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Last Updated: 22 December 2011
The Dodd–Frank Wall Street Reform and Consumer Protection Act Will Require a Change in Regulatory Culture and Mindset to be Effective
Gill North, University of New South Wales*
Ross
Buckley, University of New South
Wales[&]∗
Citation
This paper is to be published in 35(2) Melbourne
University Law Review (2011) (forthcoming). This paper may also be referenced as
[2011] UNSWLRS 52.
Abstract
The Dodd-Frank Act constitutes the most
significant reform of financial regulation in the United States since the 1930s.
Some of its
provisions are bold, particularly in the areas of consumer
protection and derivative trading. However, the political challenges for
law
reformers and regulators in the wake of the global financial crisis are far from
over. The Act is inchoate. The full scope and
nature of the new financial
regulatory system will take several years to evolve as the mandated studies and
rule making are completed
and implemented. We argue that the extent to which the
reforms achieve their stated objectives will depend most critically on three
factors: (i) the competency, integrity and forcefulness of the federal
regulators, (ii) their ability and willingness to supervise
the finance industry
on an integrated basis, and (iii) a fundamental change in the regulatory culture
and mindset.
The Global Financial Crisis (GFC) led to widespread
calls for regulatory change in the United States (US) and elsewhere. In June
2009,
President Barack Obama introduced a proposal for a ‘sweeping
overhaul of the United States financial regulatory system, a transformation
on a
scale not seen since the reforms that followed the Great
Depression.’[1]
The
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Pub L
111-203, 124 Stat 1376) (‘The Act’) was signed into law by
President Obama on July 21, 2010. The Act is named after two members of
Congress, Representative Barney
Frank who proposed the bill in the House on
December 2, 2009 and Chris Dodd the Chairman of the Senate Banking Committee.
Its stated
purposes are:
The
purposes of the Act reflect the major political and public concerns in the US
during and in the wake of the crisis:
Most of the Act
deals with these individual areas of
concern.[2] However, the reforms also
address factors that were generally acknowledged as significant underlying
causes of the crisis, such as
issues relating to the securitisation and
derivative markets and credit rating agencies.
The potential scope of
the Act is immense. The statute is nearly a thousand pages long and it
encompasses many aspects of financial
reform. One legal practitioner describes
it as ‘a profound increase in regulation of the financial services
industry’,[3] others as ‘a
paradigm shift in the American financial regulatory environment affecting all
Federal financial regulatory agencies
and affecting almost every aspect of the
nation's financial services
industry.’[4] However, the Act
is inchoate and provides only a broad framework. Some of the reforms came into
effect the day following its passing
into
law.[5] However, the operation of many
provisions is delayed or subject to rule making by the federal regulators. The
regulators are required
to conduct numerous studies and provide reports and
recommendations in order to determine the provisions governing many of the most
controversial reforms.[6] While most
of the rulemaking was scheduled for completion within 12 months, the legislative
timetables were overly ambitious.[7]
The full scope and nature of the financial regulatory framework may take several
years to emerge. Indeed, the efficacy of some of
the regulation will only be
known at the time of the next major financial crisis.
The importance
of the legislation to financial regulation and economic development globally are
hard to exaggerate. A significant
proportion of the world’s financial
services are provided in the US or by US based institutions. Moreover, as
the GFC clearly highlighted, the world’s financial systems are
inextricably interconnected. It is not feasible
for a single paper to discuss
the Act or critique its provisions comprehensively. Instead, the article
provides an overview of the
significant reforms and discusses some of the more
controversial proposals. The primary aims are to highlight the incomplete nature
of the legislation and the essential reliance on federal regulators to draft,
implement, supervise and enforce the reforms.
The article discusses the
financial regulatory structure initially. The Act provides the primary federal
regulators, the Federal Reserve
(the Fed), the US Department of the Treasury
(Treasury), the Federal Deposit Insurance Corporation (the FDIC), the Securities
and
Exchange Commission (the SEC) and the Commodity Futures Trading Commission
(the CFTC) with enlarged powers and
functions.[8] However, the regulatory
system remains cumbersome. The proposed reforms, far from streamlining the
supervisory arrangements governing
financial companies, add a layer and
complexity to the multi agency framework.
The legislative reforms are
then reviewed under the following categories: supervision of systemically
important institutions, financial
institutions, financial markets &
products, executive compensation, consumer protection, and investor protection.
These reviews
outline the most important or significant provisions, followed by
commentary and analysis. The aspirational objectives of the Dodd
Frank Act are
largely uncontroversial. Assessment of the regulation and provisions is more
difficult given the inchoate nature of
the legislation, the reliance on
regulators to complete and manage the reform processes, and the need to assess
the reforms using
a long-term lens.
We complete the analysis with
discussion on regulatory performance issues, because the ultimate success of the
legislation relies
on the regulators’ willingness and ability to manage
the reforms as an integrated package, and to work together with a primary
focus
on the bigger picture. We argue that this requires more than simply legislative
change. The real question posed by the reforms
is not whether the regulators
have sufficient powers to achieve the stated objectives of the Act, but whether
they are willing to
proactively use these powers to prevent, or to mitigate the
negative effects of, the next financial
crisis.[9]
A The Financial Regulatory Structure
There are many papers that
detail the significant financial policy reforms and development of the
regulatory framework in the US since
the
1930’s.[10] In 2009 the
Government Accountability Office (GAO), which acts as an independent review
agency of Congress, indicated that the ‘current
US financial regulatory
system ... [is a] fragmented and complex arrangement of federal and state
regulators – put into place
over the past 150 years – that has not
kept pace with major developments in financial markets and products ...
[R]esponsibilites
for overseeing the financial services industry are shared
among almost a dozen federal ... regulatory agencies ... and hundreds of
state
financial regulatory
agencies.’[11] Hubbard
suggests the ‘fragmentation of regulators is not the product of careful
design – it has evolved by layers of
accretion since the Civil War. It has
survived largely unchanged, despite repeated unsuccessful efforts at
reform.’[12] Kushmeider
indicates that ‘[m]ost observers of the US financial regulatory system
would agree that if it did not already exist,
no one would invent
it.’[13] She suggests that
repeated failures to reform the system show ‘how sensitive the issues are
for the many varied interest groups
involved’.[14]
The
financial regulatory structure in the US prior to the Act has been described as
“functional”, with financial products
or activities regulated
according to their function. The benefits of this structure were seen to be:
• a better understanding of products or activities due to regulator specialisation;
• improved regulatory innovation due to competition among regulators;
• checks and balances between the regulators;
• the ability for companies to select the regulator most appropriate for their business; and
• a system that has generally worked well, enabling deep, liquid and
efficient markets.
However, those seeking reforms argued that the
multi-agency structure resulted in:
• overlapping jurisdictions making it difficult to hold any one agency accountability for its actions;
• conflicts between state and federal regulators;
• potential regulatory gaps;
• competition between regulators in a race to the bottom for the lowest regulatory standards and lax enforcement;
• the inability for regulators to manage complex financial institutions or systemic risk;
• difficulties managing consolidated groups; and
• entrenched constituencies.
An IMF report in August 2007
indicated that the multiple federal and state regulatory frameworks in the US
overseeing the financial
market system may limit regulatory effectiveness and
slow responses to pressing issues. Two months later the GAO reported to
Congressional
Committees on the federal regulatory
system.[15] The GAO report indicated
that the regulatory structure was challenged by the developing industry trend of
large, complex, internationally
active firms whose product offerings span the
jurisdiction of several agencies. It highlighted unresolved issues around
duplicative
and inconsistent regulation of financial services conglomerates and
problems with accountability when agency jurisdiction is not
clearly assigned. A
GAO report released as testimony before the Committee on Homeland Security and
Governmental Affairs of the US
Senate in January 2009 reached a stronger
conclusion. The summary stated that ‘[a]s the nation finds itself in the
midst of
one of the worst financial crises ever, the regulatory system
increasingly appears to be ill-suited to meet the nation’s needs
in the
21st century.’[16]
The limitations and gaps posed by the fragmented regulatory arrangements were
identified as:
1. A failure to mitigate systemic risk posed by large and interconnected financial conglomerates;
2. Difficulties in dealing with significant market participants - such as nonbank mortgage lenders, hedge funds and credit rating agencies;
3. Challenges posed by new and complex investment products such as complex retail mortgage and credit products;
4. Difficulties in establishing accounting and audit standards that are responsive to financial market developments and global trends; and
5. Difficulties in coordinating international regulatory
efforts.[17]
The 2009
GAO report did not provide detailed proposals or solutions to address the
identified issues; instead it outlined principles
that an ideal regulatory
framework should reflect. It indicated that the framework should: have clearly
defined regulatory goals;
be comprehensive; adopt a system wide focus; be
efficient and effective; ensure consistent consumer and investor protection;
ensure
that regulators are independent with sufficient resources, clout and
authority; and ensure consistent financial oversight with minimal
taxpayer
exposure.[18]
The reforms
outlined in the following sections include provisions to address the issues
identified by the GAO excepting the accounting
and audit standard difficulties.
Whether these reforms will result in the ideal regulatory system proposed by the
GAO remains an
open question.
B Supervision of Systemically Important Financial Institutions
1 The Act
(i) Financial Stability Oversight Council
President
Obama wanted to limit the overall size of individual financial institutions to
avoid a concentration of risk in a small
number of financial companies and to
reinforce the principle that no institution is too big to fail. This aspiration
is translated
into provisions that potentially require systemically important
companies to hold minimum levels of risk based capital beyond those
generally
applicable under other
regulation.[19] Banks holding
companies with $50 billion or more in assets and nonbank financial companies
designated as systemically important (designated
NFCs)[20] can be made subject to
“enhanced prudential” requirements beyond those imposed by other
regulation. Individual regulators
are authorised to determine the specific
leverage and capital measures.[21]
The Fed is also empowered to act in relation to bank holding companies
with $50 billion or more in assets and systemically important
NFCs that pose a
‘grave threat to the financial stability of the United
States’.[22] The Fed may:
limit the ability to merge with, consolidate or affiliate with another company;
restrict the financial products offered;
require the termination of activities;
impose conditions on the way a business activity is conducted; or require the
selling or transfer
of assets.[23]
In addition, mergers, acquisitions and other business combinations are
prohibited if the resulting enlarged company would hold more
than 10% of the
total consolidated liabilities of all banks and supervised
NFCs.[24]
The reforms extend beyond concern with individual financial institutions to
the supervision of systemic risk and financial stability.
The Fed remains
primarily responsible for the systemic risk regulation and supervision. In
addition, the Act establishes a Financial
Stability Oversight Council (Council),
which includes representatives from all of the major regulatory
bodies,[25]
to identify risks to the financial stability of the United States, to promote
market discipline, and to respond to emerging
threats.[26] The role of the Council is to
provide advice, communication and coordination across the regulatory framework.
It is required to define
and monitor systemic risk regulation, conduct research,
keep abreast of ongoing market developments, and to make recommendations
on
prudential standards and market activity.
(ii) Orderly Liquidation Authority
Title II of the Act creates
an Orderly Liquidation Authority (OLA) that empowers the FIDC to serve as a
receiver for large interconnected
financial companies whose insolvency poses a
significant risk to financial stability or is likely to seriously adversely
affect the
US economy.[27] As
receiver of a financial company, the FIDC assumes control of the liquidation
process with broad powers.[28]
The Act prevents the use of taxpayers’ funds to pay for any aspect
of the receivership process.[29] All
costs are to be recouped from creditors or shareholders of the
institution,[30] from the
disposition of assets of the company, or from assessments on other financial
companies.[31]
2 Commentary & Analysis
The reforms in Titles 1 and II of the Act reflect
elements of proposals put forward by some scholars. Herring argued in 2009 that
‘supervisors need to place much greater emphasis on increasing the
resilience of the system by ensuring that no institution
is too big, too
complex, or too interconnected to
fail.’[32] He suggested that
systematically important institutions should be required to file and update a
winding-down plan and where required,
supervisors should be empowered to require
changes in the size or structure of firms.
Skeel argues that the final
reforms single out the largest institutions for special treatment. He suggests
the OLA processes provide
‘unconstrained regulatory discretion’ with
the ‘basic expectations of the rule of law – that the rules will
be
transparent and knowable in advance ... are subverted by this
framework.’[33] Taylor argues
that OLA institutionalises a harmful bailout process because it is not possible
for the FIDC to wind down large complex
financial institutions without
disruption. He criticises the significant discretionary powers given to the FIDC
and suggests the
problems of “too big to fail” and the political and
regulatory capture by certain large financial institutions will
continue.[34]
Wilmarth
concludes that the too-big-to-fail (TBTF) policy remains ‘the great
unresolved problem of bank
supervision’.[35] He suggests
the Act makes meaningful improvements in the regulation of large financial
conglomerates. However, it does not solve
the TBTF problem because: (i) it
relies primarily on capital based regulation, the same supervisory tool that
failed to prevent the
1980s savings and thrift crisis and the recent crisis;
(ii) the efficacy of the supervisory reforms depend on the same federal
regulatory
agencies that failed to stop excessive risk taking during both
crises; and (iii) the effectiveness of the Council is open to question
given the
history of turf wars and bureaucratic issues that have typically been associated
with governmental multiagency oversight
bodies in the
US.[36]
The arguments of
Skeel, Taylor and Wilmarth are valid. The Fed, the Council and the FIDC are
given broad discretion to supervise and
monitor the largest financial
institutions, leaving the door ajar to regulatory abuse or
capture.[37] In practice, the
Federal Reserve is only likely to use its powers under section 121(a)(4) to
break-up a systemically important financial
institution in extraordinary
circumstances.[38] Successful
implementation of the OLA provisions will also be difficult, and the skill and
competency of the regulators will be significantly
challenged. Determinations on
the appropriate time to positively intervene and break up or assume control of a
company will be complex,
confronting and intensely political
decisions.[39] If the regulatory
agencies take a conservative approach, the break up or winding down of a large
firm may be too late to avoid another
major crisis with potentially significant
economic consequences. Conversely, the premature or poorly managed break up or
winding
down of an important firm is likely to be politically very costly.
Perhaps the weakest aspect of the reforms in Titles 1 and 2 is the
domestic focus. One of the most important lessons from the GFC
was the essential
interconnectedness of global financial markets and systems. The GFC was
primarily rooted in factors originating
in the US. However, the circumstances of
the next global financial crisis may be driven from elsewhere. Many of the
largest financial
institutions operate outside of the US and will not be subject
to these provisions. Thus, the Fed, the Council and the FIDC need
to work
closely with global policy makers and regulators to ensure the reforms achieve
their purposes. The efficacy of the provisions
and processes in Titles 1 and 2
will only be seen fully in the next financial crisis.
C. Financial Institutions
The Act extends the breadth of the regulatory
framework. The primary aims of the extended regulatory oversight are to restrict
the
scope of activity of some financial institutions as a means of reducing
systemic risk and increasing the transparency of capital
market trading.
1 The Act
(i) Insurance Companies
The insurance regulatory
framework in the US is generally state-based. However, the ability of the
Council to designate an insurance
company as a significant NFC brings the
insurance holding company system within the federal regulatory framework. In
addition, Title
V of the Act creates a Federal Insurance Office within Treasury
to monitor all aspects of the insurance
sector.[40]
(ii) Depository Institutions
The Act emphasises the traditional role of banks and
saving and loan entities as intermediators between depositors and mortgagors.
Section 619 prohibits depository institutions and their affiliates from engaging
in proprietary trading; or acquiring or retaining
an interest in a hedge fund or
a private equity fund, or sponsoring such a
fund.[41] These provisions (commonly
referred to as the Volcker Rule, after former Chairman of the Federal Reserve,
Paul Volcker) apply to
proprietary trading and fund activities by US banks in
any location. They also apply to proprietary trading and fund activities of
non-US banks in the US, or such activities outside of the US if they involve the
offering of securities to US residents. Designated
NFCs are not subject to the
Volcker Rule, but they may be required to hold additional capital and
quantitative limits may be set
in relation to such
activities.[42]
“Proprietary trading” is broadly defined in the Act as
engaging as a principal for the trading account of a banking organisation
or
supervised NFC in ‘any transaction to purchase or sell, or otherwise
acquire or dispose of, any security, any derivative,
any contract of sale of a
commodity for future delivery, any option on any security, derivative, or
contract, or any other security
or financial instrument’ that the
Regulators may determine by
rule.[43] In other words, the
Volcker Rule generally prohibits the buying and selling of securities as
principal for the entity’s trading
account. However, some trading activity
is specifically permitted, including:
The Act
requires the Council to study the Volcker Rule and to make recommendations on
its implementation.[45] The Council
completed this study and reported to Congress on 18 January
2011.[46] The Council Report
advocated robust implementation of the Volcker Rule and recommended that the
federal regulatory agencies consider
taking the following actions:
3. Require banking entities to perform quantitative analysis to detect
potentially impermissible proprietary trading without provisions
for safe
harbors.
4. Perform supervisory review of trading activity to distinguish
permitted activities from impermissible proprietary trading.
5. Require
banking entities to implement a mechanism that identifies to agencies which
trades are customer-initiated.
6. Require divestiture of impermissible
proprietary trading positions and impose penalties when warranted.
7. Prohibit banking entities from investing in or sponsoring any hedge fund
or private equity fund, except to bona fide trust, fiduciary
or investment
advisory customers.
8. Prohibit banking entities from engaging in
transactions that would allow them to “bail out” a hedge fund or
private
equity fund.
9. Identify “similar funds” that should be
brought within the scope of the Volcker Rule prohibitions in order to prevent
evasion of the intent of the rule.
10. Require banking entities to publicly
disclose permitted exposure to hedge funds and private equity
funds.[47]
Timothy Geithner, the Treasury Secretary who leads the Council, indicated
that ‘we have to be careful to strike the right balance
between putting in
place new rules that protect consumers and investors and the economy, without
stifling the competition and innovation
that drives economic
growth.’[48]
(iii) Hedge Funds & Private Equity Funds
Registered hedge fund advisers are subject to the
same disclosure requirements as other registered investment advisers in the US.
However, prior to the GFC, most hedge funds: were not registered with the SEC;
were exempt from investment company and investment
advisor registration; and
were not required to report
quarterly.[49] Regulators were
‘satisfied that there [was] no need for more intensive investor-protection
regulation affecting hedge funds,
because investors in such funds [were] high
income individuals or institutions that [could] fend for
themselves.’[50]
Registration with the SEC was not required because the funds were within
the safe harbour of Regulation D under the private offering
exemption of Section
4(2) of the Securities Act of
1933.[51] Most funds were exempt
from registration as investment companies under Sections 3(c)(1) and 3(c)(7) of
the Investment Company Act
of 1940 as the securities were issued as private
placements, and there was either less than 100 investors or the securities were
offered to “qualified purchasers”. Section 203(b)(3) exempted
advisors from registration under the Investment Advisors
Act of 1940 provided
there were fewer than 15 clients, no services were offered to the public, and no
advice was given to registered
investment companies.
The Act requires
hedge funds and private equity funds that were previously exempt under Section
3(c)(1) or 3(c)(7) of the Investment
Company Act, to register with the
SEC.[52] In addition, the exemption
under s 203(b)(3) of the Investor Advisers Act has been repealed, and all
advisors to private funds, whether
registered or not, are required to provide
ongoing reports to the SEC.[53]
(iv) Credit Ratings Agencies
Section 931 of the Act
indicates that Congress found that credit rating agencies are ‘central to
capital formation, investor
confidence, and the efficient performance of the
United States economy’. The rating agencies ‘play a critical
“gatekeeper”
role in the debt market that is functionally similar to
that of securities analysts ... and auditors ...’ Their activities
are
‘fundamentally commercial in character and should be subject to the same
standards of liability and oversight as apply
to auditors, securities analysts,
and investment bankers’. Inaccurate ratings on structured financial
products ‘contributed
significantly to the mismanagement of risks by
financial institutions and investors ... Such inaccuracy necessitates increased
accountability
on the part of the credit rating agencies’.
The
Act seeks to minimise conflicts of interest and improve the transparency of
credit ratings processes by imposing corporate governance
processes, and
disclosure, reporting and procedural regulation. Disclosure is required of
credit rating assumptions, procedures and
methodologies; the potential
limitations of a rating; information on the uncertainty of a rating; the extent
to which third party
services have been used in arriving at the rating; an
overall assessment of the quality of available and considered information;
and
information relating to conflicts of
interest.[54] A standardised form
must be used to disclose the information to enable
comparability.[55] The agencies must
consider credible information from sources other than the product
issuer.[56] The findings and
conclusions of any third party due diligence report must be published and the
third party must certify and explain
the extent of the review
performed.[57] The SEC is also
mandated to establish a rule requiring agencies to provide published periodic
performance reports that reveal the
accuracy of ratings provided over a range of
years and for a variety of types of credit
ratings.[58]
The Act
specifically provides for private investor actions against a credit ratings
agency under the Securities Exchange Act of 1934,
in the same manner and to the
same extent as apply to statements made by an accounting firm or a securities
analyst.[59] It also alters the
pleading standards under the Private Securities Litigation Reform Act of 1995 so
that a complaint need only state
facts that give rise to a strong inference that
the ratings agency knowingly or recklessly failed to conduct a reasonable
investigation
of the facts relied on or failed to obtain reasonable verification
of the factual elements.[60]
The Act mandates the SEC to conduct a range of studies on, among other
issues:
The SEC
is empowered to enact a rule that requires the SEC to nominate a ratings agency
if the study finds such a requirement is necessary
or appropriate in the public
interest or for the protection of investors, so as to prevent issuers playing
agencies off against each
other and ‘shopping’ for favourable
ratings.[64]
2 Commentary & Analysis
(i) Volcker Rule
Prior to the GFC, the
concept and practical reality of what constituted a bank, a nonbank financial
institution, an insurance company,
a hedge fund, a fund manager, a private
equity advisor or a broker in the US had become blurred with the advent of large
financial
conglomerates. Significant areas of activity of many financial
institutions, particularly the largest players, didn’t fit neatly
within
the jurisdictions of single regulators. Moreover, some areas of financial market
activity, such as private equity and over-the-counter
(OTC) trading, and some
market participants, such as credit rating agencies and hedge funds advisors,
were either not regulated at
all or only minimally regulated.
The
Volcker Rule represents a partial policy reversal to the period from 1933 to
1999 when the US had Glass-Steagall
restrictions[65] in operation. These
rules were initially introduced in the Banking Act of 1933, which generally
prohibited:
These rules to effectively separate the businesses of commercial
banking and investment banking or banking and securities activities
were
extended in 1956 by the passing of the Bank Holdings Company
Act.[70] However, restrictions on
the integration of banking and securities businesses were gradually relaxed from
the 1970s, until formal
repeal of the Glass-Steagall measures by the
Gramm-Leach-Bliley Act of 1999.
Some scholars suggest it is surprising
that opposition to repeal of the Glass Steagall restrictions was not
stronger.[71] However, deregulation
in the 1980s and 90s was strongly supported by most policy makers, scholars and
the judiciary, as well as the
finance industry. Most of the theories to support
the push for increasing deregulation and ever-larger financial conglomerates
were
economic or efficiency based. The commonly cited arguments for larger and
more integrated global financial institutions (or universal
banking as it is
sometimes called) were scale and diversification benefits, and the need to
enhance efficiency, to spread risk, and
to foster innovation. There were critics
who warned about the potential concentration of
risk.[72] However, these parties
often failed to express their arguments in compelling economic terms, and when
they did so, their voices were
generally overwhelmed in the drive for new
financial and economic growth and enhanced competitiveness or dominance on the
global
financial stage.
The size and scale of financial institutions are
not the only factors that have changed significantly since the 1980s. The
structure
of capital markets and trading patterns have also undergone a series
of transformative phases.[73]
Market activity levels have rapidly escalated, particularly trading in
derivative instruments.[74] An
increasing proportion of this activity is computer generated ‘high
frequency’ trading.[75] Mary
Shapiro, the Chairman of the SEC recently testified that
proprietary trading firms play a dominant role by providing liquidity through
the use of highly sophisticated trading systems capable
of submitting many
thousands of orders in a single second. These high frequency trading firms can
generate more than a million trades
in a singe day and now account for more than
50 percent of equity trading
volume.[76]
It is never easy, and
often not possible, to turn the clock back. Institutions will look for ways to
continue trading under the new
regime. The extent to which the Volcker Rule
effects trading activity in the US and reduces potential systemic risk will
depend on
how the provisions are interpreted and enforced by the regulators and
judiciary. The regulators are being asked to tread a fine line.
The initial step
of defining “proprietary trading” is difficult enough. Implementing
and monitoring the Volcker Rule
across varying markets, assets and institutions
in an environment subject to constant change will be even more
challenging.[77]
The
broader impacts of the trading restrictions are uncertain. Ultimately, the
Volcker Rule is only likely to be effective as a global
strategy. If other major
markets fail to adopt and enforce equivalent rules, institutions are likely to
take advantage of gaps or
weaknesses in the provisions and regulatory frameworks
to move their trading to areas where proprietary trading is not restricted
or
oversight is limited.
(ii) The Hedge Fund Provisions
The benefits and risks posed by the hedge fund
industry and the case for more regulation continue to be hotly debated. No
evidence
has been found suggesting that hedge funds were a direct casual factor
of the GFC. However, as Eichengreen and Mathieson highlight,
each crisis or
episode of volatility in financial markets brings the role played by the hedge
fund industry in financial market dynamics
to the
fore.[78] Hedge funds were
implicated in the 1992 currency crisis in Europe. Similarly, there were
allegations of large hedge fund transactions
in various Asian currency markets
in the lead up to, and in the wake of, the Asian financial crisis in 1997. These
concerns were
compounded by the near collapse of a major hedge fund, Long Term
Capital Management in the US and more recent problems with hedge
funds tied to
subprime mortgages.
The absolute level of global trading by hedge funds
continues to grow, representing an increasing proportion of total market
trading.[79] Many hedge funds trade
primarily in derivative instruments, which ‘compounds problems of
information and evaluation for bank
management, [other investors] and
supervisors alike’.[80] These
issues become more acute on a global basis. It is therefore important that hedge
fund activities are encompassed within the
regulatory structure to allow
supervisors a comprehensive overview of markets.
(iii) The Rating Agency Provisions
Some scholars argued prior to the GFC that rating
agencies were sufficiently motivated ‘to provide accurate and efficient
ratings
because their profitability is directly tied to
reputation’.[81] Schwarcz
concluded that ‘public regulation of ratings agencies [was] an unnecessary
and potentially costly policy
option.’[82] However, the
public listing of a ratings company results in an inherent conflict between the
managerial incentive to provide paying
clients with their desired ratings, and
to thereby increase the level of ratings provided and company profits, and the
public interest
that requires accurate ratings. Listokin and Taibleson propose
an incentive scheme in which ratings are paid for with the debt
rated.[83] This proposal is novel
and interesting, but is unlikely to be acceptable to the agencies because it
would make financial management
of the company very difficult. Hunt argues that
the ‘incentive problem can be corrected by requiring an agency to disgorge
profits on ratings that are revealed to be of low quality by the performance of
the product type over time, unless the agency discloses
that the ratings are of
low quality.’[84] This
approach poses significant implementation issues. It is not clear who would make
the ex post judgments on the quality of the
ratings. There may be a range of
factors resulting in poor performance that were not reasonably foreseeable by
the rating agencies.
Moreover, even when issues associated with the ratings
quality could be directly linked to the agency, a disgorgement of the agency
profit after the event would not assist investors who had suffered damage
arising from the poor quality
rating.[85]
Coffee suggests
that analysis of the reforms relating to credit rating agencies requires
acknowledgement of three simple truths: (1)
an “issuer pays”
business model invites the sacrifice of reputational capital in return for high
current revenues; (2)
ratings competition is good, except when it is bad; and
(3) in a bubbly market, no one, including investors, may have a strong interest
in learning the truth. He concludes that only a strong and highly motivated
watchdog can offset this process of repression and
self-delusion.[86] Coffee argues
that reform that fails to address the “issuer pays” business model
‘amounts to re-arranging the deck
chairs on the Titanic, while ignoring
the gaping hole created by the
iceberg.’[87] He emphasises
the importance of getting the regulation right and suggests it is necessary to
encourage a “subscriber pays”
model[88] to compete with the
“issuer pays” model. A mandated subscriber pays model is worthy of
further consideration as the reforms
included in the Act, which predominantly
rely on disclosure rules, may not be adequate to address the strong temptation
for agencies
to prefer short term profits over longer term reputational
issues.[89]
Finally, there are questions around the constitutionality of the
provisions enabling private investor actions against credit ratings
agencies.
Litigation against the ratings agencies has generally been unsuccessful in the
United States because the courts have upheld
the agencies claim for protection
under the First Amendment of the Constitution, on the basis that their ratings
are statements of opinion and not statements of fact or recommendations to
purchase, sell or hold
any
securities.[90]
D Capital Markets & Products
1 The Act
(i) Securitization
The
Act seeks to enhance the accountability and diligence of parties issuing or
originating asset backed securities (ABS) by requiring
them to retain some of
the credit risk (to keep some “skin in the game”). The retained risk
may not be hedged or transferred.
The required risk retention is a
minimum 5 percent. However, assets that are not subject to the retained risk
requirement include
securitization of “qualified residential
mortgages”, securitization of federally guaranteed mortgage loans, and
other
assets issued or guaranteed by the US and its
agencies.[91] These provisions are a
good example of the incomplete nature of this legislation, as the definition and
standards of a “qualified”
residential mortgage are to be determined
by the Federal banking agencies, the SEC, the Secretary of Housing and Urban
Development
and the Director of the Federal Housing Finance
Agency.[92]
An issuer of ABS
must disclose asset or loan level data on the identity of brokers or originators
of the assets, compensation of the
brokers or originators, and the amount of
risk retained if this is required for investors to carry out independent due
diligence.[93] ABS credit ratings
must provide a description of the representations, warranties and enforcement
mechanisms and how they differ from
issuances of similar
securities.[94] Disclosure of
fulfilled and unfulfilled repurchase requests is required so that investors can
identify underwriting
deficiencies.[95] The Act mandates
the SEC to issue rules requiring issuers of ABS to conduct a review of the
underlying assets and to disclose the
outcome to investors.
(ii) Derivatives & Swap Trading
Title VII of the Act entitled ‘Wall Street
Transparency and Accountability’ extends regulatory oversight to OTC
derivatives
and markets. The new regime encompasses commodity swaps, interest
rate swaps, total return swaps and credit default swaps. The CFTC
is responsible
for regulating swaps, while the SEC is responsible for the regulation of
security-based swaps,[96] with the
definitions of “swaps” and “security-based swaps”
leaving ambiguities that will need to be
resolved.[97] Foreign currency
products other than spot and exchange-traded contracts will be subject to CFTC
supervised regulation. Any security-based
swap that contains an interest rate,
currency or commodity component will be subject to regulation by both the CFTC
and SEC, in consultation
with the Fed.
The stated purposes of the
reforms are to increase the transparency, liquidity and efficiency of OTC
derivatives markets and to reduce
the counterparty and systemic risk. The
adopted mechanisms to achieve these goals are:
The
Act requires the SEC and the CFTC to establish detailed mandatory clearing
processes, business conduct standards, and capital
and margin requirements. The
Act empowers the CFTC and SEC to clear a swap or to require designated swaps to
be cleared.[101] This means that
swaps that are subject to mandatory clearing requirements but which clearing
houses determine are not eligible for
clearing will effectively be prohibited. A
swap is exempt from the clearing and exchange trading requirements if one of the
counterparties
is an end user that is hedging commercial risk. However, the
exemption only applies to a counterparty that is not a financial entity;
that is
using swaps to hedge or mitigate commercial risk; and that notifies the SEC how
it generally satisfies its swap related financial
obligations.[102] The CFTC and SEC
are required to create rules to mitigate conflicts of interests arising from
control of clearing houses, exchanges
and swap facilities by industry
participants.[103]
All
swap dealers and major swap participants are subject to risk-based capital
requirements.[104] In addition,
the Act provides the CFTC with powers to impose aggregate position limits across
markets in order to:
Similarly, the SEC may establish size limits on individual or
aggregate swap positions as a means to prevent fraud and
manipulation.[106]
Finally, the SEC is mandated to adopt business conduct standards
requiring swap dealers and participants to disclose material risks
and
characteristics of a swap, material incentives or conflicts of interest, and
mark-to-market information.[107]
When advising special entities such as municipalities and pension plans, swap
dealers have a duty to act in the best interests of
the special
entity.[108] A duty must also be
established requiring swap dealers or major participants to ‘communicate
in a fair and balanced manner
based on principles of fair dealing and good
faith.’[109]
(iii) Payment, Clearing and Settlement Activities
The Act provides for the supervision of systemically important financial market utilities and payment, clearing and settlement activities conducted by financial institutions. The CFTC and the SEC are required to enact regulation in consultation with the Council and the Fed containing risk management standards for designated utilities and activities.[110] The standards to be considered include:
2 Commentary & Analysis
The Act does not prohibit or limit specific types of
derivative instruments such as synthetic Collateralised Debt Obligations (CDOs)
that attracted much adverse comment in the aftermath of the GFC. Instead, the
CFTC and SEC are empowered to report on any instruments
that may undermine the
stability of a financial market or have adverse consequences for participants in
the market.[112] This approach
acknowledges that capital markets are constantly evolving, and that to be
effective, regulation and regulatory responses
must adapt to changing conditions
and product innovation. The legislative reforms will only be meaningful if they
deter or mitigate
the fallout from the next financial crisis, which will almost
certainly centre on different products and circumstances than those
leading up
to the GFC.
The intended effect of the swap related
provisions appears to be to encourage standard or vanilla type swaps that are
cleared through
an exchange and clearinghouse in order to improve systemic
oversight. Clearinghouses generally manage default risk by netting offsetting
transactions, by collecting an upfront margin on trades that serve as a reserve
in the event of default by a member, and by the establishment
of a guarantee
fund to cover losses that exceed the margin collected. On products such as swaps
and commodities, the collateral generally
includes an ongoing variation margin.
The Act replicates this model by requiring margin payments by swap
counterparties outside of
clearinghouses such as transactions through the OTC
markets. The collateral, margin and disclosure requirements are likely to
promote
greater use of standardised structured products and vehicles and
discourage more complex and highly leveraged structures.
Many parties
have argued for greater transparency in post GFC securistisation and derivative
markets.[113] Some argue that the
reforms do not go far enough. For instance, some suggest that naked credit
default swaps should be banned. Others
suggest the provision exceptions are too
broad and as a consequence, a large portion of the derivative trading will
continue unhindered.[114] Skeel
concludes that despite the substantial uncertainties in the legislation, the new
framework for clearing derivatives and trading
them on exchanges ‘is an
unequivocal advance’.[115]
We agree. When trades are cleared through clearing houses, the risk of default
is independently managed and minimised. To the extent
the reforms encourage
derivative trades through exchanges rather than OTC markets, market transparency
and regulatory scrutiny are
likely to be significantly improved Global
supervisors need ready and regular access to derivative trading positions to
understand
capital market developments and to determine systemic risks.
Consequently, these reforms may enhance the operation of markets and
long-term
economic efficiency.
Nevertheless, the difficulties involved in
monitoring global systemic risk should not be underestimated. Capital market
trading in
the US is highly fragmented across many exchanges, electronic
communication networks, and broker dealers. The number of orders ‘executed
in non-public trading venues such as dark pools and internalizing broker-dealers
now account for nearly 30 percent of
volume’.[116] The increasing
prevalence of high frequency trading through direct access market providers
makes it difficult and time consuming
for regulators to identify trades and the
traders involved. The reporting of trading activity even within the US
‘often has
format, compatibility and clock-synchronization
differences.’[117] These
issues are significantly compounded when trying to determine global exposures.
Regulators are improving their systems and audit
trails in an endeavour to
better monitor trading activity and market developments, but the continuing
rapid growth of global trading
activity make this an ongoing challenge.
E Executive Compensation
1 The Act
The
reforms seek to address public concerns on compensation paid to company
executives, particularly to managers of financial institutions.
The Act requires
enhanced disclosure and accountability on compensation paid to executives of
listed companies. Shareholders are
provided with a non-binding vote on some
executive compensation issues including ongoing executive packages and golden
parachutes.[118] Companies must
explain the basis of the relationship between executive compensation and
financial performance,[119] and
disclose the ratio of the compensation of the Chief Executive to employee
compensation.[120] In addition,
incentive-based compensation paid to executives may be clawed back when based on
financial reporting that is materially
noncompliant with the securities
laws.[121]
The more
controversial provisions are contained in section 956. These provisions require
the regulators to enact regulation prohibiting
certain incentive-based
compensation packages for executives or directors of bank holding companies and
other “covered financial
companies”.[122] The
regulators must issue regulations “that prohibit any types of
incentive-based payment arrangement ... that the regulators
determine encourages
inappropriate risks by covered financial institutions –
(1) by providing an executive officer, employee ... with excessive compensation, fees, or benefits; or
(2) that could lead to material financial loss to the covered financial institution.”[123]
The
Fed, the FIDC, and the Office of the Comptroller of the Currency, which issued
joint guidelines on executive remuneration in June
2010, will monitor
compensation paid to bankers in the US. The regulators are also reviewing
incentive practices at large financial
institutions.
Notably, the Act
requires the employment of management responsible for the financial condition of
a failing covered financial company
to be
terminated.[124] The provisions
also provide that ‘management, directors, and third parties having
responsibility for the condition of the financial
company bear losses consistent
with their
responsibility.’[125]
2 Commentary & Analysis
The legislators clearly want to be seen to
potentially hold individuals that have presided over the collapse of financial
companies
personally liable for some of the losses. However, the provisions that
seek to potentially clawback some of the compensation paid
to managers,
directors and third parties of failed covered financial companies, as well as
reimbursement of some of the losses borne,
are broad and imprecise and will
require judicial
interpretation.[126]
The
likely outcomes from s 956 are also uncertain. The section prohibits any
incentive-based compensation arrangement that (a) encourages
inappropriate risk
taking by providing excessive compensation to staff; or (b) encourages
inappropriate risk taking that could lead
to material financial loss for the
institution. Accordingly, incentive-based compensation that is not excessive is
still prohibited
if it could lead to risks being taken sufficient to cause
material losses. It will be interesting to see how the final rules define
‘excessive’ compensation and how the regulators will interpret the
compensation arrangements that while not necessarily
excessive still encourage
material and inappropriate risk taking.
At a global level, the G20
finance ministers backed away from a joint pledge to cap bank bonuses in
2009.[127] However, on 8 July 2010
the European Parliament passed legislation limiting bonuses at banks, hedge
funds and other financial
institutions.[128] The new rules,
which took effect from the beginning of 2011, require bonuses to be structured
on a long-term basis, with restrictions
on upfront cash bonuses, requirements to
retain at least 50% of total bonuses for a period contingent on long term
investment performance,
and strict limits on compensation paid to the executives
of institutions that were bailed out or supported using taxpayer
monies.[129] The US may enact
similar bonus restrictions. Some financial institutions in the US are
pre-empting such a move and are deferring
more than 50% of the bonuses
awarded.[130]
F Consumer Protection
1 The Act
Title X of the Act, the
Consumer Protection Financial Protection Act of 2010, creates and empowers a new
and independent Consumer
Financial Protection Bureau (CFPB) to develop consumer
protection rules.[131] The purpose
of the CFPB is to ‘seek to implement and, where applicable, enforce
Federal consumer financial law consistently
for the purpose of ensuring that all
consumers have access to markets for consumer financial products and services
and that markets
for ... [these] products and services are fair, transparent and
competitive.’[132] The
definition of consumer financial products or services is broad, and includes
credit cards, mortgages, credit bureaus, debt collection,
and any product that a
bank or financial holding company provides to consumers except
insurance.[133]
The Act
provides the CFPB with powers to issue regulations, to examine compliance, and
to take enforcement action under federal financial
consumer
laws.[134] The CFPB has broad
authority over depository institutions with assets in excess of $10 billion,
other financial institutions that
broker, originate or service mortgage loans,
and other large participants that market consumer financial
services.[135] The Bureau may
prevent these institutions from engaging in unfair, deceptive or abusive
practices in the provision of consumer financial
products and
services.[136]
The CFPB
encompasses a research unit to monitor trends in the provision of consumer
financial products, a Community Affairs Unit to
focus on consumer education, and
a centralised Complaints
Unit.[137] It also includes the
establishment of an Office of Fair Lending and Equal
Opportunity,[138] an Office of
Financial Education,[139] and an
Office of Service Member
Affairs.[140]
The Act
aims to significantly strengthen mortgagee rights and protections. Title XIV of
the Act, the Mortgage Reform and Anti-Predatory
Lending Act, imposes new
mortgage underwriting standards, prohibits or restricts specified mortgage
lending practices and regulates
payments to mortgage loan officers and brokers.
Lenders are banned from steering consumers into high cost unaffordable loans.
Lenders
must verify a borrower’s ability to repay the mortgage in its
entirety, including consideration and documentation of specified
factors such as
the borrower’s credit history, employment status, income, and
debt-to-income ratio.[141] A
borrower may raise a violation of these standards as a foreclosure
defense.[142] However, there are
safe harbour provisions relating to “qualified mortgages” that meet
specified criteria, including
points and fees of less than three percent of the
total new loan amount.[143] In
addition, intermediaries of mortgage refinancings must be able to show that
borrowers are better off as a result of a refinancing.
To better align
intermediary incentives with those of their clients, compensation payments based
on interest rate premiums (commonly
referred to as yield spread premiums) or
other terms of the loans other than the amount of the principal are
prohibited.[144] Penalty
provisions relating to prepayments of certain loans are also
disallowed.[145] Notable
enhancements to the mortgage disclosure rules include mandatory notice of resets
of the interest rate and negative amortization
occurrences.[146]
2 Commentary & Analysis
The development of credit consumer law in the US has
a chequered history that is closely aligned to the property boom and bust cycles
and changes in the institutional and product
structures.[147] Up until the
1970s the savings and loans entities (S&Ls) were the major providers of
mortgage credit. However, as the securitisation
markets grew, the S&Ls lost
market share to mortgage companies with access to cheaper funds. Financial
deregulation shifted the
mortgage industry to a predominantly national system,
with mortgages provided on an originate-to-distribute model from mortgagee
companies that were predominantly
unregulated.[148]
During
the 1980s and 90s consumer advocates highlighted issues around predatory and
high cost lending and were successful in achieving
some policy
change.[149] However, there was
intense lobbying from the finance industry opposing calls for a strengthening of
consumer protection law.[150]
Continuing issues around predatory lending resulted in a series of federal
policy reviews. In 2000 the US Department of Housing and
Urban Development and
the US Treasury Department issued a report recommending that the Fed use its
authority under the Home Ownership
and Equity Protection Act (HOEPA) of 1994
more forcefully to deter predatory
practices.[151] The Fed held
hearings on potential reforms and recommended changes that potentially increased
the number of loans subject to the
Act. However, despite continued reviews and
warnings from many quarters about the dangers of subprime loans and the
increasing use
of complex loan structures, lending regulation at a federal level
was not substantially
changed.[152] In addition,
conflicts between state and federal regulators increased as federal regulators
used their preemption powers to override
enhancements to state mortgage
regulation.[153] In 2007 the
legitimacy of the preemption authority was tested in the Supreme Court in
Watters v Wachovia Bank,
N.A.[154] The Court held that
the state regulators could not interfere with the “business of
banking” of federally regulated institutions
by subjecting national banks
or their OCC-licensed operating subsidiaries to state audits and surveillance
under rival oversight
regimes.[155]
In 2007 the
Fed held further hearings on subprime and predatory lending and proposed
increased regulation. A bill containing more
substantive protection for
consumers was passed in the House in
2008.[156] This bill laid the
groundwork for many of the provisions in the subsequent Act.
The establishment of an independent and well-resourced consumer
protection regime that encompasses research, education, complaints
and
enforcement arms, provides a potentially powerful consumer advocate. Critics
argue that the Consumer Bureau has been given too
much power. Others suggest
that consumer’s interests were woefully underrepresented during the crisis
and the establishment
of the CFPB is overdue and a step
forward.[157]
A single
consumer agency solution potentially addresses the argument that the prior
architecture inevitably led to consumer protection
falling through the cracks
and taking a back seat to the agencies’ primary mission of financial
safety and soundness.[158] One of
the most tragic outcomes of the crisis in the US has been the large number of
people forced from their homes due to mortgage
defaults.[159] Bar-Gill and Warren
concluded in 2008 that ‘[e]vidence abounds that consumers [were] sold
credit products that [were] designed
to obscure their risks and to exploit
consumer
misunderstandings.’[160] The
evidence indicates that many of the practices adopted for selling financial
products and services prior to the GFC had become
abusive, and accountability
and enforcement mechanisms across the financial intermediary industry were
weak.[161] Numerous studies of the
mortgage markets by government agencies and independent bodies during the
2000-2006 period found that a high
proportion of those sold high interest rate
subprime loans would have qualified for lower cost prime market
loans.[162] In addition, scholarly
and policy research found a correlation between unfair credit terms and minority
status.[163] In 2000 the joint
Department of Housing and Urban Development -Treasury Task Force on Predatory
Lending warned
In some low-income and minority communities, especially where competition is
limited, predatory lenders may make loans with interest
rates and fees
significantly higher than the prevailing market rates, unrelated to the credit
risk posed by the borrower.[164]
In 2006 research on the Detroit area by the University of Michigan concluded
that
... even within similar low-income neighbourhoods, black homeowners are
significantly more likely to have prepayments penalties or
balloon payments
attached to their mortgages than non-black homeowners, even after controlling
for age, income, gender and credit
worthiness.[165]
A series
of criminal and civil actions relating to mortgage practices have been settled,
or are underway. For instance, Bank of America
has reached a $US2.8 billion
settlement with Fannie Mae and Freddie Mac over claims that Countrywide
Financial, which Bank of America
bought in 2008, routinely provided mortgages to
parties who they knew could not afford
them.[166]
In 2007 Warren
proposed a new federal consumer protection agency to ensure minimum safety
standards for all consumer financial
products.[167] The Act seeks to
provide such safety standards on mortgage products by encouraging the use of
qualified or standardised mortgages
rather than complex and expensive mortgage
structures, and by discouraging the payment of excessive fees. Critics argue
that the
regulation will result in reduced product choice. However, the extent
to which mortgagees benefit from sophisticated bells and whistles
is debateable.
In any event, the provisions as they stand currently do not prevent the design
of flexible features into mortgage
products.
The new CFPB is a bold
reform. However, the practical benefits of the new regime to consumers will
depend on: the new agency’s
commitment to fairness in credit markets; the
independence of the agency staff; the detailed final rules; and consistent
enforcement
of the measures
adopted.[168] The history of
consumer credit law in the US suggests the agency will be heavily pressured by
industry to weaken the final rules
and to supervise with a light
touch.[169]
G Investor Protection
1 The Act
The Act clarifies the
authority of the SEC to establish rules requiring disclosure prior to the
purchase of financial products or
services by retail
clients.[170] The Act requires
documents in a summary format that contain clear and concise information about
the investment objectives, strategies,
costs and risks, and any compensation or
other financial incentive received by the
intermediaries.[171] Rule
development to encourage clear, concise and effective marketing and disclosure
documentation prior to the sale of financial
products and services is a
regulatory approach that has been used for many years, arguably with some
success, in other
jurisdictions.[172]
The
most contentious financial intermediary issues were left open to further
investigation and consultation. The Act requires the
SEC to review the duties
and standards of care applying to brokers, dealers and investment advisors when
providing personalised investment
advice and recommendations in connection with
the purchase of retail investment
products.[173] While the SEC is
given the power to establish a fiduciary standard,
[174] clients may consent to
material conflicts of interest if these are adequately
disclosed.[175]
The SEC is
mandated to study a number of financial intermediary issues, including: how to
improve investor access to intermediary
registration
information;[176] the need for
greater regulatory oversight and enforcement of financial service
intermediaries;[177] and whether
to restrict or prohibit certain sales practices, conflicts of interest, and
intermediary compensation schemes that are
deemed detrimental to the public
interest and investor protection. The GAO is required to study mutual fund
marketing[178] and potential
conflicts of interest if these are adequately
disclosed.[179]
Regulation to enhance protection for direct investors (that is,
investors who invest in securities without intermediary assistance)
has also
been strengthened. The Act establishes a new Investor Advisory
Committee,[180] an Office of the
Investor Advocate[181] and a
retail investor Ombudsman.[182]
The Advisory Committee, which represents retail and institutional investors,
will advise and consult with the SEC on:
The
Investor Advocate will identify regulatory issues and problems specifically
affecting retail investors.[184]
The new Ombudsman will act as mediator between retail investors and the
SEC.[185]
The SEC
enforcement powers have been strengthened. The SEC may pay significant monetary
amounts to individuals who provide information
that leads to a successful SEC
enforcement action.[186] Monetary
penalties may be imposed in administrative cease-and-desist proceedings against
a person for a violation of securities
regulation.[187] In addition, the
rules, penalties, and standards on aiding and abetting have been significantly
enhanced.[188]
Finally, the Act tightens the rules on short selling. Monthly public
disclosure on short positions is
required,[189] and short selling
that is deemed to be manipulative is
prohibited.[190]
2 Commentary & Analysis
(i) Intermediary Conflicts of Interest
There are no easy
regulatory or empirical solutions to issues around how to best deal with
financial intermediary conflicts of interest.
Full disclosure of actual or
potential conflicts is the most common and reasonable regulatory response.
Empirical evidence confirms
that clients do not always adequately comprehend or
properly assess the effects of intermediary conflict disclosures. However,
regulatory
options such as prohibiting the selling of products when a conflict
exists are not always feasible, practical or beneficial to potential
clients.[191]
(ii) Intermediary Duty of Care
The mandated study on financial intermediary duties
of care and standards reflects the longstanding debate in the US on the
differences
in the applicable laws and regulations applying to investment
advisors and broker dealers. Financial advisors are regulated under
the
Investment Advisers Act of 1940, while brokerage firms are regulated under the
Securities Act of 1934 and the rules of the Financial
Industry Regulation
Authority (FINRA), a self-regulatory authority. Brokers are able to exempt
themselves from the investor adviser
regulation on the basis that the advice
provided is “solely incidental” to brokerage
services.[192]
The duties
of brokers and advisers were vigorously debated in Congress and at the US
Treasury Department during the policy reform
processes. While the initial draft
legislation by the Senate Banking Committee removed the broker-dealer exemption
from the Investment
Advisers Act, Congress was unable to reach consensus and the
exemption was not removed in the Act signed into law.
The SEC was
concerned by the differential regulatory approach to the two intermediary
groups.[193] It argued during the
reform review period that all intermediaries providing financial advice should
be subject to equivalent regulation
and every financial professional should be
subject to a uniform standard of
conduct.[194] It suggested the
demarcation between the functions of the two groups of intermediaries is blurred
and clients fail to understand
the differences between the services
provided.[195] The SEC sought
public feedback on 14 outlined issues, including on (i) the potential impact
upon retail customers that could result
from potential changes in the regulatory
requitement or legal standards of care, and (ii) the effectiveness of the
enforcement of
the intermediary standards of care. The large number of comments
received reflected the interest and controversy surrounding this
area of
law.[196] In January of this
year, the SEC completed its mandated study concerning the obligations of
brokers, dealers and investment advisers
and reported to
Congress.[197] The Report
recommends establishing a uniform fiduciary standard for the provision of
investment advice to retail customers. That
is, the standard that currently
applies to investment advisors would apply to broker-dealers when they provide
retail advice.[198]
The
debates around possible harmonisation of intermediary duties and standards of
care are linked to the nature and scope of the fiduciary
obligations. All
investment advisers in the US are deemed to be in a fiduciary relationship with
their clients and as such, owe duties
of loyalty and
care.[199] The courts have
consistently indicated that the fiduciary standard requires advisers to act
continuously in their clients “best
interest”.[200] The adviser
recommendations must be suitable to a client’s circumstances. While
advisers ‘may benefit from a transaction
with or by a client ... the
transaction must be fully
disclosed.’[201] By
contrast, the fiduciary obligations that apply to broker-dealers are less
clear.[202] Laby suggests there is
general consensus that a broker with discretionary trading authority over a
customer account is subject to
fiduciary obligations, whereas a broker without
discretionary power is not a fiduciary. However, he concedes that this general
rule
is subject to numerous exceptions, resulting in general confusion in this
area of law.[203]
The
specific client outcomes resulting from the fiduciary obligations applying to
the two intermediary groups are difficult to define
or explain because of a
dearth of case law on broker dealer
duties.[204] Laby provides the
example of the sale of securities to a client from the firms’ own account.
He indicates that a broker dealer
can do this, however, an investment adviser
cannot because of the potential conflict of
interest.[205] He concludes that
‘advice is an essential ingredient of a broker’s financial services,
rendering the solely incidental
exclusion no longer applicable and justifying a
fiduciary duty for brokers providing
advice.’[206]
Langevoort
agrees that the differential regulatory regimes applying to advisers and brokers
are becoming untenable.[207] He
warns there are no easy or comfortable solutions. The establishment of a general
fiduciary duty for broker-dealers may not improve
the current position because
fiduciary obligations are by their very nature open
needed.[208] He suggests the SEC
need to provide ‘more textured rules that apply to both brokers and
advisers on each of the crucial aspects
of the advisory
relationship.’[209]
We
endorse Langevoort’s recommendations. The issue of harmonisation of duties
of care across advisers is only a first step.
Arguably, the more difficult and
significant policy issue concerns the appropriate nature and scope of the
intermediary duties on
a day-to-day basis. It is not easy to establish
intermediary duty of care standards that achieve an appropriate balance between
financial
intermediaries and clients. Determining what is in a client’s
best interest at a particular time and on an ongoing basis can
be difficult.
Intermediaries, their advisors and clients need policy guidance that is as clear
as possible on expected behaviour
in circumstances that fall within the large
“grey or uncertain” areas. In practice, some clients, whether
sophisticated
or otherwise, are eager to take on risk during boom times but are
quick to pass the blame to an intermediary when things go wrong.
Most parties
would concur that client compensation is justified when product or advisory
disclosure is fraudulent or blatantly misleading.
However, what should a
fiduciary standard or a best interest duty require from an broker dealer or a
financial advisory intermediary
when a client actively seeks riskier products
such as margin loans or derivative products during the good times? To what
extent are
most clients able to theoretically and empirically understand notions
of risk, reward and lifestyle flexibility? And should an intermediary
determine
the appropriateness of the product or advice based primarily on the ability of
the client to absorb the risk? These are
complex issues that policy makers,
scholars, lawyers, financial advisors and investors continue to grapple with in
all jurisdictions.
The protection of investors and consumers is generally a
paternalistic endeavour.[210]
Ultimately, policy makers need to carefully consider the extent to which
investors and consumers should be accountable for their
own interests, actions
and decisions.
(iii) Direct Investor Provisions
The establishment of an Investor Advisory Committee,
an Office of the Investor Advocate, and a retail investor Ombudsman are positive
novel developments that other jurisdictions should note. The credibility of the
SEC depends to a large extent on its actual and perceived
ability to protect
investors from exploitation. The cost of these reforms is likely to be low while
the potential investor benefits
may be significant. Institutional investors tend
to have effective representative bodies with established access and
relationships
at all political and regulatory levels, whereas retail investors
often lack sufficient resources, administrative structures, and
political and
regulatory access to gain an effective
voice.[211]
(iv) Short Selling Provisions
The short selling reforms are balanced and in line
with global regulatory trends. Market participants typically argue that short
selling
enhances market efficiency. However, these claims are open to question
when the trading is not disclosed or subject to any supervisory
oversight.[212] The provisions do
not prohibit or significantly restrict short selling activity. Instead, they
seek to improve market transparency
by requiring disclosure of short positions
on a delayed basis, and to enhance market efficiency by banning trading that is
not driven
by economic fundamentals.
H Regulatory Performance
To operate effectively, the Act requires proactive,
well-informed and coordinated intervention by the regulators. The success of the
reforms therefore depends to a large extent on the competency, integrity and
forcefulness of the individual regulators and their
ability and willingness to
supervise the finance industry on an integrated basis. However, the important
issues around regulatory
capture, competition for regulatory turf, and the lack
of action by regulators to developments prior to the GFC were not fully debated
or resolved during the legislative review
processes.[213]
There are
significant risks associated with the inchoate legislative approach and the
number and extent of the required studies, reports
and rules. The Act requires
533 rules and 93 Congressional reports to be written, and 60 studies to be
completed.[214] Further, there are
multiple stages required before the final rules are established, placing a heavy
burden on the regulators.[215] As
a result of inadequate funding, the SEC is reallocating its existing resources
to satisfy the requirements under the Act, which
threatens the reach and
efficacy of its front line functions such as
enforcement.[216] The regulators,
particularly the SEC and the CFPB, are entrusted with extensive discretionary
powers. The SEC must write 205 of the
mandated rules and the CFPB is required to
write a further 70, leaving the door open to regulatory capture by the very
financial
institutions that these bodies are supposed to
supervise.[217]
Regulatory
capture is a major issue in the US, as in many other countries. The financial
services industry ‘has been the single
largest contributor to
congressional campaigns since
1990’.[218] One study
indicates that the largest six banks and their industry bodies spent nearly
$US600 million lobbying Congress on the proposed
reforms.[219] Even the
institutions that were bailed out using taxpayer funds paid significant sums to
lobbyists.[220] Volcker highlights
the political difficulties the regulators face. He suggests the response to
warnings of destabilising developments
in an institution or a market when things
are going well will generally be we “know more about banking and finance
than you
do, get out of my hair, if you don’t get out of my hair I’m
going to write to my
congressman.”[221]
There
is little doubt that the world has changed after the GFC. However, the extent to
which recent events have altered the cultures
and mindsets of the regulators in
the US (and elsewhere) is not yet clear. Posner argues that prior to the GFC
‘the regulators
of financial intermediaries were asleep at the
switch’.[222] Volcker
suggests there was ‘a certain neglect of supervisory responsibilities,
certainly not confined to the Federal Reserve,
but including the Federal
Reserve.’[223] It is easy in
hindsight to argue that the regulators should have responded differently. It is
more important to understand why the
regulators acted the way they did, and what
changes in approach are required for the reforms to succeed. The regulatory
responses
to developments in the home mortgage markets leading up to the GFC
suggest that the US regulators need to radically change the framework
used to
assess the net societal effects of the financial policy they administer.
In 1994 Congress passed the HOEPA prohibiting identified abusive
practices. In addition, the Congress granted the Fed the power to
prohibit other
unfair, deceptive or abusive practices that it became aware
of.[224] However, despite the
continuing evidence of abusive home credit
practices,[225] from 2000 to 2007
the Fed emphasised educational campaigns to improve consumers’ financial
literacy and initiated only minor
regulatory
changes.[226] This approach was
consistent with the well established global patterns of increasing deregulation
and a strong reliance on markets
- a fundamental belief in the ability of
markets to deal with themselves, a view that regulatory interference in markets
should be
kept to a minimum, an emphasis on efficiency or economic factors, and
a belief that consumers should act rationally and look after
their own
interests. The actions of the Fed were also consistent with the long-standing
policy in the US to encourage people to own
their own homes. Based on these
worldviews, the Governors saw the growth in the subprime market as a natural and
positive development
that was allowing millions of people to own their own
homes. They were therefore reluctant to interfere, and even though they
acknowledged
that abuses were occurring, they determined that the greater
economic good or the net societal benefit was served by allowing the
lending to
continue.[227] As late as May
2007, Chairman Bernanke indicated that
we believe that the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system ...
Credit market innovations have expanded opportunities for many households.
Markets can overshoot, but ultimately, market forces also
work to rein in
excesses. For some, the self-correcting pullback may seem too late and too
severe. But I believe that, in the long
run, markets are better than regulators
at allocating
credit’[228]
It
wasn’t until 2008 that the Fed significantly strengthened the level of
protection provided to consumers by amendments to
the HOEPA
regulation.[229] Notably, these
amendments were made using its existing regulatory
powers.[230]
I Conclusion
The Act represents the most substantive
reform of financial regulation in the US since the 1930s. It contains some bold
legislative
changes. The establishment of a well-resourced single consumer
protection agency may provide consumers with a regulatory body focused
primarily
on their interests. The reforms around trading of derivatives are important and
may enhance long-term economic outcomes.
Likewise the mere existence of
provisions that provide for some of the losses arising from failed companies to
be potentially borne
by the management and directors may encourage more prudent
and cautious behaviour on the part of well-advised executives and directors.
However, the communication, implementation and operational capacities of
Congress and the federal regulators over the next few years
will be challenged
to the limit as the vast array of rules are rolled out. The extent of required
rulemaking under the Act leaves
all parties with significant uncertainties. The
nature and scope of the reforms will only be known once the mandated studies and
rulemaking are completed and the regulation is fully implemented.
Financial institutions will respond vigorously to the reform agenda.
Wall Street lobbying to influence or derail the studies that
have been mandated
and water down the implementing regulations will be
intense.[231] New financial
products and innovations to minimise the potential adverse effects to
institutions and to gain competitive advantages
seem inevitable. Indeed, the
most certain consequence of the reforms is that both regulators and financial
institutions in the US
are in for a very interesting and demanding few years
ahead.
Timothy Geithner recently highlighted the need for the right
balance between rules that protect consumers and investors and the economy,
without stifling the competition and innovation that drives economic
growth.[232] While few parties
would disagree with this aspiration, maintaining such a balance over entire
economic cycles is notoriously difficult.
The temptation for us all, including
policy makers, regulators, financial institutions, other capital market
participants, and consumers,
is to opt for short-term economic gains and to
ignore longer-term risks and the adverse consequences of inaction.
The success of the reforms over the long term will depend heavily on
regulatory performance.[233] As
Shiller suggests, ‘the success of the Act, and the agencies created to
study aspects of the market, will depend on appointing
the right people ... It
is a good Act but only to the extent that we make it a good
Act.’[234] Given the
longstanding regulatory struggle around mortgage consumer protection leading up
to the GFC, and the reluctance of the federal
regulators to use their existing
powers and discretion to intervene to mitigate the building excesses and
exposures, the key question
that arises is whether the regulatory responses will
be different the next time around. Have the views of the federal regulators,
particularly the Fed, fundamentally changed in relation to the ability of
markets to order themselves and the necessity of regulatory
oversight and
action?[235] Has the Fed’s
conception, application and consideration of the “net societal
benefit” test altered since 2007?
Are the federal regulators willing to
assess and determine economic policy goals using a longer-term lens that better
balances the
longer term costs and public interest factors with the expected
short-term benefits? And are the federal regulators willing to use
their
previous and new powers and discretion to achieve the stated purposes of the
Act? An affirmative response to these questions
will require deep changes
to the culture and mindset of the US regulatory agencies. Whether these
changes are achievable remains the pressing question.
* Research Fellow, Faculty of Law, University of New South Wales.
∗∗ Professor of International Finance Law, Faculty of
Law, University of New South Wales; Fellow, Asian Institute of International
Financial
Law, University of Hong Kong. The authors would like to thank the
Australian Research Council for the Discovery Grant that made this
research
possible, and Martin North and the two anonymous referees for their valuable
feedback. All responsibility rests with the
authors.
[1] Barack Obama, ‘Remarks
by the President on 21st Century Financial Regulatory Reform’ (Speech
delivered at the White House,
17 June
2009).
[2] As such, the reform is
likely to be seen by many parties as ‘post GFC reform’ or as
regulation following a crisis. See,
eg, Stephen Bainbridge, ‘Quack Federal
Corporate Governance Round II’ (2011) 95 Minnesota Law Review 1779.
Bainbridge argues that the Dodd Frank Act is a bubble act enacted in response to
a major negative economic event and it represents
a populist backlash against
corporations and/or markets.
[3] Skadden, Arps, Slate, Meagher
& Flom LLP & Affiliates, ‘The Dodd-Frank Act: Commentary and
Insights’, (Commentaries,
12 July 2010) Introductory Letter from Executive
Partner.
[4] Wikipedia,
Dodd–Frank Wall Street Reform and Consumer Protection Act (1
February 2011) available
at
http://en.wikipedia.org/wiki/Dodd%E2%80%93Frank_Wall_Street_Reform_and_Consumer_Protection_Act.
[5]
The Act, § 4, 124 Stat 1376,
1390.
[6] For a summary of the
mandated rules, studies and reports, see United States Chamber of Commerce,
Center for Capital Market Competitiveness,
Dodd-Frank Act of 2010: Summary of
Rulemaking, Studies, and Congressional Reports by Title,
<http://chamberpost.typepad.com/files/dodd-frank-summary-sheet.pdf>
NERA Economic Consulting, Dodd-Frank Rulemakings and Studies,
<http://www.nera.com/6911.htm>
.
[7]
The article provides only minimal commentary on events since the Act was passed.
Ongoing updates on the reform timetables and rulemaking
processes are available
from the regulator websites. See, eg ,The Federal Reserve Board, Dodd Frank Act
Proposals at Dehttp://www.federalreserve.gov/generalinfo/foia/dfproposals.cfm;
U.S Commodity Futures Trading Commission,, Dodd Frank Act at http://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm;
U.S. Securities and Exchange Commission (SEC), Implementing the Dodd-Frank Wall
Street Reform and Consumer Protection Act at http://www.sec.gov/spotlight/dodd-frank.shtml.
There are also many third party websites providing commentary on the reform
schedules and outcomes.
[8] See
United States Government Accountability Office (GAO), ‘Financial
Regulation: Industry Trends Continue to Challenge the
Federal Regulatory
Structure’ (Report to Congressional Committees, GAO, October 2007) for a
detailed outline of the Federal
regulatory structure prior to the reforms.
[9] See Final Report of the
National Commission on the Causes of the Financial and Economic Crisis in the
United States (Commission Report),
The Financial Crisis Inquiry Report
(January 2011) xviii. The Commission Report states that we ‘do not accept
the view that regulators lacked the power to protect
the financial system. They
had ample power in many arenas and they chose not to use
it’.
[10] See, eg, Rose
Kushmeider, ‘The US Federal Financial Regulatory System: Restructuring
Federal Bank Regulation’ (2005)
17 (4) FDIC Banking Review. In the
appendix of the paper, Kushmeider provides a summary of 24 major
reviews/proposals for regulatory restructuring.
[11] GAO, ‘Financial
Regulation: A Framework for Crafting and Assessing Proposals to Modernize the
Outdated US Financial Regulatory
System’ (Report to Congressional
Addressees, GAO, 21 January
2009).
[12] Glenn Hubbard,
‘Finding the Sweet Spot for Effective Regulation’ (November 2009)
6(11) The Economists Voice, Article 4, 4. Hubbard indicates that the
establishment of a systemic risk council is flawed and represents fragmentation
by another
name.
[13]
Kushmeider, above n 10.
[14]
Kushmeider, above n 10.
[15] GAO,
above n 8, 15. The IMF report was undertaken as part of part of the IMF’s
regular consultations of member countries under
Article IC of IMF’s
Articles of Agreement.
[16] GAO,
above n 11.
[17]
Ibid.
[18] GAO, above n 11, 9-24.
[19] The Act, § 115,
124 Stat 1376, 1403.
[20] A
nonbank financial company is defined as a company that is predominantly engaged
in financial activities: The Act, § 102(a)(4), 102(a)(6), 124 Stat
1376, 1391, 1392.
[21] The
Act, § 171, 124 Stat 1376,
1435.
[22] The Act,
§§ 121, 163, 124 Stat 1376, 1410, 1422.
[23] The Act,
§§ 121. Section 121(a) provides that the Board of Governors, upon an
affirmative vote of not fewer than 2/3 of the voting
members of the Council then
serving shall –
1. limit the ability of the company to merge with, acquire, consolidate with, or otherwise become affiliated with another company;
2. restrict the ability of the company to offer a financial product or products;
3. require the company to terminate one or more activities;
4. impose conditions on the manner in which the company conducts 1 or more activities; or
5. if the Board of Governors determines that the actions described in
paragraphs 1 through 4 are inadequate to mitigate a threat to
the financial
stability of the United States in its recommendation, require the company to
sell or otherwise transfer assets or off-balance
sheet items to unaffiliated
entities.
All of these actions are subject to prescribed procedural
requirements.
[24] The
Act, § 622, 124 Stat 1376, 1632. The Act requires the
Council to complete a study on the extent to which this size affects financial
stability, moral hazard, the efficiency
and competitiveness of the financial
firms and markets, and the cost and availability of credit and other financials
services to
households and businesses. This study was completed in Janaury 2011.
See Financial Stability Oversight Council (FSOC) ‘Study &
Recommendations Regarding Concentration Limits On Large Financial
Companies’ (January 2011) available at
http://www.treasury.gov/initiatives/Documents/Study%20on%20Concentration%20Limits%20on%20Large%20Firms%2001-17-11.pdf.
The FSOC note
at pg 8 that in ‘the near term, the concentration limit is
mostly likely to restrict or otherwise affect acquisitions by four
financial
institutions-Bank of America Corporation, J. P. Morgan Chase & Company,
Citigroup, Inc, and Wells Fargo & Company
– because only these four
firms, based on current estimates, appear to hold more than 5 percent of the
aggregate liabilities
of all financial companies subject to the concentration
limit.’.
[25] The
Act, § 111, 124 Stat 1376, 1392. The Council voting members include the
Secretary of the Treasury, the Chairman of the Board of
Governors, the
Comptroller of the Currency, the Director of the Consumer Bureau, the Chairman
of the Securities Exchange Commission
(SEC), the Chairperson of the Corporation,
the Chairperson of the Commodity Futures Trading Commission (CFTC), the Director
of the
Federal Housing Finance Agency, the Chairman of the National Credit Union
Administration Board and an independent member. The nonvoting
members include
the Director of the Office of Financial Research, the Director of the Federal
Insurance Office, a State insurance
commissioner, a State banking supervisor and
a State securities commissioner. See FSOC 2011 Annual Report available at http://www.treasury.gov/initiatives/fsoc/Pages/default.aspx.
[26]
The Act, § 112(a), 124 Stat 1376, 1394-5.
[27] The Act, § 203,
124 Stat 1376, 1450. To be placed into receivership under the Orderly
Liquidation Authority, a financial company must
be a ‘covered financial
company’ and a written determination must be made at the initiative of the
company, or at the
request of the Secretary of the Treasury, the FIDC, the SEC,
or in a case involving an insurance company, the Director of the Federal
Insurance Office and the Board of Governors, that the company presents systemic
risk.
[28] See The Act,
§ 203(e), 124 Stat 1376, 1454. Insurance companies cannot be placed into
receivership under The Act and must be liquidated or rehabilitated under
state law proceedings.
[29]
The Act, § 214(c), 124 Stat 1376,
1518.
[30] The Act, §
204, 124 Stat 1376, 1454.
[31]
The Act, § 214(b), 124 Stat 1376,
1518.
[32] Richard Herring,
‘The Known, the Unknown, and the Unknowable in Financial Policy: An
Application to the Subprime Crisis’
(2009) 26 Yale Journal on
Regulation 391, 404.
[33]
David Skeel Jr, ‘The New Financial Deal: Understanding the Dodd-Frank Act
And Its (Unintended) Consequences’ (Research
Paper No 10-21, University of
Pennsylvania Law School, Institute for Law and Economics, October 2010) 8
(published by Wiley in December
2010 as a book)
[34] John B Taylor, ‘The
Dodd-Frank Financial Fiasco’, The Wall Street Journal (online), 1
July 2010
<http://online.wsj.com/article/SB10001424052748703426004575338732174405398.html>
.
See also Kenneth Scott, ‘Dodd Frank: Resolution Or Expropriation?’
(Working Paper, Stanford Law School, 25 August
2010); Jeffrey Gordon and Chris
Muller, ‘Confronting Financial Crisis: Dodd-Frank’s Danger and the
Case for a Systemic
Emergency Insurance Fund’ (2011) 28 Yale Journal on
Regulation 151. Scott argues that the Orderly Liquidation Authority
procedure gives unprecedented power and discretion to an administrative
official,
going far beyond banking law to the point of posing serious
Constitutional problems. He is concerned by the lack of due diligence
and
judicial overview.
[35] See
Arthur Wilmarth, ‘The Dodd-Frank Act: A Flawed and Inadequate Response to
the Too-Big-To-Fail Problem’ (2011) 89 Oregon Law Review 951, 1052.
[36] Wilmarth, above n 35,
1053-1054
[37] Notably, Mark
McDermott suggests the potential harshness of the provisions may mean that the
most salutary effect will be to minimize
the circumstances under which it will,
in fact, be used. He argues that the Act’s broad provisions and the power
vested in
the FIDC may work best when used as a threat to compel a private
solution: Skadden, Arps, Slate, Meagher & Flom LLP & Affiliates,
above n
3, 102.
[38] Wilmarth, above n
35, 1025. Wilmarth highlights that the Federal Reserve Board’s (Fed)
divestiture authority under the Bank
Holding Company Act of 2006, 12 USC
§§ 1841-50 (2006) has never been successfully used for a major banking
organisation.
He suggests that given the more stringent procedural and
substantive constraints on the Fed’s authority under section 121,
the
prospects for a Fed ordered breakup of a systemically important financial
institution seem remote at
best.
[39] Section 203(b)
indicates that having received a recommendation, the Secretary in consultation
with the President shall appoint the
FIDC as receiver of a covered financial
company if he or she determines that: the financial company is in default or in
danger of
default; the failure of the financial company would have serious
adverse effects on financial stability in the United States; no
viable private
sector is available to prevent the default; the effect on the claims or
interests of creditors, counterparties and
shareholders of the financial company
and other market participants of proceedings under The Act is
appropriate, given the impact of any action under The Act would have on
financial stability in the United States; and an orderly liquidation would avoid
or mitigate such adverse effects.
[40] The Act, § 502,
124 Stat 1376, 1580.
[41] The
Act, § 619, 124 Stat 1376,
1620.
[42] The Act, §
619, 124 Stat 1376, 1620.
[43]
The Act, § 619, 124 Stat 1376,
1620.
[44] The Act, §
619, 124 Stat 1376, 1620.
[45]
The Act, § 619, 124 Stat 1376,
1620.
[46] FSOC, ‘Study
& Recommendations on Prohibitions on Proprietary Trading & Certain
Relationships with Hedge Funds &
Private Equity Funds’ (Report, FSOC,
January 2011) available at
http://www.treasury.gov/initiatives/Documents/Volcker%20sec%20%20619%20study%20final%201%2018%2011%20rg.pdf.
The FSOC note at pg 18 that ‘certain class of permitted activities –
in particular, market-making, hedging, underwriting
and other transactions on
behalf of customers – often evidence outwardly similar characteristics to
proprietary trading, even
as they pursue different objectives’. Notably,
the study concludes at pg 43 that ‘[s]upervisory review is likely to be
the ultimate lynchpin in effective implementation by Agencies’.
[47] FSOC, above n 46, 3.
[48] Ian Katz and Rebecca
Christie, ‘Volcker Rule Should be Robust, Financial Oversight Panel
Says’ Bloomberg (online), 19 January 2011
<http://www.bloomberg.com/news/2011-01-18/volcker-rule-s-implementation-should-be-robust-oversight-council-says.html>
.
[49]
Lisa Brice, ‘2010 Financial Reform As It Relates To Hedge Funds’
(Working Paper, 19 July
2010).
[50] Brice, above n 49.
See also Barry Eichengreen and Donald Mathieson, ‘Hedge Funds: What Do We
Really Know?’ (Economic
Issues No 19, International Monetary Fund,
September 1999); GAO, ‘Hedge Funds: Regulators and Market Participants Are
Taking
Steps to Strengthen Market Discipline, but Continued Attention is
Needed’ (Report to Congressional Requesters, GAO, January
2008).
The timing of the GAO report is such that the commentary reflects only the
early GFC responses.
[51] There
is no limit on the amount of capital raised under Rule 506 when a company does
not market its securities through general solicitation
or advertising and the
securities are sold only to ‘accredited investors’.
[52] The Act, § 403,
124 Stat 1376, 1571.
[53] The
Act, § 404, 124 Stat 1376,
1571.
[54] The Act, §
932(a), 124 Stat 1376, 1872.
[55]
The Act, § 932(a), 124 Stat 1376,
1872.
[56] The Act, §
932(a), 124 Stat 1376, 1872.
[57] The Act, §
932(a), 124 Stat 1376, 1872.
[58]
The Act, § 932(a), 124 Stat 1376, 1872. The SEC has issued the
following proposed rules: Nationally Recognized Statistical Ratings Organization
(NRSRO) reports of internal controls; technical amendments to NRSO Rules;
transparency of NRSRO ratings performance; credit ratings
procedures and
methodologies; certification by third parties; and establishing fines and other
penalties. The rules are available
at
http://www.sec.gov/spotlight/dodd-frank/accomplishments.shtml
[59]
The Act, § 933(a), 124 Stat 1376, 1883.
[60] The Act, §
933(b)(2), 124 Stat 1376, 1883. On September 29 2010, the SEC revised
Regulation FD to remove the exemption for entities
whose primary business is the
issuance of credit ratings: http://www.sec.gov/rules/final/2010/33-9146.pdf
[61] The Act, §
939(h), 124 Stat 1376, 1887.
[62]
The Act, § 939C, 124 Stat 1376,
1888.
[63] The Act, §
939F, 124 Stat 1376, 1889. On May 10 2011, the SEC requested public input to
assist the study on the rating process for structured
finance products available
at
http://www.sec.gov/spotlight/dodd-frank/accomplishments.shtml.
[64]
The Act, § 939F(d), 124 Stat 1376, 1889.
[65] Banking Act of 1933,
Pub L No 73-66, 48 Stat 162 (‘Banking Act’).
[66] Banking
Act § 16. However, commercial banks were permitted to purchase and sell
securities on the order of and for the account of customers.
[67] Banking Act
§§ 16, 21.
[68]
Banking Act § 20.
[69] Banking Act §
32.
[70] Bank Holding Company
Act of 1956, 12 USC §§ 1841-48 (1956).
[71] See, eg, Emilios
Avgouleas, ‘The Reform of “Too-Big-To-Fail” Bank: A New
Regulatory Model for the Institutional
Separation of “Casino” from
“Utility” Banking’ (Working Paper, University of Manchester,
14 February
2010).
[72] See, eg,
Robert Litan, ‘Evaluating and Controlling the Risks of Financial Product
Deregulation’ (1985) 3 Yale Journal on Regulation 1. Litan argued
that while product diversification would theoretically make it possible for
banks to reduce the volatility of their
earnings, the freedom to diversify could
increase instability in the banking system because of the danger that funds
raised from
insured depositors will be used to support unduly risky investments.
[73] See Gill North,
‘Structural Developments in Global Capital Markets: Promoting Efficiency
or A Risky & Unstable Mathematical
Playground?’ (Working Paper, UNSW,
September 2011); Gill North and Ross Buckley, ‘A Financial Transaction
Tax: Inefficient
or Needed Systemic Reform’ (2012) 43(3) Georgetown
Journal of International Law forthcoming (March/April
2012)
[74] See, eg, Stephan
Schulmeister, ‘A General Financial Transaction Tax: A Short Cut of the
Pros, the Cons and a Proposal’
(Working Papers No 344, Austrian Institute
of Economic Research, October 2009) 5; Zsolt Darvas and Jakob von Weizsacker,
‘Financial
Transaction Tax: Small is Beautiful’, (Policy
Contribution No PE 429.989, Policy Department A: Economic and Scientific Policy,
European Parliament, January 2010) 4.
[75] Thornton Matheson,
‘Taxing Financial Transactions: Issues and Evidence’ (Working Paper
WP/11/54), International Monetary
Fund, March 2011; Sony Kapoor,
‘Financial Transaction Taxes: Tools for Progressive Taxation and Improving
Market Behaviour’
(Policy Brief, Re-Define, February 2010) 6. Matheson
indicates that 10-20 percent of foreign exchange trading volume, 20 percent
of
options trading volume and 40 percent of futures trading volume in the US is
algorithmic or computer based.
[76] Mary Schapiro, ‘US
Equity Market Structure’ (Testimony before the Subcommittee on Securities,
Insurance and Investment
of the United States Senate Committee on Banking,
Housing, and Urban Affairs and the United States Senate Permanent Subcommittee
on Investigations, 8 December 2010).
[77] See, eg, Charles Whitehead,
‘The Volcker Rule and Evolving Financial Markets’ (2011) 1
Harvard Business Law Review 39, 69. Whitehead suggests the Volcker Rule
fails to reflect important shifts in the financial markets. He argues for a
narrow definition
of proprietary trading and a fluid approach to implementing
the Rule.
[78] Eichengreen et
al, above n 50. See also Nicole Boyson, Christoff Stahel and Rene Stulz,
‘Hedge Fund Contagion and Liquidity
Shocks’ (2010) 65 Journal of
Finance 1789. Boyson et al link contagion in the hedge fund industry to
liquidity shocks.
[79] Kapoor,
above n 75, 6. Kapoor suggests that hedge funds account for 90% of the trading
volume in convertible bonds, between 55-60%
of the transaction in leveraged
loans, almost 90% of the trading in distressed debt, and more than 60% of the
trading volume in the
credit default
market.
[80] Eichengreen et al,
above n 50.
[81] Steven L
Schwarcz, ‘Private Ordering of Public Markets: The Rating Agency
Paradox’ (2002) 1 University of Illinois Law Review 1, 26.
[82] Schwarcz, above n 81,
2.
[83] Yair Listokin and
Benjamin Taibleson, ‘If You Misrate, Then You Lose: Improving Credit
Rating Accuracy Through Incentive Compensation’
(2010) 27 Yale Journal
on Regulation 91.
[84] John
Hunt, ‘Credit Rating Agencies and the “Worldwide Credit
Crisis”: The Limits of Reputation, the Insufficiency
of Reform, And a
Proposal for Improvement’ (2009) Columbia Business Law Review 109,
112.
[85] See John Coffee Jr.,
‘Ratings Reform: The Good, The Bad, and The Ugly’ (Colombia Law and
Economics Working Paper No 359,
The Center for Law and Economic Studies –
Columbia University School of Law / Law Working Paper No 145/2010, European
Corporate
Governance Institute, September 2010)
28.
[86] Coffee, above n 85, 53.
[87] Coffee, above n 85, 58.
[88] Coffee defines the
‘subscriber pays’ model as one that requires institutional investors
to obtain their own ratings from
a ratings agency not retained by the issuer or
underwriter before they purchase the debt securities: Coffee, above n 85,
33.
[89] Commission Report, above
n 9, 207. The Commission Report cites a statement by Jerome Fons a former
managing director of Moody’s
Investor Services to the FIDC on 22 April
2010 that the ‘main problem was ... that the firm became so focused,
particularly
the structured area, on revenues, on market share, and the
ambitions of Brian Clarkson, that they willingly looked the other way,
traded
the firms’ reputation for short-term profits’.
[90] Commission Report, above n
9, 120.
[91] The Act,
§ 941(b), 124 Stat 1376,
1891.
[92] The Act, §
941(b), 124 Stat 1376, 1891. In March of this year, the regulators jointly
issued proposed rules regarding risk retention
by securitizers of asset-back
securities available at
http://www.sec.gov/news/press/2011/2011-79.htm
[93]
The Act, § 942(b), 124 Stat 1376, 1897. For comprehensive analysis
on loan level disclosure, see Howell Jackson, ‘Loan-Level Disclosure
in
Securitization Transactions: A Problem with Three Dimensions’
(Public Law Working Paper No 10-40, Harvard Law School, 27 July 2010).
Jackson concludes that with a few modest refinements, loan
level disclosures
could revolutionize the manner in which mortgage originations in the United
States are policed.
[94] The
Act, § 943(1), 124 Stat 1376, 1897. The SEC has adopted new rules
relating to representation and warranties in asset-based securities
offerings:
Release Nos 33-9175; 34-63741 (January 20, 2011) available at http://www.sec.gov/news/press/2011/2011-18.htm..
[95]
The Act, § 943(2), 124 Stat 1376,
1897.
[96] The Act, §
722, 124 Stat 1376, 1672.
[97]
The Act, §§ 721(19), 721(21), 124 Stat 1376, 1665, 1666. In
April 2011 the SEC and CFTC issued proposed swap definitions for public
comment
available at ://www.sec.gov/news/press/2011/2011-99.htm
[98] The Act, § 723,
124 Stat 1376, 1675.
[99]
The Act, § 731, 124 Stat 1376,
1703.
[100] The Act,
§§ 727, 729, 124 Stat 1376, 1696,
1701.
[101] The Act,
§ 723(a), 124 Stat 1376,
1675.
[102] The Act,
§ 723(a)(3), 124 Stat 1376,
1675.
[103] The Act,
§ 728, 124 Stat 1376, 1697. The SEC has issued a series of proposed rules
for comment relating to derivatives, available from
http://www.sec.gov/spotlight/dodd-frank/accomplishments.shtml.
[104] The Act, §
731, 124 Stat 1376, 1703.
[105] The Act, §
737, 124 Stat 1376, 1722.
[106]
The Act, § 763(h), 124 Stat 1376,
1778.
[107] The Act,
§ 731, 124 Stat 1376,
1703.
[108] The Act,
§ 731, 124 Stat 1376, 1703.
[109] The Act, §
731, 124 Stat 1376, 1703.
[110] The Act, §
805, 124 Stat 1376, 1809. In March 2011 the SEC issued proposed rules regarding
systemically important clearing agencies.
In July 2011, the SEC, CFTC and the
Federal Reserve Board reported to Congress on the framework for designated
clearing entity risk
management. The proposed rules and the Report to Congress
are available at http://www.sec.gov/spotlight/dodd-frank/accomplishments.shtml.
[111] The Act, §
805(c), 124 Stat 1376,
1810.
[112] The Act,
§ 714, 124 Stat 1376, 1647. See Lynn Stout, ‘Derivatives and The
Legal Origins of the 2008 Credit Crisis’ (2011)
1 Harvard Business Law
Review 1. Stout argues that the credit crisis was primarily due to enactment
of the Commodities Futures Modernization Act of 2000, which
removed long
established legal constraints on speculative trading in over-the-counter
derivatives. She is concerned that Title VII
of the Act is subject to possible
exemptions that may limit its effectiveness.
[113] See, eg, Hubbard, above
n 12, 1; Carlos Tavares, Short Selling and OTC Derivatives Policy
Options (9 January 2011) VoxEU
<http://www.voxeu.org/index.php?q=node/5996>
.
[114]
Keith Spence, ‘Developments in Banking and Financial Law’ (2009) 29
Review of Banking & Financial Law
10.
[115] See Skeel, above n
33, 13.
[116] Schapiro, above
n 76, 11.
[117] Schapiro,
above n 76, 7.
[118] The
Act, § 951, 124 Stat 1376, 1899. New rules under section 951 were
adopted in January 2011: SEC, Shareholder Approval Of Executive
Compensation And
Golden Parachute Compensation Release Nos. 33-9178; 34-63768; File No. S7-31-10
(25 January 2011) available at
http://www.sec.gov/rules/final/2011/33-9178.pdf.
[119]
The Act, § 953(a), 124 Stat 1376,
1903.
[120] The Act,
§ 953(b)(1), 124 Stat 1376, 1904..
[121] The Act, §
954, 124 Stat 1376, 1904.
[122] The Act, §
201, 124 Stat 1376, 1422. Covered financial institutions with assets of less
than one billion dollars are exempted from these
provisions, see The Act,
§ 956(f), 124 Stat 1376,
1906.
[123] On March 30 2011,
the Fed issued a joint proposed rule with the OCC, FDIC, OTS, NCUA, SEC and FHFA
to prohibit incentive-based compensation
arrangements that encourage
inappropriate risk-taking by covered financial companies, and to require the
disclosure and reporting
of certain incentive-based compensation information by
covered financial companies. See Incentive Based Compensation Arrangements
available at http://www.sec.gov/rules/proposed/2011/34-64140.pdf.
The final rules are still being developed.
[124] The Act, §
206(4), 124 Stat 1376,
1459.
[125] The Act,
§§ 204(a)(3), 204(2), 124 Stat 1376, 1454.
[126] The Act,
§§ 204(a)(3), 204(2), 124 Stat 1376,
1454.
[127] Ashley Seager and
Toby Helm, ‘Brown Wins G20 Battle Against Caps on Bank Bonuses’,
The Observer (online), 6 September 2009
<http://www.guardian.co.uk/business/2009/sep/06/brown-halts-bonus-caps>
.
[128]
European Parliament Legislative Resolution of 7 July 2010 on the Proposal for a
Directive of the European Parliament and of the Council
Amending Directives
2006/48/EC and 2006/49/EC As Regards Capital Requirements for the Trading Book
and for Re-Securitisations, and
the Supervisory Review of Remuneration Policies,
EUR. PARL. DOC. P7_TA(2010)0274 (2010). Cf. Remuneration of Directors of Listed
Companies and Remuneration Policies in the Financial Services Sector, Eur. Parl.
Doc. INI/2010/2009 (2010).
[129] Karen Maley, ‘The
War on Bank Bonuses’, Business Spectator, 13 July 2010
http://www.businessspectator.com.au/bs.nsf/Article/Banks-Bonu-European-Union-Financial-Crisis-US-pd20100712-7A9S3?OpenDocument.
[130]
See eg, Jessica Holzer, ’SEC, in Split Vote, Backs Bonus Curbs on Brokers,
Hedge Funds’, Wall Street Journal (online) March 3, 2011; Justin
Baer and Francesco Guerrera, ‘Morgan Stanley Defers 60% of Bonuses’,
Financial Times, 20 January 2011
<http://www.ft.com/cms/s/0/64b30844-24c7-11e0-a919-00144feab49a.html#axzz1D3tpydve>
.
[131]
The Act, §§ 1011, 1012, 124 Stat 1376, 1964,
1965.
[132] The Act,
§ 1021, 124 Stat 1376,
1979.
[133] The Act,
§§ 1002(5), 1002(15), 1021, 124 Stat 1376, 1956, 1957,
1979.
[134] The Act,
§§ 1002(12), 1022, 124 Stat 1376,
1957.
[135] The Act,
§ 1024-1027, 124 Stat 1376,
1987-1995.
[136] The
Act, § 1031, 124 Stat 1376,
2005.
[137] The Act,
§ 1013(b), 124 Stat 1376,
1968.
[138] The Act,
§ 1013(c), 124 Stat 1376,
1970.
[139] The Act,
§ 1013(d), 124 Stat 1376,
1970.
[140] The Act,
§ 1013(e), 124 Stat 1376,
1972.
[141] The Act,
§ 1411, 124 Stat 1376,
2142.
[142] The Act,
§ 1413, 124 Stat 1376,
2148.
[143] The Act,
§ 1412, 124 Stat 1376,
2146.
[144] The Act,
§ 1403, 124 Stat 1376,
2139.
[145] The Act,
§ 1414, 124 Stat 1376,
2149.
[146] The Act,
§§ 1032, 1414, 1418, 1420, 124 Stat 1376, 2006, 2149, 2153,
2155.
[147] See Daniel
Immergluck, ‘Private Risk, Public Risk: Public Policy, Market Development,
and the Mortgage Crisis’ (2009) 36 Fordham Urban Law Journal 447
for a detailed historical outline.
[148] Immergluck, above n 147,
466. Enactment of the Alternative Mortgage Transaction Parity Act, 12 USC
§§ 3801-3805 (1982), in 1982 enabled the mortgage companies that were
subject to state based regulation to opt
for supervision by the federal
regulator.
[149] For instance,
the Home Ownership and Equity Protection Act of 1994, Pub L
No 103-325, 108 Stat 2190 required greater disclosure of high priced loans and
prohibited some loan practices and terms.
[150] Industry opposition to
new regulation governing mortgage lending was most visible at the state level.
State legislators were often
pressured to repeal or to weaken proposed policy by
industry lobbyists arguing that regulation would reduce economic development:
see Immergluck, above n 142, 471-475.
[151] U.S. Department of
Treasury and US Department of Housing and Urban Development, ‘Curbing
Predatory Home Mortgage Lending’
(Report, June
2000).
[152] Those opposed to
stronger regulation argued that the existing lending laws were resulting in
suboptimal economic outcomes. See, eg,
US Office of the Comptroller of the
Currency, ‘Economic Issues in Predatory Lending’ (Working Paper,
2003). The report
replied on an industry funded report which found the number of
subprime loans had declined in North Carolina as a result of the passing
of
anti-predatory lending law.
[153] For instance, in 2003
Elliot Spitzer, the Attorney General for New York State threatened to sue the
OCC. See also Adam Levitin,
‘Hydraulic Regulation: Regulating Credit
Markets Upstream’ (2009) 26(2) Yale Journal on Regulation
143.
[154] 550 US 1, 21
(6th Cir,
2007).
[155] The Act
seeks to clarify the role of state authorities and the standards and limits of
preemption. It enhances the states’ authority
to enforce state and federal
law against federal banks and other financial institutions in specified
circumstances: The Act, §§ 1041, 1042, 124 Stat 1376, 2011,
2012. It confirms that The Act only pre-empts state law to the extent
that they are ‘inconsistent’ with The Act: § 1041(a),
124 Stat 1376, 2011. It also clarifies the preemption standards and the
circumstances when state law is deemed
to have been pre-empted: § 1044, 124
Stat 1376, 2014. See discussion in Skadden, Arps, Slate, Meagher & Flom LLP
& Affiliates,
above n 3,
183-184.
[156] On July 30,
2008, the Federal Reserve Board (the FRB) published a final rule amending
Regulation Z implementing the Truth in Lending Act, 15 USC §§
1601 et seq. (1968) (‘TILA’) and the
Home Ownership and Equity Protection Act of 1994, Pub L No
103-325, 108 Stat 2190. Further, the US Congress enacted the Housing and
Economic Recovery Act of 2008, 12 USC §§ 4501 et seq. (2008) on
July 30, 2008, which included amendments to the TILA known as the
Mortgage Disclosure Improvement Act of 2008 (MDIA). The main purpose of the
TILA is to enable consumers to make informed use of credit information.
The TILA requires full disclosures about credit terms and
costs.
[157] See, eg, Skeel,
above n 33, 13; Elizabeth Warren, ‘Unsafe At Any Rate’ (Summer 2007)
5 Democracy: A Journal of Ideas
8.
[158] Levitin, above n 153,
155.
[159] See Raymond Brescia,
‘The Cost of Inequality: Social Distance, Predatory Conduct, and the
Financial Crisis’ (2010) 66
NYU Annual Survey of American Law 9;
Vincent Dilorenzo, ‘The Federal Financial Consumer Protection Agency: A
New Era of Protection or Mode of the Same?’
(Legal Studies Research Paper
Series Paper No 10-0182, St John’s University School of Law, September
2010) 42. There are approximately
75 million owner-occupied residential
properties in the US, of which 70% are mortgaged. Of the 52 million mortgaged
properties, 1
in 7 (8 million), are in some stage of the foreclosure process or
are at least 30 days delinquent on a mortgage payment. One in five
of the
mortgaged properties are in a negative equity position. The incidence of
foreclosures are heavily concentrated in low-income
communities and communities
with predominantly black or Hispanic populations.
[160] Oren Bar-Gill &
Elizabeth Warren, ‘Making Credit Safer’ (2008) 157 University of
Pennsylvania Law Review 1, 100.
[161] See, eg, Levitin, above
n 153, 151; Oren Bar-Gill et al, above n 160.
[162] Oren Bar-Gill et al,
above n 160, 38-39. Bar-Gill and Warren cite studies by the National Training
and Information Center, Freddie
Mac, Fannie Mae, the Department of Housing and
Urban Development, and the Wall Street Journal.
[163] Dilorenzo, above n 159,
59-60.
[164] US Department of
the Treasury and US Department of Housing and Urban Development, above n 151,
72.
[165] Dilorenzo, above n
159, 60.
[166] ‘Bank of
America Settles Over Mortgages’ Sydney Morning Herald (online) 5
January 2001
<http://www.smh.com.au/business/bank-of-america-settles-over-mortgages-20110104-19f22.html>
.
[167]
Warren, above n 157.
[168]
See, eg, Dilorenzo, above n 159.
[169] See Brescia, above n
159.
[170] The Act,
§ 919, 124 Stat 1376,
1837.
[171] The Act,
§ 919, 124 Stat 1376,
1837.
[172] See, eg, Financial
Services Authority, ‘Good and Poor Practices in Key Features
Documents’ (FSA, September 2007) 5; Australian
Securities and Investments
Commission, ‘Disclosure: Product Disclosure Statements (and other
disclosure obligations)’
(Regulatory Guide No 168, ASIC, 6 September
2010).
[173] The Act,
§ 913, 124 Stat 1376, 1824. In January the SEC reported to Congress: SEC,
Study on Investment Advisers and Broker-Dealers (January 2011)
http://www.sec.gov/news/studies/2011/913studyfinal.pdf.
[174] The Act, §
913(g), 124 Stat 1376, 1828. This issue was highlighted by the allegation that
Goldman Sachs acted inappropriately when it
recommended structured finance
products to its clients while simultaneously selling on its own account:
See SEC, ‘Securities and Exchange Commission v Goldman, Sachs &
Co. and Fabrice Tourre, 10 Civ. 3229 (BJ)’ (Litigation Release 21489,
16 April 2010). As part of a $US550 million settlement with the SEC in relation
to civil charges that it mislead clients, Goldman conceded it made a mistake by
not disclosing the role of a hedge fund Paulson &
Co to investors. The firm
agreed to toughen oversight of mortgage securities, certain marketing material
and employees who create
or market such securities. Goldman will pay $US250
million to investors in the Abacus deal and the remaining US$300 million will
be
paid the US government: Susanne Craig and Kara Scammell, ‘Goldman Admits
Mistakes in $US550m SEC Settlement’, The Australian (with the Wall
Street Journal) July 16, 2010. Possible criminal prosecutions against the firm
and individual employees are still
proceeding.
[175] The Act, §
913(g), 124 Stat 1376,
1828.
[176] The Act,
§ 919B(a), 124 Stat 1376, 1838. The SEC completed this study in January
2011: SEC, Study and Recommendations on Improved Investor Access to
Registration Information (January 2011) http://www.sec.gov/news/studies/2011/919bstudy.pdf.
[177]
The Act, § 914, 124 Stat 1376, 1830. On January 21 2011 the SEC
reported to Congress regarding the need for enhanced resources for investment
adviser examinations and enforcement; available at
http://www.sec.gov/news/studies/2011/914studyfinal.pdf.
[178]
The Act, § 918(a), 124 Stat 1376, 1837. The GAO completed this study
in July 2011; available at
http://www.gao.gov/new.items/d11697.pdf
[179]
The Act, § 919A, 124 Stat 1376,
1837.
[180] The Act,
§ 911, 124 Stat 1376, 1822. In practice, the Investor Advisory Committee
was established by Mary Schapiro in 2009 under the
Federal Advisory Committee
Act, 5 USC App. (1972). The Act provides specific statutory authority for
the creation of the Committee.
[181] The Act, §
915, 124 Stat 1376, 1830.
[182]
The Act, § 919D, 124 Stat 1376, 1840. In June 2011 the SEC provided
a letter to the Congress in lieu of a report.
[183] The Act, §
911, 124 Stat 1376, 1822.
[184]
The Act, § 915, 124 Stat 1376,
1830.
[185] The Act,
§ 919D, 124 Stat 1376,
1840.
[186] The Act,
§ 922(a), 124 Stat 1376, 1841. The adopted rules to implement a
whistleblower incentive and protection program were issued
by the SEC in May
2001 available at
http://www.sec.gov/spotlight/dodd-frank/accomplishments.shtml.
[187]
The Act, § 929P(a), 124 Stat 1376,
1862.
[188] The Act,
§§ 929M, 929N, 929O, 124 Stat 1376, 1861, 1862,
1862.
[189] The Act,
§ 929X(a), 124 Stat 1376,
1870.
[190] The Act,
§ 929X(b), 124 Stat 1376,
1870.
[191] See, eg, Levitin,
above n 153, 148.
[192]
Investment Advisers Act of 1940, 15 USC §§ 202(a)(11)(C),
80(b)-3(a)(11)(C) (2006).
[193]
Mary Schapiro, the Chair of the SEC, told the Senate Committee on Banking,
Housing and Urban Affairs that the services provided by
brokers and advisers are
virtually identical from the investor’s perspective: Mary Schapiro,
‘Enhancing Investor Protection
and Regulation of Securities
Markets’, (Testimony in Hearings Before the Senate Committee on Banking,
Housing and Urban Affairs,
11th Congress, 26 March
2009).
[194] See, eg, Mary
Schapiro, ‘SEC Oversight: Current State and Agenda’ (Testimony in
Hearing Before the Subcommittee on Capital
Markets, Insurance and
Government-Sponsored Enterprise, United States House of Representatives
Committee on Financial Services, 11th Congress, 14 July 2009); Elisse
Walter, ‘Regulating Broker-Dealers and Investment Advisors: Demarcation or
Harmonisation?’
(Speech delivered at the Mutual Fund Directors Forum Ninth
Annual Policy Conference, Washington D.C., 5 May
2009).
[195] Schapiro, above n
194.
[196] The comments are
available at
http://www.sec.gov/comments/4-606/4-606.shtml.
[197]
SEC, ‘Study Regarding Obligations of Brokers, Dealers and Investment
Advisers’ (Release No 34-62577; IA-3058; File No
4-606, SEC, 27 July
2010); SEC, ‘Study On Investment Advisers and Broker-Dealers (January
2011).
[198] SEC, above n 197,
ii.
[199] SEC v Capital
Gains Research Bureau Inc, [1963] USSC 204; 375 US 180, 191 (2nd Cir, 1963).
[200] See, eg, SEC v
Tambone, 550 F 3d 106, 146 (1st Cir
2008).
[201] SEC v Capital
Gains Research Bureau Inc, [1963] USSC 204; 375 US 180, 191 (2nd Cir, 1963).
[202] For a detailed outline
of this topic, see Arthur Laby, ‘Fiduciary Obligations of Broker-Dealers
And Investment Advisers’
(2010) 55 Villanova Law Review 701.
[203] Laby, ibid.
[204] Laby, above n 202, 705.
Most broker dealer disputes are handled through arbitration.
[205] Laby, above n 202, 702.
See also Arthur Laby, ‘Resolving Conflicts of Duty in Fiduciary
Relationships’ (2005) 54 American University Law Review 75.
[206] Laby, above n 202,
742.
[207] Donald Langevoort,
‘Brokers as Fiduciaries’ (2010) 71 University of Pittsburgh Law
Review 439, 441.
[208]
Langevoort, above n 207, 456. See also Mercer Bullard, ‘The Fiduciary
Study: A Triumph of Substance Over Form?’ (Working
Paper, University of
Mississippi – School of Law, 30 August 2010). Bullard highlights that the
fiduciary duty is inherently
principles-based. The conduct standards that apply
under a fiduciary duty are revealed through case
law.
[209] Langevoort, above n
207, 455.
[210] See, eg,
Levitin, above n 153,
148.
[211] See Alicia Davis
Evans, ‘A Requiem For The Retail Investor?’ (2009) 95 Virginia
Law Review 1105.
[212]
Tavares, above n 113.
[213]
Levitin, above n 153, 155-161.
[214] United States Chamber of
Commerce, above n 6.
[215]
The rulemaking procedure generally includes the issuance of a concept release or
notice of proposed rulemaking. This is followed
by a proposed rule that is
released for public comment. Once the final rule is issued, there is generally a
phasing in period to
allow industry time to prepare for compliance.
[216] Congress initially
authorised annual budget increases to the SEC for the next five years, with $1.3
billion approved for 2011, stepping
up to $2.25 billion in 2015: The Act,
§ 991, 124 Stat 1376. However, the budget deal agreed in April 2011
between the Administration and House Republicans resulted
in significant cost
cutting. The SEC received only a small increase in its funding for 2011 and is
reallocating resources or using
its existing officers to satisfy some of the
requirements under the Act. The funding of the CFPB is more flexible. The
director of
the CFPB determines the amount reasonably necessary to carry out the
authorities of the Bureau, up to a funding cap based on a percentage
of the
total operating expenses of the Fed: The Act, § 1017, 124 Stat 1376,
1975.
[217] See Skeel, above n
33. Skeel suggests the objectives of the Act are right on target. However, he is
concerned by (1) the government
partnership with the largest financial
institutions and (2) ad hoc intervention by regulators rather than more
predictable, rules-based
response to
crises.
[218] Levitin, above n
153, 161. Levitin cites Sunlight Foundation, Industry Sector Campaign
Contributions, 1990-2008 (5 April 2010)
<http://media.sunlightfoundation.com/viz/sector_contributions.html>
.
[219]
Kevin Conner, The Big Bank Takeover: How Too Big to Fail’s Army of
Lobbyists Has Captured Washington, (11 May 2010) Institute for
American’s Future
<http://www.ourfuture.org/report/2010051911/big-bank-takeover>
.
[220]
Paul Kile, Bailed Companies Spend Millions to Lobby Congress, (22 July
2009) Propublica http://www.propublica.org/article/bailed-out-companies-spend-millions-to-lobby-congress
Senate disclosure forms indicate that as the rule making processes are
negotiated, the lobbying spend and efforts are continuing
in the Congress and at
the regulatory agencies.
[221]
Damian Paletta, ‘Ronald Reagan’s Fed Chief Takes Aim at
America’s Battered Financial System’ The Australian (with
the Wall Street Journal) (online), 24 September 2010
<http://www.theaustralian.com.au/business/news/reagans-fed-chief-takes-aim-americas-battered-financial-system/story-e6frg90x-1225928703094>
.
In practice, it is difficult for regulators to raise the alarm about potentially
adverse developments when markets and economies
are performing well.
Individuals, particularly those with positions and reputations to protect, do
not want to be seen to have acted
to stop the money rolling in or to be shown in
hindsight to have made the wrong call. As Jane Diplock, Chair of the
International
Organization of Securities Commissions expresses it, ‘[w]hen
everybody appears to be making money, and there’s exuberance
in the
markets, it’s extremely difficult to be the Jeremiah saying: “Look,
that’s a cliff you’re about to
run over”. Nobody wants to hear
that message, least of all politicians whose funds are perhaps being swollen by
the very people
making all this money’: Australian Securities and
Investments Commission: ‘Securities and Investment Regulation: Beyond
the
Crisis’ (1–3 March 2010, Melbourne, Australia) available
at
<http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/SS10-
Summer%20School%202010%20Report-web.pdf/$file/SS10-Summer%20School%202010%20Reportweb.
pdf>.
[222] See Richard Posner,
‘Financial Regulatory Reform: The Politics of Denial’ (2009) 6(11)
The Economists’ Voice Article 1, 2. Posner argues that the two main
causes of the financial crisis were incompetent monetary policy and ‘the
regulators
of financial intermediaries were asleep at the switch’. He
suggests these problems are not cured by the legislative reforms.
Posner
explains the lack of discussion about regulatory failure as the presence of the
politics of denial because the government’s
senior economic officials were
implicated in the failures.
[223] Paletta, above n 221.
[224] Federal Trade
Commission Act Amendments of 1994, 15 USC § 45(n) (1994). The
1994 Amendment provided that: The Commission shall have no authority under this
section or section
to declare unlawful an act or practice on the grounds that
such act or practice is unfair unless the act or practice causes or is
likely to
cause substantial injury to consumers which is not reasonably avoidable by
consumers themselves and not outweighed by countervailing
benefits to consumers
or to competition. In determining whether an act or practice is unfair, the
Commission may consider established
public policies as evidence to be considered
with all other evidence. Such public policy consideration may not service as a
primary
basis for such
determination.
[225] In 2001
the Federal Reserve acknowledged increased reports of home purchase loans and
re-financings which generally included one
or more of the following:
1. making unaffordable loans based on the borrower’s home equity without regard to the borrower’s ability to repay the obligation;
2. inducing a borrower to refinance a loan repeatedly, even though the refinancings may not be in the borrower’s interest, and charging high points and feeds each time the loan is refinanced, which decreases the consumer’s equity in the house; and
3. engaging in fraud or deception to conceal the true nature of the loan
obligation from an unsuspecting or unsophisticated borrower
– for example,
‘packing’ loans with credit insurance without a consumer’s
consent: Truth in Lending, 66 Fed Reg 65604 (20 December 2001).
The
Fed also acknowledged evidence of targeting of vulnerable groups. The Board
noted: The reports of actual cases [about predatory
lending] are ... widespread
enough to indicate that the problem warrants addressing. Homeowners in certain
communities – frequently
the elderly, minorities and women –
continue to be targeted with offers of high-cost, home-secured credit with
onerous loan
terms. The loans, which are typically offered by nondepository
institutions, carry high up-front fees and may be based solely on
the equity in
the consumers’ homes without regard to their ability to make the scheduled
payments. When homeowners have trouble
repaying the debt, they are often
pressured into refinancings their loans into new unaffordable, high-fee loans
that rarely provide
economic benefits to the consumers. These refinancing may
occur frequently. The loan balances increase primarily due to fees that
are
financed resulting in reductions in the consumers’ equity in their homes
and, in some cases, foreclosures may occur. The
loan transaction may also
involve fraud and other deceptive practices.
[226] Dilorenzo, above n 159,
79.
[227] Edmund Andrews,
‘Fed and Regulators Shrugged As the Subprime Crisis Worsened’,
New York Times (New York) 18 December 2007,
A1.
[228] Chairman Ben
Bernanke, ‘The Subprime Mortgage Market’ (Speech delivered at the
Federal Reserve Bank of Chicago’s
43rd Annual Conference on
Bank Structure and Competition, Chicago, 17 May 2007).
[229] Truth in Lending,
73 Fed Reg 44522 (30 July
2008).
[230] See Posner, above
n 222, 4. Posner concludes that the Federal Reserve and the other
regulators had the power to avoid the monetary excesses that accelerated
the
housing boom and to stop questionable lending and trading decisions by financial
institutions. See also Commission Report, above
n 9, 187. The Commission Report
Chapter 9 conclusion states that the Federal Reserve failed to recognize the
cataclysmic danger posed
by the housing bubble to the financial system and
refused to take timely action to constrain its growth, believing that it could
contain the damage from the bubble’s collapse.
[231] Damian Paletta,
above n 221. Volker praises the financial reforms, but says the system remains
at risk because it is subject to future
‘judgments’ of individual
regulators who will be relentlessly lobbied by banks and politicians to soften
the rules.
[232] Ian Katz and
Rebecca Christie, ‘Volcker Rule Should be Robust, Financial Oversight
Panel Says’ Bloomberg (online), 19 January 2011
<http://www.bloomberg.com/news/2011-01-18/volcker-rule-s-implementation-should-be-robust-oversight-council-says.html>
.
[233]
Richard Posner, above n 222, 4.
[234] See also Amanda White,
Dodd-Frank Act Will Stand or Fall on Right People (15 September 2010)
top1000funds.com
<http://www.top1000funds.com/news/2010/09/15/dodd-frank-act-will-stand-or-fall-on-right-people/>
.
[235]
See Gill North and Ross Buckley, ‘A Fundamental Re-examination of
Efficiency in Capital Markets in Light of the Global Financial
Crisis’
[2010] UNSWLawJl 30; (2010) 33 University of New South Wales Law Journal 714.
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