Journal of Corporation Law (Forthcoming)
55 Pages Posted: 6 Dec 2013 Last revised: 17 Jun 2015
Date Written: May 26, 2014
The organizational structure of financial conglomerates gives rise to fundamental regulatory challenges. Legally, the structure subjects firms to multiple, incompatible client duties. Practically, the structure provides firms with a huge reservoir of non-public information that they may use to further their self-interests, potentially harming clients and third parties. The primary regulatory response to these challenges and a core feature of the financial regulatory architecture is the information barrier or Chinese wall. Rather than examine measures to strengthen information barriers, to date legal scholars have focused on the circumstances in which to deny them legal effect, while economists have focused on demonstrating information barriers' practical ineffectiveness in a range of important contexts.
This paper discusses the phenomenon of failing information barriers, explains why it occurs, and proposes a regulatory solution. The paper argues that limits on market discipline and evidential difficulties in detecting and proving the use of non-public information account for the failures of information barriers. It shows how the Volcker Rule, a core plank of the Dodd-Frank Act, will likely reduce harms flowing from failing information barriers, despite the rule’s intended focus on financial stability. To address the ongoing regulatory challenges, the article proposes the use of statistical inference to both detect and prove trading by financial conglomerates using non-public information and thus the failure of information barriers. Employed in so-called forensic finance to detect wrongdoing, the analyses can be used to rule out benign rationales – including superior trading skill and mere coincidence – for financial conglomerates’ abnormal trading returns. The article designs a regulatory strategy based on the use of statistical analyses. Although recognizing limits with the strategy, the article argues that it nevertheless holds promise in addressing the regulatory challenges of financial conglomeration.
Keywords: Chinese walls, Financial conglomerates, Information Barriers, Volcker Rule, Insider trading, Statistical evidence
JEL Classification: K22, G21, G24
Suggested Citation: Suggested Citation
Tuch, Andrew F., Financial Conglomerates and Information Barriers (May 26, 2014). Journal of Corporation Law (Forthcoming); Washington University in St. Louis Legal Studies Research Paper No. 13-11-01. Available at SSRN: https://ssrn.com/abstract=2363312 or http://dx.doi.org/10.2139/ssrn.2363312
By Mark Roe
By Jesse Fried
By Mark Roe