[House Hearing, 113 Congress]
[From the U.S. Government Publishing Office]
HEARING ON THE ``FINANCIAL INSTITUTION BANKRUPTCY ACT OF 2014''
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HEARING
BEFORE THE
SUBCOMMITTEE ON
REGULATORY REFORM,
COMMERCIAL AND ANTITRUST LAW
OF THE
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED THIRTEENTH CONGRESS
SECOND SESSION
__________
JULY 15, 2014
__________
Serial No. 113-112
__________
Printed for the use of the Committee on the Judiciary
Available via the World Wide Web: http://judiciary.house.gov
______
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COMMITTEE ON THE JUDICIARY
BOB GOODLATTE, Virginia, Chairman
F. JAMES SENSENBRENNER, Jr., JOHN CONYERS, Jr., Michigan
Wisconsin JERROLD NADLER, New York
HOWARD COBLE, North Carolina ROBERT C. ``BOBBY'' SCOTT,
LAMAR SMITH, Texas Virginia
STEVE CHABOT, Ohio ZOE LOFGREN, California
SPENCER BACHUS, Alabama SHEILA JACKSON LEE, Texas
DARRELL E. ISSA, California STEVE COHEN, Tennessee
J. RANDY FORBES, Virginia HENRY C. ``HANK'' JOHNSON, Jr.,
STEVE KING, Iowa Georgia
TRENT FRANKS, Arizona PEDRO R. PIERLUISI, Puerto Rico
LOUIE GOHMERT, Texas JUDY CHU, California
JIM JORDAN, Ohio TED DEUTCH, Florida
TED POE, Texas LUIS V. GUTIERREZ, Illinois
JASON CHAFFETZ, Utah KAREN BASS, California
TOM MARINO, Pennsylvania CEDRIC RICHMOND, Louisiana
TREY GOWDY, South Carolina SUZAN DelBENE, Washington
RAUL LABRADOR, Idaho JOE GARCIA, Florida
BLAKE FARENTHOLD, Texas HAKEEM JEFFRIES, New York
GEORGE HOLDING, North Carolina DAVID N. CICILLINE, Rhode Island
DOUG COLLINS, Georgia
RON DeSANTIS, Florida
JASON T. SMITH, Missouri
[Vacant]
Shelley Husband, Chief of Staff & General Counsel
Perry Apelbaum, Minority Staff Director & Chief Counsel
------
Subcommittee on Regulatory Reform, Commercial and Antitrust Law
SPENCER BACHUS, Alabama, Chairman
BLAKE FARENTHOLD, Texas, Vice-Chairman
DARRELL E. ISSA, California HENRY C. ``HANK'' JOHNSON, Jr.,
TOM MARINO, Pennsylvania Georgia
GEORGE HOLDING, North Carolina SUZAN DelBENE, Washington
DOUG COLLINS, Georgia JOE GARCIA, Florida
JASON T. SMITH, Missouri HAKEEM JEFFRIES, New York
DAVID N. CICILLINE, Rhode Island
Daniel Flores, Chief Counsel
C O N T E N T S
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JULY 15, 2014
Page
OPENING STATEMENTS
The Honorable Spencer Bachus, a Representative in Congress from
the State of Alabama, and Chairman, Subcommittee on Regulatory
Reform, Commercial and Antitrust Law........................... 1
The Honorable Henry C. ``Hank'' Johnson, Jr., a Representative in
Congress from the State of Georgia, and Ranking Member,
Subcommittee on Regulatory Reform, Commercial and Antitrust Law 3
The Honorable Bob Goodlatte, a Representative in Congress from
the State of Virginia, and Chairman, Committee on the Judiciary 4
The Honorable John Conyers, Jr., a Representative in Congress
from the State of Michigan, and Ranking Member, Committee on
the Judiciary.................................................. 5
WITNESSES
Donald S. Bernstein, Partner, Davis Polk & Wardwell LLP
Oral Testimony................................................. 8
Prepared Statement............................................. 12
Thomas H. Jackson, Professor, William E. Simon School of
Business, University of Rochester
Oral Testimony................................................. 36
Prepared Statement............................................. 39
Stephen E. Hessler, Partner, Kirkland & Ellis LLP
Oral Testimony................................................. 58
Prepared Statement............................................. 60
Steven J. Lubben, Professor, Seton Hall University School of Law
Oral Testimony................................................. 81
Prepared Statement............................................. 83
APPENDIX
Material Submitted for the Hearing Record
Discussion Draft of the ``Financial Institution Bankruptcy Act of
2014''......................................................... 100
Questions for the Record submitted to Donald S. Bernstein,
Partner, Davis Polk & Wardwell LLP............................. 129
Response to Questions for the Record from Thomas H. Jackson,
Professor, William E. Simon School of Business, University of
Rochester...................................................... 131
Response to Questions for the Record from Stephen E. Hessler,
Partner, Kirkland & Ellis LLP.................................. 135
Response to Questions for the Record from Steven J. Lubben,
Professor, Seton Hall University School of Law................. 138
HEARING ON THE ``FINANCIAL INSTITUTION BANKRUPTCY ACT OF 2014''
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TUESDAY, JULY 15, 2014
House of Representatives,
Subcommittee on Regulatory Reform,
Commercial and Antitrust Law
Committee on the Judiciary,
Washington, DC.
The Subcommittee met, pursuant to call, at 3:57 p.m., in
room 2141, Rayburn House Office Building, the Honorable Spencer
Bachus (Chairman of the Subcommittee) presiding.
Present: Representatives Bachus, Goodlatte, Marino,
Holding, Johnson, and Conyers.
Staff Present: (Majority) Anthony Grossi, Counsel; Ashley
Lewis, Clerk; and (Minority) Susan Jensen, Counsel.
Mr. Bachus. Good afternoon. The Subcommittee on Regulatory
Reform, Commercial and Antitrust Law hearing will come to
order.
And, without objection, the Chair is authorized to declare
a recess of the Committee at any time.
And we have had kind of a helter-skelter day. And that may
be a little severe, that word. But we expect to have votes
probably in a little over 30 or 40 minutes. So we are going to
still have opening statements, and then we will hear your
statements, and we will have time for both of those, if that is
okay. And I will start with my opening statement.
Having lived through it legislatively, first during the
financial crisis of the fall of 2008 and then the deliberations
that resulted in Dodd-Frank, I know that a question people
often ask is why distressed financial firms were not resolved
through the bankruptcy process instead of drawing on emergency
government support, or what many people characterize as
bailouts, government bailouts.
Over the last few years, industry legal and financial
regulatory experts have examined this question in detail. This
Committee, through its ongoing oversight of the Bankruptcy
Code, has closely reviewed the question in addition to
consulting experts in the field, and we have actually heard
from several of you before. We have held a number of hearings
on the issue, including two hearings in the past year on this
precise matter.
Two points of general agreement appear to have emerged. The
first is that the single-point-of-entry approach seems to be
the most feasible and efficient method to resolve a financial
institution that is organized with a holding company atop its
corporate structure. The second point of agreement is that the
Bankruptcy Code as currently drafted containsimpediments to
using the single-point-of-entry approach.
The bankruptcy process has long been favored as the primary
mechanism for dealing with distressed and failing companies
because of its impartiality, adherence to established
precedent, judicial oversight, and grounding in the principles
of due process and rule of law.
We are here today as part of an effort to structure a
bankruptcy process that is better equipped to deal with the
specific issues raised by failing financial firms. By doing so,
we can also address what some have described as bailout fatigue
on the part of the American taxpayer.
The subject of today's hearing, draft legislation titled
the ``Financial Institution Bankruptcy Act,'' includes several
provisions that could improve the ability of financial
institutions to be resolved through the bankruptcy process.
It allows for a speedy transfer of a financial firm's
assets to a newly formed company. It would continue the firm's
operations for the benefit of its customers, employees,
creditors, and the financial stability of the marketplace. This
quick transfer is overseen by and subject to approval of an
experienced bankruptcy judge and includes due-process
protection for parties in interest.
Second, the draft bill provides the financial institutions'
regulators with standing to be heard on issues impacting the
general financial marketplace. Under a narrow set of
circumstances, the Federal Reserve would be allowed to initiate
a bankruptcy case over the objection of a financial
institution. Specifically, the Federal Reserve must demonstrate
to a judge by a preponderance of evidence that the financial
institution is at or near insolvency and commencing a case is
necessary to prevent substantial harm to financial stability.
In addition, there are provisions that facilitate the
transfer of derivative and similarly structured contracts to
the newly formed company which will improve the ability of the
company to continue the financial institution's operations.
Finally, the legislation recognizes the factually and
legally complicated questions presented by the resolution of a
financial institution. To that end, the bill provides that
specialized bankruptcy and appellate judges will be designated
in advance to preside over these cases.
We have an esteemed panel of witnesses with expertise on
bankruptcy and financial implications of the draft legislation.
I will look forward to their testimony and the ensuing
discussion as the Committee continues its consideration of this
important issue.
And let me say before I turn to the Ranking Member, under
Dodd-Frank, a study was commissioned, which actually the
Federal Reserve and the Bank of England both said that
bankruptcy, a single point of entry--they endorsed that
approach.
And we have worked very closely with Members of the
Democratic minority on this, and I think this is one of those
issues where there is some bipartisan agreement that we can
work together. And I think we have; our staffs have worked
closely together on this.
And so, with that, I would recognize my Ranking Member, Mr.
Johnson, for his opening statement.
Mr. Johnson. Thank you, Mr. Chairman.
And I, too, am heartened by the manner in which our staffs
have been able to coordinate and cooperate and get to this
point with a product that can be said to be bipartisan.
And I also want to acknowledge the brilliance of the people
on this panel today. It doesn't get much better, from an
intellectual point of view, than the gentlemen that we have
seated before us today.
Thank you for your work, all of you.
And today's hearing concerns legislation that would attempt
to accommodate the efficient winding down of a systemically
important financial institution while promoting stability in
the financial marketplace, rather than forcing a resolution
under Title 2 of the Dodd-Frank Act. In other words, this
legislation concerns how the Bankruptcy Code should treat the
failure of the next Lehman Brothers, whose collapse caused
untold insecurity in our Nation's financial system and wreaked
havoc across the globe.
Four years ago, Congress enacted the Dodd-Frank Act in
response to the greatest financial crisis since the Great
Depression. I support this landmark legislation because it was
a crucial step in reining in financial institutions that caused
immeasurable hardship to so many American families. Built on
the back of predatory lending of subprime mortgages to the most
vulnerable members of society, including low-income,
minorities, and the elderly, the great recession was indeed a
study in corporate greed.
But despite stemming the hemorrhaging of our Nation's
financial system, it is clear that Dodd-Frank left too many
issues unaddressed. Banks are still too big for regulation, too
big for trial, too big to fail, and too big to jail. I would
also note that under the Roberts Court's interpretation of
corporate speech, banks are also too big to respect the
reproductive rights of women and too big to be bound by
campaign finance law.
Later this week, this Subcommittee will conduct an
oversight hearing on the Department of Justice's attempt to
rein in fraud against the elderly and consumers. Imagine that.
Banks are also too big to investigate for fraud and money
laundering and too big to be held accountable for defrauding
Americans.
With these observations in mind, it is my strong belief
that any legislation to accommodate the winding down of a
systemically important fiscal institution must promote the
public interest through a transparent process.
Although I commend the Chair for the staff-level process
for the discussion draft we are considering today, we have not
heard from the bank regulators and many other important
stakeholders on the draft bill. The purpose of this legislation
should be the protection of the public interest. The input from
bank regulators and other interested parties, specifically on
the question of whether this legislation truly protects
consumers, is vital to my support for the underlying bill.
We are all in the same boat when it comes to our Nation's
financial system. I therefore urge the Chair to allow ample
time to hear from all parties and stakeholders for their
comment on this legislation and to not impose an arbitrary
deadline on legislation that affects one of the most important
aspects of the financial system.
Lastly, as I mentioned in this Subcommittee's hearing on
Title 2 of Dodd-Frank in March, it is imperative that this
Subcommittee consider the strengths and weaknesses of the
Bankruptcy Code in not just business bankruptcy but in consumer
bankruptcy, as well.
Few other areas are as important to most Americans as the
crippling effects of student-loan debt, which has reportedly
ballooned into the largest source of debt for American
consumers. This debt is practically nondischargeable, growing
exponentially, and has far-reaching consequences. I have little
doubt that, if we put our minds to it, we could reach a
bipartisan solution to alleviate the suffering of many of those
consumers who are affected and afflicted by crushing student-
loan debt.
Furthermore, I would remind the Chair that it is very
difficult for the minority to routinely support the majority's
priority legislation without reciprocity in consideration of
issues. There are a number of outstanding bipartisan issues,
like consumer bankruptcy, that merit discussion. I urge the
Chair to consider these requests.
And I look forward to our witnesses' testimony on the
discussion draft of the Financial Institutions Bankruptcy Act
of 2014.
And, with that, I yield back.
Mr. Bachus. Thank you, Mr. Johnson.
I would now like to recognize the full Committee Chair, Mr.
Bob Goodlatte of Virginia, who later tonight will be playing
tennis for charity against an opponent from the Administration.
Mr. Goodlatte. On the other hand, I might be here working
on immigration reform.
Mr. Bachus. The great tennis match might be postponed, huh?
Mr. Goodlatte. I thank the Chairman and welcome our
panelists today.
This is an important hearing. Our Nation's financial system
provides the lifeblood for industry to develop, grow, and
prosper. Ensuring that this system functions efficiently in
both good times and bad is critical to the ongoing vitality of
our economy.
The recent financial crisis illustrated that the financial
system and existing laws were not adequately prepared for the
insolvency of certain institutions which threaten the very
stability of the global economy and our financial industry.
There has been considerable debate over whether Congress' main
response the financial crisis, the Dodd-Frank Wall Street
Reform and Consumer Protection Act, is adequate to respond to a
future crisis.
Today's hearing, however, is not focused on that debate.
Instead, we turn our attention to the private and public
efforts to strengthen the Bankruptcy Code so that it may better
facilitate the resolution of an insolvent financial firm while
preserving the stability of the financial markets.
The subject of today's hearing, the Financial Institution
Bankruptcy Act of 2014, is a reflection of these efforts. The
bill is calibrated carefully to provide transparency,
predictability, and judicial oversight to a process that must
be executed quickly and in a manner that is responsive to
potential systemic risks.
Additionally, it incorporates the single-point-of-entry
approach, which a growing consensus of experts in public and
private industry believe is the most effective and feasible
method to resolve a financial institution that has a bank
holding company.
The Judiciary Committee has a long history of improving the
Bankruptcy Code to ensure that it is equipped properly to
administer all failing companies. The Financial Institution
Bankruptcy Act adds to this history by enhancing the ability of
financial firms to be resolved through the bankruptcy process.
The development of the discussion draft before us today has
been a collaborative effort that included the financial and
legal community as well as the Democratic staff. This
collaboration has continued through a broader circulation of
the bill, including to, among others, the Federal Reserve, the
FDIC, the courts, and Treasury. We look forward to feedback
from all parties regarding the proposed text of the bill.
Over the course of the past year, during two separate
hearings, this Committee has heard testimony that the
Bankruptcy Code could be improved and that a measure that
creates a new Subchapter V within Title 11 of the Bankruptcy
Code should be enacted.
Today, we will hear from a panel of experts whether the
draft before us meets these goals and whether the text could be
further refined. I look forward to hearing from today's
witnesses on this important measure.
Thank you, Mr. Chairman, for holding this hearing, and I
yield back to you.
Mr. Bachus. Thank you, Chairman Goodlatte.
I would now like to recognize the full Committee Ranking
Member, Mr. John Conyers, Jr., of Michigan, for his opening
statement.
Mr. Conyers. Thank you, Chairman Bachus.
Welcome, witnesses.
I am the last presenter on this side of the table. And we
are trying to ensure that the resolution of complex bank
holding companies on the verge of insolvency can be better
facilitated under the Bankruptcy Code, and I would appreciate
your views on that.
Any legislative fix should be premised on the critical
lessons learned from the near collapse of our Nation's economy
just 5 years ago. Without doubt, the great recession was a
direct result of the regulatory equivalent of the wild west.
And in the absence of any meaningful regulation of the mortgage
industry, lenders developed high-risk subprime mortgages and,
frankly, used predatory marketing tactics, targeting the most
vulnerable.
These doomed-to-fail mortgages were then securitized and
sold to unsuspecting investors, including pension funds and
school districts. Once the housing bubble burst, the ensuing
2008 crash stopped the flow of credit and trapped millions of
Americans in mortgages they could no longer afford, causing
waves of foreclosures across the United States, massive
unemployment, and international economic upheaval.
And to this day, we are still dealing with the lingering
effects of the great recession of 2008. Neighborhoods across
the Nation are still blighted by vast swaths of abandoned
homes. Many municipalities, big and small, continue to struggle
with the attendant costs resulting from mortgage-foreclosure-
induced blight as well as reduced revenues.
Thus, lesson number one is the legislation should make it
easier, not harder, for regulators to respond to an imminent
threat to the Nation's financial marketplace.
Then, as demonstrated by the failure of Lehman Brothers and
the resultant near collapse of Wall Street, it is critical that
liquidity and trust in the financial marketplace be restored as
soon as possible after the collapse of a major financial
institution. Fortunately, Dodd-Frank goes a long way toward
reinvigorating a regulatory system that makes the financial
marketplace more accountable and, hopefully, more resilient.
The act also institutes long-needed consumer protections.
While Dodd-Frank establishes a mandatory resolution mechanism
to wind down a systemically significant financial institution,
the act implicitly prioritizes using a bankruptcy solution
before invoking Dodd-Frank's orderly liquidation process. This
is because the Bankruptcy Code has, for more than 100 years,
enabled some of the Nation's largest companies to regain their
financial footing, including, more recently, General Motors and
Chrysler.
But for bankruptcy to be truly viable as an alternative to
a Title 2 resolution process, the bank holding company must
have access to lenders of last resort, even if it is the
Federal Government. Unfortunately, the draft bill is utterly
silent on that critical component. In fact, the Senate
counterpart to this measure strictly forbids government
assistance. So I need you to think with me of whether we are
engaged, at least to some degree, in a futile effort.
And, in concluding, this legislation must be carefully
analyzed to ensure that the constitutional due-process and
property rights are not violated. Although there appears to be
a consensus that the bankruptcy law must be amended to better
accommodate the resolution of large bank holding companies, we
must ensure that fundamental rights and protections are not
adversely affected, even unintentionally.
In the rush to expedite the transfer of a troubled
company's assets, does the bill ensure that the interests of
all affected parties are adequately protected? And I hope you
will respond to that. Does the legislation strike the right
balance between stemming panic contagion and transparency? Are
the legislation's time limits for judicial determinations and
appeals workable?
And so here we are today trying to struggle through these
and other considerations, and we have to continue to realize
that the regulators and the Federal courts play a critical role
in these determinations. And so I invite you to join us in what
is a very, very important hearing.
And Mr. Chairman, I yield back the balance of my time.
Mr. Bachus. Thank you, Ranking Member Conyers.
Without objection, all Members' written statements will be
made a part of the record.
As Ranking Member Johnson said, we have a very
distinguished panel before us, and I will first start by
introducing our witnesses.
Mr. Don Bernstein is partner of Davis Polk, where he heads
the firm's insolvency and restructuring practice. During his
distinguished 35-year career, he has represented nearly every
major financial institution in numerous restructurings, as well
as leading a number of operating firms through bankruptcy,
including Ford, LTV, and Johns Manville.
Mr. Bernstein has spent the last several years working on
resolution plans, commonly referred to as living wills, for
large financial firms, as well as representing financial
institutions on resolution-related issues.
Mr. Bernstein has earned multiple honors for his practice,
including being elected by his peers as chairman of the
National Bankruptcy Conference, the most prestigious
professional organization in the field. Mr. Bernstein received
his A.B. Cum laude from Princeton University and his J.D. From
the University of Chicago Law School.
We welcome you.
Professor Tom Jackson holds faculty positions in the
William E. Simon School of Business Administration and the
Department of Political Science at the University of Rochester,
where he also served as president from 1994 to 2005.
Before he became Rochester's ninth president, Mr. Jackson
was vice president and provost for the University of Virginia,
where he first joined as the dean of Virginia's School of Law.
Previously, he was professor of law at Harvard and served on
the faculty at Stanford University.
He clerked for U.S. District Court Judge Marvin Frankel in
New York from 1975 through 1976 and then for Supreme Court
Justice and later Chief Justice William H. Rehnquist from 1976
to 1977.
Professor Jackson is the author of bankruptcy and
commercial law texts used in law schools across the country.
Recently, he has spent considerable time on the issue of
improving the Bankruptcy Code to facilitate the resolution of
financial institutions, including working with the Hoover
Institute, the Bipartisan Policy Center, and the FDIC on this
issue.
And he received his B.A. From Williams College and his J.D.
From Yale Law School.
So, welcome.
Mr. Stephen Hessler is a partner of the restructuring group
of Kirkland & Ellis. His practice involves representing
debtors, creditors, and investors in complex corporate Chapter
11 cases, out-of-court restructurings, acquisitions, and
related trial and appellate litigation.
He has counseled clients across a broad range of
industries, including energy, gaming, hospitality, and real
estate, telecommunications, financial institutions, and
manufacturing.
Prior to joining Kirkland & Ellis, Mr. Hessler was a law
clerk for Judge Ambro at the United States Court of Appeals for
the Third Circuit, as well as Justice Hepburn at the United
States District Court for the Western District of Kentucky. He
also served on the staff of Senator Spencer Abraham.
In addition to practicing law, Mr. Hessler is a frequent
lecturer and author on a variety of restructuring-related
topics. He currently serves as the chairman of one of the
advisory boards to the American Bankruptcy Institute's
Commission to Study the Reform of Chapter 11. He also teaches a
restructuring class each fall at the University of Pennsylvania
to both law school and Wharton students.
Mr. Hessler recently was selected by Turnarounds and
Workouts as one of their 2013 outstanding young restructuring
lawyers. He received his B.A. And J.D. From the University of
Michigan, where he served as a managing editor of Michigan's
Law Review.
Again, quite impressive.
And particularly for you who teach classes at law schools,
or Wharton students in your case, you better know your subject
if you teach at that level.
Professor Steven Lubben is the holder of the Harvey
Washington Wiley Chair in corporate governance and business
ethics at Seton Hall and is a recognized expert in the field of
corporate finance and governance, corporate restructuring,
financial distress, and debt.
He is the author of a leading corporate finance text and a
contributing author to the Bloomberg Law on Bankruptcy
treatise. He is also a columnist for the New York Times Deal
Book page.
And I read that. I will have to pay more attention to your
articles.
Following graduation from law school, Professor Lubben
clerked for Justice Broderick in the New Hampshire Supreme
Court. He then practiced bankruptcy law in the New York and Los
Angeles offices of Skadden & Arps, where he represented parties
in Chapter 11 cases throughout the country.
Since joining Seton Hall, Professor Lubben has presented
his papers at academic conferences around the world and
frequently provides commentary on Chapter 11 and related issues
for national and international media outlets, including the
Wall Street Journal, the New York Times, the Financial Times,
Reuters, the Associated Press, Bloomberg, and BBC.
Professor Lubben received his B.A. From the University of
California Irvine and his J.D. From Boston University, his LLM
from Harvard Law School and his Ph.D. From the University of
Groningen--is that right?
Mr. Lubben. Yes, close.
Mr. Bachus. He tried to teach me, but I couldn't get it--in
the Netherlands.
Mr. Lubben. My wife can't get it either, so don't worry
about it.
Mr. Bachus. Thank you.
All right. We will start with Mr. Bernstein.
TESTIMONY OF DONALD S. BERNSTEIN, PARTNER,
DAVIS POLK & WARDWELL LLP
Mr. Bernstein. Thank you, Chairman Bachus and Ranking
Member Johnson, as well as Chairman Goodlatte, Ranking Member
Conyers, and the other Members of the Subcommittee. I want to
thank you for inviting me to testify before this Subcommittee
once again about the resolution of systemically important
financial institutions under the Bankruptcy Code.
I am especially pleased to be commenting on the draft,
which I commend the staff on, of the Financial Institution
Bankruptcy Act of 2014 that would add a new Subchapter V to
Chapter 11 of the Bankruptcy Code dealing with insolvencies of
large financial firms.
In light of time constraints, I am going to focus on a few
key issues in my testimony; I am not going to focus on
everything. But I commend the testimony to you.
The first issue is bankruptcy as the first method of
resolution but retaining Title 2 of Dodd-Frank, as well. As
others have mentioned, Title 2 can only be invoked if
resolution in bankruptcy can't be effectively accomplished. And
I think this is as it should be.
Bankruptcy is a transparent process. It is driven by the
rule of law. But Title 2 should remain as a backup resolution
tool. It is important to have that available. And we don't know
whether we will ever need to use it, and, hopefully, if this
bill is passed, it will make it far less likely that we will
need to use Title 2.
When I was before the Subcommittee in December, I did
recommend that the Bankruptcy Code be amended to add tools to
facilitate what I called at the time whole-firm
recapitalizations, similar to the single-point-of-entry
resolution strategy advocated by the FDIC.
I think it is increasingly recognized, not only in the
United States but in other parts of the world, that whole-firm
recapitalization is the best way of resolving large financial
institutions in a manner that minimizes losses, minimizes
systemic disruption, and prevents taxpayer bailouts.
This is because recapitalization preserves the going-
concern value of a financial firm by avoiding what I will call
a short-stop liquidation of the kind that we had in Lehman
Brothers. It maintains the continuity of the firm's operations
that may be critical to the financial system. Examples are
custody, clearance, settlement of transactions. All of these
things run through our financial institutions, and if they get
disrupted or stopped, it could be very systemically damaging.
And, most importantly, the recapitalization imposes the
firm's losses on private-sector creditors rather than on
taxpayers. This is a highly important point because, by
removing an implicit government backstop of financial firms, it
incentivizes private-sector creditors to appropriately price
risks and, most importantly, to engage in more effective
monitoring of these firms.
And I would point out--and Representative Conyers made the
point about making sure that financial firms are not taking
undue risks--the creditors should actually be monitoring that.
And having an incentive for them to do it, by making it clear
that they are going to absorb the losses, is extremely
important.
Professor Jackson and I describe in our testimony that
single-point-of-entry recapitalization is facilitated by the
bank holding company structure that we have in the United
States. In other countries, they don't necessarily have holding
companies.
What a holding company does is it creates a class of
structurally subordinated debt at the holding company which can
be used to be bailed in, or recapitalized, by being left behind
in our system in a bankruptcy or a receivership. And the
process is described in all of the witness statements, so I am
not going to belabor it, but it facilitates a recapitalization
solution to have this holding-company structure.
The bill we are looking at today embraces the idea of
whole-firm recapitalization. It includes many of the tools that
I discussed in December, and I think the bill's overall
approach is the right one. And its passage, with some minor
modifications, would be a substantial step forward in helping
to assure that taxpayer-funded bailouts never happen again.
I want to focus on three particular points in the
legislation, and you will see why I think they are important.
The first one is the definition of ``capital structure debt.''
That is the debt that gets left behind when you recapitalize
the firm. I noted in my written testimony that the bill's
expansion of the definition of ``capital structure debt'' to
include all unsecured debts of the holding company and to omit
the words ``debts for borrowed money'' reduces the clarity that
the market has over how the recapitalization is going to occur.
The Federal Reserve has announced that they plan to require
companies to have substantial amounts of capital structure
debt, and the discussion has been about long-term debt, which
is not, for example, held by mutual funds or money market
funds. And I actually favor the definition that is in the
Senate version of the bill because it focuses on long-term
debts with maturities of longer than a year and debt for
borrowed money, and there are two reasons for this. First of
all, I think it really corresponds to the expectation of what
the Federal Reserve is likely to put out, and it is going to
make it clear to creditors which class of debt is going to be
the debt that ends up being used to recapitalize the firm.
One of the criticisms that has been leveled against Title
II is that the statute doesn't make it sufficiently clear which
category of debt is going to be the debt that is going to be
bailed in and how that decision is going to be made.
Second, as I mentioned, those debts with maturities of less
than a year are held in various places where they could become
systemically significant. And if capital structure debt is
defined to include those potentially systemically significant
debts, it could require that a provision be included in the
bill to give regulators the discretion to exclude certain
capital structure obligations for favored treatment so that if
there is a systemic risk associated with some of the capital
structure debt, it would be assumed by the bridge company
rather than left behind.
The National Bankruptcy Conference recommended this
particular solution in its letter to the Subcommittee of
January 29. The NBC was concerned that a bright-line test might
create activities to avoid the test. But as noted in the
written testimony, with the Federal Reserve actually
promulgating a requirement that this debt be in place, I think
the risk of avoidance goes away because the financial
institutions will actually have to maintain the debt on their
balance sheets. So this debt will be there if it is needed.
The second topic I want to discuss is the topic of the
special trustee. The special trustee provision in this bill, in
my view, is important and should be retained. Its use is not
mandatory, but it does have an important purpose. From the
point of view of the market, and from the point of view of
foreign regulators, it is highly important that the new bridge
company be returned to a state of normalcy as soon as possible.
This will enhance the likelihood of quickly regaining access to
private-sector liquidity and reduce the risk of ring fencing by
local regulators.
To accomplish these goals, it may be highly desirable that
the recapitalized firm be perceived as healthy enough to longer
be subject to the bankruptcy process. The provisions of section
1186 of the bill permit the court to transfer the bridge
company to a special hand-picked trustee, and it gives the
court the necessary authority to accomplish this if it is in
the best interests of the estate and is going to preserve the
value of the asset.
The last point I want to mention is the question of how the
proceedings get commenced. I think it is very appropriate for
the Federal Reserve to be given the right to file an
involuntary case against a SIFI if a board of directors has not
voluntarily done so in the appropriate circumstances; however,
I think it is a failure if the Federal Reserve actually has do
that. A dispute over commencement of the case could seriously
impair the effectiveness of resolution proceedings.
With this in mind, I think the bill should do what it can
to encourage voluntary petitions in Subchapter V cases where
the firm is in financial distress. And I have suggested that
the bill adopt an approach similar to the one taken in Title II
of Dodd-Frank, where the simple act of filing or consenting to
a case under Subchapter V should not cause liability for the
board. Boards will remain accountable for their prebankruptcy
actions, but they shouldn't feel at risk for the simple act of
invoking Subchapter V.
In my written testimony I have made a number of other
technical comments both about the safe harbor provisions as
well as the provisions relating to avoidance actions. I
generally support these provisions. I think they are critical
to accomplishing the goal of Subchapter V. However, I think
some of the technical tweaks I suggest are merely cross-
reference errors in some cases, but they should be fixed so
that the provisions work as intended. I welcome the opportunity
to discuss these technical points directly with the staff, and
would also like the opportunity to study the bill further and
provide additional technical comments if I have any.
Once again, I am extremely grateful for the opportunity to
present my views. I believe this bill is a very important step
forward, and I thank the Committee for considering this
legislation. I would, of course, be pleased to answer any
questions about my written statement or my oral testimony.
Thank you.
[The prepared statement of Mr. Bernstein follows:]
__________
Mr. Bachus. Thank you.
What we are going to do at this point, we have 2 minutes,
50 seconds plus whatever time they give us to get to the floor.
The opening statements, you know, instead of 5-minute opening
statements on this, I would prefer to have, if you need 10 or
12 minutes, you have it, and that way we will--because we very
much want your comments, and we are not just simply going
through the motions.
So we will recess until the votes are through on the floor.
The Committee staff can keep you appraised of that and give you
a pretty good idea about when we will be returning. How many
votes on the floor? Just two votes. So we should be back
probably in 15, 20 minutes. We will resume. And then I think
taking your testimony as opposed to asking questions is
probably going to be the best way to do this.
We are in recess at this time. Thank you.
[Recess.]
Mr. Farenthold [presiding]. The Committee will come to
order. Chairman Bachus asked me to get started in his absence.
He is on the floor with an amendment to the appropriations
bill. He will return shortly, and I will return the gavel to
him. But in the interests of getting everybody home in time to
see their families tonight, we will recognize Mr. Jackson for
the customary 5 minutes.
TESTIMONY OF THOMAS H. JACKSON, PROFESSOR, WILLIAM E. SIMON
SCHOOL OF BUSINESS, UNIVERSITY OF ROCHESTER
Mr. Jackson. Thank you.
Chairman Bachus, Ranking Member Johnson, Representative
Farenthold, also Chairman Goodlatte and Ranking Member Conyers,
this is my second time testifying before you this year on a
subject near and dear to my heart, which is bankruptcy law,
specifically the role bankruptcy law can and should play in the
best possible resolution of a troubled financial institution,
and how the bill under consideration, the Financial Institution
Bankruptcy Act of 2014, is a solid starting point permitting
that to happen, thus fulfilling the vision of the Dodd-Frank
Act and the FDIC that bankruptcy should be the primary
resolution mechanism, which it cannot be, I believe, in its
current form.
It is clear from this bill that much has occurred since my
March testimony, and I am grateful particularly to the staff
for that.
First, what do I mean by the best possible resolution of a
troubled financial institution? I mean a resolution process
that meets three important tests: First, one that both
minimizes losses and places them on appropriate pre-identified
parties; second, one that minimizes systemic consequences;
third, one that does not result in a government bailout. And I
might add, for me, a fourth: One that is predictable in the
sense of conforming to the rule of law in its myriad decisions.
At the time of the 2008 financial crisis, everyone seemed
to acknowledge that bankruptcy law should play a major role,
but there were also a general lack of confidence that it was up
to the task. The resulting Dodd-Frank Act, while placing
bankruptcy at the core of a resolution regime, also found it
necessary to create an administrative backstop to it. And let
me spend a minute on that, because it demonstrates, I think,
the clear need for amendments to the Bankruptcy Code along the
lines of the Financial Institution Bankruptcy Act of 2014.
The primary role bankruptcy law is expected to play, even
under the Dodd-Frank Act, is reflected first in the requirement
of resolution plans, the so-called living wills, under Title I
of that act. These plans are specifically to be focused on and
tested against bankruptcy. Thus, a resolution plan must be
resubmitted if it, quote, ``is not credible or would not
facilitate an orderly resolution of the company under the
Bankruptcy Code.'' And the firm must ultimately be reshaped so
that its resolution plan will, quote, ``facilitate an orderly
resolution of such company under the Bankruptcy Code.''
It is also reflected in the statutory requirements for
implementing an administrative resolution proceeding, the
orderly liquidation authority under Title II. Such a resolution
proceeding cannot be commenced without a determination that the
use of bankruptcy law would have a serious adverse effect on
U.S. financial stability. It is widely acknowledged, I think,
that bankruptcy law is or should be the preferred resolution
mechanism. To quote from the FDIC when it released its single
point of entry strategy paper in December, quote, ``The statute
makes clear that bankruptcy is the preferred resolution
framework in the event of the failure of a SIFI.''
But there is a disconnect between those premises and
today's Bankruptcy Code. There is an emerging consensus that
the best resolution system, one that meets the standards I
indicated above, involves, A, loss-bearing capacity known in
advance that, B, can be jettisoned in a rapid recapitalization
of a financial institution. In the U.S., this system is
represented by the FDIC's single point of entry proposal for
the recapitalization via a bridge company of a SIFI holding
company under Title II of the Dodd-Frank Act. Compared to this
administrative resolution proposal, the current Bankruptcy Code
is clearly found wanting.
The essence of this kind of recapitalization is, first,
leaving behind equity and the loss-bearing debt--presumably
long-term unsecured debt that has been required by the
regulators, the Federal Reserve Board, to bear the loss; and,
second, transferring everything else--assets, liabilities,
rights and subsidiaries--to a bridge company that, because of
the stripping off of the loss-bearing debt, is presumably both
solvent and in a position to deal with the needs of its
subsidiaries. And this must be done with great speed so as to
restore market confidence without a contagion-producing run.
Yet because of the exemption of qualified financial contracts
from most of bankruptcy's provisions, including the automatic
stay, and because of the lack of clear statutory language
permitting the assignment of liabilities or the override of
cross-default or change-of-control provisions, the current
Bankruptcy Code cannot provide the necessary assurance of a
rapid recapitalization. This will lead, in my view, either to
ineffective resolution plans and/or the reality that the
orderly liquidation authority under Title II will, contrary to
the starting premises, become the default resolution mechanism.
The bill you are considering, the Financial Institution
Bankruptcy Act of 2014, by adding a new Subchapter V to Chapter
11 of the Bankruptcy Code, and by paying attention to these
concepts, neatly provides the necessary amendments to permit a
rapid recapitalization that will, first, leave losses on
previously identified parties, equity and long-term debt
holders; and second, rapidly recapitalize the parent
institution in a way that will make clear that it is solvent,
its business has been kept together, and it is able to deal
with the subsidiaries so as to restore market confidence and
reduce contagion.
What is required? In addition to the specific loss-
absorbency capacity known in advance that, as Don Bernstein
indicated, the Federal Reserve Board is working on and is
really a necessary ingredient in all of this, it requires
explicit statutory authorization for a rapid transfer of the
holding company's assets, liabilities, rights, and
subsidiaries, minus the loss-absorbing debt and equity to a
bridge institution, and that it would have stays and overrides
of certain provisions to enable that to happen.
The bill you are considering does all of this and as well
provides an important role in the process for the Federal
Reserve Board and the FDIC in a proceeding run before
preidentified bankruptcy judges, with appeals going to a
predesignated appellate panel consisting of court of appeals
judges.
While the details are many--and I am happy to get into them
with staff in further discussions, and my written statement to
some extent does this--and, yes, I think the Financial
Institution Bankruptcy Act of 2014 is, as a result, necessarily
somewhat complex at points, the concept is simple. Through what
ends up being modest amendments to the Bankruptcy Code which
would be effectuated by this bill, it indeed can be considered
the primary resolution vehicle for SIFIs as envisioned by the
Dodd-Frank Act. And because it is a judicial proceeding, it
places primacy on the rule of law, on market-based solutions
rather than agency control, and on a process that is fair and
known in advance, indeed planned for via the living wills, the
resolution plans that now can legitimately focus on a viable
bankruptcy solution.
In your deliberations on the Financial Institution
Bankruptcy Act of 2014, I believe some technical changes need
to be made, and there is some other relatively small issues
that I think warrant further consideration. Don Bernstein's
written and oral statements, and I have had time to read his
written statement, contains several, and I concur with them.
I have glanced at the suggestions of the other two
witnesses that you will be hearing from today, and I believe a
number of them probably warrant consideration as well. But
importantly, none of them undermine the basic structure and
importance of the bill before you.
So with that modest caveat that there are things I think
need consideration and work, I want to emphasize what I think
is an incredibly important step by your consideration of the
Financial Institution Bankruptcy Act of 2014.
Again, I want to thank the Subcommittee for allowing me
this opportunity to present my views, and even moreso for its
wisdom and its consideration of the Financial Institution
Bankruptcy Act of 2014. I would, of course, be delighted to
answer any questions you may have about my testimony.
[The prepared statement of Mr. Jackson follows:]
__________
Mr. Farenthold. Thank you very much, Professor Jackson.
Mr. Hessler, you are up.
TESTIMONY OF STEPHEN E. HESSLER, PARTNER,
KIRKLAND & ELLIS LLP
Mr. Hessler. Good afternoon, Chairman Bachus, Chairman
Goodlatte, Ranking Member Johnson, Ranking Member Conyers, and
Representative Farenthold. Thank you for inviting me to testify
at today's hearing. My name is Steve Hessler, and I am a
partner in the Restructuring Group of Kirkland and Ellis LLP.
My practice primarily involves representing debtors, and my
recent engagements include some of the largest and most complex
corporate reorganizations in history.
I have also written at length about Title II of the Dodd-
Frank Act, and I have specifically advocated that adopting
relatively discrete amendments to Chapter 11 would better
facilitate the orderly reorganization of systemically important
financial institutions. To that end, I am pleased that
Subchapter V incorporates many of the prescriptive alternatives
that I have long favored.
The written materials that I have submitted include a
lengthy comparative analysis of the various insolvency
resolution frameworks at issue, but in my testimony this
afternoon, I will focus on the most significant reasons that I
believe, as a debtor practitioner, Subchapter V is the best-
designed option so far, both structurally and philosophically,
to maximize estate value for the benefit of stakeholders, while
also protecting against the broader economic contagion that
could result from the unmitigated failure of a financial
corporation.
First, perhaps the signal benefit of Subchapter V is that a
financial corporation case will be administered by a
predetermined panel of experienced bankruptcy court judges
within the established practice and precedent of the Bankruptcy
Code instead of politically sensitive regulators within an
untested nonjudicial process.
Second, Subchapter V amends the Bankruptcy Code to allow
the Federal Government to file an involuntary petition and to
commence a Chapter 11 case without the debtor financial
corporation's consent. To echo the remarks of Mr. Bernstein,
given that regulators already have various methods of
essentially forcing a financial company to commence a voluntary
case under the Code, making this ability explicit and subject
to bankruptcy court approval hopefully will help further
incentivize financial corporations to confront their problems
early on and to diligently pursue responsible restructuring
options.
Third, the Bankruptcy Code does presently provide that
counterparties to qualified financial contracts are not subject
to section 362's automatic stay against termination. This means
a Chapter 11 filing by a financial corporation could be marked
by chaos at the outset as counterparties proceed to terminate
and enforce their rights in the debtor's assets. Subchapter V
addresses this issue by subjecting qualified financial
contracts to the automatic stay, but only for 48 hours.
Although I have concerns that this time period may be too short
to be viable, Subchapter V, unlike Title II, at least provides
for debtor involvement and bankruptcy court approval of the
contract assumption determinations.
Fourth, beyond Subchapter V's key amendments, I also want
to focus on what I think is quite notable, which is the core
provisions of Chapter 11 that Subchapter V does not modify, and
I want to cite three key examples. The first is that the
Bankruptcy Code requires debtors to adhere to the so-called
absolute priority rule, which generally provides that creditors
with similar legal rights must receive the same treatment, and
that junior creditors may not receive any recovery until senior
creditors are paid in full. Unlike Title II, which provides
that similarly situated creditors may receive dissimilar
treatment, Subchapter V does not disturb the primacy of the
absolute priority rule, which is one of the most fundamental
principles of Chapter 11, and is critical to ensuring the fair
and equitable treatment of creditors of financial corporations.
Next, Subchapter V also does not amend a debtor's exclusive
right to file a reorganization plan under section 1121. This
means that the Federal Reserve and the FDIC, like all other
parties in interest, would have standing to file a motion to
terminate exclusivity for cause, but the government
appropriately must first obtain bankruptcy court permission
before abrogating a debtor's prerogatives on these fundamental
restructuring decisions.
Thirdly, regarding directors and officers, in my experience
their knowledge, expertise, and commitment is indispensable to
effectuating a debtor's soft landing into and orderly passage
through Chapter 11. In this regard, Subchapter V exercises, I
believe, admirable restraint in not vilifying, much less
disqualifying, a financial corporation's existing leadership
from continuing to serve the debtor in possession postpetition,
subject, of course, to already applicable Bankruptcy Code
grounds for removal as justified.
Lastly, while I am very supportive of Subchapter V, I do
want to note for the record there are certain provisions about
which I have reservations, most significantly regarding the
single point of entry approach that is central to Subchapter V.
While the immediate separation and transfer of good bank assets
in certain respects does mirror the so-called melting ice cube
very fast section 363 asset sales that already are occurring
under Chapter 11, Subchapter V codifies and accelerates these
practices. That said, Subchapter V does also employ a number of
safeguards on this front, including, critically, bankruptcy
court approval under existing section 363 of the debtor's
proposed transfer and plan distribution of trust assets.
I also believe there are certain issues around the
procedures for commencing a Subchapter V case, especially in
the highly compressed initial ruling deadlines, the record-
sealing requirements, and limited judicial review. These
provisions depart from standard bankruptcy principles of due
process and transparency. So my preliminary reaction is to
favor greater flexibility and openness. Here as well, however,
I am very aware that the drafters of Subchapter V are striving
very hard to balance those imperatives against the widely held
views that the good assets of a financial corporation cannot
withstand the prolonged public scrutiny of a typical Chapter 11
filing. To that end, I look forward to further careful
consideration and further discussions with the Subcommittee
staff on these key issues.
I thank the Subcommittee for allowing me to share my views
on this important legislation, and I welcome the opportunity to
answer any questions about my testimony.
[The prepared statement of Mr. Hessler follows:]
__________
Mr. Farenthold. Thank you very much.
We will now go to Professor Lubben.
TESTIMONY OF STEPHEN J. LUBBEN, PROFESSOR,
SETON HALL UNIVERSITY SCHOOL OF LAW
Mr. Lubben. Thank you very much.
Mr. Farenthold. Could you make sure your microphone is on
and close to your mouth, please, sir?
Mr. Lubben. Thank you very much, Chair Bachus,
distinguished Members of the Subcommittee. My name is Steven J.
Lubben. I hold the Harvey Washington Wiley Chair in Corporate
Governance and Business Ethics at Seton Hall University School
of Law in Newark, New Jersey.
When considering financial institution failure, to my mind
context is key. The context in which the failure happens is
key. You need a range of options to address the failure of a
financial institution, ranging from current Chapter 11
practices to the orderly liquidation authority. And I commend
the proposed Subchapter V as a new addition to the regulatory
toolbox. And accordingly, it applies the approach that was
successfully used in the automotive bankruptcy cases to the
case of financial institutions, and thus gives the regulators
and financial institutions another approach to deal with
possible failure.
I also commend the bill for utilizing the experienced
bankruptcy judges to conduct the proceedings. One of the key
benefits of the American approach to corporate reorganization
is the use of specialized knowledgeable bankruptcy judges, and
I do, again, commend the bill for utilizing those judges for
resolving financial institutions.
I do believe that the bill could be improved in a few ways,
however, and I will focus on three of those in my comments
today. First of all, unlike some prior witnesses, I have some
doubts about the utility of the special trustee concept. At
heart, I think the special trustee concept confuses the
debtor's ownership of the shares of the bridge company with the
ongoing operations of the bridge company. It is an issue that
could be addressed more straightforwardly and less confusingly.
In particular, I think that the special trustee provisions add
unneeded complexity and uncertainty to Subchapter V, and I
would urge a rethink of those.
Next, I would urge the Subcommittee to give further thought
to the fate of the debtor after the sale of the assets to the
bridge company. Understandably, the bill focuses primarily on
the successful movement of the debtor's assets, which is
primarily going to be the equity and the operating subs, to the
bridge company, but it doesn't really address the question of
what happens next. This may seem a bit overly technical, but
the debtor's creditors may rightly argue that leaving them to
recover claims in an unfunded liquidation proceeding of the
remaining debtor amounts to appropriation of their claims.
Presumably that makes the investment decision to invest in bank
holding company debt somewhat difficult, which we probably
don't want to do.
At the very least, I think we need a mechanism to convert
the case from Subchapter V to a liquidation under Chapter 7,
but, as my comments suggest, the Subcommittee may want to
consider, if conversion is not the likely outcome in many
cases, if there is no mechanism for reorganizing the debtor or
even coming to a liquidation plan.
Specifically, we need to think about ways to fund the case
after the transfer of the asset has happened, and precisely
what is going to happen, and what role regulators will play in
that new case.
Third, I suggest the Subcommittee should consider what will
happen if a Subchapter V proceeding fails. In other words, if
you do transfer the assets to the new bridge institution, and
the institution continues to experience a run, what is going to
happen at that point? Can the bridge company itself be put into
a Dodd-Frank orderly liquidation authority proceeding? At the
very least, you may want to make it explicit that the bridge
company succeeds to whatever eligibility its former self had.
In addition, does the bankruptcy court have an ability to
convert a Subchapter V proceeding to some other sort of
insolvency proceeding? And does the court have an ability to
coordinate with regulators?
Likewise, does the bankruptcy court have an ability to
block regulatory actions that might undermine a Subchapter V
proceeding. For example, what if a State insurance regulator or
a State banking regulator decides to take action against an
operating subsidiary that undermines the viability of the
Subchapter V process? Does the bankruptcy court have an actual
ability to stay them?
Presumably, if they have such a power, it is not going to
extend to foreign regulators, which I think then highlights the
reality that solving the ``too big to fail'' problem is as much
about the structure of financial institutions as it is about
the specifics of any insolvency process. Insolvency, in other
words, is a very small piece of a much larger regulatory
structure.
Thank you very much.
[The prepared statement of Mr. Lubben follows:]
__________
Mr. Farenthold. Thank you very much.
I appreciate all of your testimonies. And we will begin
with some questions.
I will be the first to admit that I am not the expert in
bankruptcy. I practiced law for a while, took one bankruptcy
class. So just really getting up to speed on this Committee,
and I appreciate you-all's help with that.
With that in mind, I want to step back and start with a
30,000-foot view for those who will be reading this record who
are not as expert as you guys are. I just want to get
everybody's 30,000-foot opinion. Do you agree that the
Bankruptcy Code could be improved to facilitate the resolution
of financial institutions? I think that I got a yes from
everybody's testimony. Does anybody disagree with that
statement?
All right. I think we are good. All our panelists seem to
be nodding their head in the affirmative.
Can you all also generally agree, subject to some of the
revisions that is in your written testimony, that you could
support the Financial Institution Bankruptcy Act? Anybody have
any reservations beyond what is in their testimony?
I think we got all affirmative nods there, too. I like it
when we can get everybody to agree here.
All right. Professor Jackson, let me ask you, do you
believe the enactment of Subchapter V would reduce the
necessity for regulators to initiate Title II resolution
proceedings?
Mr. Jackson. I do. I believe, as Don Bernstein indicated,
Title II should be there as a backstop. The world is an
uncertain place. But I believe that enactment of a bill along
these lines, with some of the amendments people have talked
about, will significantly reduce the need for invocation of
Title II of Dodd-Frank, because, again, in order to invoke it,
you have to find a bankruptcy is wanting. I think this largely
fixes the problems that currently exist that would make
bankruptcy wanting. So the short answer to your question is
yes.
Mr. Farenthold. Anybody else want to weigh in on that? Mr.
Hessler, or Professor Lubben, Mr. Bernstein?
All right. Mr. Hessler, I will ask you, why do you believe
the Federal Reserve should be provided with the authority to
commence involuntary Subchapter V proceedings?
Mr. Hessler. There is two reasons. One is practical; one is
a little more theoretical. First, the practical reason is there
are various regulatory maneuvers that regulators, including the
Fed, could take that would otherwise effectively make it
inevitable that a financial corporation had to file for
bankruptcy in any event.
But from a more important, I think, theoretical
perspective, and it was echoing some remarks of Mr. Bernstein
as well, the fact that there is the explicit ability for an
involuntary to be commenced against a financial corporation
hopefully will incentivize them to, as early as possible, as
they approach the zone of insolvency, to begin to responsibly
explore what would be alternative or viable restructuring
alternatives instead of otherwise turning a blind eye to the
problem for as long as possible, safe in the awareness that
nobody can force them into bankruptcy until things are truly
dire.
Mr. Farenthold. Mr. Bernstein?
Mr. Bernstein. I think there is one additional reason,
which is if the Fed believes that the company, if the firm
needs to be in a resolution procedure, if we didn't have this
provision, its only recourse would be to consult with the FDIC
and Treasury and do a Title II procedure. So this gives them
another option.
Mr. Farenthold. All right. Mr. Hessler, let's talk a little
bit about the importance of retaining existing management for
like newly formed bridge companies or holding companies. The
concern is that if the financial institution got in trouble to
begin with, and we are hanging onto some of the same
management, you know, there is a potential problem. Does the
Bankruptcy Code provide sufficient methods to remove these bad
managers?
Mr. Hessler. It does. It does. First of all, just some
background context from that. As I said, in my experience the
overwhelming majority of cases, the overwhelming number of
Chapter 11 cases, were not caused by bad actions by management.
They tend to be balance sheet restructurings either having to
do with macroeconomic effects that were unanticipated, or
potentially entirely justifiable business decisions that turned
out to be wrong, but not the type of malfeasance or other type
of actions that would otherwise warrant, as Title II would upon
the invocation of proceedings, simply cleaning the slate and
removing all of the top directors and officers.
So like I said, in my experience that would actually be
disastrous if you did that, because you would have a rudderless
ship going into bankruptcy. And what Title II anticipated was
not just regulatory help, but the employment of various
consultants and third parties to otherwise assist in what is
going to be a very rapid transfer of assets and then
liquidation. It is extremely impractical, in my opinion, that
that could be effected that quickly in a way that doesn't
otherwise cause massive chaos and confusion.
And the last thing I would add to your direct question is
the Bankruptcy Code already provides that creditors or other
parties in interest can seek the appointment of a trustee. And
the trustee has the powers to otherwise relieve the debtors of
directors and officers if, in fact, that is warranted by the
circumstances.
Mr. Farenthold. I see, Professor Jackson, you have got your
hand up. You want to weigh in here?
Mr. Jackson. One other concurring comment with respect to
that. The system assumes that there may be utility to
continuing the management. The management may or may not have
been responsible. In the case of the 2008, it was sort of a
systemic-wide use of the mortgages that everybody did. But the
Bankruptcy Code, whether through the trust or through the
ownership--remember, the ownership of the--the beneficial
owners of this new entity, this bridge company, are the people
left behind, the old long-term debt and equity interests that
are left behind, and the debtor, and like any corporation that
is functioning, they ultimately have the control and ability to
replace both the board and management, and I think that is as
it should be. They may decide to, and they may decide not to,
but they are the right people to be making that decision.
Mr. Farenthold. All right. I see my time is up.
We will now recognize the Ranking Member of the
Subcommittee, the gentleman from Georgia.
Mr. Johnson. Thank you.
Well, let's suppose that a Federal Government backstop as a
creditor of last resort is a mechanism in place should this
legislation be signed into law, passed and signed into law. And
let's assume that the Federal Government then uses taxpayer
money to assist or bridge the chasm between when the bankruptcy
is filed to a more stable period, thus avoiding a catastrophic
meltdown. Let's say that that is in place.
Does this legislation insulate the bad actors, namely those
who control a large unaccountable business, that brought the
business to that point? Does this legislation insulate that
kind of malfeasance, which could border upon willful behavior
that could even implicate some criminal law violations? But
does this legislation insulate those types of bad actors and
shield them from accountability?
Mr. Bernstein. Representative Johnson, I don't think it
shields anyone from liability. And, in fact, remember that if
this bank is going to be continuing in business, it still is a
regulated entity. So whatever actions need to be taken with
respect to any sort of malfeasance of the kind that you are
talking about are still available.
Mr. Hessler. Just to add to that, to echo Mr. Bernstein,
the legislation in no way places any limitations on the ability
to otherwise address those issues.
The other thing I would just note, the Federal Government,
both the legislators as well as regulators, are entirely
understandably and entirely justifiably focused on remedial
actions for fraud, mismanagement, and things like that that
would occur.
The one thing I would just, you know, highlight or
reiterate is nobody is more motivated to address those issues
than creditors, because they are the ones who are even more
directly impacted. So there is already an enormous amount of
incentivization and investigatory powers that creditors have to
make sure that, to the extent those circumstances exist, that
they are remedied. And creditors do not hesitate to go and seek
the appointment of a trustee and the removal of management and
directors and officers if, in fact, there is any credible
evidence of the type of malfeasance or even criminal actions
that you just mentioned.
Mr. Lubben. If I could add, Representative Johnson, I did
want to say----
Mr. Farenthold. Get a little closer to the microphone.
Mr. Lubben. Okay. I did want to say that I do think that if
the circumstances arise that you indicate, where the Federal
Government is providing funding to a failed financial
institution, the Federal Government should have the rights of
any other--that any other DIP lender would have in that
circumstance. And therefore, I do have some concerns with the
special trustee provisions in this bill, that they complicate
the ability for the Federal Government, for example, to demand
an equity stake in the bridge entity. If taxpayer money is at
risk in the reorganization of a financial institution, the
taxpayers, to my mind, should have some stake in the upside of
that financial institution, too.
Mr. Johnson. Professor Jackson?
Mr. Jackson. I basically concur with the statements that
have already been made. The only place there would be any
insulation at all, as Don Bernstein suggested, you might
insulate the trustee, the directors of the company for the
filing of the bankruptcy case itself, which I think is a wise
thing. But other than that, they are subject to regulatory
authority, they are subject to rule of law, they are subject to
criminal prosecution. And I think importantly to note, they are
subject to the debtor, which is going to have the long-term
debt holders, and they would have an incentive not only to
remove the management that they think may have done something,
but actually seek funds from them, because that may be some of
the funding that they could get in terms of their own
reorganization of the debtor or whatever, liquidation of the
debtor. So I think there is lots of incentives here not to let
bad actors get away with it.
Mr. Johnson. To date are any of you aware of anyone who has
been prosecuted for their role in causing the great recession?
It looks like there is no--none of our witnesses can speak on
that, so I assume that that means nobody knows of anyone who
has been prosecuted. I will refrain from asking whether or not
you think that there is anyone who should be prosecuted, but I
will ask this question: Will this legislation work without a
Federal Government----
Mr. Bachus [presiding]. Would they be under immunity if
they did offer that somebody ought to be prosecuted?
Mr. Johnson. They probably have some legislative immunity
since they are testifying, but we won't put them in that spot.
But would this legislation work without a Federal
Government backstop as a creditor of last resort?
Mr. Lubben. The legislation will work. It would obviously
work, I think, much better with the Federal Government
providing liquidity, because in the context of a financial
crisis, you probably cannot depend on the free market, the
private market providing the degree of liquidity a large
financial institution is going to require.
Mr. Johnson. Mr. Hessler, would you disagree with that?
Mr. Hessler. I would not disagree with that.
Mr. Johnson. Professor Jackson?
Mr. Jackson. No. And I actually have a pragmatic concern
that since the orderly liquidation fund is available under
Title II of Dodd-Frank, if something comparable to that is not
available to the bridge company in a bankruptcy proceeding,
there may still be powerful reasons to use Title II of Dodd-
Frank to access the orderly liquidation fund, where I would
rather have the bankruptcy proceeding take precedence.
Mr. Johnson. Thank you.
Mr. Bernstein. I agree with everything the others have
said.
Mr. Johnson. All right. Thank you. With that, I will yield
back.
Mr. Bachus. Thank you.
Let me start off saying lender of last resort, or whether
that is the government or someone else, we think that is maybe
something for the Financial Services Committee to address, and
we have tried to structure this text to avoid going there. But
it is something that is worthy of consideration. I do
understand that.
And I will start with Mr. Bernstein. The Financial
Institution Bankruptcy Act deploys a very quick process where
assets are transferred in a time frame that can be as short as
24 hours. Do you believe this expediency is necessary, or can a
financial institution endure a longer bankruptcy process?
Mr. Bernstein. Mr. Chairman, I do believe it is necessary.
I will make a reference to the movie ``It's a Wonderful Life''
with Jimmy Stewart. You remember what happened at the building
and loan when there was a run on the bank, and he was able to
get everybody in the room and say, you are a depositor, but
don't take your money out because your money is in your
neighbor's house.
Well, that is what banks do. They are in the business of
maturity transformation, and they can't liquify their assets in
the face of a run. And if you end up having a prolonged
bankruptcy proceeding, and they aren't fixed very quickly,
which this bill permits you to do because of the
recapitalization it allows, you end up having a run that
becomes unmanageable; whereas if you fix it, and you are able
to go back into the market and get credit, the bank will
stabilize. And that is really the objective here, and you can
only do that if it is fast.
Mr. Bachus. Thank you.
And, Professor Jackson, I might ask you the same question.
Do you have any input on that response?
Mr. Jackson. No. I agree with the response. The comment I
would make is that you need the rapidity for two reasons. One,
you need to restore market credibility, otherwise I think it
will spread to other institutions.
The second reason is you are staying a lot of players in
order to have this happen. You are staying all the qualified
financial contracts. You are staying a lot of things because
you want to keep everything in place for the transfer. And it
seems to me that that itself is a powerful reason to call for
rapid, essentially 48-hour, resolution of this. It would be
nice if it could be longer, but I just don't think it is
practical.
Mr. Bachus. Yeah. I think the text we are using is 48
hours, or 2 days. If the Financial Institution Bankruptcy Act
were enacted today, or in law today, and you had a Lehman-style
insolvency a year from now, say, would the bill improve the
resolution process for that firm, and would the result be
better than the result we had in the Lehman bankruptcy?
Mr. Bernstein. Mr. Chairman, I think the bill, plus some of
the other things that have been going on, would make it a lot
better. First of all, financial firms are a lot better
capitalized today than they were when Lehman Brothers failed.
In addition, the Federal Reserve is going to impose a long-term
debt requirement, which is going to create loss-absorbing debt
at the holding company level. And once you have got those two
things, you then have a situation where this legislation could
really make a difference and permit a company to actually be
resolved very efficiently.
Mr. Bachus. Professor Jackson?
Mr. Jackson. One other thing to add to that. And I actually
think Lehman Brothers was--Harvey Miller's work for them was
magical under the circumstances. Remember, they had done no
prebankruptcy planning whatsoever. The board had not even
considered it. One of the great features of Title I of Dodd-
Frank is the resolution plan living wills that are focused on
bankruptcy so that you are not going to have a situation again
in which a company like Lehman Brothers needs to enter
bankruptcy, not having a clue what it is going to do once it is
in bankruptcy. So I think the living wills are also an
important part of the background here.
Mr. Bachus. Right. And at this time I am going to interrupt
my questioning and let the former Chairman of the full
Committee Mr. Conyers start his questions.
Mr. Conyers. Thank you for your generosity, Chairman
Bachus.
I merely wanted to raise this aspect in the granting of
Subchapter V relief in terms of the very short windows of time
for these decisions to be made. On page 6 it is 12 hours; on
page 7 it is 14 hours; page 8 it is 14 hours. And I am just
wondering can we be assured that the judicial role is
meaningful when you have to be looking at your watch at the
same time that you are making humongous kinds of
decisionmaking? Could you talk with me about that for a little
while, gentlemen?
Mr. Jackson. I will take a stab at it. It is a difficult
question. Obviously, all of us would like a judicial process to
have more time, but it is offset by some need for speed.
A couple of just sort of background comments. Yes, I don't
think there is time for a whole lot of consideration, but it
does bring in the important regulators, the Federal Reserve
Board and the FDIC, whose perspective--if their perspective is
contrary to that of the debtor, for example, who files, I think
that will be a very interesting hearing before the bankruptcy
judge. The bankruptcy judge does not have to approve the
transfer.
But the second point I would make is once you have filed,
it is almost a self-fulfilling prophecy that you need to
resolve this firm. This firm is not going to easily get out of
bankruptcy on its own because of the market signal it sent by
being in bankruptcy. So once the case is commenced, I am not
sure there is a whole lot of people who are harmed by the speed
in which this happens as long as you have well-established,
preidentified parties who get left behind. Everybody else goes
with the company and presumably will not be harmed. And the
equity and the whatever the debt, the long-term debt, whatever,
the capital structure debt, are people who know ahead of time
that they are going to be left behind, they know their
priority, and it seems to me under those circumstances their
ex-post remedies are probably the best we can do under these
circumstances.
Mr. Conyers. Any other comments on this?
Mr. Hessler. I would tend to agree with that. And I
addressed in both my written testimony, as well as I spoke of
today, that it is highly unusual. And as a debtor practitioner,
I can imagine how chaotic that would be to be dealing with
those time periods.
I would note as a practical matter that I think there is a
high likelihood that if a debtor is on the brink of being told
that an involuntary is going to be commenced against it, that
there is a high likelihood--it would probably go ahead and
commence its own voluntary proceeding so as to continue to
maintain control of its case. And if a debtor itself opted to
commence that voluntary proceeding, these very compressed time
periods for the appeal, they are irrelevant at that point in
time because no one is going to be challenging the debtor's
determination that, given its insolvency, a bankruptcy
proceeding is appropriate under the law.
Mr. Conyers. Yes, sir.
Mr. Bernstein. I agree with what has been said. I also want
to make one other point. We have to look at what the outcome of
the proceeding is. Unlike other cases where you are doing a
section 363 transfer very quickly, this asset is not being
transferred away to a third party, so there is no question of
whether there is an adequate price or not. It makes the
decision much easier for the court because the asset is being
preserved for the benefit of the estate.
So not only with respect to the time periods for an
involuntary filing, and I agree with everything that has been
said about how likely it is, once there is an involuntary
filing, people are not going to be prejudiced because you
really need to be in the proceeding. But more importantly, the
consequence of that is going to be the asset is going to be
protected through the process of moving it to a place where it
is safe and can continue to maintain its value rather than
being transferred away.
Mr. Conyers. My second question was dealing with the
requirement that the pleadings be filed under seal. And I take
it that this would also prevent runs and panic and so forth
from happening.
So I am going to go to my last question, which is by
allowing a failed bank holding company to spin off its
subsidiaries so they can continue to function, does this
present a possible issue of moral hazard? Because they are
going on unimpeded, and they are really in big trouble, but
maybe nobody knows it.
Mr. Bernstein. May I answer that, Representative Conyers?
It is Don Bernstein.
There are two things that are going on here. One is, yes,
the company is continuing in business, but there is a group of
creditors and shareholders who are going to be left behind and
are going to be suffering the losses. And the question of moral
hazard is going to surround making sure that they understand
that prior to any failures so that they do proper monitoring
and risk management, and they know that they are going to
suffer the losses if this happens. So I think there is, you
know, actually some positive impact of this in terms of the
ability of the market to regulate these companies.
Mr. Conyers. Professor?
Mr. Lubben. I might be somewhat more skeptical about the
moral-hazard issue. I think the moral-hazard issue might still
well prevail. But I think that goes back to my comment in my
opening remarks, that the insolvency process has to be a small
piece of a much larger regulatory approach. And probably moral
hazard is not best addressed through the insolvency process; it
is best addressed through the financial institution regulators
more directly.
Mr. Conyers. Mr. Chairman, that concludes my questions, and
I thank you for your generosity.
And I thank the witnesses. This has been a very, very
special panel, as far as I am concerned.
Mr. Bachus. Thank you, Mr. Conyers. As you know, I have the
greatest respect for you over the last 22 years, and you served
as my Chairman when I first arrived here on the Hill. So thank
you.
Mr. Conyers. Thank you.
Mr. Bachus. I am going to ask some questions.
We were talking about Lehman Brothers, and, of course,
Lehman Brothers, because of Bear Stearns, I think most people
expected Lehman to receive a government assistance. And I think
there was a reliance by Lehman, to a certain extent, that that
was coming, and it never came.
But it did serve a benefit, in that I think it highlighted
some needed changes in the Bankruptcy Code if you were going to
choose that as opposed to a government-assisted resolution. So
I think we may have benefited from that. Certainly, the Lehman
shareholders did.
I am going to ask Professor Jackson, can Subchapter V be
used to resolve financial institutions that have international
operations and subsidiaries? And I think Mr. Conyers sort of
mentioned that.
Mr. Jackson. Yes, it can, but, obviously, a limitation of
any U.S. Law, whether it be bankruptcy law or whether it be
Title 2 of Dodd-Frank, is that it cannot directly impact
foreign operations that are incorporated in other countries. It
can set out a template, and it can give confidence to the
foreign regulators that the rule of law will be followed, but I
think that what you need in addition--and I think it is taking
place--is international conversations and coordinations around
this issue.
I think it is hugely helpful that the European Union and
the FDIC have agreed that single-point-of-entry-like
proceedings are the appropriate way to go. I have a lot of
confidence that they will work on these issues of cross-country
collaborations, which I don't think we can solve on our own.
I would just make the point that whatever the problems
exist for bankruptcy law, they are going to exist for Title 2
of Dodd-Frank, as well. The one difference is maybe foreign
regulators would prefer seeing a regulator do this than a
bankruptcy judge do this, but I think a lot of that depends on
the FDIC's confidence in the bankruptcy process. And if they
give their imprimatur to the process, then I think there will
be very little distinction between whether it is Title 2 of
Dodd-Frank or section 5 of Chapter 11 under this proposed bill.
Mr. Bachus. Right.
And I guess the fact that it is only the top holding
company that files the bankruptcy, it does maybe lessen some of
those complications.
Mr. Jackson. Somewhat.
Mr. Bachus. But not----
Mr. Jackson. The problem is--and the bill effectively
addresses this, but of course it cannot address it effectively
extraterritorially--is a lot of the contracts that you want to
keep in place at the operating subsidiary levels, like the
qualified financial contracts and others, may have cross-
default provisions, may have change-of-control provisions that
you don't want them to be able to enforce, and so we are still
going to need help from the foreign regulators in keeping those
things in place.
Mr. Bachus. All right.
Mr. Bernstein, do you----
Mr. Bernstein. No, I don't have really anything to add.
There is also work under way to develop contractual solutions
so that if you do go through an appropriate proceeding and, for
example, a bridge company were created that assumed the
guarantee and what have you, that the contracts would remain in
place even in foreign countries.
Mr. Bachus. All right.
And any suggestions you all have on whether there ought to
be any statutory language in this bill or in a financial
services bill or companion bill, perhaps?
Professor Jackson, do you believe that enactment of
Subchapter V into law would reduce the necessity for regulators
to initiate a Title 2 resolution proceeding?
Mr. Jackson. Quite clearly, yes.
Mr. Bachus. And, Mr. Hessler, do you agree?
Mr. Hessler. I do agree, as well.
Mr. Bachus. Okay.
I have been told that Mr. Farenthold asked you questions
concerning the Federal Reserve and some other questions, so I
am not going to repeat those.
My final question, for Professor Lubben: In your written
testimony, you indicated that it may be better to keep the
equity of the newly formed bridge company in the possession of
the debtor. Are there any risks associated with this proposed
approach, particularly with the perception of the bridge
company existing in, rather than out of, the bankruptcy
process?
Mr. Lubben. This goes to the question of separating the
management of the bridge company from the ownership of the
equity of the bridge company.
I think there would be ways to make it clear that
management is distinct from share ownership and that it would
still allow the debtor, the old debtor, to access the value of
those shares if they needed to fund their bankruptcy case. And
I think, as I suggested in my written testimony, these may be a
little bit more clear-cut.
So the risk is just not making that distinction clear, but
I think it could be made clear. So I think it is a solvable
problem.
Mr. Bachus. Well, I think there was some mention earlier by
Mr. Bernstein or Professor Jackson, I think, that if you
allowed, you know--that particularly the filing of a bankruptcy
would not lead to any liability on the part of the board of
directors.
Mr. Bernstein. Yeah, we both mentioned that. We think that
is an important feature so that you encourage voluntary, as
opposed to the involuntary, proceedings.
And if I might just comment on the question that Professor
Lubben just discussed, one of the difficulties, which was
mentioned by Professor Jackson, is the lack of understanding by
foreign regulators of the bankruptcy process and moving the
bridge company back into private ownership, albeit a trustee,
but not ownership by the bankrupt holding company, and having
it back in an environment where it is dealing directly with its
primary regulators and the primary regulators are in control,
and those are the people who are talking to the foreign
regulators, may go a long way to stabilizing the new company's
relationship with the regulators so they don't take precipitous
action.
Mr. Bachus. All right.
Mr. Hessler. If I could just add one quick thought on that,
what happens at present under just a conventional Section 363
sale, even one that happens quickly where most of the debtor's
assets are sold, you know, to somebody entirely outside of
bankruptcy, in those circumstances what typically happens is
nearly all of the management and certainly all of the
management that is tied to the operations of the assets that
are being transferred go with the assets. And I expect that
that would happen here once the transfer happens under the
single-point-of-entry approach.
To Professor Lubben's point, also, about potential
disjunction between, you know, sort of, creditor access to the
assets, you know, where the management otherwise lines up, my
instinct is that creditors would be very supportive of
management going over into the bridge company along with the
assets, given that it is their economic interest in the equity
being held in the trust that is ultimately going to come to
them through the plan distribution. So, you know, my instinct
is that creditors actually would be heartened that this
approach contemplates that.
Mr. Bachus. All right. Thank you.
I might ask this. You know, the Senate bill has been
mentioned. They actually have Chapter 14 as opposed to a
Subchapter 11, but is there any--is that a matter of substance,
or is that just----
Mr. Jackson. Not really a matter of substance. I actually
think Subchapter V of Chapter--my Hoover counterparts may not
like me to say this, but I think Subchapter V of Chapter 11 is
the cleaner way to go.
Mr. Bachus. Uh-huh. Thank you.
Mr. Lubben. And I would actually concur on that. And I
think there actually may be a subtle substantive reason to do
it this way--namely, it makes clear that the other parts of
Chapter 11 still apply to----
Mr. Bachus. Yeah. And I think that was our reasoning, that
it is a part of--it is not a separate----
Mr. Bernstein. I agree with that.
Mr. Bachus. Thank you.
Mr. Hessler. As do I.
Mr. Bachus. I was afraid to ask that, but I am glad I did.
But, you know, it obviously is something you want to know. And
I don't think they have any objection to that either.
This concludes today's hearing, and thanks to all our
witnesses for attending. It is always good for you to hear
compliments about your abilities. Witnesses don't always get
that from the panel, but there was unanimous recognition of all
of your qualifications, experience, and abilities. And we
appreciate you giving your valuable time to us. I am glad you
are not billing at your normal hourly rate, for the attorneys.
But, without objection, all Members will have 5 legislative
days to submit additional written questions for witnesses or
additional materials for the record.
This hearing is adjourned. And I thank you for your
patience.
[Whereupon, at 6:06 p.m., the Subcommittee was adjourned.]
A P P E N D I X
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Material Submitted for the Hearing Record
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Note: The Subcommittee did not receive a response to these
questions at the time of the printing of this hearing record.