Exploiting Regulatory Inconsistencies

Abstract

In many instances, sophisticated parties exploit inconsistencies between regulatory regimes to achieve beneficial treatment under each regime by obtaining classification under one regime that is, at least superficially, inconsistent with classification under the other regime. For instance, parties might design an instrument that is treated as “debt” for tax purposes, but “equity” for purposes of capital requirements instituted by financial regulators.

This Article asks whether exploiting regulatory inconsistencies is problematic. This Article concludes that inconsistency, in and of itself, is not necessarily a problem. Different regulatory regimes might classify a transaction differently when doing so best serves the unique goals of each regime. However, in other cases, inconsistency could be a byproduct of inaccurate classification by at least one regulatory regime. In such cases, the relevant regulator needs to reconsider its classification scheme.