Davis Polk Releases Comprehensive Review of Financial Crisis Laws

It has been my privilege to support my partners as the editor of Davis Polk’s recently issued Financial Crisis Manual, which has been written by 21 Davis Polk partners and counsel working in a collaborative team that is the hallmark of our firm culture. The Manual is a comprehensive review of financial crisis laws as they apply to US financial institutions. Written for anyone who wants to understand the flurry of new legislation and other rulemaking that has occurred at a dizzying speed over the last year and a half, it covers the major Federal Reserve programs, Treasury’s capital investments and warrants, the FDIC’s debt guarantees, the public-private investment program, the enforcement landscape and executive compensation. It is also meant to be, through the hyperlinks in each Chapter, a reference work gathering in one place the scattered primary sources of financial crisis laws, regulations and contracts.

As practicing lawyers, we leave to others the tasks of analyzing the causes of the crisis and assessing the government’s responses to it. That said, the political and social context in which financial crisis rulemaking occurred resulted in regulations with characteristics that affect the way lawyers interpret the law and provide advice to clients. According to one commentary, this system “married transactional practice to administrative law.” Here are a few observations about the characteristics of US financial crisis laws.

Ad Hoc Emergency Process. In contrast to the traditional legislative process, financial crisis rulemaking was done on a rapid, ad hoc, emergency basis to address immediate concerns about the stability and continued existence of the global financial system. Programs were proposed, adopted and in cases quickly abandoned in response to changing market conditions and other concerns. The speed of market developments, aided by twenty-first century communication channels, upended the traditional pattern and timeline of legislative and regulatory change. Regulations were issued on an interim basis without prior notice and comment. Guidelines, interim rules, FAQs and even press releases heralded new regulation. Since a FAQ or a guideline is often changed without notice or public announcement, it became necessary for lawyers to track changes in real-time. And unlike a proposed regulation, interim regulations and guidelines are applicable immediately without industry or consumer comment. All of this took place within the framework of Chevron deference.

Treasury as Contractual Counterparty. Another characteristic of financial crisis law is Treasury as contractual counterparty and investor. During the crisis, the government, as the single available capital lifeline, announced programs via term sheets that, with only minor changes, became the largely non-negotiable standard contracts for all program participants. All of the capital injection contracts contain an unusual provision permitting Treasury to amend them unilaterally and retroactively in case of a statutory change. Since being signed, these contracts have, in fact, been amended twice by statute. In addition, the government used lessons garnered from its role as contractual counterparty to a few TARP recipients receiving exceptional assistance as the basis of future rulemaking that was more widely applicable. As a result, in many respects, TARP recipients find themselves subject to a complex web of contractual obligations, legislative and regulatory actions. Lawyers working in this area cannot, therefore, rely only on the contracts posted online, since they often do not reflect the statutory amendments. Nor can they interpret the regulations without understanding the contracts that may be applicable. Any examination of compensation restrictions is especially caught in this interplay as my partners explain in the relevant Chapter.

Transparency, Accountability, Investigations and Enforcement. This new style of rapid rulemaking took place within a highly charged political, social and economic context, which has led, over time, to increasing calls for transparency and accountability, investigations and enforcement. While Congress gave Treasury wide latitude under EESA to define the scope and mechanics of program implementation, it also created three new Congressionally-mandated oversight bodies. Of these, the COP and the SIGTARP have been the most active and their reports have influenced both later law and regulatory action. The Federal Reserve’s exercise of its emergency powers has led to calls for more auditing and transparency of the Federal Reserve. Treasury, as contractual counterparty, has committed itself to transparency by posting all of its contracts online. First by contract and then by law, SIGTARP has the ability to review the books and records of TARP recipients. Media efforts to obtain information by FOIA reflect their view that this information is desired by their readers. Congress has also created the FCIC to investigate the causes of the crisis, and various DOJ, SEC and FDIC investigations, enforcement actions and lawsuits, as well as SIGTARP investigations, are just beginning to show their public face.

Gradual Winding Down. We have now entered into a phase of the gradual winding down of the many temporary programs, some of which are noted in the sidebar, but the impact of financial crisis laws may not be as temporary as one might initially think. As the Treasury has recently observed in its report The Next Phase of Government Financial Stabilization and Rehabilitation Policies (September 14, 2009), the recovery remains “partial and fragile” and “the process of terminating crisis-related programs must be done in a measured way that does not derail the nascent economic recovery.” Indeed, while many of the laws, regulations and programs discussed in this manual were intended to be temporary, lasting only so long as emergency conditions persisted, their impact will continue long after the programs expire. The end of the programs may mean the end of new investments or loans, but the program’s expiration does not end the government’s investment or the applicability of financial crisis law to private actors. Even when Treasury’s authority to make investments expires, financial institutions carrying Treasury investments will have to comply with executive compensation, employment and lobbying restrictions. Moreover, it remains to be seen whether the new style of lawmaking created during the financial crisis as well as the political risk of retroactive changes, influences how financial regulation is made and interpreted in the future. As a result, many of these regulations will have an impact beyond what may have been initially intended.

Global Regulatory Response. The financial crisis was global in nature and there was, at a high level, a broad similarity in the financial crisis regulatory solutions sought by regulators in most developed countries. There was also an increased call for regulatory cooperation across borders both in the response to the crisis and the calls for reform. While a full discussion of the cross border response is outside the scope of the Manual which focuses solely on US financial crisis laws, within some of the Chapters we have pointed out some international comparisons. The impact of international cooperation on regulatory reform and the gradual winding down of programs remains to be seen.