The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), which became law on July 21, 2010, brings wide-ranging and radical change to the United States financial regulatory system. While the Act will undoubtedly have its most profound effect on financial institutions, it will also have a very significant impact on public companies in all industries, municipalities that issue securities, investors, consumers and many other constituencies.
The Act is more than 2,300 pages long and covers a vast array of topics. Moreover, because the Act leaves many of the specific substantive requirements and other details of the new regulatory regime to be established by agency rulemaking over the next few years, it is not yet possible to discuss how many particular provisions of the Act will function in practice. Consequently, this bulletin is meant to provide only a very high-level summary of certain key provisions of the Act. It is not meant to provide definitive answers about the ultimate impact of the Act, but rather to help our clients and friends begin to identify the areas in which they ought to be asking questions about how the Act will affect them. If you have questions about these provisions or would like assistance preparing a response to them, please do not hesitate to contact one of the attorneys listed in this bulletin.
REGULATORY AGENCY REFORM
The Act makes very substantial changes to the structure and authority of the federal agencies that oversee financial institutions. These changes include:
Creation of the Financial Stability Oversight Council (“FSOC”) (§§ 111 - 123): Created as of July 21, 2010, the FSOC is chaired by the Secretary of the Treasury and made up primarily of the heads of the major federal financial regulatory agencies. Its purpose is to identify and respond to systemic risks to the financial stability of the U.S. Most importantly, the FSOC is tasked with identifying “systemically significant” institutions that pose such a risk (“Significant Institutions”). Significant Institutions include “large, interconnected” bank holding companies with assets of at least $50 billion and certain non-bank financial companies. Significant Institutions may be subject to enhanced regulation, including heightened reporting and disclosure requirements and stricter prudential standards, based on the FSOC’s recommendation.
Dissolution of the Office of Thrift Supervision (“OTS”) (§ 311- 327): Within eighteen months, the OTS will be dissolved and its functions will be transferred to the Federal Reserve, the Comptroller of the Currency, and the FDIC.
“Orderly Liquidation Authority” Granted to the FDIC (§§ 201 - 217): The FDIC now has the authority to liquidate “failing financial companies that pose a significant risk to the financial stability of the United States” via a receivership process that does not permit reorganization or rehabilitation. Significantly, the FDIC is charged with exercising this authority in a manner intended to cause those responsible for the institution’s failure to bear its losses. Among other things, the Act (i) requires the FDIC to fire the members of management it deems responsible for the institution’s condition, (ii) subordinates officers’ and directors’ compensation claims, (iii) forbids payments to equityholders until all other claims are satisfied, and (iv) provides an expedited mechanism for the institution to pursue claims against officers, directors and other managers.
Creation of the Federal Insurance Office (“Insurance Office”) (§ 502): Effective immediately, the Act establishes within the Treasury Department an Insurance Office whose functions include monitoring the insurance industry, assessing the insurance regulatory system where there are areas that might increase systemic risk to the financial system, and setting federal policy for international aspects of the insurance system. The Insurance Office also has the authority to recommend to the FSOC that an insurer be designated as a Significant Institution subject to supervision by the Federal Reserve.
The Volcker Rule: Prohibitions on Proprietary Trading and Certain Relationships with Hedge Funds and Private Equity Funds (§ 619): Within two years, banking entities will be prohibited from engaging in proprietary trading and sponsoring or owning equity in hedge funds or private equity funds. The Act provides certain significant exclusions and exceptions to these prohibitions, including exemptions for bona fide hedging activities and for investments of up to 3% of a bank’s Tier 1 capital in hedge and private equity funds.
Swaps “Spin-Off” (§716): The Act provides that no Federal assistance may be provided to any federally insured depository institution that deals in swaps or is a major participant in the swaps market, with exceptions for certain bona fide hedges. As a result, these institutions will be required to spin off most of their swaps to affiliates that are not federally insured. The appropriate federal banking agency will grant each affected institution a transition period of up to two years in which to spin off or cease swaps activity.
Enhanced Bank Capital Standards (§ 616): In establishing future capital standards, the Federal Reserve must seek to make such standards “countercyclical” so that the amount of capital required to be maintained increases in times of economic expansion and decreases in times of economic contraction.
Incentive Compensation at Covered Financial Institutions (§ 956): New regulations to be imposed within nine months will (i) require each “covered financial institution” to disclose sufficient information on its incentive-based compensation to permit a determination regarding whether the compensation structure is excessive or could lead to material financial loss to the institution, and (ii) prohibit compensation practices that federal regulators determine could lead to such loss or encourage employees to take inappropriate risks.
Pay It Back Act: The End of TARP (Title XIII): The authorized amount of TARP funding is reduced from $700 billion to $475 billion. No TARP funds may be spent on any program not initiated prior to June 25, 2010, and any money repaid to or otherwise recaptured by the TARP Fund must be used for deficit reduction.
A. Whistleblower Provisions
Incentives (§ 922(b)): An Investor Protection Fund is established within the Treasury Department to fund the activities of the SEC’s Inspector General and to pay awards to whistleblowers. Whistleblowers who provide the SEC with information leading to a successful enforcement action will receive between 10% and 30% of the amount collected in monetary sanctions in the action.
Protection (§ 922(h)): The Act enhances the whistleblower protections implemented by the Sarbanes-Oxley Act. Whistleblowers who have been terminated or discriminated against for making applicable disclosures may now receive (i) reinstatement to their position with full seniority and other benefits, (ii) two times the amount of backpay, with interest, and (iii) compensation for litigation costs, expert witness fees, and reasonable attorney’s fees.
B. Corporate Governance
Proxy Access (§ 971): The Act expressly gives the SEC authority to require public companies to allow shareholders to list director candidates on proxy materials provided by the company.
Broker Discretionary Voting (§ 957): Effective immediately, an amendment to the 1934 Act, expanding slightly on last year’s changes to NYSE Rule 452, forbids brokers that do not receive voting instructions from their clients from casting discretionary votes in shareholder votes concerning executive compensation, director elections (except for uncontested elections at registered investment companies), and “any other significant matter.”
CEO/Board Chairperson Position (§ 972): Within six months, reporting companies will be required to disclose in their annual proxy statements whether they have the positions of CEO and Chairperson of the Board filled by one person or by different individuals and their reasons for doing so.
Sarbanes-Oxley §404(b) Relief For Non-Accelerated Filers (§ 989G): Since Sarbanes-Oxley was enacted the SEC has repeatedly pushed back the commencement of § 404(b) auditor attestation requirements for non-accelerated filers (i.e., registrants with a public float of less than $75 million). The Act permanently exempts these filers from the requirement that they include in their annual report on Form 10-K their auditor's attestation of their management's assessment of the company's internal controls. Although these filers will still be required to include the management assessment in their Forms 10-K, removing the auditor's attestation requirement eliminates a substantial Sarbanes-Oxley 404 compliance cost for these filers. The Act also charges the SEC with performing a study to identify ways to reduce the burden of Sarbanes-Oxley § 404(b) compliance for registrants with public floats between $75 million and $250 million.
C. Compensation and Compensation Disclosure
Additional Executive Compensation Disclosure (§ 953 & 955): The SEC must (within an unspecified timeframe) issue rules subjecting public companies to new disclosure requirements, including disclosure of (i) the relationship between executive compensation and the company’s financial performance, (ii) the ratio of the CEO’s annual compensation to the median annual compensation of all other company employees, and (iii) whether any employee or board member is permitted to purchase financial instruments designed to hedge any decrease in the market value of equity securities granted by the issuer as part of the employee or director’s compensation or held, directly or indirectly, by the employee or director.
Say-on-Pay: Shareholder Vote on Executive Compensation (§ 951): Reporting companies must give shareholders a nonbinding vote at least once every three years on whether to approve the compensation of corporate executives. The first such vote shall occur at the first shareholder meeting held more than six months following the passage of the Act. Beginning six months from now, a nonbinding shareholder vote will also be required for “golden parachute” compensation packages offered to executive officers as part of an acquisition, merger, consolidation, sale or other disposition of all or substantially all of the company’s assets.
Compensation Committee Independence (§ 952): Within one year, the SEC must issue rules prohibiting the national securities exchanges from listing any security of an issuer unless the issuer’s compensation committee consists only of members deemed to be “independent” based on a consideration of a number of factors, including the source of a committee member’s compensation and any affiliations between the member and the issuer, its subsidiaries, and affiliates. In addition, the compensation committee may select only compensation consultants, legal counsel, or other advisers that are independent, based on factors to be identified by the SEC. The rules must provide for a reasonable opportunity to cure defects that would result in de-listing.
Recovery of Erroneously Awarded Compensation (§ 954): The SEC must (within an unspecified timeframe) issue rules requiring issuers to develop and implement policies to recover incentive compensation awarded to executive officers on the basis of erroneous financial statements.
Bureau of Consumer Financial Protection (“BCFP”) (Title X): The Act establishes the BCFP as an independent, executive agency within the Federal Reserve System “to regulate the offering and provision of consumer financial products or services under the Federal consumer financial laws.”
Increase in FDIC Deposit Insurance (§ 335): The Act permanently increases the standard maximum deposit insurance amount to $250,000.
Pre-emption (§ 1044): Effective immediately, the Act limits the circumstances in which state consumer financial laws applicable to federally chartered banks and their subsidiaries are preempted by federal laws, enhancing the ability of state regulators to impose very strict standards, particularly on non-bank subsidiaries of federally chartered institutions.
Mortgage Reform and Anti-Predatory Lending Act (Title XIV): This legislation requires that, within thirty months, regulations be in effect which (i) impose new mortgage origination standards, (ii) limit the extent to which originators of residential mortgages may be compensated based on the terms of the loan, (iii) prohibit certain prepayment penalties and mandatory arbitration clauses in residential mortgages, (iv) restrict mortgages with negative amortization, (v) impose new disclosure and notice requirements, and (vi) set limits specific to “high-cost mortgages”.
Hedge Funds and Private Investment Advisers (Title IV): Many hedge fund managers that previously avoided registration under the Investment Advisors Act of 1940 via the “private adviser” exemption are now required to register with the SEC. The SEC will issue rules requiring all registered advisers to record and report certain information, including the amount and type of assets under management, use of leverage, counterparty credit risk exposure, trading and investment positions, and valuation policies.
Changes to the Asset-Backed Securities (“ABS”) Market (§§ 941 – 946): Within nine months, new regulations will require securitizers to retain an economic interest in the credit risk of assets that they transfer via ABS. The regulations will differ for different types of assets. Securitizers will also be required to disclose information about the assets backing each tranche or class of security, and will be subject to regulations regarding representations and warranties for ABS.
Accredited Investors (§ 413): The accredited investor standard is adjusted so that, effective immediately, the primary residence of natural persons is excluded from the calculation of net worth. In four years, the net worth standard will be raised above the current $1 million level, and at least once every four years thereafter the SEC will review and, if necessary, revise the definition of an “accredited investor.”
Rating Agencies (§ 932, 933, 939B): Within one year, the SEC must issue rules providing that a nationally-recognized statistical rating organization (“NRSRO”) (i) may not allow sales and marketing considerations to influence its production of credit ratings, and (ii) must disclose the data and methodology behind each rating. NRSROs will be required to establish and document an effective internal control structure governing the process of determining ratings, and to submit an annual report to the SEC that will include an assessment and certification of these controls. NRSROs will also be subject to new corporate governance and reporting requirements, including a requirement to report certain employment activities of former NRSRO employees. A new Office of Credit Ratings will review each NRSRO at least once a year to ensure regulatory compliance. The SEC may impose fines and other penalties on a non-compliant organization and suspend or revoke its registration.
Regulation of the Swaps Market (Title VII): This market, which has been largely unregulated until now, is placed under the supervision of the SEC and CFTC. Within one year, the two agencies will determine which swaps will be required to be cleared through a registered clearinghouse that will be the counterparty to each affected swap, and which will be closely monitored by federal regulators. The Act exempts swaps in which one party is a non-financial end-user using swaps to hedge risk, and the SEC and CFTC are authorized to create certain other exemptions. Swaps that need not be submitted to a clearinghouse must nevertheless be reported to a “swap data repository” or to the SEC or CFTC. The Act also imposes requirements on “swap dealers” and “major swap participants” regarding registration, reporting and recordkeeping, and capital and margin standards, most of which will take effect within one year.
MUNICIPALITIES AND MUNICIPAL ADVISERS
Regulation of Municipal Securities and Changes to the Board of the MSRB (§§ 975 - 979): Municipal advisers are now required to register under the 1934 Act and are deemed to have a fiduciary duty to any municipal entity for whom they act. The composition of the Municipal Securities Rulemaking Board (“MSRB”) is modified, as is its authority to impose disciplinary actions. An Office of Municipal Securities is established within the SEC to administer SEC rules with respect to municipal securities and to coordinate with the MSRB rulemaking and enforcement actions.