On July 21, 2010, President Obama signed into law the “Wall Street Reform and Consumer Protection Act,” the main architects of which were Senate Banking Committee Chairman Christopher J. Dodd and House Financial Services Chair Barney Frank. Their intent was a sweeping overhaul of the nation’s financial system in response to widespread calls for change, since the fall of 2008 and the global credit crisis which followed. While the bill lays the groundwork for that overhaul, it now falls to regulators to put the financial reform law into effect, a task likely to span the next several years.
Contentious disputes, aggressive lobbying, and – ultimately – compromises resulted in a bill that will have potentially broad impact on financial and non-financial institutions. Those provisions of most interest to Banking Advisor readers are summarized here.
New consumer "watchdog" agency
The law created a new independent “watchdog” agency housed within the Federal Reserve that is charged with protecting American consumers in financial transactions and ensuring consumers of financial products like mortgages and credit cards are provided with clear and accurate information about those products, and not subjected to hidden fees, abusive loan terms, or deceptive practices. The Consumer Financial Protection Bureau (CFPB) will be led by an independent director appointed by the President of the United States and confirmed by the Senate. The first goal of the new director and agency will be to create a simplified disclosure form for mortgage loans. It also has the authority to write rules for consumer protections governing all bank and non-bank entities offering consumer financial services or products. This agency will have the authority to examine and enforce regulations for banks and credit unions with assets of over $10 billion and all mortgage-related businesses and large non-bank financial companies.
The actions taken by this agency will apply to banks and financial companies below the $10 billion threshold as well. The oversight and implementation of the CFPB’s standards and requirements, once written and approved, will rest with the company’s primary federal regulator, generally the FDIC or OCC (The Dodd-Frank Act eliminated the Office of Thrift Supervision (OTS) by merging it into the OCC). Bankers generally believe the ultimate requirements arising from heightened federal regulatory oversight of consumer banking products will measurably increase the costs associated with this aspect of their businesses.
The Financial Stability Oversight Council
This newly created entity, a nine-member council led by the Treasury Secretary, will have crystal ball responsibility. Its role will be to identify, monitor, and address emerging systemic risks to the financial system, especially those posed by complex financial firms that grow large and interconnected enough to pose a threat to the financial stability of the US should they fail to meet their obligations to creditors and customers. Enhancing transparency, data collected and analyzed to identify and monitor those risks will be made public in periodic reports and Congressional testimony. With a two-thirds vote by its members, the council will have the authority to regulate failing non-bank financial companies and to require a large, complex company to divest some of its holdings, if it poses a grave threat to the financial stability of the US. By giving the council the ability to make recommendations to the Federal Reserve for stricter rules regarding capital, leverage, liquidity, risk management, and other requirements of larger companies, the goal of the law is to avoid having taxpayers foot the bill for bailouts of failing companies. New requirements and procedures will be in place regarding the orderly shutdown or liquidation of failing companies, as well as funding by industry – not taxpayers -- of the cost of those liquidations.
Streamlined bank supervision
The new law also creates clear lines of responsibility among bank regulators. The Federal Deposit Insurance Corporation (FDIC) will regulate state banks and thrifts of all sizes and bank holding companies of state banks with assets below $50 billion. The Office of the Comptroller of the Currency (OCC) will regulate national banks and federal thrifts of all sizes and holding companies of national banks and federal thrifts with assets below $50 billion. The Office of Thrift Savings is eliminated and there will be no new charters for federal thrifts, though existing thrifts will be grandfathered in. The Federal Reserve will regulate bank and thrift holding companies with assets over $50 billion. The law also preserves the dual banking system, leaving in place the state banking system governing most community banks.
Executive compensation and corporate governance
The new law imposed several new requirements on public companies, including publicly-held banks, relating to executive compensation and corporate governance. An impetus of the provisions is to rein in perceived excessive executive pay and help shift management’s focus from short-term profits to long-term growth and stability.
Public companies must hold several types of shareholder advisory votes on executive compensation, starting in 2011. The Securities and Exchange Commission (SEC) proposed rules for implementing these requirements on October 18, 2010, with the intent to adopt final rules sometime between January and March 2011. It is important to note that in its proposed rules, the SEC did not exclude smaller reporting companies from these requirements.
These shareholder advisory vote requirements include:
- Say-on-Pay vote: A non-binding shareholder vote on executive compensation to be held at the first annual meeting on or after January 21, 2011. This vote must be held no less frequently than once every three years and must be held whether or not final SEC rules are in effect.
- Frequency vote: Also, at the first annual meeting on or after January 21, 2011, public companies must hold a separate non-binding vote in which shareholders will express their opinion on whether the Say-on-Pay vote should be held annually, biennially, or triennially. The frequency vote must be held at least once every six years.
- Requirements not subject to adoption of final SEC rules: The requirements to hold the Say-on-Pay vote and frequency vote at the first annual meeting on or after January 21, 2011 are effective regardless of whether the final SEC rules have been adopted.
- Parachutes disclosure and Say-on-Parachutes vote: The proxy materials to approve any merger, sale of assets, or similar transaction must include enhanced disclosure of the golden parachutes compensation to executives related to the transaction. The proxy materials must also include a separate shareholder advisory vote on the parachutes compensation, unless the enhanced disclosure was part of a prior Say-on-Pay vote and there are no new arrangements. The parachutes disclosure and Say-on-Parachutes vote requirements are not effective until the final SEC rules go into effect.
Companies can prepare for implementation of these requirements by taking steps to enhance the clarity and transparency of compensation disclosure, reviewing compensation practices that may be considered problematic, and engaging with large shareholders on potential red flags in the company’s compensation practices. It will also be important to establish the link between executive pay and company financial performance.
Changes to the Federal Reserve
The Federal Reserve will oversee large holding companies with assets over $50 billion and other systematically significant financial firms. The Board of Governors of the Federal Reserve will now have a formal responsibility to identify, measure, monitor, and mitigate risks to US financial stability. To eliminate conflicts of interest, no company, subsidiary, or affiliate of a company that is supervised by the Federal Reserve will be allowed to vote for directors of Federal Reserve banks and their past or present officers, directors, and employees cannot serve as directors. In addition, the bill provides that the President of the United States, with the advice and consent of the Senate, appoints the president of the Federal Reserve of New York.
There are numerous more provisions in the bill affecting other areas of financial commerce, including the sale of mortgage-backed securities (companies that sell them must retain at least 5 percent of the credit risk), credit rating agencies, hedge funds, insurance, and municipal securities. The bill is estimated to cost $20 billion over five years. To help offset that cost, $11 billion of the fund repaid by banks who participated in the federal bank bailout will be redirected to support the provisions in the bill. As legislative committees struggle to fine tune the bill’s provisions, expect more information on its impact on financial institutions from the Banking Advisor.
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