On December 11, 2009 the U.S. House of Representatives passed, by a 223-202 vote, the Wall Street Reform and Consumer Protection Act (the Act), a comprehensive overhaul of the U.S. financial system intended to remedy the deficiencies which allowed the U.S. economy’s historical failure. The Act would implement many of the changes recommended in President Obama’s recently released white paper entitled “Financial Regulatory Reform: A New Foundation.” Below are some of the most important changes.
Financial Regulation Changes
- Systemic Risk Regulator. The Act will create a new regulator to oversee financial institutions that pose systemic risks to the financial system, the Financial Stability Oversight Council (the Council).
- Higher Standards for Financial Institutions. The Council will impose stricter regulatory standards, including leverage limits, limits on risk concentration, and higher capital requirements on financial institutions that are systemic risks.
- Risk Retention for Lenders. Parties that originate loans will be required to retain at least five percent of any loan that is transferred, sold, or securitized.
- End of “Too Big to Fail.” Financial institutions will no longer receive government assistance out of the fear that they are too big to fail. The Act vests the Federal Deposit Insurance Corporation with the authority to unwind these large failing institutions. The cost of unwinding these institutions will be paid from the financial institution’s assets and a Systemic Dissolution Fund, which large institutions will fund from fees.
Investor Protection
- Fiduciary Duties. All brokers, dealers, and investment advisers will have a fiduciary duty towards investors.
- No Mandatory Arbitration. The Securities and Exchange Commission (SEC) is authorized to prohibit broker-dealers from including mandatory arbitration clauses in standard contracts.
Compensation Changes
- Say on Pay. Shareholders of public companies will receive an annual advisory vote on compensation and golden parachutes.
- Disclosure. Financial institutions with assets exceeding $1 billion will be required to disclose incentive-based compensation structures to financial regulators.
Derivatives Law Changes
- Registration. Swap dealers and major swap participants will have to register with the appropriate regulator. There will be capital requirements for each party to secure its obligations. (A swap is a financial contract with payment tied to a certain financial event, like changes in an index or stock price.)
- Regulation. The SEC and the Commodity Futures Trading Commission (CFTC) will regulate swaps. The SEC will regulate swaps based on securities, like credit-default swaps, and the CFTC will regulate all other swaps, like interest rate and currency swaps.
- Clearing. The Act will require that certain swap transactions be processed through a clearinghouse. Transactions involving a party that is neither a swap dealer nor a major swap participant will not need to be cleared.
Consumer Protection
- Consumer Financial Protection Agency. The Act creates the Consumer Financial Protection Agency (CFPA), which will have the authority to ban practices that it deems predatory or deceptive.
- Jurisdiction. The CFPA will regulate all financial providers, including banks, thrifts, credit unions, and non-bank financial institutions.
Mortgages
- Predatory Practices. The Act will implement higher standards for lenders, including requirements that lenders steer borrowers from higher cost loans and that they only make loans that borrowers can repay.
Capital Market
- Registration. Investment advisers will be required to register with the SEC, if they advise private funds that manage in excess of $150 million in assets. This includes hedge funds and private equity funds. Venture capital companies are exempt from this requirement, but must submit reports to the SEC.
- Ratings Agencies. The Act will require greater transparency for how ratings agencies develop their ratings, impose restrictions to limit their conflicts of interest, and subject them to potential securities liability if a securities rating is included in a registration statement.
Federal Insurance
- Federal Insurance Office. The Act creates the Federal Insurance Office (FIO) to address insurance issues, traditionally a state matter, on the national level. The FIO does not preempt state insurance regulators. It will serve as the country’s international voice for insurance matters and will collect information about insurance holders nationally.
The Senate now has an opportunity to consider the Act or propose an alternative bill on financial reform. There are still many hurdles before the Act or anything similar becomes law. The Obama Administration has placed a priority on implementing health care reform, so health care will likely take precedence over financial reform for the remainder of 2009. But in 2010, there will be a strong push to finalize financial regulation changes. We will continue to update you on the changing financial landscape as the Act, or a similar proposal by Senate, moves through the legislative process.
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