before, and two more earlier in the week. The 10-Q, as I mentioned, is a quarterly filing. Like, one every three months. It’s weird to file 23 of them in a week. Also it filed five 10-Ks today and another one earlier this week. “We are filing this document to bring all of our filings current as required by federal law,” lots of the 10-Qs say. Though some add, fairly enough: “No one is assisting Patrick J Jensen in all this hard work. He is Human. This form is basically the same as the prior report, except for the dates/period have changed.” I hope he knows how to copy and paste text? Another mentions:


“ACCR COMEBACK SONG FOREVER,” says this 10-Q, linking to a YouTube video of “Stairway to Heaven.” They are good securities filings.

We talked last month about Rockwell Medical Inc., whose board fired its chief executive officer (maybe!), and whose CEO then put out an SEC filing saying that, no, actually, he hadn’t been fired at all, thank you very much, that it was the board who was out of order. I pointed out that in some limited sense, if you know a public company’s password to the SEC’s Edgar filing system, you can grab control of the company while no one is looking: If you put out an 8-K saying that you’re the CEO, then the board can put out a statement saying that you’re not, but it is not necessarily easy for outside observers to know who is telling the truth. The control of a whole big public company can be contested in the narrow space of its Edgar filings.

This is … the opposite. This is a public company stripped of everything that makes it a public company—it has no financial records, no debt, no operations, no employees, no money, not even a coffee pot—except a guy, a computer, and an Edgar password. (And a comeback song.) It is just the pure abstract notion of a public company, sending out filings into the void, looking for someone to believe in it. And buy it for $15 million.

Don’t stress.

Yesterday the Federal Reserve released the results of its annual practice stress tests of big banks. Everyone passed. These tests check whether the banks would meet their minimum capital requirements in a “severely adverse” case—“a severe global recession with the U.S. unemployment rate rising by almost 6 percentage points to 10 percent, accompanied by a steepening Treasury yield curve”—but are basically practice for next week’s CCAR (Comprehensive Capital Analysis and Review) stress tests, which have consequences. CCAR tests whether the banks would meet their requirements in the adverse case after returning the capital they want to return; a bank that fails CCAR doesn’t get to return the capital. (The results of the practice test might be a bit worrying for Goldman Sachs Group Inc. and Morgan Stanley, which passed, but by a thinner margin than they might like.) This week’s tests just let everyone practice pontificating about stress tests so they can be ready for next week.

So let’s get to it. Here’s Neel Kashkari:

“The question is not: How do banks perform when the economy is strong?” Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, said in an interview. “The question is: How do banks perform if there is a major economic downturn? And our analysis at the Minneapolis Fed says that the banks are still too big to fail.”

Well. That is literally the point of the stress tests. They are precisely a recognition of the fact that “the question is not: How do banks perform when the economy is strong,” and an effort to find out the answer to the better question “How do banks perform if there is a major economic downturn?” If the banks perform well when the economy is strong, fine, worry about a downturn, but if the banks perform well on the stress tests when the economy is strong, then that—nominally—means that they would perform well in a major economic downturn.

Of course you could dispute that, and everyone does. The stress tests are a necessarily hypothetical exercise, and any actual downturn would probably look different from their scenarios. But they are an effort to build a counter-cyclical element into bank regulation, to prevent complacency by asking each year not just “how well capitalized are the banks this year?” but also “how well capitalized would the banks be if this year had been terrible?” And “a senior Fed official said this year’s economic scenarios were the toughest to date, a response to the strong economy”: The better things actually are, the worse they should hypothetically be, to keep everyone on their toes.

Still I guess you could argue that there's a sort of meta-pro-cyclical component to the stress tests:

Investors hope deregulation will reduce the costs of complying with rules, give banks more freedom to pursue profitable business and allow them to pay out even more capital. … 

“People say the banks are doing well, so we don’t need to change,” said Phillip L. Swagel, a professor of international economic policy at the University of Maryland and a Treasury official during the administration of George W. Bush. “But, no, if we can do it better, then let’s make it better.”

If the banks are doing so well in good times that they’d do well in bad times, then that might make regulators so comfortable that they relax the rules that force them to focus on the bad times.

Fannie and Freddie.

Sure fine whatever let’s pretend this will happen:

This proposal would transform the way the Federal Government delivers support for the U.S. housing finance system to ensure more transparency and accountability to taxpayers, and to minimize the risk of taxpayer-funded bailouts, while maintaining responsible and sustainable support for homeowners. Proposed changes, which would require broader policy and legislative reforms beyond restructuring Federal agencies and programs, include ending the conservatorship of Fannie Mae and Freddie Mac, reducing their role in the housing market, and providing an explicit, limited Federal backstop that is on-budget and apart from the Federal support for low- and moderate-income homebuyers.

That’s from this White House … thing … called “Delivering Government Solutions in the 21st Century: Reform Plan and Reorganization Recommendations,” and just from that title you know not to take it seriously. If you’ve spent the last 10 years betting that Fannie and Freddie will not be returned to private ownership, you’ve been right every time. I suppose one day you’ll be wrong, but it’ll be a while.


I don’t really know what to make of Tether Ltd., the issuer of a digital currency that is pegged to the dollar, and that it claims is fully backed by dollar reserves, but that won't say where those reserves are kept or produce an audit. They do rather seem to be trying their best:

Tether Ltd., issuer of a digital currency, said its bank deposits of $2.55 billion were confirmed by the law firm co-founded by FBI director Louis Freeh as the company seeks to reassure investors that its cryptocurrency is backed by U.S. dollars.

Freeh Sporkin & Sullivan LLP didn’t conduct an official audit but had access to Tether’s accounts at two banks for weeks and released data on how much money the company held on a single day, June 1, Tether’s general counsel said in an interview. That amount is nearly equal to the value of all Tether digital coins in circulation that day, $2.54 billion, according to Tether executives who spoke to the law firm.

“The bottom line is an audit cannot be obtained,” says Tether’s general counsel, but I guess a law firm report is … audit-like … ish? Here is the report.

Here’s a weird thing though. “FSS picked June 1 as the day to analyze without Tether’s knowledge, the law firm said in its report released Wednesday.” We talked last week about a paper by John Griffin and Amin Shams of the University of Texas arguing that the issuance of Tether seems to correlate with increases in Bitcoin’s price; here at Bloomberg Opinion, Aaron Brown has pointed out that the paper actually shows quite small economic effects. But beyond the main finding of the paper, Griffin and Shams asked a question about end-of-month trading at Tether:

Due to the lack of full transparency regarding audit processes and banking relationships, the blogosphere has questioned whether Tether is always fully backed by dollars. We shed more light on this by borrowing from the intermediary asset pricing literature, specifically Du, Tepper, and Verdelhan (2017) and He and Krishnamurthy (2018), that argue that banks’ compliance with period-end capital requirements may create a sizable effect on asset prices. To assure traders of the existence of dollar reserves, Tether has issued EOM bank statements from December 2016 to March 2017 audited by a Chinese accounting firm. … If Tether does not maintain a full reserve daily but does seek to maintain the reserve at the EOM, there could be negative selling pressure on Bitcoin prices to convert Bitcoin to USD reserves before the EOM. 

Their hypothesis here is that Tether might not be fully backed by dollars at all points during the month, but instead could issue Tethers to buy Bitcoins during the month and then sell a bunch of Bitcoins at the end of the month in order to have enough dollars in its month-end accounts. And they found:

There is a clear monotonic relationship between monthly Tether issuance and the EOM negative price pressure. In months with no Tether issuance, there is no EOM effect. However, in months with large Tether issuance, there is a 6% negative benchmarked return. Further in supplemental results, we also estimate a regression of EOM return on monthly Tether issuance and find that it explains 37% of the variations in EOM returns. 

So that June 1 quasi-audit date is interesting. Maybe next time they pick a random day to analyze it could be, like, August 14.

How are Bernie Madoff’s mansions doing?

Great, thanks for asking, reports the Wall Street Journal. They had to go on a bit of a personal journey:

When she moved in, Ms. Kahn invited her friends over for a so-called smudging party, she said, where they burned lavender and sage, and recited prayers and poems, to rid the home of negative energy.

But things are better now.

Things happen.

Walmart defies investor push to rewrite bond rules. Mahathir Seeks to Recover $4.5 Billion 1MDB Funds, Goldman Fees. Guggenheim payouts point up internal tensions at the top. Deutsche Bank Breaks Up Its Global Corporate-Strategy Group. Elon Musk’s “Saboteur” Says He Witnessed “Really Scary Things” at Tesla. 400 flown from James Bond mountain after Swiss cable car breaks down. NASA reveals new plan to stop asteroids before they hit Earth.

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