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Dodd-Frank Wall Street Reform and Consumer Protection Act for Financial Institutions

Corporate Services Update James D. Friedman

On July 15, 2010, the United States Senate passed the House-approved Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act"), which was signed by President Obama on July 21, 2010. The Dodd-Frank Act represents a sweeping restructuring of United States financial regulation in response to the financial system's near collapse in late 2008. It consists of 16 distinct sections addressing all areas of financial regulation. Significant elements of the Dodd-Frank Act include:

  • Creation of a new independent watchdog agency intended to serve the interests of consumers of financial products and services.

  • New regulations designed to reduce the risk that taxpayers will be required to bail out large financial institutions.
  • Creation of an overall financial council that will have oversight of the financial system, and is intended to identify and address systemic risks posed by large, complex companies and products.
  • Increased regulation with respect to over-the-counter derivatives, asset-backed securities, hedge funds and mortgage brokers.
  • A requirement that public company shareholders have a nonbinding vote on executive compensation and authorization for the U.S. Securities and Exchange Commission (the "SEC") to adopt rules granting shareholder access to public company proxy statements for shareholder director nominees.
  • New regulations for transparency and accountability of credit rating agencies.
  • Strengthened ability of regulators to pursue financial fraud, conflicts of interest and manipulation of the financial system.

This update is one in a series of updates that will be prepared by the Quarles & Brady LLP Financial Services Task Force to address portions of the Dodd-Frank Act that are of particular interest to our clients. The following is an overview of the implications of the Dodd-Frank Act on financial institutions.

Financial Institutions

The Dodd-Frank Act ushers in a new era of financial regulation, particularly for financial institutions. The Dodd-Frank Act calls for widespread changes, both structurally and substantively, to which financial institutions must adapt. Further, various governmental agencies have been given additional rulemaking authority, which financial institutions will feel the effects of, even though the exact rules have yet to be made. This client update is intended to summarize some of the key elements of the Dodd-Frank Act that will affect financial institutions.

First, the Board of Governors of the Federal Reserve (the "Board") has been granted additional authority over nonbank financial companies and bank holding companies. In particular, the Board may require both types of entities to submit reports regarding their financial conditions and the systems they have in place to monitor and control risk, and the Board may conduct its own examinations of financial condition and risk management systems. To further ensure financial stability, the Board will establish prudential standards and reporting requirements for nonbank financial companies and large, interconnected bank holding companies. These standards will likely be more stringent than those currently in place and will address risk-based capital requirements, leverage limits, liquidity requirements, resolution plans and credit exposure report requirements, and concentration limits. The Dodd-Frank Act also requires bank holding companies to be well capitalized and well managed.

To further reinforce the stability of financial institutions, the Dodd-Frank Act requires nonbank financial institutions and some bank holding companies to establish risk committees and provide the Board with plans for their orderly resolution in the event of material financial distress. In an effort to prevent such resolution from being necessary, the Board will prohibit nonbank financial institutions from having credit exposure to any unaffiliated company that exceeds 25 percent of the capital stock and surplus of the company and will conduct annual stress tests. In addition, the Dodd-Frank Act places restrictions on permissible acquisitions of other large institutions, presumably in an attempt to control concentrated risk, and even goes so far as to allow the Board to order nonbank financial companies and bank holding companies to divest certain assets or operations, or create intermediate holding companies for which the parent company must be a "source of strength." The Dodd-Frank Act also strengthens restrictions on the amount of credit that can be extended to any one person by including in the cap items that previously did not count for such a purpose: derivative transactions, repurchase agreements, reverse repurchase agreements, securities lending transactions, and securities borrowing transactions.

While the Dodd-Frank Act places more stringent requirements on the industry, even financial institution executives will be affected. The Dodd-Frank Act requires regulators to draft rules that direct covered financial institutions to disclose the structure of all incentive-based compensation arrangements. Moreover, the new regulations will be designed to prevent any such compensation arrangements that encourage inappropriate risk-taking. The Dodd-Frank Act's executive compensation provisions do not apply to financial institutions with less than $1 billion in assets.

Furthermore, the Dodd-Frank Act also impacts the Federal Deposit Insurance Corporation (the "FDIC") and its regulation of financial institutions. For instance, the Dodd-Frank Act places a floor on the reserve ratio at 1.35 percent of the estimated insured deposits or the comparable percentage of the assessment base. The Dodd-Frank Act also increased FDIC deposit insurance to $250,000 and made the increase retroactive to apply to any depositors of any institution for which the FDIC was appointed as receiver or conservator between January 1 and October 3, 2008.

In addition to rules and regulations that directly apply to financial institutions, the Dodd-Frank Act also calls for a restructuring of the financial service industry's regulators. In particular, the Dodd-Frank Act abolishes the Office of Thrift Supervision (the "OTS") and splits its duties primarily between the Office of the Comptroller of Currency (the "OCC") and the Federal Reserve. The OCC will absorb those OTS functions related to federal and state savings associations, and it will take over rulemaking authority for savings associations. The Federal Reserve, in turn, will now supervise and have rulemaking authority over savings and loan holding companies. The changes will take place one year after the Dodd-Frank Act's enactment.

Though the Dodd-Frank Act eliminates the OTS, it creates several new agencies, including the Bureau of Consumer Financial Protection (the "BCFP"). The BCFP is part of the Federal Reserve, and its purpose is to "regulate the offering and provision of consumer financial products or services under the Federal consumer financial laws."  In general, the BCFP intends to implement and enforce federal laws so as to ensure that all consumers have access to fair, transparent and competitive markets for consumer financial products and services. To that end, the BCFP has rulemaking authority over consumer financial laws, enforcement power (to be coordinated with the Federal Trade Commission) and exclusive authority to require reports from and monitor insured depository institutions with total assets greater than $10 billion.

The BCFP, which will be run by a director appointed by the president and confirmed by the Senate, will receive its funding from the Federal Reserve, but the Dodd-Frank Act expressly forbids the Federal Reserve from interfering with the BCFP's operations and decisions. The Dodd-Frank Act also calls for the creation of various other agencies under the umbrella of the BCFP. For instance, the Dodd-Frank Act establishes the Office of Fair Lending and Equal Opportunity, which will provide oversight and enforcement to ensure fair, equitable and nondiscriminatory access to credit for individuals and communities, and will coordinate fair lending and fair housing efforts of the BCFP with other federal and state agencies. The Dodd-Frank Act also establishes several offices intended to develop and implement financial education efforts, including the Office of Financial Education, Office of Service Member Affairs, and the Office of Financial Protection for Older Americans. In addition to the BCFP, the Dodd-Frank Act also authorizes grants, cooperative agreements and financial agency agreements to enable low and moderate income individuals to establish the right accounts for their needs and gain meaningful access to the system.

Finally, the Dodd-Frank Act attempts to place restrictions on and accountability into the federal government's emergency lending and guarantee policies. If the Board provides emergency assistance to an entity, it must submit a report to Congress within seven days that justifies the loan and discloses the identity of the other party and the terms of the loan. In addition, the FDIC is charged with creating a widely available program that guarantees the obligations of solvent, insured depository institutions or depository institution holding companies in times of economic distress. The FDIC may borrow funds from the Treasury to guarantee such obligations, but the guarantees can only be utilized if the FDIC or the Board have determined a liquidity event exists that warrants the program's use. To ensure that funds are and have been used appropriately, the Comptroller General will audit all loans and other assistance provided by the Board from December 1, 2007 until the enactment date of the Dodd-Frank Act.

Clearly, the Dodd-Frank Act is going to have a dramatic effect on the landscape of the financial services industry. The size of that impact remains to be seen, though, as in many cases the Dodd-Frank Act simply authorizes agencies to draft regulations. Consequently, financial institutions should be aware of and plan for the above-noted changes, but additional regulations are likely on the horizon.

For more details on the Dodd-Frank Act, or if you have any questions, please contact Jim Friedman at (414) 277-5735 / jim.friedman@quarles.com or your Quarles & Brady LLP attorney.