Senator Christopher Dodd (D-CT), the chair of the Senate Banking Committee, has circulated a revised financial services reform proposal designed, in broad terms, “[t]o promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail’, to protect the American taxpayer by ending bailouts, [and] to protect consumers from abusive financial services practices…”
To read the 1,336 page text of the proposed legislation, click here; to read an 11-page summary prepared by the Senate Banking Committee, click here.
In setting forth these ambitious goals this week, Senator Dodd announced that his bill is founded on four key elements:
- An end to “too big to fail” bailouts of significant financial firms, by creating new prudential capital and leverage safeguards, requiring the establishment of “funeral plans” for large firms to provide for their orderly dissolution, and enhancing the Federal Reserve’s authority over both major banking and other financial firms in the event of such liquidations
- Creation of an independent consumer “watchdog,” known as the Consumer Financial Protection Bureau, housed within the Federal Reserve but independent of the Fed and with regulatory autonomy through its Presidentially-appointed director and autonomous rule-making and enforcement authority
- Establishment of an “early warning system” through the formation of a Systemic Risk Council designed to identify and address threats to the stability of the economy posed by large financial companies and complex products, and
- Enhancing transparency and accountability of “exotic” vehicles and financial instruments by requiring the registration of hedge funds and the regulation of over-the-counter derivatives
The bill represents a significant shift from the approach set forth in Senator Dodd’s initial financial services reform proposal in November of last year with respect to the overall regulatory structure and the role of the Federal Reserve; in numerous other ways, the new Dodd proposal tracks his November draft . There are numerous important differences not only between the earlier and the current Dodd proposals, as well as significant differences between the Senator’s current approach and the bill (H.R. 4173) passed by the House of Representatives last December.
The fate of the Senate proposal, scheduled for mark-up in the Senate Banking Committee the week of March 22, remains unclear. Senator Dodd released the proposal with no Republican support and with the ongoing concern of some Democrats. Even if, and assuming, the proposed legislation is adopted by the Senate Banking Committee, further changes will be needed to gain sufficient support to assure adoption by the full Senate; Sen. Richard Shelby (R-AL), for example, has expressed the view that the bill will be difficult to pass without Republican support. Then the Senate bill will need to be reconciled with the House-passed bill. Accordingly, we have highlighted below critical differences in approach, and their impact for the financial services industry and the firms subject to such regulation.
Reliance on existing bank regulatory agencies: The Dodd November draft called for the creation of a single “super” regulator, to be known as the Financial Institutions Regulatory Administration, which would have assumed the regulatory functions of the Office of Thrift Supervision (OTS), the Office of the Comptroller of the Currency (OCC), the state bank supervisory functions of the Federal Deposit Insurance Corporation (FDIC) and the state bank/bank holding company authority of the Federal Reserve. In lieu of this approach, the current Dodd proposal merges the OTS into the OCC and reallocates federal regulatory oversight and examination for depository institutions and their holding companies among the OCC, FDIC and Federal Reserve.
Following this proposed realignment, (i) the FDIC would regulate state banks (including state member banks) and thrift and bank holding companies of state banks with total consolidated assets below $50 billion; (ii) the OCC would regulate nationally chartered banks and thrifts and holding companies of such banks and thrifts with total consolidated assets below $50 billion; and (iii) the Federal Reserve would regulate all holding companies with total consolidated assets over $50 billion. With respect to multi-charter holding companies with total consolidated assets below $50 billion, when such holding company owns or controls both state and federally chartered depository institutions, regulation and oversight will be allocated to either the FDIC or the OCC depending on the total consolidated assets of the state and federal depository subsidiaries. The OCC would regulate the holding company if the total consolidated assets of all federally chartered depository subsidiaries exceed the total consolidated assets of the state chartered depository subsidiaries. The FDIC would regulate the holding company if the total consolidated assets of state chartered depository subsidiaries exceeded the total consolidated assets of the federally chartered subsidiary depositories. In this way, the new Dodd proposal is closer in concept to the House-passed bill, the major area of divergence being the more limited scope of regulatory authority for the Federal Reserve in the current Dodd plan, constrained to the largest holding companies meeting or exceeding the minimum $50 billion asset threshold.
Consumer financial protection without a new agency: While emphasizing that inadequate consumer protection in the financial services area contributed to the current economic crisis, Senator Dodd failed to attract the support of any Republicans on the Senate Banking Committee in his effort to establish a new federal agency with jurisdiction over such matters. Instead, the new Dodd proposal calls for the establishment of the Consumer Financial Protection Bureau as an “autonomous” division within the Federal Reserve. Among the Bureau’s functions would be authority to unilaterally issue regulations concerning consumer credit practices, to collect information obtained from banks and credit unions (regardless of asset size) with respect to the number and dollar amount of customer deposit accounts by branch or deposit-taking facility, and the geo-coding of all deposit customers while distinguishing between residential and commercial customers and between savings and checking accounts.
To answer those Senate Democrats critical of placing the responsibility for enhanced consumer regulation within the Federal Reserve, Senator Dodd stressed his proposal’s language providing for the director of the Bureau to be named directly by the President and confirmed by the Senate, to serve for a period of five years (or such longer period until a successor is approved). Until the first director of the Bureau is confirmed, the Treasury Secretary will serve as the director of the Bureau. The new Dodd proposal also provides independent rule-making and enforcement authority on the part of the Bureau, broad authority to initiate and prosecute litigation, and for dedicated funding – not contingent on Federal Reserve approval nor the Congressional appropriation process. The Bureau’s budget would be funded from the Federal Reserve and be determined as a percentage of the combined earnings of the Federal Reserve System, rather than through the appropriations process.
Although the new Financial Stability Oversight Council, also established by the current Dodd proposal, can reverse a rule or determination proposed by this new Consumer Financial Protection Bureau (a two-thirds majority vote is needed), significant operational autonomy is expected under the proposal. This approach is a significant departure in form rather than substance from the November Dodd draft, and retains many of the same elements included in the legislation passed by the House of Representatives last December, and as advocated by President Obama.
Systemic risk regulation: As noted above, the new Dodd proposal envisions the establishment of a Financial Stability Oversight Council, which would be a new nine member group of federal financial regulators chaired by the Treasury Secretary and representatives of multiple agencies, including the Federal Reserve, the OCC, the FDIC, the Securities and Exchange Commission (SEC) and the Commodities Futures Trading Commission (CFTC). The proposal also creates an Office of Financial Research as a part of this Council, designed to collect and analyze information pertinent to identifying emerging risks to the economy and to the financial sector. The Council would make recommendations to the Federal Reserve on comprehensive and strict capital, leverage, liquidity, risk management and related issues for imposition on the larger, systemically important institutions remaining under the Federal Reserve’s supervision. By a two-thirds vote, the Council could authorize a Federal Reserve decision to break up a large banking enterprise, and similarly to assert jurisdiction over a nonbank concern that might pose a threat to the financial stability of the United States.
The Financial Stability Oversight Council in the present Dodd proposal is comparable to the formulation for an inter-agency Financial Services Oversight Council contained in the House- passed bill which, like the version of the Financial Stability Oversight Council contained in the new Dodd proposal, would recommend standards for regulation to the Federal Reserve for the systemically important firms under scrutiny.
Enhanced liquidation mechanisms: The new Dodd proposal contemplates a greater role for the Federal Reserve and for the FDIC in recommending to the Treasury Secretary that the FDIC be named receiver for a failing financial that has been determined to be a suitable candidate for orderly disposition or liquidation; in such cases, the Treasury Secretary will be able to petition a special three-judge panel, to be known as the Orderly Liquidation Authority Panel, to ratify such receivership. The FDIC would be able to utilize a new $50 billion Orderly Liquidation Fund to be ultimately funded by special assessments on large financial institutions (defined as those with assets of more than $50 billion) “…on a graduated basis that assesses financial companies having greater assets at a higher rate.” During the liquidation process, the FDIC would be aided by the requirement that these entities maintain “funeral plans” for the rapid and orderly shutting down of a troubled firm. Firms that fail to submit timely or adequate plans will be subject to higher capital requirements and restrictions on growth and activity or even divestiture requirements.
This aspect of the new Dodd proposal departs from the Dodd November draft, which, though also calling for “funeral plans” and providing for a resolution authority, did not require funding of the liquidation fund to be effectuated through assessments until after the fact of such resources being used in the context of an actual liquidation. Thus, the new Dodd proposal is closer to the provisions in the House-passed bill.
Greater bank regulatory powers: The new Dodd initiative includes a series of novel elements designed to strengthen the powers of banking regulators to supervise the operation of entities under their supervision. Most significant is the incorporation of the so-called Volcker Rule, in the form of a requirement on pertinent bank regulatory agencies to limit the ability of banking firms to engage in proprietary trading activities and to invest or manage hedge fund vehicles. In addition, the new Dodd proposal also includes a provision that would restrict the right of firms that had obtained TARP funding as a consequence of obtaining bank holding company status to withdraw from the supervisory jurisdiction of the Federal Reserve. Other provisions in the Dodd proposal would limit the ability of individuals who worked for an entity regulated by the Federal Reserve from being members of the board of directors of any Federal Reserve Bank, while also requiring that the President of the New York Federal Reserve Bank be directly appointed by the President of the United States (and subject to Senate confirmation). These provisions represent additions to the approach set forth in the November Dodd draft; the House-passed bill does not contain comparable provisions. However, the concept is strongly supported by Chairman Barney Frank.
Higher standards for derivatives, securitizations and hedge funds: Similar to the provisions contained in the Dodd November draft, the new Dodd proposal contemplates significant additional regulation of over-the-counter derivatives, and the registration of hedge funds with more than $100 million in assets under management. These provisions are comparable to requirements in the House-passed bill, but Senator Dodd has indicated that the derivatives section may be amended to reflect additional consultations and agreements reached between Senators Reed and Gregg of the Banking Committee. In addition, as is true for the bill passed by the House of Representatives, the new Dodd proposal would require asset and mortgage backed securitizers and originators to retain 5 percent of the overall credit risk associated with the transferred loan assets; this standard represents a reduction from 10 percent in the original Dodd November draft.
Executive compensation and corporate governance: The new Dodd proposal would extend to shareholders of public companies “say on pay” (non-binding shareholder vote) with respect to the compensation of certain executives. This provision is similar to the House-passed bill and the original Dodd November draft. However, the new Dodd proposal goes further by requiring a clawback to recover any incentive-based compensation to an executive that is attributable to erroneous financial reporting. Federal banking agencies are also charged with establishing rules for unsafe or unsound compensation practices at bank holding companies and insured depository institutions. In addition, in the new Dodd proposal, shareholders will be allowed proxy access, through regulation of the SEC, to be able to nominate members of the public company’s board of directors. This too is a provision that builds upon the comparable treatment of this issue in the House-passed bill, which confirms the authority of the SEC to regulate in this area.
Insurance and credit rating agency regulation: The new Dodd proposal establishes the Office of National Insurance within the Treasury Department to monitor the insurance industry and to coordinate cross-border insurance regulation. This new office would act primarily in a fact-gathering and advisory capacity, though it would also represent a new federal role in the regulation of the business of insurance, a responsibility historically and by law reserved for the states. The House-passed bill has a similar provision. As was also true of the earlier Dodd November draft, the new proposal creates the Office of Credit Rating Agencies at the SEC, requiring credit agencies to register with such office and to provide data and information to the SEC to assure that ratings are provided with integrity, and to forestall potential conflicts-of-interest. Similar to the House-passed bill, the new Dodd proposal creates a private right of action on the part of an investor if a credit rating agency knowingly or recklessly fails to investigate information received from a third party, as well as the ability of the SEC to terminate the registration of such agency, but the standard for bringing a private cause of action is more onerous in the new Dodd proposal than that contemplated in the House-passed bill.
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