[House Hearing, 114 Congress]
[From the U.S. Government Publishing Office]
FINANCIAL INSTITUTION BANKRUPTCY ACT
OF 2015
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
REGULATORY REFORM,
COMMERCIAL AND ANTITRUST LAW
OF THE
COMMITTEE ON THE JUDICIARY
HOUSE OF REPRESENTATIVES
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
ON
H.R. 2947
__________
JULY 9, 2015
__________
Serial No. 114-35
__________
Printed for the use of the Committee on the Judiciary
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
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
LAMAR S. SMITH, Texas ZOE LOFGREN, California
STEVE CHABOT, Ohio 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 HAKEEM JEFFRIES, New York
BLAKE FARENTHOLD, Texas DAVID N. CICILLINE, Rhode Island
DOUG COLLINS, Georgia SCOTT PETERS, California
RON DeSANTIS, Florida
MIMI WALTERS, California
KEN BUCK, Colorado
JOHN RATCLIFFE, Texas
DAVE TROTT, Michigan
MIKE BISHOP, Michigan
Shelley Husband, Chief of Staff & General Counsel
Perry Apelbaum, Minority Staff Director & Chief Counsel
------
Subcommittee on Regulatory Reform, Commercial and Antitrust Law
TOM MARINO, Pennsylvania, Chairman
BLAKE FARENTHOLD, Texas, Vice-Chairman
DARRELL E. ISSA, California HENRY C. ``HANK'' JOHNSON, Jr.,
DOUG COLLINS, Georgia Georgia
MIMI WALTERS, California SUZAN DelBENE, Washington
JOHN RATCLIFFE, Texas HAKEEM JEFFRIES, New York
DAVE TROTT, Michigan DAVID N. CICILLINE, Rhode Island
MIKE BISHOP, Michigan SCOTT PETERS, California
Daniel Flores, Chief Counsel
C O N T E N T S
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JULY 9, 2015
Page
THE BILL
H.R. 2947, the ``Financial Institution Bankruptcy Act of 2015''.. 3
OPENING STATEMENTS
The Honorable Tom Marino, a Representative in Congress from the
State of Pennsylvania, 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 38
The Honorable Bob Goodlatte, a Representative in Congress from
the State of Virginia, and Chairman, Committee on the Judiciary 39
The Honorable Dave Trott, a Representative in Congress from the
State of Michigan, and Member, Subcommittee on Regulatory
Reform, Commercial and Antitrust Law........................... 40
The Honorable John Conyers, Jr., a Representative in Congress
from the State of Michigan, and Ranking Member, Committee on
the Judiciary.................................................. 40
WITNESSES
Donald S. Bernstein, Esq., Partner, Davis Polk & Wardwell LLP
Oral Testimony................................................. 43
Prepared Statement............................................. 45
Stephen E. Hessler, Esq., Partner, Kirkland & Ellis LLP
Oral Testimony................................................. 59
Prepared Statement............................................. 61
Richard Levin, Esq., Partner, Jenner & Block LLP
Oral Testimony................................................. 85
Prepared Statement............................................. 87
APPENDIX
Material Submitted for the Hearing Record
Response to Questions for the Record from Donald S. Bernstein,
Esq., Partner, Davis Polk & Wardwell LLP....................... 128
Response to Questions for the Record from Stephen E. Hessler,
Esq., Partner, Kirkland & Ellis LLP............................ 132
Response to Questions for the Record from Richard Levin, Esq.,
Partner, Jenner & Block LLP.................................... 134
FINANCIAL INSTITUTION BANKRUPTCY ACT OF 2015
----------
THURSDAY, JULY 9, 2015
House of Representatives,
Subcommittee on Regulatory Reform,
Commercial and Antitrust Law
Committee on the Judiciary,
Washington, DC.
The Subcommittee met, pursuant to call, at 10:10 a.m., in
room 2141, Rayburn House Office Building, the Honorable Tom
Marino (Chairman of the Subcommittee) presiding.
Present: Representatives Marino, Goodlatte, Farenthold,
Collins, Walters, Ratcliffe, Trott, Bishop, Johnson, Conyers,
and DelBene.
Staff Present: (Majority) Anthony Grossi, Counsel; Andrea
Lindsey, Clerk; and (Minority) Susan Jensen, Counsel.
Mr. Marino. The Subcommittee on Regulatory Reform,
Commercial and Antitrust Law will come to order.
Good morning everyone. I apologize for the delay. We all
have three or four things going on at once, starting at 7 in
the morning. So without objection, the Chair is authorized to
declare recesses of the Committee at any time. We welcome
everyone to today's hearing on H.R. 2947, the ``Financial
Institution Bankruptcy Act of 2015.'' I will now recognize
myself for an opening statement.
Last Congress, the Financial Institution Bankruptcy Act was
reported favorably by this Committee and passed the House under
suspension of the rules. This week, the legislation was
reintroduced, and today, we build on last year's record by
further examining the bill. In the wake of the financial crisis
of 2008, Congress enacted the Dodd-Frank Wall Street Reform and
Consumer Protection Act. That legislation was intended to
address, among other things, the potential failure of large
financial institutions.
While the Dodd-Frank Act created a regulatory process for
such an event, the Act states that the preferred method of
resolution for a financial institution is through the
bankruptcy process. However, the Dodd-Frank Act did not make
any amendments to the bankruptcy code to account for the unique
characteristics of a financial institution. The legislation
before us today fills that void.
The Financial Institution Bankruptcy Act is the product of
years of study by industry, legal, and financial regulatory
experts, as well as bipartisan review over the course of three
separate Subcommittee hearings last Congress. The legislation
includes several provisions that improve the ability of a
financial institution to be resolved through the bankruptcy
process. It allows for a speedy transfer of a financial firm's
assets to a newly formed company. That company would continue
the firm's operations for the benefit of its customers,
employees, and creditors, and ensure the financial stability of
the marketplace.
This quick transfer is overseen by, and subject to the
approval of an experienced bankruptcy judge, and includes due
process protections for parties-in-interest. The bill also
creates an explicit rule in the bankruptcy process for the key
financial regulators. In addition, there are provisions that
facilitate the transfer of derivative and similarly structured
contracts to the newly formed company. This 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
financial institutions. To that end, the bill provides that
specialized bankruptcy and appellate judges will be designated
in advance to preside over these cases.
The bankruptcy process has long been favored as the primary
mechanism for dealing with distressed and failing companies.
This is due to its impartial nature, adherence to established
precedent, judiciary oversight, and grounding in the principles
of due process and the 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.
As an original cosponsor of the bill, I look forward to
hearing from today's expert panel of witnesses on the merits of
the Financial Institution Bankruptcy Act and whether any
further refinements to the bill are necessary. I now recognize
the Ranking Member of the Subcommittee on Regulatory Reform,
Commercial, and Antitrust Law, Mr. Hank Johnson, for his
opening statement. Mr. Johnson.
[The bill, H.R. 2947, follows:]
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
__________
Mr. Johnson. Thank you, Mr. Chairman. H.R. 2947, the
``Financial Institution Bankruptcy Act of 2015,'' amends the
bankruptcy code to establish a process for the expedited
judicial resolution of large financial institutions to soften
the disruptive effects of their collapse.
I trust the courts and am sympathetic to the notion that a
judicial process may be preferable to an administrative process
for resolving systemically important financial institutions
that present a risk to the economic stability of our Nation,
but I'm concerned that the lack of a funding mechanism for H.R.
2947 may make the bill unworkable.
A key difference between an orderly resolution under Dodd-
Frank and the resolution contemplated by this bill concerns the
proper mechanism for funding the reorganization of the debtor.
In a typical bankruptcy case, the debtor's reorganization may
be funded by private parties or by the Federal Government as
illustrated by the General Motors bankruptcy.
In many instances, liquidity provided by the U.S.
Government to prevent the collapse of financial institutions
has either returned a profit to the government or is likely to
be repaid. The National Bankruptcy Conference (NBC), which
includes the Nation's leading bankruptcy scholars and
practitioners, explained in a letter to the Committee in June
that, ``meeting the liquidity needs of a distressed financial
institution is essential to successfully resolving the firm
without creating undue systemic risk.''
This critical mechanism has prevented the collapse of
several major financial institutions without cost to the
taxpayer. It is my understanding that this element does not
currently exist in the bill for jurisdictional reasons.
Nevertheless, I remain optimistic that the Chair will continue
to work across party lines to accommodate these concerns prior
to the bill's consideration on the floor.
In addition to these concerns, I would caution the Chair
against efforts to combine this bill with legislation that
would strike Title II of the Dodd-Frank Act. Such efforts would
be unacceptable and would meet strong opposition. As the
National Bankruptcy Conference further noted, laws currently in
place such as Title II of the Dodd-Frank Act should ``continue
to be available even if the bankruptcy code is amended to
better address the resolution of systemically important
financial institutions'' because ``the ability of U.S.
regulators to assume full control of the resolution process to
elicit the cooperation from non-U.S. regulators is an essential
insurance policy against systemic risk and potential conflict
and dysfunction among the multinational components of these
institutions.''
Title II of the Dodd-Frank Act also serves as a valuable
backstop to the bankruptcy process should this bill become law.
Additionally, as the conference has also noted, it is important
that financial regulators have a very significant role in the
timely resolution of a financial institution regardless of
whether by bankruptcy or orderly liquidation.
As the Conference noted, the ``heavy involvement of U.S.
regulators would be critical if adverse systemic effects from
the failure of the systemically important financial institution
are to be prevented or minimized.''
It would be unwise to overlook the expertise of financial
regulators who are charged with considering the impact of a
resolution on the economy and financial markets in favor of a
process that is intended to produce maximum returns to
creditors while facilitating the debtor's reorganization.
Thank you, Mr. Chairman, and I yield back.
Mr. Marino. Thank you, Mr. Johnson.
The Chair now recognizes the Chairman of the full Judiciary
Committee, Congressman Goodlatte of Virginia for his opening
statement.
Mr. Goodlatte. Thank you, Mr. Chairman. I appreciate your
holding this hearing.
Our Nation's financial system provides the life blood for
industry, small businesses, and our communities 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 threatened the very stability of the global
economy and our financial industry.
There has been considerable debate over whether Congress'
main response to 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 2015,'' 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 risk.
Additionally, it incorporates the ``single point of entry''
approach, which a growing consensus of experts in public and
private industry believes 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
legislation before us today has been a collaborative effort
that included the financial and legal community, Members of
Congress on both sides of the aisle, the Federal Reserve, the
FDIC, the courts, and Treasury.
I applaud Congressman Trott for continuing the efforts of
last Congress to strengthen the bankruptcy code and Chairman
Marino for holding today's hearing on this important reform. I
look forward to hearing from today's witnesses on the Financial
Institution Bankruptcy Act and whether the passage of time has
resulted in the need for any further revisions to the bill.
And at this time it is my pleasure to yield the balance of
my time to the gentleman from Michigan, Mr. Trott, the chief
sponsor of the legislation for any opening remarks that he
might have.
Mr. Trott. Thank you, Chairman. I also want to thank
Chairman Marino and Ranking Member Johnson for holding this
hearing, and also thank our witnesses for again providing their
insight on this bill.
The health of our financial institutions, particularly
large multinational players, is critical to not only our
economy but also our citizens. Consequently, how we react when
a systemically important financial institution fails is of
particular concern.
The Financial Institution Bankruptcy Act of 2015 seeks to
address those concerns and put in place a better process. The
bill amends the bankruptcy code so as to allow the insolvency
of a financial institution to be resolved through the Chapter
11 process. The Chapter 11 process provides rules that are
designed to accomplish an equitable and predictable resolution
of competing claims.
Chapter 11 is a relatively efficient process, and the
integrity and transparency ensured by due process protections
will reduce the risk to our overall economy and reduce the
potential of a taxpayer funded bailout.
As an aside, my hometown is Detroit, Michigan, and I am
here to tell you that the bankruptcy process can add great
value to difficult financial situations that undermine our
economy and our communities.
Thank you again, Chairman. I yield back my time.
Mr. Goodlatte. And I yield back. Thank you, Mr. Chairman.
Mr. Marino. Thank you, Chairman.
The Chair recognizes the full Judiciary Committee Ranking
Member, Congressman Conyers from the State of Michigan for his
opening statement.
Mr. Conyers. Thank you, Mr. Chairman and Members of the
Committee. I join in congratulating my colleague from Michigan,
Mr. Trott, for his authorship of the measure that is before us.
I support it, and I am a cosponsor of it. As a matter of fact,
there are a number of reasons for my support.
Number one, the bill addresses a real need, recognized by
regulatory agencies, bankruptcy experts, and the private sector
that the bankruptcy law must be amended so that it can
expeditiously restore trust in the financial marketplace as
soon as possible after the collapse of a major financial
institution.
Many of us recall the failure of Lehman Brothers in 2008
which caused a worldwide freeze on the availability of credit,
which not only affected Wall Street but Main Street as well.
The near collapse of our Nation's economy because of
Lehman's failure revealed that current bankruptcy law is ill
equipped to deal with complex financial institutions in
economic distress. H.R. 2947 would establish a specialized form
of bankruptcy relief under Chapter 11 of the Bankruptcy Code by
which the holding company of a large financial institution
could voluntarily use or be forced to use by the Federal
Reserve Board, under certain conditions.
The debtor's operating subsidiaries would continue to
operate outside of bankruptcy while the debtor's principal
assets--such as secured property, financial contracts, and the
stock of its subsidiaries--would be transferred to a temporary
bridge company. The bridge company, under the guidance of a
trustee, in turn, would liquidate these assets to pay the
claims of the debtor's creditors.
The legislation would also impose a temporary stay to
prevent parties from exercising their rights in certain
qualified financial contracts. Each critical step of this
process would be under the supervision of a bankruptcy judge
and subject to the right of appeal.
Another reason for my support is that it appropriately
recognizes the important role of the Dodd-Frank Act in the
regulation of large financial institutions. Without doubt, the
Great Recession was a direct result of the regulatory
equivalent of the Wild West. In the absence of any meaningful
regulation of the mortgage industry, lenders developed high
risk subprime mortgages and 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. The ensuing 2008 crash froze credit and
trapped millions of Americans in mortgages they could no longer
afford, causing waves of foreclosures, massive unemployment,
and international economic upheaval.
The Dodd-Frank Act goes a long way toward reinvigorating a
regulatory system that makes the financial marketplace more
accountable and hopefully more resilient. In particular, Title
II of Dodd-Frank establishes a mandatory resolution process to
wind down large financial institutions, which is a critical
enforcement tool for bank regulators to ensure compliance with
the Act's heightened regulatory requirements.
Nevertheless, Dodd-Frank clearly recognizes that bankruptcy
should be a first resort and that Title II's orderly resolution
process should be a last resort. In fact, Title I of the Act
explicitly requires these companies to write so-called living
wills that must explain how they will resolve their financial
difficulties in a hypothetical bankruptcy scenario. This is
because bankruptcy law has, for more than 100 years, enabled
some of the Nation's largest companies to regain their
financial footing, including General Motors and Chrysler
Corporations.
But to be a truly viable alternative to Dodd-Frank's
resolution process, the bankruptcy law must be amended to
facilitate the rapid administration of a debtor's assets in an
orderly fashion that maximizes value and minimizes disruption
to the financial marketplace.
And finally, I am pleased to note that this bill is the
product of a very collaborative, inclusive, and deliberative
process, which I hope would be more regularly employed in this
Congress and not the exception when it comes to drafting
legislation.
While an excellent measure, H.R. 2947 unfortunately does
not include any provision allowing the Federal Government to be
a lender of last resort, which nearly every expert recognizes
is a necessary element to ensure financial stability. I
recognize, however, that this is an issue not within the
Committee's jurisdiction but more within the area of the
jurisdiction of the Financial Services Committee.
I welcome the witnesses, particularly Mr. Levin, and I
thank the witnesses for their participation here today, and I
yield back the balance of my time.
Mr. Marino. Thank you, Congressman Conyers.
Without objection, other Members' opening statements will
be made part of the record. The Chair will begin by swearing in
our witnesses before introducing them. Would you please rise
and raise your right hand.
Do you swear that the testimony you're about to give before
this Committee is the truth, the whole truth, and nothing but
the truth, so help you God?
Let the record reflect that the witnesses have answered in
the affirmative. Thank you. Please be seated.
I will now introduce each of the witnesses before anyone
gives their opening statement. Mr. Don Bernstein is a partner
at 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 Steel, and Johns Manville. Mr. Bernstein has earned
multiple honors for his practice, including being elected by
his peers as the chair 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 JD from the University of Chicago Law
School. Thank you, Mr. Bernstein, for being here
Mr. Stephen Hessler is a partner in 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. In addition to
practicing law, Mr. Hessler is an author and frequent lecturer
on a variety of restructuring related topics, including, as a
professor at the University of Pennsylvania, where he teaches a
restructuring class to both law school and Wharton students.
Mr. Hessler has been recognized by both Chambers and
Turnarounds & Workouts as an outstanding restructuring lawyer.
Mr. Hessler received his BA and JD from the University of
Michigan, where he served as the managing editor of Michigan's
Law Review. Welcome.
Mr. Richard Levin is a partner in the Bankruptcy, Workout
and Corporate Reorganization Practice of Jenner & Block. Mr.
Levin is the current chair of the National Bankruptcy
Conference, a fellow of the American College of Bankruptcy, and
a lecturer of bankruptcy law at the Harvard Law School. In
almost 40 years of practice, Mr. Levin has gained a reputation
as one of the foremost restructuring, bankruptcy and creditor/
debtor rights lawyers. Notably, Mr. Levin served as a
bankruptcy counsel to the House Judiciary Committee and was one
of the principal authors of the 1978 U.S. Bankruptcy Code. Mr.
Levin received his undergraduate degree from MIT and his JD
from Yale Law School where he served as editor of Yale Law
Review. Welcome, Mr. Levin.
Mr. Levin. Thank you, Mr. Chairman.
Mr. Marino. Each of the witnesses' written statements will
be entered into the record in its entirety, and I ask each of
the witnesses to summarize their statements, you've been
through this before, in 5 minutes or less. To help you stay
within your time, you see the lights in front of you, but as I
do, when I'm sitting at that table making a statement, I'm
concentrating on making my statement and not watching the
lights.
So what I will politely and diplomatically do if it gets
too far over the 5 minutes, is I will reach for the gavel and
just sort of raise it to get your attention, and ask you to
succinctly come to a close in your statement.
I'm going to recognize our witnesses for their opening
statement. Mr. Bernstein.
TESTIMONY OF DONALD S. BERNSTEIN, ESQ.,
PARTNER, DAVIS POLK & WARDWELL LLP
Mr. Bernstein. Thank you, Chairman Marino, and thank you,
Chairman Goodlatte, and also Congressman Trott for introducing
and being a sponsor of the bill, as well as Congressman
Conyers. I want to say that you have made my job easy in terms
of meeting the 5-minute requirement because the statements were
so good in terms of summarizing the bill. I'm just going to
skip to my major points
So, just as a little bit of background, this idea of single
point of entry resolution of a financial firm is a result of a
lot of work that's been done at the FDIC and in other contexts,
including under Title II of Dodd-Frank, with the idea that if
you set up financial institutions correctly in the United
States with bank holding companies, you should be able to
recapitalize their operations if the operations have losses
because there is loss absorbency at the holding company level.
And in fact, there are a number of features that are being
added to the way bank holding companies are structured in order
to facilitate resolution under the Bankruptcy Code, which has
been an outgrowth of the resolution planning process under the
Dodd-Frank Act. One of these is a concept that is being adopted
globally, which is called, ``Total Loss Absorbing Capacity.''
That consists of two things. It consists of the capital of
the bank and also a layer of debt that can effectively be
bailed in or converted, in effect, to equity so that no capital
needs to be infused from sources outside the firm, including no
taxpayer funds would have to be infused to create the capital
necessary.
The capital levels of financial institutions since 2008,
especially the largest ones, have essentially doubled from
where they were in 2008, and then if you add a requirement that
is in the process of being developed and is likely to be
imposed by regulators for total loss absorbing capacity, it
will double again in effect and permit the use of bankruptcy
and single point of entry resolution to use that loss absorbing
capacity in order to resolve firms.
Most of the largest financial institutions actually have
that layer of indebtedness already, so we are actually at a
point where the resources are available to recapitalize these
firms.
Secondly, there has been a massive increase in the amount
of liquidity that's being maintained by all the firms.
Congressman Conyers made the point about a liquidity source. I
know the NBC makes that point in their letter and I make it as
well in my testimony, my written testimony, but today, with the
levels of liquidity that the banks are maintaining, they can
resolve themselves in a severely adverse economic scenario
based on the balance sheet liquidity that they are currently
maintaining. So that is--and it's a huge increase from the way
it was in 2008.
The third area that single point of entry requires is a
clean holding company, a holding company that can be left
behind in a bankruptcy proceeding when the operating
subsidiaries have been recapitalized and then get transferred
to a bridge company. And pursuant to regulatory requirements
and also pursuant to the resolution planning process, the firms
are also putting themselves in a place where they are not
having material operations occurring in the holding company
where there is little or no short-term debt in the holding
company, and subsidiaries are not guaranteeing holding company
debts. So that is another aspect of how the companies are
putting themselves in a position to actually utilize the single
point of entry process.
And finally, because the amendments that are in section
1188 of the proposed bill have not been enacted, there has been
a very strong effort by both regulators and by the firms to
amend financial contracts to remove cross defaults to a holding
company bankruptcy so that the financial contracts cannot be
terminated the way they were in Lehman Brothers and can
continue in effect, of course with appropriate protections for
counterparties, because the guarantees would be moved to the
new bridge company and would therefore not be subject to the
debt that's been left behind in the old bankrupt company.
So all of those features, and there were some others that I
mention in my written testimony, are putting things in a
position to actually accomplish single point of entry.
Now, there were two provisions in the bill that I wanted to
mention that I think are worth just highlighting. The first one
is the ability of the Federal Reserve to commence an
involuntary case. One of the difficulties that's been raised
with that provision is involuntary cases normally come with the
right to oppose them and other parties need to be heard by the
court, there might be appeals, and in my view, if the due
process issues are so overwhelming with respect to that issue,
it's not critically necessary to include that provision.
And I see you raising your gavel, so what I will do is wait
for questions if there are questions on that issue or on the
other provision that I wanted to address. Thank you.
Mr. Marino. Thank you, Attorney Bernstein. See it works
very subtilely.
[The prepared statement of Mr. Bernstein follows:]
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__________
Mr. Marino. Attorney Hessler, please.
TESTIMONY OF STEPHEN E. HESSLER, ESQ.,
PARTNER, KIRKLAND & ELLIS LLP
Mr. Hessler. Thank you. Chairman Marino, Chairman
Goodlatte, Ranking Member Johnson, Ranking Member Conyers,
other Members, thank you for inviting me to testify at today's
hearing.
As noted in your very kind introduction, I'm a partner in
the restructuring group of Kirkland & Ellis, LLP. Although my
practice includes representing creditors, equity holders, and
other constituencies in complex distressed matters, I mostly
represented major corporations as company counsel in some of
the largest and most challenging bankruptcies in history. I am
speaking especially from that perspective this morning.
I am distinctly pleased to appear before this Subcommittee
again regarding the Financial Institution Bankruptcy Act of
2015, also known as Subchapter V. It was my privilege to
testify in July 2014 in support of the prior version. Given the
comprehensive record scrutinizing Subchapter V, I will not
repeat my prior testimony and will instead this morning focus
on two issues.
First, the comparative benefits of a judicial process such
as Chapter 11 versus a regulatory process such as Title II of
the Dodd-Frank Act for addressing a major bank's failure, and
second, how the 48-hour delay of the qualified financial
contract safe harbors from the automatic stay is critical to
the effectiveness of Subchapter V.
Turning to the first issue. The touchstone analytical
framework for evaluating Subchapter V should not be as a stand-
alone proposal, but rather, as compared to Chapter 11 in its
current form, Chapter 11 as amended by Subchapter V and Title
II. Among these alternatives, Subchapter V is the best designed
option both structurally and philosophically to advance the
private and public policies that animate the reorganization of
a financial corporation.
The hallmarks of an optimal resolution regime for failing
SIFIs must be clear and established rules administered by an
impartial tribunal. Subchapter V is a financial corporation
specific supplement to the existing reorganization provisions
of Chapter 11 of the Bankruptcy Code. And thus, it builds upon
decades of practice and precedent that have refined the code
and that otherwise provide a well tested and proven successful
reorganization framework for major corporations, including
SIFIs and their stakeholders.
Importantly, Subchapter V does not directly preclude or
supplant the potential applicability of Title II. Critically,
however, by design and operation, the availability of
Subchapter V will make it far less likely that Title II will
ever be invoked.
Turning to my second point. As a general rule, upon a
debtor commencing a Chapter 11 case, contract counterparties
are automatically stayed from terminating their agreements and
engaging in self-help remedies against estate assets, but the
Bankruptcy Code currently provides that counterparties to so-
called qualified financial contracts, such as derivatives,
repurchase, and swap agreements enjoy a so-called safe harbor
from the automatic stay.
Consequently, a Chapter 11 filing by a financial
corporation with significant qualified financial contracts
could be chaotic at the outset as counterparties that are not
subject to the automatic stay proceed to terminate and enforce
their rights in the debtor's assets. Subchapter V addresses
this potential problem by precluding access to these safe
harbors for 48 hours after the commencement of the case, which
is consistent with the time period under Section 1185 for
effecting the transfer of the subsidiary operating assets which
include qualified financial contracts to the bridge company
under the single point of entry approach highlighted by Mr.
Bernstein.
I have previously criticized Title II for imposing too
brief a stay on this front until only 5 p.m. Eastern on the
business day following the FDIC's appointment as receiver, and
as a general matter, my default position remains that safe
harbors should not exist at all. That said, for the following
four reasons, I am persuaded that Subchapter V proposes a
workable construct in this context.
One, since passage of the Dodd-Frank Act in 2010, financial
corporations have had 5 years to draft and refine their living
wills. Ideally, the enactment of Subchapter V will reinforce
the need to be prepared to make expedited qualified financial
contract transfer and assignment decisions.
Two, Subchapter V requires that decisions on whether to
transfer and assign all of the debtor financial corporation's
assets, expressly including qualified financial contracts, must
be made within 48 hours. It logically follows that 48 hours is
a sufficient period to stay qualified financial contract
counterparties from taking remedial actions that would
interfere with these determinations.
Three, the implicit expectation of Subchapter V is that
essentially all qualified financial contracts will be
transferred to the bridge company. Because Subchapter V
precludes cherry-picking only certain qualified financial
contracts for assignment, this should reduce the burden of
having to make transfer determinations for every individual
agreement.
Lastly, the most likely alternative to a Subchapter V case,
which is Title II, proposes a shorter stay than 48 hours, and
Chapter 11 without Subchapter V provides for no stay at all on
qualified financial contract counterparty termination. This
means Subchapter V's 48-hour stay is actually the most robust
option under the current and potential SIFI insolvency regimes
at issue.
I look forward to further careful consideration of the
important issues addressed by Subchapter V. I thank the
Subcommittee for allowing me to share my views on this
legislation, and I welcome the opportunity to answer any
questions about my testimony.
Mr. Marino. Thank you, Attorney Hessler.
[The prepared statement of Mr. Hessler follows:]
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__________
Mr. Marino. Attorney Levin, did I--am I pronouncing it
correctly? Levin or Levin?
Mr. Levin. It is Levin, Mr. Chairman
Mr. Marino. Levin. I apologize for the mispronunciation.
Mr. Levin. Not a problem.
Mr. Marino. Please, your opening statement.
TESTIMONY OF RICHARD LEVIN, ESQ.,
PARTNER, JENNER & BLOCK LLP
Mr. Levin. Thank you. Thank you, Mr. Chairman. Thank you
for your kind introduction. I thank the Members of the
Subcommittee for their attention here today.
I want to reiterate that as chair of the National
Bankruptcy Conference, I am speaking here today only on behalf
of the Conference, not on behalf of my own views or the views
of my law firm, Jenner & Block, or the views of any clients of
Jenner & Block.
You have our written statement, Mr. Chairman, which I
understand will be included in the record. It covers many more
things than I will address today orally, but I want to
highlight a few points.
First, I would like to describe that the National
Bankruptcy Conference is in general agreement with what Mr.
Bernstein and Mr. Hessler have already said. There is a lot
of--as there is within the Subcommittee--there is a lot of
agreement within the financial and bankruptcy community about
many terms of this bill. It was very carefully crafted and
constructed to address many of the concerns that had been
addressed, especially with respect to financial contracts.
That said, the National Bankruptcy Conference, which
generally supports bankruptcy legislation, has concerns about
the workability of this legislation considered in an isolated
form. But what has happened over the last several years since
the financial crisis is that many other structures have arisen
that make this bill much more workable than it would have been
had it been enacted say in 2009 or 2010, the single point of
entry concept development, the provisions in financial
contracts that provide for nontermination upon the guarantor's
or the parent guarantor's bankruptcy and many other things that
Mr. Bernstein and Mr. Hessler have addressed, but the
Conference nevertheless is concerned about the workability of
this legislation.
We do not oppose it. We are not, I will say, vigorous
supporters of it. We are, I think, mild supporters of the
legislation as a good alternative for the reasons that Mr.
Hessler just described. But let me describe the few concerns
that we have.
One is that the, the regulators in every other financial
area of stockbrokers, insurance companies, usually have the
speed and the agility and the expertise to take over and
resolve a distressed financial institution. Here we are talking
about the holding companies where the regulators, in normal
times, have a lot of expertise. Bankruptcy courts do not have
that expertise. They are going to be asked to move very quickly
over what we call a resolution weekend. We all recognize that
things have to move that fast. And we think that therefore the
regulators should continue to play a major role in this
process.
The judicial supervision is useful for transparency and due
process, we agree with that, but we do not believe that given
the speed that is required and the time it takes to get
educated about the intricacies and complexities of these
institutions that all of this can be put upon even a well
trained bankruptcy judge and that the regulatory role is still
very important in the process.
We believe it's also important because of cross border
issues. Regulators in other countries are much more comfortable
dealing with the regulators that they have worked with for
years in supervising these institutions rather than with an
unknown bankruptcy judge who might be every bit as qualified
and capable as the regulators but is not a known quantity and
therefore would create uncertainty and therefore risk.
So the next point is that--the point on involuntary
petitions. We are concerned about due process with the amount
of time that is available to deal with involuntary petitions,
and we favor the voluntary route. I think we can witness the
Lehman experience, which in a voluntary petition works, that we
don't need a regulator in a voluntary because the regulators
have enough tools to persuade management and a board of
directors that a voluntary petition is necessary. So we support
the idea of voluntary use of Subchapter V.
We are concerned about the lender of last resort issue. We
know that's outside this Committee's jurisdiction, so I won't
spend much time on it other than to say we think its
availability will obviate the need for its use, and that's an
important point.
And finally, we do support the provision in this bill,
which was not--which has not been in some other proposals, that
this proceeding take place before bankruptcy judges who are
expert in financial reorganization rather than before the
district court who does not have the same expertise as the
bankruptcy court.
With that, Mr. Chairman, I'm happy to address any questions
the Committee might have.
Mr. Marino. Thank you, Attorney Levin.
[The prepared statement of Mr. Levin follows:]
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__________
Mr. Marino. The Chair will now start by asking questions of
the panel, and I ask my colleagues to keep their questions at 5
minutes or less and give you ample time to answer
Mr. Bernstein, I would like to start with you for a moment.
We know that banks have increased their liquidity reserves, but
if a bank were to fail and the bridge company--would the bridge
company still have to receive some type of loan to cover the
issue concerned, or do banks have enough liquidity to keep
those loans at a minimum?
Mr. Bernstein. Thank you. At current liquidity levels,
which have been enhanced since 2008, the banks have used severe
stress testing of those liquidity models in a resolution
context, and they show that they do have enough liquidity. I
agree with Mr. Levin's point that if there were a liquidity
backstop, it wouldn't be used, but having it there would help
to stabilize the firm more quickly simply because it exists.
So I think the need for--there is no need for liquidity
because of the current balance sheet levels, but having a
liquidity backstop would serve the purpose of helping to
facilitate the resolution and getting the company to be
stabilized more quickly to give the market confidence.
Mr. Marino. Thank you. Attorney Hessler, you stated in your
last, I think, testimony about your reservations concerning the
single point of entry approach, and have you come up with an
alternative to that? Would you please explain that in a little
more detail? I did it get it in your opening statement, but
could you elaborate on it, please?
Mr. Hessler. Sure. I have not come up with an alternative
way, but I would say--and this was emphasized in my testimony
submitted for today. Over the last year since my testimony last
summer, I spent significant additional time contemplating the
bill, and I am at this point comfortable with the single point
of entry approach, and I guess very quickly I'll tick off four
reasons why I think it is----
Mr. Marino. Please.
Mr. Hessler [continuing]. A viable construct.
First of all, a point that was highlighted by Mr. Bernstein
in his opening statement. SIFIs have corporate structures that
don't comport with conventional bankruptcy practice. Many of
the operating subsidiaries either cannot be filed for
bankruptcy or need to be liquidated in a regulatory proceeding.
So Subchapter V, the single point of entry approach
actually facilitates and accommodates the unique corporate
structure of systemically important financial institutions.
The second point is while the discreet steps of single
point of entry may be a unique addition to Chapter 11, the
transfer determination, that in and of itself is subject to
Bankruptcy Code and bankruptcy court approval within well
established and applicable law under the legal principles of
sections 363 and 365 of the Bankruptcy Code.
The third point is more of a practical matter, which is,
again, although single point of entry would be a novel addition
to the Bankruptcy Code, as already noted, versions of this very
rapid sale have been happening already. Lehman is the most
extreme example, which was the sale of all the operating assets
within, you know, four to 5 days of the petition, but there
have been other sort of lightning fast with the ``melting ice
cube sales'' that are already happening under the Bankruptcy
Code, and so understood, the single point of entry approach
actually just formalizes and codifies something that's already
going on.
And then lastly, and I talk about this at great length in
my testimony, if you actually walk through the expectations of
various creditors, secured creditors, unsecured creditors, and
equity interest holders, the distributional scheme that is
effected by single point of entry is consistent with typical
Chapter 11 principles.
Mr. Marino. Thank you. Attorney Levin, you talk about the
regulators having a role in this, and I do agree that they
should have a role in this, but their decisions, in part, are
subjective. How can we assure that at least their subjective
findings are going to be consistent? I have a concern when so
many subjectivity is involved in this situation by someone who
is not a judge or an experienced bankruptcy judge, please.
Mr. Levin. Fair point, Mr. Chairman. I'd note, however,
that in a lot of these areas, even in the bankruptcy courts,
the decisions are discretionary, and therefore, to a large
degree, subjective. The courts set out broad rules for what
kinds of transactions are permitted, but within those broad
rules, there is tremendous subjectivity in their application.
And I would note that the regulators themselves have begun
adopting regulations on how this process would work, so it is
controlled as well. If you have the combination of the
regulators and the bankruptcy court supervising this process, I
think you get the best of both worlds in that area.
If I might follow up on Mr. Hessler's last----
Mr. Marino. Quickly, please
Mr. Levin [continuing]. Remark. There is a real--there is a
dividing line that's very important in the single point of
entry concept. The dividing line is the transfer of the
operating assets to the bridge company.
From that point, what goes on in the bankruptcy case is
purely bankruptcy. It's not regulatory. It's not financial
institution. The financial institution has been moved to the
bridge company, and the bridge--what's going on in the bridge
company is totally outside of the bankruptcy realm. It should
be a healthy operating financial institution that will be
subject to regulatory control.
I think Subchapter V, meaning no pun, bridges that nicely
and separates them and therefore works to facilitate both
systems in due process and transparency and protection of
creditors and protection of systemically important--protection
of the system with a systemically important financial
institution, and that, I think, addresses the fourth of Mr.
Hessler's points that he made.
Mr. Marino. Thank you. My time is expired. The Chair
recognizes the Ranking Member, the gentleman from Georgia,
Congressman Johnson.
Mr. Johnson. Thank you. Mr. Levin, in a letter that the NBC
sent to our Subcommittee last month, the conference stated that
any amendments to the Bankruptcy Code relating to the
resolution of SIFIs should make it clear that regulators retain
Title II's orderly liquidation authority despite the pendency
of bankruptcy.
Does H.R. 2947 sufficiently ensure that regulators retain
their Title II authority, notwithstanding the pendency of the
bankruptcy?
Mr. Levin. Yes. I haven't--the bill was introduced this
week, and I haven't had a chance to review it, but my
understanding was that it does not affect the regulators' other
authorities for liquidation.
Mr. Johnson. All right. Thank you. Can a Subchapter V
operate as intended if there is no secured lender of last
resort such as the Federal Government?
Mr. Levin. Possibly. It's a far riskier proposition. Mr.
Bernstein notes that the banks are far better capitalized now
than they were 6 or 7 years ago, very true. I would expect that
a SIFI that winds up in Subchapter V probably would not be as
well capitalized as most banks are today, and therefore, there
would be a need for liquidity. That liquidity might be supplied
by the recapitalization of the subsidiaries when they are
transferred over to the bridge company and they're
recapitalized by contribution of the parent from the assets,
but at the same time it might not be adequate and therefore
liquidity could be important.
To the extent it's a bank subsidiary, the Federal Reserve
discount window provides that. To the extent it's a broker/
dealer or an insurance company or another kind of financial
institution such as a derivatives trading institution, there is
no apparent source of liquidity, and that could create risk in
the bridge company.
As I said earlier, and this is the important point to
stress, the market is less likely to run if it knows the
liquidity facility is there than if there isn't one. If the
market knows that the liquidity facility is there, people will
feel protected, and therefore, there will be less need for a
liquidity facility. I sometimes characterize it as akin to our
nuclear arsenal. The fact that we have it means that we don't
have to use it.
Mr. Johnson. Thank you. Mr. Hessler, your response to that
same question?
Mr. Hessler. I agree with the general thrust of Mr. Levin's
response. I think it's possible that the absence of the Federal
funding mechanism would not impair the ability of the bridge
company to operate effectively because of the recapitalization
that occurs upon the transfer of the assets. To the extent that
is otherwise available, though, that could be reassuring to the
market.
Mr. Johnson. Thank you. Mr. Levin, in a letter that the NBC
sent to our Subcommittee last month, the conference described
several significant concerns. Among them, the NBC stated that
under certain circumstances the bankruptcy process might not be
best equipped to offer the expertise, speed, and decisiveness
needed to balance systemic risks against other competing goals
in connection with resolution of systemically important
financial institutions and thus Title II of Dodd-Frank should
be retained even if H.R. 2947 becomes law.
And as you've stated, it appears that this legislation does
retain--or I mean, it doesn't repeal it, so I mean, legislation
is retained, but there is an ability of the regulators to
assert authority during the pendency of the Subchapter V
action. Please describe what types of companies or
circumstances might warrant the application of Title II's
orderly liquidation authority in lieu of a resolution in
bankruptcy?
Mr. Levin. Subchapter V would address most of the problems
that Title II would address. The fact that it was there and
Dodd-Frank says that bankruptcy is the preferred alternative
might make bankruptcy workable and probably will make
bankruptcy workable in that circumstance. But none of us is
prescient enough to know all of the bad things that could
happen in a rapidly evolving crisis. And I don't have a
specific answer for the particular circumstances that might
require a different regulatory regime than Subchapter V, but
what is called the triple key entry for Title II as well as the
statutory preference for bankruptcy, we think it's useful to
have that backup which would only be used in the most extreme
circumstances, which are difficult to imagine and lay out at
this point.
The fact is, the banks are well capitalized now. Things are
going pretty well. This is not likely to be used for many
years. We don't know what the system will look like several
years from now if and when it ever becomes necessary for a SIFI
to be resolved in a crisis situation. So that--I think that is
what lies behind our position more than any specific
circumstances.
Mr. Johnson. All right. Thank you, and I yield back.
Mr. Marino. Thank you. The Chair now recognizes the Vice-
Chairman of the Subcommittee on Regulatory Reform, the
gentleman from Texas, Mr. Farenthold.
Mr. Farenthold. Thank you very much, Mr. Chairman.
And actually Mr. Levin has a great lead in to my question.
We are a bunch of lawyers up here that spend a lot of time
looking at this and getting into the weeds. I want to take a
step back and look at the big picture of this.
We recently enacted Dodd-Frank, which is a very burdensome
regulatory scheme, which went--from what I hear from a lot of
banks and from a lot of people, seeking to borrow from banks.
We got a situation where just recently we had the increased
liquidity rules that we've been talking about. We really are
looking at a very worse case scenario, something that none of
us can imagine at this point.
Can--maybe Mr. Bernstein, can you give me an idea? What
kind of bankruptcy events are we talking about here?
Mr. Bernstein. Yes. So I actually think this is less
related to the facts on the ground at the time of any
particular resolution than it is to--it's, frankly, almost a
foreign policy issue. In the context of my practice, I've been
dealing a great deal with foreign regulators.
Foreign regulators do not understand bankruptcy. The main
benefit and the primary benefit, I think, of retaining Title II
is to give confidence to foreign regulators that if something
is going wrong in the bankruptcy process, the regulators do
have the ability to step in. Simply because they deal with the
U.S. regulators every day, there is active dialogue with them,
they think they understand where the U.S. regulators are coming
from, so it's not necessarily something that will need to be
used because this bill actually has the appropriate process.
But in terms of preventing a foreign regulator from seizing
a foreign subsidiary when we're trying to keep them out of
bankruptcy, it may go a long way in giving the regulator
confidence that they don't have to do that because they know
that the U.S. regulators can step in.
Mr. Farenthold. All right. Now, again, I think we're kind
of get into the weeds now. And then again, this may be a little
bit off topic of the bill, but would all of you agree that we
really are dealing with a worse-case scenario situation here,
something that is very--is not foreseeable at this point, would
anybody disagree with that on the panel? I see no one does, so
let me go on to my second question and----
Mr. Levin. I don't disagree with that, but as I said a
moment ago, Mr. Farenthold, had anybody asked us this question
in the 1990's, we would have given the same answer.
Mr. Farenthold. Okay. Let me go on to my second question.
Mr. Hessler--or did you want to weigh in on this first?
Mr. Hessler. There is one thing that I think would be
hopefully clarifying about the interrelationship between Title
II and Subchapter V. So nothing in Subchapter V diminishes
Title II.
Mr. Farenthold. Right.
Mr. Hessler. It doesn't touch it. However, I think it's
important that Subchapter V also be examined on its own merits
because there's a critical provision, which is Section 1184,
which provides standing to Federal Government regulators to be
involved in a bankruptcy case. That presently does not exist
within Chapter 11.
Mr. Farenthold. And obviously the taxpayers could
potentially be left holding the bag if the Federal regulators
aren't----
Mr. Hessler. Well, the decision on that, the Federal
Government at present can only participate in a bankruptcy case
to the extent it is a creditor----
Mr. Farenthold. Right.
Mr. Hessler [continuing]. Not the debtor. So the point I
want to make is sort of irrespective of Title II and what it
does and doesn't provide or the future of Title II, whether it
has one or not, just within Subchapter V, it specifically and
on its own provides that critical grant of standing for Federal
regulators to advance their public interest mandates in a
Chapter 11 case.
Mr. Farenthold. Got you. All right. My other question is,
one of the objections we're hearing to Subchapter V is it
actually increases the incentive for private regulation, which
I would guess is say the creditors putting more creditor
favorable terms, you know, regulations are by the creditors
rather than by the government.
Do you believe the bill increases the incentive for the
creditors of banks to put in these more burdensome requirements
for the banks or no?
Mr. Hessler. Subchapter V? No, I think--I actually believe
that it puts a disincentivization for risky creditor behaviors.
Creditors understand Chapter 11. It's well established and the
governing principles are highly effective and highly proven. I
actually think it's Title II, which is much more of an unknown
quantity and an unknown entity that actually increases creditor
uncertainty as to how a Title II untested proceeding would go,
so I actually think Subchapter V, which really just adds
additional clarifying facets to Chapter 11, I actually believe
that's helpful for maximizing responsible creditor behavior.
Mr. Farenthold. And Actually Mr. Bernstein wants the weigh
in on this as well.
Mr. Bernstein. Yes. I think the one thing about whether
it's the provisions of this bill or the fact that the FDIC has
made it clear that holding company creditors rather than
taxpayers will absorb losses, that will increase the level of
monitoring by creditors, and they will be making decisions
about whether to invest based on how they see the institution
operating rather than based on the feeling that they are going
to be bailed out.
And I think that is a very important aspect of this bill.
It is probably a good thing.
Mr. Farenthold. Thank you very much. I see my time has
expired, Mr. Chairman.
Mr. Levin. If I may add, Mr. Chairman, the fact that the
ISDA has adopted this protocol that provides a stay in the
financial contract itself of 48 hours shows exactly the
opposite kind of creditor behavior. The creditors are helping
to facilitate the process.
Mr. Farenthold. Thank you.
Mr. Marino. Thank the Chair recognizes the Ranking Member
of the full Judiciary Committee, Congressman Conyers.
Mr. Conyers. Thank you, sir. Mr. Levin, the National
Bankruptcy Conference states regulators should not have the
power to commence an involuntary Subchapter V. Do you have any
reasons to let us know why the Conference takes this position?
Mr. Levin. Yes, Mr. Conyers.
Mr. Conyers. Please.
Mr. Levin. An involuntary petition is like any lawsuit. It
entitles the defendant, here the alleged debtor, to a defense.
The amount of time necessary available for a resolution, we
call it the resolution weekend, is so short that there really
can be no meaningful defense. And there can be no meaningful
appeal if the transfer process to the bridge company is to
occur over a resolution weekend in response to an involuntary
petition. So we think it undercuts due process to allow an
involuntary bankruptcy petition.
As I said earlier in my openings statement, we believe the
regulators have enough tools at their hands to persuade a board
of directors why it is important to file a voluntary petition
at the beginning of a resolution weekend, rather than go
through the contested in voluntary process. And we think that
will suffice to protect the system.
Mr. Conyers. Thanks. Now Subchapter V, could it operate as
intended if there is no secured lender of last resort, Mr.
Levin, such as the Federal Government. How would you respond to
those who would say that this could amount to a taxpayer funded
bailout of Wall Street people.
Mr. Levin. We don't think it is a bailout because of the
nature of lender-of-last-resort funding. Lender-of-last-resort
funding has three requirements; one, that there be good
collateral so that the lender, whether it is the Federal
Reserve, or the Federal Government, or whether it is some other
Federal corporation or agency is fully protected by the
collateral it receives.
The second is that the interest rate be what is referred to
in literature as a punitive interest rate so that it is higher
than--so there is no desire to access it for convenience. And
for a moment I'm drawing a blank on the third and I'm going to
ask Mr. Bernstein to help me on the third requirement.
Mr. Bernstein. Above market interest rate.
Mr. Levin. That was----
Mr. Bernstein. You already said that? Then I don't remember
the third one.
Mr. Conyers. All right, two then.
Mr. Levin. In any event, the point is this is not a bail
out in the sense that the Federal Government or any agency is
contributing money, taking an equity position, taking an equity
risk. This is helping the financial institution take valuable
assets that it has and make them liquid until those assets can
be sold in a orderly market, rather than be dumped at fire sale
prices and depress the market for everybody.
Mr. Conyers. Well, do you think that by allowing it--if
there is no secured lender of last resort--that we may be in
some ways rewarding irresponsible behavior?
Mr. Levin. I don't think a bankruptcy is a reward for
irresponsible behavior whether or not there is a lender of last
resort.
Mr. Conyers. Now, going to Mr. Bernstein for his response
to this question. If Subchapter V was in existence when Lehman
failed, would it have achieved a better result with respect to
the case's impact on the Nation's financial marketplace?
Mr. Bernstein. It is a complicated question because many
other things that are in place today weren't in place at that
time. I think one of the things that it would have helped is
this bill would have potentially permitted Lehman to adopt a
different strategy. It could have used a single point of entry
strategy and could have preserved its derivative contracts.
The problem with Lehman at the time, though, is it didn't
have the total loss absorbing capacity and might not have been
able to recapitalize the subsidiaries. So that piece of it,
which is now being required, not only in the U.S. but by global
regulators, is very important. And if you have both of those
pieces, the provisions in this bill or in the contractual ISDA
to protocol, plus the total loss absorbing capacity, you would
have had a totally different result in Lehman Brothers, I
think.
Mr. Conyers. So your answer is a substantially yes.
Mr. Bernstein. That's correct, your Honor. Your Honor--
Congressman.
Mr. Conyers. Thank you. Thank you, Mr. Chairman.
Mr. Marino. Thank you. The Chair recognizes the gentleman
from Michigan, Congressman Trott.
Mr. Trott. Thank you, Chairman.
Mr. Levin, so you raised a few concerns, one concern was
the lack of experience potentially in a bankruptcy judge and
the need for regulators to be involved. Didn't like the
involuntary provision, which I agree with your comments in that
regard. The lender of last resort concerns and then I think
also then the need for experienced judges, not district judges.
So the first concern is what surprised me a little bit. You
know, Dodd-Frank came upon us in 2010, the FDIC has been
working on rules for single point of entry since then. So you
have, you know, you believe regulators are going to be able to
act more efficiently and quickly because of their experience
than a bankruptcy judge?
Particularly under section 298 we have one of the 10
experienced bankruptcy judges has been appointed for this
purpose to deal with complex insolvency. I don't know if I
understand why you have more confidence in the ability of
regulators to move quickly and react than a bankruptcy judge
who essentially does it every day?
Mr. Levin. I'll tell you that the Conference had the view
back in 2009 and 2010 of great concern about the regulators
being able to do what you just described. But I think we've all
learned a lot in 5 years, and the regulators have learned a
lot. And we've watched them evolve in their thinking and learn
and write regulations so they are in a much better position now
to deal with this kind of circumstance than they would have
been 5 or 6 years ago. But with that said, I want to go back to
what I said in my opening statement. I think Subchapter V gives
us the best of both worlds.
The bankruptcy judge does not have enough knowledge about
the company to be able to do it alone--the regulator--and does
not have enough knowledge about the systemic affects of
whatever is done. The regulators do not have the same process
and remove that a bankruptcy judge has. And by combining the
efforts of the two of them, I think you get a much better
result than one alone. And this applies only to the resolution
weekend and the transfer to the bridge. That's where the
important difficult decisions have to be made. After that
happens, the bankruptcy judge is fully well qualified to handle
all of the rest of the case.
Mr. Trott. Okay. Appreciate that clarification. Mr. Hessler
made a comment about uncertainty as it relates to Title II. Mr.
Levin, you made a comment, it will be many years before this
perhaps even comes into play and we don't know, you know, how
things will play out and how soon the provisions will be
interpreted.
Would you agree with Mr. Hessler's comments that the same
can be said of Title II.
Mr. Levin. Oh, yes, definitely. I mean there are parts of
the Bankruptcy Code, Subchapter IV of Chapter 11 railroad
reorganization is very rarely used, one case recently, nobody
could have envisioned in 1978 what a Chapter 9 of Detroit might
have looked like in 2013. So we have to think way into the
future, and there's going to be uncertainty whichever way we
go.
Mr. Trott. Mr. Bernstein, so let's say H.R. 2947 was in
place and we have a Lehman type insolvency. Can you just
discuss for a moment how that would have played out
differently?
Mr. Bernstein. Yes. And this relates to Congressman
Conyers' question. I think if we had this bill, plus all the
other changes that are being made in the resolution planning
process, I think we would have had an extremely different
outcome in Lehman Brothers. Lehman Brothers holding company
would have filed, the subsidiaries would have been
recapitalized so that they would have sufficient capital not to
go into bankruptcy.
The subsidiaries would have been transferred to a new
bridge holding company. And the derivatives contracts
importantly would not have terminated, which would avoid
enormous losses that would threaten the viability of those
subsidiaries. So there wouldn't have been the systemic
disruption that occurred at the time of Lehman Brothers, which
is very important.
Mr. Trott. So to that point I got delivered yesterday a
copy of Hoover institute's book on making failure feasible. I
read their mission statement in terms of the resolution
project. And it said if a clear and credible measure can be put
in place that convinces everyone that failure will be allowed,
then expectations of bailouts will disappear. If we get rid of
the risk reducing behavior that are fostered by guarantees,
then that would be a good thing. And then also a clear process
to reduce panic, H.R. 2947 would have accomplished that in
Lehman?
Mr. Bernstein. Yes, it would have. In fact, as you'll see
in that Hoover book, there are several chapters devoted to this
type of single point of entry resolution and their conclusion
is it would be very effective in that way.
Mr. Trott. It is a fascinating book, I'm not too far into
it yet.
But Mr. Hessler, one quick question, I am out of time.
Ranking Member Johnson raised a concern about the funding. So
back to Lehman, you know, the professional fees in Lehman were
$2 billion, I believe. Can you just speak for a moment on
funding concerns specifically as it relates to Ranking Member
Johnson and this bill?
Mr. Hessler. Yeah, I think it is what Mr. Levin is
hopefully clarifying for me. There are two funding questions at
issue in Subchapter V proceeding. Upon the transfer of the
assets to the bride company, it is the access to liquidity of
the bridge company.
Mr. Trott. We've talked about that plenty.
Mr. Hessler. That's not governed by Subchapter V because
that is not in the jurisdiction of the bankruptcy. There is
potentially the issue of for the purposes of finding the wind
down----
Mr. Trott. Do you have any concerns in that regard?
Mr. Hessler. No. There is regular DIP lending capacity and
there that will be a significantly more limited funding need
because what at issue the wind down of undesirable assets.
That's what's happening in the Chapter 11 case upon single
point of entry transfer.
Mr. Trott. Thank you, sir.
Mr. Hessler. Thank you.
Mr. Marino. The Chair now recognizes the Congresswoman from
the State of Washington, Ms. DelBene.
Ms. DelBene. Thank you Mr. Chairman. Thanks to all of you
for being here with us today. Some of my questions were asked
already, but I just had a quick question for you Mr. Hessler on
living will requirements and I just wondered what your thoughts
were on this legislation in terms of whether or not it would
help facilitate the Dodd-Frank living will requirements?
Mr. Hessler. I believe it will. I think the living will
practices today have already begun to put in place the road map
for what a Subchapter V proceeding would look like. And I think
this is a point I want to augment that we've been talking how
would Lehman have looked under a Subchapter V proceeding, and
thus far really all that we have focused on is what would the
cause have looked have looked like once it's filed.
The one thing I'd want to mention to the Committee is from
what we do in the vast majority of our work is spent preparing
debtors for a soft landing into bankruptcy. So perhaps the most
important consideration that I would urge lawmakers to keep in
mind is with legislation what sort of incentives and
disincentives does it put in place for directors and officers
to confront restructuring challenges and begin to prepare and
address those issues as early as possible.
And this is something I talked about in my testimony. Title
II has the provision that directors and officers are
effectively all wiped out, the are all going to get fired and
compensation is going to get clawed back and it's sort of all
types of punitive measures. I actually think that creates a
disincentive for directors and officers to begin taking
responsible actions that are otherwise necessary to maximize
stakeholder recoveries in a bankruptcy.
And so I think that's a very important part in Subchapter V
I think it very, very hopefully incentivizes management to
begin to prepare for bankruptcy because it sees an orderly path
forward to otherwise affect a resolution of a failing bank.
Mr. Levin. We sometimes refer to what Title II does as
requiring management to sign its own death warrant.
Ms. DelBene. Any other feedback on that one?
Mr. Bernstein. I think this bill would definitely
facilitate structures already being used in the living wills of
the largest financial institutions and I think that that is a
very positive development.
Ms. DelBene. Thank you. Thank you Mr. Chair. I yield back.
Mr. Marino. Thank you, the Chair recognizes the gentleman
from Texas, Congressman Radcliffe.
Mr. Radcliffe. Thank you, Chairman. I would also like to
thank my friend and colleague, the gentleman from Michigan,
Congressman Trott for his work on this issue.
The 2008 financial crisis hurt a lot of folks in Northeast
Texas. And some of the families in my district are frankly
still working to get back on solid financial footing. And I'll
be the first to admit that I'm not an expert on bankruptcy
issues. But following that crisis I think it became obvious to
all of us that these technical, complicated bankruptcy issues
are having a huge impact on everyday Americans. And issues that
impact everyday Americans are the ones that we as policymakers
certainly want to make sure that we're addressing.
There were a lot of questions and frustrations that have
come out of the financial crisis. For example, why did
distressed financial firms receive government bailouts, instead
of being forced to seek resolution through the bankruptcy
process? Now I know in the years since this crisis this
Committee has worked very hard to improve the Bankruptcy Code
and make sure that it is equipped to handle all failing
companies. I appreciate all of you witnesses being here today
to provide your expertise on the proposed legislation. I want
to find out whether it is in fact going to achieve its intended
goal.
So I want to kick things off by asking about a provision in
the bill that would allow the Federal Reserve to initiate a
bankruptcy case over the objection of a financial institution.
Now, a lot of folks in my district have a real distrust of
the Federal Reserve. They see it as a dangerously powerful
body, one with little oversights and little transparency. So if
you gentleman were chatting with my constituents about possibly
giving the Federal Reserve this new authority, how would you
allay their concerns? And what would you tell them about how
this new authority would help them?
Mr. Bernstein. Yes, there is a lot of uncertainty as a
financial crisis develops and boards of directors may hesitate
to act. I do not believe that the Federal Reserve will end up
ever using the power if they are granted the power to file
involuntary petitions, because the fact that the Federal
Reserve can do it if it's necessary will cause corporate
managements to be very focused on when the right time to go
into Chapter 11 is. And that, taken together with the living
will process, I think the two together make it very unlikely it
will ever be used. And it is really only a failsafe for a
situation where the company management may be paralyzed at that
time.
That being said, I don't think it is an essential part of
this bill for the reasons that Mr. Levin stated, which is there
are other supervisory powers that the Federal Reserve has. And
the Federal Reserve is going to be intimately involved in the
living will process, and they have been, so I think there is
going to be a constant dialogue with the regulators and the
financial institutions that make this provision almost
unnecessary.
Mr. Radcliffe. Mr. Hessler.
Mr. Hessler. Yeah, no, I would add to that. I think the
involuntary provision is an unhelpful distraction to what is
otherwise a very good bill. Already there are provisions in the
Bankruptcy Code that provide creditors the express right to
file an involuntary case against a debtor to commence an
involuntary Chapter 15. Those are exceedingly rare and the
reason they are is debtors are very aware of those creditor
powers and they are usually already very engaged in dialogue
with the creditors, debtors do not like to get tossed into
bankruptcies on a timeline and terms that are not of their own
making. So they will file voluntarily before involuntary can be
initiated. I fully expect that's what would happen here in the
context of SIFIs, that they would be well aware of what Feds
otherwise can do and even without the express involuntary
rates, the Feds could probably force a bankruptcy anyway, and
the company is going to file in advance of that so that it can
maintain control of its own case.
Mr. Radcliffe. Mr. Levin, anything you'd like to add? I
will give you a chance.
Mr. Levin. Nothing to add. The Conference agrees with both
of those.
Mr. Radcliffe. Terrific. Mr. Hessler, I spend a
considerable amount of my time these days listening to
constituents who have to deal with the immense burdens and
expense of complying with Dodd-Frank. Personally I'd like to
get rid of Dodd-Frank all together, but at the very least I
would like to see us moving forward with respect to solving
some of its challenges.
So let me ask you this, in your opinion, would the bill
before the Committee today reduce the necessity for regulators
to initiate a Title II resolution proceeding under Dodd-Frank?
Mr. Hessler. Yes, it would. I addressed it in my testimony
and in my opening statement. I think the availability of
Subchapter V will effectively render the need for a Title II
unnecessary.
Mr. Radcliffe. Mr. Bernstein, will you comment on that?
Mr. Bernstein. I agree, I agree with Mr. Hessler.
Mr. Radcliffe. Thank you. I see that I'm out of time and I
yield back.
Mr. Marino. Seeing no other Congressmen or women, this
concludes today's hearing. I want to thank the witnesses for
attending, I want to thank our guests for attending. And each
time I have an opportunity to listen to you gentlemen I learn
something so thank you very much for today's testimony.
Without objection, all Members will have 5 legislative days
to submit additional written questions for the witnesses or
additional materials for the record.
This hearing is adjourned.
[Whereupon, at 11:30 a.m., the Subcommittee was adjourned.]
A P P E N D I X
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Material Submitted for the Hearing Record
Response to Questions for the Record from Donald S. Bernstein, Esq.,
Partner, Davis Polk & Wardwell LLP
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Response to Questions for the Record from Stephen E. Hessler, Esq.,
Partner, Kirkland & Ellis LLP
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Response to Questions for the Record from Richard Levin, Esq.,
Partner, Jenner & Block LLP
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
[all]