JUNE 3, 2010
Senate financial reform bill adopted
“The Senate passed bill represents the most complex, and most
important legislation the banking industry has faced in 70 years.”
- American Bankers Association
“With the passage of the Wall Street Reform bill, we have taken a
major step toward creating a sound economic foundation for the
American people we represent. This is their victory.”
- Senator Christopher J. Dodd
By: Raymond J. Gustini, Lloyd H. Spencer, William E. Kelly, Tiana Butcher, John LaBoda, Barry M. Rothchild,
and Paulette J. Morgan
Capping nearly three weeks of floor debate and a series of partisan clashes over direction and the
impact of tighter regulation on the banking and financial system, the Senate, by a 59–39 vote, passed
the Restoring American Financial Stability Act of 2010 on Thursday, May 20, 2010. The bill will now
be reconciled in conference with the bill passed by the House in December 2009. It will then be sent
to the President for his signature. The conference will likely begin on or about June 8 after Congress
returns from its Memorial Day recess. Work could be completed in the month of June so that the bill
can be signed before the July break.
The Senate named its conferees on Tuesday, May 24. The House is expected to name conferees next
week. The Senate conferees are Democrats Christopher Dodd (Connecticut), Tim Johnson (South
Dakota), Jack Reed (Rhode Island), Charles Schumer (New York), Blanche Lincoln (Arkansas),
Patrick Leahy (Vermont) and Tom Harkin (Iowa). Republican conferees are Richard Shelby
(Alabama), Bob Corker (Tennessee), Mike Crapo (Idaho), Judd Gregg (New Hampshire), and Saxby
Chambliss (Georgia).
The Senate-passed bill is, along with health care, a centerpiece of the Obama administration’s two-
year legislative agenda. Described as one of the broadest changes to banking and financial regulation
in decades, the bill is designed to reduce systemic risk in America’s financial system, provide greater
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protections to consumers that use financial products, including mortgages, regulate the derivatives
market, rationalize compensation by linking it to performance, and provide greater transparency and
oversight in previously private markets such as hedge funds. The bill eliminates the Office of Thrift
Supervision (the “OTS”), revises federal banking law preemptions, and includes new authority for
state attorneys general to enforce federal consumer finance laws. The bill, which has variously been
described as “sweeping,” “epic,” and the “greatest change in [the] financial sector regulation since the
1930s,” will cause fundamental change in many areas of the banking and financial services industries
and related markets. At over 1,600 pages, it is vast and complex. Even with the daunting length,
implementing the bill’s many provisions will still require the release of dozens of detailed regulations
over several years since in many parts of the bill only broad outlines are suggested and tight timelines
for regulations, such as provided under Sarbanes-Oxley, are not present in every case.
The anticipated early July enactment presumes the ability to work out areas of difference between the
House and Senate and also to complete certain unfinished work in the Senate bill itself. In the rush to
Senate passage, there was a surprise cloture vote cutting off debate, leaving no time for a managers’
amendment to clean up ambiguous areas. As a result, certain controversial issues were not addressed
by the Senate. For example:
Derivatives—Although the subject of intense lobbying by many large banks, Wall Street firms,
swaps, and derivatives broker dealers, no changes were made to Title VII, sponsored by Senator
Blanche Lincoln, Senate Agriculture Committee chair and Senator Chris Dodd. This title deals with
trading and clearing of derivatives and included the push out by a bank or bank holding company of
derivatives trading operations.
Auto dealer exemption—Auto dealers fought to obtain an exemption from rules of the Consumer
Finance Protection Bureau and were unsuccessful. Senate conferees have been “instructed” to seek
the amendment in conference.
The Collins amendment—A floor amendment, sponsored by Senator Susan Collins (R-ME) and
supported by the FDIC, was designed to equate capital requirements of large and small bank holding
companies. Instead, the amendment eliminated the use of trust preferred securities as Tier 1 capital
by bank holding companies and possibly eliminates the benefit of TARP capital at the holding
company level as well.
The Volcker rule—This provision, which prohibits proprietary trading by holding companies and
banks of bonds, securities, and derivatives, may also be addressed in conference.
The discussion below describes the bill’s major titles. A final version of the bill by the Senate may be
seen by clicking on this link. As the Conference moves toward agreement and eventual enactment,
more information will be provided. More detailed analysis of specific sections will be provided in
future weeks.
Title I — Financial stability
The desire to create new regulation for systemic risk in the U.S. financial system was met by the
creation of the Financial Stability Oversight Council (“FSOC”). The FSOC would be chaired by the
Treasury Secretary and have nine voting members, including the Federal Deposit Insurance
Corporation (“FDIC”), the Securities and Exchange Commission (“SEC”), the Commodities Futures
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Trading Commission (“CFTC”), the Office of the Comptroller of the Currency (“OCC”), the
Federal Reserve Board (“FRB”), the Federal Housing Finance Agency (“FHFA”), the head of the
newly-created Bureau of Consumer Financial Protection (“BCFP”), and an independent presidential
appointee with insurance expertise.
Covered entities include any non-bank, systemically significant financial institution that is placed
under FRB jurisdiction by the FSOC after a two-thirds vote. Once the FSOC acts, a covered entity
would be subject to comprehensive examination and supervisory jurisdiction of the FRB. Once
under FRB jurisdiction, such systemically significant companies would be subject to heightened
prudential standards, including risk-based capital and liquidity requirements. The “Hotel California”
provision would prohibit large financial companies owning banks that received TARP assistance
from dropping bank charters to avoid heightened scrutiny. In the case of such bank holding
companies, FRB supervision would be automatic.
Title I also contains the controversial Collins Amendment, introduced by Senator Susan Collins.
Initially intended to equate holding company capital for large and small bank holding companies, the
amendment references the prompt corrective action (“PCA”) definitions of Tier 1 capital at the bank
level as a minimum holding company capital requirement. However, since Tier 1 capital for banks
does not include trust preferred securities, the amendment would prohibit the inclusion of trust
preferreds at the holding company level as Tier 1 capital and require significant balance sheet
deleveraging by holding companies unless remedied.
Title II — Orderly liquidation authority
This section was adopted essentially as reported by the Senate Banking Committee. As passed, it
would create a new procedure for resolving the liquidation of systemically significant non-bank
financial companies by giving special resolution authority to the FDIC after review by a three-judge
Delaware bankruptcy panel after a series of recommendations on systemic significance by the FRB
and the FDIC, and a finding by Treasury on the systemic risk posed by the company as an alternative
to traditional bankruptcy.
Also, the bill as reported by the Senate Banking Committee, contained a requirement to prefund the
$50 billion resolution fund. Republicans, however, alleged that pre-funding institutionalized the
concept of “too big to fail” while doing little to prevent such failures. By agreement with ranking
Minority member Senator Richard Shelby, Senator Dodd’s revised package eliminated the $50 billion
fund and the FSOC will assess systemically significant institutions and large bank holding companies
for costs of resolution “after the fact.” Currently, large bank holding companies with over $50 billion
in assets hold about 66% of the nation’s banking deposits. The House version of the bill, as passed in
December, still contains the prefunded $50 billion fund.
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Title III — Transfer of powers to the Comptroller of the Currency, FDIC, and the
Federal Reserve Board
As originally drafted, nearly 5,000 state member banks would have been transferred from the FRB to
the FDIC as the principal federal bank regulatory agency. However, this title was changed
significantly as a result of a floor amendment by Senators Kay Bailey Hutchison (R-TX) and Amy
Klobuchar (D-MN). The Hutchison/Klobuchar amendment passed by a 90–9 vote and as a result
the FRB retained jurisdiction over FRB state-member banks. Further, the OCC would function as
principal bank regulator for national banks and of federally chartered thrift institutions. Small bank
holding companies (under $50 billion in assets) and thrift holding companies would be supervised by
the FRB. State non-member banks and state chartered thrifts (but not their holding companies)
would be supervised by the FDIC. The OCC would have rulemaking authority over all thrifts. No
new thrift charters would be awarded after enactment, but existing charters, including branching
authority, would be preserved. The OTS would be eliminated and its functions split among various
federal agencies. Any pending OTS rule changes would become proposed regulations of the OCC.
Change in calculation for deposit insurance premiums
The Senate also approved an important change in the way in which federal deposit insurance
premiums are calculated. Under current law, federal deposit insurance premiums are assessed on the
basis of total domestic deposits. As revised, pursuant to a 98–0 vote on an amendment sponsored by
Senators Jon Tester (D-MT) and Kaye Bailey Hutchison, deposit insurance premiums will instead be
based on a bank’s total assets net of tangible equity. This change would have the effect of increasing
deposit insurance premiums for banks with relatively low ratios of domestic deposits to total assets—
generally the model followed by the largest banks. Lower insurance costs for deposits could in the
future favor retail deposit funding strategies over wholesale funding and increase competition among
all banks for retail deposits.
A similar provision is present in the House bill.
Title IV — Regulation of hedge fund advisors and others
As a general matter, advisers to hedge funds of over $100 million would be required to register with
the SEC and to make certain disclosures for systemic risk purposes.
Recordkeeping and reporting obligations of private equity fund advisers
The bill would exempt advisers to private equity funds of less than 15 clients from the registration
requirements of the Investment Advisers Act of 1940 (the “Advisers Act”), but it would impose on
advisers to such funds (but not on advisers to venture capital funds) an obligation to maintain such
records and to file with the SEC such reports as the SEC determines necessary and appropriate in the
public interest and for the protection of investors, taking into account fund size, governance,
investment strategy, risk, and other factors. As with the rules defining “venture capital fund” and
“private equity fund,” the bill would require the SEC to issue, within six months after enactment of
the legislation, final rules regarding record maintenance and reports by advisers to private equity
funds.
The bill also includes several other provisions affecting private investment funds and their advisers.
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State jurisdiction over smaller registered investment advisers
The bill would amend the Advisers Act to change the threshold at which exclusive jurisdiction over
registered investment advisers (including advisers who have registered voluntarily) shifts from state
securities regulators to the SEC. Under current law, registered advisers with less than $25 million in
assets under management are subject to the exclusive jurisdiction of the state securities
administrators in the jurisdictions in which they conduct business, and such advisers are prohibited
from registering with the SEC. The bill would raise this threshold to $100 million in assets under
management, thereby subjecting advisers with less than $100 million under management to the
exclusive jurisdiction of the state securities regulators.
Regulation D offerings and state blue sky laws
In addition, the bill would modify the preemption of state securities registration laws applicable to
private placements conducted under Rule 506 of Regulation D. The National Securities Market
Improvement Act of 1996 (“NSMIA”) automatically exempts from state registration requirements
private placements of securities made in compliance with the SEC’s Rule 506. The bill would provide
that such exemption would not apply to any such offering if the SEC has not reviewed the Form D
Notice of such offering within 120 days after filing. The SEC’s current practice is not to review or
comment on Form D filings, except in unusual circumstances. As passed by the Senate, the bill
would subject issuers of securities in private placements (including private investment funds and the
entities in which they invest) to the risk of retroactive application of state securities registration laws,
requiring such issuers either to pre-clear their offerings with the SEC by filing Form D well in
advance of an offering or to comply with separate blue sky exemptions in each state in which an
offering will be made (with offerings being prohibited in those states where an applicable exemption
is not available).
Accredited investors
Title IV would also require the SEC to revise Regulation D to change the definition of the term
“accredited investor” by indexing the minimum annual income and minimum net worth thresholds
(currently $200,000 of annual income and $1 million in assets) to adjust for inflation since their
adoption in 1982.
Differences between Senate bill and House bill
Although the provisions of the Senate bill, as far as they relate to private investment funds and their
managers, are similar to those of H.R. 4173, the Wall Street Reform and Consumer Protection Act of
2009, which was adopted by the House on December 12, 2009, the bills differ in certain ways. For
example, the Senate bill exempts from the registration requirements of the Advisers Act advisers to
both venture capital funds and private equity funds, while the House bill exempts only advisers to
venture capital funds and would, therefore, require private equity fund managers to register as
advisers under the Advisers Act. On the other hand, the House bill excludes advisers to any type of
private investment fund with less than $150 million under management from the registration
requirements of the Advisers Act, while the Senate bill has no minimum asset value below which
advisers who otherwise would be required to register would be exempt. The House bill does not have
any provisions relating to the “accredited investor” definition or NSMIA’s preemptive provisions.
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Title V — Insurance
Under Title V, an Office of National Insurance is created within the Treasury to monitor all aspects
of domestic insurance activity to identify gaps in regulation or issues that could contribute to
systemic risk across all insurance lines except for health insurance. The Office would also coordinate
federal policy on international insurance matters and could preempt state insurance laws that conflict
with international insurance agreements and result in less favorable treatment of a non-United States
domiciled insurer than a state domiciled insurer. The language of the Senate bill closely tracks that of
the House bill passed in December.
Title VI — Improvements to regulation of bank and savings association holding
companies and depository institutions
Title VI of the Senate bill would enhance the regulation of depository institutions and their holding
companies and includes the controversial “Volcker Rule.” It also deals with the longstanding
controversy over the industrial bank loophole and source of strength requirements and concentration
limits.
Title VI seeks to buy time on the non-bank controversy by placing a three-year moratorium on FDIC
approval of any application (received after November 10, 2009) for deposit insurance or a change in
control of a credit card bank, industrial bank, or trust bank that is directly or indirectly owned by a
commercial firm. A commercial firm is defined to mean any entity that derives at least 15% of its
consolidated annual gross revenue from activities that are “not financial” in nature. The title would
prohibit such actions by a commercial firm for a three-year period. The GAO is required to conduct
a study of the exceptions in the Bank Holding Company Act for these institutions.
Functionally regulated subsidiaries exemption and reporting
In addition to making changes to existing law regarding the requirements concerning examinations,
Title VI expands the ability of the appropriate federal banking agency to examine and to impose
capital requirements on functionally regulated subsidiaries of bank holding companies and to take
enforcement action against such subsidiaries.
The Senate bill directs the appropriate federal banking agency to take into consideration the impact
on concentration risks to the stability of the United States banking or financial system when
approving or disapproving proposed bank and nonbank acquisitions. In addition, bank holding
companies would also be required to be well capitalized and well managed in order to make an
interstate bank acquisition. Bank holding companies will also have to be well capitalized and well
managed to engage in expanded financial activities under the Bank Holding Company Act.
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Concentration limits
Title VI placed overall limitations on the growth of U.S. financial institutions by limiting size to an
amount not to exceed 10% of the aggregated consolidated liabilities of all financial companies. The
FSOC could grant exceptions to the limit.
Transactions with affiliates
Title VI would amend the restrictions on transactions with affiliates and insiders in Section 23A of
the Federal Reserve Act by including credit exposure from derivatives transactions and securities
borrowing and lending as covered transactions and requiring collateral for covered transactions. It
also strengthens insider loan restrictions and limits asset purchases from insiders. It also eliminates
the exception for transactions with financial subsidiaries.
Lending limits for national banks
Credit exposure on derivative transactions, repurchase agreements, reverse repurchase agreements,
and securities lending and borrowing will be included as loans or extensions of credit for national
banks and thrifts when calculating lending limits. National bank limits will apply to state banks. Title
VI would also prevent banks and thrifts subject to formal or informal enforcement orders such as a
Memorandum of Understanding (“MOU”) from converting charters. The remaining restrictions on
de novo bank branching would be lifted.
Source of strength—Bank holding companies, savings and loan holding companies, and, if the
insured depository institution does not have a holding company, any company that directly or
indirectly controls the depository institution, will be required by statute to serve as a source of
financial strength for the subsidiary or controlled depositary institution. Further, an industrial
company that controls an insured depository institution such as an industrial loan corporation could,
for the first time, be subject to the source of strength requirements.
Securities holding companies—Title VI would revise the investment bank holding company
election provisions. Currently, if the investment bank does not have a bank or thrift affiliate, it may
elect to be supervised by the SEC. The Senate bill would permit securities holding companies to elect
to be subject to comprehensive consolidated supervision by the Federal Reserve. Such supervision
would include capital adequacy and risk management standards, examination and recordkeeping
requirements and would subject such securities holding companies to the provisions of the Bank
Holding Company Act other than the restrictions on nonbanking activities and investments, but
would include prior approval requirements for acquisitions of more than five percent of the voting
shares of a bank or bank holding company.
The Volcker Rule—proprietary trading prohibition
Title VI contains a provision reflecting the “Volcker Rule” initially proposed by former FRB Chair
Paul Volcker. As contained in the Senate bill, insured depository institutions, companies that control,
directly or indirectly, an insured depository institution or that are treated as a bank holding company
under the Bank Holding Company Act would be generally prohibited from engaging in “proprietary
trading” and would not be permitted to invest in or sponsor hedge funds or private equity funds. The
prohibitions would be implemented over time. First, an initial study by FSOC would be required to
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be completed within six months. Then bank regulatory agencies would develop regulations within
nine months after completion of the study. After that, institutions covered by the initiative would
have two years to divest relevant businesses or comply with the rule subject to up to three one-year
extensions that may be granted by the appropriate federal banking agency. The prohibition on
proprietary trading would not apply to U.S. government securities, GNMA, FNMA, and FHLMC
instruments. It also would exclude state and municipal bonds.
Title VII — Improvements to regulation of over the counter derivatives markets
Title VII, which reflects an agreement between Senator Dodd and Senate Agriculture Committee
Chair Blanche Lincoln, remains one of the most controversial provisions in the bill. Although similar
to the House bill, it goes beyond the House bill in many respects. It contains expansive definitions of
“swaps dealers” and “major swaps participants.” Because of the breadth of the definition, even
routine interest rate swaps offered to bank customers could be covered. It also enables regulators to
impose margin requirements for swaps transactions and codifies methods by counterparties to do the
same. Numerous changes are made to margin requirements and capital requirements, and clearing
and trading on an exchange is immediate in many circumstances. An anticipated showdown on the
Senate floor between advocates of stricter derivatives regulation and banks, swaps dealers,
municipalities, and others who strenuously objected to the scope of Title VII and its impact on
traditional activities never materialized. An effort by Senator Dodd to postpone and study the impact
of certain provisions of Title VII without making substantive changes was withdrawn in the face of
objections from Senator Lincoln and other Senate Agriculture Committee members. The provisions
of Title VII will now be a focal point in discussions between House and Senate conferees. Among its
important provisions are:
Swaps push out—In an already controversial title, the swaps push out language in Section 716 drew
significant comment. As drafted, it would prohibit “federal assistance” (including advances from the
Federal Reserve discount window or deposit insurance coverage by the FDIC) to any swaps entity.
Since this would include loans or purchase of equity of a swaps entity, it would have the effect of
requiring banks to separate derivatives activities from banking activities in order to continue to be
eligible to receive these important benefits.
Fiduciary duty—The Dodd bill provides that a swap dealer that provides advice regarding, or offers
to enter into, or enters into a swap with a state, state agency, city, county, municipality, or other
political subdivision of a state or a federal agency (a “Municipal Entity”), or a pension plan,
endowment, or retirement plan has a fiduciary duty to such entity. This fiduciary duty would apply to
interest rate and commodity swaps and could, for example, require that the counterparty act for the
benefit of the Municipal Entity, foregoing the counterparty’s own advantage if necessary. This
required fiduciary duty is not usually present in the typical contractual relationship between a swap
dealer and a municipal counterparty. The House bill does not contain a similar fiduciary requirement.
Commercial end user exemption—The Dodd bill and the bill passed by the House in December,
each contain a new rule that requires swaps to be cleared through an exchange with exception for
“commercial end users” to elect not to clear through a clearing agency.
The Dodd bill defines “commercial end user” as any person (other than a financial entity) who, as its
primary business activity, owns, uses, produces, processes, manufactures, distributes, merchandises,
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or markets goods, services, or commodities (which shall include but not be limited to coal, natural
gas, electricity, ethanol, crude oil, gasoline, propane, distillates, and other hydrocarbons) either
individually or in a fiduciary capacity.
The Dodd bill will require that certain swaps (determined by SEC or CFTC rule) will be “cleared.” If
cleared, then the clearing organization will clear the swap through a registered securities or swap
exchange.
Title VIII — Payment and clearing system regulation
This title is designed to mitigate payment system risk. Title VIII imposes new regulation and controls
on companies meeting the definition of “Financial Market Utilities” (“FMU”) that are clearing,
paying, or settling payments, securities, or other financial transactions. Rules are required to ensure
that such entities have sufficient capital. The FSOC determines who is an FMU, which could include
any bank (including foreign bank branches), insurance company, broker, commodities firm, credit
union, investment company, or advisor.
Title IX — Investor protections and improvements to the regulation of securities
Title IX of the bill is designed to enhance investor protection through new rules relating to disclosure
of executive compensation and the link between compensation and performance. Title IX also
effects a significant change in how the SEC is funded. It permits, in effect, the SEC to fund itself
each year through collection of fees and assessments. This could allow the SEC to grow without
adherence to the Congressional budget process to fund such growth. Finally, Title IX profoundly
alters the business model of the credit rating agencies such as Moody’s, Fitch, Standard & Poor’s, i.e.,
National Recognized Statistical Rating Agencies (“NRSROs”).
Increasing investor protection
The bill creates the Office of the Investor Advocate within the SEC to assist retail investors in
resolving problems with the SEC, self-regulatory organizations, financial service providers, and
investment products. The SEC will also conduct studies of financial literacy, financial planners, and a
GAO study of mutual fund advertising. Funding is also provided to assist states to develop greater
investment protection for elderly investors.
Increasing regulatory enforcement and remedies
The bill substantially replicates the House version by enhancing the SEC’s whistleblower award
program by increasing the amount of whistleblower awards enabling awards of 10–30% of amounts
collected from sanctions following a successful enforcement action. Whistleblower payments would
no longer be limited solely to insider trading, and other areas such as fraud and foreign corrupt
practices violations would be eligible. Retaliation against whistleblowers is prohibited.
Bad actors and felons
Under current law and practice, persons who were barred in one segment of the securities industry,
for example, as an investment advisor, could still participate as a broker-dealer. The bill expands the
“bad guy” bar across industry groups and provides the ability of the SEC to impose “collateral bars”
against any person associated with, or seeking to become associated with, a broker or dealer at the
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time of alleged misconduct from being associated with an investment adviser, municipal securities
dealer, municipal advisor, transfer agent, or NRSRO. In other words, the SEC would, in investor
protection matters, have the power to bar a person across all securities industry groups. It also
disqualifies felons and other “bad actors” from Regulation D Offerings.
New strict regulation of credit rating agencies
Credit rating agencies described in the legislation as playing a critical “gatekeeper” role in the debt
market similar to securities analysts for equities, will be subject to significant new regulation by the
SEC. In addition, the ability of issuers to unilaterally select and retain rating agencies would be
prohibited. The Office of Credit Rating Agencies would be established within the SEC. The office
would have dedicated staff and would be empowered to issue new rules for internal controls,
conflicts, transparency, and policies and procedures regarding all aspects of credit rating agencies.
The office would also have the authority to impose penalties for non-compliance with SEC rules.
Rating agencies would be examined at least once a year.
Also, the SEC would receive the authority to temporarily suspend or permanently revoke the
registration of an NRSRO with respect to a particular class or subclass of securities if the NRSRO
does not have adequate financial or managerial resources to consistently produce ratings for
securities “with integrity.”
Among the other provisions dealing with rating agencies:
The SEC will develop rules to prevent sales and marketing considerations from
influencing the production of ratings. For example, an NRSRO compliance officer
could no longer participate in development of rating methodologies or in sales or
marketing.
NRSRO boards of directors must meet new independence requirements and at least
half of an NRSRO board must be “independent.”
Annual internal control reports must be submitted to the SEC with an assessment
on the effectiveness of the internal controls.
Private right of action—Private rights of action against rating agencies under Section 15E of the
Exchange Act would be available to investors. Further, the Dodd bill provides that the Securities
Exchange Act of 1934 penalty provisions apply to rating agencies in the same manner as registered
public accounting firms, or securities analysts, and that statements by ratings agencies should not be
deemed forward looking under Section 21E.
Amendments—Credit rating agencies were also the subject of two seemingly contradictory floor
amendments to the Dodd bill. First, an amendment by Senator George LeMieux (R-FL) removed all
references to rating agency investment grades from the Investment Company Act of 1940, Securities
Exchange Act of 1934, the Federal Deposit Insurance Act, the National Banking Act, and the
Federal Housing Enterprises Financial Safety and Soundness Act of 1992. The purpose of the
amendment was to eliminate an inherent “subsidy” in selected federal laws requiring investment
grade ratings. The second amendment, sponsored by Senator Al Franken (D-MN) would prohibit
rating agency “shopping” on asset-based securities offerings by mandating that the NRSRO
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performing the initial rating be assigned by a new self-regulatory board established under SEC rules
and not selected by the issuer.
The two contradictory amendments, one removing an implicit subsidy for rating agencies in federal
law, and the other a federal agency assigning ratings, will be resolved in conference.
The Dodd bill will also impose significant changes to the securitization process:
Holdback—Requires federal banking agencies and the SEC to prescribe regulations requiring a
securitizer to retain an economic interest of at least 5% of the credit risk for any asset that the
securitizer, through the issuance of an asset-backed security, transfers, sells, or conveys to a third
party. Note, however, that only sales to securitizers are covered, making sales of whole loans to non-
securitizer third parties exempt. Regulators may impose lower risk retention requirements if
underwriting and diligence meet certain standards.
Due diligence—Requires any issuer of an asset-backed security to perform a due diligence analysis
of the assets underlying the asset-backed security and to disclose the results of that analysis.
The Senate also crafted an important exception to the securitization retention provision regarding
securitizations for “qualified mortgages.” The floor amendment, sponsored by Senator Mary
Landrieu (D-LA), provides that the 5% “holdback” provisions for securitizers do not apply to
securitizations consisting solely of “qualified residential mortgages.” The definition of the term
“qualified residential mortgages” would be developed jointly by the federal bank regulatory agencies,
HUD, and the Federal Housing Finance Agency. The rule will take into account such matters as loan
to value ratios, income levels, and features related to the loan itself such as balloon payments.
Accountability and Executive Compensation
Compensation disclosures—Like the audit committee independence rules, this provision permits
compensation committees of boards of directors to hire independent compensation consultants and
compensation committee counsel. Any use of a compensation consultant would be a mandatory
disclosure in proxy materials. Each issuer is required to disclose required compensation information
in proxy and consent solicitation materials for an annual meeting of the shareholders. The
information must show the relationship between executive compensation and the financial
performance of the issuer, and consider any change in the value of the shares of stock and dividends.
Also the Dodd bill mandates that each issuer disclose the median amount of compensation paid to all
employees, except the chief executive officer, the annual total compensation of the chief executive
officer, and the ratio of these amounts.
Clawback—Requires issuers to develop and adopt policies permitting the clawback of incentive
compensation paid on the basis of past (three years) inaccurate financial statements arising from “any
material noncompliance with any financial reporting requirement under the securities laws.” Current
and past executives are covered and the term “incentive compensation” would include stock options.
The provision does not provide any exceptions for individuals that were not involved in misconduct
that led to the restatement.
Say on pay—For any vote where compensation disclosure is required, shareholders shall have non-
binding votes to approve the compensation of senior executive officers.
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Board independence—For all exchange listed issuers, each member of the compensation
committee of the board of directors must be independent. Also, additional independence
requirements similar to those applied to audit committee members under existing law, would apply to
compensation committee members.
Corporate governance
Majority vote—Requires that, in an uncontested election for membership on the board of directors
of an issuer, the SEC would direct the exchanges to develop rules mandating that a majority of the
votes of eligible shareholders will be required to elect each director. Currently, a mere plurality of
votes cast is sufficient to elect directors. A director that receives less than a majority of the votes
must tender resignation to the board of directors and the board shall have the discretion to either
accept the resignation (immediately or at reasonable future date) or decline to accept the resignation
and publicly announce the specific reasons why the board chose not to accept the resignation. In a
contested election, a plurality vote is required to elect a director. The SEC is required to direct
national exchanges to develop such rules within one year of enactment and to delist any issuer that is
not in compliance with the majority election provision.
Proxy nomination—Authorizes, but does not require, the SEC to issue rules that permit
shareholders to use proxy solicitation materials to nominate individuals to the board of directors.
Chairman and CEO disclosure—Requires an issuer to disclose, in the annual proxy statement sent
to investors, the reasons why the issuer has chosen the same person or different persons to serve as
chairman of the board of directors and chief executive officer.
The bill permits the SEC to “self fund” its annual budget. Under the mechanism, the SEC would
submit the budget to Congress and the budget would be automatically funded outside of the
appropriations process. The SEC would then repay the budget from annual fees and assessments.
The new approach is likely to enable the SEC to have greater resources and to use funding for longer
term initiatives and projects that are not consistent with the year-to-year Congressional budgeting
process.
Title X — Establishment of the Bureau of Consumer Financial Protection
Title X of the Dodd bill creates the Bureau of Consumer Financial Protection (the “BCFP” or the
“Bureau”) as an independent bureau within the Federal Reserve System where it would have
“rulemaking, supervisory and enforcement authority” over consumer “financial products or services”
under the federal consumer finance laws. The House bill, H.R. 4173, adopted on December 11, 2009,
called for the establishment of a stand alone consumer financial protection agency, while the Dodd
bill provides for the BCFP to operate within the FRB. Even though sited within the FRB, the Bureau
is not under the FRB’s jurisdiction and is independently funded by an annual special assessment from
the gross revenues of the Federal Reserve System.
The BCFP is to be led by a Director, appointed by the President with the advice and consent of the
Senate. While the bill grants the BCFP very broad powers, it also provides for coordination between
the Bureau and the SEC, the CFTC, the Federal Trade Commission (the “FTC”), and other federal
agencies and state regulators.
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Purpose, objectives, and functions
The overarching purpose of the BCFP, as stated in Section 1021 of the bill, is to implement and
enforce federal consumer financial law consistently so that “markets for consumer financial products
and services are fair, transparent, and competitive.” More specifically, BCFP’s objectives are to
ensure that consumers are provided timely and understandable information in order to make
responsible decisions about financial transactions and that consumers are protected from unfair,
deceptive, or abusive acts and from discrimination. The bill provides some guidance with respect to
the term “abusive” in providing that to find an act or practice abusive, the act or practice must
materially interfere with the ability of the consumer to understand a term or condition of a product
or service or take unreasonable advantage of a lack of understanding as to the material risks, costs, or
conditions of the product or service; the inability of the consumer to protect his own interest in
selecting or using a product or service; or the reasonable reliance by the consumer on a covered
person to act in the interests of the consumer. It is unclear how these standards will be interpreted
going forward, particularly, the prohibition against “abusive acts,” although existing regulations and
enforcement may shed some light on this standard, including Section 806 of the Fair Debt Collection
Practices Act, which prohibits abusive acts in the collection of debt.
Covered persons/financial products or services
The BCFP would have supervisory, rulemaking, and enforcement authority over banks and non-bank
entities, i.e., “covered persons,” for virtually all consumer finance activities except insurance, CFTC
regulated, and SEC regulated services.
The term “covered persons” includes both “any person that engages in offering or providing a
consumer financial product or service,” and affiliates of such persons, if acting as a service provider.
A “service provider” is defined as any person that provides a material service to a covered person in
connection with the provision of a consumer financial product or service and includes a person that
participates in designing, operating, or maintaining the product or service.
The “financial products or services” subject to regulation by the Bureau are defined as “extending
credit and servicing loans, including acquiring, purchasing, selling, brokering, or other extensions of
credit” and other formats that are the functional equivalent of such transactions or where the
underlying activity is related to consumer credit. It would include:
Leasing of real or personal property
Deposit taking
Funds custodian
Appraisals
Check cashing
Certain financial data processing
Debt collection
Stored value or payment instruments
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Financial advisory
Federal consumer financial law
The term “Federal consumer financial law” under the Bureau’s jurisdiction is defined to include the
provisions of Title X, the enumerated consumer laws therein, the laws for which authorities are
transferred under subtitles F and H, and any rule or order prescribed by the Bureau, under an
enumerated consumer law or pursuant to the transferred authorities.1
Notably, the term “Federal consumer financial law” does not include the Federal Trade Commission
Act. The Federal Trade Commission retains its authority under the Federal Trade Commission Act
or any other law.
Establishment, powers, and autonomy
The BCFP is required to establish a functional unit for research on developments in markets for
consumer financial products or services, access to fair and affordable credit, consumer awareness and
understanding of the costs, risks, and benefits of consumer financial products or services and
consumer behavior with respect to such products or services. The Bureau is also charged with
establishing a unit for community affairs for providing information and assistance and a unit for
collecting and tracking complaints. The research efforts will relate to offices the Bureau is charged
with establishing. These include the Office of Fair Lending and Equal Opportunity, the Office of
Financial Literacy, and the Office of Service Member Affairs. Each of these offices will coordinate
efforts with other federal agencies and state regulators, as appropriate. Under the bill the Bureau
must create a Consumer Advisory Board to advise and consult with the Bureau and to provide
information on emerging practices and trends. There are provisions for funding, provided by an
annual percentage of gross revenues from the Federal Reserve System, as well as penalties and fines,
including the establishment of a victims’ relief fund to be known as the Consumer Financial
Protection Civil Penalty Fund, into which civil penalties will be deposited. These funds will be used
for payments to victims and for consumer education and financial literacy programs.
Rulemaking/examination/enforcement
The Bureau is granted exclusive rulemaking authority for consumer protection under the standards
enumerated, including the requirement to consider, along with the potential benefits and costs to
consumers and covered persons, the potential reduction of access to consumer financial products or
1
Alternative Mortgage Transaction Parity Act of 1982, 12 U.S.C. 3801 et seq.; Consumer Leasing Act of
1976, 15 U.S.C. 1667 et seq.; Electronic Fund Transfer Act, 15 U.S.C. 1693 et seq.; Equal Credit Opportunity
Act, 15 U.S.C. 1691 et seq.; Fair Credit Billing Act, 15 U.S.C. 1666 et seq.; Fair Credit Reporting Act, 15 U.S.C.
1681 et seq., with certain exceptions; Home Owners Protection Act of 1998, 12 U.S.C. 4901 et seq.; Fair Debt
Collection Practices Act, 15 U.S.C. 1692 et seq.; Subsections (b) through (f) of Section 43 of the Federal
Deposit Insurance Act, 12 U.S.C. 1831t(c)(f); Sections 502 through 509 of the Gramm-Leach-Bliley Act, 15
U.S.C. 6802-6809, with an exception; Home Mortgage Disclosure Act of 1975, 12 U.S.C. 2801 et seq.; Home
Ownership and Equity Protection Act of 1994, 15 U.S.C. 1601 note; Real Estate Settlement Procedures Act of
1974, 12 U.S.C. 2601 et seq.; S.A.F.E. Mortgage Licensing Act of 2008, 12 U.S.C. 5101 et seq.; Truth in
Lending Act, 15 U.S.C. 1601 et seq.; Truth in Savings Act, 12 U.S.C. 4301 et seq., and Section 626 of the
Omnibus Appropriations Act, 2009 (Public Law 111 8)
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services. The BCFP’s jurisdiction for supervision would cover (i) “non-depository covered persons,”
(ii) “very large depository institutions,” and (iii) “other depository institutions.”
Non-depository covered persons—The Bureau will have exclusive rulemaking and examination
authority over non-depository covered persons, i.e., non-banks, including payday lenders, debt
collection, consumer reporting agencies and other persons who are larger participants in the markets
for consumer financial products or services as defined by rule as well as the offering, providing, or
servicing of consumer real estate loans and loan modification or foreclosure relief services in
connection with such loans.
Very large depository institutions—With respect to “very large” banks, savings associations and
credit unions with assets of more than $10 billion, the Bureau would also have supervision and
enforcement authority. To minimize regulatory burden, there are provisions for coordinated
examinations and appeals for findings that are in conflict with the institution’s prudential regulator
and state bank regulatory authorities.
Other depository institutions—For banks, savings associations, and credit unions with $10 billion
or less in assets, examinations would be conducted by prudential regulators. However, the Bureau
can require reports as necessary to support the role of the Bureau and may, at its discretion, include
examiners on a sampling basis of the examinations performed by the prudential regulator.
Exempt entities
There are a number of entities that are exempt from BCFP’s enforcement including persons
regulated by a state insurance regulator, the SEC, a state securities commission, the CFTC, or the
Farm Credit Administration. There are, additionally, a number of other types of exemptions or
limitations; for example, the Bureau has no authority to establish a usury limit applicable to the
extension of credit, unless explicitly authorized by law.
Relief/penalties
Section 1055 of the bill grants the court or the Bureau the jurisdiction to award any appropriate legal
or equitable relief, including rescission or reformation of contracts, refund of money or return of real
property, restitution or disgorgement or compensation for unjust enrichment, payment of damages
or other monetary relief, public notification regarding the violation, including costs of notification,
limits on activities or function of the person, and civil money penalties. While the bill authorizes the
payment of damages, it does not authorize exemplary or punitive damages. Provisions for penalties
are included.
Enforcement by state attorneys general and regulators/preemption
Except with respect to a national bank or federal savings association, the attorney general of a state
may bring a civil action in the name of the state in a federal or state court to enforce provisions of
the title or regulations thereunder, and to secure remedies under the title or otherwise under
applicable law; similarly, a state regulator may bring an action to enforce the provisions of the title or
regulations thereunder with respect to any entity that it is state-chartered, incorporated, licensed, or
otherwise authorized to do business under state law. Before initiating such action, the attorney
general or state regulator must provide the BCFP with a copy of the complaint to be filed and a
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specified notification and the BCFP may intervene and remove the action to federal court. The
attorney general may not bring an action against a national bank or federal savings association with
respect to a violation of the title, but may bring an action to enforce a Bureau regulation. The
authority of a state attorney general or state regulator to otherwise enforce a provision of an
enumerated federal consumer law or an action or proceeding arising solely under the law in effect in
that state is preserved.
State consumer laws are preempted only if (i) application of a state consumer financial law would
have a discriminatory effect on national banks, in comparison with the effect on a state-chartered
bank; (ii) the state consumer financial law is preempted in accordance with the legal standard of the
Barnett Bank decision, Barnett Bank of Marion County, N.A. v. Nelson, Florida Insurance Commissioner, et al.,
517 U.S. 25 (1996) and any preemption determination may be made by a court, or by regulation or
order of the Comptroller of the Currency on a case-by-case basis, in accordance with applicable law;
or (iii) the state consumer financial law is preempted by a provision of federal law other than Title X.
Preemption is not available with respect to any subsidiary or affiliate of a national bank (other than a
subsidiary or affiliate that is chartered as a national bank).
Title XI — Federal reserve system provisions
Under this title, lending authority in “unusual exigent circumstances” would be narrowed and
Treasury approval would be required. The President of the New York Federal Reserve Bank would
be appointed by the President.
Title XII — Improving access to financial institutions
Under this title, Treasury could implement grant programs so that Community Development
Financial Institutions (“CDFIs”) could establish loan loss reserves.
Title XIII — Pay It Back Act
This title reduces TARP funding to $550 billion and prohibits future TARP assistance except for
immediate and substantial threats to the U.S. economy.
For further information, please contact your regular Nixon Peabody attorney or:
Raymond J. Gustini, (202) 585-8725 or rgustini@nixonpeabody.com
Lloyd H. Spencer, (202) 585-8303 or lspencer@nixonpeabody.com
Steven Plevin, (415) 984-8462 or splevin@nixonpeabody.com
Bruce J. Baker, (585) 263-1232 or bbaker@nixonpeabody.com
Mats G. Carlston, (212) 940-3121 or mcarlston@nixonpeabody.com
Bart Pisella, (212) 940-3038 or bpisella@nixonpeabody.com
Keith Krasney, (212) 940-3062, or kkrasney@nixonpeabody.com
William E. Kelly, (617) 345-1195, or wkelly@nixonpeabody.com
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Tiana Butcher, (202) 585-8359, or tbutcher@nixonpeabody.com
John LaBoda, (585) 263-1044, or jlaboda@nixonpeabody.com
Barry M. Rothchild, (212) 940-3187, or brothchild@nixonpeabody.com
Paulette J. Morgan, (212) 940-3703, or pmorgan@nixonpeabody.com
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