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Course number: 2696 - Globalization: Business, Legal and Public Policy Issues
January Term, 2016 — January 4-8, 11-15, 18-20
9am - 12:15pm
Classroom: TBD*
Instructor:
Lewis B. Kaden
John Harvey Gregory Lecturer on World Organization
Griswold Room 206*
Office Tel: +1 617 496 5416; 212 424 2607
email: [email protected]
Faculty Assistant:
Sandra Mays*
Griswold 2 South
Office Tel: +1 617-496-3358
email: [email protected]
Overview:
Globalization has increased the interconnection and integration of developed and
developing countries as changes in technology, communications, trade and transportation
bring them closer together. At the same time, cultural, economic and political differences
also create tensions and challenges to governments, business organizations, trade
associations and civic groups, families and individuals. This course examines six cases
in which these interests around the globe grapple with the challenges and opportunities
which accompany globalization.
Office Hours*:
Tuesday and Thursday from 3-4pm
Course Requirements:
The course will examine six cases that spotlight various issues in the business, legal, and
public policy spheres related to globalization. Each case is intended to occupy two days
or 6.5 hours of class time. Writing assignments and group exercises are assigned for each
day of class, with instructions included in the course packet. The group exercises will
ask each group to look at the issues and choices from the perspective of one party or
group with an interest in the subject matter of the case. At the end of the course, students
will submit a short 6-8 page paper (approximately 2,000 words) that reflects thoughtful
analysis about one of the six cases. The paper is a thought piece, drawing on the
materials and class discussion and not requiring additional research.
The writing assignments are not intended to be graded or evaluated; they will be used to
help frame class discussion. In approaching the writing assignments, rather than focusing
on style, it is important to focus on expressing your thoughts on the questions posed and
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issues raised. The primary requirement of the course is preparation for each class, thought
given to the issues and active participation in the discussion and debate. Our emphasis is
not so much a search for the “right” answers – usually there are conflicting views and
opinions – but rather thoughtful engagement, analysis and expression of views on those
conflicts and choices.
The Syllabus:
For each case, there is a brief case statement, a number of questions to consider, and
background material containing readings. Readings are required; recommended but
optional readings will be clearly marked as such in the reading lists associated with each
case. For some of the materials, the assigned reading is an excerpt from a longer report,
document or book. In each case, the syllabus includes a reference to the longer works for
those interested in pursuing it further. Some of the readings are documents such as
settlement agreements or legal complaints. If the entire document is included, it is
because I think it is useful to see what it includes, although some sections are worthy of
closer reading and for others that may not be necessary. Also, journalistic pieces can
generally be read quickly, and learning to choose what to skim and what to read closely is
an important part of training in the skills that are frequently part of being a business
executive, public official or senior lawyer.
Finally, I would appreciate if before the course begins, each student can send me a very
brief statement of any experience, background or interest that influenced your decision to
register for the course so that I learn a little more about you than the limited information
that the Registrar provides.
I expect there will be students from HLS, HBS and KSG. It is intended that the materials
provide each of you enough background to participate actively in the discussions of each
case, whether you have any experience in business, law, or public policy beyond your
student experience so far.
My hope is that your varied backgrounds and experience will make the class discussion
and exchange of views more interesting than would be the case if the group was less
diverse.
Class Schedule*:
Jan. 4-5: Global Labor Standards
Jan. 6-7: Trade
Jan. 8, 11: Corruption
Jan 12-13: Financial Crisis
Jan 14-15: Cyber Security
Jan. 19-20: Multijurisdictional Law Enforcement: Public-Private Regulatory Regimes
*Note: This syllabus is subject to edits and updates in the Fall which are not likely to
be material.
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GLOBAL LABOR STANDARDS
The Rana Plaza Tragedy
On April 24, 2013, an eight-story building comprised of retail stores and garment factories called
Rana Plaza collapsed in Savar, an industrial suburb of Dhaka, killing 1,137 people and injuring
more than 2,500. Most of the victims were factory workers who stitched garments for export to
developed countries.
Some of the survivors described the collapse as similar to an earthquake, starting with a
loud cracking sound followed by the floor opening up beneath their feet as the beams broke in
half. Investigations uncovered that cracks had appeared in Rana Plaza the day before its collapse
and the shops on the lower floors had been evacuated. Because of frequent power cuts, heavy
generators had been installed on the factory premises to keep the production line active at all
times and caused major vibrations throughout the building while running. Authorities had
approved only five of the eight floors that were actually built. Both the police and the
Bangladesh Garment Manufacturers and Exporters Association (BGMEA), one of the largest
trade associations in Bangladesh representing the garment industry, had told Sohel Rana, the
building’s owner, that his building was unsafe, but Rana ignored them and the factories stayed
open. Workers were told by factory managers that the building had been inspected once more
and was now considered safe, and also received threats that they would be fired if they did not
show up to work.
Rana was arrested and initially charged with negligence. On June 1, 2015 the police in
Bangladesh filed formal murder charges against Rana and 40 others, including his parents,
several factory owners in the building, and at least a dozen government officials. Charges for
building code violations were also submitted to a court in Dhaka against 18 people, 17 of whom
were among those charged with murder, including Rana and his parents.
Before the collapse, Rana Plaza had housed five different garment manufacturers: New
Wave Bottoms on the second floor, Phantom Apparels on the third, Phantom Tac on the fourth,
and Ether Tex and New Wave Style on the sixth and seventh floors. Because of widespread
subcontracting, few retailers knew straightaway whether their products had been made at Rana
Plaza or not. Primark was one of the few companies that promptly admitted that they had
contracted with New Wave Bottoms, and made a unilateral commitment to compensate the
victims and their families. Ether Tex claimed to have produced clothing for Walmart at their
Rana Plaza facility, but Walmart denied the allegation. As branded garments and copies of
contract orders were found in the rubble, some retailers went through their own records and
realized they had to walk back some of their previous statements, including Benetton.
The Ready Made Garment (RMG) Industry in Bangladesh
Rana Plaza was not the first deadly factory accident to occur in the Bangladeshi ready-
made garment (RMG) industry. An estimated 500 people had been killed in factory accidents
over the past decade, including 73 workers in an earlier factory collapse in Savar in April 2005.
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90 percent of the country’s buildings do not meet building codes, and weak infrastructure and
poor electrical supply increase the risk of fires in factories.
Bangladesh is a country of 160 million people with the greatest population density in the
world. The garment industry accounts for 80% of Bangladesh exports and 18% of the country’s
GDP. Its global competitiveness in this industry is considered to be ranked second only to China
and has helped alleviate widespread poverty. But its comparative advantage is its ability to
produce low cost garments at high capacity with good quality needlework. It is dependent on raw
material imports, lacks sufficient skilled labor, and has had continuing political instability.
Freedom House rates Bangladesh as a “partly free” country, and corruption is widespread—even
in the garment industry, where many members of Parliament have personal investments in the
garment business. Labor rights have historically not been well protected, and the US State
Department considers “poor working conditions and labor rights” to be among the most pressing
human rights issues in Bangladesh.
Subcontracting practices and the lack of inspectors and regulatory oversight remain a
serious problem. Larger manufacturers who have contracts with Western companies frequently
subcontract work to smaller factories, both as a cost-cutting strategy for prime contractors, but
also to ensure that orders are completed on time, which may be required if they take on more
orders than they have capacity for in their own facilities. A common practice in the Bangladeshi
garment industry is to deduct 5 percent of the price for each week that an order is delayed, which
gives factory owners and managers an incentive to push their workers to maximum production
and, in the case of Rana Plaza, at the cost of lives. Retailers also risk losing control of an
increasingly complex supply chain.
The use of agents who help facilitate deals between Western buyers and Bangladeshi
suppliers further increases this complexity and reduces transparency. Agents also contribute to
weaker relationships between buyers and suppliers by offering retailers flexibility and by
negotiating short-term contracts. This may lead to downward pressure on labor standards as
suppliers may delay investment in their facilities to improve working conditions due to the
insecurity of short-term contracts.
Multiple Parties
Some argue that the national government needs stronger, more effective regulation of the
garment industry and should raise the minimum wage, improve factory conditions, and enforce
basic safety standards. But others point to the increasing costs that these regulations would incur,
which would make Bangladeshi products less attractive on the global market. Many western
consumers advocate living wages and decent hours for garment workers in Bangladesh while
demanding cheap clothes in stores at home. Western retailers create jobs, pay taxes, and
contribute to the common good in developing countries, but also wish to supply the growing
demand from consumers in North American and European markets and the low costs of
Bangladesh products create attractive margins.
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The Bangladeshi government
Prime Minister Sheikh Hasina came to power after leading a coalition of 14 parties to victory in
the election in 2008. The election was on the whole considered relatively fair and free by most
international observers. However, her reelection on January 5, 2014 was more controversial. The
main opposition party boycotted the election after they feared an unfair contest. Freedom House,
an American NGO, rates Bangladesh as a “partly free” country. 2013 was one of the most violent
in Bangladesh since the country gained its independence; about 500 people died in protests and
political clashes. Hasina’s government has promised to improve labor standards in the country,
but progress on inspections, conditions and benefits for workers has been slow.
Bangladesh Garment Manufacturers & Exporters Association (BGMEA)
BGMEA is one of the largest trade associations in the country representing the RMG sector.
Since its inception, BGMEA has been dedicated to promote and facilitate the apparel industry
through policy advocacy to the government and services to its members. Its membership base
has grown rapidly over the years. BGMEA had less than 400 factories among its members in
1984 that altogether employed some 120,000 workers. Today it has about 4,500 member
factories employing 4 million garment workers.
Factory owners
There are about 4,500 registered garment factories in Bangladesh. Some of the manufacturers are
important players in the global market. Because the textile industry amounts to about 80 percent
of Bangladesh’s total exports, the larger manufacturers dominate the BGMEA and have
substantial influence in the Bangladesh business, civic, and political community. Some of the
large factories meet building and safety standards and are frequently visited by major buyers for
whom they are prime contractors. However, smaller, independently owned factories take on
many subcontracts from the prime contractors. Sometimes these subcontractors in turn
subcontract orders to other factories, which makes the supply chain even more complicated.
Many of these small and independent factories have very low wages and poor working
conditions.
Garment workers and labor unions
Bangladesh garment workers frequently work very long hours. A typical worker may stitch 120
pairs of trousers per hour, 10 hours a day, six days a week, and 50 weeks per year. That amounts
to 360,000 pairs of trousers annually. And many workers do this for wages starting at $68 a
month. Labor rights have historically not been well protected. The American State Department
considers “poor working conditions and labor rights” to be among the most pressing human
rights issues in Bangladesh. After Rana Plaza, the Bangladeshi government has made it easier to
join and start labor unions. In 2013 alone, 96 new trade unions registered with the Department of
Labor, bringing the total number up to 222.
International Labor Organization (ILO)
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The ILO was founded in 1919 as a specialized agency within the United Nations. Its mission is
to promote social justice and internationally recognized human and labor rights. The tools that it
has at its disposal include conventions which produce recommendations for minimum standards
of labor rights, including freedom of association, collective bargaining, and the right to organize.
The ILO can also provide technical assistance and training to labor and employer organizations.
As with many international organizations, one of the most frequent points of criticism directed at
the ILO is that it lacks the power to enforce the standards it sets.
Western consumers
In 1997, the average woman in the United Kingdom bought 19 items of clothing a year. Ten
years later, in 2007, the number had jumped to 34. The demand for cheap garments has grown
significantly over the past decades. Bangladesh exports about $25 billion worth of garments
every year, which is equivalent to almost a fifth of the country’s GDP. Most of the goods are
bought by retailers in Europe and North America.
Western retailers
Of Bangladesh’s garment exports, about 60 percent go to the European Union, 25 percent to
America and 5 percent to Canada. Among the major European retailers are HRM, Adidas,
Benetton, Mango, Next, Zara, and Primark. American retailers buying Bangladeshi products
include Gap, J.C. Penney, L.L Bean, Macy’s, Target and Walmart.
Garment manufacturing in Bangladesh is important to the country and attractive to investors.
Low labor costs and high quality products have generated the industry’s rapid growth.
In the aftermath of Rana Plaza
The Rana Plaza tragedy put a harsh light on factory safety, weak enforcement of standards, little
transparency for subcontracting practices and widespread competition with other countries eager
to expand their garment industry. Bangladesh risks losing their competitive edge unless they act
on these problems.1 Reform requires action from global buyers, local suppliers, governments
and development organizations.
The continuing challenge for Bangladesh is whether it can improve working conditions,
strengthen business relationships, increase oversight and inspections, strengthen workers’ ability
to advocate change and reform public policies in ways that upgrade the garment sector while
maintaining its competitive position in the global market.
A key question is whether common ground can be found where many of the parties can come
together around solutions that they feel benefit them, or if change will have to come through
unilateral action.
1 http://cpi.transparency.org/cpi2013/results/
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Some measures have already been taken by the Bangladeshi government as well as by foreign
governments, the international community, and Western retailers. There is evidence of
improvements. But have the measures been sufficient? What could have been done differently?
And what should each party do next to prevent another Rana Plaza from occurring in the future?
Sources Consulted
Julfikar Ali Manik and Jim Yardley, “Building Collapse in Bangladesh Leaves Scores
Dead” (news article in The New York Times, April 24, 2013)2
Julfikar Ali Manik and Nida Najar, “Bangladesh Police Charge 41 With Murder Over
Rana Plaza Collapse” (news article in The New York Times, June 1, 2015)3
“Disaster in Bangladesh – Rags in the ruins: A tragedy shows the need for a radical
improvement of building standards (news article in The Economist, May 4, 2013)4
“Another Beating” (news article in The Economist, January 11, 2014)5
Jason Burke, “Rana Plaza: one year on from the Bangladesh factory disaster” (news
article in The Guardian, April 19, 2014)6
Kim Bhasin, “A Year After Deadly Collapse, Bangladesh’s Garment Industry Remains
Broken” (news article in the Huffington Post, April 24, 2014)7
Pamela Engel, “Here Are Some Of The Biggest Brands That Make Clothes In
Bangladesh” (news article in Business Insider, May 13, 2014)8
BGMEA at a Glance, Bangladesh Garment Manufacturers and Exporters Association
(BGMEA) (online publication, undated)9
Bangladesh, Freedom House (online publication, undated)10
2 http://www.nytimes.com/2013/04/25/world/asia/bangladesh-building-collapse.html 3 http://www.nytimes.com/2015/06/02/world/asia/bangladesh-rana-plaza-murder-charges.html?_r=0.
4 http://www.economist.com/news/asia/21577124-tragedy-shows-need-radical-improvement-building-
standards-rags-ruins 5 http://www.economist.com/node/21593476.
6 http://www.theguardian.com/world/2014/apr/19/rana-plaza-bangladesh-one-year-on 7 http://www.huffingtonpost.com/2014/04/24/bangladesh-factory-workers_n_5200427.html
8 http://www.businessinsider.com/big-brands-in-bangladesh-factories-2013-5
9 http://www.bgmea.com.bd/home/about
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Country Reports on Human Rights Practices for 2013: Bangladesh, U.S. Department of
State, Bureau of Democracy, Human Rights and Labor (government publication, undated)11
“Bangladesh Reduced Number of Poor by 16 million in a Decade” (press release from
The World Bank, June 20, 2013)12
Sanchita Banerjee Saxena and Véronique Salze-Lozac’h, “Competitiveness in the
Garment and Textiles Industry: Creating a supportive environment – A Case Study of
Bangladesh” (Occasional Paper No. 1, July 2010 from The Asia Foundation)13
Achim Berg, Saskia Hedrich, and Sebastian Kempf, “Bangladesh’s ready-made garments
landscape: The challenge of growth” (case study by Mckinsey & Company, Inc., November
2011)14
Rosemary Westwood, “What does that $14 shirt really cost? From the archives:
Bangladesh disaster raises tough questions about cheap clothes” (infographic and article from
Maclean’s, May 1, 2013)15
10 https://freedomhouse.org/country/bangladesh#.VZaRQKPD_cs.
11 http://www.state.gov/documents/organization/220600.pdf 12 http://www.worldbank.org/en/news/press-release/2013/06/20/bangladesh-reduced-number-of-poor-by-
16-million-in-a-decade 13 http://asiafoundation.org/resources/pdfs/1OccasionalPaperNo.1BGGARMENTwithCover.pdf
14 http://www.mckinsey.de/sites/mck_files/files/2011_McKinsey_Bangladesh.pdf 15 http://www.macleans.ca/economy/business/what-does-that-14-shirt-really-cost/
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Global Labor Standards Classwork
Before Class 1
Please approach the background material with an eye to the position of the party to which
you are assigned and respond to each of the discussion questions that follow. Send a written
response to one of the questions to Mr. Kaden ([email protected]) the day before Class 1
by 9:00 pm.
Parties
1. Government of Bangladesh [Last names starting with A – E]
2. Foreign Governments (USA, EU) [Last names starting with F – J]
3. Factory Owners [Last names starting with K – N]
4. Western Retailers [Last names starting with O – R]
5. Factory Workers and Labor Unions [Last names starting with S - V]
6. International Organizations [Last names starting with W – Z]
Global Labor Case Discussion Questions
1. To what extent is there a trade-off between raising wages and requiring companies to
invest in improving factory safety? Between increasing domestic labor standards and
maintaining competitiveness in the global market? How should victim compensation factor into
this analysis? What do you think about Muhammad Yunus’s proposal for a global minimum
wage?
2. How would you approach the issues associated with subcontracting? What can western
retailers do in countries where the rule of law is weak and the incentive to fabricate building
certificates and inspection reports is great? Do you think the NYU Center for Business and
Human Rights proposal for “direct, strategic sourcing” (page 26) is a viable alternative? How
effective do you think it will be?
3. What are the differences and similarities between the Alliance and the Accord? Are the
differences material? Do either effectively or adequately address the situation in Bangladesh?
What are some of their advantages and shortcomings? How can these shortcomings be
addressed?
4. What kind of duties and responsibilities do foreign governments have towards
developing countries such as Bangladesh? What role should they play in improving labor
conditions within Bangladesh? What about international organizations such as the International
Labour Organization (ILO)? Western retailers and consumers?
5. What kind of lessons can be drawn from the efficacy of the Fair Labour Association
(FLA), a collaboration between academia, civil society, and the private sector? Refer to The
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Economist article, “When the jobs inspector calls”. How would you evaluate the “National
Tripartite Plan of Action on Fire Safety in the RMG Sector”, an initiative launched as a
cooperation between government, employers, and workers (“National Action Plan”), and Better
Work Bangladesh, a program implemented as a partnership between the ILO and the
International Finance Corporation (IFC)? What are their strengths and weaknesses? How would
you measure success for each of these programs?
Global Labor Case Background Material
Rehman Sobhan, “Bangladesh’s Disaster: Perspectives on the Political Economy” (blog
post for Centre for Policy Dialogue, March 20, 2014)
Tripti Lahiri and Christina Passariello, “Why Retailers Don’t Know Who Sews Their
Clothing” (news article in The Wall Street Journal, July 24, 2013)
Testimony of Scott Nova, Executive Director of the Worker Rights Consortium and a
representative of the Accord, from hearing on “Prospects for Democratic Reconciliation and
Improving Workers’ Rights in Bangladesh” (Senate Committee on Foreign Relations, February
11, 2014)
Muhammad Yunus, “After the Savar tragedy, time for an international minimum wage”
(opinion piece in The Guardian, May 12, 2013)
Steven Greenhouse and Elizabeth Harris, “Battling for a Safer Bangladesh” (news article
in The New York Times, April 21, 2014)
Nine senators write a letter to Barack Obama urging him to promote workers’ rights in
Bangladesh (June 25, 2013) [only available in course packet]
Karel De Gucht: “Rana Plaza Aftermath” (speech at informal OECD ministerial meeting,
June 26, 2014) [only available in course packet]
Interview with Atiqul Islam, President of BGMEA (January 8. 2014) [link:
http://www.bgmea.com.bd/home/pages/President_Interview#.VZbC16PD_ct]
Better Work, “Q&A on Better Work Programme in Bangladesh” (attachment to press
release, undated)
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Better Work, “Case Study: Fire & Building Safety in the Ready-Made Garment Sector of
Bangladesh” (Better Work publication, undated)
Sarah Labowitz and Dorothée Baumann-Pauly, “Business as Usual is Not an Option:
Supply Chains and Sourcing after Rana Plaza” (report by the Center for Business and Human
Rights at New York University, Stern School of Business)
The Economist, “Working conditions in factories – When the jobs inspector calls: Do
campaigns for “ethical supply chains” help workers?” (news report, March 31, 2012)
The International Federation for Human Rights (FIDH), “One Year After the Rana Plaza
Catastrophe: Slow Progress and Insufficient Compensation” (NGO publication, April 24, 2014)
The International Federation for Human Rights (FIDH), “Two years after the Rana Plaza
disaster, victims still awaiting adequate compensation” (NGO publication, April 23, 2015)
Bangladesh Sustainability Compact – Technical Status Report (European Commission
publication, April 24, 2015)
Richard M. Locke, “We Live In A World of Global Supply Chains” (excerpt from
forthcoming textbook)
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Global Labor Standards Classwork
Before Class 2
Discuss the following with your assigned group and submit a written proposal or memo
to the iSights course page the day before Class 2 by 9:00 pm:
How would you organize an effective campaign to address the challenges facing the
RMG sector in Bangladesh? What role should be played by the factory owners, labor
organizations, various governments, major global retailers, and international organizations such
as the ILO and World Bank?
Please read your colleagues’ proposals prior to class to prepare for in-class discussion.
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TRADE
A. Introduction
The Trans-Pacific Partnership (TPP) is a proposed trade agreement between twelve countries:
Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, the
United States and Vietnam. If the TPP were to be successfully negotiated, it would be one of the
most significant regional trade agreements in history. The twelve TPP countries account for
about 40% of global output. Peter Petri of the Peterson Institute for International Economics has
estimated that closing a TPP agreement would raise global GDP by $295 billion a year, $78
billion of that going directly to the United States.16
Over the past few years, officials have talked positively about the prospects of reaching an
agreement. Prime Minister Lee Hsien Loong of Singapore said in February 2014 that negotiators
were “very close” to closing a deal.17 Australia’s Trade Minister, Andrew Robb, said at the same
time that the TPP negotiators “really are at the very advanced stage.”18 After the meeting of TPP
negotiators before the G-20 meeting in Brisbane, news reports indicated substantial progress had
been made. But more work is ahead as they tackle both substantive differences and potential
divisions within some countries. Movement is expected on TPP negotiations after President
Obama signed the bill that renewed trade promotion authority for his office on June 29, 2015.19
The negotiations have been criticized for lack of transparency and negotiations behind closed
doors,20 and often these comments about process mask significant differences between
participants and among constituency groups in each country. This byplay is common in all
major international trade negotiations, and proponents of the deal and how the negotiations have
been handled thus far point out that it would be impossible to strike a good deal if negotiation
strategies and goals were all public. In addition, they note that over 1,150 meetings have been
held on Capitol Hill so far on the TPP alone.21
16
“Taking aim at imports”, article in The Economist, February 22, 2014. Retrieved from:
http://www.economist.com/news/united-states/21596939-protectionists-congress-could-scupper-crucial-free-trade-deals-taking-aim-imports. 17 “Singapore PM says TPP deal ‘very close’, article in SBS, February 18, 2014. Retrieved from: http://www.sbs.com.au/news/article/2014/02/18/singapore-pm-says-tpp-deal-very-close. 18 “Robb hopeful for TPP talks in Singapore”, article in SBS, February 17, 2014. Retrieved from: http://www.sbs.com.au/news/article/2014/02/17/robb-hopeful-tpp-talks-singapore.
19 Greg Nelson, “On Trade, Here’s What the President Signed into Law”, publication on the White House
blog, June 29, 2015. Retrieved from: https://www.whitehouse.gov/blog/2015/06/29/trade-here-s-what-president-
signed-law.
20 “Barry Coates: Release the TPP negotiation documents”, editorial in the New Zealand Herald, February 21, 2014. Retrieved from: http://www.nzherald.co.nz/opinion/news/article.cfm?c_id=466&objectid=11206582 21 “Taking aim at imports”, article in The Economist, February 22, 2014. Retrieved from: http://www.economist.com/news/united-states/21596939-protectionists-congress-could-scupper-crucial-free-trade-deals-taking-aim-imports.
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Besides the TPP, China and the United States are engaged in bilateral negotiations over a treaty
on cross-border investment; China has organized talks on a Regional Comprehensive Economic
Partnership (RCEP), which includes the ten members of ASEAN and six other Asian countries;
and the US is involved with the European Union and its twenty seven member countries on the
Transatlantic Trade and Investment Partnership (TTIP).22
B. Major Issues in the Trans-Pacific Partnership Negotiations
Five major issues are at the center of the TPP negotiations: intellectual property rights; investor
protection; state owned enterprises (SOEs); sustainability and environmental protection; and
labor standards.
The TPP negotiations also involve efforts to achieve important agreements on market access.
One significant example is the US-Japan automobile sector, an issue of interest also to Mexico.
Japan currently has severe restrictions on US auto access while the US restricts access for
Japanese trucks.
Agriculture is another important issue in the TPP negotiations. The TPP countries account for
more than 30 percent of world exports and over 20 percent of world imports of agricultural
products. In many of the TPP countries, agriculture is a politically and economically important
sector. This has contributed to turning several agricultural issues into some of the main sticking
points in the negotiations. One such example is trade liberalization of dairy products. New
Zealand has advocated for far-reaching liberalization of dairy products and wants better access to
North American markets. But United States officials are wary of falling dairy prices in the
American market that could result from liberalization. Another sticking point is sugar exports:
Australia wants access to the American market for sugar, but this proposition was already
rejected earlier by American officials in bilateral trade negotiations between Australia and the
United States.23
The issue of agricultural market access became even more acute after Japan joined the TPP talks
in 2013. The Japanese Parliament supports five “sacred” agricultural product categories—rice,
wheat, beef and pork, dairy, and sugar—which it believes should be exempt from the free trade
agreement.24 In the negotiations so far, Japan has been criticized by others for its position on
22
“The promise of regional trade agreements begins to fade”, article in the Global Forecasting Service, August 20,
2014. Retrieved from: http://gfs.eiu.com/Article.aspx?articleType=wt&articleId=1432195927&secId=4. 23 “Administration Desperate to Announce Deal at TPP Ministerial, But What Is a Real Deal Versus Kabuki Aimed at Reviving Obama’s Fast Track Push and Framing His Asia Visit?”, Public Citizen publication, February 20, 2014. Retrieved from: http://www.citizen.org/pressroom/pressroomredirect.cfm?ID=4091. 24 “The Trans-Pacific Partnership: No end in sight”, article in The Economist, February 25, 2014. Retrieved from: http://www.economist.com/blogs/banyan/2014/02/trans-pacific-partnership-0.
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agriculture, but it has continued to stand its ground.25 Agriculture accounts for only 0.8% of
Japan’s GDP, but farmers have always been a powerful political constituency.26
Another issue raised in TPP talks is internet freedom.27 In the TPP, America seeks
“[r]equirements that support a single, global Internet, including ensuring cross-border data flows,
consistent with governments’ legitimate interest in regulating for purposes of privacy
protection,”28 and a recent bilateral agreement between the US and China addresses this subject.
However, the US position on intellectual property also seeks expanded copyright protection, and
critics in other TPP countries have claimed that this would force internet providers to act as
“copyright police” by cutting off people’s access to the internet for copyright violations.29 The
TPP has also spurred discussions on cybersecurity provisions that may help prevent economic
espionage that leads to unfair competition.30
1. Intellectual Property Rights
Developing rules on intellectual property rights (IPRs) is “one of the most complex and
challenging” issues in the TPP negotiations.31 The US wants TPP IPR provisions that
extend protection beyond the standards found in the WTO’s Agreement on Trade-Related
Aspects of Intellectual Property Rights (TRIPS).32 US business groups seek TRIPS-plus
provisions similar to those in the Korea-United States Free Trade Agreement (KORUS
FTA). But other TPP countries—fearing overregulation of IPR will have negative
effects—favor a TPP IPR framework that is generally consistent with, but does not
exceed, the existing TRIPS obligations. Countries including New Zealand, Malaysia,
Australia, and Vietnam have opposed aspects of US proposals on trade secrets, copyright
25 “Stage set for TPP ministerial meeting, tariff issues in focus”, article in Kyodo News International, February 21,
2014. Retrieved from: http://www.globalpost.com/dispatch/news/kyodo-news-international/140221/stage-set-tpp-ministerial-meeting-tariff-issues-focus. 26 “Free-trade pacts: America’s big bet”, article in The Economist, November 15, 2014. Retrieved from: http://www.economist.com/news/special-report/21631797-america-needs-push-free-trade-pact-pacific-more-vigorously-americas-big-bet. 27 Kevin Collier, “Sen. Ron Wyden on the problems with the Trans-Pacific Partnership”, article on The Daily Dot, September 19, 2012. Retrieved from: http://www.dailydot.com/politics/ron-wyden-trans-pacific-partnership/ 28 “Trans-Pacific Partnership: Summary of U.S. Objectives”, Office of the United States Trade Representative publication. Retrieved from: http://www.ustr.gov/tpp/Summary-of-US-objectives 29 “Administration Desperate to Announce Deal at TPP Ministerial, But What Is a Real Deal Versus Kabuki Aimed at Reviving Obama’s Fast Track Push and Framing His Asia Visit?”, Public Citizen publication, February 20, 2014. Retrieved from: http://www.citizen.org/pressroom/pressroomredirect.cfm?ID=4091. 30 Marcela Haywood, “TPP, TTIP and Getting America’s Competitiveness Back on Track”, editorial on Democracy Arsenal, October 15, 2013. Retrieved from: http://www.democracyarsenal.org/2013/10/tpp-ttip-and-getting-americas-competitiveness-back-on-track.html. 31 “Trans-Pacific Partnership Trade Ministers’ Report to Leaders, Office of the United States Trade Representative Press Release, November 10, 2014. Retrieved from: https://ustr.gov/about-us/policy-offices/press-office/press-releases/2014/November/Trans-Pacific-Partnership-Trade-Ministers-Report-to-Leaders. 32 Robust protection of IPRs is an important US objective: IP-intensive industries support nearly 40 million American jobs.See Trans-Pacific Partnership: Summary of U.S. Objectives, available at: http://www.ustr.gov/tpp/Summary-of-US-objectives.
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enforcement and the internet, and pharmaceutical patents and access to medicines.33 On
June 20, 2015, WikiLeaks leaked a negotiation draft of the Healthcare Annex to the
secret “Transparency” chapter of the TPP34, and some analysts in Australia and New
Zealand have expressed concerns regarding the effect of several provisions on domestic
healthcare policies.35
2. Investor Protection
The US seeks to include in the TPP several investment obligations, such as standards for
nondiscriminatory treatment of foreign investments and investors by host countries. One
of the more contentious investment issues is whether to include an investor-state dispute
settlement provision, which allows private foreign investors to seek international
arbitration against host governments. Australia has been the primary opponent of
including an investor-state dispute settlement mechanism. ALF-CIO and Senator
Elizabeth Warren also expressed concerns regarding the “fine print” of investor-state
dispute settlement (ISDS) provisions in the TPP that “would allow big multinationals to
weaken labor and environmental rules”.3637
3. Environment
Since NAFTA, the United States has sought advances in environmental protection and
sustainability in free trade negotiations. Recent bilateral agreements have included
provisions on the environment, with TPP commitments that prevent countries from
lowering their environmental standards in order to try to attract investment, and that
protect fisheries and endangered species.
33
Ian F. Fergusson, Mark A. McMinimy, and Brock R. Williams, “The Trans-Pacific Partnership (TPP): Negotiations
and Issues for Congress, Congressional Research Service publication, March 20, 2015. Retrieved from: http://fas.org/sgp/crs/row/R42694.pdf.
34 “TPP Transparency Chapter: Annex on Transparency and Procedural Fairness for Pharmaceutical
Products and Medical Devices”, publication on WikiLeaks, June 10, 2015. Retrieved from:
https://wikileaks.org/tpp/healthcare/.
35 “ ‘Profits over public health’: Secret TPP Healthcare Annex published by WikiLeaks”, article on Russia
Today, June 10, 2015. Retrieved from: https://www.rt.com/usa/266401-wikileaks-tpp-healthcare-annex/.
36 Mike Hall, “What’s ISDS in the TPP? Very Scary!”, blog post on ALF-CIO website, February 26, 2015.
Retrieved from: http://www.aflcio.org/Blog/Political-Action-Legislation/What-s-ISDS-in-the-TPP-Very-Scary.
37 Elizabeth Warren, “The Trans-Pacific Partnership clause everyone should oppose”, editorial in The
Washington Post, February 25, 2015. Retrieved from: https://www.washingtonpost.com/opinions/kill-the-dispute-
settlement-language-in-the-trans-pacific-partnership/2015/02/25/ec7705a2-bd1e-11e4-b274-
e5209a3bc9a9_story.html.
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In its early summary of objectives for TPP, the US stated that environmental protection
and conservation across the region was a “key priority” and it would seek the following
provisions in the regional agreement38:
Strong and enforceable environment obligations, subject to the same dispute
settlement mechanism as other obligations in TPP;
Commitments to effectively enforce domestic environmental laws, including laws
that implement multilateral environmental agreements, and commitments not to
waive or derogate from the protections afforded in environmental laws for the
purpose of encouraging trade or investment;
New provisions that will address wildlife trafficking, illegal logging, and illegal
fishing practices; and
Establishment of a means for the public to raise concerns directly with TPP
governments if they believe a TPP member is not meeting its environment
commitments, and requirements that governments consider and respond to those
concerns.
120 members of the House of Representatives sent a letter to Michael Froman, the United
States Trade Representative, urging him to ensure language on environmental protection
in the TPP. “We don’t all agree on the merits of TPP, but we all agree the administration
must continue to insist on a robust, fully enforceable environment chapter … This would
allow the U.S. to better address climate change, protect finite natural resources,
strengthen national security, and foster economic stability at home and abroad,” the letter
said.39
WikiLeaks released the secret draft text for the TPP Environment Chapter, which covers
environmental issues such as climate change, biodiversity, and trade and investment in
environmental goods and services, as well as environmental dispute resolution, on
January 15, 2014.40 Environmental groups such as the Sierra Club, WWF, and the
Natural Resources Defense Council have criticized the American government for drafting
language in the TPP negotiations that they say would be weak on the environment.41 “If
the environment chapter is finalized as written in this leaked document, President
Obama’s environmental trade record would be worse than George W Bush’s,” says
Michael Brune, executive director of the Sierra Club.42
38 Excerpt from USTR, TPP: Summary of US Objectives, available at: http://www.ustr.gov/tpp/Summary-of-US-objectives.
39 Letter from members of Congress to U.S. Trade Representative Michael Froman, February 20, 2014.
Available at: http://blumenauer.house.gov/images/stories/2014/02-20-14%20Blumenauer-DeFazio-
Levin%20TPP%20Environment%20Letter%20-%20Final.pdf
40 “Secret Trans-Pacific Partnership Agreement (TPP) – Environment Consolidated Text, January 15, 2014.
Retrieved from: https://wikileaks.org/tpp-enviro/.
41 Shawn Donnan, “Green groups fear US U-turn on Pacific trade deal vows, article in the Financial Times.
Retrieved from: http://www.ft.com/cms/s/0/561715b0-7e14-11e3-b409-00144feabdc0.html.
42 Id.
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Environmental protection appears to be one of the main points of controversy in the TPP
negotiations. Reports suggest that the United States is facing strong opposition from other
TPP parties over the environment. Some countries are pressing to drop the US demand
that environmental-protection standards be legally enforceable through a dispute-
settlement mechanism.43 In addition, a consensus is still lacking on how to address
climate change, as well as whether environmental standards should be part of the treaty
text itself or put into a separate accord.
4. Labor
Vice President Joe Biden has said that the TPP and the other trade agreements that the
Obama administration is currently negotiating should “include unprecedented steps to
protect labor standards.”44 American negotiators have stated that they want the TPP to
lead to implementation and enforcement of the ILO’s Declaration on Fundamental
Principles and Rights at Work. The declaration is based on five different principles:
freedom of association, right to collective bargaining, a ban on forced labor, abolition of
child labor, and a ban on employment discrimination. A particularly contentious issue in
the negotiations is whether labor standard commitments should be subject to the dispute
settlement procedures of the overall TPP agreement. According to recent public
statements, some progress has been made with respect to “enforceable” labor standards,
but no clear consensus has so far emerged.45 The US initial summary of objectives
included these goals for labor provisions46:
Ensuring respect for worker rights is a core value. That is why in TPP the United
States is seeking to build on the strong labor provisions in the most recent U.S.
trade agreements by seeking enforceable rules that protect the rights of freedom of
association and collective bargaining; discourage trade in goods produced by
forced labor, including forced child labor; and establish mechanisms to monitor
and address labor concerns.
/…/
43 “The Trans-Pacific Partnership: Try Procrastination and Prevarication”, article in The Economist,
February 21, 2014. Retrieved from: http://www.economist.com/blogs/banyan/2014/02/trans-pacific-partnership.
44 Joe Biden, “We cannot afford to stand on the sidelines of trade”, article in the Financial Times, February
27, 2014. Retrieved from: http://www.ft.com/intl/cms/s/0/bde80c72-9fb0-11e3-b6c7-00144feab7de.html.
45 Shawn Donnan, “Obama presses for Pacific Rim trade deal”, article in the Financial Times, November
14, 2014. Retrieved from: http://www.ft.com/intl/cms/s/0/aa69f72e-68d1-11e4-af00-00144feabdc0.html.
46 Excerpt from USTR, TPP: Summary of US Objectives, available at: http://www.ustr.gov/tpp/Summary-of-US-objectives.
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Requirements to adhere to fundamental labor rights as recognized by the
International Labor Organization, as well as acceptable conditions of work,
subject to the same dispute settlement mechanism as other obligations in TPP;
Rules that will ensure that TPP countries do not waive or derogate from labor
laws in a manner that affects trade or investment, including in free trade zones,
and that they take initiatives to discourage trade in goods produced by forced
labor;
Formation of a consultative mechanism to develop specific steps to address labor
concerns when they arise; and
Establishment of a means for the public to raise concerns directly with TPP
governments if they believe a TPP country is not meeting its labor commitments,
and requirements that governments consider and respond to those concerns.
The AFL-CIO, America's largest trade-union group, has been pushing for a “strong labor
chapter” that stipulates enforceable labor standards, including “basic rights such as
freedom of association and collective bargaining.”47 In May 2014, some 150 Democratic
members of the House of Representatives wrote to Michael Froman, the United States
Representative, urging him to do more to promote labor standards in the TPP
negotiations. “In countries like Vietnam in which workers have faced extraordinary
abuses, there must be binding and enforceable plans to bring those countries’ laws and
practices into compliance with TPP labor requirements. Those plans must be made
public, and the changes to the laws and practices must be fully implemented, before
Congress takes up TPP for consideration,” the letter said.48 The members of Congress
also expressed concern with the lack of freedom of association in Brunei and lax
protection of labor unions in Mexico.
None of Vietnam’s existing trade agreements with other TPP parties include labor
provisions. The Vietnam Chamber of Commerce and Industry, which represents
Vietnamese businesses enterprises, has lamented that “Vietnam is not ready for such high
requirements on labor standards and implementation, which would increase costs for
entrepreneurs, risk workers’ unemployment, and have high implementation costs.”49
George Miller, a Democratic member of the House of Representatives, has questioned
whether Vietnam will be able to comply with the TPP commitments because evidence
47 “Labor Rights”, AFL-CIO publication. Available at: http://www.aflcio.org/Issues/Trade/Trans-Pacific-
Partnership-Free-Trade-Agreement-TPP/Labor-Rights.
48 “153 House Democrats to USTR Froman: Protect Workers’ Rights in TPP Negotiations”, publication on
Committee on Education and the Workforce, Democrats website. Available at:
http://democrats.edworkforce.house.gov/press-release/153-house-democrats-ustr-froman-protect-
workers%E2%80%99-rights-tpp-negotiations.
49 Nguyen Van Phu, “TPP is a remedy but of a different kind”, guest post from the Saigon Economic Times
on the Financial Times blog, October 10, 2013. Retrieved from: http://blogs.ft.com/beyond-brics/2013/10/10/guest-
post-tpp-is-a-remedy-but-of-a-different-kind/.
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suggests that many workers in Vietnam are “routinely denied basic labor standards.”50
Similarly, Khai Nguyen, a former senior research analyst at the World Bank and lecturer
at the School of the Advance International Studies of Johns Hopkins University, has said
that if negotiators keep pushing for strong labor provisions, “Vietnam will necessarily be
barred entry to the partnership.”51
Froman views the issue in a more positive light, asserting that because Vietnam takes part
in the TPP negotiations, there is a “mechanism to improve adherence to labor rights and
working conditions in Vietnam that would not exist otherwise.52”
Controversy also arose over whether Malaysia would receive an upgrade in its human-
trafficking status in the State Department’s Trafficking in Persons report so that it can
maintain its position in TPP negotiations.53 Senator Bob Menendez included a provision
into the trade bill renewing fast track authority to prohibit the executive from entering
into fast-tracked trade agreements with Tier 3 countries, and Malaysia had received a
downgrade to Tier 3 in 2014.54
5. State-Owned Enterprises
State-owned enterprises (SOEs) are an important part of the economies of several current
prospective TPP countries. The US seeks TPP rules to level the competitive playing field
between private businesses and SOEs and mitigate the market distortions caused by state-
owned firms’ structural advantages and government backing. Among current TPP
countries, Vietnam, Malaysia, Singapore, and Japan all have significant SOE sectors.
Current TPP countries are still debating the form and content of the SOE provisions.
These rules will have implications for the SOEs of potential future members and trading
partners, especially China.
50 Nguyen Van Phu, “TPP is a remedy but of a different kind”, guest post from the Saigon Economic Times
on the Financial Times blog, October 10, 2013. Retrieved from: http://blogs.ft.com/beyond-brics/2013/10/10/guest-
post-tpp-is-a-remedy-but-of-a-different-kind/.
51 Khai Nguyen, “Vietnam risks TPP slot on labor reality”, article in the Asia Times Online, March 6, 2014.
Retrieved from: http://www.atimes.com/atimes/Southeast_Asia/SEA-01-060314.html.
52 Nguyen Van Phu, “TPP is a remedy but of a different kind”, guest post from the Saigon Economic Times
on the Financial Times blog, October 10, 2013. Retrieved from: http://blogs.ft.com/beyond-brics/2013/10/10/guest-
post-tpp-is-a-remedy-but-of-a-different-kind/.
53 Howard LaFranchi, “Has US desire for Asia trade deal trumped slavery with Malaysia’s ranking?”,
article in the Christian Science Monitor, July 13, 2015. Retrieved from: http://www.csmonitor.com/USA/Foreign-
Policy/2015/0713/Has-US-desire-for-Asia-trade-deal-trumped-slavery-with-Malaysia-s-ranking.
54 Vicki Needham, “Menendez worried Obama will upgrade Malaysia in trafficking report”, article in The
Hill, July 8, 2015. Retrieved from: http://www.csmonitor.com/USA/Foreign-Policy/2015/0713/Has-US-desire-for-
Asia-trade-deal-trumped-slavery-with-Malaysia-s-ranking.
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C. Relationship to China
Although China is not participating directly in the TPP negotiations, similar issues are the
subject of ongoing bilateral talks between the US and China in the Strategic Economic
Dialogue and the Bilateral Negotiations on an Investment Treaty. Many of the same
issues as well as other matters are also on the agenda in the talks on a Regional
Comprehensive Economic Partnership (RCEP). The TPP countries plus South Korea
account for the majority of all Chinese merchandise exports and close to half of all its
imports. If the US and China make progress on TPP and the issues in the forefront of
their bilateral relationship and China makes progress on RCEP, these complementary
agreements could become the foundation of an Asia-Pacific pact including almost all
countries in the region. 55 Wang Shouwen, China’s deputy trade minister, has described
the TPP and the RCEP as “two wheels of a bicycle.”56
55
“Free-trade pacts: America’s big bet”, article in The Economist, November 15, 2014. Retrieved from:
http://www.economist.com/news/special-report/21631797-america-needs-push-free-trade-pact-pacific-more-vigorously-americas-big-bet. 56 Id.
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Trade Background Reading
1. Jeffrey J. Schott, Barbara Kotschwar & Julia Muir, Peterson Institute for International
Economics, Understanding the Trans-Pacific Partnership (2013).
2. Ian F. Fergusson et al., Congressional Research Service, The Trans-Pacific Partnership
(TPP) Negotiations and Issues for Congress (2015).
http://fas.org/sgp/crs/row/R42694.pdf.
3. The Economist, Free-trade pacts: America’s big bet (2014).
http://www.economist.com/news/special-report/21631797-america-needs-push-free-
trade-pact-pacific-more-vigorously-americas-big-bet
4. William F. Jasper, “Globalists Now Pushing To Bring China Into TPP” (publication
on The New American, June 29, 2015).
http://www.thenewamerican.com/usnews/foreign-policy/item/21156-globalists-now-
pushing-to-bring-china-into-tpp
5. Noah Feldman, “China’s the reason why U.S. needs the TPP” (editorial in The Japan
Times, June 21, 2015).
http://www.japantimes.co.jp/opinion/2015/06/21/commentary/japan-
commentary/chinas-the-reason-why-u-s-needs-the-tpp/#.Va_1uKPD9Hg
6. Rosa DeLauro, DeLauro, Miller Lead 151 House Dems Telling President They Will Not
Support Outdated Fast Track for Trans-Pacific Partnership (2013).
http://delauro.house.gov/index.php?option=com_content&view=article&id=1455:delauro
-miller-lead-151-house-dems-telling-president-they-will-not-support-outdated-fast-track-
for-trans-pacific-partnership&Itemid=21
7. Excerpt from 2015 Taiwan White Paper, “Taiwan and the TPP: the Time is Now”
(AmCham publication, June 5, 2015).
http://www.amcham.com.tw/topics/2015/06/2015-taiwan-white-paper/
8. USTR, TPP: Summary of US Objectives
http://www.ustr.gov/tpp/Summary-of-US-objectives
9. USTR, TPP Trade Minister’s Report to Leaders, Nov. 10, 2014
http://www.ustr.gov/about-us/press-office/press-releases/2014/November/Trans-Pacific-
Partnership-Trade-Ministers-Report-to-Leaders
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INTERNATIONAL CORRUPTION *
A. Introduction
Anti-corruption legislation is one of the foremost areas in which the US has come to aggressively
assert its jurisdiction across transnational lines. The US Foreign Corrupt Practices Act (FCPA),
enacted in 1977, is one of the strongest codified bodies of law on foreign corruption. The FCPA
imposes criminal penalties on US companies and foreign issuers of US stock that bribe foreign
government officials, thus exporting US legal standards to foreign countries that often have
different business cultures and practices. Since the mid-1970s, US businesses have complained
that the FCPA puts them at a disadvantage in many foreign markets, where competitors face
fewer legal constraints and may engage in questionable business practices (e.g., bribery) that are
prohibited under US law. Multinational corporations face a complicated legal landscape, in
which aggressive extraterritorial enforcement of the FCPA overlaps with a growing body of
foreign anti-corruption laws. This case explores the issues confronting multinational companies
that are subject both to the reality of corruption in many markets and to a range of anticorruption
enforcement risks.
The case uses Siemens AG and its related companies’ long record of FCPA violations to explore
the challenge of doing business in countries where corruption is common. We will examine how
a company arrives at an anti-corruption policy, how it seeks to achieve compliance with that
policy, what it needs to do in the face of red flags, and how it should respond to an FCPA
investigation.
The readings provide facts for discussion of other aspects of international corruption: the
Walmart bribery scandal raises issues about the role of inside lawyers; JP Morgan and
GlaxoSmithKline raise further nuances of foreign bribery issues; the virtues of a strong
compliance program are illustrated by a case involving Morgan Stanley where an officer was
indicted but the company was given a pass; Enron’s response to Sherron Watkins reveals issues
related to corporate whistleblowers.
*Note: The following Siemens chronology and much of the reading list for this case was
prepared by Ben W. Heineman, Jr, Michael Solender, and David Wilkins for their Seminar on
“Challenges of the General Counsel: Lawyer as Leader” which has been offered by them at
Harvard Law School and by Messrs. Heineman and Solender at Yale Law School. I thank them
for giving me permission to use these materials for this case.
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B. Siemens Chronology
Post WWII – Siemens has difficulty competing for business in many Western countries and seeks opportunities in certain less developed countries where corruption is more common.
Pre-1999 – Bribery at Siemens companies is largely unregulated. German law does not prohibit foreign bribery and allows tax deductions for bribes paid in foreign countries. Company not listed on U.S. stock exchange and thus not subject to U.S. regulation. Uses cash and off-books accounts to make payments as necessary to win business. Uses network of payment mechanisms to funnel money via third parties in a way that obscures purpose and ultimate recipient of funds.
1998-2004 – A Siemens company pays over $40 million in bribes to senior officials in government of Argentina to secure project to produce national identity cards.
2/15/1999 – German law implementing Organization for Economic Cooperation and Development (OECD) Convention on Combating Bribery of Foreign Public Officials in International Business Transactions comes into force.
3/1999 – Policy circulated reminding employees of general need to observe laws and regulations.
2000-2002 -- Siemens companies awarded 42 contracts under Iraqi Oil for Food Program, for which they pay $1,736,076 in kickbacks to the Iraqi government.
2000-2002 – A Siemens company pays more than $5 million in bribes through consultants in Bangladesh in connection with communication projects.
4/25/2000 – Managing board rejects proposal by the general counsel to create a company-wide list of business consultants and a committee to review these relationships.
6/2000 – Legal department forwards memo to supervisory board chairman and CFO identifying certain off-book accounts and saying they had to be maintained “in harmony with principles of orderly accounting.” Identifies three bank accounts in Switzerland which are run as trust accounts and for which confiscation was ordered by the Swiss courts. CFO does not respond.
7/5/2000 – Circular issued requiring operating Siemens groups and regional companies to include anti-corruption clause in all contracts with third parties, e.g., agents, consultants, brokers.
2001-2007 – Siemens companies pay estimated $16.7 million in bribes to Venezuelan government officials in connection with the construction of metro transit systems in the cities of Valencia and Maracaibo.
3/12/2001 – Company lists on New York Stock Exchange.
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7/2001 – Company establishes position of corporate officer for compliance and expands existing antitrust compliance system to cover anti-corruption issues. Officer works part-time on compliance, and until 2004, has a staff of just two lawyers.
7/18/2001 – Company issues business conduct guidelines that say: “No employee may directly or indirectly offer or grant unjustified advantages to others in connection with business dealings, neither in monetary form nor as some other advantage.” Also provides that gifts to business partners should “avoid the appearance of bad faith or impropriety” and no gifts should be made to public officials or other civil servants.
2002-2003 – A Siemens company pays approximately $25 million in bribes funneled through intermediaries to government customers in connection with two projects for installation of high voltage transmission lines in South China.
2002-2005 – A Siemens company pays approximately $30 million in bribes to a former director of the state-owned Israel Electric Company in connection with four contracts to build and service power plants. Payments made through a “consultant” which turned out to be a Hong Kong-based clothing company with no expertise in power generation.
2002-2007 – A Siemens company pays approximately $22 million to business consultants who use some portion of the funds to bribe officials in connection with seven projects for the construction of metro trains and signaling devices on behalf of government customers in China.
6/13/2002 – Company issues principles and recommendations, not mandatory policies, regarding business-related internal controls and agreements with business consultants, including that such agreements should be in writing, transparent, and as detailed as possible. Contains no discussion of how to conduct due diligence on consultants or agents.
2003-2007 – A Siemens division pays approximately $14.4 million in bribes to an intermediary in connection with sales of medical equipment to five Chinese-owned hospitals, as well as to fund lavish trips for Chinese doctors.
7/2003 – News media reports that prosecutors in Milan are investigating bribes paid to energy company partly owned by Italian government in connection with two power plant projects. Siemens managers made €6 million payments to officials through slush funds in Liechtenstein using a Dubai-based business consultant.
9/9/2003 – U.S. law firm submits memo to company concluding that there is ample basis for either the SEC or DOJ to start at least an informal investigation of the company’s role in the Italian energy matter and that the U.S. government would expect an internal investigation to be carried out on behalf of senior management.
10/2003 – Outside auditor KPMG identifies and flags for review €4.12 million in cash that was brought to Nigeria by the communications business group. Compliance attorney at the Company conducts a one-day investigation and writes a report indicating that communications employees admitted the payments were not an isolated event and warned of numerous violations of the law.
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11/2003 – CFO reviews compliance report on Nigerian cash, but no further action is taken. Bribes continue to be paid until employees arrested in November 2006.
11/2003 – To comply w/ Sarbanes Oxley, company issues Code of Ethics for Financial Matters.
11/2003 – Compliance officer drafts memo describing deficiencies in compliance organization which is forwarded to officers of company.
2004 – Corporate finance audit employee raises concerns about use of intercompany accounts. He is phased out of his job.
2004-2006 – A Siemens division pays approximately $5.3 million in bribes through business consultants to government officials in Bangladesh in connection with a contract with the country’s telegraph & telephone board.
4/24/2004 – Judge in Milan issues written opinion concluding that company viewed bribery as “at least a possible business strategy.” Liechtenstein and Emirates bank accounts had been “disguised deliberately.” Legal memo about ruling sent to managing board, which included CEO and CFO, on 5/4/2004. Company and its managers enter into plea bargain with criminal authorities in Italy and pay €0.5 million fine and disgorge €6.2 million in profits.
7/2004 – CFO delivers anti-bribery speech to high level business managers.
8/4/2004 – Company promulgates its first company-wide policy on use of bank accounts and external payment orders, restricts bank accounts controlled by employees and third parties.
6/29/2005 – Company issues mandatory rules governing use of consultants, prohibiting success fees and requiring compliance officers to sign off on business consulting arrangements.
3/2006 – Siemens Greece manager admits €37 million “bonus payments” to government officials.
4/2006 – KPMG audit identifies over 250 suspicious payments made through an intermediary.
11/2006 – Criminal authorities raid company offices in Munich.
Siemens engages Davis Polk to represent the company and Debevoise & Plimpton to conduct an independent investigation for the audit committee. Debevoise hires Deloitte & Touche, translators, computer experts, litigation support firms, and other third parties to assist in the investigation. Investigation will be extensive and unimpeded. Government will give company credit for cooperation. Nearly all senior management, including chair of supervisory board, CEO, GC, head of internal audit, and chief compliance officer, are replaced. New position created on board with specific
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responsibility for legal and compliance matters. FCPA compliance training implemented.
10/31/2007 to 2/29/2008 – Company-wide amnesty program underway. Senior employees who voluntarily disclose to Debevoise truthful and complete information about possible violations will be protected from unilateral employment termination and company claims for damages. Not binding on prosecutors or regulators. Company would bring employee to the attention of authorities if subject of a government investigation.
10/2007 – In connection with charges relating to corrupt payments to foreign officials by Siemens’s telecommunications operating group, the Munich Public Prosecutor’s Office announces a settlement with Siemens under which the company agrees to pay €201 million, or $287 million, including a €1 million fine and €200 million in disgorgement of profits.
12/15/2008 – Siemens and three of its subsidiaries plead guilty to violations of the FCPA. As part of the plea agreements, Siemens agrees to pay a $448.5 million fine; and Siemens Argentina, Bangladesh, and Venezuela each agree to pay a $500,000 fine, for a combined total criminal fine of $450 million. Siemens agrees to retain an independent compliance monitor for a four-year period to oversee the continued implementation and maintenance of a robust compliance program and to make reports to the company and the Department of Justice.
Siemens reaches a settlement with the SEC, charging the company with violating the FCPA’s anti-bribery, books and records, and internal controls provisions and agrees to pay $350 million in disgorgement of profits.
Siemens agrees to resolve the investigation by the Munich Public Prosecutor’s Office of Siemens operating groups other than the telecommunications group and agrees to pay €395 million or approximately $569 million, including a €250,000 corporate fine and €394.75 million in disgorgement of profits.
Siemens has paid a combined total of more than $1.6 billion in fines, penalties and disgorgement of profits, including $800 million to U.S. authorities, making the combined U.S. penalties the largest monetary sanction ever imposed in an FCPA case since the act was passed by Congress in 1977. Siemens also incurred $800 million in forensic costs to investigate itself across the globe. It had to restate more than $500 million loses for bribes that had been improperly booked as business expenses. The cost of “in kind” time and resources is large, but incalculable.
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International Corruption Discussion Questions
1. Why should the US be able to regulate business activities in other countries?
2. Does it make sense to prevent US companies from entertaining foreign government
officials when that is common practice in the local market and the company's competitors
are not bound by such restrictions? If, in the short term, such rules put US companies at a
competitive disadvantage, what is the long term goal of such policies? Are such goals
realistic?
3. What are other examples of legal restrictions on US companies that put them at a
competitive disadvantage with foreign companies? Have such restrictions proved
beneficial to US companies and/or the United States as a whole in the long run?
Consider sanctions regimes, e.g., against apartheid-era South Africa.
4. Should it make a difference whether the government official who is receiving the lavish
entertainment is functioning in a regulatory or commercial capacity?
5. Should it make a difference if the company can prove it simply cannot compete in a
particular market without making these kind of payments?
6. Should the US Justice Department care whether the company is paying police officers
and customs officials in Saudi Arabia to do their job?
7. Should the Justice Department be encouraging in-house lawyers to act as whistleblowers?
Why or why not?
8. What are the options of a company with an employee who is about to be disciplined for
legitimate reasons, but then threatens to become a whistleblower?
9. Consider the criticism that the FCPA is really just a licensing fee. If company X engages
in bribes and gets enough contracts to drive out local competition in a market and
becomes the dominant player as a result, it well be much better off having done so and
paying tens or even hundreds of millions of dollars to achieve that market position. What
should regulators and prosecutors do in those situations to deter future similar conduct?
10. What were the major FCPA violations and compliance program failings of Credit Suisse?
What aspects of a “model” compliance program were missing?
11. What are the most significant adverse impacts of this kind of corruption scandal on a
multinational corporation like Credit Suisse? Fire top officers? Internal time/resources?
Fines/penalties? Forensic investigatory costs? Lost business? Reputation?
12. Must (or should) the company investigate other markets once evidence appears of
systematic bribing in a single market? Consider the implications of investigations
spreading from one jurisdiction to another, e.g., with GlaxoSmithKline.
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13. What was the value in legal proceedings: (a) to Siemens of its effort to investigate its
bribery around the globe starting in 2006; (b) to Morgan Stanley in having a robust anti-
bribery compliance program?
14. How does the current landscape of anti-corruption legislation (FCPA, UK Bribery Act,
OECD Convention) encourage/discourage fair competition among corporations? What
are the pros and cons of the United States binding its corporations to laws like the FCPA
that do not apply to foreign corporations?
15. Which anti-corruption statute (FCPA, UK Bribery Act, OECD Convention) best balances
corporate incentives and regulatory/social policy goals? In light of the different
consideration given to an MNC’s internal compliance program under the FCPA and the
UKBA, consider the pros and cons of adopting some form of compliance defense—e.g.,
should compliance procedures be a factor in determining a corporation’s liability, or
should they be relevant only at the sentencing phase?
16. In situations in foreign markets where bribery is covered by the FCPA but competitors
are routinely bribing to get business, should a company engage in a calculus that weighs
the benefit of obtaining the business against the probability of such bribery being
uncovered and the costs to the company if the bribery is uncovered? Why not bribe if
the commercial benefits outweigh the compliance costs?
17. If bribery is not covered by the FCPA—either in public settings where certain elements
are not satisfied or in purely private settings—should a company engage in such activity
in corrupt nations where competitors are bribing officials to win orders? What are: (a)
other legal considerations; (b) ethical considerations relating to the internal operation of
the company and effect on corporate culture; (c) public policy considerations relating to
the developing nation. If corruption is rampant, is withdrawal from a country necessary?
18. Should a company prohibit facilitating payments—payments in a foreign country to
induce an official to carry out a ministerial duty—that are lawful under the FCPA but
may be illegal, if unenforced, under the laws of the foreign nation?
19. If you were the CEO, General Counsel or a Director of Siemens, what would you do to
prevent, deter, detect, and sanction future violations of anti-bribery laws and regulations?
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International Corruption Background Reading
Anti-Corruption Legislation: FCPA
1. DOJ Criminal Division and SEC Enforcement Division, A Resource Guide to the U.S.
Foreign Corrupt Practices Act, (Nov. 14, 2012), pp. 2-19, 23-26, 38-45, 68-69, 82-83,
http://www.justice.gov/criminal/fraud/fcpa/guide.pdf.
Anti-Corruption Legislation: UK Anti-Bribery Act 2010
2. U.K. Ministry of Justice, Bribery Act 2010: Guidance (2011), pp. 1-31,
http://www.justice.gov.uk/downloads/legislation/bribery-act-2010-guidance.pdf.
3. A Tale of Two Laws, Economist, Sept. 17, 2011,
http://www.economist.com/node/21529103.
Global Anti-Corruption Enforcement and Compliance
4. Robb Adkins, Benjamin Kimberley, “The Globalization of Anti-Corruption Enforcement:
Recent Trends and Developments,” International White Collar Enforcement, 2014
Edition (Aspatore 2014), 2014 WL 10502. [see attached PDF]
Enforcement Trends
5. David M. Zornow, et al., The United States Foreign Corrupt Practices Act: SEC and
DOJ Enforcement Trends, Skadden, Arps Memorandum, April 22, 2013, pp. 8-11,
http://www.law.yale.edu/documents/pdf/cbl/Skadden_FCPA_SEC_and_DOJ_Enforceme
nt_Trends.pdf.
6. 2014 Year-End FCPA Update, Gibson, Dunn Memorandum, Jan. 5, 2015, pp. 2-7,
http://www.gibsondunn.com/publications/Documents/2013-Year-End-FCPA-Update.pdf.
7. FCPA Digest: Recent Trends and Patterns in FCPA Enforcement, Shearman & Sterling
Memorandum, Jan. 2014, pp. 1-6, http://www.shearman.com/~/media/Files/Services/FCPA/2014/FCPADigestTPFCPA010614.pdf.
8. RAND Center for Corporate Ethics and Governance, New Markets, New Challenges:
Dealing with Anti-Corruption Regulation in Emerging and Expeditionary Markets, Conference Proceedings (Jan. 12, 2012), pp. iii, 5-10, 15-20, http://www.rand.org/content/dam/rand/pubs/conf_proceedings/2012/RAND_CF304.pdf.
9. Ashby Jones, FCPA: Company Costs Mount for Fighting Corruption, Wall St. J., Oct.
12, 2012,
http://online.wsj.com/news/articles/SB10000872396390444752504578024893988048764
.
10. Ashby Jones, Extradition is Hurdle in FCPA Prosecutions, Wall St. J., Oct. 2 2012,
http://online.wsj.com/articles/SB10000872396390444004704578028430536186670.
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11. Samuel Rubenfeld, Small Bribes, Big Problems: What’s a Company to Do?, Wall St. J.,
June 27, 2014, http://blogs.wsj.com/riskandcompliance/2014/06/27/small-bribes-big-
problems-whats-a-company-to-do-to-stop-them/.
12. Samuel Rubenfeld, New Corruption Laws May Level the Field for US Business, Wall St.
J., March 15, 2013, http://blogs.wsj.com/corruption-currents/2013/03/15/new-corruption-
laws-may-level-the-field-for-us-business/.
13. U.S. Chamber Institute for Legal Reform, Comments on FCPA Guidance, 2013,
http://www.instituteforlegalreform.com/uploads/sites/1/Coalition_Letter_to_DOJ_and_S
EC_re_Guidance_2-19-13.pdf.
Walmart: Mexico Bribery and Cover-up
14. David Barstow, Vast Mexican Bribery Case Hushed Up By Walmart After Top-Level
Struggle, N.Y. Times, April 21, 2012, http://www.nytimes.com/2012/04/22/business/at-
wal-mart-in-mexico-a-bribe-inquiry-silenced.html?_r=3&.
15. Elizabeth A. Harris, After Bribery Scandal, High-Level Departures at Walmart, N.Y.
Times, June 4, 2014, http://www.nytimes.com/2014/06/05/business/after-walmart-bribery-scandals-a-pattern-of-quiet-departures.html?rref=business&module=Ribbon&version=context®ion=Header&action=click&contentCollection=Business%20Day&pgtype=Blogs&_r=0.
16. Ben W. Heineman, Jr., “Who’s Responsible for the Walmart Mexico Scandal?”, Harvard
Business Review, May 15, 2014, http://blogs.hbr.org/2014/05/whos-responsible-for-the-
walmart-mexico-scandal/.
17. Ben W. Heineman, Jr., “Walmart Bribery Case Raises Fundamental Governance
Issues,” Harvard Law School Forum on Corporate Governance and Financial Regulation (2012), http://blogs.law.harvard.edu/corpgov/2012/04/28/wal-mart-bribery-case-raises-fundamental-governance-issues/.
18. Ben W. Heineman, Jr., “News Corp, Walmart and CEO Failure to Investigate Wrong-
Doing,” Harvard Business Review (2012),
http://www.law.harvard.edu/programs/corp_gov/articles/Heineman_HBR_05-04-12.pdf.
JP Morgan: Asia Hiring
19. Ben Protess and Jessica Silver-Greenberg, Chinese Official Made Job Plea to JPMorgan
Chase Chief, N.Y. Times, Feb. 9, 2014, http://dealbook.nytimes.com/2014/02/09/chinese-
official-made-job-plea-to-jpmorgan-chase-chief/.
20. Aruna Viswanatha, U.S. expanding corporate foreign bribery probes to include hiring,
Reuters, April 25, 2014, http://www.reuters.com/article/2014/04/25/us-usa-corruption-
hiring-idUSBREA3O25Z20140425.
21. Ben Protess and Jessica Silver-Greenberg, On Defensive, JPMorgan Hired China’s Elite,
N.Y. Times, Dec. 29, 2013, http://dealbook.nytimes.com/2013/12/29/on-defensive-
jpmorgan-hired-chinas-elite/.
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GlaxoSmithKline: China Bribery
22. Chad Bray, GlaxoSmithKline Under Investigation by Serious Fraud Office, N.Y. Times,
May 28, 2014,
http://www.nytimes.com/2014/05/29/business/international/glaxosmithkline-under-
investigation-by-serious-fraud-office.html.
23. David Barboza and Katie Thomas, Former Head of Glaxo in China Is Accused of
Bribery, N.Y. Times, May 13, 2014,
http://www.nytimes.com/2014/05/15/business/international/glaxosmithkline-china.html.
24. Robert Radick, The Glaxo-China Bribery Scandal: A New Policeman Walks the Beat,
Forbes, July 25, 2013, http://www.forbes.com/sites/insider/2013/07/25/the-glaxo-china-
bribery-scandal-a-new-policeman-walks-the-beat/
Morgan Stanley: Robust Compliance Program
25. Amy Conway-Hatcher, “The Big Three FCPA Lessons from the Morgan Stanley Case,”
Corporate Counsel (2012). [see attached PDF]
Enron: Whistleblowers
26. Neal Batson, Final Report of Court Appointed Examiner in Enron Bankruptcy Case, pp.
6-13, 48-55, http://www.concernedshareholders.com/CCS_ENRON_Report.pdf.
27. Peter Lattman, The Vinson & Elkins Enron Connection: The Plot Thickens, Wall St. J.,
June 1, 2006, http://blogs.wsj.com/law/2006/06/01/the-vinson-elkins-enron-connection-
the-plot-thickens/.
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FINANCIAL CRISIS
I. Introduction
The financial crisis began in the summer of 2007 with the “bursting” of the U.S. housing bubble.i
While many believed it would remain confined to the U.S. mortgage market, by 2008, it had
turned into a full-fledged financial crisis that froze up credit markets around the world and
threatened the global financial system.ii Former Federal Reserve Board Chairman Ben Bernanke
described it as “the worst financial crisis in global history, including the Great Depression,” and
former Treasury Secretary Timothy Geithner described the economy as essentially “in free
fall.”iii By 2009, the world economy had entered a global recession, the “deepest post-WWII
recession by far.”iv
II. Background
A. The Subprime Mortgage Crisis
The U.S. housing bubble began with the market for mortgage loans made to “sub-prime,” or low-
income, borrowers, which boomed between 2001 and 2006. Innovations in securitization, easy
access to credit, sometimes without customary evidence of income, credit balance practices and
speculative bursts of investments in additional homes, especially in resort communities, helped
spin a run-up in housing prices, allowing people to buy houses at prices they might not have
previously thought they could handle. Many of these borrowers, however, depended on loans
with variable interest rates and low initial “teaser” rates. When it came time to reset the loans,
rising interest rates and a weakening economy made it difficult for them to meet their mortgage
obligations.v This inability to pay, combined with a general decline in housing prices, led to the
“bursting” of the housing bubble in 2007vi, and the recession that followed depressed the ability
to meet housing and other obligations for millions of homeowners.
The financial innovations that had facilitated easy credit for subprime borrowers were the same
financial innovations that also served to spread the risks associated with these subprime loans
globally. Securitization of mortgages allowed trillions of dollars in risky mortgages to become
embedded throughout the financial system through pooled mortgage securities, largely in the
form of collateralized debt obligations (CDOs).vii The CDO market grew from $275 billion in
2000 to $4.7 trillion by 2006.viii At the same time, the spread of credit default swaps (CDS)
allowed investors to hedge against the risk of nonpayment, and these CDS were then traded on
secondary markets. In 2001, the notional value of CDS outstanding was $919 billion; by the end
of 2007, CDS volume was $62 trillion. Moreover, derivative dealer banks had moved from using
CDS to hedge against the risk of nonpayment on their investments to pure betting on the
likelihood of default. In 2008, about 80 percent of CDS outstanding were “naked”—that is, pure
financial bets. The widespread use of mortgage-backed securities and their transformation into
credit default swaps thus served to magnify greatly the underlying mortgage risk represented by
a declining housing market.ix
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The “burst” of the bubble—the realization by market participants that subprime mortgages and
then certain other credits like credit card obligations, student loans, car loans and long term
consumer loans were seriously deficient in their underwriting and disclosures, combined with the
decline in housing prices—led financial institutions to suffer large credit losses that were
increasing at a rate that made projected reserves required to cover losses difficult to assess
accurately.x In October 2007, at the Economic Club of New York, Federal Reserve Chairman
Ben Bernanke warned of a weakness in structured financial products, namely the difficulty in
coming up with valuations in periods of stress, and joked that he wanted to know “what those
damn things are worth.”xi Moreover, the most widely-used financial modeling formulas—used
by everybody from bond investors and Wall Street banks to ratings agencies and regulators—
began to fail when markets during 2008 and 2009 began behaving in ways nobody expected,
with losses far in excess of the most severe stress assumptions.xii
B. Spillover Effects
The financial crisis quickly evolved into an economic recession, highlighting the extent of the
integration of the housing market into the regular economy. U.S. gross domestic product (GDP)
contracted by 0.3 percent in 2008 and 3.5 percent in 2009, before growing again by 3.0 percent
in 2010 and 1.7 percent in 2011.xiii Low consumer spending—due to the huge decrease in
household wealth, followed by heightened insecurity and tighter lending standards—slowed
significantly the recovery, which took place at less than half the average rate exhibited during
other recoveries in the United States since the end of World War II.xiv
The crisis also spilled over into other markets, as both international and local financial
institutions and investors around the globe discovered they had significant exposure to the U.S.
subprime market and actively used short-term wholesale funding markets.xv The effects were
exacerbated by the excessive rise of short term funding to cover longer duration liabilities. In
turn these developments spread the recession to other countries creating a vicious cycle of
adverse economic consequences to households and businesses. Many of the factors that led to the
U.S. subprime crisis were present in other advanced economies, including, for example, home-
grown real estate bubbles in many European countries and elsewhere.xvi Furthermore, as
advanced economies suffered, their trading partners—including the export-driven economies of
Asia and the more commodity-based economies of Africa and Latin America—were also hit
hard.xvii The global effects of the crisis prompted a global policy response, notably through the
G-20 and the Financial Stability Board (FSB), which have assumed more responsibility for
coordinating international financial policy reform.xviii
C. U.S. Government Response
As rumors of Bear Stearns’ weakness—due to its large exposure to the U.S. mortgage market—
spread through the end of 2007 and beginning of 2008, its stock plummeted and creditors refused
to roll over maturing credits, beginning a true run on the bank. By the night of March 14, 2008,
Secretary of the Treasury Paulson and then-President of the Federal Reserve Bank of New York
Geithner told CEO Alan Schwartz that he had to make a deal to be taken over. Bear agreed to be
taken over by JPMorgan, facilitated by significant assistance by the Federal Reserve Board,
which agreed to loan JPMorgan $30 billion to fund Bear’s assets.xix This rescue of Bear Stearns
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represented the first time in history that the Federal Reserve had helped to rescue an investment
bank;xx Federal Reserve Chairman Bernanke defended the move—which was authorized under
the Fed’s emergency lending authority—on the grounds that “the sudden failure of Bear Stearns
likely would have led to a chaotic unwinding of positions . . . and could have severely shaken
confidence” in U.S. financial markets.xxi
Around the same time, Fannie Mae and Freddie Mac, the two government-sponsored enterprises
that held or guaranteed more than $5 trillion in U.S. mortgage debt, were headed for failure. In
July 2008, Congress passed the Housing and Economic Recovery Act, giving the Treasury
Department “almost unlimited authority” to inject capital into Fannie and Freddie, as well as
giving the newly-christened Federal Housing Finance Agency (FHFA) authority to take them
over.xxii By the morning of September 8, the FHFA had forced Fannie and Freddie into
conservatorship and replaced the CEOs, while the Treasury Department had committed up to
$200 billion in government capital to prevent them from defaulting.xxiii
The Fannie and Freddie rescues were not sufficient to ease investor fears, and the next weakest
of the large investment banks, Lehman Brothers, was on the brink of failure. Geithner and
Paulson tried to facilitate an acquisition by Bank of America or Barclays, but Paulson made clear
that the government would not subsidize a purchase like it had for Bear.xxiv To the surprise of
many—including Lehman’s CEO Dick Fuld—the Fed and the Treasury Department refused to
supply credit support, the British regulators refused to approve an acquisition by Barclays, and
Lehman filed for Chapter 11 bankruptcy protection on September 15, 2008, the biggest
bankruptcy filing in U.S. history.xxv
Two days after Lehman declared bankruptcy, the Fed did provide funding to avert a bankruptcy
of AIGxxvi without private sector support, lending up to $85 billion in exchange for what was
effectively a 79.9% equity stake in the giant insurance company.xxvii This seeming about-face
was widely understood to be a result of fear that AIG actually was so interconnected with
virtually every major financial institution in the world that it’s collapse would lead to a
disastrous string of failures in the global system.xxviii
That same day, the Reserve Primary Fund—a money market fund that had heavily invested in
Lehman commercial paper—“broke the buck,” casting suspicion on all money market funds,xxix
creating an even more intense liquidity crisis for financial institutions, and forcing the Treasury
Department to guarantee all investors’ account balances in MMFs for a year.xxx This guarantee
helped prevent other funds from “breaking the buck”, although it did not solve the risk of similar
runs by counterparties or of runs on other stand-alone investment banks, such as Merrill Lynch,
Morgan Stanley, and Goldman Sachs,xxxi which were heavily reliant on short-term funding
markets, including commercial paper and money market funds, and the growing threat to the
stability of even larger banks like Citigroup, Bank of America, JP Morgan Chase and Wells
Fargo.xxxii The Fed and Treasury officials agreed to convert Morgan Stanley and Goldman Sachs
into bank holding companies, which would give them the umbrella of Fed protection, so long as
they raised the requisite amount of capital.xxxiii The Fed and Treasury were not able to arrange a
merger of Goldman Sachs or Morgan Stanley with one of the universal banks, but GS received a
capital infusion from Warren Buffet’s Berkshire Hathaway, and Morgan Stanley succeeded in
arranging a capital investment by the Mitsubishi Group.
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On October 3, 2008, President Bush signed the Emergency Economic Stabilization Act (passed,
again, by a Democratic-controlled Congress), which provided for the injection of up to $700
billion in government funds into financial institutions through the Troubled Assets Relief
Program (TARP).xxxiv Treasury used TARP to inject capital into nine “systemically important”
financial institutions—Citigroup, Bank of America, JP Morgan, Wells Fargo, Goldman Sachs,
Morgan Stanley, State Street, Bank of New York Mellon, and Merrill Lynch. Citi received $25
billion from TARP in October 2008; $20 billion in November 2008; and a capital boost through
the conversion of preferred into common shares in February 2009.xxxv On December 19, 2008,
the Treasury used TARP funds to bail out the auto industry, through a $13.4 billion loan to
General Motors and a $4.0 billion loan to Chrysler.xxxvi
The Treasury Department finished exiting its TARP investment in Citigroup in January 2011,
realizing a $12.3 billion profit.xxxvii In December 2012, the Treasury Department announced the
sale of its final shares of AIG common stock,xxxviii yielding an overall positive return of $22.7
billion on the Federal Reserve and Treasury’s combined $182 billion commitment to AIG.xxxix
While the Treasury Department has recouped much of its investment in the auto industry, unlike
the bank and AIG investments, the TARP auto industry bailout will likely remain a net cost to
the government.xl Nevertheless, the estimated cost of TARP in August 2009 was $341 billion; by
2014, the estimated cost had decreased to $27 billion.xli
III. Reform
In the wake of the financial crisis, arguably the leading item on the list of reform issues was
correcting the notion that certain institutions that were “too big to fail,” or “too interconnected to
fail.”xlii The U.S. reform effort—primarily through the Dodd-Frank Wall Street Reform and
Consumer Protection Act of 2010—sought to fix this through a variety of means: boosting
capital and liquidity requirements so that financial institutions are less leveraged and less prone
to liquidity crunches; banning proprietary trading and certain principal investing and
management of prime equity and real estate funds; and devising plans to allow an institution to
fail, but to ensure that it happens in an organized manner rather than the chaotic global
bankruptcy process of Lehman.xliii The U.S. reforms largely track the global reform effort, not
coincidentally, as finance ministries, central bankers, and regulators around the world have
undertaken a sweeping and ambitious coordinated reform effort in this area over the past several
years. In addition, the reform effort has taken note of and sought to change practices related to
compensation and recruitment in the financial industry, as well as consumer protections, and
enhanced research on data collection in Treasury so it will have the data on capital, investment
and risk across all participants in the financial system.
A. Systemic risk regulation
The financial crisis exposed, among other things, the degree of complexity and
interconnectedness of the global financial system, and the dangers resulting therefrom—namely,
that one triggering event, such as the failure of a large financial firm, could provoke a liquidity
shock that would seriously impair financial markets and harm the broader economy.xliv
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In the United States, the Dodd-Frank Act created a new regulatory body—the Financial Stability
Oversight Council (FSOC)—charged with identifying risks to the financial stability of the United
States; promoting market discipline; and responding to emerging risks to the stability of the
financial system.xlv Under the new regulatory regime, bank holding companies with $50 billion
or more in assets are considered Systemically Important Financial Institutions (SIFIs) and subject
to enhanced prudential standards. In addition, FSOC has the authority to classify nonbank
financial companies as “nonbank SIFIs” and subject them to supervision by the Federal Reserve
based on a finding that their material financial distress—or the nature, scope, size, scale,
concentration, interconnectedness, or mix of their activities—could pose a threat to U.S.
financial stability.xlvi The FSOC have designated certain non-banks as systemically stringent,
including GE, Prudential Financial, AIG and Met Life.
In addition to this new regulatory mandate in the United States, governments around the world
sought to coordinate action related to systemic risk, including through the adoption by the Basel
Committee on Banking Supervision (BCBS) of higher capital requirements for global
systemically important banks (G-SIBs) (discussed in more detail below).xlvii The Basel
Committee put forth a number of other initiatives designed to mitigate systemic risk, including
countercyclical capital buffers, liquidity requirements, increased capital charges for exposures to
large financial institutions, large exposure rules, and deductions from capital for equity
investments in banks.xlviii The G-20 is also working to reduce risk in OTC derivatives markets by
enacting reforms to improve transparency and decrease counterparty exposures among market
participants, including through mandated central clearing for standardized OTC derivatives, and
setting new standards for margin requirements on non-centrally-cleared derivatives.xlix
B. Capital and liquidity
The crisis also revealed the fact that banks and other financial institutions had been allowed to
operate with too much leverage and too little capital.l After the crisis, there was nearly universal
agreement that existing capital requirements should be higher, and that new requirements should
be put in place to ensure that financial institutions had in place sufficient liquidity buffers.li
Due to a much longer history of international cooperation in this area, questions regarding the
levels at which capital and liquidity ratios should be set are resolved largely by the Basel
Committee, comprised of the membership of the G-20 and a few others. Following the crisis, the
BCBS adopted the Basel III agreement, which strengthened minimum capital requirements,
introduced a minimum “leverage ratio,” and introduced two required liquidity ratios. The
Liquidity Coverage Ratio requires a bank to hold sufficient high-quality liquid assets (HGLA) to
cover its total net cash outflows over 30 days; the Net Stable Funding Ratio requires the
available amount of stable funding to exceed the required amount of stable funding over a one-
year period.lii
The United States has adopted and is in the process of implementing stricter requirements than
the Basel Committee minimum requirements, including a risk-based capital surcharge for global
systemically important banks (G-SIBs), a higher leverage ratio for G-SIBs, and a requirement
that foreign banking organizations form U.S. holding companies that will be required to meet
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these capital requirements.liii In addition, the United States has led the charge on regulatory
initiatives designed to limit the risks of overreliance on short-term wholesale funding by banks
and non-bank financial actors. The Federal Reserve has long raised concerns about the systemic
risk posed by the short-term wholesale funding market, and particularly by securities financing
transactions (SFTs)—repos, reverse repos, securities borrowing and lending, and securities
margin lending.liv Federal Reserve Board Governor Daniel Tarullo has outlined three initiatives
currently under works to address this issue: (i) a proposal to incorporate the use of short-term
wholesale funding into the risk-based capital surcharge applicable to U.S. G-SIBs; (ii) proposed
modifications to the BCBS’s NSFR standard to strengthen liquidity requirements that apply
when a bank acts as a provider of short-term funding to other market participants; and (iii)
numerical floors for collateral haircuts in SFTs to help address the risk that post-crisis reforms
will drive systemically risky activity toward areas of the financial system where prudential
standards do not apply (i.e., to non-banking organizations).lv
C. Recovery and Resolution
One of the most important measures of the financial reform program dealing specifically with
large banks has been the work on resolution mechanisms for SIFIs. Dodd-Frank in the United
States provided the FDIC with Orderly Liquidation Authority (OLA), a regime to conduct an
orderly resolution of a financial firm if the bankruptcy of the firm would threaten financial
stability.lvi Internationally, the FSB adopted in 2011 the Key Attributes of Effective Resolution
Regimes for Financial Institutions, a new standard for resolution regimes for systemic firms that
was largely modeled on the U.S. approach.lvii Nevertheless, one of the biggest remaining
challenges in this area concerns the development of adequate and transparent cooperation
mechanisms for ‘home’ and ‘foreign’ regulators for the purposes of conducting orderly cross-
border resolutions.lviii
Closely associated with the work on orderly resolution mechanisms is the “living will” exercise
for SIFIs.lix Under Dodd-Frank, SIFIs and nonbank SIFIs must periodically submit resolution
plans—a.k.a. “living wills—to the Federal Reserve and the FDIC. Each living will must describe
the company’s strategy for rapid and orderly resolution in the event of material financial distress
or failure of the company, and include both public and confidential sections.lx In August 2014,
the FDIC and the Fed rejected the living wills of all eleven financial institutions that submitted
them in 2013, on the grounds that “the plans provide no credible or clear path through
bankruptcy that doesn’t require unrealistic assumptions and direct or indirect public support.”lxi
The regulators encouraged the banks to make their bankruptcy plans more credible by
“establishing a rational and less complex legal structure,” showing they can quickly produce
reliable information about their exposures, and amending derivatives contracts to make them
easier to bring through bankruptcy.lxii
D. Consumer Protection
In a now-famous article published in 2007, then-Harvard Law School Professor Elizabeth
Warren outlined a plan for a Financial Product Safety Commission, a consumer protection
commission dedicated to financial products.lxiii The Dodd-Frank Act created this new
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independent agency in 2010 as the Consumer Financial Protection Bureau (CFPB), and in 2013,
the Senate confirmed President Obama’s appointee, Richard Cordray, as the first Director of the
CFPB.lxiv The CFPB’s authority extends over banks, credit unions, mortgage brokers and
servicers, foreclosure relief services, credit card issuers and many other businesses deemed to
provide consumer financial goods and services.lxv Since its inception, the CFPB has set up a
consumer complaint process; pioneered a data-based method for assessing which institutions
deserve the most scrutiny; undertaken a wide range of enforcement actions against companies
engaged in deceptive lending practices, including for-profit educational institutions; and met
every rulemaking deadline set by Dodd-Frank.lxvi
E. Talent and Compensation
Another much-discussed area of reform revolves around compensation practices for
professionals in the financial industry, and in particular, the concern that executive compensation
in the industry encourages excessive risk-taking. As Former Chairman of the Federal Reserve
Paul Volcker observed in 2008:
Perhaps most insidious of all in discouraging discipline has been pervasive
compensation practices. In the name of properly aligning incentives, there are
enormous rewards for successful trades and deals and for loan originators. The
mantra of aligning incentives seems to be lost in the failure to impose
symmetrical losses – or frequently any loss at all – when failures ensue. The point
has been made time and again, yet, with rare exceptions, compensation
committees and their consultant acolytes seem unable to break the pattern. That
may not be an area that law or regulation can, or should, deal with effectively.
Surely it is a matter for the leadership of large institutions, particularly those
sheltered by official support.lxvii
In April 2009, the FSB published its Principles for Sound Compensation Practices, with the
objective of setting baseline compensation principles for the financial industry. A 2013 report by
the Institute of International Finance found that “the vast majority” of banks had implemented all
of the FSB standards relevant to them, including standards on the alignment of compensation
with risk-adjusted performance, strengthening remuneration governance, and limiting guaranteed
bonuses and increasing the use of deferrals.lxviii Nevertheless, the United States has moved less
quickly in this area than our EU counterparts: on January 1, 2014, the EU’s “banker bonus
cap”—by which the bonus granted to an individual deemed a ‘Material Risk Taker’ cannot be
greater than their fixed salary (or double their fixed salary, with shareholder approval)—entered
into effect.lxix Meanwhile, the U.K. has challenged the bonus cap in the European Court of
Justice on the grounds that the new rules go beyond what is permissible under EU treaties, and
that they create “damaging consequences and perverse incentives.”lxx EU officials, however,
have criticized the practice developed by banks to mitigate the effect of bonus caps by having
portions of incentive compensation shifted to “allowance”. These officials have recently
proposed measures to tighten the restrictions, which are now the subject of debate within the EU.
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Addendum: Financial Crisis Chronology – Citigroup
Monday, October 1, 2007
Citi pre-announced 3Q earnings, writing down $1.4 billion of leveraged loan commitments and
$1.3 billion in subprime mortgage holdings. It also announced a $2.6 billion charge for
anticipated losses in consumer credit.
Monday, October 15, 2007
Citi formally reported earnings for 3Q with profits of $2.2 billion, down 58% from 3Q2006. Citi
reported its exposure to subprime assets in the Collateralized Debt Obligations (CDO’s) was
about $13 billion.
November 4-5, 2007
Citi announced Charles Prince’s departure as Chairman and CEO and also reported that its CDO
exposure was $55 billion, not the $13 billion reported three weeks earlier. The difference was
$43 billion of the “super senior” tranche of CDO’s, which included $25 billion of “liquidity
puts” financing client purchases of “super seniors”, the highest rated tranche of CDO’s. Through
the “liquidity puts”, Citi had essentially retained the risk of ownership when it sold the securities
to clients.
Monday, March 17, 2008
Bear Stearns, on the brink of failure, is acquired by JP Morgan with assistance from the Federal
Reserve Bank of New York which loaned $30 billion to JP Morgan to facilitate the merger.
Friday, July 11, 2008
The FDIC and the Office of Thrift Supervision shut down and seized Indy Mac, a sizeable
California savings bank.
Wednesday, July 30, 2008
Congress passes a law authorizing Treasury to bail out the GSE’s Fanny Mae and Freddy Mac,
placing oversight and management in the Federal Housing Finance agency. The CEOs of both
agencies were replaced on Labor Day and Treasury committed $200 billion.
Monday, September 15, 2008
Lehman Bros filed for bankruptcy at 1:45am on Monday, September 15, 2008. It had been
unable to work out a take-over by either Barclay’s or Bank of America and the US Government
refused to extend federal support.
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Thursday, September 16, 2008
AIG, the largest international insurance company, could not attract new private capital and faced
a dramatic loss of confidence from counter-parties based on mounting losses from structured
investment products. The Fed stepped in and ultimately loaned AIG $180 billion, taking back
79.9% of the equity as well as security for the loan and an interest rate charge of 14%.
Monday, September 29, 2008
Citi and Wachovia Corp, which was on the brink of failure, agreed that Citi, with assistance from
the FDIC, would acquire Wachovia for $1 a share. Five days later, after encouragement from the
FDIC, Wachovia agreed instead to a merger with Wells Fargo, which paid $7 a share and
required no FDIC assistance.
October 6-10, 2008
The stock market fell 18%, the biggest weekly drop since 1933.
Monday, October 13, 2008
On Columbus Day, October 13, 2008, Secretary of Treasury Henry Paulson, Fed Chairman Ben
Bernanke, NY Federal Reserve Board President Tim Geithner and other US government officials
summoned CEO’s of nine large financial institutions to the Treasury and gave them an hour to
sign documents accepting a government investment of $225 billion of preferred stock--$25
billion each in Citigroup, JP Morgan, Wells Fargo; $15 billion in Bank of America, $10 billion
in Morgan Stanley, Goldman Sachs, Merrill Lynch; $3 billion in Bank of New York and $2
billion in State Street.
November 2008
In November, the US government invested an additional $20 billion from TARP funds into Citi
and at the same time protected Citi’s “tail risk” by insuring $306 billion of its assets subject to
Citi taking the first $39.5 billion in losses, and 10% of the losses after that; Treasury agreed to
absorb $5 billion of additional losses if they occurred, the FDIC took the next $10 billion and the
FRB took responsibility for the rest.The market responded positively to the rescue plan with
Citi’s stock price increasing 58% and the price of its credit default swaps declining 50%.
December 2008
The US government did a similar rescue deal for BAC, which also had acquired Merrill Lynch.
January 2009
Citigroup announced it would divide its assets and operations between its “franchise of the
future”, Citicorp, and a collection of troubled assets and operating businesses available for sale,
“Citi Holdings”, more than $800 billion assets of its $2.3 trillion balance sheet were put into Citi
Holdings.
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Friday, February 20, 2009
Citi’s stock price fell to $2 and days later to $1. Bank of America’s credit default swaps – the
cost of insuring its bonds – rose to 15%. Although both Citi and BAC had enough “regulatory
capital” under the prevailing regulatory requirements, the market and regulators were moving to
a new capital standard under which only common equity counted. By that measure, Citi’s
leverage ratio was 60:1 and BAC’s was 40:1 - $60 or $40 in assets for every dollar of common
equity. The market was refusing to treat as capital even the preferred stock investment made by
the US government four months earlier when each of Citi and BAC had received first $25 billion
and later $20 billion from the US government..
February 2009
Inside the White House, and among former Central Bank Governors there was a lively debate
about whether nationalization of the banks was needed and inevitable.
Sunday, February 22, 2009
Secretary Geithner and National Economic Council Director Larry Summers advised the
President in a memo that Citigroup, Bank of America and Wells Fargo were all in severe distress
and that AIG’s deep problems could soon spread to both Met Life and Prudential.
Monday, March 2, 2009
The US government committed an additional $30 billion to AIG to enable it to meet its current
obligations.
March-June, 2009
Public outrage over AIG payments of contractual commitments to pay bonuses to managers
involved with the company’s troubled investment products led to the appointment by Secretary
of Treasury Geithner of Ken Feinberg as the compensation czar under TARP with responsibility
to set the compensation for the highest paid 25 people in each of the companies with outstanding
TARP investments from the US government.
Monday, March 23, 2009
The first positive reaction occurred in the markets after the Treasury disclosed its “Public Private
Investment Program” (PPIP) with federal funds up to $1 trillion available to buy troubled assets
from the banks. The announcement helped calm the market and restore confidence in the
financial system and was the first hopeful sign that the crisis might be slowing. Private investors
were attracted to these assets because they began to see potential gains as the economy
recovered. As a result, only $22 billion of government investments were made under the asset
purchase program.
April, 2009 – to date
Citi gradually recovered, regaining profitability slowly and its stock recovered from the $1 low
of February 2009 and returning from time to time to the equivalent of $5.50 after adjusting for a
10:1 reverse stock split. By the end of 2010, Citi had repaid the US government in full plus a
gain for the Treasury of $13 billion.
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Wednesday, June 10, 2009
The Treasury authorized a conversion of its preferred stock in Citi to common equity side by side
with a conversion of preferred to common stock by certain private investors including the
Government of Singapore and Prince Al-Waleed bin Talal of Saudi Arabia. The US
Government and private investors’ conversion of preferred into common stock was targeted to
add up to an additional $58 billion in new common equity capital. After the conversion, the US
government owned 34% of Citi’s common equity.
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IV. Financial Crisis Discussion Questions
Part A: Crisis Management
Overall, “of the twenty-five largest financial institutions in the United States at the start of 2008,
thirteen either failed (Lehman, Washington Mutual); received government assistance to avoid
failure (Fannie, Freddie, AIG, Citi, Bank of America); merged or were acquired to avoid failure
(Bear, Countrywide, Merrill Lynch, Wachovia); or transformed their business structure and
raised private capital to avoid failure (Morgan Stanley, Goldman Sachs)”.lxxi The vast majority of
this occurred through ad hoc government action that stretched the authority of institutions like
the Fed beyond what was previously thought possible.lxxii As Former Federal Reserve Chairman
Paul Volcker said at the Economic Club of New York in April 2008:
Simply stated, the bright new financial system—for all its talented participants,
for all its rich rewards—has failed the test of the market place. To meet the
challenge, the Federal Reserve judged it necessary to take actions that extend to
the very edge of its lawful and implied powers, transcending certain long
embedded central banking principles and practices. The extension of lending
directly to non-banking financial institutions—while under the authority of
nominally “temporary” emergency powers—will surely be interpreted as an
implied promise of similar action in times of future turmoil. What appears to be
in substance a direct transfer of mortgage and mortgage-backed securities of
questionable pedigree from an investment bank to the Federal Reserve seems to
test the time honored central bank mantra in time of crisis—“lend freely at high
rates against good collateral”—to the point of no return.lxxiii
The Dodd-Frank Act made changes to the Federal Reserve’s emergency authority by prohibiting
its use for insolvent firms, requiring the Fed to develop emergency lending procedures and
assign lendable value to its collateral, and imposing consultation and reporting requirements
designed to improve accountability.lxxiv In addition, the Fed’s capacity to invoke emergency
authority was modified under Dodd-Frank to be subject to the approval of the Secretary of the
Treasury.lxxv
1. Did the government assistance programs during the crisis create or exacerbate a problem of
moral hazard in the financial industry? If the crisis was, as Bernanke suggests, a “classic
financial panic,” is reform enough to prevent a future crisis?
2. Will a government backstop (e.g., the role of the Fed as the Lender of Last Resort) always be
necessary? What are the potential pitfalls of the changes Dodd-Frank made to the emergency
authority of the Fed?
3. Former Treasury Secretary Larry Summers says that “[a] competent lender of last resort—in
Bagehot’s sense of one who lends freely at a penalty rate against good collateral—actually turns
a profit, as the IMF did in its response to the financial crises of the 1990s.”lxxvi Do the Treasury
and the Fed’s actions during the crisis qualify for this standard?
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4. What could have been done differently? Should Lehman have been “allowed to fail,” as the
popular narrative goes, where Bear and AIG were not?
5. What is meant by “Systemically significant”? Is it determined simply by the rise of the system if
the institution fails? Or are there positive contributions to the global financial system by the
existence and scale of the SIFI’s?
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Part B: Long-term financial market reform
1. Former FDIC Chair Sheila Bair argues that under Dodd-Frank, taxpayer bailouts are “completely
prohibited,” and that the problem of Too Big to Fail has been abolished. Meanwhile, U.S.
Senator Elizabeth Warren argues that the problem of Too Big to Fail has only gotten worse,
pointing to the evidence that today, the four biggest banks are 30% larger than they were five
years ago. U.S. Senator Sherrod Brown also thinks that “too big to fail is alive and well,” but not
because of the size of the institutions, but because the biggest banks have yet to submit credible
living wills to the FDIC.lxxvii
What does “too big to fail” (TBTF) mean? What should be the primary concern—size of
institutions or possibility of taxpayer-funded bailouts? Can the two be separated? Has the TBTF
problem been solved? Will it be solved once banks submit living wills that are deemed sufficient
by the Fed and the FDIC?
2. The reform effort has created some tension between efforts to coordinate regulatory reform at the
international level (that is, a focus on cross-border regulation) and efforts to maintain the safety
and soundness of domestic financial systems. While Dodd-Frank exhorts U.S. regulators to
coordinate with their foreign counterparts, it also includes enhanced powers for them to oversee
and terminate operations of foreign financial institutions in the United States.lxxviii Under this
authority, the Federal Reserve is in the process of finalizing a rule that will require a foreign
banking organization with $50 billion or more in U.S. assets to place virtually all of its U.S.
subsidiaries in a U.S. intermediate holding company (IHC). The IHC will be subject to U.S.
Basel III, capital planning, Dodd-Frank stress testing, liquidity, and risk management
requirements.lxxix Some have called this a new form of “financial protectionism” that will force
foreign banks to “ring-fence” their capital or assets within a jurisdiction and lead to a
“Balkanization” of banking activity, as financial institutions will shift away from international
activity.lxxx
How should regulators think about balancing the need to mitigate the vulnerabilities created by a
highly interconnected global financial system with the desire to preserve the benefits of
interconnectedness, such as the ability to share risks across a variety of jurisdictions?
3. The end of the financial crisis has not been accompanied by an end of alleged wrongdoing at
some of the world’s largest financial institutions. Perhaps most notably, the LIBOR scandal (and
associated rate-rigging scandals) revealed that traders continued to manipulate global interest
rates even after 2008.lxxxi New York Fed President Bill Dudley said in a speech that
enhancements to the current regulatory regime “may not solve another important problem
evident within some large financial institutions—the apparent lack of respect for law, regulation
and the public trust.”lxxxii
What issues within the financial industry has the post-crisis reform effort not addressed? The
difficulty of imposing regulatory convergence across national boundaries? Is compensation a
problem? What can be done about it? What about the Balkanized structure of regulatory
authority in the US?
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Is culture something that can be changed? How would you change it? How would you deal with
the problems of repeated ethical lapses such as the allegations of collusion in setting rates, the
incidence of fraud, the number of regulatory breaches; the challenge of assuming effective risk
management, compliance and controls?
What about the competition for talent and the culture within regulatory or supervisory
institutions? Are concerns of regulatory capture in the financial industry the same, better, or
worse than in other industries? What can or should change in this regard?
4. In a response to Judge Rakoff’s piece, one corporate lawyer wrote:
[U]nder present corporate and securities law, horrible management of a financial
institution is not a civil wrong, much less a crime, so long as appropriate procedural steps
were taken and there was adequate disclosure to investors of the risks associated with the
practices and transactions in question. . . . Without a doubt, there were far too many
sloppy and reckless business practices leading up to the 2008 meltdown. . . . There was
also far too little oversight of the persons responsible for these practices by their
ostensible superiors on boards of directors and in upper management. However, under
our present system of corporate and securities laws, there is a fundamental difference
between reckless practice and fraud. . . . ([M]ore) high-level executives have not been
prosecuted because they have not committed crimes or civil wrongs as the law now
stands. lxxxiii
Judge Rakoff replied:
[M]anagement, that is, executives, have been the subject of numerous private and
regulatory lawsuits in the wake of the financial crisis, in a great many of which they have
accepted judgments against them, even if not admitting liability.To note just the most
prominent example, in June 2009 the SEC (which has no power to bring criminal
prosecutions) brought a civil action against Countrywide Financial Corporation’s three
most senior executives—Angelo Mozilo, David Sambol, and Eric Sieracki—accusing
them of falsely and intentionally misrepresenting the quality of Countrywide’s mortgage-
backed securities over a period of several years. Four days before the case was scheduled
to go to trial, the defendants settled, with Mr. Mozilo agreeing to pay $67.5 million. . . .
Although, in accordance with the SEC’s policy at the time, the defendants were permitted
to settle “without admitting or denying” the allegations of fraud, one is left to wonder
why the Department of Justice did not bring a parallel criminal case.lxxxiv
Is financial regulatory reform enough? Does this argue for a fundamental revision or U.S.
corporate laws? Or would it be enough for, as Judge Rakoff suggests, the Department of Justice
to undertake criminal prosecutions that parallel the SEC’s civil enforcement actions?
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Before Class 1
Please read the assigned articles below and respond to one of the discussion questions from part
A. Send your response to this question to Professor Kaden ([email protected]) the day
before Class 1 by 9:00 pm
V. Financial Crisis Reading list
Helpful Background Materials.
The following readings are especially helpful in explaining some of the technical concepts in this
module:
1. James B. Stewart, “Eight Days: The battle to save the American financial system,” The
New Yorker (September, 21, 2009).
2. Alan Blinder, “After the Music Stopped: The Financial Crisis, the Response, and the
Work Ahead” (2013).
a. Chapter 1: “What’s a nice economy like you doing in a place like this?”
b. Chapter 6: “The Panic of 2008”
c. Chapter 10: “It’s Broke, Let’s fix it: The need for Financial Reform”
3. Glossary of Financial Crisis Terms, Federal Reserve Bank of Boston (Revised April
2011).
4. Rose, C., & Sesia, A. (2009). What Happened at Citigroup? (Rev. July 20, 2009)
HBS No. 9-310-004. Boston, MA: Harvard Business School Publishing
5. Hon. Jed Rakoff, “Why Have No High-Level Executives Been Prosecuted?”
6. Ben Bernanke, “The Crisis as a Classic Financial Panic” (Speech of November 8, 2013)
7. Stanley Fischer, “Financial Sector Reform: How Far Are We?” (Speech of July 10, 2014)
8. Sheila Bair, “Dodd-Frank really did end taxpayer bailouts,” Washington Post (May 28,
2013)
9. Lawrence Summers, “Beware Moral Hazard Fundamentalists,” Financial Times (Sept.
23, 2007)
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Financial Crisis Reading list cont’d:
10. Cline and Gagnon, “Lehman Died, Bagehot Lives: Why did the Fed and Treasury Let a
Major Wall Street Bank Fail?” PIIE Policy Brief, September 2013.
11. FCIC Conclusions, January 2011
12. FCIC Dissenting Statement, January 2011.
13. Simon Johnson and James Kwak, “Policy Advice and Actions during the Asian and
Global Financial Crises” (Chapter 5 of Responding to Financial Crisis: Lessons from
Asia Then, the United States and Europe Now, edited by Changyong Rhee and Adam S.
Posen, published by the Peterson Institute for International Economics and the Asian
Development Bank).
14. Timothy Geithner, “Stress Test: Reflections on Financial Crises”—pp. 176-186; 190-195;
202-206; 255-257
15. Daniel K. Tarullo, “Good Compliance, Not Mere Compliance” (Speech of October 20,
2014)
16. William C. Dudley, “Enhancing Financial Stability by Improving Culture in the Financial
Services Industry” (Speech of October 20, 2014)
Optional resources
1. “Margin Call,” Lions Gate Films, Inc., 2011. Film
2. “The Giant Pool of Money,” Transcript, This American Life, NPR, (originally aired May
5, 2008). Audio: http://www.thisamericanlife.org/radio-archives/episode/355/the-giant-
pool-of-money
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Before Class 2
Imagine you are a new employee at a federal agency tasked with identifying the gaps in existing
financial reform efforts. Reflecting on the readings and discussion from class 1, write a brief
response to one of the following sub questions from part B and submit it to the course iSites page
before Class 2 by 9:00 pm. Be prepared to discuss your response with the class.
1) What issues within the financial industry has the post-crisis reform effort not addressed? The
difficulty of imposing regulatory convergence across national boundaries? Is compensation a
problem? What can be done about it? What about the Balkanized structure of regulatory
authority in the US?
2) Is culture something that can be changed? How would you change it? How would you deal
with the problems of repeated ethical lapses such as the allegations of collusion in setting rates,
the incidence of fraud, the number of regulatory breaches; the challenge of assuming effective
risk management, compliance and controls?
3) What about the competition for talent and the culture within regulatory or supervisory
institutions? Are concerns of regulatory capture in the financial industry the same, better, or
worse than in other industries? What can or should change in this regard?
i. HAL S. SCOTT AND ANNA GELPERN, INTERNATIONAL FINANCE: TRANSACTIONS, POLICY,
AND REGULATION 36 (19th ed. 2012) [hereinafter “SCOTT AND GELPERN”].
ii. SCOTT AND GELPERN, 37.
iii. Pedro Nicolai Da Costa, Bernanke: 2008 Meltdown Was Worse Than Great Depression, WALL STREET
JOURNAL (August 26, 2014).
iv. International Monetary Fund, WORLD ECONOMIC OUTLOOK xii (April 2009).
v. CARMEN M. REINHART AND KENNETH S. ROGOFF, THIS TIME IS DIFFERENT: EIGHT
CENTURIES OF FINANCIAL FOLLY 213 (2009) [hereinafter “REINHART AND ROGOFF”].
vi. ALAN S. BLINDER, AFTER THE MUSIC STOPPED: THE FINANCIAL CRISIS, THE RESPONSE,
AND THE WORK AHEAD 38–39 (2013) [hereinafter “BLINDER”].
vii. THE FINANCIAL CRISIS INQUIRY REPORT, FINAL REPORT OF THE NATIONAL COMMISSION
ON THE CAUSES OF THE FINANCIAL AND ECONOMIC CRISIS IN THE UNITED STATES xvi
(January 2011).
viii. Felix Salmon, Recipe for Disaster: The Formula That Killed Wall Street, WIRED MAGAZINE (February 23,
2009).
ix. BLINDER, 67–68.
x. Ben S. Bernanke, Speech at the Fourteenth Jacques Polak Annual Research Conference, Washington D.C.
(November 8, 2013).
xi. BLINDER, 78.
xii. Felix Salmon, Recipe for Disaster: The Formula That Killed Wall Street, WIRED MAGAZINE (February 23,
2009).
xiii. SCOTT AND GELPERN, 43.
xiv. Congressional Budget Office, What Accounts for the Slow Growth of the Economy After the Recession?
PUB. NO. 4346 1–4 (November 2012).
xv. REINHART AND ROGOFF, 242.
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xvi. REINHART AND ROGOFF, 244.
xvii. REINHART AND ROGOFF, 246–47.
xviii. SCOTT AND GELPERN, 84–85.
xix. SCOTT AND GELPERN, 59.
xx. SCOTT AND GELPERN, 58.
xxi. Yalman Onaran, Fed Aided Bear Stearns as Firm Faced Chapter 11, Bernanke Says, BLOOMBERG (April 2,
2008).
xxii. TIMOTHY GEITHNER, STRESS TEST: REFLECTIONS ON FINANCIAL CRISES 170–71 (2014)
[hereinafter “GEITHNER”].
xxiii. GEITHNER, 174.
xxiv. GEITHNER, 176–86.
xxv. SCOTT AND GELPERN, 62.
xxvi. SCOTT AND GELPERN, 64.
xxvii. Matthew Karnitschnig et al., U.S. to Take Over AIG in $85 Billion Bailout; Central Banks Inject Cash as
Credit Dries Up, WALL STREET JOURNAL (September 16, 2008).
xxviii. GEITHNER, 190–94.
xxix. GEITHNER, 195.
xxx. SCOTT AND GELPERN, 57.
xxxi. GEITHNER, 202–04.
xxxii. SCOTT AND GELPERN, 37.
xxxiii. GEITHNER, 205–06.
xxxiv. SCOTT AND GELPERN, 69.
xxxv. SCOTT AND GELPERN, 69–71.
xxxvi. SCOTT AND GELPERN, 71.
xxxvii. Tom Barkley, TARP Profit on Citigroup: $12.3 Billion, WALL STREET JOURNAL (January 27, 2011).
xxxviii. U.S. Department of the Treasury, Treasury Notes (December 12, 2012), available at:
http://www.treasury.gov/connect/blog/Pages/AIG-wrapup.aspx.
xxxix. U.S. Department of the Treasury, Investment in AIG (last updated December 11, 2013), available at:
http://www.treasury.gov/initiatives/financial-stability/TARP-Programs/aig/Pages/status.aspx.
xl. U.S. Department of the Treasury, Auto Industry (last updated September 16, 2014), available at:
http://www.treasury.gov/initiatives/financial-stability/TARP-Programs/automotive-
programs/Pages/default.aspx.
xli. CONGRESSIONAL BUDGET OFFICE, REPORT ON THE TROUBLED ASSET RELIEF PROGRAM 7
(April 2014).
xlii. BLINDER, 268.
xliii. BLINDER, 263–85.
xliv. James Bullard et al., Systemic Risk and the Financial Crisis: A Primer, FEDERAL RESERVE BANK OF
ST. LOUIS REVIEW 403 (September/October 2009).
xlv. U.S. Department of the Treasury, Financial Stability Oversight Council (last updated April 25, 2013),
available at: http://www.treasury.gov/initiatives/fsoc/Pages/home.aspx.
xlvi. U.S. Department of the Treasury, Financial Stability Oversight Council: Designations (last updated
December 17, 2013), available at: http://www.treasury.gov/initiatives/fsoc/designations/Pages/default.aspx.
xlvii. Janet L. Yellen, Speech at the American Economic Association/American Finance Association Joint
Luncheon, San Diego, California (January 4, 2013) [hereinafter “Yellen Speech”].
xlviii. Yellen Speech.
xlix. Yellen Speech.
l. BLINDER, 271.
li. BLINDER, 271¬–72.
lii. Stanley Fischer, Speech at the Martin Feldstein Lecture, National Bureau of Economic Research, Cambridge,
Massachusetts (July 10, 2014) [hereinafter “Fischer Speech”].
liii. Fischer Speech.
liv. The Harvard Law School Forum on Corporate Governance and Financial Regulation, Fed Outlines Proposals
to Limit Short-Term Wholesale Funding Risks (January 3, 2014).
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lv. Daniel K. Tarullo, Testimony before the U.S. Senate Committee on Banking, Housing, and Urban Affairs,
Washington, D.C. (September 9, 2014).
lvi. Fischer Speech.
lvii. Daniel K. Tarullo, Speech at the Federal Reserve Board and Federal Reserve Bank of Richmond Conference,
Washington, D.C. (October 18, 2013) [hereinafter “Tarullo Speech”].
lviii. Tarullo Speech.
lix. Fischer Speech.
lx. FDIC, Title I and IDI Resolution Plans (last updated July 7, 2014), available at:
https://www.fdic.gov/regulations/reform/resplans/.
lxi. Peter Eavis, Federal Reserve and F.D.I.C. Fault Big Banks’ ‘Living Wills’, NEW YORK TIMES (August 5,
2014).
lxii. Ryan Tracy et al., U.S. Tells Big Banks to Rewrite ‘Living Will’ Bankruptcy Plans, WALL STREET
JOURNAL (August 5, 2014).
lxiii. See Elizabeth Warren, Unsafe at any Rate, DEMOCRACY (Summer 2007).
lxiv. Consumer Financial Protection Bureau, About Us (last updated August 26, 2014), available at:
http://www.consumerfinance.gov/the-bureau/.
lxv. Reuters, New U.S. consumer financial bureau has wide powers (September 14, 2010).
lxvi. Lydia DePillis, A watchdog grows up: The inside story of the Consumer Financial Protection Bureau, THE
WASHINGTON POST (January 11, 2014).
lxvii. Paul Volcker, Speech at the Economic Club of New York (April 8, 2008).
lxviii. Institute of International Finance, Compensation Reform: Embedding Global Standards (October 2013).
lxix. PricewaterhouseCoopers, Regulatory Brief: EU bonus cap to take effect January 1, 2014 (July 2013).
lxx. Jim Brunsden, EU Banker-Bonus Cap Faces U.K. Challenge in Highest Court, BLOOMBERG (September 5,
2014).
lxxi. GEITHNER, 255–56.
lxxii. SCOTT AND GELPERN, 61.
lxxiii. Paul Volcker, Speech at the Economic Club of New York (April 8, 2008).
lxxiv. SCOTT AND GELPERN, 82–83. See Dodd-Frank Act, Section 1101.
lxxv. SCOTT AND GELPERN, 82–83. See Dodd-Frank Act, Section 1101.
lxxvi. Lawrence Summers, Beware moral hazard fundamentalists, FINANCIAL TIMES (September 23, 2007).
lxxvii. Ryan Tracy et al., U.S. Tells Big Banks to Rewrite ‘Living Will’ Bankruptcy Plans, WALL STREET
JOURNAL (August 5, 2014).
lxxviii. SCOTT AND GELPERN, 86.
lxxix. The Harvard Law School Forum on Corporate Governance and Financial Regulation, US Intermediate
Holding Company: Structuring and Regulatory Considerations for Foreign Banks (April 14, 2014).
lxxx. Linda Goldberg and Arun Gupta, Ring-Fencing and “Financial Protectionism” in International Banking,
FEDERAL RESERVE BANK OF NEW YORK: LIBERTY STREET ECONOMICS (January 9, 2013).
lxxxi. The Economist, The Rotten Heart of Finance (July 7, 2012).
lxxxii. William C. Dudley, Speech at the Global Economic Policy Forum, New York City (November 7, 2013).
lxxxiii. Marty Robins, Why Have Top Executives Escaped Prosecution? THE NEW YORK REVIEW OF BOOKS
(April 3, 2014).
lxxxiv. Jed S. Rakoff (reply), Why Have Top Executives Escaped Prosecution? THE NEW YORK REVIEW OF
BOOKS (April 3, 2014).
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CYBER SECURITY
Prime Oil & Gas (“Prime”) is a multi-billion dollar, multinational public oil and gas
company, headquartered in the U.S. and with customers primarily in the U.S. and Europe.
Prime’s business includes oil and gas exploration, refining, export, and delivery to customers.
Recently, Prime has been growing its natural gas business due to the shale-gas and fracking
boom in the United States. However, the U.S. cannot absorb all of the natural gas supply because
the U.S. infrastructure is primarily set up for oil and gasoline, not natural gas. Prime has been
looking to other markets to profit off its accumulated supply of natural gas.
In contrast with the U.S., Europe’s energy infrastructure is designed largely for natural
gas consumption. Russia, the second largest natural gas producer after the U.S., supplies much
of Europe’s natural gas needs, and the Russian oil and gas companies transport the gas to Europe
by pipeline. Russia charges high prices for the natural gas it sells to the Europeans, and given
recent tensions between Russia and Europe over Ukraine, the Europeans are now more than ever
looking for ways to become less dependent on Russia for its energy needs. The U.S. government
would also like to see Europe become less dependent on Russia to fulfill its energy demands so
that Europe can join the United States in taking a harder line against Russia, particularly by
imposing sanctions against Russia.
U.S. energy companies have already been taking steps to enter the European natural gas
market and compete with Russia. Technology exists to liquefy natural gas, which makes it
possible to transport and thus export the liquefied natural gas (LNG) to Europe. The process
requires a liquefaction facility that cools the gas to transform it into liquid, special double-hulled
ships to keep the LNG sufficiently cool to stay in liquid form, and regasification facilities to
return LNG to its gaseous state. U.S. LNG is cheaper than Russian LNG because natural gas is
so plentiful in the U.S. Therefore, Russia is carefully watching the developments in the U.S.
natural gas sector.
Prime sees a huge business opportunity in selling LNG to its European customers.
Particularly now that the Transatlantic Trade and Investment Partnership, a free trade agreement
between the European Union and the United States, is in negotiation, Prime is making plans to
increase its business in Europe. Prime already has one liquefaction and another regasification
facility and has started selling LNG in Europe. However, one of the challenges to this new line
of business is that the liquefaction and regasification process is extremely expensive and
dangerous. Prime has wanted to expand by building additional facilities in both the U.S. and
Europe, but it has had significant trouble finding a location for these facilities because local
communities and governments do not want these plants in their backyards. To address this issue,
Prime put its research and development team to work to develop new technology that would
enable them to convert natural gas into LNG and vice versa in a more cost-effective, safer and
environmentally friendly way. Prime succeeded in making these highly innovative chemical and
engineering advances, and although the technology is still a secret, the company is now ready to
implement this technology in order to export natural gas to Europe as a major competitor. Prime
will offer lower prices with a safer regasification process, a major blow to Russia’s energy
business in Europe.
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Prime also plans to leverage its new technology by partnering with foreign gas
companies. Prime has almost completed negotiations to form a joint venture with a gas company
in Qatar and a gas company in Turkey. Qatar has a large natural gas supply and is close to
Europe, and Turkey is the starting point for the recently completed Nabucco-West gas pipeline to
Europe. Qatar already has one facility to liquefy natural gas for export, but Qatar now wants to
partner with Prime to use Prime’s new technology for a second liquefaction facility in order to
increase its exports. Like Prime, Qatar recognizes that there is high demand for natural gas in
Europe, especially given Europe’s desire to diversify its energy source beyond Russia. Turkey
wants to partner with Prime in order to build a regasification plant to increase the volume of
natural gas exported to Europe through its pipeline. Turkey, too, recognizes that it would benefit
from finding additional natural gas suppliers given worsening relations between Europe and
Russia.
Prime had some strategic concerns about the joint venture, but has decided to move ahead
with the deal. Prime was concerned that by increasing Qatar’s ability to export, it might be
creating another natural gas competitor in Europe, which could hurt Prime’s natural gas exports
to Europe. There had also been concerns that the transaction would raise issues with the
Committee on Foreign Investment in the United States (CFIUS), the U.S. government agency
which reviews the national security implications of foreign investments. The region has recently
been volatile given the Arab uprising, fighting in the Middle East, and the conflict in Ukraine, so
the transaction could have raised national security concerns. Moreover, the joint venture will
give Turkey and Qatar information about Prime’s computer systems, possibly making the
company vulnerable to hacking. The companies have not yet created the joint venture, nor has
Prime shared its technology, but the deal is nearly sealed.
However, Prime is facing a major PR challenge. Groups like the Sierra Club have been
increasingly vocal against energy companies like Prime that are expanding their fracking and
natural gas production, raising concerns about the impact on the water supply and recent data
indicating that the use of natural gas and the LNG production process increases carbon
emissions. These issues have recently been picked up in the media and by government officials.
This is not a good time for Prime to be facing heightened criticism given its priority on
implementing its new LNG liquefaction and regasification technology.
To make matters worse, Prime’s website was recently hacked by Anonymous, a notorious
group of hackers that frequently hack as a form of protest. The hackers did not inflict any
permanent damage to the company, but they placed images of cross and bones, explosions, and
dying polar bears all over Prime’s website. It took the company twenty-four hours to remove the
images. U.S. federal prosecutors managed to identify, arrest, and indict the particular hackers
who engaged in the attack on Prime—a huge coup for the government given the difficulty in
identifying these hackers. The convicted hackers face several years in jail. Prime is still facing
significant PR backlash on environmental issues, and the company must decide how it wants to
respond to the news of the hackers’ indictment.
However, Prime is also facing some more serious hacking troubles. Prime detected a
breach in its servers where it stores sensitive information, including the designs for its new
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technology to convert natural gas for export more safely and cost efficiently. The company
suspected that the hackers gained access to those designs, and it considered whether to report the
breach to government authorities. Prime’s CEO made the decision to notify U.S. law
enforcement and agreed to give the FBI and NSA full access to its computer systems so that the
government could attempt to trace who these hackers were. The government discovered that a
group of Russian government-sponsored hackers were responsible for infiltrating Prime’s
computer systems and that they had taken information regarding Prime’s new technology. Prime
has also realized that this attack happened one day after the U.S. imposed a new round of
sanctions against Russia in response to Russia’s latest actions in Ukraine.
Prime is now concerned about what it can do to protect its very valuable LNG
technology. Prime’s technology team has begun to find its designs for the LNG technology
appearing on black market web sites based in the Isle of Man, Gibraltar, and Belarus. The
company is seeking some way to block these sites and prevent the further spread of its
confidential, valuable technology. Prime is frustrated that it has become a pawn in the U.S.-
Russia geopolitical struggles, and it wants support from the U.S. government in protecting its
intellectual property.
At the request of the U.S. government, Prime refrained from disclosing the hack and the
theft to its shareholders for three weeks in order to facilitate the government’s efforts to identify
the hackers by not tipping them off. However, Prime now faces an inquiry from the U.S.
Securities and Exchange Commission (“SEC”) for not disclosing the breach sooner to
shareholders. The company had made a general announcement one week before the hack that it
was going to implement a new technology that made LNG production safer and less expensive.
The SEC claims that shareholders have been hurt because they bought Prime stock at an
artificially inflated price in the period between the hack and its disclosure. Prime wants to defend
itself by arguing that the only reason it did not make the disclosure was because U.S. law
enforcement officials asked them not to do so.
The Qatari and Turkish gas companies have now also learned of the breach at Prime and
that this much coveted natural gas liquefaction and regasification technology is no longer
proprietary. Both companies have started to delay the deal closing on the joint venture, offering
public explanations that Prime knows is not the real reason for their newfound hesitation. Prime
has heard from unofficial sources that both Qatar and Turkey are now possibly in talks with
Russia about a partnership—indicating that they may be leaning toward siding with Russia in the
larger geo-political struggle. This is certainly very worrisome for Prime, who is beginning to
think it may have taken too great a risk in moving forward with the joint venture, but it is also of
major concern to the U.S. State Department.
At the same time, Prime is also facing a lawsuit by the Federal Trade Commission
(“FTC”) as a result of the Russian hack. In addition to Prime’s intellectual property, the hackers
stole Prime’s customers’ personal data. Because Prime’s business includes heating oil and gas
delivery to homeowners in the U.S. and Europe, Prime offered its customers a mobile device
application that enables customers to remotely check their heating oil and gas supply and to
order more. The Russian hackers were able to access customers’ names, addresses, and phone
numbers through their mobile devices using Prime’s mobile application. If a Prime customer did
not have the mobile application, his or her personal information was not taken. Nevertheless, the
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FTC has sued Prime for 1) deceiving the public by overstating the effectiveness of its cyber
security, and 2) engaging in unfair business practices (i.e. investing inadequately in cyber
security) that caused substantial injury to consumers that the consumers could not reasonably
avoid themselves. Prime thinks it may be able to challenge the suit given that there is no
indication yet that customers’ personal information has been shared by the hackers, no credit
card information or social security numbers were stolen, and given that the information was
removed from customers’ phones, arguably placing the burden of protecting personal
information on the individual.
Just a few months ago, Prime’s future looked bright as it was about to break into the
European market as a major competitor with its new technology. Now, despite its best efforts to
implement cyber security, its intellectual property has been stolen as part of a larger geopolitical
struggle, it faces lawsuits from several government agencies, and its public image has suffered an
even larger blow. In considering how to address all these new problems and the prospects for its
future ahead, Prime is contemplating pressing the U.S. government for increased cyber security
support for U.S. companies, including subsidies for cyber security investments and legislative
changes to enable U.S. companies to employ self-help measures to investigate and neutralize
cyber-attacks.
Before Class 1
Please read the 3 background pieces and all the articles from the reading subsections to which
you are assigned and respond to one of the discussion questions that follow. Send your response
to this question to Professor Kaden ([email protected]) the day before Class 1 by 9:00
pm.
You may also choose to review the articles in the optional “recent controversies” section.
Reading Assignments – Class 1.
1. IP theft: U.S. and China cybersecurity relations [Last names starting A – I]
2. Privacy at stake: cyber theft of personal information [Last names starting J – Q]
3. Denial of service attacks (DOS): “hacktivism,” warfare, and financial motivations
[Last names starting R – Z]
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Readings - Class 1
Cybersecurity Background
1. David Clark, Thomas Berson, and Herbert S. Lin, At the Nexus of Cybersecurity and
Public Policy, The National Academies Press.
2. Verizon, 2015 Data Breach Investigations Report, April 2015.
3. McAfee, The Economic Impact of Cybercrime and Cyber Espionage, Center for Strategic
and International Studies, July 2013.
IP theft: U.S. and China cybersecurity relations
4. Economic Espionage and Trade Secret Theft: An Overview of the Legal Landscape and
Policy Responses.
5. The Washington Post Editorial Board, The U.S. needs to tame the cyber-dragon,
February 14, 2013
6. Edward Wong, U.S. Case Offers Glimpse Into China’s Hacker Army, The New York
Times, May 22, 2014
7. Shane Harris, Exclusive: Inside the FBI’s Fight Against Chinese Cyber-Espionage,
www.foreignpolicy.com, June 18, 2014
8. Adam Segal, Department of Justice Indicts Chinese Hackers:What Next, Council on
Foreign Relations, May 19, 2014
9. Adam Segal, Chinese Cyber Espionage: We Know the Who, How, Why, and Why it
Matters – We’re Missing the What to Do, Council on Foreign Relations, June 11, 2014
10. Nicole Perlroth, Russian Hackers Targeting Oil and Gas Companies, the New York
Times, June 30, 2014
11. Jack Goldsmith, More Questions About the USG Basis for Complaints about China’s
Cyber Exploitations, Lawfare, May 30, 2013
12. Michael Riley, How the U.S. Government Hacks the World, Bloomberg Businessweek,
May 23, 2013
13. Kristine Kwok and Stephen Chen, Snowden effect changes US-China dynamic on
cybersecurity, U.S. China Perception Monitor, June 17, 2014
Privacy at stake: cyber theft of personal information
14. Michael Riley, Ben Elgin, Dune Lawrence, and Carol Matlack, Missed Alarms and 40
Million Stolen Credit Card Numbers: How Target Blew It, Bloomberg Businessweek,
March 13, 2014
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15. The White House, Executive Office of the President, Big Data: Seizing Opportunities,
Preserving Values, May 2014.
16. Mark Scott, Europe Urges U.S. to Handle Data Private With Care, The New York
Times, November 27, 2013
17. David Jolly, European Union Takes Steps Toward Protecting Data, The New York
Times, March 12, 2014
Denial of service attacks (DOS): “hacktivism,” warfare, and financial motivations
18. Somini Sengupta, The Soul of the New Hacktivist, The New York Times, March 17, 2012
19. John Markoff, Before the Gunfire, Cyberattacks, The New York Times, August 13, 2008
20. Nicole Perlroth and Quentin Hardy, Bank Hacking Was the Work of Iranians, Officials
Say, The New York Times, January 8, 2013
21. William J. Broad, John Markoff and David E. Sanger, Israeli Test on Worm Called
Crucial in Iran Nuclear Delay, The New York Times, January 15, 2011
22. Nicole Perlroth and David E. Sanger, Nations Buying as Hackers Sell Flaws in Computer
Code, The New York Times, July 13, 2013
23. Nicole Perlroth, Cybercriminals Zero In on a Lucrative New Target: Hedge Funds, The
New York Times, June 19, 2014
24. Noah Hampson, Hacktivism: A New Breed of Protest in a Networked World, 35 B.C. Int'l
& Comp. L. Rev. 511 (2012)
Recent Cybersecurity Controversies [Optional]
1. Nicole Perlroth, Sony Pictures Computers Down for a Second Day After Network Breach,
The New York Times, November 25, 2014.
2. Brooke Barnes and Nicole Perlroth, Sony Pictures and F.B.I. Widen Hack Inquiry, The
New York Times, December 3, 2014.
3. Press Statement by White House Secretary of State, John Kerry, Condemning
Cyberattack by North Korea, December 19, 2014.
4. David Sanger and Martin Fackler, N.S.A. Breached North Korean Networks before Sony
Attack, Officials Say, The New York Times, January 19, 2015.
5. David E. Sanger and Julie Davis, Hacking Linked to China Exposes Millions of U.S.
Workers, The New York Times, June 4, 2015.
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Cybersecurity Discussion Questions
1. Should the hacks of protest organizations such as Anonymous be treated as part of free
speech? In the case study, the Anonymous hack only harmed Prime’s public image; it did not
result in the theft of any of Prime’s property. Should we treat “protest” hacking different
from other types of hacking?
2. Why would the U.S. government indict foreign nationals when it is unclear whether they will
be able to prosecute them? Do you think this was wise on the U.S.’s part given the U.S.’s
own cyber espionage? Is the U.S.’s public position on China’s or Russia’s cyber espionage
valid? Why? In the case study example, should the U.S. government bring charges against
the Russian hackers?
3. What options are available to Prime after a cybersecurity breach? What risks does the
company face? What, if any, should be the limits of corporate civil liability for cybersecurity
breaches where customer information is stolen, as in the Target case or customer funds are
taken, as in the case of hedge fund hacking? How should policy makers allocate
responsibility in this rapidly changing environment? Is there a significant role for
regulation? For insurance? For diplomatic solutions through trade and investment treaties?
Should these be pursued on a multi-lateral global basis, through regional negotiations or as
bilateral agreements?
4. Compare EU and U.S. privacy law. What are the pros and cons of each approach?
What should a company do if it were to face a conflict in its ability to simultaneously abide
by EU and US privacy law?
5. Should the private sector cooperate with the government on cybersecurity issues? To what
extent? What are the advantages and disadvantages of a company disclosing to the
government that it has suffered a cyber-attack? What should a company do if it gets
conflicting messages from different parties of the U.S. government, like Prime in the case
study?
6. Should private companies take matters into their own hands to rebuff cyber-attacks? Should
they launch counter-attacks? Should they attempt to identify the hackers, such as determining
whether the hackers are private parties or government-sponsored? What are the risks of
companies taking counter-measures in response to a cyber-attack? Should the law protect
such countermeasures?
7. What should a private company do if it believes it was attacked by entities that are part of or
affiliated with a foreign government as part of a geopolitical struggle? Does your view of a
company’s obligation or options depend on whether you believe the hackers were driven by
geo-political strategy, economic gain or other interests? Does a private company have any
way to avoid becoming a victim in geopolitical conflicts or international criminal behavior?
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8. To what extent is it possible to protect intellectual property in today’s rapidly changing
technology landscape? How does this affect innovation?
9. How can the government effectively legislate in an area such as cybersecurity which evolves
almost daily? In the absence of formal legislation on cybersecurity, does the guidance that
organizations like the DOJ produce suffice to guide companies in the face of cyber - attacks ?
Which organizations should get a say in formulating such ‘guidance’ for companies?
10. Should government regulators bring enforcement actions against companies who have lost
customer personal information in a cyber -attack? Can a company use its compliance with the
DOJ guidelines, for example, as an affirmative defense when it faces charges for data loss
after a cyber-attack? On the other hand, can a company’s non-compliance with such
guidelines be used against it in enforcement actions?
11. Should companies be required or incentivized to invest more on cybersecurity? Should
certain companies receive a greater subsidy or incentive to increase cybersecurity protections
because of the nature of their technologies or data and the likely motivations of those
responsible for the breach?
12. Do individuals have responsibility for the personal information accessible on their mobile
phones? Should Prime be liable in private lawsuits for stolen customer information where the
information was stolen from customers’ phones and not directly from Prime’s servers?
13. Should there be a coordinated global response to cyber-attacks against private entities? What
would the response entail?
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Before Class 2
Reflecting on the new set of readings (below) and the readings and discussion from Class
1, submit a brief memo or proposal describing your thoughts on the following prompt to
the course iSites page before Class 2 by 9:00 pm.
Describe the key elements that new federal legislation on cybersecurity must comprise to
be able to effectively deal with this issue in today’s world. Rather than dealing with the
broad issue of cybersecurity, your proposal can focus on the particular issue you
confronted in the readings for Class 1, for e.g. hacktivism or consumer privacy.
Readings - Class 2
How do we and should we respond to cybersecurity breaches? How should the
private sector cooperate with the government?
1. Preet Bharara, Asleep at the Laptop, The New York Times, June 3, 2012
2. William A. Owens, Kenneth W. Dam, and Herbert S. Lin, Editors, Technology, Policy,
Law, and Ethics Regarding U.S. Acquisition and Use of CYBERATTACK
CAPABILITIES, National Research Council of the National Academies, pp. 202-213
3. Ian Urbina, Hacker Tactic: Holding Data Hostage, Hackers Find New Ways to Breach
Computer Security, The New York Times, June 21, 2014
4. Paul A. Ferrillo, Weil, Gotshal & Manges LLP, Cybersecurity, Cyber Governance, And
Cyber Insurance: What Every Public Company Director Needs to Know, The
Metropolitan Corporate Counsel, June 16, 2014
5. Nicole Perlroth and Elizabeth A. Harris, Cyberattack Insurance a Challenge for Business,
The New York Times, June 8, 2014
6. Haynes and Boone, A Desk Guide to Data Protection and Breach Response
7. Paul Rosenzweig, The Most Important Cybersecurity Case You’ve Never Heard Of,
Lawfare, May 29, 2013
8. Brent Kendall, Ruling Rejects Hotelier Wyndham’s Claim That Agency Lacks Power
Over Cybersecurity Practices, The Wall Street Journal, April 7, 2014
9. Sidley Austin LLP, SEC Launches Cybersecurity Examination Initiative – Promoting
Cyber Preparedness, April 24, 2014
10. Sidley Austin LLP, White House Releases NIST Cybersecurity Framework, February 13,
2014
11. King & Spalding, Five Things Every In-House Counsel Should Understand About The
NIST Cybersecurity Framework, February 25, 2014
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12. Optional: The Report of the Commission on the Theft of American Intellectual Property,
The IP Commission Report, The National Bureau of Asian Research, May 2013
13. Reuters, U.S. senators push ahead with cybersecurity legislation, Thomson Reuters, June
17, 2014
14. Melissa E. Hathaway, Change the Conversation, Change the Venue and Change Our
Future, Centre for International Governance Innovation, May 13, 2013.
Executive and Legislative developments in U.S. Cybersecurity
15. The White House, Securing Cyberspace – President Obama Announces New
Cybersecurity Legislative Proposal and Other Cybersecurity Efforts, January 13, 2015
16. The Department of Justice, Sharing Cyber threat information under 18 USC §2072(a)(3),
May 9, 2014.
17. The Department of Justice and the Federal Trade Commission, Antitrust Policy Statement
of Sharing Cybersecurity Information, April 10, 2014.
18. The Department of Justice, Cybersecurity Unit, Best Practices for Victim Response and
Reporting of Cyber Incidents, April 15, 2015.
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MULTIJURISDICTIONAL LAW ENFORCEMENT:
PUBLIC-PRIVATE REGULATORY REGIMES
Japan Tobacco International (JTI) Case
A. International Cigarette Smuggling In the late 1990s, many countries were being flooded with smuggled cigarettes, especially
popular American brands such as Camel and Marlboro.57 Because American cigarettes were
often subject to high taxes and import duties, smugglers began buying these cigarettes in
countries where they were not heavily taxed, such as Ukraine and Panama, and smuggling them
into higher-tax countries like Colombia, Spain, and Italy.58 Smuggled brand name cigarettes
could be sold at a much cheaper price than their legally imported counterparts, while still earning
substantial profits and leading to increased market share over other brands and local
competitors.59
Targeted countries were concerned for several reasons. First, cigarette smuggling cost
governments billions of dollars in lost tax revenue.60 Second, countries believed that tobacco
smuggling was linked to organized terrorism, organized crime, and drug money laundering.61
57 Cigarette smuggling was big business. According to one claim, “[f]ully one-third of all cigarettes
produced in the word end up being smuggled.” NOW: Tobacco Traffic (PBS Television Broadcast Apr. 19, 2002),
available at http://www.pbs.org/now/transcript/transcript114_full.html.
58 Id.; Suzanne Daley, Europeans Suing Big Tobacco in U.S., N.Y. TIMES, Nov. 7, 2000, available at
http://www.nytimes.com/2000/11/07/us/europeans-suing-big-tobacco-in-us.html (“Faced with little or no growth in
sales in the United States, American tobacco companies have been aggressively expanding their overseas sales and
marketing. But American brands, subject to various taxes and import duties, are expensive—as much as $6.67 a
pack in Norway—and smugglers are increasingly avoiding duties by illegally bringing cigarettes into markets like
Spain and Italy and selling them for 20 to 30 percent less than the legal price.”).
59 Marc Schapiro, Big Tobacco, THE NATION, Apr. 18, 2002, available at
http://www.thenation.com/article/big-tobacco ( “Smuggling has enabled multinational tobacco companies to
increase sales volume dramatically by evading local tariffs and competing head to head with domestic producers,
thereby helping to establish internationally recognizable brands.”; “If you have high tariffs or a state [tobacco]
monopoly, [the pattern is to] smuggle to get into the market, weaken the state monopolies, and lead the market into
the hands of the multinationals.”); see also Complaint at 21, European Cmty. v. RJR Nabisco, Inc., 150 F. Supp. 2d
456 (E.D.N.Y. 2001) (No. 00-CV-06617) (“The Defendants have increased their market share by making their
cigarettes available to the general public within the European Community at prices below that which could be
charged by their competitors whose products are sold lawfully and, therefore, are more expensive.”).
60 See, e.g., Ethan Bilby, Europe’s Illegal Cigarette Trade Grows Again—Report, REUTERS, Apr. 17, 2013,
available at http://uk.reuters.com/article/2013/04/17/uk-eu-tobacco-idUKBRE93G0Q020130417 (reporting
estimates of 12 billion Euros in lost tax revenue in 2012); Raymond Bonner, Europe Turning to U.S. to Fight Illicit
Cigarettes, N.Y. TIMES, May 8, 1998, available at http://www.nytimes.com/1998/05/08/world/europe-turning-to-us-
to-fight-illicit-cigarettes.html (reporting estimates of $1.5 billion in lost tax revenue in 1997).
61 See infra, note 68.
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B. Europe and Colombia Go to Court To combat the problem of cigarette smuggling, the targeted countries went to court.
Colombia, various European countries and the European Community (EC) brought multiple civil
suits in U.S. federal court against large tobacco companies like Philip Morris, R.J. Reynolds,
British American Tobacco, and Japan Tobacco International.62 Led by a Florida lawyer, Kevin
Malone, who had made a career of representing plaintiffs in air-crash class action litigation,63
Colombia and the European Community, on behalf of itself, brought nearly identical suits in the
Eastern District of New York in 2000.64 The plaintiffs claimed that the tobacco companies had
violated the federal Racketeer Influenced and Corrupt Act (RICO) and were also liable under
various state common law causes of action.65 The plaintiffs alleged that the tobacco companies
intentionally over-supplied certain markets knowing that the cigarettes would be smuggled into
Colombia and Europe,66 actively conspired with smugglers and assisted them in their smuggling
activities,67 and knew their smuggling activity was tied to organized crime and drug money
laundering.68
For their part, the tobacco companies insisted they were equally victims of cigarette
smuggling. They argued that many of the supposedly brand name cigarettes were, in fact, cheap
counterfeits that threatened to undercut their sales and valuable brand names.69
62 For a summary of the cases and their complicated procedural history, see European Cmty. v. RJR
Nabisco, Inc., 424 F.3d 175, 177–179 (2d Cir. 2005).
63 See Bio: Kevin A. Malone, KRUPNICK, CAMPBELL, MALONE, BUSER, SLAMA, HANCOCK, LIBERMAN,
available at http://www.krupnickcampbell.com/attorneys/kevin-a-malone; Myron Levin, Philip Morris Asks to Settle
Suits, L.A. TIMES, July 21, 2001, available at http://articles.latimes.com/2001/jul/21/business/fi-24871.
64 See European Cmty. v. RJR Nabisco, Inc. (European Community I), 150 F. Supp. 2d 456 (E.D.N.Y.
2001); Complaint, Dept. of Amazonas v. Philip Morris Co., Inc., 150 F. Supp. 2d 456 (E.D.N.Y. 2001) (No. 00-CV-
02881); Complaint, European Cmty. v. RJR Nabisco, Inc., 150 F. Supp. 2d 456 (E.D.N.Y. 2001) (No. 00-CV-
06617). The Colombian law suit was actually brought by a number of individual Colombian states, or Departments,
rather than the Republic of Colombia.
65 Complaint at 1–2, European Community I, 150 F. Supp. 2d 456.
66 Id. at 24 (“The Defendants sell large quantities of cigarettes to entities and/or destinations even though
the Defendants know, based on their own marketing studies, that the legitimate demand for cigarettes from those
entities and/or destinations cannot possibly account for the orders made and the massive quantities delivered. Under
these circumstances, the Defendants know that their cigarettes are being sold for illegal purposes.”).
67 Id. at 19–20 (“Defendants have collaborated with smugglers, encouraged smugglers and, directly and
indirectly, sold cigarettes to persons and entities who they know, or had reason to know, were smugglers.”); id. at 24
(“Defendants knowingly label, mislabel, or fail to label their cigarettes so as to facilitate and expedite the activities
of the smugglers.”); id. (“Defendants generate false or misleading invoices, bills of lading, shipping documents, and
other documents that expedite the smuggling process.”).
68 Id. at 19 (claiming that Defendants “have actively engaged in smuggling activities and concealed such
conduct through illegal acts, including money laundering”); id. at 90–95 (discussing ties to terrorism, money
laundering, and organized crime).
69 See, e.g., NOW: Tobacco Traffic, Philip Morris Responds (PBS Television Broadcast Apr. 19, 2002) (No
serious treatment of the subject of cigarette smuggling can ignore the increasing and dramatic impact of counterfeit
cigarettes. Billions of counterfeit cigarettes are produced each year and smuggled into markets around the world.
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The district court, however, never ruled on the substance of these smuggling allegations.
In July 2001, the court dismissed the European Community’s initial complaint on technical
standing grounds. It found that the European Community’s alleged injury (a reduced budget
resulting from member states’ inability to collect tax revenue) did not flow from the defendant’s
alleged violations of RICO law, at least for the purposes of standing.70 The European
Community wasted no time in returning to court, bringing a second suit a few weeks later. To
circumvent the standing issue, this time the European Community was joined by various
European Community member states, who could assert an injury sufficient to support standing
under RICO.71 This suit was again joined to the Colombian suit.
In February 2002, the district court dismissed the combined European and Colombian
lawsuits on standing grounds, this time finding that the U.S. federal courts lack the power to
adjudicate alleged violations of foreign tax law, or what is known at the “revenue rule.”72 As the
district court explained, “[t]he revenue rule provides that courts of one sovereign will not enforce
final tax judgments or unadjudicated tax claims of other sovereigns”73 unless the rule is either
abrogated by treaty74 or “the plaintiff can show adequate manifestation of executive and
legislative will sufficient to allay the foreign relations and separation of powers concerns the
underlying the revenue rule.”75 Applying the rule to the claims, the district court found that the
rule barred the action:
The present actions involve RICO claims for injury in the form of lost customs duties,
lost value added taxes, and lost excise taxes, and also for injury in the form of
additional contributions by Member States to the European Community to
compensate for tax revenue that the European Community otherwise would have
collected. Predicated on smuggling, the claims all clearly implicate the revenue rule
in that they would necessarily cause this court to pass on foreign tax laws.
Plaintiffs also bring various RICO claims predicated on harms derivative of
smuggling. The injuries include, inter alia, loss of funds spent to combat cigarette
smuggling, and coordinate damage to the security and integrity of Plaintiffs’ relevant
institutions and markets. Additionally, Plaintiffs seek equitable and injunctive relief
designed to impede smuggling, improve future defenses against smuggling, and
This results in incalculable damage to the brand owners’ goodwill and integrity of the brands through the mistaken
attribution of contraband cigarettes of inferior quality to producers such as Philip Morris, as well as tax losses to
governments.”), available at http://www.pbs.org/now/transcript/transcript_pm.html.
70 European Community I, 150 F. Supp. 2d at 501.
71 See European Cmty. v. Japan Tobacco, Inc. (European Community II), 186 F. Supp. 2d 231 (E.D.N.Y.
2002). The European Community member states were Belgium, Finland, France, Greece, Germany, Italy,
Luxembourg, the Netherlands, Portugal, and Spain.
72 Id. at 235.
73 Id.
74 Id. at 236.
75 Id. at 235.
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recoup monies lost to smuggling. All of these claims also trigger the revenue rule
under the [Second Circuit’s] Attorney General of Canada ruling. Here, as there, “we
would have to examine whether, when and to what extent the smuggling existed,
which would require a determination that tax laws were applicable to defendants.”76
Frustrated in their efforts to combat cigarette smuggling, the European and Colombian
plaintiffs spent the next several years appealing the decision with little success.77 In January
2004, the Second Circuit affirmed the district court’s dismissal.78 However, in May 2005 the
Supreme Court granted certiorari and remanded for further consideration in light of its
intervening decision in Pasquantino v. United States.79 Pasquantino held that the revenue rule,
while prohibiting civil suits to enforce the tax laws of another country, still permitted the United
States to criminally prosecute individuals or companies who violated foreign tax laws.80 On
remand, the Second Circuit re-affirmed the district court’s original ruling that the lawsuits were
barred by the revenue rule.81
For their part, the tobacco companies fought back by bringing various claims in the Court
of Justice of the European Communities, seeking annulment of the European Commission’s
authorization of the U.S. lawsuits on the grounds it was illegal. However, these claims were
ultimately rejected by the Court of Justice.82
C. The Problem The refusal of the courts to resolve the substantive legal issues surrounding cigarette
smuggling did not end the matter. Governments in Colombia and Europe still faced cigarette
smuggling and lost tax revenue. The tobacco companies faced an uncertain legal environment in
key markets. They were also worried that increased media attention and political pressure abroad
would grab the attention of the United States Department of Justice, which was able to criminally
prosecute companies that knowingly assisted in the violation of foreign tax laws under
76 Id. at 237 (quoting Attorney General of Canada v. R.J. Reynolds Tobacco Holdings, Inc., 268 F.3d 103,
133 (2d Cir. 2001).
77 See European Cmty. v. RJR Nabisco, Inc., 424 F.3d 175 (2d Cir. 2005), cert. denied European Cmty. v.
RJR Nabisco, Inc., 546 U.S. 1092 (2006).
78 European Cmty. v. RJR Nabisco, Inc., 355 F.3d 123 (2d Cir. 2004) cert. granted, judgment vacated, 544
U.S. 1012 (2005).
79 European Cmty. v. RJR Nabisco, Inc., 544 U.S. 1012 (2005).
80 Pasquantino v. United States, 544 U.S. 349 (2005).
81 European Cmty. v. RJR Nabisco, Inc., 424 F.3d 175 (2d Cir. 2005), cert. denied European Cmty. v. RJR
Nabisco, Inc., 546 U.S. 1092 (2006).
82 Reynolds Tobacco and Others v. Commission, 2006 E.C.R. I-07795 (finding that the European
Commission’s authorization of the lawsuit was not subject to review by the Court under the Treaty of the European
Union).
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Pasquantino.83 In addition, both sides continued to be hurt by the increasing prevalence of
counterfeit cigarettes. On top of these problems, the relationship between the parties had soured.
Both sides had shown a willingness to fight expensive, protracted legal battles, and neither side
was willing to give up. Bilateral negotiations were also unlikely, given the number of countries
involved and, on the European side, the various supra-national organizations, including the
European Commission, the European Anti-Fraud Office (OLAF), the European Parliament, and
its Trade and Justice Committees.
Faced with limited legal options, the parties found a novel solution. The readings that
follow present this solution, focusing on one tobacco company, Japan Tobacco International
(JTI). JTI is the international division of Japan Tobacco, the largest tobacco company in Japan84
and one of the four largest tobacco companies in the world.85 JTI owns the rights to popular R.J.
Reynolds brands sold outside the United States, such as Winston, Camel, and Benson &
Hedges.86
* * * * *
D. Other Public-Private Regulatory Regime Contexts The preceding discussion presents one context in which a public-private regulatory
regime can, and did, arise. However, due to the nature of the issues and parties involved, no two
regimes will be the same. This section introduces several other types of public-private regulatory
regimes, which are discussed in greater detail in the following readings.
1. Swiss Banks and the U.S. Department of Justice Swiss banking has long been synonymous with secrecy. This has changed in the last few
years, however, as the U.S. Department of Justice (DOJ) has launched a campaign against Swiss
bank secrecy. Intent on cracking down on Americans who evade U.S. tax law through secret
Swiss bank accounts, the DOJ has dramatically altered the Swiss banking industry in a short
period of time.
In the mid-2000s, the DOJ began investigating UBS, the largest Swiss bank, on the
grounds that UBS violated U.S. criminal law by aiding American clients in setting up offshore
bank accounts to avoid U.S. tax laws.87 As a result of the investigation, the DOJ and UBS
83 As noted above, the revenue rule barred the civil suit brought by the EC and European Commission, but
did not bar criminal prosecution by the United States for violations of foreign tax law. See supra note 80 and
accompanying text.
84 Japan Domestic Tobacco Business, JT.COM, available at
http://www.jt.com/about/division/tobacco/japan/index.html.
85 Bloomberg Industry Market Leaders: Tobacco, BLOOMBERG, available at
http://www.bloomberg.com/visual-data/industries/detail/tobacco/an9. Japan Tobacco is the second largest tobacco
company in the world by sales and the fourth largest by market share, behind Philip Morris, Imperial Tobacco
Group, and British American Tobacco. Id.
86 JTI At a Glance, JT.COM, available at http://www.jti.com/our-company/jti-at-a-glance/.
87 U.S. Department of Justice, Press Release: UBS Enters into Deferred Prosecution Agreement, Feb. 18,
2009, available at http://www.justice.gov/opa/pr/ubs-enters-deferred-prosecution-agreement; Lynnley Browning, A
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entered into a deferred-prosecution agreement in 2009, under which UBS agreed to turn over
information on certain American clients in exchange for the DOJ’s promise not to prosecute.88
Following the UBS agreement, the DOJ announced a program offering other Swiss banks
amnesty through similar deferred- or non-prosecution agreements.89 Although some banks have
ended up in court—including the oldest private Swiss bank, Wegelin, which declared bankruptcy
after pleading guilty to assisting in U.S. tax evasion90—hundreds of banks have signed on.91
Switzerland, for its part, recently reversed centuries of tradition by relaxing laws that previously
prevented Swiss banks from revealing certain bank customer information.92 Although the final
word on the DOJ’s efforts has not yet been written, its innovative and expansive use of deferred-
prosecution agreements has sent waves through the banking industry.
2. Spitzer, Merrill Lynch, SEC, and the Global Analyst Research Settlement Following the tech stock market bubble of the late 1990s and the ensuing crash in 2000,
then-New York Attorney General Eliot Spitzer launched an investigation into the major
investment banks. Spitzer was investigating the claim that investment bank analysts were
incentivized to issue bullish ratings for companies that were clients of other parts of the banks.93
Investors who bought stocks relying on the positive ratings pointed to this conflict of interest
when the stocks subsequently suffered significant losses during the crash.
Spitzer’s investigation initially focused on Merrill Lynch. Relying on a little-known New
York law, the threat of indictment, and publicity, Spitzer reached a settlement with Merrill
Lynch under which the bank paid a $100 million fine and restructured how analysts were paid.94
Spitzer’s investigations attracted significant attention because of the aggressive use of the state’s
Attorney General office and because this was an area usually regulated by the federal Securities
Swiss Bank Is Set to Open Its Secret Files, N.Y. TIMES, Feb. 19, 2009, available at
http://www.nytimes.com/2009/02/19/business/worldbusiness/19ubs.html.
88 Deferred Prosecution Agreement, United States v. UBS AG, No. 09-60033-CR-COHN (S.D. Fla. Feb.
18, 2009).
89 Department of Justice, Joint Statement between U.S. DOJ and Swiss Federal Department of Finance and
Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks, Aug. 29, 2013, available at
http://www.justice.gov/iso/opa/resources/7532013829164644664074.pdf.
90 Nate Raymond & Lynnley Browning, Swiss Bank Wegelin to Close After Guilty Plea, REUTERS, Jan. 4,
2013, available at http://www.reuters.com/article/2013/01/04/us-swissbank-wegelin-idUSBRE9020O020130104.
91 David Voreacos, Swiss Banks Seek Tax Amnesty as Third Accept U.S. Offer, BLOOMBERG, Jan. 26, 2014,
available at http://www.bloomberg.com/news/2014-01-25/tax-amnesty-program-draws-106-swiss-banks-u-s-
prosecutor-says.html.
92 John Letzing, Swiss Banks Say Goodbye to a Big Chunk of Bank Secrecy, WALL STREET JOURNAL, July
1, 2014, available at http://blogs.wsj.com/moneybeat/2014/07/01/swiss-banks-say-goodbye-to-a-big-chunk-of-bank-
secrecy; Vanessa Houlder, Switzerland Pledges to Lift Veil on Tax Secrecy, FINANCIAL TIMES, May 6, 2014,
available at www.ft.com/intl/cms/s/0/65447580-d514-11e3-9187-00144feabdc0.html.
93 Nicholas Thompson, The Sword of Spitzer, LEGAL AFFAIRS, May/June 2004.
94 Charles Gasparino, Merrill Will Pay $100 Million Fine to Settle New York’s Analyst Probe, WALL
STREET JOURNAL, May 22, 2002, available at http://online.wsj.com/articles/SB1021984263586757080.
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and Exchange Commission rather than the states.95 Although Spitzer threatened to go after other
Wall Street firms as well, the SEC ultimately entered with its own investigation into the
practices. The result was a Global Research Analyst Settlement entered into by the SEC and ten
Wall Street firms that was similar to the settlement Spitzer reached with Merrill Lynch.96
3. Cybersecurity Regulation Although cybersecurity is discussed in another case in the course, cybersecurity
regulation also presents an area where public-private regulatory regimes might emerge in the
future. Recent attacks on prominent targets such as JP Morgan, Target, and Home Depot have
increased public and corporate awareness of the importance of cyber security.97 Currently, no
comprehensive regulatory framework exists.98 Instead, companies are faced with a rapidly
changing patchwork of state and federal legislation, case law, regulatory action, and voluntary
standards.99 This uncertain regulatory arena, combined with companies’ interests in protecting
customers’ and their own data, creates a field that is potentially ripe for public-private regulatory
regimes.
Before Class 1
Please read through the readings and respond to each of the discussion questions that follow. No
written response is due prior to class; the discussion questions below will be used to structure
class discussion.
Discussion Questions: Day 1
A. What are public-private regulatory regimes?
1. How would you characterize these kinds of agreements legally? Does it really matter how
we characterize them?
2. What makes the agreements “regulatory” as opposed to legal settlements or contracts?
The agreements do not appear to be regulatory in the traditional sense of rules
promulgated by legislatures or agencies. In identifying the agreements as “regulatory,”
does it matter whether the agreements are forward-looking versus backward-looking? Are
95 Nicholas Thompson, The Sword of Spitzer, LEGAL AFFAIRS, May/June 2004.
96 Securities Exchange Commission, SEC Fact Sheet on Global Analyst Research Settlements, Apr. 28,
2003.
97 See, e.g., Tom Braithwaite, JP Morgan Cyber Attack Hits 76 Million Households, FINANCIAL TIMES, Oct.
2, 2014.
98 Paul A. Ferrillo & David J. Schwartz, Alert: Cyber Security, Cyber Governance, and Cyber Insurance,
Weil, Gotschal & Manges LLP, Sept. 4, 2014.
99 Id.
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broad versus narrow in scope? Involve one private actor versus several? Have the
potential to affect entities other than the parties to the agreement?
3. Does it matter who the public parties to the agreement are? Note the various public
entities involved in the agreements in the readings: a supranational entity (the European
Commission), sovereign states (the European nations), regulators (the SEC), federal
prosecutors (the DOJ), and state prosecutors (the NY Attorney General). Does the nature
of the public party affect whether the agreement is considered a regulatory regime? As
will be explored further below, what are the concerns with prosecutors being involved in
a regulatory role?
4. What is the difference between a regulatory “regime” versus an isolated agreement? Is it
similar to whether we consider an agreement to be “regulatory”?
5. What is the difference between an international public-private regulatory regime and a
multi-lateral treaty? Read Clause 25 of the JTI Agreement. Does the fact that other EU
countries can unilaterally sign onto the agreement make it analogous to a multi-lateral
treaty?
B. Parties’ interests and motivations
1. In answering the following questions, consider what motivated the parties to enter into
the various agreements. In other words, how do the agreements satisfy the various
parties’ interests and what are the advantages of a cooperative agreement versus court or
a legal settlement?
2. When JTI and the other tobacco companies entered into their respective cooperation
agreements, they were ostensibly “winning” in the conflict with the EU, at least on the
legal front. Why, then, would JTI (and the other tobacco companies) have entered into
such an agreement? Consider whether the obligations created by the agreement put JTI at
a competitive disadvantage in the European market and what impact the agreement would
have on JTI's EU competitors? What pressures might JTI have faced and from whom?
3. What characteristics of the Additional Payment Clauses (Sections 7.10 and 7.11) make it
desirable for both JTI and the European governments? Why would JTI have agreed to no-
fault payments for certain seizures?
4. Under Section 13 of the JTI agreement, JTI can deduct from its payments any monetary
liability resulting from conduct that occurred before the agreement was executed. The
benefit to JTI is obvious: their payments under the agreement remain constant. How do
the European countries benefit?
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D. Enforcement of public-private regulatory regimes and agreements
1. How are the various agreements enforced, and what are the consequences of failure?
Note the unusual enforcement mechanisms in the JTI agreement to ensure JTI’s
compliance with the agreement (Section 11) and to resolve any disputes over the
agreement (Section 14). Do you think this system is sufficient to ensure compliance and
resolve any disputes? Why would the European governments not insist on being able to
audit JTI to ensure compliance? Would this system work without a supranational entity
like the European Commission?
E. Multijurisdictional issues
1. What are some of the problems that might arise if agreements such as the JTI agreement
were to become a more common method for dealing with multinational or
multijurisdictional disputes?
2. JTI was initially sued in U.S. courts. Why did the European Commission and European
states bring suit in the U.S. rather than a European court? What interests did U.S. courts
have in the dispute? What other mechanisms may have been pursued for resolving the
dispute? Why do you think they were not pursued?
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Background Reading: Day 1
Japan Tobacco International
1. NOW: Tobacco Traffic, Transcript, Apr. 19, 2002, pp. 1–8.
2. Marc Schapiro, Big Tobacco, The Nation, Apr. 18, 2002.
3. Suzanne Daley, Europeans Suing Big Tobacco in U.S., N.Y. Times, Nov. 7, 2000.
4. Bio: Kevin A. Malone, Krupnick, Campbell, Malone, Buser, Slama, Hancock &
Liberman.
5. Charles Lunan, Crash Lawsuits Expected to Keep Date Courts Busy, The Sun-Sentinel,
Dec. 22, 1995.
6. Myron Levin, Philip Morris Asks to Settle Suits, L.A. Times, July 21, 2001.
7. Complaint, European Community v. RJR Nabisco, Inc., pp. 1–26.
8. Opinion, European Community v. Japan Tobacco, Inc., Feb. 19, 2002.
9. Opinion, Pasquantino v. United States, 544 U.S. 349 (2005).
10. Mark Tran, Philip Morris reaches $1.25 Billion EU Agreement, The Guardian, July 9,
2004.
11. European Union, Press Release: European Commission and JTI Sign 15-Year Agreement
to Combat Contraband and Counterfeit Cigarettes, Dec. 14, 2007.
12. JTI and European Community Cooperation Agreement.
13. JTI and European Community Mutual Cessation Agreement.
14. Algirdas Šemeta, Speaking Points, Committee on Budgetary Control, European
Parliament, European Commission, Oct. 7, 2014.
15. Peter Evans, Tobacco Firms Step up Fight Against Cigarette Smuggling, Wall Street
Journal, Mar. 25, 2014.
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Before Class 2
Please read through the readings and respond to the following prompt. Send a written response to
Professor Kaden ([email protected]) the day before Class 2 by 9:00 pm.
Large, international companies often face regulation from multiple jurisdictions,
whether on the domestic, international, or supranational stage. What are the
benefits of public-private regulatory regimes or multi-party agreements when dealing
with multijurisdictional regulation?
The discussion questions below will be used to structure class discussion.
Discussion Questions: Day 2
A. Parties’ interests and motivations
1. What motivation did Swiss banks have to sign deferred-prosecution agreements with the
DOJ? Why would a small Swiss bank like Valiant, which had fewer than 500 American
client and appears not to have done anything illegal, enter into an agreement?
2. Given the bi-partisan Congressional pressure on the DOJ to go after Swiss banks (see
Politico article, Panel: DOJ Lax on Swiss Bank Fraud), why would the DOJ utilize
deferred-prosecution agreements rather than simply go to court? If the DOJ believes it
has a case against UBS, why wouldn't the DOJ just prosecute UBS?
3. All of the agreements in the readings were multi-lateral rather than bi-lateral. What are
the advantages and disadvantages of one over the other? For JTI, what was the advantage
of negotiating a multi-party agreement rather than an agreement with each European
state? For the DOJ, what are the benefits of creating a global amnesty program rather
than prosecuting individual Swiss banks?
4. What are the advantages and disadvantages of waiting on the sidelines while a competitor
enters into these kinds of agreements? Is JTI better off having been one of the first
companies to sign a cooperation agreement? What about the Swiss banks? Swiss banks
have faced very different outcomes depending on when and how they came forward. For
example, Credit Suisse has received a much heavier penalty than UBS, who came
forward earlier, and Wegelin went out of business after entering a guilty plea. Does this
suggest there are strategic decisions in how companies enter into such agreements?
Likewise, was Merrill Lynch better off or worse off for having settled with the NY
Attorney General before the SEC announced its global settlement?
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B. Risks involved in negotiations and agreements
1. What are the risks of entering into these types of agreements? Consider, for example, that
governments cannot generally provide a release of future criminal claims. Since none was
provided in the JTI agreement, how could JTI be assured it would not be charged with
criminal conduct the day after signing the agreement? Likewise, how can Swiss banks
prevent the DOJ from changing the terms of their agreement, as they claim it is doing in
the readings?
2. Another risk companies face is that entering into negotiation in the first place may reveal
sensitive information. For example, Swiss banks entering into deferred prosecution
agreements with the DOJ may have to disclose information the DOJ might not otherwise
be able to obtain, thereby opening the Swiss banks to subsequent prosecution. How can
Swiss banks minimize this type of risk?
3. One important issue is how the parties publicize the agreement. If one party disparages
the other parties, criticizes the agreement, or accuses the other party of violating the
agreement, the agreement may quickly collapse or generate bad will. There are also
political considerations. For example, some believed Eliot Spitzer aggressively used the
media in reaching the settlement with Merrill Lynch. How can parties minimize this kind
of risk?
C. Enforcement of public-private regulatory regimes and agreements
1. How does the Global Analyst Research Settlement ensure compliance, i.e., that
recommendations of research analysts at financial firms are independent of the firms’
financial interests? How is this different from the JTI agreement?
2. How do the DOJ-Swiss bank deferred prosecution agreements ensure compliance? To the
extent the program mainly depends on voluntary disclosure by the banks, how can the
DOJ ensure the banks are actually disclosing all the necessary information and will
continue to do so in the future?
E. Multijurisdictional issues
1. The Swiss bank reading material demonstrates that different jurisdictions sometimes have
conflicting laws, such as the Swiss banking privacy laws that prevented disclosure of
information required by U.S. law. Should these types of tensions in international law be
resolved through public-private regulatory regimes, or are they better left for the treaty
process? What are the downsides to relying on treaties to resolve such tensions?
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F. Prosecutors as regulators
1. The Swiss bank and Merrill Lynch material both involve settlements signed by
prosecutors rather than agencies or countries. (The SEC could also be considered as
acting in a prosecutorial role.) We normally don’t think of prosecutors as regulators.
Should we?
2. What are some of the problems associated with prosecutors wearing a regulatory hat? At
the time, some accused New York’s Attorney General, Eliot Spitzer, of being
overzealous in acting as a regulator, overstepping the bounds of both his office and what
the law actually prohibited, and being politically motivated. Do these concerns have
merit? Agencies like the SEC already wear both enforcement and regulatory hats, so what
is the difference between an agency like the SEC and a state attorney general? Are there
any special considerations when threats of prosecution involve financial companies?
G. Public-private regulatory regimes today
1. The agreements with JTI and other tobacco companies have generally been considered
successful. The EU is currently negotiating with PMI over whether to extend their
agreement, which is set to expire in 2016, and it appears the agreement will be renewed.
But could similar agreements be entered into today, especially after the financial crisis?
Would they be perceived as being too lenient to the companies?
2. Where else do public-private regulatory regimes exist? In what other areas would public-
private regulatory regimes work?
Background Reading: Day 2
Swiss Banks and the U.S. Department of Justice
16. Department of Justice-UBS Deferred Prosecution Agreement and press release.
17. Department of Justice, Joint Statement between U.S. DOJ and Swiss Federal Department
of Finance and Program for Non-Prosecution Agreements or Non-Target Letters for
Swiss Banks, Aug. 29, 2013.
18. David Voreacos, Swiss Banks Seek Tax Amnesty as Third Accept U.S. Offer, Bloomberg,
Jan. 26, 2014.
19. Vanessa Houlder, Switzerland Pledges to Lift Veil on Tax Secrecy, Financial Times, May
6, 2014.
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20. Rachael Bade, Panel: DOJ Lax on Swiss Bank Fraud, POLITICO, Feb. 25, 2014.
21. Daniel Wilson, Germany, France Want EU Pushback on US Bank Penalties, Law360,
Aug. 4, 2014.
22. David Voreacos, Giles Broom & Jeffrey Vogeli, Swiss Banks Ask U.S. to Amend
Proposed Tax Amnesty Deals, Bloomberg, Oct. 23, 2014.
Spitzer, Merrill Lynch, SEC, and the Global Analyst Research Settlement
23. Charles Gasparino, Merrill Will Pay $100 Million Fine to Settle New York’s Analyst
Probe, Wall Street Journal, May 22, 2002.
24. Securities Exchange Commission, SEC Fact Sheet on Global Analyst Research
Settlements, Apr. 28, 2003.
25. Nicholas Thompson, The Sword of Spitzer, Legal Affairs, May/June 2004.
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