Faculty of Business Seminar Series / Nejat Seyhun

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

Abstract :

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 allows us to observe the information banks receive and what they do with it. When banks are hired as financial advisers, they become 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’ detriment.  We thus argue that not only should the Volcker Rule remain intact, it should be vigorously enforced.

Place: Meeting Room AB2-345