The Dodd-Frank Act: a cheat sheet - Morrison & Foerster
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The Dodd-Frank Act:
a cheat sheet
Morrison & Foerster Morrison 1 FoersterTHE DODD-FRANK
WALL STREET REFORM
AND CONSUMER
PROTECTION ACT,
OR DODD-FRANK
ACT, REPRESENTS
THE MOST
COMPREHENSIVE
FINANCIAL
REGULATORY REFORM
MEASURES TAKEN
SINCE THE GREAT
DEPRESSION.
Morrison 2 FoersterThe Dodd-Frank Act implements changes that, among other things, affect the oversight and supervision of financial institutions, provide for a new resolution procedure for large financial companies, create a new agency responsible for implementing and enforcing compliance with consumer financial laws, introduce more stringent regulatory capital requirements, effect significant changes in the regulation of over the counter derivatives, reform the regulation of credit rating agencies, implement changes to corporate governance and executive compensation practices, incorporate the Volcker Rule, require registration of advisers to certain private funds, and effect significant changes in the securitization market. Although the legislation calls for a number of studies to be conducted and requires significant rule-making, we all will be required to be intimately acquainted with the Dodd-Frank Act. In the pages that follow, we summarize the principal aspects of the Dodd-Frank Act. As lawyers, we would reflexively say that this is a summary, and only a very brief summary at that, and that all of this is qualified in its entirety by reference to our more complete (and far longer) descriptions and analyses….As people who receive lots of summaries, we would say short is usually better. We hope you’ll find these short summaries useful.
Numerous government agencies are
Financial Stability Reform responsible for regulating financial institutions.
Commentators have noted that without a
governing body to oversee the various agencies,
we remain vulnerable to regulatory gaps and
oversight failures. The Dodd-Frank Act creates
the Financial Stability Oversight Council
(“Council”) to oversee financial institutions.
Creation of the Council Duties of the Council
− Chaired by Secretary of Treasury − Collect information necessary to assess
− Voting members consist of heads of risks to the U.S. financial system
the Treasury, Federal Reserve, OCC, − Provide direction to the Office of
SEC, CFTC, FDIC, FHFA, NCUA, and Financial Research to support the work
the Bureau of Consumer Financial of the Council
Protection (“Bureau”), as well as an − Monitor the financial services market
independent member with insurance place and identify potential threats
expertise appointed by the President and to U.S. financial stability, as well as
confirmed by the Senate regulatory proposals affecting integrity,
− Non-voting members include the efficiency, competitiveness, and stability
director of the Office of Financial of the U.S. financial markets
Research, the director of the Federal − Facilitate information sharing and
Insurance Office, a state insurance coordination among member agencies
commissioner, a state banking and other federal and state agencies
supervisor, and a state securities
commissioner − Recommend to the member agencies
general supervisory priorities and
Purpose of the Council principles reflecting the outcome of
− Identifying risks to U.S. financial discussions among the member agencies
stability that may arise from ongoing − Identify gaps in regulation that could
activities of large, interconnected pose risks to the financial stability of the
financial companies as well as U.S.
from outside the financial services − Require Federal Reserve supervision
marketplace for nonbank financial companies that
− Promoting market discipline by may pose risks to U.S. financial stability
eliminating expectations of government in the event of their material financial
bailouts distress or failure
− Responding to emerging threats to − Review and submit comments to the
financial stability SEC and any standard-setting body
Morrison 4 Foersterwith respect to an existing or proposed to standards established by the Federal
accounting principle, standard, or Reserve
procedure
Other
− Provide a forum for discussion
and analysis of emerging market − Creates the Office of Financial Research,
developments and financial regulatory which will support the Council through
issues, and to resolve jurisdictional data collection and research
disputes among members of the Council − Financial companies and nonbank
− Provide an annual report and testimony financial companies can appeal Council
before Congress regarding financial requirement to implement stricter
stability standards
− Recommend heightened prudential − Council must conduct a study on
standards for nonbank financial feasibility, benefits, costs, and structure
companies and large, interconnected of a contingent capital requirement for
bank holding companies supervised by nonbank financial companies
the Federal Reserve − Council must make recommendations
− Recommend to primary financial to the Federal Reserve and other federal
regulatory agencies new or heightened regulators regarding concentration
standards and safeguards for activities limits, public disclosures, credit
that increase risks of significant liquidity, exposure, maintenance of long-term
credit, or other problems spreading hybrid debt convertible to equity and
among bank holding companies, general financial information reports
nonbank financial companies, and U.S. − If the applicable agency chooses not
financial markets to implement any recommendation
− Identify systemically important financial provided by the Council, it must provide
market utilities and payment, clearing, a report explaining its rationale
and settlement activities, and require
such utilities and activities to be subject
Morrison 5 FoersterAgencies and Agency Oversight Reform The various government agencies regulating
the financial industry with their varying rules
and standards led to certain entities not being
regulated at all, with others subject to less
oversight than their peer financial firms organized
under different charters. The Dodd-Frank Act
overhauls the existing agency oversight system as
described below.
Major Agency Changes holding companies; Federal Reserve will
− Creation of the Financial Stability continue to regulate State member banks
Oversight Council (Council) − The OCC will regulate national banks
− Creation of the Office of Financial and federal thrifts of all sizes, and will
Research within the Treasury to support have all rulemaking authority relating to
the Council thrifts
− Creation of an independent Bureau of − The FDIC will regulate state thrifts of all
Consumer Financial Protection (Bureau) sizes
within Federal Reserve − The OTS will be eliminated, all OTS
− Creation of the Office of National functions, powers, authorities, rights and
Insurance within the Treasury duties will be transferred to the Federal
Reserve, the OCC, or the FDIC
− Creation of the Office of Credit Rating
Agencies within the SEC − The SEC will require registration of
hedge funds that manage over $100
Major Changes in Agency Oversight million as investment advisers; threshold
− Federal Reserve will regulate thrift for investment advisers subject to federal
holding companies and subsidiaries of regulation to be raised from $25 million
thrift holding companies, and will have to $100 million
all rulemaking authority relating to thrift
Morrison 6 Foerster− The SEC will require registration of required to periodically submit “living
municipal financial advisers, swap wills” to regulators in the event of
advisers and investment brokers; financial distress
Municipal Securities Rulemaking Board − Federal Reserve will be subject to a one-
rules to be enforced by the SEC time GAO audit of the Federal Reserve’s
Other lending facilities
− Regulators will be required to implement
regulations that prohibit banks,
bank holding companies and certain
nonbank financial institutions from
proprietary trading and investments and
sponsorships of hedge funds and private
equity funds
− Federal Reserve will have rule-
making authority (and will act upon
recommendations of the Council)
with respect to rules prohibiting
proprietary trading and investments and
sponsorships of hedge funds and private
equity funds
− Large complex companies will be
Morrison 7 FoersterThe final shape of securitization reform is
Securitization Reform beginning to gel. In addition to the changes
effected by the Dodd-Frank Act, the SEC recently
released a 667-page proposed rule amending
Regulation AB’s registration, disclosure, and
reporting requirements for asset-backed securities
and other structured finance products. And
the FDIC released a proposed rule amending
its “securitization rule” safe harbor to require
financial institutions to retain more of the credit
risk from securitizations and reflect recent
accounting changes. This was preceded by the
FASB’s revisions to accounting rules relating
to sales of financial assets and consolidation of
certain off-balance sheet entities, revisions to bank
capital rules to reflect FASB’s accounting changes
and the enactment of the Hiring Incentives to
Restore Employment Act, which imposes a 30%
withholding tax on foreign financial institutions,
including certain offshore securitization vehicles.
Morrison 8 FoersterThe major elements of securitization reform are:
Credit Risk Retention loan brokers or originators, the nature
− 5% to be retained by the securitizer; and extent of the compensation of
however, if originator retains some the broker or originator of the assets
amount of risk, only the remaining risk backing the security, and the amount
(up to 5% total) will be allocated to of risk retention of the originator or
securitizer securitizer of such assets
− Risk retention also to apply to CDOs, − Fulfilled and unfulfilled repurchase
securities collateralized by CDOs and requests across all trusts will be
similar instruments aggregated by the originator, so investors
may identify originators with clear
− Risk retention types, forms and underwriting deficiencies
amounts for commercial mortgages to
be determined by regulators, including − Due diligence analysis must be
permitting a third party that purchases performed by securitizer and provided to
a first-loss position at issuance and investors
who holds adequate financial resources Representations and Warranties
to back losses substituting for the risk
retention requirement of the securitizer − Credit rating agencies must explain, in
reports accompanying credit ratings,
− Percentage retained can be lowered representations, warranties, and
based on underwriting standards used enforcement mechanisms available
− An exemption for qualified residential to investors and how they differ
mortgages from representations, warranties and
− Other exemptions will be available at enforcement mechanisms in similar
regulators’ discretion issuances
− No hedging or transfer of risk Other
− Creation of different asset classes, which − Regulations relating to credit risk
may be subject to different regulations retention requirements will become
effective one year from enactment
Required Disclosures for residential mortgage assets, and
− Asset-level or data-level detail, including will become effective two years from
data with unique identifiers relating to enactment for all other asset classes
Morrison 9 FoersterDerivatives Regulation Title VII of the Dodd-Frank Act, to be known as
the Wall Street Transparency and Accountability
Act of 2010, will impose a comprehensive and
far-reaching regulatory regime on derivatives
and market participants. Major elements of Title
VII are summarized below.1 However, many
sections of Title VII require various studies to be
undertaken and mandate or permit significant
rulemaking by the Commodity Futures Trading
Commission (“CFTC”), the Securities and
Exchange Commission (“SEC”), and various
Federal banking regulators. As a result, a full
assessment of the impact of Title VII will only be
possible once that rulemaking advances.
1
Unless otherwise specified, for convenience we refer to swaps and security-based swaps as “swaps,” swap dealers and security-based swap dealers as “swap
dealers,” and major swap participants and major security-based swap participants as “major swap participants” or “MSPs.” We also use the term “applicable
regulator” to refer to the CFTC, in the case of swaps, and the SEC, in the case of security-based swaps. For a description of the Act’s prohibition on proprietary
trading, please see our separate summary of the Volcker Rule.
Morrison 10 FoersterLincoln Provision (the “Swaps Pushout” be physically settled, futures contracts,
Rule) listed FX options, debt securities,
− No “Federal assistance” (e.g., advances securities options and forwards that
from any Federal Reserve credit facility are subject to the Securities Act of
or discount window that is not part of a 1933 (“33 Act”) and the Securities
broad-based eligibility program, FDIC Exchange Act of 1934 (“34 Act”), and
insurance, or guarantees) may be provided security-based swaps. FX swaps and
to any “swaps entity” (i.e., swap dealers FX forwards qualify as swaps, unless
and non-bank major swap participants, or the Secretary of the Treasury determines
MSPs). otherwise; however, notwithstanding any
such determination, all FX swaps and
− The prohibition does not apply to insured FX forwards must be reported to a swap
depository institutions that limit their data repository or, in the absence of one,
swap activities to (i) hedging and other to the applicable regulator, and swap
similar risk mitigating activities directly dealer and MSP counterparties to FX
related to their activities and (ii) engaging swaps and FX forwards must conform to
in swaps involving rates or reference business conduct standards applicable to
assets that are permissible for investment swap dealers and MSPs.
by national banks. For purposes of the
exception in clause (ii), CDS is permissible • Security-based Swap. A “security-
only if cleared. based swap” is a swap on a single
security or loan or a narrow-based
− The prohibition only applies to swaps security index (generally, an index with
entered into after the end of the transition 9 or fewer component securities). The
period, which could be up to five years definition also includes credit default
after enactment. swaps relating to a single issuer or the
Regulatory Framework and Key issuers in a narrow-based security index.
Definitions − The Act creates two new categories of
− The Act creates parallel regulatory regimes significant market participants: swap
for the CFTC and SEC and divides dealers and major swap participants.
jurisdiction between the two regulators • Swap Dealer. A “swap dealer” is
based on whether a “swap” or a “security- any person who holds itself out as a
based swap” is involved. The CFTC will dealer in swaps, makes a market in
have jurisdiction over “swaps” and certain swaps, regularly enters into swaps with
swap market participants, and the SEC counterparties as an ordinary course of
will have jurisdiction over “security-based business for its own account, or engages
swaps” and certain security-based swap in any activity causing the person to
market participants. Banking regulators be commonly known in the trade as a
will retain jurisdiction over certain dealer or market maker in swaps. The
aspects of banks’ derivatives activities term excludes persons that enter into
(e.g., capital and margin requirements, swaps for their own account, either
prudential requirements). individually or in a fiduciary capacity,
• Swap. This term is broadly defined but not as a part of a regular business. It
to include many types of derivatives also does not include insured depository
across various asset classes, but excludes, institutions that offer to enter into swaps
among other things, nonfinancial or with their customers in connection with
security forwards that are intended to originating loans with those customers.
Morrison 11 FoersterThe Act requires the CFTC and SEC to category, type, or class of swaps.
Derivatives Regulation (continued) prescribe a de minimis exception to being
designated as a swap dealer.
• Mandatory clearing requirement will
not apply to existing swaps if they are
• Major Swap Participant. A “major reported to a swap data repository or,
swap participant” (“MSP”) is any person if none, to the applicable regulator in a
who is not a swap dealer and: timely manner.
• Maintains a “substantial position” − Commercial End User Exception.
(to be defined by the applicable The Act provides an exception to the
regulators) in swaps for any major mandatory clearing requirement if one of
swap category, excluding positions the counterparties to the swap (i) is not
held for hedging or mitigating a financial entity, (ii) is using swaps to
commercial risk and positions hedge or mitigate commercial risk, and
maintained by any employee benefit (iii) notifies the applicable regulator how
plan for the primary purpose of it generally meets its financial obligations
hedging or mitigating any risk associated with entering into non-cleared
directly associated with the operation swaps. Application of the exception is at
of the plan; the sole discretion of the commercial end
• Whose outstanding swaps create user.
substantial counterparty exposure • The term “financial entity” includes
that could have serious adverse effects swap dealers, MSPs, commodity
on the financial stability of the U.S. pools, private funds (as defined in the
banking system or financial markets; Investment Advisers Act of 1940),
or employee benefit plans, and persons
• Is a financial entity that is highly predominantly engaged in activities
leveraged relative to the amount of that are in the business of banking
capital that it holds, is not subject or in activities that are financial in
to any Federal banking agency’s nature, but excludes certain captive
capital requirements, and maintains a finance affiliates. The Act directs
“substantial position” in outstanding the applicable regulators to consider
swaps in any major swap category. whether to exempt small banks,
savings associations, farm credit system
• Certain captive finance affiliates of institutions, and credit unions.
manufacturers that use swaps to hedge
commercial risks relating to interest rate − Mandatory Trade Execution. To the
and FX exposures are excluded from the extent that a swap must be cleared, it
definition of major swap participant. must be executed on an exchange or swap
execution facility, unless no exchange or
Clearing and Trading Requirements swap execution makes the swap available
− Mandatory Clearing. A swap must for trading.
be cleared if the applicable regulator − Non-ECPs. Persons who are not eligible
determines that it is required to be cleared contract participants (“ECPs”) must
and a clearing organization accepts the always enter into swaps via an exchange.
swap for clearing. • For swaps, the illegality applies to the
• The determination process may be non-ECP.
initiated by the applicable regulator or • For security-based swaps, the illegality
by a clearing organization, and may applies to any person effecting the
relate to any single swap or any group, transaction with or for the non-ECP.
Morrison 12 FoersterRegulation of Swap Dealers and Major − Business Conduct Standards. Swap
Swap Participants dealers and MSPs must conform with
− Registration. Swap dealers and MSPs business conduct standards, including:
must register as such and will be subject • Disclosure to non-swap dealer and
to a regulatory regime that will be defined, non-MSP counterparties of the
to a very large extent, by rulemaking. material risks and characteristics of
Registration is required with an applicable the swaps and any material incentives
regulator regardless of whether the entity or conflicts of interest that the swap
is registered with the other applicable dealer or MSP may have in connection
regulator or is a depository institution. with the swaps; and
− Capital and Margin. The applicable • Additional responsibilities with respect
regulators (for non-banks) and the to “special entities” (i.e., States,
Federal banking regulators (for banks) municipalities, State and Federal
will set minimum capital requirements agencies, pension plans, governmental
and initial and variation margin plans, and endowments):
requirements for swap dealers and MSPs. • A swap dealer that acts as an
• To offset the “greater risk” of non- advisor to a special entity has a
cleared swaps, the capital and margin duty to act “in the best interests of”
requirements must help ensure the the special entity; and
safety and soundness of the swap
• A swap dealer or an MSP that
dealers and MSPs and be appropriate
offers or enters into a swap with
for the risk associated with the non-
a special entity must comply
cleared swaps held by those entities.
“with any duty” established by
• The Act permits the use of noncash the applicable regulator that
collateral and, for non-cleared swaps, requires the swap dealer or MSP
requires swap dealers and MSPs “to have a reasonable basis to
to hold their counterparties’ initial believe” that the special entity is
margin, upon request, in a segregated advised by a qualified independent
account at an independent third party representative.
custodian.
Miscellaneous
• The Act does not provide an
exemption to the margin requirements − The Act increases eligibility requirements
for commercial end users, although for ECPs
Senators Dodd and Lincoln stated in − The applicable regulators are authorized to
a June 30, 2010 letter to Chairmen establish aggregate position limits and large
Frank and Peterson their view that the trader reporting requirements for swaps.
Act does not authorize the regulators − Swaps shall not be considered to be
to impose margin requirements on insurance and may not be regulated as
commercial end users. Note, however, insurance contracts under State law.
that imposing margin requirements − The SEC is authorized to expand the
on swap dealers and MSPs for non- beneficial ownership rules in sections 13 and
cleared swaps could, in effect, be 16 of the 34 Act to security-based swaps.
passed on to end users through swap − Offers and sales of security-based swaps to
pricing and/or margin requirements non-ECPs must be registered, notwithstanding
imposed by swap dealers and MSPs. sections 3 and 4 of the 33 Act.
Morrison 13 FoersterInvestor Protection Reform The financial crisis took many investors by
surprise. It became clear that investors in certain
financial products, such as auction rate securities,
did not understand how the secondary market
for such securities functioned. Ponzi schemes
were exposed at a rapid pace and clients lost faith
in those with custody of their securities and/or
funds. On December 30, 2009, the SEC adopted
amended Rule 206(4) under the Investment
Advisers Act to address certain custody issues.
Congress also aims to increase investor protection
as a means of bolstering investor confidence and
bringing investors back to the capital markets.
Morrison 14 FoersterLiability and Disclosures Point-of-Sale Disclosures
− Empowers the SEC to promulgate a − SEC may issue rules regarding required
fiduciary standard for broker-dealers that point-of-sale disclosures
provide personalized investment services
Short Sales
− Mandates a study by the SEC on imposing
a uniform fiduciary duty on financial − Requires a study on short selling
intermediaries who provide similar advisory SEC Powers
services
− SEC may share information with federal,
− Mandates a study on whether there are foreign and state regulators and law
legal or regulatory gaps in standards in the enforcement without waiving privilege
protection of retail customers relating to
− SEC will be self-funded
the standards of care for various financial
intermediaries − SEC may engage in consumer testing
− Prohibits or limits use of mandatory − Oversight of private funds managed by
arbitration investment advisers
− SEC may require disclosures if a broker- Other
dealer sells only proprietary products
− Awards to whistleblowers
Custody and Client Requests − Creation of SEC Investor Advisory
− SEC will review rule changes of self- Committee to consult on initiatives to
regulatory organizations that affect custody promote investor confidence
of customer securities or funds − Changes the accredited investor standard by
− Independent verification of client assets held excluding, in the calculation of net worth,
in custody of adviser the value of an investor’s primary residence
− Requires a study on appropriate criteria for
Conflicts of Interest
determining accredited investor status and
− SEC shall facilitate the provision of simple eligibility to invest in private funds
and clear investor disclosures regarding the
− Requires a study of the feasibility of a self-
terms of relationships with broker-dealers
regulatory organization to oversee private
and investment advisers and disclosures of
funds
conflicts of interest
− Provides for special protection for senior
− Requires a study on conflicts of interest
investors
involving analysts
Morrison 15 FoersterCredit Rating Agency Reform The Credit Rating Agency Reform Act passed
in 2006 requires credit rating agencies (CRAs)
to register with the SEC and submit reports.
Recently proposed amendments to SEC rules
attempt to address concerns raised regarding
CRAs following the financial crisis, and
the Dodd-Frank Act goes even further.
Liability Prohibited Activities
− Eliminates the exemption provided by − SEC to promulgate rules separating
Rule 436(g) under the 33 Act from the rating activities from sales and marketing
consent filing requirement for registration activities
statements and potentially subjects CRAs − SEC may impose fines, including fines for
to liability under Section 11 of the 33 Act failure to supervise
− Duty to report violations of law to − Each CRA must establish, maintain,
appropriate authorities enforce, and document an effective
− Enforcement and penalty provisions of the internal control structure
34 Act apply to CRA statements to same − CRAs must submit an annual report to the
extent as to registered public accounting SEC, including a CRA internal controls
firms or securities analysts report along with a CEO attestation
− Modification to “state of mind”
requirement for private securities fraud Governance
actions against CRAs for money damages − At least half of the CRA board of directors
must comprised of independent directors
Required Disclosures (no fewer than 2), with a portion of the
− Qualitative and quantitative directors to include users of ratings
methodologies and assumptions used − Independence is based on the presence no
− Historical rating performance data consulting, advisory or compensatory fee
required over multiple years, including for or status as an associated person of the
ratings that were withdrawn CRA, and on not being disqualified from
− SEC to issue rules requiring CRAs to any deliberation involving a particular
disclose information on initial ratings and rating
subsequent changes; disclosures to be − Independent directors to serve for a fixed,
comparable across CRAs non-renewable term not to exceed 5 years,
− SEC must require each CRA to with compensation not linked to the
accompany publication of each rating business performance of the CRA
with a prescribed form that details, − The board of directors has specifically
among other things, ratings methodologies mandated oversight responsibilities
Morrison 16 Foersterwith respect to policies and procedures for − SEC will conduct annual exam of each
determining ratings, conflicts of interest, CRA; SEC to report on CRA exams
internal controls and hiring and promotion
Other
Conflict of Interest − Due diligence reports prepared by third
− Compliance officers cannot participate in parties for asset-backed securities must
determining ratings or methodologies, or in be disclosed and certified
sales activities or setting of compensation − SEC will issue rules regarding requisite
levels for certain employees training, experience and competence for
− Compliance office compensation must not be CRA analysts
linked to financial performance of a CRA and − SEC will issue rules regarding ratings
must be arranged to ensure independence of procedures and methodologies
the compliance officer
− SEC rules will require that CRAs
− Compliance report required to be filed establish, maintain and enforce policies
annually with the SEC and procedures that define and disclose
− A one-year look-back requirement is imposed the meaning of any ratings symbol
on any involvement of specified persons in the − Statutory references to ratings are
ratings process, as well as required reporting removed from federal statutes, and
of employment transitions for specified CRA federal agencies will review reliance on
personnel references to ratings
− Procedures required for the receipt, retention − SEC will conduct a study regarding
and treatment of complaints independence of CRAs
− SEC to promulgate additional regulations to − Additional studies will be required to be
prevent sales and marketing from influencing conducted, including studies regarding
ratings; SEC may suspend or revoke a CRA’s alternative business models, the creation
registration for violations of an independent professional analyst
Oversight organization, and the ratings process for
structured finance products
− Establishes SEC Office of Credit Ratings;
director of Office reports to SEC
Chairman
− Establishes fines, penalties for CRAs;
administers SEC rules applicable to
CRAs
Morrison 17 FoersterThe Volcker Rule Provisions The Volcker Rule provisions, named for former
Federal Reserve Chairman Paul Volcker, are
premised on the belief that speculative trading
activities contributed in part to the financial crisis.
The original House bill did not contain Volcker
Rule provisions, although it did contain certain
limitations on permitted activities (for example,
the House bill permitted a ban on proprietary
trading that poses systemic risk). In January
2010, the Obama Administration endorsed
the Volcker Rule. The Senate bill imposed a
prohibition on most proprietary trading by U.S.
banks and their affiliates, subject to limited
exceptions, and restricted covered institutions
from owning, sponsoring or investing in hedge
funds or private equity funds.
Discussions relating to the Volcker Rule were
among the most heated.
Morrison 18 FoersterThe following summarizes the key Volcker Rule provisions
contained in the Dodd-Frank Act (Title VI):
Prohibition on Proprietary Trading and affiliates or subsidiaries of the
There are important distinctions made foregoing.
between the activities that may be “Nonbank financial companies” are certain
conducted by banking entities and those U.S. or foreign companies that, though not
that may be conducted by nonbank BHCs or insured depository institutions,
financial companies supervised by the predominately engage in financial activities
Federal Reserve. (as defined in the Bank Holding Company
− Except for certain permitted activities, Act) and which will become subject to the
a “banking entity” cannot (1) engage supervision of the Federal Reserve based on
in proprietary trading, or (2) acquire or a determination by the Council.
retain any equity, partnership or other De Minimis Investment
ownership interest in or sponsor a hedge
fund or private equity fund (collectively A banking entity may make and retain an
“fund activities”). investment in a fund that the banking entity
organizes and offers; provided, that, it seeks
− A “nonbank financial company” that unaffiliated investors for the fund; within
engages in proprietary trading or fund one year of a fund’s start date, the banking
activities will be subject to additional entity’s investments shall not exceed more
capital requirements and quantitative than 3% of the total ownership interests in
limits, to be established by rule. However, such fund; and the aggregate of investments
if a nonbank financial company engages in all such funds does not exceed 3% of the
in any permitted activities (i.e., any banking entity’s Tier 1 capital.
of the activities that a banking entity
is permitted to engage in), the capital Permitted Activities
requirements or quantitative limits applied The following activities are “permitted
to the nonbank financial company for activities”:
those activities will be the same as those
− transactions in U.S. government securities
applied to banking entities engaging in
(including securities of the GSEs);
such permitted activities.
− transactions in connection with
Proprietary trading is defined as engaging
underwriting or market-making activities,
as principal for the trading account of
to the extent designed not to “exceed the
the banking entity or nonbank financial
reasonably expected near term demands of
company in any transaction to purchase
clients, customers or counterparties”;
or sell, or otherwise acquire or dispose of,
any security, any derivative, any contract of − risk-mitigating hedging activities in
sale of a commodity for future delivery, any connection with a banking entity’s
option on any such security, derivative, or individual or aggregate positions, contracts
contract, or any other security or financial or holdings that are designed to reduce
instrument that the appropriate federal the banking entity’s specific risks in
agencies may determine. connection with such positions, contracts
or holdings;
“Banking entities” are bank holding
companies (BHCs), non-U.S. entities treated − customer transactions;
as BHCs, insured depository institutions, − SBIC investments;
Morrison 19 Foerster− the purchase or sale of securities and − the acquisition or retention of an
The Volcker Rule Provisions (continued) derivatives by a regulated insurance
company engaged in the insurance
ownership interest or the sponsorship of
a fund by a banking entity solely outside
business, subject to state insurance of the U.S. if interests in the fund are not
regulation and federal safety and offered or sold to a U.S. resident and the
soundness review; banking entity is not directly or indirectly
− organizing and offering a private equity or controlled by a banking entity organized
hedge fund, if the banking entity: in the U.S.; and
• provides bona fide trust, fiduciary, or − all other activities deemed appropriate
investment advisory services; by the applicable oversight agencies that
would promote the safety and soundness
• provides trust or related services
of the banking entity.
and offers interests in the fund only
in connection with providing such No activity may be deemed a permitted
services only to bank customers; activity if it would (1) result in a material
conflict of interest for the banking entity;
• does not acquire or retain an
(2) result in a material exposure for the
equity interest, partnership interest,
banking entity to high-risk assets or high-
or other ownership interest in
risk trading strategies; or (3) pose a threat
the funds except for de minimis
to the safety and soundness of the banking
investments (see above);
entity.
• observes the restrictions on affiliate
transactions; Permitted Services
• does not, directly or indirectly, A banking entity or a nonbank financial
guarantee or assume, or otherwise company may provide prime brokerage
insure, the obligations or services to a sponsored fund if the provision
performance of the fund; of such services complies with other
applicable restrictions of the regulations
• does not share a name or
and the CEO (or equivalent officer) of the
derivation of a name or other
banking entity certifies annually to such
marketing with the fund;
compliance. Prime brokerage transactions
• does not permit any director or will be subject to Section 23B.
employee of the banking entity to
take or retain an equity interest, Capital Requirements
partnership or other ownership Oversight agencies will adopt additional
interest in the fund, except for capital requirements and quantitative limits.
any director or employee who
is directly engaged in providing Restrictions on Affiliate Transactions
investment advisory services to the A banking entity that serves as an
fund; and investment adviser or sponsor to a fund or
• discloses to prospective and actual that organizes and offers interests in a fund
fund investors that losses sustained may not enter into “covered transactions”
by the fund are not borne by the (as defined under Section 23A of the
banking entity; Federal Reserve Act) with the fund and that
banking entity also shall be subject to the
− certain proprietary trading that occurs
restrictions of Section 23B of the Federal
solely outside of the U.S. by a banking
Reserve Act in respect of transactions with
entity that is not directly or indirectly
the fund.
controlled by a banking entity organized
under the laws of the U.S.;
Morrison 20 FoersterRequired Study these purposes, including synthetic asset-
Within six months of enactment, the backed securities) shall not engage in any
Council will conduct a study and make transaction that would involve or result in
recommendations regarding implementation any material conflict of interest with respect
of these measures. Within nine months of to any investor in a transaction arising out
completion of the study, the appropriate of such affiliate. This prohibition will apply
agencies will consider the findings and for a one-year period that begins on the
adopt rules to implement these measures. offering date.
Within 270 days of enactment of the Dodd-
Phase-In Period Frank Act, the SEC shall promulgate rules
Generally, these provisions shall take effect to implement this prohibition.
on the earlier of: 12 months after the date The prohibition shall be subject to
of the issuance of the final rules, or two exceptions for the following:
years after the date of enactment of the
Dodd-Frank Act. • Risk-mitigating hedging activities
in connection with underwriting or
Bank entities and nonbank financial offering the asset-backed security;
companies will have two years after the provided such activities are designed
effective date (or two years after the date to reduce specific risk to the financial
on which the entity becomes subject to intermediary associated with positions
Federal Reserve supervision as a bank arising in connection with the asset-
entity or a nonbank financial company) to backed security offering; and
bring their activities into compliance. This
phase-in period may be extended by the • Purchases or sales of asset-backed
Federal Reserve for one year at a time, with securities made pursuant to and
extensions not to exceed an aggregate of consistent with commitments by the
three years. However, the Federal Reserve financial intermediary to provide
may extend the period in order to permit liquidity for the asset-backed security.
compliance with a contractual obligation
that was in effect on May 1, 2010.
Conflict of Interest Provisions (Merkley
Provisions)
An underwriter, placement agent, initial
purchaser, sponsor (or any affiliate) of
an asset-backed security (as defined
under Section 3 of the 34 Act, but, for
Morrison 21 FoersterCompensation and Corporate Governance Lingering concerns with executive compensation
and corporate governance practices at public
companies (including companies outside of the
financial services industry) culminated in specific
provisions of the Dodd-Frank Act that require
new stock exchange listing standards, mandated
resolutions for public company proxy statements,
and expanded disclosures for all public companies
soliciting proxies or consents. As a result of these
provisions, companies will potentially have to
change the composition and operation of their
compensation committees, adopt new governance
and compensation policies, and prepare for an
advisory vote on executive compensation.
Morrison 22 FoersterSay-On-Pay executives versus the company’s financial
− Companies must include a resolution in performance
their proxy statements asking shareholders − Companies must disclose the median
to approve, in a non-binding vote, the annual total compensation of all
compensation of their named executive employees (except the CEO), the
officers annual total compensation of the CEO,
− A separate resolution will be required to and the ratio of the median employee
determine whether the Say-on-Pay vote total compensation to the CEO total
takes place every one, two, or three years compensation
− To the extent that any “golden − Disclosure is required of whether any
parachute”-related compensation is not employee or director (or designee of such
approved as part of a Say-on-Pay vote, a persons) is permitted to purchase financial
separate non-binding vote will be required instruments designed to hedge their equity
to approve that compensation in the securities
event of a merger or similar extraordinary Clawbacks
transaction
− Stock exchanges must adopt standards
− The proxy statement for a meeting requiring that listed companies develop
involving a “Say-on-Golden Parachute” and implement policies providing for the
vote would need to include “clear and recoupment of compensation in the event
simple” disclosure of the golden parachute of an accounting restatement
arrangements or understandings and the
amounts payable − Enhanced disclosure will be required of
a company’s policy on incentive-based
Compensation Committee and Adviser compensation that is based on financial
Independence information required to be reported under
− Stock exchanges must adopt listing the securities laws
standards providing that the members Other Governance Provisions
of the compensation committee meet
enhanced independence standards − The Act authorizes the SEC to promulgate
comparable (but not identical) to what rules allowing certain shareholders
is required for audit committee members to include director nominees in the
under the Sarbanes-Oxley Act company’s proxy materials, but does not
prescribe specific standards for those rules
− New listing standards will prescribe that
a compensation committee may only − Disclosure is required of the reasons why
select compensation consultants, legal the company has chosen to have one
counsel, or other advisers after taking into person serve as Chairman and CEO, or to
consideration independence standards have different individuals serve in those
established by the SEC roles
− Enhanced disclosure is required regarding − Brokers are not permitted to use
the use of compensation consultants and discretionary authority to vote proxies
any conflicts of interest in connection with election of directors,
executive compensation, or other
Enhanced Compensation Disclosure significant matters as determined by the
− Disclosure is required of the relationship SEC
of the compensation actually paid to
Morrison 23 FoersterCapital Requirements Generally, the Dodd-Frank Act imposes more
stringent regulatory capital requirements on
financial institutions. The Act requires that the
Council make recommendations to the Federal
Reserve regarding the establishment of heightened
prudential standards for risk-based capital,
leverage, liquidity and contingent capital.
Supervised Nonbanks and Bank Holding Collins Amendment Provisions
Companies with Total Consolidated Assets − Require the establishment of minimum
Equal to or Greater than $50 Billion leverage and risk-based capital
− The Federal Reserve must establish requirements
prudential standards for these institutions, • Set the risk-based capital requirements
which include: and the Tier 1 to total assets standard
• Risk-based capital requirements; applicable to insured depository
• Leverage limits; institutions under the prompt
corrective action provisions of the
• Liquidity requirements; Federal Deposit Insurance Act
• Requirements for a resolution plan; • Set these current rates as a floor
and
• Limit regulatory discretion in
• Concentration limits establishing Basel III requirements
− These standards also should include − Raise the specter of additional capital
a contingent capital requirement, requirements for activities that are
requirements for enhanced public determined to be risky, including, but
disclosures, short-term debt limits, a not limited to, derivatives, securitized
risk committee requirement, a stress test products, financial guarantees, securities
requirement, and maximum leverage ratio borrowing and lending and repos
− These institutions will be subject to a − All of these requirements become effective
maximum debt-to-equity ratio of 15-to-1 upon the adoption of implementing
Morrison 24 Foersterregulations, which are required to be Required Studies
passed within 18 months of the Act’s − There are a number of studies
enactment required that impact regulatory capital
Effect on Hybrids requirements
− The application of the prompt corrective • Hybrids: Within 18 months of
action provisions for insured depository enactment, the GAO must conduct
institutions to bank holding companies a study on the use of hybrid
no longer permits the inclusion of trust capital instruments and make
preferred securities or other hybrid recommendations for legislative or
securities in the numerator of Tier 1, regulatory actions regarding hybrids
subject to certain exceptions and phase-in • Contingent capital: within two years
periods as discussed below of enactment, the Council must present
• Mutual holding companies and the results of a study on contingent
thrift and bank holding companies capital that evaluates, among other
with less than $15 billion in total things, the effect on safety and
consolidated assets are not subject to soundness of a contingent capital
this prohibition requirement, the characteristics and
amounts of contingent capital that
• Intermediate U.S. holding companies should be required and the standards
of foreign banks have a five-year for triggering such requirements;
phase-in period following this study, the Council may
• For newly issued securities (those recommend to the Federal Reserve
issued after May 19, 2010), the certain minimum contingent capital
requirement is retroactively effective requirements
• For bank holding companies and
systemically important nonbank
financial companies, hybrids issued
prior to May 19, 2010 will be subject
to a phase in from January 2013 to
January 2016
Morrison 25 FoersterConclusion
In short
There will be much more to come
once the studies mandated by the
Dodd-Frank Act are completed.
There also is every reason to believe
that the rule-making process will
be a long and winding road. We
will provide regular updates on our
dedicated regulatory reform webpage
http://www.mofo.com/resources/regulatory-reform/.
Morrison 26 FoersterMorrison 27 Foerster
Morrison 28 Foerster © 2010 Morrison & Foerster | mofo.com | Attorney Advertising
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