Andrew Tuch has an interesting new paper (albeit one I'm not sure whose policy recommendations I agree with) on so-called Chinese Walls:
The organizational structure of financial conglomerates gives rise to fundamental regulatory challenges. Legally, the structure subjects firms to multiple, incompatible client duties. Practically, the structure provides firms with a huge reservoir of non-public information that they may use to further their self-interests, potentially harming clients and third parties. The primary regulatory response to these challenges and a core feature of the financial regulatory architecture is the Chinese wall or information barrier. Rather than examine measures to strengthen Chinese walls, to date legal scholars have focused on the circumstances in which to deny them legal effect, while economists have focused on demonstrating Chinese walls' practical ineffectiveness in a range of important contexts.
This paper discusses the phenomenon of failing Chinese walls, explains why it occurs, and proposes a regulatory solution. The paper argues that limits on market discipline and evidential difficulties in detecting and proving the use of non-public information account for the failures of Chinese walls. It shows how the Volcker Rule, a core plank of the Dodd-Frank Act, will likely reduce harms flowing from failing Chinese walls, despite the rule’s intended focus on financial stability. To address the ongoing regulatory challenges, the article proposes the use of statistical inference to both detect and prove trading by financial conglomerates using non-public information and thus the failure of Chinese walls. Employed in so-called forensic finance to detect wrongdoing, the analyses can be used to rule out benign rationales – including superior trading skill and mere coincidence – for financial conglomerates’ abnormal trading returns. The article designs a regulatory strategy based on the use of statistical analyses. Although recognizing limits with the strategy, the article argues that it nevertheless holds promise in addressing the regulatory challenges of financial conglomeration.
I may comment on his policy recommendations later. For the moment, however, I simply want to suggest that it is past time to retire the phrase "Chinese wall." I'm not the most politically correct guy in legal academics, but I nevertheless find the phrase inapt and potentially offensive.
As a California appellate judge aptly noted:
“Chinese Wall” is [a] piece of legal flotsam that should be emphatically abandoned. The term has an ethnic focus that many would consider a subtle form of linguistic discrimination. Certainly, the continued use of the term would be insensitive to the ethnic identity of the many persons of Chinese descent. . . .
Aside from this discriminatory flavor, the term “Chinese Wall” is being used to describe a barrier of silence and secrecy. . . . [But] “Chinese Wall” is not even an architecturally accurate metaphor for the barrier to communication created to preserve confidentiality. Such a barrier functions as a hermetic seal to prevent two-way communication between two groups. The Great Wall of China, on the other hand, was only a one-way barrier. It was built to keep outsiders out--not to keep insiders in.
Peat, Marwick, Mitchell & Co. v. Superior Court, 245 Cal. Rptr. (App. 1988) (Low, P.J., concurring).
In law firms, terms such as “ethical wall” or “ethical screen” are emerging as alternatives. See, e.g.,Ronald R. St. John, When an Ethical Screen Can Be Used to Avoid Vicarious Disqualification of a Law Firm Remains Unsettled, L.A. Lawyer, Feb. 2005, at 29 (“This technique has been referred to in the past as a Chinese wall and is now commonly called an ethical screen.”).
Outside the law firm setting, however, the term “insulation wall” seems superior. Cf. Bernard Shapiro & Neil D. Wyland, Ethical Quandaries of Professionals in Bankruptcy Cases, C836 ALI-ABA 15 (1993) (noting “the recently politically correct expression ‘insulation wall’”). First, it does not connote the professional responsibility aspects associated with the ethical wall terminology. Second, it provides a more exact “architecturally accurate metaphor” than does ethical wall, because it connotes the need to isolate the actors from pressure and to prevent them from providing information to outsiders.
