Abstract
Liability of financial regulators is a controversial topic in Europe. Some countries have statutory protections in place to protect their financial regulators from being sued, while other countries are submitting their financial regulators to normal liability rules. The main argument for protection can be found in the chilling effect the threat of tort law could have on the performance of financial regulators. On the other hand, the preventive effect of tort law is considered one of the most important arguments in favour of holding financial regulators liable. In order to understand which of these two arguments is valid, I examine the impact of liability rules on the behaviour of Dutch financial regulators by using a positive economic analysis. The basic economic model of regulator liability suggests that tort law gives financial regulators incentives to take adequate care in performing their assigned tasks. This model, however, is not quite accurate. When taking into account several specific characteristics of the context in which the Dutch financial regulators operate, it becomes clear that the current liability regime in the Netherlands does not give proper incentives for taking adequate care. On the contrary, with the existence of a deposit guarantee system, safeguard clauses and the possibility for insurance, under deterrence is more likely to occur. This also means that the threat of liability leading to defensive conduct is unlikely. Thus, from a Law and Economics perspective, neither of the mentioned arguments seems to be valid in the case of Dutch financial regulators. Because financial regulators in other European countries have several of the mentioned characteristics in common, the outcome of this analysis may also apply to them.
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References and Notes
See Tison, M. (2003) Challenging the Prudential Supervisor: Liability Versus (Regulatory) Immunity. Financial Law Institute Working Paper 2003–2004.
For an economic analysis of the liability of Dutch financial regulators see also Dijkstra, R.J. and Visscher, L.T. (2007) Een pleidooi voor beperkte aansprakelijkheid van financieel toezichthouders wegens falend toezicht. [A plea for limited liability of financial supervisors for failing supervision] Tijdschrift voor Financieel Recht 9 (5): 140–147.
See for example Schedule 1, Section 19(1) of the Financial Services and Markets Act (FMSA) 2000 (United Kingdom), Article 4 (2–3) Financial Supervision Authority Act (FSAA) and Article 58 FSAA in combination with Article 13 (3) of the State Liability Act (Estonia), Section 25A Central Bank of Ireland Act 1997 (Ireland). The term immunity seems to indicate that these financial regulators cannot be sued at all. However, this is not the case. Exceptions to this immunity are formed by acts of omissions in bad faith (see for instance Schedule 1, Section 19(3) FMSA 2000 for the UK situation).
For example Germany. See Proctor, C. (2002) Regulator immunity and legal risk. The Financial Regulator 7 (3): 27–39.
Proctor, C. (2004) The liability of financial regulators for financial institution failures. Amicus Curiae 52(March/April): 23–28.
See Basel Committee on Banking Supervision. (2006) Core Principles for Effective Banking Supervision. Basel, Switzerland: Bank for International Settlements.
For this argument see Delston,8 pp. 1–2; Tison,1 p. 7; Proctor,4 p. 27; Singh,9 p. 216 and more in general Booth and Squires,10 p. 180.
Delston, R.S. and Campbell, A. (2006) To protect or not to protect, that is the question: Statutory protections for financial supervisors – How to Promote Financial Stability by Enacting the Right Laws. Paper presented at the Seminar on Current Developments in Monetary and Financial Law; 23–27 October, Washington DC.
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Booth, C. and Squires, D. (2005) The Negligence Liability of Public Authorities. Oxford: Oxford University Press.
Among many others see, for instance, Cooter and Ulen,12 p. 325; Shavell,13 p. 1; Van Boom,14 p. 287; Visscher,15 p. 1; Giesen,16 pp. 14–15 and Van Dam,17 p. 136. Besides tort law there are also other instruments that, in theory, could give financial regulators incentives for taking (greater) care. Examples of these instruments are public law, criminal law and threat of reputation loss.
Cooter, R. and Ulen, T. (2007) Law & Economics, 5th edn. New York: Pearson Addison Wesley.
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See Giesen,16 p. 15. It is important to notice that not all accidents will be avoided due to the presence of tort liability. While it was never meant to deter accidents entirely, tort law is aimed at lessening the number and severity of accidents that would otherwise occur.
See Tison,1 p. 3. This type of liability occurs most frequently and receives a lot of media attention. Examples include Vie d’Or, Befra, Van der Hoop (the Netherlands), BCCI (UK) and Banque Phocéenne (France).
Positive economic analysis has to be distinguished from a normative economic analysis. The latter goes one step further and makes policy recommendations based on the consequences of various policies. The key concept for normative analysis is efficiency. However, in this paper, I give no recommendations based on the outcome of my positive economic analysis. My only goal is to show the readers, from a theoretical point of view, the most likely impact of tort law on the behaviour of financial regulators.
Many of these characteristics will also apply to other financial regulators in Europe.
A lawyer being asked the same question would probably answer ‘consumer protection’.
See for example Heremans, D. (2000) Regulation of banking and financial markets. In: B. Bouckaert and G. de Geest (eds.) Encyclopedia of Law and Economics. Volume II. Civil Law and Economics. Cheltenham, UK: Edward Elgar, pp. 950–986.
See Heremans,23 p. 951.
See Singh,9 p. 3 and Heremans,23 p. 961.
See Heremans,23 p. 961.
See De Mot, J. (2001) Overheidsaansprakelijkheid voor toezicht: Een economische analyse. [Governmental liability for failing supervision: An economic analysis], Nederlands Juristen Blad (NJB) 76: 1670–1684.
See for example Giesen,16 p. 15.
This basic economic model of tort law is mainly derived from Cooter and Ulen,12 pp. 335–349.
Notice that this is the situation in which a financial institution goes bankrupt. Other forms of third-party liability are not dealt with in this paper.
Note that not only the quality of supervision, but also the amount of supervision, reduces the risk that financial institutions cause damage through unlawful behaviour. In this paper, I assume that the total amount of supervision is stable and that the quality of supervision is a variable that can be influenced.
See Tison,1 p. 5.
Notice that unlawful behaviour does not always lead to instant damage. Suppose a bank does not comply with the applicable prudential regulation. In the short term, it is unlikely that this will cause damage to their clients. However, the risk of future damage for the clients increases.
For a more detailed explanation see Cooter and Ulen,12 p. 340.
Under the assumption that the financial regulator may not or is not able to recover (a part of) the damages from the financial institution.
Nowadays, almost every lawyer is familiar with the basic knowledge of law and economics and, as a result, with the possible deterrent impact of tort law on the behaviour of various actors. As a consequence, lawyers often use these insights in their publications without a detailed understanding of the underlying mechanisms.
See Spitzer, M.L. (1977) An economic analysis of sovereign immunity in tort. Southern California Law Review 50: 515–548.
The underlying model refers to the ‘Homo Economicus.’ People will act egoistically rational in that they will minimize the costs they are faced with in order to maximize their wealth.
See Kramer and Sykes,40 p. 278; Rosenthal,41 pp. 2, 28.
Kramer, L. and Sykes, A.O. (1987) Municipal liability under § 1983: A legal and economic analysis. Supreme Court Review 249: 249–301.
Rosenthal, L. (2006) A Theory of Government Damages Liability: Torts, Constitutional Torts and Takings. Bepress Legal Series, Paper 967.
See Van Roosebeke,43 p. 118.
Van Roosebeke, B. (2006) State Liability for breaches of European law. An economic analysis. Dissertation University of Hamburg, Germany.
See Cohen,45 p. 218.
Cohen, D.S. (1990) Regulating regulators: The legal environment of the state. University of Toronto Law Journal 40 (213): 213–270.
See Spitzer,37 p. 522.
Niskanen produced the first formal model focusing on decision makers in government, mostly bureaucrats. See Niskanen, W.A. (1971) Bureaucracy and Representative Government. Chicago, IL: Aldine Artherton.
Rosenthal,41 p.18.
An important assumption is that the potential impact of liability claims (in percentage of their total budget) is big enough to motivate them in taking adequate care. David Cohen showed in his article that legal liability costs are often not a major concern to any particular department in determining its budgetary estimates.45 Actual legal exposure never exceeds 0.2 per cent of a departmental budget.
Uncertainty regarding the level of care can decrease over time due to the development of a lot of jurisprudence.
See Kahan,52 p. 437.
Kahan, M. (1989) Causation and incentives to take care under the negligence rule. Journal of Legal Studies, University of Chicago Press, 18 (2): 427–447.
See for instance Section 3.8–3.12 of the conclusion of A-G mr. Timmerman with regards to the outcome of the Vie d’Or case (Supreme Court of the Netherlands, 13 October 2006, no. C04/279HR).
See Section 4.3.3.53.
Derived from Schwartz,56 p. 191.
Schwartz, R. (1998) Auditors’ liability, vague due care, and auditing standards. Review of Quantitative Finance and Accounting 11 (2): 183–207.
See Craswell and Calfee,58 p. 288.
Craswell, R. and Calfee, J.E. (1986) Deterrence and uncertain legal standards. Journal of Law, Economics and Organization 2 (2): 279–303.
See Schäfer and Schönenberger,60 p. 618.
Schäfer, H. and Schönenberger, A. (2000) Strict Liability versus Negligence. In: B. Bouckaert and G. De Geest (eds.) Encyclopedia of Law and Economics. Volume II. Civil Law and Economics. Cheltenham, UK: Edward Elgar, pp. 597–624.
See for instance Schwartz,56 p. 194.
See Dari-Mattiacci, G. and Schäfer, H.B. (2005) The Core of Pure Economic Loss. George Mason University Law and Economics Research Paper Series nr. 05–22, p. 20.
See 2008/0199 (COD) Proposal for a Directive of the European Parliament and of the Council amending Directive 94/19/EC on Deposit Guarantee Schemes as regards the coverage level and the payout delay.
On 7 October 2008, the Dutch minister of Finance announced the new guarantee limits. See also the memorandum of the Dutch Ministry of Finance (FM/2008-2610M) in which the current deposit guarantee limits of the EU are expressed.
See note 64.
See note 64.
See note 63.
See Dutch Parliament (2005–2006), publication 30 300 IXB, no. 2, p. 23 and Dutch Parliament (1995–1996), publication 24 843, no. 1, p. 12. See also the memorandum of the Dutch Ministry of Finance of 17 November 2006 (FM 2006 01624M).
See Shavell, S. (1979) On Moral Hazard and Insurance. The Quarterly Journal of Economics 93 (4): 541–562.
Moral hazard refers to the tendency of insurance protection to alter an individual's motive to prevent loss. See Shavell,69 p. 541.
The AFM refused to make the content of their insurance policy public.
Acknowledgements
I thank Ross Delston, Maurits Barendrecht, Louis Visscher, Machteld de Hoon, Hans Degryse, Reinout Wibier and Charles Proctor for their helpful comments.
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Dijkstra, R. Liability of financial regulators: Defensive conduct or careful supervision?. J Bank Regul 10, 269–284 (2009). https://doi.org/10.1057/jbr.2009.7
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DOI: https://doi.org/10.1057/jbr.2009.7