May 15, 2018 - The risk retention saga for CLO managers went on from July 2010 until this past week, almost 8 years. During that time the LSTA filed 6 comment letters with the regulatory agencies, pursued legislation that would mitigate the effects of the final risk retention rule, filed suit against the SEC and Federal Reserve Board, filed 7 legal briefs, and attended countless meetings. The path was long and challenging, but ultimately successful. What are some of the political and strategic lessons that can be learned from this long risk retention battle? The American Banker recently published an op-ed submitted by LSTA Executive Director Lee Shaiman, a former portfolio manager for both large and small firms. While expressing gratitude for the great result, Mr. Shaiman noted how costly and difficult the CLO risk retention saga was for many of our members and for the LSTA itself. He identified three primary causes for the imposition of what he considered an “ill-fitting rule”. First, the Dodd-Frank Act itself was done too quickly, without the type of deliberation typically expected of such far-reaching financial regulatory legislation. Second, the trend of Congress delegating so much of the responsibility for implementing financial and other rules went too far with Dodd-Frank. Finally, the rulemaking process involved the SEC and three banking agencies, each with its own views and conflicting mandates. Congress would be better off in the future identifying a single, lead agency (in this case, the SEC, which regulates almost all CLO managers) to implement specific rules.
We have also learned much from this experience about the strategic use of litigation in the realm of financial regulation. At a recent webinar at Sidley in Chicago (a recording of which is available here), the LSTA’s lead counsel, Richard Klingler of Sidley, noted that the use of strategic litigation to limit regulation has been used in other industry sectors such as telecom, oil & gas, and health for decades and has only recently started being adopted in the financial sector. The main reason for its slow acceptance has been fear of upsetting the regulators. This fear is unfounded, as reflected in the LSTA’s experience where the agencies have continued to engage cordially and openly with the LSTA, with the SEC even issuing a no-action letter on CLO refinancings while the litigation was ongoing. Importantly, the strategic use of the possibility of litigation can also inform rulemaking, policy formation and enforcement negotiations and is therefore a critical tool in financial regulation.