14 Fatal Flaws in the Dodd Finance Regulation Bill

Over at Eurasia Review, James Gattuso takes a look at the new Democrat-authored corporate financial reform bill and comes up with fourteen serious flaws. Some of them include:

1. Creates a protected class of “too big to fail” firms. Section 113 of the bill establishes a “Financial Stability Oversight Council,” charged with identifying firms that would “pose a threat to the financial security of the United States if they encounter “material financial distress.” These firms would be subject to enhanced regulation. However, such a designation would also signal to the marketplace that these firms are too important to be allowed to fail and, perversely, allow them to take on undue risk.

2. Provides for seizure of private property without meaningful judicial review. The bill, in Section 203(b), authorizes the Secretary of the Treasury to order the seizure of any financial firm that he finds is “in danger of default” and whose failure would have “serious adverse effects on financial stability.” This determination is subject to review in the courts only on a “substantial evidence” standard of review, meaning that the seizure must be upheld if the government produces any evidence in favor of its action. This makes reversal extremely difficult.

3. Creates permanent bailout authority. Section 204 of the bill authorizes the Federal Deposit Insurance Corporation (FDIC) to “make available … funds for the orderly liquidation of [a] covered financial institution.” Although no funds could be provided to compensate a firm’s shareholders, the firm’s other creditors would be eligible for a cash bailout. The situation is much like the scheme implemented for AIG in 2008, in which the largest beneficiaries were not stockholders but rather other creditors, such as Deutsche Bank and Goldman Sachs–hardly a model to be emulated.

11. Subjects non-financial firms to financial regulation. Regulation under this legislation would extend far beyond banks. Many firms largely outside the financial industry would find themselves caught in the regulatory net. Section 102(B)(ii) of the bill defines a “nonbank financial company”” as a company “substantially engaged in activities … that are financial in nature.” The phrase “financial in nature” is defined in existing law quite broadly. According to former Treasury official Gregory Zerzan, it includes things such as “holding assets of others in trust, investing in securities … or even leasing real estate and offering certain consulting services.”

13. Allows activist groups to use the corporate governance process for issues unrelated to the corporation or its shareholders. Section 972 of the bill authorizes the SEC to require firms to allow shareholders to nominate directors in proxy statement. Such proxy access turns corporate board elections from a process designed to ensure that each board has a good mix of skills and experience into a popularity contest where the long-term interests of the stockholders become secondary to political agendas or corporate raiders. The process can also be used by labor unions, politicians who manage public pension funds, and others to force corporations to respond to pet social or political causes.

This last point is interesting because it codifies one of Saul Alinsky’s most effective power tactics — encouraging large numbers of shareholders to pressure corporations through proxy voting. Alinsky used this tactic most famously against Eastman Kodak, who at the time (early 1960’s) engaged in blatant racially discriminatory hiring practices:

After endless months of frustration, we finally decided we’d try to embarrass Kodak outside its fortress of Rochester, and disrupt the annual stockholders’ convention in Flemington, New Jersey. Though we didn’t know it at the time — all we had in mind was a little troublemaking — this was the seed from which a vitally important tactic was to spring. I addressed the General Assembly of the Unitarian-Universalist Association and asked them for their proxies on whatever Kodak stock they held in order to gain entree to the stockholders’ meeting. The Unitarians voted to use the proxies for their entire Kodak stock to support FIGHT — 5620 shares valued at over $700,000.

The wire services carried the story and news of the incident rapidly spread across the country. Individuals began sending in their proxies, and other church groups indicated they were prepared to follow the Unitarians’ lead. By the purest accident, we’d stumbled onto a tactical gold mine. Politicians who saw major church denominations assigning us their proxies could envision them assigning us their votes as well; the church groups have vast constituencies in their congregations. Suddenly senators and representatives who hadn’t returned our phone calls were ringing up and lending a sympathetic ear to my request for a senatorial investigation of Kodak’s hiring practices.

As the proxies rolled in, the pressure began to build on Kodak — and on other corporations as well. Executives of the top companies began seeking me out and trying to learn my intentions. I’d never seen the establishment so uptight before, and this convinced me that we had happened onto the cord that might open the golden curtain shielding the private sector from its public responsibilities. It obviously also convinced Kodak, because they soon caved in and recognized FIGHT as the official representative of the Rochester black community. Kodak has since begun hiring more blacks and training unskilled black workers, as well as inducing the city administration to deliver major concessions on education, housing, municipal services and urban renewal. It was our proxy tactic that made all this possible. It scared Kodak, and it scared Wall Street. It’s our job now to relieve their tensions by fulfilling their fears.

Alinsky’s motive (ending racial discrimination in the workplace) was noble; his tactic less so. As Gattuso briefly explains, giving shareholders the power to nominate directors through proxy voting opens up a sinister window of opportunity for corporate raiders and greenmailers. And not just from directly competing firms. It doesn’t take too much imagination to envision companies that do not qualify for “Too Big To Fail” status or other protections enjoyed by Wall Street power houses being targeted almost immediately by labor unions, political factions, or any other group with an axe to grind. Businesses that don’t play nice with these special interests could be publicly derided as “in danger of default” by rogue board members, thus opening them up to investigation and possible seizure by the Treasury Dept. This is even more troubling considering that any corporation that manages the investment of its own capital or holds the assets of others (such as downpayments on manufactured goods) in trust could possibly become subject to these rules.

We have Karl Marx to thank for the notion that businesses would be run more “fairly” if they were controlled by the workers rather than by experienced businessmen. Of course today, we have an entire class of elites, politicians, union bosses etc. who claim to represent “workers” better than the workers can represent themselves. It is these special interest groups that would benefit from the Dodd bill — not employees, not common shareholders, and certainly not consumers.

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