By Todd Sprang, CPA
At 2,300 pages, the Dodd-Frank Wall Street Reform and Consumer Protection Act is, by most definitions, a monumental piece of legislation. It also is one of the most sweeping reforms of the American financial system since the Great Depression.
The act is intended to contain risk in the financial services sector through tightened regulation, increased consumer protection, and stricter oversight of public companies. For the financial services industry, it is likely to mean a greater compliance burden and higher costs.
Final regulations, which are expected to run to 5,000 pages or more, have yet to be written. All we have now is a sort of rough outline for how the law will be put into place. Here is what it looks like:
Impact on financial services sector
The law creates two new government agencies:
Financial Stability Oversight Council (FSOC) – A new agency is being created to monitor systemic financial risks. This means that financial institutions, non-bank financial services entities, and insurance firms soon will be segregated into new categories of systematically important and non-systematically important risks to the overall financial system. Segregation will result in additional reporting and compliance requirements, and will ultimately change the business model for financial institutions and other entities.
These entities also will be subject to heightened capital and liquidity requirements, and will need to provide a formal plan (often called a living will) to help with an orderly resolution in the event of a failure. It would appear that the too big to fail mentality has ended.
Bureau of Consumer Financial Protection (BCFP) – This new agency will assume the responsibility of issuing and monitoring consumer protection laws. BCFP is independent of the Federal Reserve System and is given sweeping authority to create and issue new rules that directly affect the financial services sector with respect to unfair, deceptive or abusive practices with consumers. Institutions with less than $10 billion in assets will be examined and monitored by existing regulatory agencies, although the BCFP also has the authority to participate in those regulatory examinations.
Additional regulations impact virtually every corner of the financial services sector:
- Derivatives trading and mortgage lending – Will now operate under stricter reporting and compliance requirements, increasing costs for financial institutions.
- Investment trading and the Volcker Rule – The Volcker Rule, named for former Federal Reserve Board Chairman Paul Volcker, was established to limit financial institutions from making speculative investments, such as those deemed to have played a significant role in the recent financial crisis. Specifically, the rule was written with the intent of diminishing proprietary trading that is not at the request of their clients. The rule also attempts to provide limitations on the ability of financial institutions to enter into asset securitizations or invest in private equity and hedge funds, and monitors the total liability levels of the institution.
- Interchange fees – Fees associated with interchange transactions will now be developed by the Federal Reserve System to ensure that transaction fees are “reasonable and proportionate to the cost of the card network’s expense for processing the transaction.” What should happen is a reduction in higher fees to consumers, but this may limit the fee income generated by the smaller institutions, requiring a rethinking of budgets and business models.
- Permanent increase in deposit insurance – Deposit insurance for banks, thrifts, and credit unions is now permanently fixed at $250,000.
- Elimination of the Office of Thrift Supervision – The OTS will be shut down and will transfer powers mainly to the Office of the Comptroller of the Currency. However, the act preserves the thrift charter. Those institutions will need to adjust to the transfer over a period of one year from the signing of the act, but there is an additional six-month extension to fully transfer those powers.
Impact on public companies
The act also targets publicly traded companies that are not in the banking and financial services sectors. Most of the impact is in the area of executive compensation. The Securities and Exchange Commission (SEC) will create regulations to implement the basic provisions outlined in the legislation.
Compensation committees – Committees must be independent, and must select legal counsel, advisors, and consultants that are independent.
Compensation disclosure – There are expanded compensation disclosure requirements for the annual proxy statement, including:
- Median of annual total compensation of all employees other than the CEO
- Annual total compensation of the CEO
- The ratio between these two categories
“Claw back” policy –Aims to recover incentive compensation paid to executives based on misstated financial statements.
Shareholder “say on pay” – Gives shareholders the ability to vote on executive compensation and golden parachute clauses.
Proxy – Provides the SEC with power to issue proxy access rules so shareholders can nominate directors.
Broker voting – Prohibits a broker who is considered the non-beneficial owner of a company’s shares from voting on certain issues unless specifically instructed by the beneficial owner.
Sarbanes-Oxley 404(b) – Companies with less than $75 million in market capitalization are permanently exempted from auditor attestation regarding internal controls over financial reporting.
There are many rules yet to be debated, comments to be made, and rules to be finalized. When the rules are completed, it is expected that virtually every aspect of the financial services industry will be affected, including, but certainly not limited to:
- Entity legal and tax structure
- Operations, business lines, and product offerings
- Corporate and organizational structure and governance
- Compliance and risk management
- Regulatory and public reporting
- Internal controls
- Information technology infrastructure
It appears the biggest burden will be on smaller community institutions, where significantly more rules and regulations will increase compliance costs such as training, staffing, documentation, disclosures, and external examination. Larger institutions have greater resources for building up the necessary people, processes, and procedures to deal with the law’s requirements.
Ultimately, there may end up being fewer small institutions, but in the interim, everyone is likely to reexamine their fees and rates in an attempt to recapture at least some of the new costs.
There are as many questions as there are answers in this far-reaching legislation. What is clear is that the business model for financial institutions and the financial services sector will almost certainly change. How that will look in the real world has yet to be determined.
About the author:
Todd Sprang is a partner in Clifton Gunderson’s Oak Brook, IL, office. Sprang is a financial institutions specialist and has more than nine years of upper management and partner-level experience.