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REISA
Legislative Update
Financial Reform
Becomes Law – July 21, 2010
The Dodd-Frank Wall Street Reform and Consumer Protection Act (HR
4173) has been passed by the United States Congress and sent to the
President for his signature. This legislation, considered the most
significant overhaul of financial regulation in the U.S. since the 1930s,
passed the U.S. House June 30 by a vote of 237-192 and passed
the U.S. Senate July 15 by a vote of 60-39. President Obama is
expected to sign the bill into law today, Wednesday, July 21, 2010.
What Comes Next?
Once
the President signs the financial reform bill into law, much of the
debate shifts from the halls of Congress to the offices of federal
regulatory agencies (e.g., the Federal Reserve Board, SEC, CFTC, FDIC and
the new CFPB). Congress delegated many of the implementation details to
the regulators, and that process will take place over the next 6 to 18
months. The impact will be staggered, as rule-making will be spread over
a two-year period, if not longer. While the effective date for final
rules varies, many of the provisions provide for a transition period to
allow affected companies time to meet new requirements.
Studies…More to
Come
As part of the legislation, Congress included requirements for over 60
different studies and reports by the various oversight agencies. As these
studies are likely to produce legislative recommendations and potentially
new regulations, financial regulatory reform will remain an ongoing
process for the next few years, even after the bill’s passage.
Come to the Annual
Conference, October 17-19, to Learn More
REISA will continue to support its membership with similar
legislative notices. The October Conference in Las Vegas will be one of
the largest gatherings of securities professionals this year, and one of
the primary focuses of the conferences is to cover regulatory issues in
detail. Unlike other associations, REISA is very focused on regulations
and best practices. FINRA, NASAA, and possibly the SEC will be there
at the top levels, to meet with BD principals and officers, RIAs,
registered reps, and investment advisors. Besides panels, there will be closed-door,
town hall sessions with BD/RIAs, sponsors, and RR/IA (each separately),
where they can discuss hot topics and work face-to-face with those who
most need clarification and information from FINRA, NASAA, and the SEC. See the benefits for broker-dealers/RIAs to attend. See the benefits for registered reps/financial advisors
to attend. Benefits for all other attendees. Register now!
All 2,300 Pages of
the Conference Report
Major provisions of the Dodd-Frank Wall Street Reform and Consumer
Protection Act are detailed below. To read the 2,300-page legislative
text of the conference report (CR), click here.
Major Provisions that Affect REISA Membership:
New
Accredited Investor Definition, (Sec. 413; CR pages 542-545)
The
bill retains the existing net-worth threshold for who could be considered
an “accredited investor” eligible to participate in such placements at
$1,000,000, but now excludes the value of their primary residence from
the calculation. The SEC has contacted REISA to inform us that this
definition will be in effect immediately upon President Obama’s signature
of the bill. Documents with investors that do not meet the new threshold
should be rejected. Approved offerings should be supplemented to reflect
new accreditation standard.
Reg. D Bad Boy
Carve-Outs, (Sec. 926; CR pages 1294-1295)
The bill will modify sections
of the bill relating to “Regulation D,” which governs private sales of
securities to small groups of selected investors. The SEC will forbid
private placements by “bad actors” with a record of judgments against
them.
Changes to Fed and
State Supervision (Sec. 410; CR pages 539-541)
The bill raises the asset threshold for federal regulation of
investment advisers from $30 million to $100 million, which means that a
greater number of smaller investment advisers will be subject exclusively
to state supervision.
Minimum Assets for
SEC Adviser Registration.
The minimum assets under management SEC registration threshold for
state-regulated investment advisers will be $100 million in general, but
$25 million for advisers who (1) would not be subject to registration and
examinations by their home states or (2) would otherwise be required to
register with 15 or more states.
Study: Fiduciary
Duty for Broker-Dealers (Sec. 913; CR pages 1221-1237)
In an area where the House and Senate were unable to agree until the
final hours of the conference, the bill requires the SEC to conduct a
six-month study of whether to apply a fiduciary standard of care to
registered broker-dealers as well as investment advisers. The bill will
give the SEC authority to make changes to the standard, if the study
determines that should take place. Notably, the sort of fiduciary
standard the SEC could apply is limited to specific language negotiated
on the House side. Brokers would have a fiduciary duty “when providing
personalized investment advice about securities to a retail customer,”
and the standard would not require brokers "to have a continuing
duty of care or loyalty to the customer after” providing that advice.
Other Provisions of Interest for REISA Membership:
Mandatory
Arbitration Clauses (Sec. 921; CR pages 1269-1267)
SEC has authority to prohibit
or impose conditions or limitations on the use of agreements
broker-dealers and RIAs use that require customers or clients to
arbitrate disputes if it finds conditions are not in the public interest
and for the protection of investors. The provision could raise litigation
risks for securities firms.
Study: Enhancing
Investment Adviser Examinations by SEC (Sec. 914; CR pages 1237-1238)
A study will occur within six months to review and analyze the
examination record and actions of the past five years by the SEC to
determine the need for enhanced examinations by the SEC and possibly one
or more additional regulatory organizations in overseeing investment
advisers and dully registered broker-dealers.
Study: Improved
Investor Access to Information on IAs and BDs (Sec. 919B; CR pages
1260-1261)
A study will occur within six months to improve access of investors
to registration, disciplinary actions, regulatory, judicial, arbitration
proceedings, and other information about registered and previously
registered investment advisors, broker-dealers, and their associated
persons.
Study: The use of
Financial Designations (Sec. 919C; CR pages 1261-1264)
A study will occur within 180 days to review if State and Federal
regulations adequately protect investors and other consumers form
financial planners that use misleading titles, designations, or marketing
materials. The possible need to establish additional standards and ethical
guidelines will also be determined.
Additional
Reading -- Major
Provisions of the Bill:
Systemic Risk
Council
The bill will create a 10-member Financial Stability Oversight Council
(FSOC) – consisting of several existing regulators and the new consumer
regulator – to monitor systemic risk and set capital, liquidity and
leverage standards for large, complex financial firms found to be
“systemically significant.” These standards will then be implemented by
the Federal Reserve, if necessary. The Council will have authority to
break up financial companies in extreme situations. Notably, the bill
establishes a debt-to-equity leverage limit of 15-to-1 for a bank holding
company with assets of at least $50 billion (or a non-bank financial
company supervised by the Fed) if the Council decides they pose “a grave
threat to U.S. financial stability.” Regulators will also be required to
include off-balance-sheet activities when they calculate a firm’s capital
requirements.
Resolution
Authority
The bill creates a new federal process for shutting down large, failing
financial firms in an orderly fashion. This title of the bill has been
the subject of politically charged debate between the parties since early
2009, with both sides alleging that their proposals would perpetuate the
market’s assumptions that some firms are “too big to fail.” Democrats
insisted throughout that resolving a giant, interconnected firm would
require billions in capital to keep the company operating until its parts
could be sold.
The House’s $150 billion “dissolution fund,” capitalized not by taxpayers
but by a fee on banks, was removed in conference at Republicans’
insistence. In its place, the FDIC can use a line of credit from Treasury
to pay resolution costs, but the FDIC must have a “mandatory repayment
plan” in place before it could use that money. Creditors of the failed
firm who were paid by the government will also be subject to “clawbacks”
for any funds in excess of what they would have gotten in liquidation.
After that, firms with more than $50 billion in total assets would pay
assessments to cover any remaining costs; with higher-risk firms paying
first.
The Fed will only be able to use its Section 13(3) emergency lending
authority for payments to help “solvent companies,” where “solvency” is
certified by borrowers, and the central bank will not be able to create a
loan program or facility designed to “remove assets from the balance
sheet of a single company.”
‘Volcker Rule’
The bill’s much-debated “Volcker Rule” provisions will prohibit banks
from “proprietary trading” for their own accounts, as opposed to their
customers. Under language drafted by Dodd, banks will be allowed to make de minimis
investments in hedge funds and private equity, using no more than 3
percent of their tangible common equity. A bank’s investment in a private
fund also could not exceed 3 percent of that fund’s total ownership
interest. The bill also aims to reduce conflicts of interest by prohibiting
banks from short-selling any asset-backed securities they underwrite, an
approach taken from the draft Merkley-Levin amendment in the Senate.
The bill gives regulators relatively little discretion to develop rules
in this area because the ban will be written into the statute. The new
FSOC will conduct a study of the restrictions and regulators will
implement them nine months afterward, with banks getting one year to
comply with the rules after they are issued. The rules are not expected
to be final until about 18 months from enactment.
Bureau of Consumer
Financial Protection
One of the bill’s keynote titles will establish a Bureau of Consumer
Financial Protection (BCFP), based in the Federal Reserve, with
autonomous authority to draft and enforce rules on retail financial
products such as mortgages and credit cards. The conference adopted
provisions adding payday lenders, check-cashers, money remittance
services and private student loan providers to the BCFP’s purview. In a
setback for the Obama Administration, the conference ultimately agreed
that auto dealers would not be covered by the authority of the new
consumer regulator. Instead, the final bill will allow the Federal Trade
Commission to respond more quickly to potential abuses among car dealers
by expediting its rulemaking process.
Pre-Emption of
State Laws
In a provision that was closely watched by banks – whether the BCFP’s
rules would pre-empt state consumer protection laws – the
conference report allows the Office of the Comptroller of the Currency
(OCC) to rule that state laws are pre-empted on a case-by-case basis only
when the law “prevents or significantly interferes” with the business of
banking. The bill also allows state attorneys general to enforce certain
BCFP rules against national banks, considered a setback for the banking
industry.
Over-the-Counter
Derivatives
Another of the bill’s signature titles will regulate, for the first time,
the over-the-counter (OTC) derivatives market, whose value has been
estimated at between $300 trillion and $600 trillion. The bill will give
the CFTC and SEC new powers and require most swaps trades to be cleared
through clearinghouses and traded on public exchanges, with an exemption
from those requirements for commercial “end users” of derivatives.
“Standardized” derivatives will be required to be processed through
central clearinghouses, which guarantee losses if the clearing facility
accepts the trade and a counterparty ultimately defaults. Derivative
trades not accepted for clearing will face higher capital and margin
requirements. Cleared trades will then have to be traded on a registered
swap execution facility or a designated contract market. Derivatives
traders will have to report all transactions, including those exempted
from clearing, to a central swap data repository. Captive finance
companies affiliated with manufacturers such as Boeing, Ford Motor Co.,
Caterpillar and John Deere are specifically exempted from the clearing
and trading requirements that apply to swap dealers.
When swap dealers do business with local governments and pension funds,
the bill prohibits deceptive practices and prescribes business standards
for dealing with such clients, such as disclosing certain information and
making sure the client is able to evaluate the risks associated with
trades being executed for them. The final bill also includes a provision
clarifying that no clearinghouse can be compelled to accept the credit
risk of another clearinghouse. That language was requested by CME Group,
owners of major futures exchanges in Chicago and New York that also
operate their own clearinghouses. Another provision allows clearinghouses
to accept non-cash collateral for swaps.
Lincoln ‘Push-Out’
Provision
The final derivatives title includes a narrower version of
controversial language drafted by Sen. Lincoln, requiring larger banks to
divest certain swaps trading operations in order to retain their access
to deposit insurance and the Federal Reserve discount window. Banks could
establish separate derivatives operations under their holding companies,
but these will have to be funded from the banks’ own capital base. In a
compromise negotiated by House Agriculture Chairman Collin Peterson
(D-MN) in the final hours of the House-Senate conference last month, banks
will be allowed to continue trading the two largest classes of OTC
derivatives – interest-rate swaps and foreign-exchange swaps – as well as
gold and silver swaps and investment-grade credit default swaps. Banks
will also be allowed to use derivatives to hedge their own risks. But in
the areas of agriculture, uncleared commodities, most metals, and energy,
banks will have to shift their swaps operations to a separately
capitalized affiliate within their holding company. Banks will have up to
two years to shift those trading operations.
Tier 1 Capital
Requirements for Banks
Language drafted by Sen. Collins will require the Financial Stability
Oversight Council to impose minimum leverage and risk-based capital
standards on banks, bank holding companies and non-bank financial firms
identified by the FSOC. The Council will have to raise the requirements
as the firms get bigger or engage in risky practices. The House-Senate
conference committee modified Collins’ original provision on
trust-preferred securities (TruPS), which would have prohibited banks
from counting TruPS toward their mandatory Tier 1 capital. The conference
report will allow bank holding companies with less than $15 billion in
assets to continue counting their existing TruPS as Tier 1. Larger banks
will have a five-year phase-in period to comply with the prohibition and
shed those securities.
Interchange Fees
In another of the bill’s more controversial provisions, the conference
report will allow the Federal Reserve to set rates on the interchange
fees (“swipe fees”) that banks and credit card issuers charge merchants
when their customers pay with debit cards. The language, drafted by Sen.
Richard Durbin (D-IL), says the rates must be “reasonable and
proportional to the actual cost incurred by the issuer or payment card
network with respect to the transaction.” Merchants will be able to offer
discounts if their customers generally use credit cards, debit cards,
cash or checks, but not for using a specific card or network.
Banks and credit unions with $10 billion or less in assets will be exempt
from the fee limits. The conference adopted House language narrowing what
will be considered an “interchange transaction fee” that the Federal
Reserve will have to oversee, to exclude network fees charged by Visa and
MasterCard. In response to concerns from state treasurers, the prepaid
and debit cards used to distribute federal, state and local government
benefits (such as welfare, unemployment insurance and food stamps) will
not be included under the new rules. Under certain conditions, most other
prepaid cards will be exempted.
Federal Reserve
Audit
The bill will require the Government Accountability Office to perform a
one-year, one-time audit of all emergency loans and financial assistance
extended by the Federal Reserve since 2007. The GAO will also review
discount window and open market transactions by the Fed, and such
information – including the names of all borrowers – will have to be
released publicly two years after the transactions were begun.
Proxy Access
In another area where the House and Senate had difficulty reaching an
agreement, the final bill will give the SEC authority to expand
shareholders’ access to the proxy ballot, which would make it easier for
investors to nominate a minority slate of directors on corporate boards.
The conference report allows the SEC to impose certain restrictions on
what sorts of shareholders may use the proxy – such as a requirement that
they own a given percentage of shares – but it does not specify what that
threshold should be. The bill includes a provision allowing the SEC to
exempt small businesses from the requirement.
SEC Chairman Mary Schapiro has said the agency already has authority to
prescribe proxy access rules, and the SEC in the process of developing a
rule that would allow shareholders of companies with a global market cap
of at least $700 million to gain access to the proxy ballot if they own
at least 1 percent of the company's shares, or 3 percent at mid-size
companies and 5 percent at smaller public firms. The shareholders would
have to hold their shares for at least a year.
Banking Regulatory
Consolidation
The bill will eliminate the Office of Thrift Supervision (OTS), which
critics had called a lax regulator, and fold the OTS into the Office of
the Comptroller of the Currency, which will become the chief prudential
regulator for all national banks and thrifts. The bill preserves the
thrift charter, however. These measures fall well short of the much more
ambitious consolidation of banking regulators that Chairman Dodd had
envisioned in the first financial reform bill he introduced in late 2009.
Executive
Compensation
In another corporate governance provision, the bill allows shareholders
to hold a non-binding vote on top executives’ compensation. The bill says
that “Say on Pay” vote may take place as infrequently as every three
years, if shareholders choose, but not less than that. Shareholders would
also be able to hold a non-binding vote on “golden parachute” severance
payments made to top executives who depart in mergers. The bill also
authorizes the SEC to restrict incentive-based pay packages at financial
firms that are found to be overly risky, and it requires that members of
compensation committees at a public company’s board of directors be
independent.
SEC Self-Funding
In another area that was contentious for the House-Senate conference –
whether the SEC should be allowed to determine its own annual budget
independently (because the agency is funded by securities transaction
fees), instead of going through the congressional appropriations process
– the final bill reflects a compromise written by Senate Banking
Committee Ranking Member Richard Shelby (R-AL). Under this
provision, the SEC will continue to have its budget approved by
appropriators, but the agency will also have access to a reserve fund of
up to $100 million every fiscal year to pay for things such as capital
improvements of new technology.
Predatory Lending
The final bill includes a long section devoted to mortgage reform
provisions targeting predatory lending, drawn from the original
House-passed bill. Among many other provisions, this part of the bill
will require lenders to ensure that borrowers are able to repay a loan;
ban prepayment penalties for certain loans; and prohibit “yield spread
premiums” that reward mortgage brokers for steering borrowers into loans
with higher interest rates. Regulators will have to draft standards
assuring that mortgages have a “net tangible benefit” to the borrower.
The bill gives the Federal Housing Administration and other federal
agencies authority to define a “qualified mortgage” that they insure,
guarantee or administer, and those mortgages could be exempted from the 5
percent risk retention requirement. The final bill also includes House
language Rep. Paul Kanjorski (D-PA) intended to improve home appraisal
independence standards.
‘Risk Retention’
for Mortgage Securitizers
In another section intended to promote stronger loan underwriting
practices, the final bill requires mortgage securitizers to retain up to
5 percent of the loans they package. The bill’s authors argue this will
give lenders more “skin in the game” instead of selling all their loans
directly into the secondary market. But “safe harbor” provisions in the
bill will allow banking regulators and federal housing officials to
exempt certain kinds of loans, such as fixed-rate, fully amortizing
mortgages, from the retention requirement. The bill also will allow
regulators to permit alternative retention requirements for commercial
mortgage-backed securities. And it will require regulators to study, and
then establish, risk retention rules for collateralized debt obligations
(CDOs) – complex, structured products made up of risk-weighted “tranches”
of underlying asset-backed securities.
Credit Rating
Agencies
The bill requires the major credit rating agencies, such as Moody’s,
Fitch and Standard & Poor’s – technically known as Nationally
Recognized Statistical Ratings Organizations (NRSROs) – to disclose their
methodologies, their use of third parties for due diligence, and their
ratings track record. It would establish a new oversight office within
the SEC with authority to fine ratings agencies, gives the SEC power to
de-register a firm that consistently gives poor ratings.
Notably, the bill requires the SEC to study, for one year, conflicts of
interest within the credit rating industry as well as compensation
practices and how to measure the accuracy of ratings. Depending on the
study’s findings, the SEC could be required to implement an independent
ratings clearinghouse, led by members representing investors, that would
assign a ratings agency (on a rotating basis) when debt issuers need a
rating for a new security – or some alternative mechanism. The proposal
for a ratings clearinghouse was drawn from a successful Senate floor
amendment offered by Al Franken (D-MN).
The bill will also allow investors to sue rating agencies if they
“knowingly and recklessly” failed to conduct a “reasonable” review of key
information when a rating is developed. Agencies will be prohibited from
providing risk management or other investment advice to a corporation
whose debt it rates,
Deposit Insurance
The bill will permanently raise the FDIC’s authority to insure deposits
from $100,000 per account to $250,000. The $250,000 increase applies
retroactively to January 1, 2008, which will cover losses by depositors
in IndyMac Bancorp Inc., which failed in July 2008. Significantly,
the FDIC will now base its formula for determining insurance premiums on
a bank’s assets instead of its domestic deposits, which will raise
premiums for larger banks. The bill also extends until 2012 the
Transaction Account Guarantee (TAG) program, which gives companies
unlimited support for non-interest-bearing transaction accounts exceeding
the agency’s $250,000 limit.
Industrial Loan
Companies and Credit Card Banks
The conference report will allow the FDIC to approve industrial loan
company (ILC) applications if a commercial firm acquires the ILC through
a merger or acquisition. The bill otherwise imposes a three-year
moratorium in changes of control for ILCs, unless they are in danger of
default. The conference dropped a proposed moratorium on applications for
ILCs and credit card banks, allowing for limited investments in the
parent company. Credit card banks will also be allowed to issue
cards to small businesses.
Regional Federal
Reserve Banks
The final bill includes a House provision relating to the boards of
regional Federal Reserve banks. To discourage conflicts of interest on
such boards, the three members appointed by commercial banks will be
barred from nominating the bank’s president, leaving that task to the six
non-bankers on the board.
Sarbanes-Oxley
Section 404
The bill will permanently exempt companies with market capitalization of
less than $75 million from the Sarbanes-Oxley Act’s Section 404
requirements for independent internal control audits. The bill also
requires the SEC to study of ways to reduce compliance burdens for
companies with market caps between $75 million and $250 million who have
been complying with Section 404’s requirements.
Stoneridge Ruling
The conference report dropped a House provision that would have given
private investors the right to sue parties for aiding and abetting
securities frauds, such as bankers, attorneys and accountants. Instead,
the final bill requires the GAO to study the merits of creating a right
of action against aiders and abettors. The bill does give the SEC
authority to file such lawsuits.
Private Fund
Registration
The bill requires advisers to hedge funds and private equity funds to
register with the SEC if those funds have more than $150 million in
assets. State regulators would oversee smaller funds. (The conference dropped
the House bill’s requirement that registered advisers disclose
information to investors and creditors about the private funds they
advise, such as the amount of assets under management, counterparty risk
exposure and trading positions.) Venture capital funds were exempted from
the registration requirement.
Federal Insurance
Office
The bill will create a new Federal Insurance Office (FIO) within Treasury
to monitor the insurance industry. The FIO would identify to the new
Financial Stability Oversight Council any insurers that should be treated
as systemically significant. The FIO will also have to report to Congress
on ways to modernize insurance regulation, and it will also negotiate
international insurance matters for the United States. This section of
the bill also streamlines regulation of surplus lines insurance and
reinsurance through a series of state-level changes.
Covered Bonds
The conference adopted a House provision authored by Rep. Scott Garrett
(R-NJ) that aims to foster a market in “covered bonds” by establishing a
regulator for such instruments in the Treasury and setting rules for
issuers.
Fixed Annuities
Notably, the conference report exempts fixed-index annuities from SEC
oversight. Such products, which offer a guaranteed minimum value as well
as an additional return tied to a stock index, will instead be treated as
insurance and regulated by the states. This provision was a setback for
the SEC, which under former chairman Christopher Cox had sought to
classify fixed annuities as securities.
Carried Interest
Find out more about this issue and REISA's position.
Questions
If you have any questions, contact Brandon Balkman at bbalkman@reisa.org or 801.419.9610.
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