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Volume 105

Article

Remutualization

Erik F. Gerding, Professor of Law and Wolf-Nichol Fellow, University of Colorado Law School

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15 Mar 2020

Lynn Stout heartily embraced heterodox economic theories for describing capital markets and a progressive zeal for reforming them. Yet when she came to formulate her policy prescriptions for financial markets, one of the most prominent progressive corporate and financial law scholars of the twentieth century could sometimes take these twin intellectual engines into surprisingly “conservative” waters. Lynn’s landmark 1999 article in the Duke Law Journal, “Why the Law Hates Speculators” provides an example of her coming to the unexpected policy conclusions of returning to ancient solutions to the problems of modern financial markets.1Lynn A. Stout, Why the Law Hates Speculators: Regulation and Private Ordering in the Market for OTC Derivatives, 48 DUKE L.J. 701, 777–78 (1999). She advocated for identifying and reducing excessive financial speculation in derivatives markets by reviving the common law doctrine of insurable interest.2Id. at 777–82. Under this doctrine, insurance and, in turn, derivative contracts are only legally enforceable if at least one of the parties uses the contract to transfer or hedge a preexisting risk. Id. at 725. If the contract involves the transfer of risks to which neither counterparty was subject before the bargain was struck, then courts would not enforce the agreement. Id. at 724–27. The operation of this rule can be seen in a simple example: the common law would not enforce a contract in which one person purchases fire insurance for a neighbor’s house.

This Article explores how a similar intellectual move—returning to common law or traditional approaches to financial institution governance—can inform and improve a range of financial reforms. In particular, this Article seeks to revive the use of organizational form as a tool of financial regulation. Very old varietals, including partnerships and mutual companies, decanted in new bottles can promote financial stability, lower incentives for excessive risk-taking by financial intermediaries, provide mechanisms to police their market conduct, and better align their incentives with the interests of their customers and consumers.

In arguing for the use of organizational form as a regulatory tool, this Article examines a common but somewhat hidden thread running through a range of innovative, contemporary scholarship on financial regulation. In a number of works, both the contemporaries and intellectual heirs of Professor Stout have explored ways to “remutualize” ownership of financial intermediaries. For instance, Professors Claire Hill and Richard Painter argue that reintroducing elements of the old partnership structure of investment banks would curb excessive risk-taking by, and change the culture of, those important financial intermediaries.3See CLAIRE A. HILL & RICHARD W. PAINTER, BETTER BANKERS, BETTER BANKS: PROMOTING GOOD BUSINESS THROUGH CONTRACTUAL COMMITMENT 146–48 (2015). Professor Saule Omarova moves from the level of the firm to the level of industry and argues for a self-regulatory legal regime in which large financial institutions would collectively bear the costs of systemically risky activities and thus police each other’s behavior.4See Saule T. Omarova, Wall Street as a Community of Fate: Toward Financial Industry Self-Regulation, 159 U. PA. L. REV. 411, 419–20 (2011). Her ideas harken back to historical structures in which exchanges were mutually owned and regulated by the brokers who traded on them.5See, e.g., Roberta S. Karmel, Turning Seats into Shares: Causes and Implications of Demutualization of Stock and Futures Exchanges, 53 HASTINGS L.J. 367, 403–07 (2002) (tracing legislative and regulatory history of stock exchange demutualization in the United States). It also recalls how the organizational form used to operate on an industry-wide level: in the nineteenth century, large banks formed clearinghouses that provided a form of deposit insurance to one another and helped a large swath of the financial sector withstand banking panics.6Gary Gorton, Clearinghouses and the Origin of Central Banking in the United States, 45 J. ECON. HIST. 277, 282–83 (1985). Professor Paolo Saguato examines a different, modern version of clearing-houses: entities that facilitate the clearing and settlements of trillions of dollars of securities and derivatives trades each day.7Paolo Saguato, The Ownership of Clearinghouses: When “Skin in the Game” Is Not Enough, the Remutualization of Clearinghouses, 34 YALE J. ON REG. 601, 601 (2017). Modern clearinghouses, or clearing companies, reduce risk to parties to these transactions and to the entire financial system by serving as central counterparties to trades.8Id. at 601, 603–05. Professor Saguato argues that the demutualization of clearinghouses results in their shareholders having incentives to increase the risk profile of these entities at the expense of both members (i.e., the financial institutions using the company to clear and settle trades) and the entire financial system.9Id. at 642–46. He proposes various mechanisms to give control of clearing company risk-taking back to the members/users, who have the ultimate risk exposure.10Id. at 659–65.

Still other scholars examine the way in which credit unions and other financial cooperatives tend to offer loans and other financial products with more favorable and less exploitative terms to borrowers and consumers.11See, e.g., Ryan Bubb & Alex Kaufman, Consumer Biases and Mutual Ownership, 105 J. PUB. ECON. 39, 46 (2013) (finding that credit unions have lower purchase and default annual percentage rates and lower late and over-the-limit fees than investor-owned issuers).

Older works by Professor Henry Hansmann and others demonstrate that mutually owned banks and other lenders tend to make less risky investments and run a lower risk of failure.12See, e.g., HENRY HANSMANN, THE OWNERSHIP OF ENTERPRISE 249–50, 255–57 (2000). In life insurance, mutual companies tend to have much more conservative financial reserve practices than their investor-owned counterparts.13See id. at 267–70.

Common threads unite these different strands of scholarship. Each of these scholars argues that the organizational form that a financial institution takes matters intensively for one or more of the following policy concerns: the institution’s risk-taking; the risk of financial failure; and consumer protection. Each of these strands of scholarship examines how an organizational form other than the investor-owned corporation may further one or more of these policy objectives. An alternative entity form may lower the risk that a financial institution would: fail and thus impose costs on investors, customers, or the financial system;14By lowering the risk that a financial institution will fail, an alternative entity form may also mitigate systemic risk, i.e., lower the incidence and severity of financial crises; the failure of financial institution triggering the failure of other institutions represents one channel for systemic risk to propagate. George G. Kaufman & Kenneth E. Scott, What Is Systemic Risk, and Do Bank Regulators Retard or Contribute to It?, 7 INDEP. REV. 371, 372–73 (2003) (describing how systemic risk may arise from chain reaction of financial institution failures). However, even financial firms organized as partnerships or mutuals may not consider the full systemic risk implications of their failure in their decisions to take risks as some of the costs of their failure are externalized on other firms or the entire financial system. break laws or commit misconduct;15See, e.g., Andrew Park, The Endless Cycle of Corporate Crime and Why It’s So Hard to Stop, DUKE LAW NEWS (Jan. 13, 2017), https://law.duke.edu/news/ endless-cycle-corporate-crime-and-why-its-so-hard-stop/ [https://perma.cc/ T88V-YZNK] (“In scandal after scandal . . . big corporations or their employees are found to be flouting laws, often at the expense of consumers or investors.”). or exploit customers or consumers.16See, e.g., Luke Landes, Mutual Vs. Public Insurance Companies, CONSUMERISM COMMENTARY (July 31, 2019), https://www.consumerismcommentary.com/ mutual-vs-public-insurance-companies/ [https://perma.cc/37FB-ZCWG] (last updated July 31, 2018).

Alternative entities—partnerships,17Partnership, BLACK’S LAW DICTIONARY (11th ed. 2019) (“A voluntary association of two or more persons who jointly own and carry on a business for profit.”). mutuals,18Mutual Company, BLACK’S LAW DICTIONARY (11th ed. 2019) (“A company that is owned by its customers rather than by a separate group of stockholders.”). and cooperatives19Cooperative, BLACK’S LAW DICTIONARY (11th ed. 2019) (“An organization or enterprise (as a store) owned by those who use its services.”).—offer one or more of these policy advantages over the investor-owned corporation by changing the basic relationship between a firm’s owners and its management. Some of the aforementioned scholarship focuses on changes in control rights or liability rules with respect to the entity. For example,Professors Hill and Painter write on the benefits that come with an investment bank partnership: personal liability chastens the risk-taking of partners and gives them the incentive and tools to monitor and exercise control over the actions of their co-owners.20Cooperative, BLACK’S LAW DICTIONARY (11th ed. 2019) (“An organization or enterprise (as a store) owned by those who use its services.”). However, the benefits of alternative entity forms flow from more than just the rules surrounding liability and control rights. After all, in many modern partnerships, mutuals, and cooperatives, control is delegated to a small cadre of managers21For example, Professors Hill and Painter highlight the role that executive committees played in governing the old investment banking partnerships. HILL & PAINTER, supra note 3, at 101. and the personal liability of owners in many forms such as mutuals remains limited.22For example, state statutes typically limit the liability of policyholders in a mutual insurance company to payment of premiums specified in the policy. E.g., NEB. REV. STAT. § 44-218 (2019). Alternative entity forms exert a profound and often socially beneficial influence on the behavior of these managers by changing the identity of the residual claimant of the firm.23See Oliver E. Williamson, Organization Form, Residual Claimants, and Corporate Control, 26 J.L. & ECON. 351, 356–60 (1983). Even if a firm’s residual claimant—–the economic actor or actors entitled to the firm’s net cash flows after all debts and other claims have been paid24Eugene F. Fama & Michael C. Jensen, Separation of Ownership and Control, 26 J.L. & ECON. 301, 302–03 (1983).—has weak levers to control management, management has no other claimants to whom it is ultimately beholden. This can dramatically reorient management’s incentives and refashion its culture. Management in an investor-owned corporation faces strong pressures to serve profit-seeking shareholders with potentially no other ties to the firm.25Leo E. Strine, Jr., One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term?, 66 BUS. LAW. 1, 9–13 (2010). Management of a corporation may follow the norm of shareholder wealth maximization.26Bernard S. Sharfman, Shareholder Wealth Maximization and its Implementation Under Corporate Law, 66 FLA. L. REV. 389 (2014). By contrast, management of partnerships, mutuals, and cooperatives are ultimately responsible to altogether different constituents: employees or producers (as is the case with investment banking partnerships) or consumers (as with mutual or cooperative banks and insurance companies).27This explanation tracks Henry Hansmann’s work, which sees the identity of the residual claimant as central to the behavior of alternative entities such as mutuals and cooperatives. Hansmann explains the importance of the identity of the residual claimants compared to control rights in the following passage: [B]y virtue of their ownership, the patrons are assured that there is no other group of owners to whom management is responsive. It is one thing to transact with a firm whose firm whose managers are nominally your agents but are not much subject to your control; it is another to transact with a firm whose managers are actively serving owners who have an interest clearly adverse to yours. HANSMANN, supra note 12, at 48.

The organizational form, and particularly alternatives to investor-owned corporations, represents a potentially powerful but forgotten tool in the regulatory arsenal. Redefining who bears liability for a firm’s debts in the case of its insolvency, who the firm’s residual claimant is, and who exercises control and how that control is exercised, can profoundly alter a firm’s risk-taking and treatment of consumers.28See id. at 255–56, 269–70. Moreover, the organizational form as a regulatory tool offers advantages over existing financial regulation. It engages firm owners, and not just government regulators, in policing risk-taking, market conduct, and legal compliance.29See infra section IV.C. It also offers governance mechanisms that are more time-tested than many recent novel proposals that seek to expand the fiduciary duties of directors and officers, whether in terms of the duties owed, which persons owe the duties, and to whom those duties run.30For a review and critique of corporate governance proposals to address systemic risk, particularly proposals involving modifying fiduciary duties of bank directors and officers, see Robert C. Hockett, Are Bank Fiduciaries Special?, 68 ALA. L. REV. 1071, 1107–10 (2017).

Deploying the set of tools offered by remutualization requires careful consideration not only of the benefits but also of the costs. Chief among those costs are the difficulties that alternative entity forms would face in raising large amounts of capital and expanding the scope and complexity of their operations.31See infra section IV.A.3; HANSMANN, supra note 12, at 273–74. However, this might prove to be a virtue. Investment banks reverting to partnership form or large lenders or insurance companies remutualizing would create checks on the size and complexity of these financial institutions. The organizational form would serve as an alternative to breaking up large financial institutions to address “Too-Big-To-Fail” and related concerns.32For a primer on the “Too-Big-To-Fail” problem and an argument that the Dodd-Frank Act did not solve it, see Arthur E. Wilmarth, Jr., The Dodd-Frank Act: A Flawed and Inadequate Response to the Too-Big-to-Fail Problem, 89 OR. L. REV. 951 (2011). In this sense, remutualization bears a strong resemblance to Professor Stout’s proposal on derivatives, as requiring an “insurable interest” would curb the volume of derivatives.33After the global financial crisis, Professor Stout revisited her Duke Law Journal article and argued that her earlier policy proposals would reduce both the size of the mushrooming derivatives market and systemic risk. See, e.g., Lynn A. Stout, Regulate OTC Derivatives by Deregulating Them, REGULATION, Fall 2009, at 30, 33 (suggesting a return to “common-law rule against difference contracts” to counteract “speculation [that] drives the OTC [(“over the counter”)] derivative markets” and increases systemic risk). In this Article, Professor Stout cited a startling statistic: at the end of 2008, when the financial crisis was peaking, the notional value of all credit default swaps, a derivative used to hedge the credit risk of bonds was $67 trillion, while “the total market value of all the underlying bonds issued by U.S. companies outstanding was only $15 trillion.” Id.

At the same time and by contrast, mutuals may face conflicts among residual claimants when a firm offers very different financial products.34See HANSMANN, supra note 12, at 263, 283–84 (stressing the “importance of homogeneity of interest among the members of a mutual company”). Mutual companies work best for their owners, when those owners have homogenous interests. Homogeneity reduces conflict among residual claimants.35Id. The potential comparative advantages of an investor-owned corporation, however, must be weighed against its costs both to customers and financial markets as described in this Article. There are also overarching risks of financial institutions conglomerating and offering products and services across multiple financial sectors.36See infra notes 184–87 and accompanying text.

Some scholars have described the agency costs faced by owners of partnerships, mutuals, and cooperatives who have limited effective ability to control management. However, mutuals, cooperatives, and partnerships address agency costs in a subtler way beyond control rights. As explained below, changing the identity of the residual claimant of the firm ensures that management will not prioritize the interests of any other claimant above the owners, particularly those of profit-seeking investors.37HANSMANN, supra note 12, at 48. Moreover, evidence from the insurance industry suggests the agency cost concerns associated with mutuals are muted; in many studies, mutual firms do not suffer from worse financial performance or charge higher prices than their investor-owned counterparts.38See infra notes 148–65 and accompanying text.

Professor Hansmann provides a valuable framework for thinking about which stakeholders should optimally own a firm and toward what form of ownership firms in any given industry tend to gravitate. Financial firms, like any other firm, have multiple “patrons,” including employees/producers, capital providers, customers, suppliers, purchasers, and other counterparties. A firm could be owned by any one of these types of patrons. Owners might be:

  • investors whose primary role is to supply capital and whose main interest in the firm are investment returns;
  • employees or producers (as is the case with investment banks in the past and law firm partnerships up to the current day);
  • customers (for example, in mutual banks or insurance companies); or
  • counterparties in an industry (as with members of the old banking or modern securities/derivative clearinghouse).39See HANSMANN, supra note 12, at 46–49.

In Professor Hansmann’s framework, any choice of entity has two sets of costs associated with it:

Market contracting costs: the costs of patrons who do not have ownership rights over the firm who must contract with the firm in the marketplace; and

The ownership costs of the patrons that do have those rights.40See id. at 48 (discussing both costs of market contracting and costs of ownership).

This framework comes straight from the established “theory of the firm” literature.41Id. at 19–20. Professor Hansmann theorizes that the optimal form of entity is one that minimizes the sum of market contracting and ownership costs.42Henry Hansmann, Ownership of the Firm, 4 J.L. ECON. & ORG. 267, 273 (1988) (“Efficiency will be best served if ownership is assigned [s]o that total transaction costs for all patrons are minimized. This means minimizing the sum of both the costs of market contracting for those patrons who are not owners, and the costs of ownership for the class of patrons who are assigned ownership.” (footnote omitted) ). Over time, firms in an industry may gravitate towards the optimal form, e.g., toward investor- or mutually owned firms.

This Article explores whether modern investment banks, commercial banks, insurance companies, and firms within a financial industry sector as a collective impose too high market-contracting costs on a wide set of patrons of the firm. To the extent that customers, consumers, and counterparties of firms in a particular financial services sector cannot adequately protect their interests via contract—whether due to asymmetric information with respect to the products and services being offered, behavioral biases, or market structures—some version of partnership, mutual, or cooperative may become increasingly attractive in terms of net social benefits.43HANSMANN, supra note 12, at 21–22. Furthermore, when the behavior—and notably the insolvency—of a particular type of financial firm imposes significant spillover costs on financial markets, market participants cannot protect themselves through contract or investment diversification. In this situation, systemic risk manifests.44Kaufman & Scott, supra note 14, at 371–74. One of these alternative forms may then become even more attractive as a means to mitigate this risk. A partnership, mutual, or cooperative might reduce firm size or internalize spillover costs, in either case reducing the risk profile of the firm vis-à-vis financial markets. In these scenarios, higher market contracting costs might outweigh any costs associated with ownership of these alternative organizational forms. Note that while an alternative organizational form might address systemic risk, it can never do so to perfection. Absent regulation or external constraints, no financial firm has incentive to completely internalize all the costs of its failure. The analysis in this Article is instead comparative: what net social benefits or costs does an alternative organizational form for a financial company have relative to an investor-owned counterpart?

Returning to many of these alternative organizational forms—the partnerships, mutuals, cooperatives, or clearinghouses—would rethink and reverse the wave of demutualization that swept through the financial services sector from the 1970s to the early 2000s. This wave resulted in financial services firms converting to investor-owned corporations and conducting initial public offerings (IPOs).45In addition to investment banks and mutual insurance companies, other types of financial intermediaries with similar organizational structures also chose to transform into publicly traded corporations. For some of the literature on the demutualization of stock exchanges, see Reena Aggarwal, Demutualization and Corporate Governance of Stock Exchanges, 15 J. APPLIED CORP. FIN. 105, 107–10 (2002); Caroline Bradley, Demutualization of Financial Exchanges: Business as Usual?, 21 NW. J. INT’L L. & BUS. 657, 667–73 (2001); Andreas M. Fleckner, Stock Exchanges at the Crossroads, 74 FORDHAM L. REV. 2451, 2575–85 (2006); Karmel, supra note 5 at 409–13. In the 2000s, the Mastercard and Visa payment card networks transformed from entities owned by card-issuing banks into corporations and conducted initial public offerings. Victor Fleischer, The MasterCard IPO: Protecting the Priceless Brand, 12 HARV. NEGOT. L. REV. 137, 144–45 (2007); Eric Dash, Big Payday for Wall St. in Visa’s Public Offering, N.Y. TIMES (Mar. 19, 2008), https://www.ny times.com/2008/03/19/business/19visa.html [https://perma.cc/2CBL-A64E] (describing largest IPO in U.S. history to that date). Scholars have analyzed how incorporation and IPOs responded to antitrust litigation against the networks. See, e.g., Scott R. Peppet, Updating Our Understanding of the Role of Lawyers: Lessons from MasterCard, 12 HARV. NEGOT. L. REV. 175, 179–84 (2007) (noting that the IPO was a way for MasterCard to compete with Visa); Joshua D. Wright, MasterCard’s Single Entity Strategy, 12 HARV. NEGOT. L. REV. 225, 229 (2007) (suggesting that MasterCard’s single entity strategy could shield it from liability under Section 1 of the Sherman Act). The benefits and costs of demutualization and remutualization in the stock exchange and payment network contexts are worth exploring but are beyond the scope of this Article. Over this period, large investment banks abandoned the partnership form.46See infra section I.A. The end of the twentieth century saw a wave of demutualization among large life insurance companies.47See infra section I.C. Both types of firms, investment banks and insurance companies, became publicly traded corporations in an effort to raise capital, expand the scope of their operations into new financial markets, and compete globally.48See infra sections I.A and I.C. These different categories of financial institutions also sought to compete with one another across financial services sectors, when both regulators, and Congress lowered the Glass-Steagall-era legal walls separating the businesses of banking, securities, and insurance.49For a history of the end of Glass-Steagall, see ARTHUR E. WILMARTH, JR.,
TAMING THE MEGABANKS—WHY WE NEED A NEW GLASS-STEAGALL ACT ch. 7–8 (forthcoming 2020), and Arthur E. Wilmarth, Jr., The Road to Repeal of the Glass-Steagall Act, 17 WAKE FOREST J. BUS. & INTELL. PROP. L. 441, 492–503 (2017) [hereinafter Wilmarth, Road to Repeal]. For a germinal analysis of how the demise of Glass-Steagall fostered the creation of financial conglomerates that spanned banking, securities, and insurance business lines, see Arthur E. Wilmarth, Jr., The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis, 41 CONN. L. REV. 963, 972–79 (2009) [hereinafter Wilmarth, Dark Side of Universal Banking]; Arthur E. Wilmarth, Jr., The Transformation of the U.S. Financial Services Industry, 1975–2000: Competition, Consolidation, and Increased Risks, 2002 U. ILL. L. REV. 215, 219–20.
Looking backwards, this wave of demutualization followed a much earlier transformation in the twentieth century in which mutually owned banks and savings and loan associations lost ground to their investor-owned, corporate competitors.50HANSMANN, supra note 12, at 254–58. Note that the transformational shift toward investor-owned corporations continues into the current day albeit with a twist: prominent asset management firms have previously conducted IPOs and only recently began converting from partnerships to corporations.51Michael J. de la Merced, Blackstone Will Ditch Partnership Structure to Draw More Investors, N.Y. TIMES (Apr. 18, 2019), https://www.nytimes.com/ 2019/04/18/business/dealbook/blackstone-corporate-structure.html [https:// perma.cc/58DR-MMM9] (“The Blackstone Group said on Thursday that it planned to convert itself into a standard corporation, becoming the latest investment firm to abandon its partnership structure . . . .”); Heather Perlberg, Carlyle Plans to Announce Conversion to C-Corp With Earnings, BLOOMBERG (July 9, 2019), https://www.bloomberg.com/news/articles/2019-07-09/carlyle-plans-to-announce-conversion-to-c-corp-with-earnings [https://perma.cc/G2F4-HAB3] (“The Washington-based firm would be the last of the private-equity giants to switch from a partnership to a corporation . . . .”). At the same time, U.S. law firms and other legal service companies have recently again flirted with the idea of following several U.K. law firms and conducting an IPO.52Roy Strom, Why U.S. Legal Businesses Flirt with IPOs But Don’t Commit, BLOOMBERGLAW (Sept. 12, 2019), https://news.bloomberglaw.com/us-law-week/ why-u-s-legal-businesses-flirt-with-ipos-but-dont-commit [https://perma.cc/ D8J4-2DEV]. The changes that came when previous financial sector firms converted to the corporate form, including enhanced risk-taking and refocusing from the interests of clients and customers to those of share- holders, may now reach new sectors of the financial services industry. This makes revisiting the consequences of earlier demutualizations of financial institutions all the more pressing.

Many factors explain demutualization and the rise of investor-owned financial firms at the expense of mutuals. The increasing effectiveness of financial regulation represents perhaps the most surprising factor.53See HANSMANN, supra note 12, at 255–56. Professor Hansmann argues that the shift in the late nineteenth and early twentieth century away from mutual banks and toward investor-owned corporate banks stemmed from the fact that more effective bank regulation convinced depositors increasingly to deposit their savings with the corporate banks they previously distrusted as too unstable.54See id. at 255. Similarly, effective state insurance regulation gave assurances to life insurance policy holders that they could trust corporate insurers and not just mutuals.55See id. (explaining how these regulations “gave depositors some assurance that investor-owned banks would not speculate excessively with the funds entrusted to them. This form of regulation was evidently sufficiently effective to deprive the mutual banks of their decisive competitive advantage over investor-owned banks”). However, now, the global financial crisis has called into question the continuing effectiveness of banking and other regulations. The failure of financial institution regulation calls for a reckoning of the costs of decades of demutualization. This failure also creates an opening for reconsidering and reviving the use of partnerships, cooperatives, and mutually owned entities in financial services.56See infra Part IV.

Prosecutors and agencies might require remutualization of a firm that has committed severe misconduct as an alternative to shuttering the firm or imposing fines. Policymakers can promote remutualization by providing preferences in financial regulation. These preferences could lighten regulatory requirements in areas in which partnerships or the mutual form provide partial policy solutions. For example, if investment bank partnerships or mutually owned banks have incentives to make less risky investments and thus pose a lower risk of insolvency, then policymakers should require less regulatory capital or charge lower premia for deposit insurance.57See HANSMANN, supra note 12, at 257 (“If the government had responded by charging lower premiums on deposit insurance to mutual banks than to investor-owned banks, the mutual banks might still have been able to translate their advantages as fiduciaries into a competitive advantage vis-à-vis investor-owned banks.”). Historically, policymakers granted these sorts of regulatory preferences to some mutually owned entities.58Id. at 257–58. Legally, they may be required to do so under certain statutory regimes.59For example, the Federal Deposit Insurance Corporation Improvement Act of 1991 required that a federal agency change to a “risk-based” assessment approach for charging premia for its deposit insurance. Pub. L. 102-242, 105 Stat. 2236 (Dec. 19, 1991) (codified at 12 U.S.C. § 1817(b) ). Policymakers could also foster remutualization by restoring and expanding the tax preferences that were historically given to certain mutual firms.60HANSMANN, supra note 12, at 275–76 (describing tax incentives for life insurance mutuals).

This Article proceeds as follows: Part I takes stock of the history of demutualization across different categories of financial institutions. It sketches out the social cost of financial institutions abandoning the partnership or mutual form and reviews legal scholarship that proposes reversion to the earlier organizational forms. Part II shifts from the organizational form of individual firms to examine proposals for mutualizing risk, particularly systemic risk, across the industry. Part III discusses policy instruments that could promote remutualization. Part IV outlines the benefits and costs of using these policy instruments, including the costs of the alternative organizational forms compared to the investor-owned corporation.

To read more, click here: Remutualization.

References   [ + ]

1. Lynn A. Stout, Why the Law Hates Speculators: Regulation and Private Ordering in the Market for OTC Derivatives, 48 DUKE L.J. 701, 777–78 (1999).
2. Id. at 777–82. Under this doctrine, insurance and, in turn, derivative contracts are only legally enforceable if at least one of the parties uses the contract to transfer or hedge a preexisting risk. Id. at 725. If the contract involves the transfer of risks to which neither counterparty was subject before the bargain was struck, then courts would not enforce the agreement. Id. at 724–27. The operation of this rule can be seen in a simple example: the common law would not enforce a contract in which one person purchases fire insurance for a neighbor’s house.
3. See CLAIRE A. HILL & RICHARD W. PAINTER, BETTER BANKERS, BETTER BANKS: PROMOTING GOOD BUSINESS THROUGH CONTRACTUAL COMMITMENT 146–48 (2015).
4. See Saule T. Omarova, Wall Street as a Community of Fate: Toward Financial Industry Self-Regulation, 159 U. PA. L. REV. 411, 419–20 (2011).
5. See, e.g., Roberta S. Karmel, Turning Seats into Shares: Causes and Implications of Demutualization of Stock and Futures Exchanges, 53 HASTINGS L.J. 367, 403–07 (2002) (tracing legislative and regulatory history of stock exchange demutualization in the United States).
6. Gary Gorton, Clearinghouses and the Origin of Central Banking in the United States, 45 J. ECON. HIST. 277, 282–83 (1985).
7. Paolo Saguato, The Ownership of Clearinghouses: When “Skin in the Game” Is Not Enough, the Remutualization of Clearinghouses, 34 YALE J. ON REG. 601, 601 (2017).
8. Id. at 601, 603–05.
9. Id. at 642–46.
10. Id. at 659–65.
11. See, e.g., Ryan Bubb & Alex Kaufman, Consumer Biases and Mutual Ownership, 105 J. PUB. ECON. 39, 46 (2013) (finding that credit unions have lower purchase and default annual percentage rates and lower late and over-the-limit fees than investor-owned issuers).
12. See, e.g., HENRY HANSMANN, THE OWNERSHIP OF ENTERPRISE 249–50, 255–57 (2000).
13. See id. at 267–70.
14. By lowering the risk that a financial institution will fail, an alternative entity form may also mitigate systemic risk, i.e., lower the incidence and severity of financial crises; the failure of financial institution triggering the failure of other institutions represents one channel for systemic risk to propagate. George G. Kaufman & Kenneth E. Scott, What Is Systemic Risk, and Do Bank Regulators Retard or Contribute to It?, 7 INDEP. REV. 371, 372–73 (2003) (describing how systemic risk may arise from chain reaction of financial institution failures). However, even financial firms organized as partnerships or mutuals may not consider the full systemic risk implications of their failure in their decisions to take risks as some of the costs of their failure are externalized on other firms or the entire financial system.
15. See, e.g., Andrew Park, The Endless Cycle of Corporate Crime and Why It’s So Hard to Stop, DUKE LAW NEWS (Jan. 13, 2017), https://law.duke.edu/news/ endless-cycle-corporate-crime-and-why-its-so-hard-stop/ [https://perma.cc/ T88V-YZNK] (“In scandal after scandal . . . big corporations or their employees are found to be flouting laws, often at the expense of consumers or investors.”).
16. See, e.g., Luke Landes, Mutual Vs. Public Insurance Companies, CONSUMERISM COMMENTARY (July 31, 2019), https://www.consumerismcommentary.com/ mutual-vs-public-insurance-companies/ [https://perma.cc/37FB-ZCWG] (last updated July 31, 2018).
17. Partnership, BLACK’S LAW DICTIONARY (11th ed. 2019) (“A voluntary association of two or more persons who jointly own and carry on a business for profit.”).
18. Mutual Company, BLACK’S LAW DICTIONARY (11th ed. 2019) (“A company that is owned by its customers rather than by a separate group of stockholders.”).
19. Cooperative, BLACK’S LAW DICTIONARY (11th ed. 2019) (“An organization or enterprise (as a store) owned by those who use its services.”).
20. Cooperative, BLACK’S LAW DICTIONARY (11th ed. 2019) (“An organization or enterprise (as a store) owned by those who use its services.”).
21. For example, Professors Hill and Painter highlight the role that executive committees played in governing the old investment banking partnerships. HILL & PAINTER, supra note 3, at 101.
22. For example, state statutes typically limit the liability of policyholders in a mutual insurance company to payment of premiums specified in the policy. E.g., NEB. REV. STAT. § 44-218 (2019).
23. See Oliver E. Williamson, Organization Form, Residual Claimants, and Corporate Control, 26 J.L. & ECON. 351, 356–60 (1983).
24. Eugene F. Fama & Michael C. Jensen, Separation of Ownership and Control, 26 J.L. & ECON. 301, 302–03 (1983).
25. Leo E. Strine, Jr., One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term?, 66 BUS. LAW. 1, 9–13 (2010).
26. Bernard S. Sharfman, Shareholder Wealth Maximization and its Implementation Under Corporate Law, 66 FLA. L. REV. 389 (2014).
27. This explanation tracks Henry Hansmann’s work, which sees the identity of the residual claimant as central to the behavior of alternative entities such as mutuals and cooperatives. Hansmann explains the importance of the identity of the residual claimants compared to control rights in the following passage: [B]y virtue of their ownership, the patrons are assured that there is no other group of owners to whom management is responsive. It is one thing to transact with a firm whose firm whose managers are nominally your agents but are not much subject to your control; it is another to transact with a firm whose managers are actively serving owners who have an interest clearly adverse to yours. HANSMANN, supra note 12, at 48.
28. See id. at 255–56, 269–70.
29. See infra section IV.C.
30. For a review and critique of corporate governance proposals to address systemic risk, particularly proposals involving modifying fiduciary duties of bank directors and officers, see Robert C. Hockett, Are Bank Fiduciaries Special?, 68 ALA. L. REV. 1071, 1107–10 (2017).
31. See infra section IV.A.3; HANSMANN, supra note 12, at 273–74.
32. For a primer on the “Too-Big-To-Fail” problem and an argument that the Dodd-Frank Act did not solve it, see Arthur E. Wilmarth, Jr., The Dodd-Frank Act: A Flawed and Inadequate Response to the Too-Big-to-Fail Problem, 89 OR. L. REV. 951 (2011).
33. After the global financial crisis, Professor Stout revisited her Duke Law Journal article and argued that her earlier policy proposals would reduce both the size of the mushrooming derivatives market and systemic risk. See, e.g., Lynn A. Stout, Regulate OTC Derivatives by Deregulating Them, REGULATION, Fall 2009, at 30, 33 (suggesting a return to “common-law rule against difference contracts” to counteract “speculation [that] drives the OTC [(“over the counter”)] derivative markets” and increases systemic risk). In this Article, Professor Stout cited a startling statistic: at the end of 2008, when the financial crisis was peaking, the notional value of all credit default swaps, a derivative used to hedge the credit risk of bonds was $67 trillion, while “the total market value of all the underlying bonds issued by U.S. companies outstanding was only $15 trillion.” Id.
34. See HANSMANN, supra note 12, at 263, 283–84 (stressing the “importance of homogeneity of interest among the members of a mutual company”).
35. Id.
36. See infra notes 184–87 and accompanying text.
37. HANSMANN, supra note 12, at 48.
38. See infra notes 148–65 and accompanying text.
39. See HANSMANN, supra note 12, at 46–49.
40. See id. at 48 (discussing both costs of market contracting and costs of ownership).
41. Id. at 19–20.
42. Henry Hansmann, Ownership of the Firm, 4 J.L. ECON. & ORG. 267, 273 (1988) (“Efficiency will be best served if ownership is assigned [s]o that total transaction costs for all patrons are minimized. This means minimizing the sum of both the costs of market contracting for those patrons who are not owners, and the costs of ownership for the class of patrons who are assigned ownership.” (footnote omitted) ).
43. HANSMANN, supra note 12, at 21–22.
44. Kaufman & Scott, supra note 14, at 371–74.
45. In addition to investment banks and mutual insurance companies, other types of financial intermediaries with similar organizational structures also chose to transform into publicly traded corporations. For some of the literature on the demutualization of stock exchanges, see Reena Aggarwal, Demutualization and Corporate Governance of Stock Exchanges, 15 J. APPLIED CORP. FIN. 105, 107–10 (2002); Caroline Bradley, Demutualization of Financial Exchanges: Business as Usual?, 21 NW. J. INT’L L. & BUS. 657, 667–73 (2001); Andreas M. Fleckner, Stock Exchanges at the Crossroads, 74 FORDHAM L. REV. 2451, 2575–85 (2006); Karmel, supra note 5 at 409–13. In the 2000s, the Mastercard and Visa payment card networks transformed from entities owned by card-issuing banks into corporations and conducted initial public offerings. Victor Fleischer, The MasterCard IPO: Protecting the Priceless Brand, 12 HARV. NEGOT. L. REV. 137, 144–45 (2007); Eric Dash, Big Payday for Wall St. in Visa’s Public Offering, N.Y. TIMES (Mar. 19, 2008), https://www.ny times.com/2008/03/19/business/19visa.html [https://perma.cc/2CBL-A64E] (describing largest IPO in U.S. history to that date). Scholars have analyzed how incorporation and IPOs responded to antitrust litigation against the networks. See, e.g., Scott R. Peppet, Updating Our Understanding of the Role of Lawyers: Lessons from MasterCard, 12 HARV. NEGOT. L. REV. 175, 179–84 (2007) (noting that the IPO was a way for MasterCard to compete with Visa); Joshua D. Wright, MasterCard’s Single Entity Strategy, 12 HARV. NEGOT. L. REV. 225, 229 (2007) (suggesting that MasterCard’s single entity strategy could shield it from liability under Section 1 of the Sherman Act). The benefits and costs of demutualization and remutualization in the stock exchange and payment network contexts are worth exploring but are beyond the scope of this Article.
46. See infra section I.A.
47. See infra section I.C.
48. See infra sections I.A and I.C.
49. For a history of the end of Glass-Steagall, see ARTHUR E. WILMARTH, JR.,
TAMING THE MEGABANKS—WHY WE NEED A NEW GLASS-STEAGALL ACT ch. 7–8 (forthcoming 2020), and Arthur E. Wilmarth, Jr., The Road to Repeal of the Glass-Steagall Act, 17 WAKE FOREST J. BUS. & INTELL. PROP. L. 441, 492–503 (2017) [hereinafter Wilmarth, Road to Repeal]. For a germinal analysis of how the demise of Glass-Steagall fostered the creation of financial conglomerates that spanned banking, securities, and insurance business lines, see Arthur E. Wilmarth, Jr., The Dark Side of Universal Banking: Financial Conglomerates and the Origins of the Subprime Financial Crisis, 41 CONN. L. REV. 963, 972–79 (2009) [hereinafter Wilmarth, Dark Side of Universal Banking]; Arthur E. Wilmarth, Jr., The Transformation of the U.S. Financial Services Industry, 1975–2000: Competition, Consolidation, and Increased Risks, 2002 U. ILL. L. REV. 215, 219–20.
50. HANSMANN, supra note 12, at 254–58.
51. Michael J. de la Merced, Blackstone Will Ditch Partnership Structure to Draw More Investors, N.Y. TIMES (Apr. 18, 2019), https://www.nytimes.com/ 2019/04/18/business/dealbook/blackstone-corporate-structure.html [https:// perma.cc/58DR-MMM9] (“The Blackstone Group said on Thursday that it planned to convert itself into a standard corporation, becoming the latest investment firm to abandon its partnership structure . . . .”); Heather Perlberg, Carlyle Plans to Announce Conversion to C-Corp With Earnings, BLOOMBERG (July 9, 2019), https://www.bloomberg.com/news/articles/2019-07-09/carlyle-plans-to-announce-conversion-to-c-corp-with-earnings [https://perma.cc/G2F4-HAB3] (“The Washington-based firm would be the last of the private-equity giants to switch from a partnership to a corporation . . . .”).
52. Roy Strom, Why U.S. Legal Businesses Flirt with IPOs But Don’t Commit, BLOOMBERGLAW (Sept. 12, 2019), https://news.bloomberglaw.com/us-law-week/ why-u-s-legal-businesses-flirt-with-ipos-but-dont-commit [https://perma.cc/ D8J4-2DEV].
53. See HANSMANN, supra note 12, at 255–56.
54. See id. at 255.
55. See id. (explaining how these regulations “gave depositors some assurance that investor-owned banks would not speculate excessively with the funds entrusted to them. This form of regulation was evidently sufficiently effective to deprive the mutual banks of their decisive competitive advantage over investor-owned banks”).
56. See infra Part IV.
57. See HANSMANN, supra note 12, at 257 (“If the government had responded by charging lower premiums on deposit insurance to mutual banks than to investor-owned banks, the mutual banks might still have been able to translate their advantages as fiduciaries into a competitive advantage vis-à-vis investor-owned banks.”).
58. Id. at 257–58.
59. For example, the Federal Deposit Insurance Corporation Improvement Act of 1991 required that a federal agency change to a “risk-based” assessment approach for charging premia for its deposit insurance. Pub. L. 102-242, 105 Stat. 2236 (Dec. 19, 1991) (codified at 12 U.S.C. § 1817(b) ).
60. HANSMANN, supra note 12, at 275–76 (describing tax incentives for life insurance mutuals).

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