Failures of Chinese Walls, In Financial Houses
A new article explores the failures of Chinese walls in financial services firms. In other words, actually looking at the gulf between theory and reality as to Chinese walls. Facts and data of this sort may serve as catalysts for new legal arguments and conclusions. A portion of the summary provides the following overview:
Editor’s Note: Andrew Tuch is Associate Professor of Law at Washington University School of Law.
"In my paper, Financial Conglomerates and Chinese Walls, which was recently made available on SSRN, I examine the effectiveness of Chinese walls, or information barriers, in preventing financial conglomerates from misusing non-public information in their trading and other activities. In recent years, empirical evidence has shown that financial conglomerates’ Chinese walls fail in important contexts, allowing firms to trade using non-public information they garner from their clients. Nevertheless, Chinese walls continue to have the legal effect of allowing financial conglomerates to discharge the otherwise incompatible client duties they owe under agency law. These incompatible duties arise due to the inflexible application of agency law and to financial conglomerates’ organizational structure, under which firms act for numerous clients across a broad and diverse range of financial activities, accumulating vast quantities of non-public information in doing so. As agents, firms are duty-bound to disclose material information in their possession to clients, and yet to do so is to breach duties of confidence owed to other clients. Chinese walls help financial conglomerates to reconcile their otherwise incompatible duties.
In this paper, I discuss the phenomenon of failing Chinese walls, explain why it occurs, and propose a regulatory solution. By examining Chinese walls, the article contributes to the long-running debate in legal and financial economic literature on the merits of Chinese walls in addressing the regulatory challenges of financial conglomeration. Business and economic scholars have focused on establishing the existence of the phenomenon of failing Chinese walls, but apparently without considering regulatory reforms. To date, legal scholars have questioned the effectiveness of Chinese walls and suggested denying them legal effect, but apparently not considered how to detect and prove their failure and thereby increase incentives for firms to bolster their effectiveness. This article contributes to these strands of literature primarily by explaining why Chinese walls fail and suggesting how regulators can address those failures."