Diversifying to Mitigate Risk: Can Dodd–Frank Section 342 Help Stabilize the Financial Sector?

Washington and Lee Law Review, Aug 2018

By Kristin Johnson, Steven A. Ramirez, and Cary Martin Shelby, Published on 09/01/16

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Diversifying to Mitigate Risk: Can Dodd–Frank Section 342 Help Stabilize the Financial Sector?

Diversif ying to Mitigate Risk: Can Dodd-Frank Section 342 Help Stabilize the Financial Sector? Cary Martin Shelby 0 1 2 3 4 0 DePaul University College of Law 1 Steven A. Ramirez Loyola University Chicago School of Law 2 Kristin Johnson Seton Hall University School of Law 3 Thi s Article is brought to you for free and open access by the Washington and Lee Law Review at Washington & Lee University School of Law Scholarly Commons. It has been accepted for inclusion in Washington and Lee Law Review by an authorized editor of Washington & Lee University School of Law Scholarly Commons. For more information , please contact , USA 4 Kristin Johnson, Steven A. Ramirez, and Cary Martin Shelby, Diversifying to Mitigate Risk: Can Dodd-Frank Section 342 Help Stabilize the Financial Sector? , 73 Wash. & Lee L. Rev. 1795, 2016 Follow this and additional works at: http://scholarlycommons.law.wlu.edu/wlulr Part of the Constitutional Law Commons, and the Evidence Commons Recommended Citation - Article 5 Diversifying to Mitigate Risk: Can Dodd–Frank Section 342 Help Stabilize the Financial Sector? Kristin Johnson∗ Steven A. Ramirez∗∗ Cary Martin Shelby∗∗∗ I. Introduction ...................................................................1796 II. The Empirical Foundation for Enhanced Diversity in Finance ......................................................1806 ∗ Kristin Johnson, Professor of Law, Director of the Regulation, Governance and Risk Management Program, Seton Hall University School of Law. ∗∗ Steven A. Ramirez, Professor of Law, Associate Dean of Research & Faculty Development, Director, Business Law Center, Loyola University Chicago School of Law. ∗∗∗ Cary Martin Shelby, Associate Professor, DePaul University College of Law. I. Introduction As the global financial crisis of 2007–2009 continues to reverberate across the global economy,1 financial regulation remains at the forefront of public discourse.2 The underlying causes of the crisis still generate controversy.3 By any measure, however, the financial institutions at the center of the financial crisis are special for many reasons.4 Increasingly, these businesses 1. See, e.g., ADAIR TURNER, BETWEEN DEBT AND THE DEVIL 213 (2015) (“Seven years after the 2007–2008 financial crisis the world’s major economies are still suffering its consequences.”) ; Maximilian Walsh, Financial Crisis Still Not Over Seven Years After Lehman Brothers, AUSTRALIAN FIN. REV. (June 3, 2015) , http://www.afr.com/opinion/columnists/financial-crisis-still-not-over-sevenyears-after-lehman-brothers-20150603-ghfmkn#ixzz3pijkm4di (last visited Dec. 11, 2016) (“The Great Recession—the one we were not supposed to have—is now seven years old and, despite the best efforts of an army of professional economists, recovery remains tentative.”) (on file with the Washington and Lee Law Review). 2. See Donna Borak, Donald Trump, Jeb Hensarling Meet on Dodd-Frank Alternative, WALL ST. J. (June 7, 2016), http://www.wsj.com/articles/donaldtrump-jeb-hensarling-meet-on-dodd-frank-alternative-1465335535 (last visited Dec. 13, 2016) (highlighting the debate over Jeb Hensarling’s plan to repeal 2010 Dodd–Frank law) (on file with the Washington and Lee Law Review). 3. Compare Lynn A. Stout, Derivatives and the Legal Origin of the 2008 Credit Crisis, 1 HARV. BUS. L. REV. 1, 27–28 (2011) (assigning primary cause of the financial crisis to derivatives deregulation), with Steven A. Ramirez, The Virtues of Private Securities Litigation: An Historic and Macroeconomic Perspective, 45 LOYOLA U. CHI. L.J. 669, 720 (2014) (“[A]t bottom, massive securities fraud defines the Great Financial Crisis of 2008 and led to an historic financial collapse.”) . The financial crisis of 2008 was a highly complex event and its causes are similarly complex. See generally STEVEN A. RAMIREZ, LAWLESS CAPITALISM: THE SUBPRIME CRISIS AND THE CASE FOR AN ECONOMIC RULE OF LAW (2013) [hereinafter RAMIREZ, LAWLESS CAPITALISM] (comprehensively identifying all legal and regulatory flaws contributing to the financial crisis). Sound risk management in the financial sector could apply to mitigate many if not all of these putative causes. 4. See E. Gerald Corrigan, Are Banks Special?, in THE LAW OF FINANCIAL INSTITUTIONS 57 (5th ed. 2013) (debating whether banks are “special” enough to demonstrate a uniquely “public” character.5 While historically some financial firms may have organized as partnerships6 and the consequences of their decision-making perceived as “private,”7 in the contemporary period, the great financial crisis reveals that decisions made in the inner-sanctum of these businesses may adversely affect domestic and international economies and the public at large.8 Many such institutions engineered and invested in high risk financial instruments that ultimately generated large losses.9 These losses triggered a run on the shadow banking sector10 and later crippled the conventional banking sector and spelled calamity for the global economy.11 Ultimately, the entire receive unique regulatory treatment). 5. In conventional corporations jargon, describing a business as “public” intimates that the company has registered securities with the Securities & Exchange Commission (SEC) for sale to the public. This Article invokes a more creative understanding of “publicness.” See infra Part III.A (exploring the concept that institutions perceived as “systemically important financial institutions” or “too big to fail” may have incentives to internalize the benefits of excessive risk taking and export the negative consequences; these negative externalities may spill over to the broader domestic and international communities). 6. See, e.g., LISA ENDLICH, GOLDMAN SACHS: THE CULTURE OF SUCCESS 15 (2009) (describing the history of the ownership structure of Goldman Sachs Group, Inc.). 7. Id. 8. See infra Part III.B (explaining private transactions that are exempt from federal regulations). 9. See infra Part III.B (describing how exotic derivatives allowed banks to re-sell debt absent federal oversight). 10. See ZOLTAN POZSAR ET AL., FED. RESERVE BANK OF N.Y., STAFF REP. NO. 458, SHADOW BANKING, at 1 (2010), https://www.newyorkfed.org/medialibrary/media/ research/staff_reports/sr458.pdf (explaining how “the shadow banking system provide[s] sources of funding for credit by converting opaque, risky, long-term assets into money-like, short-term liabilities”). There is no universally agreed upon definition for shadow banking. See Steven L. Schwarcz, Regulating Shadow Banking: Inaugural Address for the Inaugural Symposium of the Review of Banking & Financial Law, 31 REV. BANKING & FIN. L. 619, 623, 626 (noting that “we lack a concrete definition of shadow banking” while also emphasizing that “a high level of institutional demand for (especially) short-term debt instruments” was a critical factor in the growth of what is now “known as the ‘shadow banking system’” (citation omitted)). 11. See TYLER ATKINSON ET AL., DALLASFED, HOW BAD WAS IT? THE COSTS AND CONSEQUENCES OF THE 2007–09 FINANCIAL CRISIS 2 (July 2013), https://dallasfed.org/assets/documents/research/staff/staff1301.pdf (estimating total cost of crisis in United States alone at up to fourteen trillion dollars). financial sector benefited from the federal bailout of the industry.12 Remarkably, the homogenous demographic make-up of the senior management teams13 changed very little after the financial crisis.14 For almost a century, a complex web of federal legislation was purportedly designed to protect the general public from the negative consequences of financial institutions’ business decisions.15 Banking laws for example, include specific capital and reserve requirements, governance mandates, and detailed licensing standards, to reduce systemic risk.16 Federal securities laws include an intricate mandatory disclosure framework for public companies to protect investors and to promote efficient and transparent markets.17 Commentators frequently posited that the culture within financial firms encouraged flouting rules.18 Many claimed that the insular settings reinforced biases and encouraged excessive 12. For example, the Federal Reserve System lent trillions to 407 financial institutions during the darkest days of the crisis. See Phil Kuntz & Bob Ivry, Fed’s Once-Secret Data Compiled by Bloomberg Released to Public, BLOOMBERG (Dec. 23, 2011, 12:01 AM), http://www.bloomberg.com/news/articles/2011-12-23/fed-sonce-secret-data-compiled-by-bloomberg-released-to-public (last visited Dec. 15, 2016) (reporting that total federal lending reached sixteen trillion dollars) (on file with the Washington and Lee Law Review). 13. U.S. GOV’T ACCOUNTABILITY OFFICE, TRENDS AND PRACTICES IN THE FINANCIAL SERVICES INDUSTRY AND AGENCIES AFTER THE RECENT FINANCIAL CRISIS 10, 15 (2013), http://www.gao.gov/assets/660/653814.pdf. 14. See generally EMMA JORDAN COLEMAN, CTR. FOR AM. PROGRESS, A FAIR DEAL FOR TAXPAYER INVESTMENTS 1 (Sep. 2009), https://cdn.american progress.org/wpcontent/uploads/issues/2009/09/pdf/public_directors.pdf (finding that one year after the financial crisis “92 percent of the management and directors of the top 17 recipients of TARP funds are still in office”). 15. See id. at 4 (introducing the Troubled Asset Relief Program intended to rescue failing financial systems). 16. See id. at 8 (attempting to create a central federal bank to increase market liquidity by cutting rates). 17. See id. at 5 (restoring trust and public confidence is critical to maintain future market stability). 18. See FIN. CRISIS INQUIRY COMM’N, THE FINANCIAL CRISIS INQUIRY REPORT xix (2011) (indicating that the primary government inquiry into the causes of the financial crisis found that “stunning instances of governance breakdowns and irresponsibility” within financial firms drove all aspects of the crisis as a key cause). risk-taking across financial markets.19 Unprecedented compensation20 and brazen behavior, buttressed by perceptions that decisions made on behalf of the firm would have limited consequences for individual senior managers, created an environment devoid of accountability.21 The fact that these institutions sported little cultural diversity did not escape notice.22 A veil of “privateness” obscured many of the complex financial products and transactions that facilitated the crisis.23 Regulators 19. See, e.g., The Causes and Current State of the Financial Crisis: Before the Fin. Crisis Inquiry Comm’n (2010) (statement of Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation) (claiming unregulated, low interest rates encouraged consumer borrowing and excessive leverage); Viral V. Acharya & Matthew Richardson, Causes of the Financial Crisis, 21 CRITICAL REV. 195, 195 (2009) [Financial institutions] had temporarily placed assets—such as securitized mortgages—in off-balance-sheet entities, so that they did not have to hold significant capital buffers against them . . . [and that] the capital regulations . . . allowed banks to reduce the amount of capital they held against assets that remained on their balance sheets—if those assets took the form of AAA-rated tranches of securitized mortgages. Thus, by repackaging mortgages into mortgagebacked securities, whether held on or off their balance sheets, banks reduced the amount of capital required against their loans, increasing their ability to make loans many-fold. The principal effect of this regulatory arbitrage, however, was to concentrate the risk of mortgage defaults in the banks and render them insolvent when the housing bubble popped. Id.; Arthur E. Wilmarth, Jr., The Dodd-Frank Act: A Flawed and Inadequate Response to the Too-Big-to-Fail Problem, 89 OR. L. REV. 951, 954 (2011) (describing the assumption that “too big to fail” institutions will receive public financial support during economic crises). 23. See FIN. CRISIS INQUIRY COMM’N, supra note 18, at xx (indicating that and lawmakers deemed large financial institutions to be “too sophisticated to regulate” and acted to exempt them from regulation.24 Notwithstanding the litany of existing federal regulation, expanding notions of “privateness”—and concomitant deregulation—dominated the pre-crisis period.25 Even financial institutions that were publicly-traded companies successfully evaded conventional disclosure mechanisms for financial instruments that were too complex to depict.26 When the crisis erupted in the fall of 2007, both public and private institutions clamored to gain direct or indirect access to federal bailout funds.27 The crisis revealed flaws in federal regulation of financial institutions’ risk management oversight.28 For decades, scholars have posited that introducing greater diversity among decision-making authorities, such as the board of major financial institutions were able to hide high leverage ratios from public investors). 24. See id. at xviii (explaining that regulating major financial firms was thought unnecessary because self-preservation supposedly shielded them from fatal risk-taking). 25. See id. at xx (“Key components of the market . . . were hidden from view . . . We had a 21st-century financial system with 19th-century safeguards.”). 26. See id. at 8 (depicting the increasingly complex financial instruments that “became too hard to ‘untangle’” within the securities market). 27. See id. at 256 (“[A] handful of banks were bailing out their money market funds and commercial paper programs in the fall of 2007 . . . .”). 28. As used in this Article, the term risk management means the mechanisms by which the business enterprise manages all risks facing the enterprise. Thus, it transcends the mere use of financial instruments to hedge portfolio positions and is closely associated with enterprise-wide risk management (ERM). See Betty Simkins & Steven A. Ramirez, Enterprise-Wide Risk Management and Corporate Governance, 39 LOYOLA U. CHI. L.J. 571, 586 (2008) (defining enterprise-wide risk management as “enhanced financial management through enhanced identification and management of all the risks facing the corporation” and showing that “[t]his systematic and comprehensive approach to risk management has been empirically tested and the results show that ERM delivers upon its theoretical promises”). Congress and the financial regulators enhanced ERM regulatory requirements in the aftermath of the financial crisis. See Kristin Johnson, Addressing Gaps in the Dodd-Frank Act: Directors’ Risk Management Oversight Obligations, 45 U. MICH. J.L. REFORM 55, 63 (2011) [hereinafter Addressing Gaps in the Dodd-Frank Act] (stating that risk management “involves organizational processes that generally include risk identifying, measuring, and mitigating procedures”). directors and senior executives, could lead to superior outcomes.29 As Christine Lagarde, former Minister of Economic Affairs, Finance and Employment of France and Managing Director of the International Monetary Fund (IMF) eloquently argued, if “Lehman Brothers had been ‘Lehman Sisters,’ today’s economic crisis clearly would look quite different.”30 Referencing a study examining a sample of banks around the world that demonstrates that less than twenty percent of bank board members are women and only three percent of bank Chief Executive Officers (CEOs) are women,31 Lagarde described the need for greater gender diversity on financial institution management teams.32 Former Citigroup Chief Financial Officer (CFO) Sallie Krawcheck shared similar reflections, positing that in her experience “diverse teams . . . tend to make more effective decisions . . . [because] they bring in more perspectives.”33 While examples of egotism and bravado abound,34 critics posit that these anecdotes only demonstrate well-established moral or 29. See infra Part II (finding that maintaining homogenous groups will draw unoriginal ideas and provide a stagnant information base). 30. Christine Lagarde, Women, Power and the Challenge of the Financial Crisis, N.Y. TIMES (May 10, 2010), http://www.nytimes.com/2010/05/11/opinion/ 11iht-edlagarde.html?dbk (last visited Dec. 15, 2016) (on file with the Washington and Lee Law Review). 32. See id. at 1 (“[E]stablishing a culture where ethical behavior is rewarded and where lapses in ethical integrity are not tolerated. More women would also help. Several studies have shown female leadership is more inclusive.”). 33. Sallie Krawcheck, How “Lehman Siblings” Might Have Stemmed the Financial Crisis, PBS NEWSHOUR (Aug. 6, 2014, 12:54 PM), http://www.pbs.org/fnewshour/making-sense/how-lehman-siblings-might-havestemmed-the-financial-crisis/ (last visited Dec. 13, 2016) (on file with the Washington and Lee Law Review). 34. Consider, for example, the email messages of Fabrice Tourre, a creator of the infamous Abacus transaction. See Chris V. Nicholson, Fabrice Tourre: Fabulous or Fatally Flawed?, N.Y. TIMES (Apr. 19, 2010, 1:49 PM), http://dealbook.nytimes.com/2010/04/19/fabrice-tourre-fabulous-or-fatally-flawed/ (last visited Dec. 13, 2016) (“The whole building is about to collapse anytime now . . . . Only potential survivor, the fabulous Fab[rice Tourre] . . . standing in the middle of all these complex, highly leveraged, exotic trades he created without necessarily understanding all of the implications of those monstrosities!!!”) (on file with the Washington and Lee Law Review); see also Donald C. Langevoort, Chasing the Greased Pig Down Wall Street: A Gatekeeper’s Guide to the ethical deficiencies in the cowboy culture of Wall Street. Scholars long ago began finding benefits from well-managed diversity but some argue more evidence is needed to make the case in favor of greater diversity.35 The challenges that all businesses face with respect to decision-making and managing risk introduce a set of questions that merits exploration. When one considers the risk management failures36 that large and systemically important Psychology, Culture, and Ethics of Financial Risk Taking, 96 CORNELL L. REV. 1209, 1226 (2011) (“This emotional and social account meshes fairly well with what we observe inside highly competitive financial firms. There is a strong emotional emphasis on team building and bonding—fraternity-like excesses included.”); Recall the claim that the bankers’ culture is of-the-moment and bows to the innate legitimacy of the market mechanism, seeking an unquestioning synchronicity with it . . . this view probably cannot be construed as a belief in the unerring accuracy of the market at any given moment so much as a Hayekian view of the necessary freedom of persons and firms to be tested in the crucible of the marketplace. 35. See, e.g., Steven A. Ramirez, Diversity and the Boardroom, 6 STAN. J.L. BUS. FIN. 85, 85–87 (2000) (collecting sources regarding the advantages of a diverse workforce). More recently, scholars recognize that while well-managed diversity may lead to superior board performance, the empirical data on the mere presence of diverse board members is mixed. See Deborah L. Rhode & Amanda K. Packel, Diversity on Corporate Boards: How Much Difference Does Difference Make?, 39 DEL. J. CORP. L. 377, 393 (2014) (“Although empirical research has drawn much-needed attention to the underrepresentation of women and minorities on corporate boards, it has not convincingly established that board diversity leads to improved financial performance.”); Lissa Lamkin Broome & Kimberly D. Krawiec, Signaling Through Board Diversity: Is Anyone Listening?, 77 U. CIN. L. REV. 431, 432–33 (2008) (“Recent quantitative studies primarily test for a relationship between board diversity and various measures of corporate performance. . . . [S]tudies find evidence that . . . board diversity positively affects firm performance. Other studies, however, find no support for this theory.”); Lisa M. Fairfax, Clogs in the Pipeline: The Mixed Data on Women Directors and Continued Barriers to Their Advancement, 65 MD. L. REV. 579, 593 (2006) (summarizing the empirical data addressing the impact of diversity contingent upon the number of women in the boardroom). We do not address this debate regarding general board diversity in this Article, instead focusing on the potential benefits of diversifying the financial sector from top to bottom, that is, from the boardroom down to rank-and-file workers. 36. See Kristin N. Johnson & Steven A. Ramirez, New Guiding Principles: Macroprudential Solutions to Risk Management Oversight and Systemic Risk Concerns, 11 U. ST. THOMAS L.J. 386, 426 (2014) (recognizing continued reliance on corporate governance-oriented reforms will ultimately increase market disruptions and recounting risk management failures before and during the financial institutions endured during the financial crisis,37 these questions become all the more poignant. To address shortcomings in federal regulatory oversight and the risk management failures, Congress adopted the Dodd–Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd– Frank Act).38 The Dodd–Frank Act introduces many transformative risk oversight policies.39 Among the reforms, Congress created an obligation for financial regulators to assess the gender and racial diversity policies of financial institutions.40 This Article focuses on Section 342(b)(2)(c) of the Dodd–Frank Act which directs each federal financial regulatory agency to assess the diversity policies and practices of entities regulated by the agency.41 The Article concludes that the Dodd–Frank Act appropriately focused on diversity as one mechanism to achieve superior risk management in the financial sector, and that regulators should more aggressively implement Congress’s statutory directive. Part II of this Article focuses on the growing empirical evidence in the psychology, finance, and management literature that demonstrates that cognitive biases influence group decision-making and that well-managed cultural and gender diversity can breakdown these cognitive biases. In terms of finance, this translates into superior risk management as diverse groups hold more heterogeneous perspectives on risk, ethics, and market decisions in a way that can lead to superior outcomes on these issues. financial crisis). 37. See Addressing Gaps in the Dodd-Frank Act, supra note 28, at 71–72 (describing risk management failures of various firms and subsequent solvency crises during the period 2007–2011) . 38. Dodd–Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010), https://www.sec.gov/about/laws/wallstreet reform-cpa.pdf. 39. See id. § 111(a) (enhancing supervision and regulation through establishment of the Financial Stability Oversight Council). 40. See id. § 342(a)(1)(B) (mandating the formation of the Office of Minority and Women Inclusion to develop standards for racial, ethnic, and gender diversity). 41. See id. § 342(b)(2) (requiring the agency administrator and Office of Minority and Women Inclusion Director to design implementation procedures and remedies resulting from violation). Part III posits that increasingly blurred lines challenge our understanding of private businesses. Increasing federal regulation illustrates a trend toward presumptions that systemically important financial institutions, in particular, are public in nature, even if private by design. The macroeconomic significance of large financial institutions justifies more stringent macroprudential regulation across the financial sector. Part IV offers a brief survey of the issues at the center of financial markets regulation: academics’ understanding, practitioners’ experience, and regulators’ best efforts to identify, implement and enforce risk management policies intended to promote macroeconomic stability and macroprudential risk management. Sound risk management in the financial sector plays a key role in dealing with regulatory and legal challenges arising from the increased public stakes in banking and finance. Part V of this Article examines the Congressional mandate for imposing an obligation for regulatory agencies to “assess” the diversity policies and practices of financial institutions regulated by the agency. Part VI contends that the transformative changes in financial markets coupled with risk management lessons from the recent crisis demand a more aggressive interpretation of financial market regulators’ obligations to “assess” diversity at financial institutions. This Part of the Article posits that the regulators should use their traditional authority to stem unsafe and unsound banking practices (and similar prudential regulations) to encourage more diversity in the financial sector. Otherwise, the regulators risk undermining Congressional efforts to mitigate risk management challenges in financial markets and ensure macroeconomic stability and macroprudential regulation.42 Section 342, while not suggesting that the increasing diversity alone solves risk management oversight concerns, offers a partial response to known risk management weaknesses in senior management teams in the financial sector.43 Congress correctly 42. Enhanced risk management figured prominently in the Dodd–Frank Act. See, e.g., Dodd–Frank Act §165(h)(3)(A) (requiring certain systemically important financial institutions to form independent “enterprise-wide risk management committees”). 43. Long before the financial crisis scholars debated the business benefits of diversity: identified a major shortcoming in the corporate governance of the financial sector. According to the joint standards promulgated by the federal regulatory agencies,44 Section 342’s mandate will only require a voluntary self-assessment of diversity-oriented risk management initiatives.45 This Article demonstrates that federal regulatory agencies’ interpretation of Section 342 frustrates Congress’s intentions regarding diversity as a risk management tool. At best, agency efforts stymie or undermine the potential for the statutory mandate. At worst, the federal regulatory agencies’ interpretation leaves Section 342 completely impotent creating greater potential for macroeconomic destabilization.46 As such, an The point here goes back to my metaphor of the firm as a nexus of negotiations. The promotion of diversity may or may not hold a position of power within the firm. If I am right [about potential costs] its power rarely will be great. Simple demands of adherence because of the rightness of the cause are unlikely to provoke a cooperative response among those who disagree on (perhaps self-serving) principled grounds. Donald C. Langevoort, Overcoming Resistance to Diversity in the Executive Suite: Grease, Grit, and the Corporate Promotion Tournament, 61 WASH. & LEE L. REV. 1615, 1642 (2004); see also Steven A. Ramirez, Games CEOs Play and Interest Convergence Theory: Why Diversity Lags in America’s Boardrooms and What to Do About It, 61 WASH. & LEE L. REV. 1583, 1613 (2004) (“CEOs play the game of homosocial reproduction when they select directors . . . [b]ut, because board diversity can improve corporate governance, racial reformers may find many allies . . . in this arena.”). 44. See Final Interagency Policy Statement Establishing Joint Standards for Assessing the Diversity Policies and Practices of Entities Regulated by the Agencies, 80 Fed. Reg. 33016 (June 10, 2015) [hereinafter Joint Guidelines] (discussing the contentious public commentary over the standards promulgated by the Office of Minority and Women Inclusion), http://www.gpo.gov/fdsys/ pkg/FR-2015-06-10/pdf/2015-14126.pdf. The Article refers to this group of regulatory agencies as the “financial regulators.” Id. 45. See infra Part V (providing a detailed explanation of the Joint Standards that apply to regulated entities). 46. Under a law and macroeconomics approach, the focus is on the relationship of law and regulation to macroeconomic performance. See Steven A. Ramirez, The Law and Macroeconomics of the New Deal at 70, 62 MD. L. REV. 515, 519 (2003) (“[L]aw can further economic output and other macroeconomic goals.”). Macroprudential regulation considers the use of law and regulation to secure financial stability on a systemic basis and therefore looks beyond prudential risk regulation at just single financial institutions. See Kristin N. Johnson, Macroprudential Regulation: A Sustainable Approach to Regulating Financial Markets, 2013 U. ILL. L. REV. 881, 903–04 (2013) [hereinafter Macroprudential Regulation] (explaining systemic risk and the consequences that flow from the opportunity to both diversify and stabilize the financial system has so far been wasted.47 The simple remedy may be for federal financial regulators to execute their mandate, enforce the statute through the broadest possible regulatory powers, and consider cultural and gender diversity in the financial sector as a key mechanism to enhance risk management and legal compliance in the financial sector. II. The Empirical Foundation for Enhanced Diversity in Finance Scholars from a range of disciplines have long studied group decision-making challenges arising in part from culturally homogenous groups.48 Among other limitations, groupthink,49 interconnectedness of financial institutions). Major financial institutions operate under pervasive public supervision because their activities can lead to severe financial instability with all of the negative economic consequences inherent in such crises, and because the largest financial firms hold a poorly defined claim on massive public resources for their survival. See Cary Martin Shelby, Are Hedge Funds Still Private? Exploring Publicness in the Face of Incoherency, 69 SMU L. REV. 405, 449–50 (2016) [hereinafter Shelby, Are Hedge Funds Still Private?] (arguing in favor of enhanced regulation of hedge funds given the enhanced publicness of their activities). 47. The Joint Guidelines state that they “create no new legal obligations,” and that the financial regulators “will not use their examination or supervisory processes in connection with the [Joint Guidelines].” Joint Guidelines, supra note 44, at 33. As such, they truly constitute “lip service” and defy the plain meaning of the statute, which requires an “assessment” of each regulated entity’s diversity policies. See 15 U.S.C. § 5452(b)(2) (2012) (imposing director-created standards to increase agency’s participation with minority-owned and women-owned businesses). 48. See, e.g., IRVING R. JANIS, VICTIMS OF GROUPTHINK 78 (1978) (discussing problems associated with “groupthink”). 49. Groupthink is “a mode of thinking that people engage in when they are deeply involved in a cohesive in-group, when the members’ striving for unanimity overrides their motivation to realistically appraise alternative courses of actions.” Marleen A. O’Connor, The Enron Board: The Perils of Groupthink, 71 U. CIN. L. REV. 1233, 1238 (2003) (quoting JANIS, supra note 48, at 78). herd behavior,50 and affinity bias51 challenge group decisionmaking. Similarly, humans naturally fall prey to confirmation bias,52 overconfidence,53 and structural bias.54 These flaws in cognition lead to an inclination to look for and adopt information that confirms intuitive beliefs and a tendency toward selective information gathering and deference to superiors such as executives or managers based on perceptions that such team members are better informed.55 Evidence suggests that these tendencies can be mitigated through enhanced cultural diversity.56 50. Financial crises frequently arise from herd behavior—a dynamic whereby decision-makers rely on the decisions of others rather than just their own information. See Abhijit V. Banerjee, A Simple Model of Herd Behavior, 107 Q.J. ECON. 797, 800 (1992) (finding that herd behavior may explain asset price volatility). Commentators note that the financial crisis was an instance of “herd-effects” and self-reinforcing judgments derived solely from the judgments of others. TURNER, supra note 1, at 40. 51. Affinity bias results from the inability of humans to make decisions free of bias relating to those we share affinity with through friendship, social status, or other socially significant relationships. See Antony Page, Unconscious Bias and the Limits of Director Independence, 2009 U. ILL. L. REV. 237, 248–49 (showing that affinity bias may infect board deliberations). 52. See id. at 265 (searching for information supporting current beliefs but ignoring contrary information). 53. See id. at 280 (pointing to “naïve realists” who falsely believe their decisions are always objective in nature). 54. See O’Connor, supra note 49, at 1265 (noting that impartial leaders may also cause structural faults as they state their own views but discourage dissent). 55. See id. at 1238 (striving for unanimity prevents individuals from considering alternative courses of action). 56. See, e.g., CREDIT SUISSE, GENDER DIVERSITY AND CORPORATE PERFORMANCE 6 (2012) (finding that “companies with at least one woman on the board would have outperformed in terms of share price performance” and that “[a]lmost all of the outperformance . . . was delivered post-2008, since the macro environment deteriorated and volatility increased”) ; David A. Carter et al., Corporate Governance, Board Diversity, and Firm Value, 38 FIN. REV. 33, 51 (2003) (“After controlling for size, industry, and other corporate governance measures, we find statistically significant positive relationships between the presence of women or minorities on the board and firm value . . . .”); Toyah Miller & María del Carmen Triana, Demographic Diversity in the Boardroom: Mediators of the Board Diversity–Firm Performance Relationship, 46 J. MGMT. STUD. 755, 774–75 (2009) (finding that between 2002 and 2005 Fortune 500 firms with gender and racial diversity on boards performed better than non-diverse firms and finding that the link can be explained through innovation and firm reputation). The focus of this Article is on cultural diversity within the financial firms, from top to bottom. Thus, we do not address here the efficacy of board In fact, discrete cultural differences exist in the U.S. with respect to many important issues, including risk perceptions and ethical sensitivities.57 These lessons also hold true in the world of finance. For example, evidence supports the conclusion that greater participation by women senior executives may militate against solvency concerns for banking institutions.58 There is strong empirical support for the conclusion that women executives exhibit less over-confidence and hold different perceptions of risk relative to men.59 A sample of 6,729 banks during the financial crisis diversity alone beyond the financial sector. Compare Joan M. Heminway, Women in the Crowd of Corporate Directors: Following, Walking Alone, and Meaningfully Contributing, 21 WM. & MARY J. WOMEN & L. 59, 79 (2014) (arguing that increasing the number of women on boards could enhance diversity because “[r]esearch offers evidence that women may bring game-changing perspectives and proficiencies to the boardroom”), with Lisa M. Fairfax, Board Diversity Revisited: New Rationale, Same Old Story?, 89 N.C. L. REV. 855, 855 (2011) (challenging generally the reliance on business rationales to justify increased board diversity and “insists that diversity advocates must pay greater attention to the role of social and moral justifications in the effort to diversify the corporate boardroom”). 57. For example, as early as 2007, scholars recognized that white-male risk perceptions were skewed. See Dan M. Kahan et al., Culture and Identity-Protective Cognition: Explaining the White-Male Effect in Risk Perception, 4 J. EMPIRICAL LEGAL STUD. 465, 465–66 (2007) (“Numerous studies show that risk perceptions are skewed across gender and race: women worry more than men, and minorities more than whites, about myriad dangers—from environmental pollution to hand guns, from blood transfusions to red meat.”). Legal scholars suggested this white-male risk perception should be balanced in the name of reducing bias, unfairness, and poor governance simultaneously. See Regina F. Burch, Worldview Diversity in the Boardroom: A Law and Social Equity Rationale, 42 LOYOLA U. CHI. L.J. 585, 594 (2011) (“This Article proposes that greater worldview diversity on corporate boards may lead to better governance and mitigate bias and unfairness in corporate decision making.”). 58. See Ajay Palvia et al., Are Female CEOs and Chairwomen More Conservative and Risk Averse? Evidence from the Banking Industry During the Financial Crisis, 131 J. BUS. ETHICS 577, 592 (2015) (concluding test results offer a positive correlation between female CEOs and lower risk of bank failure); Kristin Johnson, Banking on Diversity: Does Gender Diversity Improve Financial Firms’ Risk Oversight, 69 SMU L. REV. (forthcoming 2017) (manuscript at 29–33) (citing sources and studies exploring the significance of gender in the context of risk-management oversight) (on file with the Washington & Lee Law Review). 59. See, e.g., Jiekun Huang & Darren J. Kisgen, Gender and Corporate Finance: Are Male Executives Overconfident Relative to Female Executives?, 108 J. FIN. ECON. 822, 822 (2013) (finding that “[m]ale executives undertake more acquisitions and issue debt more often than female executives” and that female revealed that banks with women CEOs or board chairmen held more conservative levels of capital after controlling for, among other attributes, the risks in the bank’s asset portfolio, the size of the bank, and the economic conditions in the bank’s state.60 When women serve as the heads of banks, the banks tend to hold greater amounts of capital, which enables the bank to guard against insolvency concerns.61 The “observed differences in capital ratios are economically significant and indicate that female-led banks hold about 5-6% more capital than male-led banks.”62 These more conservative levels of capital translated into a lower risk of bank failure.63 As such, a rigorous analysis of cultural diversity “complement[s] . . . evaluating the safety and soundness of banks.”64 Though some may argue that this finding means women are superior risk managers,65 we argue only that heterogeneous executives give earnings guidance with wider ranges); Mara Faccio et al., CEO Gender, Corporate Risk-Taking, and the Efficiency of Capital Allocation, SOC. SCI. RES. NETWORK (Feb. 12, 2016), http://papers.ssrn.com/sol3/papers.cfm? abstract_id=2021136 (last visited Dec. 13, 2016) (“[F]irms run by female CEOs tend to make [less risky] financing and investment choices . . . than . . . firms run by male CEOs . . . CEO transitions indicates that . . . firm [risk-taking] tends to . . . around the transition from a male to a female CEO (or vice-versa).”) (on file with the Washington and Lee Law Review). 60. See Palvia et al., supra note 58, at 592 (“From a public policy perspective, the documented benefits of female leadership for bank stability may be of interest to regulators when setting future policies for promoting gender equality and the advancement of women in business.”). 61. Id. at 582 (acknowledging that the sample size is small because women are so underrepresented at the top of financial sector). 62. Id. at 592. 64. Id. 63. See id. (reporting that banks led by female CEOs hold higher levels of equity capital due to their control over the bank’s asset risk). 65. See, e.g., JULIA DAWSON ET. AL., THE CS GENDER 3000: WOMEN IN SENIOR MANAGEMENT 3 (2014) (“[G]reater diversity in boards and management are empirically associated with higher returns on equity, higher price/book valuations and superior stock price performance.”). Interpreting empirical data on cultural diversity and bank risk management is, of course, complicated. First, as always, there are limits on empirical research. As with virtually all empirical studies, variables may be omitted; the sample size may be too small; the direction of causation may not be clear; and virtually all methodologies have noteworthy shortcomings. Id. Further, for businesses, too much risk aversion may be undesirable. This Article simply highlights the best evidence on the issue of whether risk management can be optimized through enhanced cultural diversity in the financial sector. risk management is superior to culturally homogenous risk management. Similarly, another study of subprime lending at financial firms found that firms with more female representation engaged in less subprime lending.66 Utilizing a database of subprime lenders from the U.S. Department of Housing and Urban Development, Professors Muller-Kahle and Lewellyn matched subprime lenders with non-subprime lenders by size and industry and found that board configuration in the two sets of firms differed in statistically significant ways.67 Specifically, the non-subprime lenders had boards with more gender diversity, longer board tenure, and were less busy.68 The study design mitigates issues relating to causation by splitting the firms into two subsets (subprime lenders and non-subprime lenders) and focusing on the explanatory variables the year prior to any firm entering the subprime mortgage market.69 The study finds “that board gender diversity adds value to a board.”70 Furthermore, “[t]he greater the percentage of women on the board, the less likely a firm was to specialize in subprime lending.”71 In short, the deterioration of mortgage lending standards underlying the subprime debacle may have been preventable had there been greater diversity on financial institution boards.72 66. See generally Maureen I. Muller-Kahle & Krista B. Lewellyn, Did Board Configuration Matter? The Case of US Subprime Lenders, 19 CORP. GOVERNANCE: AN INT’L REV. 405 (2011). 67. Id. 68. Id. at 412–13; see also id. at 409 (defining busyness as the number of outside board seats held by each outside director divided by the number of outside directors). 69. [R]everse causality is less plausible, given our research design. In our empirical tests, all of our independent variables are collected in the year preceding the firm identified on the subprime list. Thus, measures for our explanatory [variables] in the earlier period could not have resulted from being identified as a subprime specialist in the subsequent period. Id. at 409 70. Id. at 414 (“For enhanced decision making processes, firms would be advised to strive to add diversity to boardrooms.”). 71. Id. at 413. 72. Id. at 405. Another recent study involving European banks found that Even beyond boards and senior managers, diversity pays dividends in terms of risk management in the financial sector. One study found that female loan officers are more risk averse and more inclined to restrict loans to unseasoned borrowers.73 Another study found that female loan officers also experience lower default rates on loans they approve relative to male loan officers.74 These studies suggest that financial firms would experience gains for diversifying all levels of operations, not just senior management teams.75 The above empirical studies also draw support from a rich body of empirical evidence that shows that diversity necessarily results in different approaches to risk. As early as 1988, researchers showed in experimental studies that women tend to be more conservative and risk averse than men.76 These findings were confirmed by empirical studies that investigated household investment behavior and personal financial decisions.77 In sum, according to a review of all experimental studies in the Journal of boards with more women had lower risks. See generally Ruth Mateos de Cabo et al., Gender Diversity on European Banks’ Boards of Directors, 109 J. BUS. ETHICS 145 (2012). 73. See Andrea Bellucci et al., Does Gender Matter in Bank-Firm Relationships? Evidence from Small Business Lending, 34 J. BANKING & FIN. 2968, 2968–69 (2010) (examining the impact of gender on business lending practices). 75. See id. at 1282–83 (“These findings suggest that not only the institutional and governance structure of financial institutions matters, but also the gender of the people operating in a given bank structure.”); see also Bellucci et al., supra note 73, at 2969 (suggesting that female loan officers are more risk averse than men in order to avoid defaults and losses for their institutions and maximize personal career advancement). 76. See Irwin P. Levin et al., The Interaction of Experiential and Situational Factors and Gender in a Simulated Risky Decision-Making Task, 122 J. PSYCHOLOGY 173, 180 (1988) (finding that women students were more risk averse than male students in an experimental setting). 77. See, e.g., John Watson & Mark McNaughton, Gender Differences in Risk Aversion and Expected Retirement Benefits, 63 FIN. ANALYSTS J. 52, 60 (2007) (“Considerable psychological evidence suggests that women are generally more risk averse than men . . . and the results of this study indicate that this heightened risk aversion influences the superannuation/retirement investment choices women make.”). Economic Literature, “[a] large literature documents gender differences in risk taking; women are more risk averse than men.”78 This empirical reality does not necessarily suggest that women inherently manage risk better than males; in fact, at least one study suggests that the risk aversion of females may negatively impact earnings.79 We may, however, conclude that heterogeneous risk assessments, including a diversity of perspectives offers greater informational elaboration.80 This empirical reality also applies to the approach of ethnic minorities to issues related to risk. A recent analysis of the extant empirical evidence on this point found that white males are the most aggressive demographic group in terms of investment behavior.81 African-American and Hispanic households also display more risk aversion than white households in their investment choices in the wake of the Great Recession.82 In 78. Rachel Croson & Uri Gneezy, Gender Differences in Preferences, 47 J. ECON. LITERATURE 1, 7 (2009). 79. See Catherine C. Eckel & Philip J. Grossman, Men, Women and Risk Aversion: Experimental Evidence, in 1 HANDBOOK OF EXPERIMENTAL ECONOMICS RESULTS 1061, 1069 (Charles R.C. Plott & Vernon L. Smith eds., 2008) (detailing studies that show, generally, systematic differences between male and female reaction to risk(citing HAIM LEVY ET AL., GENDER DIFFERENCES IN RISK TAKING AND INVESTMENT BEHAVIOR: AN EXPERIMENTAL ANALYSIS (1999) (unpublished manuscript))). 80. Our theory is rooted in the work of psychologists that found group intelligence can exceed the intelligence of any single member, particularly when the group is diverse. See Anita Williams Woolley et al., Evidence for a Collective Intelligence Factor in the Performance of Human Groups, 330 SCI. 686, 688 (2010) (“[R]esults provide substantial evidence for the existence of [collective intelligence] in groups . . . .”). An alternative theory also supports our thesis that the financial regulators should take stronger steps to encourage more diversity in the financial sector. Specifically, some argue that males are over-confident and systemically underestimate risk. See, e.g., Jeff Sommer, How Men’s Overconfidence Hurts Them as Investors, N.Y. TIMES (Mar. 13, 2010), http://www.nytimes.com/2010/03/14/business/14mark.html?_r=0 (last visited Dec. 15, 2016) (examining differences in investment behavior between women and men) (on file with the Washington and Lee Law Review). 81. See James Farrell, Demographic and Socioeconomic Factors of Investors, in INVESTOR BEHAVIOR: THE PSYCHOLOGY OF FINANCIAL PLANNING AND INVESTING 117 (H. Kent Baker & Victor Ricciardi eds., 2014) (compiling and reviewing empirical studies focusing on the differences in investment behavior across race and gender groups). 82. See Su Hyun Shin & Sherman D. Hanna, Decomposition Analyses of Racial/Ethnic Differences in High Return Investment Ownership after the Great addition to approaching risk differently, ethnic diversity also may help avoid and mitigate financial market bubbles.83 A recent study, published in the Proceedings of the National Academy of Sciences, by a team of six economists, business scholars, and other academics from around the world found that markets with diverse participants resist price bubbles.84 The team constructed experimental financial markets in Southeast Asia and North America.85 Market participants were randomly assigned to participate in diverse or culturally homogenous markets.86 The culturally diverse markets fit true values fifty-eight percent better than the homogenous markets.87 In addition, the homogenous market overpriced assets and trader errors were more correlated.88 This all suggests that homogenous markets are more prone to bubbles than culturally diverse markets. As the authors of the study conclude: Markets are central to modern society, and their failures can devastate people, communities, and nations. We find that price Recession, 26 J. FIN. COUNSELING & PLANNING 43, 57 (2015) (examining home ownership, risk tolerance, and education across varying demographic groups). 83. See Sheen S. Levine et al., Ethnic Diversity Deflates Price Bubbles, 111 PROC. NAT’L ACAD. SCI. 18524, 18524 (2014) (“Our results suggest that bubbles are affected by a property of the collectivity of market traders—ethnic homogeneity.”). 84. See id. at 18527 (“[T]raders in diverse markets reliably price assets closer to true values. They are less likely to accept inflated offers and more likely to accept offers closer to true value, thereby thwarting bubbles.”). 85. See id. at 18525 (explaining how the researchers selected the geographic sites of the experiments to purposely exploit non-overlapping ethnic diversity in those two locales and to generalize their findings beyond rich, developed nations). In North America, the diversity tested was whites, Latinos, and AfricanAmericans. Id. In Southeast Asia, the researchers studied diversity in the form of Malays, Indians, and Chinese traders. Id. 86. See id. at 18525–26 (detailing how the experiment involved skilled traders with training in business or finance and outlining how—because the traders in the experiments received their earnings in cash at the end of the experiment—they faced incentives to trade effectively). 87. See id. at 18526 (“Across markets and locations, pricing accuracy is 58% higher in diverse markets.”). Pricing accuracy was obtained by giving participants all information needed to price the stocks accurately, and the initial declarations of value formed the baseline for trading accuracy. Id. at 18525. 88. See id. at 18524 (“In homogenous markets, overpricing is higher and traders’ errors are more correlated than in diverse markets.”). 2015, the Agencies then adopted a final interagency policy statement, which finalized these joint diversity standards (Joint Standards).256 These Joint Standards address the following categories of activities with respect to such regulated entities: (1) organizational commitment to diversity and inclusion; (2) workforce profile and employment practices; (3) procurement and business practices and supplier diversity; and (4) practices to promote transparency of organizational diversity and inclusion.257 Under each of these categories, the Agencies then provide specific standards that regulated entities can evaluate in assessing the suitability of their diversity policies.258 The Agencies further specify that each of these standards could be tailored to the unique characteristics of each regulated entity such as size, number of employees, and total assets under management.259 Overall, these Joint Standards imply that diversity assessments should extend beyond the boardroom to include senior management, employees, and contractual relationships with suppliers and other possible sub-contractors.260 With respect to supplier diversity for example, the Agencies suggest that firms attempt to provide “a fair opportunity for minority-and womenowned business to compete for procurement of business goods and services . . . .”261 With regard to enhancing workforce diversity, the Agencies suggest that regulated entities recruit from institutions that serve large female or minority populations, such as Historically Black Colleges and Universities.262 standards and seeking comment on their perceived effectiveness). 256. Joint Guidelines, supra note 44. 257. See 78 Fed. Reg. 64,052, 64,055–56 (providing summaries of the applicability of each category of standards). 258. See id. (“The Entity provides regular progress reports to the board and/or senior management.”). 259. See id. at 64,055 (“For example . . . governance structure, revenues, . . . contract volume, geographic location, and community characteristics . . . .”). 260. See id. (setting out standards that apply to both low-level employees and upper management). 261. 80 Fed. Reg. 33017. 262. Cf. OFFICE OF MINORITY AND WOMEN INCLUSION, FDIC, 2012 REPORT TO CONGRESS 12 (2012), https://www.fdic.gov/about/diversity/rtc_3_28_13.pdf (“[T]he FDIC’s Corporate Recruitment Program continued in 2012 to maintain ongoing However, this Article primarily evaluates the implementation of diversity standards related to management, which is the first category identified by the Agencies. Senior management would likely include the board members of a regulated entity, as well as its senior officers such as the CEO and CFO, for example. With respect to this first category, the Agencies suggest that regulated entities implement the following standard (among others): “[t]he entity takes proactive steps to promote a diverse pool of candidates, including women and minorities, in its hiring, recruiting, retention, and promotion, as well as in its selection of board members, senior management, and other senior leadership positions.”263 This standard is likely designed to ensure that a diverse pool of candidates is considered for the leadership roles of regulated entities. The Joint Standards also provide that the term “diversity” specifically encompasses minorities and women, with “minorities” including “Black Americans, Native Americans, Hispanic Americans, and Asian Americans.”264 However, the Joint Standards permit regulated entities to use a more expansive definition.265 An expanded definition of diversity could possibly include “individuals with disabilities, veterans, and LGBT individuals.”266 2. Voluntariness In adopting these Joint Standards, the Agencies clarified that assessing the diversity policies of regulated entities would not entail a traditional examination or supervision process.267 More relationships with a wide range of colleges and universities to target a diverse talent pool for the CEP. These colleges and universities included 110 institutions designated as either minority-serving institutions or tribal colleges.”). 263. 78 Fed. Reg. 64052, 64055. 264. 80 Fed. Reg. 33017. 265. See id. (“This language is intended to be sufficiently flexible to encompass other groups . . .”). 266. Id. 267. See 78 Fed. Reg. 64,052, 64,054 (noting that many different types of assessments allow for both the Agencies and the public to understand diversity policies). specifically, the Agencies seemingly will not employ their enforcement powers to ensure that their regulated entities are in compliance with the statute. Regulated entities are instead instructed to implement a self-assessment of their diversity policies, using the guidance provided under the Joint Standards.268 While compliance with these Joint Standards is highly encouraged by the Agencies, it is still purely voluntary. Regulated entities will seemingly not face enforcement proceedings for failing to integrate these Joint Standards within their underlying policies and practices.269 Disclosure of such compliance (or non-compliance) has also been deemed voluntary by the Agencies.270 While the Joint Standards strongly encourage transparency—through the annual publication of diversity policies on company websites, for example—the Joint Standards clarified that such disclosure, both to the general public and to their respective Agencies, is completely voluntary.271 Many commenters appreciated the Agencies’ decision to permit self-assessments. One comment letter published by several banking associations stated that “[r]egulated entities themselves are in the best position to assess their own diversity policies and practices. Many larger regulated entities already have well considered diversity policies and a track record of implementing, applying and developing those policies in the real world.”272 In contrast, other commenters expressed concerns that permitting self-assessment would significantly detract from the stated goals of the act.273 SEC Commissioner Luis A. Aguilar strongly objected that in permitting self-assessments, the Agencies ignored the vast majority of comment letters received from “[m]embers of Congress, civil rights organizations, community-based organizations, professional associations, consumer advocacy groups, banking organizations, employer associations, financial services trade organizations, banks, credit unions, and individuals.”274 According to Commissioner Aguilar, these commenters persuasively argued that “voluntary self-assessments are ineffective because, without specific obligations and requirements, few regulated entities will conduct assessments or share assessment information.”275 If this is true, then Section 342 will have a minimal impact on actually increasing diversity in the financial sector. Americans for Financial Reform further suggested that Agency Offices should “devote staff and develop methodologies to conduct assessments of the entities that they regulate.”276 With respect to the voluntary disclosure of such diversity policies, commentators similarly expressed concerns regarding the extent to which this would hold regulated entities sufficiently accountable. Professor Cheryl Nichols suggests that Congress intended that the disclosure of diversity policies by regulated 273. See Leading Democrats Express Concerns with Agency Diversity Standards, U.S. HOUSE COMMITTEE ON FIN. SERVS. DEMOCRATS (June 18, 2015) , http://democrats.financialservices.house.gov/news/documentsingle.aspx?Docume ntID=399208 (last visited Dec. 13, 2016) (“[T]hese final rules . . . have the potential to undermine the meaningful progress Dodd–Frank made toward a more diverse financial sector.”) (on file with the Washington and Lee Law Review). 274. Luis A. Aguilar, Commissioner, Sec. Exch. Comm’n, Dissenting Statement on the Final Interagency Policy Statement: Failing to Advance Diversity and Inclusion (June 9, 2015) , http://www.sec.gov/news/ statement/dissent-interagency-policy-statement-diversity.html (last visited Dec. 13, 2016) (on file with the Washington and Lee Law Review). 275. Id. 276. Comment Letter Relating to Proposed Interagency Policy Statement Establishing Joint Standards for Assessing the Diversity Policies and Practices of Entities Regulated by the Agencies and Request for Comment from the Americans for Financial Reform, 3 (Feb. 7, 2014) , https://www.ncua.gov/Legal/ CommentLetters/CLExtension20140207AFR.pdf. entities be mandatory.277 Nichols concludes that mandatory disclosure is necessary as it would provide the data needed to ascertain the efficacy of the statute.278 VI. Safety & Soundness and Diversifying to Mitigate Risk As Part IV explained, Congress intended for Section 342 to reach businesses in the financial services sector whether organized as corporations that have distributed shares in public securities markets or limited liability companies or partnerships engaged in the shadow banking market intermediating credit. The Joint Standards encompass the weak standards that federal regulatory agencies have adopted to date. Regulators have power to reduce excessive risk taking and broad powers to order remedies concerning risk-taking innovation.279 Financial regulators hold broad power to determine legal violations in the financial sector.280 This Article suggests that financial regulators exercise these powers to further the full diversification of the financial sector in appropriate circumstances.281 We will begin our assessment of the regulatory powers the federal financial regulators wield in the banking industry and then discuss the even broader powers the SEC holds to facilitate diversity. A. The Federal Banking Regulators The starting point for understanding the powers of the federal bank regulators282 is the concept of safe and sound banking practices: the banking regulators assure the safety and soundness of banks by sanctioning unsafe and unsound banking practices uncovered, inter alia, during annual examinations.283 Since 1933, this bedrock principle of banking regulation has acted as the trigger of the federal banking regulators vast enforcement 282. Only the OCC, the FDIC, and the Fed share enforcement powers as direct regulators of banks and similar depository institutions. 12 U.S.C. § 1813 (q), (z) (2012). The NCUA holds similar power with respect to federal credit unions. 12 U.S.C. § 1786 (2012). The Fed also exercises enforcement power against bank holding companies and non-bank subsidiaries under Section 1818. 12 U.S.C. § 1818 (b)(3) (2012). As used in this Article, the term “federal bank regulators” refers to these agencies. These regulators typical conduct annual bank examinations and evaluate the safety and soundness of each regulated bank. Julie Andersen Hill, When Bank Examiners Get It Wrong: Financial Institution Appeals of Material Supervisory Determinations, 92 WASH. U. L. REV. 1101, 1107 (2015) During an examination, regulators . . . review the institution’s policies, procedures, and records. Examiners then rate the institution using the Uniform Financial Institutions Rating System. Under the System, regulators evaluate the safety and soundness of institutions using the “CAMEL” or “CAMELS” factors: capital, assets, management, earnings, liquidity, and susceptibility to market risk. Regulators rate each item on a 1 to 5 scale, with a 1 rating being the highest possible score.” Examiners also award each institution a composite rating meant to assess the overall condition of the institution. The composite score is not simply an average of the component ratings. Rather, in issuing a composite rating the regulator considers the components and “may incorporate any factor that bears significantly on the [institution's] overall condition.” Id. We argue herein that the degree of cultural diversity within a financial institution should be one factor that regulators consider in addressing the safety and soundness of a financial institution. 283. Principles of safety and soundness form the foundation of federal bank regulation. See Heidi Mandanis Schooner, Fiduciary Duties’ Demanding Cousin: Bank Director Liability for Unsafe or Unsound Banking Practices, 63 GEO. WASH. L. REV. 144, 165, 178 (1995) (“Unsafe or unsound banking practices long have served as a trigger for . . . liability under every important formal enforcement provision in the federal banking laws.”). Under these provisions bank regulators can: issue cease and desist orders, including monetary damages; remove directors and officers from office; prohibit firms from participation in the banking industry; and impose fines of up to one million dollars per day. Id. powers.284 Although mentioned in many key banking law statutes, at the federal level, the term “unsafe and unsound banking practice”285 has been defined primarily through regulatory statements and actions.286 Most recently, the OCC defined the term in an enforcement action as “any action, or lack of action, which is contrary to generally accepted standards of prudent operation, the possible consequences of which, if continued, would be abnormal risk or loss or damage to an institution, its shareholders, or the agencies administering the insurance funds.”287 The federal banking regulators rely on this definition when exercising the broad enforcement powers that Congress gave them.288 Notably, none of those statutes requires more.289 Thus, under 12 U.S.C. § 1818, the bank regulators may exercise broad powers to deal with any bank that engages in unsafe and unsound banking practices.290 The FDIC, for example, can 285. In re Adams, No. AA-EC-11-50, 2014 WL 8735096, at *2 (Sept. 30, 2014). 286. See, e.g., id. (explaining that the Federal Deposit Insurance Act contains no definition of the term “unsafe or unsound practice” and asserting John E. Horne’s definition is the primary definition used in enforcement actions). 287. Id. at *2–3 (citing Financial Institutions Supervisory Act of 1966: Hearings on S. 3158 Before the H. Comm. on Banking and Currency, 89th Cong., 2d Sess. 49 (1966) (statement of John E. Horne, Chairman of the Fed. Home Loan Bank Bd.)); see also Nw. Nat’l Bank v. U.S. Dep’t of the Treasury, 917 F.2d 1111, 1115 (8th Cir. 1990) (defining the term “unsafe or unsound business practice” as “conduct deemed contrary to accepted standards of banking operations which might result in abnormal risk or loss to a banking institution or shareholder”) (quoting First Nat’l Bank v. U.S. Dep’t of the Treasury, 568 F.2d 610, 611 (8th Cir. 1978)). 288. See id. at *3 (“The OCC and the other Federal banking agencies consistently have relied on this definition in bringing enforcement cases in the decades since [Horne’s description of the term].”); see also id. (“[A] minority of circuits apply the [Horne] definition with a restrictive gloss that serves to narrow the circumstances under which enforcement actions may be taken.”) (citing Gulf Fed. Sav. & Loan Ass’n v. Fed. Home Loan Bank Bd., 651 F.2d 259, 267 (5th Cir. 1981) (referring to an additional requirement that the practice threaten the financial stability of the bank)). 289. Professor Schooner suggests that the unsafe and unsound practice must also involve “at least a potential risk to the bank’s solvency.” Schooner, supra note 283, at 202. 290. The plain meaning of the statute fails to require any threat to the financial stability of the bank. See, e.g., In re Adams, 2014 WL 8735096, at *3–4 terminate the deposit insurance of any insured depository institution for “engaging in any unsafe and unsound practices” or operating in an “unsafe and unsound condition.”291 In addition, all federal bank regulators can issue cease and desist orders to any federally regulated bank to stop any “unsafe or unsound practice.”292 The agencies can remove any officer or director of a regulated entity if it finds that any officer or director “participated in any unsafe or unsound practice . . . .”293 The federal banking regulators can also force an insured bank into conservatorship or receivership for unsafe or unsound practices, or for operating in an unsafe or unsound condition.294 Finally, the agencies can seek civil penalties for unsafe and unsound practices of up to one million dollars per day.295 (describing the range of possible remedies enforcement staff may take against banks). It is difficult if not impossible to reconcile the decisions that narrow the regulatory reach of the enforcement power of the federal bank regulators with the Federal Deposit Insurance Corporation Improvement Act of 1991. See generally Pub. L. No. 102-242, 105 Stat. 2236 (1991) (codified in scattered sections of 12 U.S.C.). Section 1831o of title 12 of the United States Code requires the federal banking regulators to take “prompt corrective action” even against wellcapitalized depository institutions when the regulators find unsafe or unsound practices. See 12 U.S.C. § 1831o(a)(2) (2012) (requiring each appropriate federal banking agency take “prompt corrective action” to resolve problems). “With the passage of the Federal Deposit Insurance Corporation Improvement Act of 1991, Congress directed the federal banking agencies to exercise their enforcement muscle long before an institution fails or faces imminent threat of failure.” Schooner, supra note 283, at 178. This forces the regulators to assume a more formal and proactive role with regard to supervision of operating institutions. Id. 291. 12 U.S.C. § 1818 (a)(2) (2012). See id. § 1818(b) (describing the cease and desist proceeding). 293. See id. § 1818(e)(1)(A)(ii) (allowing for the removal of officers of a regulated entity when the entity is found to have “engaged or participated in any unsafe or unsound practice in connection with any insured depository institution or business institution”). Any such prohibition amounts to an industry-wide prohibition. See 12 U.S.C. § 1818(e)(7) (2012) (requiring an “industrywide prohibition” on the hiring of removed or suspended individuals). Thus, this power can operate to terminate careers. See id. at § 1818(g) (providing authority for suspension, removal, and prohibition of participation orders for certain criminal offenses). 294. See id. § 1821(c)(5) (describing the grounds for appointing a conservator or receiver). 295. See id. § 1833(b)(2) (allowing an agency to assess civil penalties for continuing violations in an amount “[not to] exceed the lesser of $1,000,000 per day or $5,000,000”). In the course of enforcing these broad powers to assure safe and sound banking, the banking regulators can restrict the growth of an institution, place limitations on the activities of an institution, or, importantly, “employ qualified officers or employees” subject to the approval of the banking regulators.296 Indeed, Congress specified that the federal banking regulators may “take such other actions as the banking agency determines to be appropriate.”297 Further, Congress statutorily recognized that the federal banking regulators may come to negotiated agreements with the banks they supervise, and violation of such agreements themselves trigger the above-referenced enforcement powers.298 Finally, the federal banking regulators may deem a bank to be engaged in an unsafe and unsound banking practice if a bank receives an unsatisfactory rating in an examination report for asset quality, management, earnings, or liquidity.299 Congress gave the federal banking regulators additional regulatory power over virtually all core facets of banks.300 Under 12 U.S.C. § 1831p-1, the federal banking regulators must promulgate standards for safe and sound internal controls, loan documentation and underwriting, interest rate risk, asset growth, compensation, and other managerial standards.301 If any bank fails to meet such standards, then the federal banking regulator may seek a remedial plan, acceptable to the regulator.302 If such a plan is not forthcoming, the relevant federal banking regulator 296. See id. § 1818(b)(6)(A)–(F) (listing the affirmative actions banking regulators may take to correct conditions resulting from violations or practices). 297. Id. § 1818(b)(6)(F). 298. See id. § 1818(a)(2)(iii), (b)(1) & (e)(1)(A)(i)(III)–(IV) (establishing a violation of a written agreement as cause for exercise of enforcement power). 299. See id. § 1818(b)(8) (providing that bank regulators may deem an institution to be “engaging in an unsafe or unsound practice” the institution is found to have unsatisfactory asset quality, management, earnings, or liquidity). 300. See id. § 1831p-1(a)(1)–(2) (listing each internal bank practice for which bank regulators may prescribe standards). 301. See id. § 1831p-1(a) (enumerating the operational and managerial standards federal banking agencies must enforce). 302. See id. § 1831p-1(e)(1)(A)(i) (explaining how if the failure to meet safety and soundness standards involves a violation of a regulation the federal banking regulator “shall” seek a corrective plan). may order the bank to take “any other action”303 necessary for the prompt correction of the deficiency.304 The Federal Reserve Board of Governors (Fed) holds additional powers with respect to bank holding companies. Specifically, under 12 U.S.C. § 1844, the Fed may order the termination of any activity or the divestiture of any subsidiary constituting a “serious risk” to the “financial safety soundness and stability” of the bank holding company or subsidiary bank.305 The bank holding company may either terminate the activity that is the source of the risk, terminate its ownership of the non-bank subsidiary where the risk resides, or terminate ownership of its bank subsidiary.306 Termination of ownership may be accomplished through sale or distribution of shares to shareholders of the bank holding company.307 Of course, the federal banking regulators need not exercise these powers in order to impose reforms if enforcement targets agree to proposed governance reforms. For example, the Fed recently sanctioned State Street Bank (a state-chartered member bank of the Federal Reserve System) and its parent company State Street Corporation (a bank holding company).308 The Fed 303. Id. § 1831p-1(e)(2)(B)(iv). 304. Section 1831o requires that “[e]ach appropriate Federal banking agency and the Corporation (acting in the Corporation’s capacity as the insurer of depository institutions under this chapter) shall carry out the purpose of this section by taking prompt corrective action to resolve the problems of insured depository institutions.” 12 U.S.C. § 1831o. 305. See 12 U.S.C. § 1844(e)(1) (allowing the Fed, “whenever it has reasonable cause to believe that the continuation by a bank holding company of any activity . . . constitutes a serious risk to the financial safety, soundness, or stability of a bank holding company subsidiary bank,” to terminate the activities). 306. See id. § 1844(e)(1)(A)–(B) (reviewing the powers of the Fed to terminate activities, ownership, and control of nonbank subsidiaries). 307. See id. (explaining that the Fed may order the termination of ownership which may occur “by sale or by distribution of the shares of the subsidiary to the shareholders of the bank holding company”). 308. See Written Agreement by and among, State Street Corporation, Boston, Massachusetts, State Street Bank and Trust, Boston, Massachusetts, Federal Reserve Bank of Boston, and Massachusetts Division of Banks, before the Federal Reserve Board of Governors, May 28, 2015, https://www.federalreserve.gov/ newsevents/press/enforcement/enf20150601a1.pdf (describing the technicalities of the alleged noncompliance). enforcement action culminated in an agreement that required State Street Corporation to, among other things: (1) submit a written plan to strengthen the board’s oversight of compliance and risk management acceptable to the regulators with respect to money laundering and compliance with the U.S. Treasury Office of Foreign Asset Control; (2) address funding for personnel, systems, and other resources as needed to achieve appropriate risk management and compliance; (3) take measures to improve the information reported to the board of directors with respect to such compliance; (4) ensure greater senior management participation in such compliance efforts; and (5) provide for enhanced monitoring and testing of compliance with respect to such regulatory mandates.309 State Street Bank also agreed to such enhanced measures to achieve compliance with regulations.310 Additionally, the bank agreed to hire an independent third party to conduct a compliance review.311 Essentially, “State Street Corp. was ordered by regulators to revamp its compliance programs after deficiencies were found related to internal controls, customer due-diligence procedures and transaction monitoring.”312 This agreed method of resolving regulatory deficiencies illustrates well the wide-ranging powers of the federal banking regulators to impose reforms in internal governance at regulated entities.313 The banking regulators also have the power to issue interpretive guidance to regulated entities. The FDIC—holding broad regulatory power due to its role as deposit insurer—issued such guidance regarding its expectations of officers and directors of FDIC insured banks.314 The FDIC expects directors to maintain “competent management,” to “establish[] business strategies and policies,” and to take actions to assure legal compliance and compliance with principles of safety and soundness.315 Officers are “responsible for compliance with applicable laws, regulations, and principles of safety and soundness.”316 Moreover, the FDIC expects managers “to respond promptly to supervisory criticism.”317 “When an institution becomes troubled, it is especially important that it have the benefit of the advice and direction of people whose 314. provides: The FDIC statement regarding fiduciary duties of officers and directors The duty of care requires directors and officers to act as prudent and diligent business persons in conducting the affairs of the bank. This means that directors are responsible for selecting, monitoring, and evaluating competent management; establishing business strategies and policies; monitoring and assessing the progress of business operations; establishing and monitoring adherence to policies and procedures required by statute, regulation, and principles of safety and soundness; and for making business decisions on the basis of fully informed and meaningful deliberation. Officers are responsible for running the day to day operations of the institution in compliance with applicable laws, rules, regulations and the principles of safety and soundness. This responsibility includes implementing appropriate policies and business objectives. Directors must require and management must provide the directors with timely and ample information to discharge board responsibilities. Directors also are responsible for requiring management to respond promptly to supervisory criticism. Open and honest communication between the board and management of the bank and the regulators is extremely important. New FDIC Guidelines Issued to Clarify the Responsibilities of Bank Directors and Officers, FDIC FIL-87-92 (Dec. 17, 1992), https://www.fdic.gov/regulations/laws/ rules/5000-3300.html (last visited Dec. 13, 2016) [hereinafter FDIC Guidelines] (on file with the Washington and Lee Law Review). See also OCC, THE DIRECTOR’S BOOK 10–17, 19–47 (2010), http://www.occ.gov /publications/publications-bytype/other-publications-reports/The-Directors-Book.pdf (articulating similar standards applicable to federally chartered depository institutions). FDIC Guidelines, supra note 314. 316. Id. 317. Id. experience and talents enable them to exercise sound and prudent judgment.”318 The FDIC speaks with particular authority in this area because it is the sole federal regulator operating as a receiver for insolvent depository institutions319 and has a legal mandate to pursue any fiduciary duty claims against former bank directors and officers.320 In this connection, the FDIC emphasizes that in considering whether to pursue such claims it will assess whether managers complied with laws, regulations, and supervisory agreements or heeded regulator warnings.321 The upshot of all of this is that the federal banking regulators have broad power to address and remedy all issues relating to safe and sound banking practices. Anytime an insured depository institution engages in any unsafe or unsound practice, or is operating in an unsafe and unsound condition, the federal banking regulators can impose any conditions necessary to stem the risks of such practice as part of their normal enforcement powers and processes.322 Nothing in Section 342 of the Dodd–Frank Act limits the regulators’ power to address and remedy issues. Section 342 limits the power to impose cultural diversity in only one way: “[N]othing in [Section 342(b)] may be construed to mandate any requirement on or otherwise affect the lending policies and practices of any 318. Id. 319. See 12 U.S.C. § 1821(c)(2)(A)(ii) (2012) (“The Corporation shall be appointed receiver, and shall accept such appointment, whenever a receiver is appointed for the purpose of liquidation or winding up the affairs of an insured Federal depositor institution . . . .”). 320. See id. § 1821(k)(1)–(3) (enumerating the liabilities of bank directors and officers). 321. See FDIC Guidelines, supra note 314 (stating that claims pursued often involve “[c]ases where a director or officer was responsible for []failure . . . to adhere to applicable laws and regulations” and that claims against “outside directors either involve insider abuse or situations where the directors failed to heed warnings . . . that there was a significant problem”). Between 1985 and 1992, the FDIC pursued claims against officers and directors about twenty-four percent of the time a bank failed. Id. 322. See, e.g., 12 U.S.C. § 1818(b)(6)(F) (including the power to order the bank to “take such other actions as the banking agency determines to be appropriate” within the power to issue a cease and desist order); 12 U.S.C. § 1818(a)(2)(A)(iii), (b)(1) & (e)(1)(A)(i)(III)–(IV) (explaining that federal banking regulators always retain the power to come to negotiated agreements with banks found to engage in unsafe or unsound practices). regulated entity, or to require any specific action based on the findings of the assessment.”323 This sole limitation does not impact the regulators’ preexisting power to address unsafe and unsound banking practices and conditions, even if such violations also implicate weak diversity policies and practices as part of the unsafe or unsound banking practice and conditions.324 The regulators also traditionally exercised their remedial power broadly and it would defy the intent of the political branches to limit the reach of the federal regulators to address diversity in the financial sector under the Dodd–Frank Act; they manifestly held the opposite intent.325 The SEC has similarly used its enforcement powers to plumb the depths of internal governance at regulated entities, as the next section of this Article will show. B. The SEC and the Securities Industry The SEC’s main concern is legal compliance and regulatory risk.326 For example, 15 U.S.C. § 78o gives the SEC power to revoke 323. Dodd–Frank Act § 342(b)(4), 12 U.S.C. § 5452(b)(4) (2012). 324. It is a fundamental canon of statutory interpretation that statutes should be construed in harmony with preexisting statutes and the implied repeals or limitations of pre-existing statutes are disfavored. See FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 133 (2000) (explaining that courts should interpret the statutes as a “symmetrical and coherent regulatory scheme” and “fit, if possible, all parts into a harmonious whole”); United States v. Spinelle, 41 F.3d 1056, 1059 (6th Cir. 1994) (citing Morton v. Mancari, 417 U.S. 535, 550 (1974)); Morton v. Mancari, 417 U.S. 535, 550 (1974) (“In the absence of some affirmative showing of an intention to repeal, the only permissible justification for a repeal by implication is when the earlier and later statutes are irreconcilable.” (citing Georgia v. Pennsylvania R. Co., 324 U.S. 439, 456–57 (1945))). Indeed, “when two statutes are capable of co-existence, it is the duty of the courts, absent a clearly expressed congressional intention to the contrary, to regard each as effective.” Id. at 551. See also Beckert v. Our Lady of Angels Apartments, Inc., 192 F.3d 601, 606 (6th Cir. 1999) (“Repeals by implication are not favored in the law and are permitted only when the earlier and later statutes are irreconcilable.” (citing United States v. Spinelle, 41 F.3d 1056, 1059 (6th Cir. 1994))). 325. See supra note 229 (detailing the legislative intent behind the Dodd– Frank Act). 326. See The Laws That Govern the Securities Industry, supra note 126 (“[T]he Securities Act of 1933 has two basic objectives: require that investors receive financial and other significant information concerning securities being the registration of broker-dealers, which is tantamount to the corporate death penalty as a broker-dealer cannot operate without an effective registration with the SEC.327 For our purposes, the key provision authorizing such revocation is Section 78o(b)(4), which provides that suspension or revocation is authorized if either the broker-dealer (or any person associated with the broker-dealer): (1) commits any fraud-based crime; (2) is found civilly responsible for fraud-related offenses; (3) is found to have willfully violated any part of the federal securities laws or regulations thereunder; or, (4) willfully aids and abets such violation.328 Of course, like the banking regulators, the SEC need not impose the corporate death penalty.329 The statute specifies that the SEC may impose any “limitations on the activities, functions, or operations of . . . [the] broker or dealer.”330 Also, like the federal banking regulators, the SEC has the power to permanently bar individuals found to have violated the federal securities laws from the securities industry.331 The SEC illustrated this point with its record-setting settlement with Goldman, Sachs & Co. relating to its alleged fraudulent sale of securities-related subprime mortgages.332 Not offered for public sale; and prohibit deceit, misrepresentations, and other fraud in the sale of securities.”). 327. See 15 U.S.C. § 78o(b)(4) (2012) (authorizing the SEC to place restrictions on a broker’s registration). 328. See id. § 78o(b)(4)(A)–(H) (enumerating the situations under which the SEC has the authority to suspend or revoke a broker’s registration). 329. See id. § 78o(b)(4) (providing the SEC options to censure, place limitations on, suspend, or revoke broker registrations). There is an additional layer of regulation in the securities industry. Specifically, all broker-dealers must maintain membership in a self-regulatory organization (SRO) such as the New York Stock Exchange (NYSE). See id. at § 78o(b)(8) (requiring broker-dealers to register pursuant to 15 U.S.C. § 78o-3—with a self-regulatory organization— before the broker-dealer may affect any transaction). 330. Id. § 78o(b)(4). 331. See id. § 78o(b)(6) (“[T]he Commission, by order, shall censure, place limitations on the activities of such person, or suspend for a period not exceeding 12 months, or bar any such person . . . .”). 332. See Goldman Sachs to Pay Record $550 Million to Settle SEC Charges Related to Subprime Mortgage CDO, SECURITIES & EXCHANGE COMMISSION, http://www.sec.gov/news/press/2010/2010-123.htm (last updated July 15, 2010) (last visited Dec. 15, 2016) (“Half a billion dollars is the largest penalty ever assessed against a financial services firm in the history of the SEC . . . .”) (on file with the Washington and Lee Law Review). only did Goldman pay $550 million to settle the claims of the SEC, it also acknowledged that material misrepresentations occurred in connection with the marketing of such securities and agreed to internal governance reforms.333 More specifically, it agreed to: [R]emedial action . . . in its review and approval of offerings of certain mortgage securities. This includes the role and responsibilities of internal legal counsel, compliance personnel, and outside counsel in the review of written marketing materials for such offerings. The settlement also requires additional education and training of Goldman employees in this area of the firm’s business.334 This settlement thus demonstrates again the power of the federal financial regulators over the internal governance of firms they regulate.335 The SEC regulates many entities beyond just broker-dealers. Indeed, the Joint Guidelines identify the SEC as the agency with the greatest number of regulated entities subject to the guidelines.336 The regulated entities subject to the Joint Guidelines and SEC regulation include: investment advisers, investment companies, self-regulatory organizations (such as the NYSE), 333. See id. (“In agreeing to the SEC’s largest-ever penalty paid by a Wall Street firm, Goldman also acknowledged that its marketing materials for the subprime product contained incomplete information.”). 334. Id. 335. More recently, the SEC settled charges with Merrill Lynch regarding its record keeping obligations for $11 million. See Merrill Lynch Admits Using Inaccurate Data for Short Sale Orders, Agrees to $11 Million Settlement, SEC. & EXCH. COMM’N, http://www.sec.gov/news/pressrelease/ 2015-105.html (last updated June 1, 2015) (last visited Dec. 15, 2016) (detailing a SEC action against Merrill Lynch) (on file with the Washington and Lee Law Review). Merrill also agreed to hire an independent consultant to assist in future record keeping obligations. Id. Merrill Lynch previously settled similar record keeping charges for $131 million involving claims that it had misled investors with respect to securities offerings. See SEC Charges Merrill Lynch with Misleading Investors in CDOs, SEC. & EXCH. COMM’N, http://www.sec.gov/News/PressRelease/Detail/Press Release/1370540492377 (last updated Dec. 12, 2013) (last visited Dec. 15, 2016) (detailing charged filed by the SEC against Merrill Lynch regarding an alleged failure to provide information to investors) (on file with the Washington and Lee Law Review). 336. See Joint Guidelines, supra note 44, at 33021 (explaining how the SEC estimated that 1,250 of its regulated entities would respond to a survey regarding diversity policies, which is 500 more respondents than the next closest agency). rating agencies, and certain institutions involved in derivatives markets.337 The SEC regulatory scheme with respect to each of these different types of financial institutions differs in important ways.338 However, there are many common themes: each of these types of entities must register with the SEC; the SEC holds the power to revoke such registrations for a variety of reasons, including legal and regulatory violations; and the SEC conducts periodic examinations of each type of regulated entity.339 Invariably, the SEC may also take action short of revoking registrations, which operates as a corporate death penalty.340 An example of the SEC’s power to influence regulated entities is in its enforcement action against an investment company, Putnam Investment Management LLC. In late 2003, SEC settled claims against Putnam relating to alleged violations of the Investment Advisers Act of 1940341 and the Investment Company Act of 1940.342 The Commission found that Putnam committed fraud in connection with the purchase and sale of securities in the form of mutual fund shares.343 Putnam failed to disclose self337. See id. at 33020 n.6 (listing the primary federal financial regulator for various institutions identified in 12 U.S.C. § 1813(q)). 338. See What We Do, supra note 127 (describing the manner in which various industries are regulated). 339. See id. (“The Act also identified and prohibits certain types of conduct in the markets and provides the Commission with disciplinary powers over regulated entities and persons associated with them.”). An example of this power is 15 U.S.C. § 78o (b)(4), discussed above. 341. Investment Advisers Act of 1940, 15 U.S.C. § 80b (2000). The Court termed that the intent of the Investment Advisers Act—like the federal securities laws in general—“was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry.” SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186 (1963). The Act accomplished this through broad anti-fraud provisions that supported private claims and registration of investment advisers. See Goldstein v. SEC, 451 F.3d 873, 876 (D.C. Cir. 2006); Arthur B. Laby, SEC v. Capital Gains Research Bureau and the Investment Advisers Act of 1940, 91 B.U. L. REV. 1051, 1081–82 (2011). 342. Investment Company Act of 1940, 15 U.S.C. § 80a (2000). 343. See In re Putnam Inv. Mgmt. LLC, Investment Company Act, S.E.C. Release No. 2192, Administrative Proceeding File No. 3-11317, 2003 WL 22683975, at *6 (Nov. 13, 2003) (“[W]hile acting as an investment advisor, [Putnam] employed devices, schemes, or artifices to defraud clients or prospective clients . . . .”). dealing securities trading—using non-pubic information to engage in market-timing—by several of its employees to investors in the mutual funds.344 The Commission further found that Putnam failed to detect and deter such trading activity through internal controls and failed to supervise its investment management professionals.345 Putnam consented to the entry of the Commission's order without admitting or denying its findings and agreed not to contest the SEC’s findings.346 It ultimately paid $55 million to settle the SEC claims.347 More importantly, for purposes of this Article, the SEC demanded, and Putnam agreed to, a series of wide-ranging corporate governance reforms.348 Putnam agreed to enhance the independence of its board, enhance shareholder voting power and disclosures, and supply support staff to board members to assist in their monitoring duties.349 The firm also agreed to make certain enhancements to its compliance including the creation of a reporting obligation from the firm’s chief compliance officer to the board, the creation of new committees for ethics and compliance, and the periodic retention of an independent consultant to review compliance policies and procedures.350 Thus, like the federal bank 344. In re Putnam Investments LLC, Administrative Proceeding No. 3-11317, SEC. EXCH. COMM’N (Nov. 13, 2003), https://www.sec.gov/litigation/admin/ia2192.htm (last visited Dec. 15, 2016) (on file with the Washington and Lee Law Review). 345. Id. 346. Id. 347. See Putnam Agrees to Pay $55 Million to Resolve SEC Enforcement Action Related to Market Timing by Portfolio Managers, SECURITIES & EXCHANGE COMMISSION (Apr. 8, 2004), https://www.sec.gov/news/press/2004-49.htm (last visited Dec. 15, 2016) (announcing Putnam’s agreement to pay a fifty-million dollar penalty and five-million dollar disgorgement) (on file with the Washington and Lee Law Review). 348. See id. (“Putnam agreed to undertake significant and far-reaching corporate governance, compliance, and ethics reforms.”) 349. See Putnam Agrees to Make Restitution and Implement Immediate, Significant Structural Reforms in Partial Resolution of SEC Enforcement Action, SEC. & EXCH. COMM’N (Nov. 13, 2003), https://www.sec.gov/news/ press/2003156.htm (last visited Dec. 15, 2016) (describing Putnam’s reforms as an effort to make “real and substantial” reforms in order to better protect mutual fund investors) (on file with the Washington and Lee Law Review). 350. See id. (enumerating the various areas of compliance Putnam agreed to reform as a result of the SEC’s order). regulators, the SEC routinely exercises its regulatory power to achieve superior compliance, risk management, and corporate governance in wayward registrants and regulated entities.351 The federal financial regulators, however, segregated the issue of diversity to the extreme margins of their respective regulatory activities, examinations, and regulatory processes. As previously mentioned, the Dodd–Frank Act directs the federal financial regulators to promulgate standards for “assessing the diversity policies” of regulated entities, and the regulators turned away from the plain meaning of the statute to create a “selfassessment.”352 Congress could not have meant “self-assessment,” otherwise there would be no need for the statutory language in Section 342(b)(4) of the Dodd–Frank Act, stating that the assessment could not alone be used for any mandate regarding “lending policies” or “to require any specific action based on the findings of the assessment.”353 This provision is meaningless and redundant in the context of self-assessments.354 Worse, the federal financial regulators state within the Joint Guidelines that “[t]he agencies will not use their examination or supervisory processes in connection with these Standards.”355 Further, the agencies state that the Joint Guidelines do not “create any new legal obligation.”356 It is as if Congress simply directed the agencies to promulgate voluntary guidelines for regulated entities to undertake self-assessments of optional diversity policies. 351. See, e.g., supra notes 343–350 and accompanying text (outlining the SEC’s enforcement action against Putnam). 352. Compare Dodd–Frank Act § 342(b)(2)(C), 12 U.S.C. § 5452(b)(2)(C) (2012) (requiring the federal financial regulators to create standards for “assessing the diversity policies and practices of entities regulated by the agency”), with Joint Guidelines, supra note 44, at 33024 (“[T]he agencies interpret the term ‘assessment’ to mean self-assessment.”). Congress did not use the term “self-assessment.” 12 U.S.C. § 5452(b)(2)(C) (2012). 353. Dodd–Frank Act § 342(b)(4), 12 U.S.C. § 5452(b)(4). 354. In general, statutes should be construed in a way that avoids rendering any provision meaningless or surplus. This interpretation “flouts the rule that a statute should be construed so that effect is given to all its provisions, [and] no part will be inoperative or superfluous.” Clark v. Rameker, 134 S. Ct. 2242, 2248 (2014) (internal quotations omitted). 355. Joint Guidelines, supra note 44, at 33. 356. Id. We suggest an alternative to breathe life into Section 342 in accordance with the plain meaning of Section 342. In accordance with the preexisting powers held by the federal financial regulators (discussed above),357 federal financial regulators should use their examination and supervisory powers to assess the diversity policies of regulated entities under the standards promulgated in the Joint Guidelines.358 Then, if those policies are sufficiently deficient that they form a basis—combined with all other facts and deficiencies found by the regulators—for adverse comments in examination reports, then such deficiencies should be treated as any other regulatory issue.359 Finally, in seeking to enhance risk management, legal and regulatory compliance, as well as ethicality, the regulators should require more aggressive efforts at diversification at miscreant firms that violate laws and regulations related to those areas. This approach effectively vindicates the act of Congress. It also vindicates the essential purpose of the Dodd–Frank Act overall. Based upon the empirical evidence developed in Part III of this Article, diversity is essential to appropriate risk management, particularly compliance and ethics risk management. Consequently, sound diversity management vindicates macroprudential regulation, macroeconomic stability and growth, and the essential publicness of the financial sector. In sum, our 357. See supra notes 322–325 and accompanying text (analyzing the power of federal regulators in depth). 358. This would encourage but not mandate diversity policies. The courts themselves already encourage such policies in every firm subject to Title VII. See Burlington Indus. v. Ellerth, 524 U.S. 742, 744–46 (1998) (articulating defense for Title VII vicarious liability for firms with appropriate policies); Faragher v. City of Boca Raton, 524 U.S. 775, 808 (1998) (holding as a matter of law that the City of Boca Raton could not establish the defense because it had failed to disseminate the policy to all of its employees, and its policy failed to include a provision allowing the complaining person to bypass the harassing supervisor); Allen v. Mich. Dep’t. of Corr., 165 F.3d 405, 409–12 (6th Cir. 1999) (finding that an African American was the victim of unreasonable abusive and offensive racial harassment and extending the above holdings to the race discrimination context); Steven A. Ramirez, The New Cultural Diversity and Title VII, 6 MICH. J. RACE & L. 127, 164–65 (2000) (reviewing case law regarding diversity policies, harassment, and hostile work environment). 359. Implicit in this approach is that diversity policy deficiencies standing alone, with no threat of serious risk of loss, are not a matter of regulatory concern. This fully actualizes Section 342(b)(4). approach squares the statutory language of Section 342 with the essential purposes of Dodd–Frank and the best learning extant on the potential of cultural diversity. VII. Conclusion Congress correctly identified a major blind spot on Wall Street—a culturally homogenous elite prone to herd behavior, groupthink, and affinity bias.360 These maladies exacted a heavy cost upon the rest of the nation in the context of the financial crisis, which was marked by a mindless real estate bubble, dubious ethics, outright violations of laws and regulations, and the worst risk mismanagement in our nation’s history. There is no certainty that a more culturally diverse financial sector would have entirely prevented the crisis or dramatically lessened its effects. Embracing the full spectrum of cultural diversity allows firms to access and balance the full spectrum of perspectives and experiences that support superior cognition, especially with respect to risk, ethics, and compliance. Nevertheless, empirical studies strongly suggest that a more culturally diverse financial sector could have reduced subprime lending, limited the extent of the real estate bubble, limited the essential lawlessness of the financial sector, and enhanced ethical decision making.361 These empirical studies are either based upon actual learning from the financial crisis or sophisticated experiments simulating market behavior.362 While omitted variables can never be ruled out and disentangling causation from mere correlation is always challenging, the studies carefully control for many factors and boast careful designs expressly to 360. See supra notes 49–51 and accompanying text (exploring the difficulties and ramifications of group think and herd behavior in financial institutions). 361. See supra note 56 and accompanying text (reviewing multiple studies that point to correlation between increased gender diversity and positive business outcomes). 362. See supra notes 56–59 and accompanying text (summarizing multiple studies that illustrate the difference between diverse and non-diverse governance results, as well as differences in perception between white males and people of other backgrounds). limit such concerns.363 In all events, a thoroughgoing embrace of cultural diversity will certainly yield superior social and economic outcomes relative to the financial crisis yielded by culturally monolithic financial firms. Viewed from the perspective of that crisis in capitalism, it is impossible for cultural diversity to fail. Consequently, we suggest that the financial regulators modify the basic approach of the Joint Guidelines and fully integrate them into all aspects of their examination and supervisory processes. Further, firms should face legal obligations with respect to diversity to the extent that mismanagement of diversity contributes to unsafe and unsound practices or creates an environment and culture of unlawful conduct. The regulators should also proactively require stronger diversity measures for firms sanctioned for unlawful behavior or risk mismanagement as part of negotiated enforcement outcomes. This more robust approach to Congress’s directive with respect to diversity is far more consistent with the plain meaning of Section 342. It also fully vindicates the macroeconomic, macroprudential, and publicness concerns that animate the Dodd– Frank Act. A more diverse financial sector is bound to allocate capital better, achieve greater systemic stability, and meet the public’s expectations of the financial sector. III. The Increasing “Publicness” of Financial Institutions ....................................................................1819 A. Federal Regulation of “Publicness” .........................1820 B. Financial Innovation and Complexity.....................1825 C. Public Subsidies for Private Institutions................1830 IV. Systemic Risk and Risk Management...........................1833 A. Risk Regulation in Financial Markets ....................1833 V. Regulating Diversity......................................................1840 A. Mechanics of Section 342. ........................................1842 B. Diversity Standards for Regulated Entities ........... 1845 1. Joint Standards ................................................. 1846 2. Voluntariness.....................................................1848 VI. Safety & Soundness and Diversifying to Mitigate Risk .............................................................1851 A. The Federal Banking Regulators ............................1852 B. The SEC and the Securities Industry ..................... 1860 20. See Lucian A . Bebchuk & Holger Spamann , Regulating Bankers' Pay, 98 GEO. L.J. 247 , 247 ( 2010 ) (discussing how executives' insulation from losses leads to a disregard for long-term risk-taking effects). 21. See generally MARY K. RAMIREZ & STEVEN A. RAMIREZ, THE CASE FOR THE CORPORATE DEATH PENALTY : RESTORING LAW AND ORDER ON WALL STREET 1-28 ( 2017 ); Kristin N. Johnson, Governing Financial Markets: Regulating Conflicts, 88 WASH. L. REV. 185 , 227 ( 2013 ) [hereinafter Governing Financial Markets] encourage directors to make risky management decisions). 22. The United States Government Accountability Office found that as of 2011 senior managers in the financial sector were eighty-nine percent whites and seventy-one percent males . U.S. GOV'T ACCOUNTABILITY OFFICE , supra note 13, at 10 , 15 . These numbers changed little from the numbers prevailing before the Great Financial Crisis at the senior manager level . Id . 31 . Christine Lagarde , Managing Dir., Int'l Monetary Fund , Speech at the Institute for New Economic Thinking: Financing and Society (May 6 , 2015 ). 74 . See Thorsten Beck et al., Gender and Banking: Are Women Better Loan Officers ?, 17 REV. FIN . 1279 , 1317 ( 2013 ) (studying the performance differences between male and female loan officers) . 268 . See id. (suggesting that the use of self-assessment promotes transparency and awareness within the entities) . 269. See 80 Fed. Reg . 33 , 017 (“[T]he Agencies have added the following new legal obligations . '”). 270. See 80 Fed. Reg . 33 , 020 (recounting that other commenters who claim that voluntary disclosure would conflict with congressional intent) . 271. See 78 Fed. Reg . 64 , 052 , 64 ,056 (stating that Agencies will use the disclosed information as resource in carrying out diversity efforts ). 272 . Comment Letter Relating to Proposed Interagency Policy Statement Consumer Bankers Ass'n , et al., 3 ( Feb . 6, 2014 ), http://consumerbankers.com/sites/default/files/2014-02-06%20Joint% 20Trades % 20Letter%20Re%20Proposed%20Interagency%20Standards%20for%20Assessing %20Diversity%20Policies%20%28OMWI%29.pdf. 277 . See Comment Letter Relating to Proposed Interagency Policy Statement Nichols 2 ( Feb . 7, 2014 ), https://www.sec.gov/comments/s7-08-13/s70813- 21 .pdf (“The word 'shall' is ordinarily considered mandatory . . . .”). 278 . See id. (arguing that such data will be essential to determine whether more regulation is needed) . 279 . See generally MARY RAMIREZ & STEVEN RAMIREZ, THE CORPORATE DEATH PENALTY: RESTORING LAW AND ORDER IN THE FINANCIAL SECTOR 1-28 ( 2017 ) commit financial crimes with no regulatory or criminal repercussions). 280. See id. (noting that, despite overwhelming proof of fraud during the 2008 financial crisis, the government failed to utilize its law enforcement tools). 281. We fully comprehend the complex political realities facing the financial and overlapping social networks are all beyond the scope of this Article . Id . 284 . See 12 U.S.C. §§ 1786 , 1818 , 1844 ( 2012 ) (specifying the enforcement tools and powers of the NCUA, the OCC, the FDIC, and the Fed) . 309 . See id. at 1-3 (describing the mandated requirements for board oversight and a compliance risk management program) . 310 . See id. 1-2 (detailing the bank's commitment to bring operations into compliance with multiple different regulations) . 311 . See id. at 7 (“Within 30 days of this Agreement, the Bank shall engage account and transaction activity . . . .”). 312 . Chelsey Dulaney & Ryan Tracy , State Street Ordered to Improve Compliance Program , WALL ST. J. (June 1 , 2015 ), http://www.wsj.com/articles /state-street-ordered-to-improve-compliance-program-1433174224 (last visited Dec. 13 , 2016 ) ( on file with the Washington and Lee Law Review). 313. In another such example, the OCC fined HSBC $500 million and ordered program. ” OCC Assesses $500 Million Civil Money Penalty Against HSBC Bank USA , N.A. , DEP'T TREASURY ( Dec . 11, 2012 ), http://www.occ.treas.gov/news- issuances/news-releases/ 2012 /nr-occ-2012 -173.html (last visited Dec . 13 , 2016 )

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Kristin Johnson, Steven A. Ramirez, Cary Martin Shelby. Diversifying to Mitigate Risk: Can Dodd–Frank Section 342 Help Stabilize the Financial Sector?, Washington and Lee Law Review, 2018,