Dodd's Financial Regulatory Reform Bill (Yes, You Should Read This)

A little over one year after the greatest financial crisis in U.S. history ended, Senate Banking Chairman Christopher Dodd unveiled his bill for financial regulatory reform. Dodd stressed that the bill will not prevent the next crisis, “nothing will,” he said. However, it appears that the rules contained in the bill would have gone a long way toward preventing the financial crisis.

President Obama called it “a strong foundation to build a safer financial system.”

Although Dodd has been unable to build bipartisan support for the plan, his new bill is comprehensive is scope and attempts to broadly restructure federal financial regulations. The bill has eleven major components and covers areas including banking, hedge fund registration, derivatives, risk assessment, executive compensation, insurance, consumer finance, and credit rating agencies.

At the mid-afternoon press conference, Dodd said the bill would end the "too-big-to-fail" concept, protect consumers, limit risk-taking, and rein in compensation packages.

To most, reading through the details of financial regulations has to be akin to watching paint dry. But frankly, this is important stuff to all investors. So, we’ve attempted to boil it down to the key elements and have summarized the highlights below.

Consumer Financial Protection Bureau: What is commonly referred to as the “consumer protection agency” will not be a standalone agency, but instead be a unit of the Federal Reserve. The agency will examine and enforce consumer rules for banks and credit unions that have assets over $10B in assets. But most importantly, the agency will also have authority over mortgage-related businesses and large nonbank financial firms. (I.E. The previously unregulated mortgage brokerage businesses that played such a large role in mortgage meltdown.)

Risk Watchdog: The Dodd bill establishes a 9-member council of systemic risk regulators, chaired by the Treasury Secretary. The measure empowers the systemic risk council to assign high-risk nonbank financial firms to fed oversight and may approve a Fed decision to order the break-up of large firms that threaten the economy's stability.

Not-Too Big To Fail: The Financial Stability Oversight Council will monitor the risk of large companies and may recommend to increase capital requirements and implement other rules in order to reduce the impact of a single institution on the system. More importantly, the bill creates a process for the FDIC to unwind any failing institution that is a systemically significant financial company. The bill requires Treasury, FDIC and the Federal Reserve to agree when a company should be “put down.” Shareholders and unsecured creditors will bear losses and management will be removed.

The Volcker Rule: The bill would require regulators to implement rules for banks and bank holding companies that would prohibit proprietary trading as well as investment in and the sponsoring of hedge funds and private equity funds. The latest addition to the bill includes “nonbank financial institutions” that are supervised by the Fed under the regulatory umbrella.

Banking Regulations: The Fed will regulate bank and thrift companies with assets over $50 billion. The FDIC will handle state banks and thrifts of all sizes and bank holding companies of state banks with assets below $50 billion. The Office of Thrift Savings will be eliminated.

Hedge Funds Must Finally Register: For some reason, hedge funds have never been required to register with the SEC. Mutual funds are required to register. Your local investment advisor with $30 million under management has to register. But yet, the REALLY fast money crowd using complex and risky securities was exempt. Well, no longer. Any hedge fund managing more than $100 million will be required to register and abide by SEC regulations.

Say on Pay: This provision will give shareholders a say on executive compensation and give the SEC authority to grant shareholder proxy access to nominate directors.

Securitization: The bill would require companies that sell securitized products such as mortgage-backed securities to retain a minimum of 5% of the credit risk and would increase disclosure rules.

Credit Rating Agencies: A VERY big part of the mortgage meltdown was the fact that securities received AAA rating that should not have. Thus, the bill creates a new Office of Credit Rating Agencies at the SEC and requires the rating companies to disclose their methodologies.

So there you have it. While the bill has a long way to go and is likely to encounter revisions, we thought it was important for investors to understand what is inside the new rules and regulations. In short, there are many good and well-meaning ideas contained in this bill. However, it is also important to understand that we had many regulators and rules in place this time around too.

 

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