Seminar: Eliminating Conflicts of Interests in Banks: The Significance of the Volcker Rule

15/12/2017 14:00

Public policy has been focused on controlling the conflicts of interests in banks for the last 85 years with limited success. Banks have a unique place in the economy as intermediaries between investors and companies that allow them to obtain significant private, proprietary information. Public policy is focused on trying to ensure that banks do not misuse this information to their own benefit to the detriment of their clients. This is a tough task.In this paper, we exploit a unique data set that allo ws us to observe the information banks receive and what they do with it. When banks are hired as finan cial advise rs, they bec ome temporary insiders and they are required to report all transactions in their client firms ' stock to the SEC. Using this unique data set, we analyze the kind of information banks acquire about their clients as part of their financial intermediary and advisory roles. Our data show that this information is highly valuable to banks, specifically, that they have been able to earn more than 25% returns above market, from proprietary trades on this information. Furthermore, since relaxation of the Glass - Steagall restrictions which had prohibited commercial banks from engaging in investment banking activities, this return on investment rose to a whopping 40%.The Volcker Rule was enacted to aid in reducing systemic risks in the banking system, and among other purposes, to eliminate conflicts of interest that arise when banks profit at the expense of their clients. We demonstrate that an added benefit of enforcement of the Volcker Rule's prohibition on proprietary trading would be to eliminate these temptations to trade on material, non - public information for their benefit and their clients' detri ment. We thus argue that not only should the Volcker Rule remain intact, it should be vigorously enforced.
Nejat Seyhun is a Professor of Finance and Jerome B. and Eilene M. York Professor of Business Administration at the University of Michigan's Stephen M. Ross School of Business. Professor Seyhun has published extensively in leading finance and economics journals, such as Journal of Finance, Journal of Financial Economics, Journal of Business, Review of Financial Studies, and Journal of Financial and Quantitative Analysis. His research activity focuses on backdating of executive options, risk-return trade-off in asset prices, intra-day impact of insider trading, long-run performance of IPOs, managerial overconfidence, Chinese walls and conflicts of interest in securities firms, option pricing, and conflict between information efficiency and rewards to information gathering. His backdating work with M.P. Narayanan has helped uncover one of the biggest corporate scandals of recent years, bringing to light a business practice with numerous legal, ethical and corporate governance implications.

15.12.2017, 14:00, EMBA 102