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Orderly Liquidation Authority

Georgetown University Law Center | Federal Regulation of Financial Institutions | Fall 2011 | Simon Lacey | sl673@law.georgetown.edu

Overview

1. OLA in the overall context of Dodd-Frank

2. OLA in the context of other (similar) instruments

3. Policy issues | problems addressed

4. How OLA is intended to work

5. Criticism of OLA as a policy instrument

6. Further reading | sources

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OLA in the context of Dodd-FrankDodd Frank: “An Act to promote the financial stability of the United States by improving accountability and transparency in the financial system, to end "too big to fail", to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial servicespractices, and for other purposes.”

Title I – Financial Stability

Title II – Orderly Liquidation AuthorityTitle III – Transfer of Powers to the Comptroller, the FDIC, and the FedTitle IV – Regulation of Advisers to Hedge Funds and OthersTitle V – InsuranceTitle VI – Improvements to RegulationTitle VII – Wall Street Transparency and AccountabilityTitle VIII – Payment, Clearing and Settlement SupervisionTitle IX – Investor Protections and Improvements to the Regulation of SecuritiesTitle X – Bureau of Consumer Financial ProtectionTitle XI – Federal Reserve System ProvisionsTitle XII – Improving Access to Mainstream Financial InstitutionsTitle XIII – Pay It Back ActTitle XIV – Mortgage Reform and Anti-Predatory Lending ActTitle XV – Miscellaneous ProvisionsTitle XVI – Section 1256 Contracts3 |

OLA in the context of other (similar) instruments

Prompt Corrective Action Introduced in 1991 under the Federal

Deposit Insurance Corporation Improvement Act (FDICIA).

Resolution by the FDIC• Purchase & Assumption Transaction (FDIC arranges

for an acquirer to purchase some or all of the failed bank’s assetsand assume some or all of the bank’s liabilities.)

• Deposit Payoff (straight liquidation)

• Open Bank Assistance (except in cases of systemic risk,

open bank assistance must meet least-cost resolution requirement and must not in any way benefit the bank’s shareholders.

Conservatorship (essentially just used as a preliminary stage to

liquidation)

Resolution Plans (“Living Wills”) as required under section

165(d) of Title I of the Dodd0Frank Act.4 |

Policy issues | problems addressed

Eliminate taxpayer bailouts of companies that are “too big to fail”

Ensure that private sector (creditors and shareholder)bear the cost of the proceedings (not taxpayers)

Ensure management is removed

“The result is a law that attempts to balance the goals of the bankruptcy and customer protection laws with the goals ofpreserving or restoring financial stability, public confidence and reasonable risk taking that may have been disrupted as a result of a financial panic”

Davis Polk Financial Reform Summary5 |

How OLA is intended to work

Covered Financial Companies

Title II of the Dodd-Frank Act defines “financial company” as a company that is incorporated or organized under any provision of federal or state law and is a: BHC; Nonbank financial company supervised by the Federal Reserve

Board; Company that is “predominantly engaged” in activities the FRB has

determined to be financial in nature under Section 4(k) of the BHCA; or

Any subsidiary of the foregoing that is predominantly engaged in activities the FRB has determined to be financial in natureunder Section 4(k) of the BHCA.

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How OLA is intended to work

Process for Determining that a Financial Company is Subject to the New Orderly Liquidation Regime

Written Recommendation to Appoint Receiver Systemic Risk Determination by Treasury Judicial Review of Determination

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How OLA is intended to work

Determination by the Treasury Secretary: That the financial company is “in default or in danger of default”; Failure of the financial company and its resolution under otherwise

applicable insolvency law would have serious adverse effects on financial stability in the US;

No viable private sector alternative is available to prevent the default of the financial company;

Effect of using OLA on claims of various stakeholders and other marketparticipants would be appropriate given the beneficial impact of using OLA on US financial stability;

Use of OLA authority better than the alternatives under otherwiseapplicable insolvency law

Federal regulatory agency has ordered the financial company toconvert all of its convertible debt instruments

Company satisfies the definition of a financial company under the statute.

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How OLA is intended to work

Judicial Review of Determination If the board of directors of the company does not acquiesce

to the appointment of the FDIC as receiver, Treasury mustconfidentially petition the US District Court for the District of Columbia for an order authorizing the appointment

The court, in a confidential proceeding, would review on an “arbitrary and capricious” standard Treasury’s determination that the covered financial company was

(a) in default or in danger of default, and

(b) is a “financial company” as defined under Title II of the Dodd-Frank Act.

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How OLA is intended to work

FDIC Appointment; Receivership Duties and Powers Orderly Liquidation Modeled on FDIA

Take over the assets of and operate the financial company, to sell assets or transfer assets to a bridge financial company, and to merge the covered financial company with another company;

Value and prioritize claims; Avoid fraudulent transfers and preferences; Seek injunctive relief against any asset anywhere (without the necessity of showing irreparable harm); Prioritize administrative expenses of the receiver; Repudiate contracts, including qualified financial contracts, and limit damages for such repudiation; Transfer qualified financial contracts and give notification of transfer; Impose a one business-day (effectively allowing a weekend to transfer) automatic stay of termination

rights for qualified financial contracts (as opposed to the three days in the original Senate-passed bill); Recognize security interests and customer interests; Enforce contracts; Invalidate ipso facto clauses; Require consent for the termination, acceleration, or declaration of default under any contract to which

the covered financial institution is a party; Pursue directors and officers of a covered financial company for gross negligence or tortuous conduct; Create and operate bridge financial companies; and Prohibit settlements with secrecy agreements and protective orders.

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Criticism of OLA as a policy instrument The fact that most large (systemically important) financial

institutions operate across multiple jurisdictions and thusforcing a financial company of such size to liquidate could:

Be unworkable in practical terms

Run contrary to the US’s foreign policy interests

Instrument works more as a disincentive for the executivemanagement and boards of such institutions to stay out of the zone where they might come in to consideration for OLA.

OLA seen as a replacement for open bank assistance butnow the only scope the government has for injecting funds into a troubled systemically important financial institution would be once it has decided to liquidate it.

Lack of judicial oversight or review

Forces FDIC to pick which creditors are made whole and whichnot, and thereby threatens to entrench crony capitalism

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Further reading | sources

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Additional sources

Financial Regulatory Reform: How Does It Help, How Does It Hurt? (A panel featuring: Kenneth Griffin, Raymond McDaniel Jr., Jim Millstein, Thomas Wilson, and moderated by Alan Schwartz | The Milken Institute | May 11, 2011)http://www.milkeninstitute.org/events/gcprogram.taf?function=detail&eventid=gc11&EvID=2818

FDIC’s Resolution Handbook (for a practical guide on how resolution authority worked before OLA http://www.fdic.gov/bank/historical/reshandbook/

Wikipedia’s page on Dodd–Frank Wall Street Reform and Consumer Protection Act http://en.wikipedia.org/wiki/Dodd%E2%80%93Frank_Wall_Street_Reform_and_Consumer_Protection_Act

The Orderly Liquidation of Lehman Brothers Holdings under the Dodd-Frank Acthttp://www.fdic.gov/regulations/reform/lehman.html

GOA Report Bankruptcy: Complex Financial Institutions and InternationalCoordination Pose Problems http://www.gao.gov/new.items/d11707.pdf

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Orderly Liquidation Authority

Georgetown University Law Center | Federal Regulation of Financial Institutions | Fall 2011 | Simon Lacey | sl673@law.georgetown.edu