Could the CFPB Change the Rules on Arbitration Clauses?

Of the 87 studies required by the Dodd Frank Act, one may get a bump up the priority list thanks to the recent U.S. Supreme Court decision in CompuCredit v. Greenwood, which upheld the rights of companies to include mandatory arbitration clauses in their user agreements. Several consumer groups disagreed with the court’s ruling and are calling on the new Consumer Financial Protection Bureau (CFPB) to get involved sooner rather than later. Section 1028 of Dodd Frank directs the CFPB to conduct a study and report to Congress on restricting mandatory pre-dispute arbitration, however, Congress set no deadline for completing the study. Once the CFPB does complete the study, the bureau has the authority to “prohibit or impose conditions or limitations” (via regulation) on arbitration agreements. The bureau’s rules must be consistent with the study.

The National Consumer Law Center (NCLC) recently issued a release protesting the court’s decision and pressing the CFPB to get started on the study. “The Supreme Court decision makes it all the more urgent for the Consumer Financial Protection Bureau to stop companies from using forced arbitration clauses to hide from the law,” said the group’s managing attorney Lauren Saunders. Saunders added, “Forced arbitration puts a thumb on the scales of justice in favor of predatory lenders...”

There are also bills in Congress that would amend the Federal Arbitration Act so that pre-dispute arbitration agreements would be invalid and unenforceable if they concern disputes related to employment, consumers, or civil rights. The Arbitration Fairness Act of 2011 (S. 987), sponsored by Sen. Al Franken (D-MN), asserts that mandatory arbitration clauses were “intended to apply to disputes between commercial entities of generally similar sophistication and bargaining power,” not consumers. Rep. Hank Johnson (D-GA) is sponsoring companion legislation (HR 1873) in the House. Both bills are sitting in their respective judiciary committees and not expected to move any time soon in this contentious election year. FRW is watching the CFPB for the next move.


Cordray Controversy Continues

Following President Obama’s January 4th announcement that he would install former Ohio Attorney General Richard Cordray as director of the Consumer Financial Protection Bureau (CFPB) using a recess appointment, a hailstorm of controversy has ensued, as lawyers, legislators and industry question the legitimacy of the move – and look for ways to undermine it.


Following the appointment, the Office of Legal Counsel stated that Congress can only prevent the president from making such appointments “by remaining continuously in session and available to receive and act on nominations,” not by holding pro forma sessions.

Senate Republicans, led by Sen. Chuck Grassley, Ranking Member of the Senate Judiciary Committee, accused the president of ignoring more than 90 years of legal precedent in making the recess appointments while the Senate remained in pro forma session. “The Justice Department and the White House owe it to the American people to provide a clear understanding of the process that transpired and the rationale it used to circumvent the checks and balances promised by the Constitution,” Grassley said. “Overturning 90 years of historical precedent is a major shift in policy that should not be done in a legal opinion made behind closed doors hidden from public scrutiny.” The letter was signed by Senate Judiciary Committee members Grassley, Sen. Orrin Hatch (R-UT), Sen. Jon Kyl (R-AZ), Sen. Jeff Sessions (R-AL), Sen. Lindsey Graham (R-SC), Sen. John Cornyn (R-TX), Sen. Mike Lee (R-UT), and Sen. Tom Coburn (R-OK).

On January 12, the Department of Justice issued a memo arguing that pro forma sessions held every third day in the Senate do not constitute a functioning body that can render advice and consent on the president’s nominees. It said the president acted consistently under the law by making the appointments. “Although the Senate will have held pro forma sessions regularly from January 3 to January 23, in our judgment, those sessions do not interrupt the intrasession recess in a manner that would preclude the president from determining that the Senate remains unavailable throughout to ‘receive communications from the president or participate as a body in making appointments,’” Virginia Seitz, assistant attorney general for the Office of Legal Counsel, wrote in the memo dated Jan. 6.


On the legislative front, there are two issues: the legislation that created Dodd-Frank, and the countless bills that will soon be introduced in response to the president’s recess appointment.

The conventional wisdom in both industry and government circles has been that the CFPB’s authority will be limited until it has a director, and that once it has a director, it will assume its full powers. Not quite. As Dodd-Frank was drafted, Section 1066 reserves many of the bureau’s powers for the Secretary of the Treasury “until the Director of the Bureau is confirmed by the Senate.” As Cordray was appointed through a recess appointment, rather than the Senate confirmation process, he will still have certain constraints on his authority. Specifically, the section transfers consumer financial protection functions of several other federal agencies to the CFPB Director.

In the absence of a Senate-confirmed director, those powers, which include the authority to regulate non-banks, should, according to statute, remain with the Secretary of the Treasury. Despite this, the CFPB has announced that it has launched its non-bank supervision program. Should that supervision become enforcement, it remains to be seen whether enforcement actions could withstand a court challenge.

Where the current legislation has raised questions, two freshman House Republicans are making moves to answer them.

On January 10, Rep. Diane Black (R-TN) introduced a House resolution “Disapproving of the President's appointment of four officers or employees of the United States during a period when no recess of the Congress for a period of more than three days was authorized by concurrent resolution and expressing the sense of the House of Representatives that those appointments were made in violation of the Constitution.” The resolution has 70 Republican co-sponsors.

On January 13, Rep. Jeff Landry (R-LA) introduced the Executive Appointment Reform Act (EARA), which would eliminate loopholes in the U.S. Code that allow for the payment of certain recess appointed individuals and also place limitations on an appointee’s ability to provide voluntary or gratuitous service. Additionally, the legislation would prevent all regulations hailing from the CFPB from becoming final until the director has been confirmed by the Senate. The bill has 22 Republican co-sponsors.


While few expected industry to enter the fray, a few major players have spoken out. 
Citigroup said that it does not view the move as a recess appointment and said it expects a court challenge. The U.S. Chamber of Commerce, a vocal critic of the bureau, has not ruled out a lawsuit, but said Friday, “We are not going to sue today.”

Cordray has said that he is working closely with industry leaders and lobbyists to ensure that their concerns are heard. “What I want to say to business is: They should embrace the bureau,” he said. “Not only are we going to protect consumers, but we are going to support the honest and responsible businesses in the financial marketplace” who were undercut by companies that did not “adhere to the same standards.”

The White House has held firm that the move was constitutional. “The Senate has effectively been in recess for weeks, and is expected to remain in recess for weeks,” White House spokesman Eric Schultz said in a statement. “Gimmicks do not override the president’s constitutional authority to make appointments to keep the government running,” he said.

What to Expect in 2012: Derivatives

In the 17 months since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), implementation has progressed slowly. Financial regulators have finalized 74 of the 243 rules required by the Act and have conducted 39 of the 87 required studies.

The regulatory process is significantly behind schedule. Regulators have proposed an additional 128 rules but have failed to finalize them by their statutory deadlines. The regulators have yet to propose 26 rules that were set to be finalized by the end of 2011. Heading into 2012, regulators will have some catching up to do, though many regulators, namely Securities and Exchange Commission (SEC) Chair Mary Schapiro and Commodity Futures Trading Commission Chair Gary Gensler, have repeatedly emphasized that they are more focused on “getting the rules right” than they are on meeting deadlines. Coupled with House Republicans’ ongoing attempts to stall regulations by cutting funding to regulators, the regulatory process will likely extend far longer than originally intended.

Title VII of Dodd-Frank, which deals with the regulation of the over-the-counter swaps markets, is one area to watch in 2012. Dodd-Frank brings the over-the-counter derivatives market under significant government regulation for the first time. Many types of derivatives will now have to be traded on exchanges and routed through clearinghouses, with regulators examining trades before they are cleared. Derivatives are jointly regulated by the CFTC and the SEC, and both regulators are significantly behind schedule.

Thus far, regulators have missed 71 Title VII rulemaking deadlines. The first quarter of 2012 is set to be the busiest time for regulators, with 25 new regulations due by March 30; 14 of which have yet to be proposed. There are an additional 16 new regulations due in the third quarter of 2012, as well as the 152 rulemakings that remain behind schedule. The upcoming year also calls for an additional 28 studies. The bulk of these studies (11) are to be conducted by the Government Accountability Office (GAO), though the SEC and the bank regulators will likely see a significant burden as well, in addition to their rulemaking responsibilities.

There have been many legislative attempts to stall, scale back, defund or otherwise prevent the implementation of Title VII. Republicans, namely Senate Majority Leader Mitch McConnell (R-KY), have said that “anything we can do to slow down, deter, or impede” the regulators’ agenda would be “good for our country.” While Republicans will likely continue to fight most of the regulations, many in industry view the rules as inevitable and have encouraged regulators to finalize them as soon as possible to give companies sufficient time to prepare for implementation.


Key Dates in 2012:

  • January 17, 2012: The CFTC's interim final rule regarding position limits for futures and swaps required under Title VII for the Dodd-Frank Act is effective.
  • April 16, 2012: Extension for rule that exempted the central counterparties from the requirement to register as clearing agencies under Section 17A of the Exchange Act 6 solely to perform the functions of a clearing agency for certain credit default swap (‘‘CDS’’) transactions. Extension expires at the earlier of a new rule or April 16, 2012.
  • July 16, 2012: Temporary relief from certain provisions of the Commodity Exchange Act (CEA) for some swaps. Expires the earlier of July 16 or the effective date of the final rules amending the CEA.
  • July 21, 2012: Prohibition of federal assistance to swaps Entities; Removal of statutory references to and use of credit ratings; National bank lending limits will be revised to include any credit exposure to a person arising from a derivative transaction, a repurchase agreement, a reverse repurchase agreement, or a securities borrowing or lending transaction as extensions of credit subject to the lending limits.



Despite Dissent, CFTC Moves Forward With Volcker Rule

Yesterday the Commodity Futures Trading Commission (CFTC) unveiled the latest iteration of regulations required under Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, known as the “Volcker Rule.” Named for former Federal Reserve Chairman Paul Volcker, the rule restricts banking entities from engaging in short-term proprietary trading for their own accounts and from sponsorship of hedge or private equity funds.

Under the proposed rule, banks would be required to establish internal compliance programs designed to monitor compliance with Section 619 and the accompanying regulations. Firms will also be required to report “certain quantitative measurements” to regulators to assist them in distinguishing prohibited proprietary trading from permitted activities.

The rule is almost identical to the Joint Volcker Rule proposed by the Federal Reserve, the Office of the Comptroller of the Currency, Treasury, the Federal Deposit Insurance Corporation, and the Securities and Exchange Commission in October 2011. Those rules have come under fire even by Volcker himself, in recent months for their length and complexity. "It's much more complicated than I would like to see," Volcker said in November. 


The CFTC voted for the proposed rules 3-2. The two dissenting Commissioners, Jill Sommers and Scott O’Malia, had harsh words for the Commission, calling the proposed rules “unworkable.” 
"Unfortunately, we are proposing rules that are virtually identical to the other agencies' proposed rules well after they have been widely criticized and after many have called for those agencies to start over, including Paul Volcker," Sommers said. "It seems as if we have put ourselves on a separate track, which I fear will needlessly complicate an already convoluted and likely unworkable set of rules," she added.

O’Malia echoed her concerns saying, "I do not support the commission's version of the Volcker rule. It is an unworkable solution that is entirely too complex and provides the commission with little or no means to enforce or to deter violations of this rule. Obviously we have to comply with the statute and do so in a responsible way, [but] my concern with this fatally flawed rule [is that] this rule does not do that."

One of the more controversial proposals included in Dodd-Frank, the Volcker Rule was first proposed in January 2010, when the financial regulatory overhaul was in its infancy. Sens. Jeff Merkley (D-OR) and Carl Levin (D-MI) introduced the original Volcker Rule as an amendment to the Senate version of Dodd-Frank, but Sen. Richard Shelby (R-AL), blocked the amendment from ever coming to a vote.

Although the language eventually made its way into the bill, Sen. Scott Brown (R-MA) used his position as the swing vote to insist that the proprietary trading ban be changed to allow banks to invest in hedge and private equity funds. The final, watered-down rule allows banks to invest up to three percent of their Tier 1 capital in private equity and hedge funds but bars banks from owning more than a three percent stake in any private equity group or hedge funds. Since then, there have been several legislative attempts to scale back or delay the rules, but none has been successful. 

The proposed rules are open for public comment for the next 60 days. While the rules have yet to be finalized, many large banks are actively divesting their proprietary trading desks to prepare for the July 21, 2012 implementation date. 

Reporting Thresholds under New Form PF for Registered Investment Advisers Managing Hedge Funds, CLOs and CDOs

CDO and CLO Managers are assessing reporting requirements under Form PF, jointly promulgated by the SEC and the CFTC as required under the Dodd-Frank Act.1 One recent issue raised by some managers who are registered investment advisers is whether assets held in CDOs and CLOs must be included for purposes of determining Form PF reporting thresholds for "private funds," "hedge funds" and "private equity funds."

On October 31st, the Commodity Futures Trading Commission (the "CFTC") and the Securities and Exchange Commission (the "SEC") jointly announced final rules relating to new reporting requirements for advisers of certain private funds, commodity pool operators and commodity trading advisors.2 The new rule will require filing of Form PF (for "private fund") by investment advisers registered with the SEC that advise private funds having at least $150 million in assets under management. Most registered investment advisers are expected to make annual filings; however, certain large fund advisers, including those with at least $1.5 billion in assets under management attributable to hedge funds, will be required to file more detailed information on a quarterly basis. These new reporting requirements are primarily intended to provide the Financial Stability Oversight Committee, the SEC and the CFTC with important information about systemic risk in the private fund industry.

The primary threshold for filing Form PF is any investment adviser that (i) is registered or required to register with the SEC, (ii) advises one or more private funds (see seven types of private funds below) and (iii) had at least $150 million in regulatory assets under management attributable to private funds at the end of its most recently completed fiscal year. For purposes of determining assets under management, the key phrase is assets "attributable to private funds." This clause is broad as it encompasses any issuer that would be an investment company but for Section 3(c)(1) or 3(c)(7) of the Investment Company Act. Collateralized debt obligation ("CDO") and collateralized loan obligation ("CLO") issuers typically rely on one of these exemptions from registration under the Investment Company Act; therefore, registered investment advisers who manage investments for CDO or CLO issuers would need to include the assets of those issuers in determining whether they meet the basic filing threshold.

An adviser meeting that initial threshold will be required to complete section 1 of Form PF, including certain basic information regarding the private funds (see seven types below) advised and information about the assets under management, fund performance and use of leverage.

Large private fund advisers will be subject to more extensive quarterly reporting requirements. These reporting requirements will apply to, among others, advisers who have at least $1.5 billion in assets under management attributable to hedge funds. Unlike the initial threshold, with reference to assets attributable to "private funds," the higher reporting obligation will attach based on assets attributable to "hedge funds." The final rules identify seven types of private funds: (i) hedge funds, (ii) liquidity funds, (iii) private equity funds, (iv) real estate funds, (v) securitized asset funds, (vi) venture capital funds and (vii) other private funds. The definition of hedge funds expressly excludes securitized asset funds. The definition of private equity funds includes private funds that are not hedge funds, liquidity funds, real estate funds, securitized asset funds or venture capital funds.

As defined in the final rule, securitized asset funds encompass any private fund "whose primary purpose is to issue asset backed securities and whose investors are primarily debt-holders." CLOs and CDOs would appear to fit within that definition. The adopting release does not provide any greater details of how an adviser should determine whether a private fund is a securitized asset fund. The determination may be significant as the determination that a CDO or CLO is a securitized asset fund (and thereby excluding it as a hedge fund or private equity fund) will exclude the related assets in determining whether the adviser is subject to the increased quarterly reporting obligations.<

In the proposed rule, securitized asset funds would have been defined as any private fund that is not a hedge fund and that issues asset backed securities and whose investors are primarily debt-holders.3 One commenter requested that the SEC clarify that hedge funds do not include securitized asset funds.4 In adopting the final rules, the SEC and the CFTC have expressly excluded securitized asset funds from the definition of hedge funds and private equity funds.

The same commenter suggested that there was a risk that CDOs could be classified as private equity funds under the proposed rule, even though the definition in the proposed rules expressly excluded securitized asset funds. While the SEC declined to adopt the proposed revisions offered by this commenter, it left open the issue of whether CDOs might properly be classified as private equity funds on the basis that CDOs often invest in asset backed securities. As CDOs and CLOs are primarily used to issue asset backed securities (similar to other types of securitizations) and whose investors are primarily debt-holders, the better reading is that CDOs and CLOs are securitized asset funds and should be excluded from hedge funds and private equity funds when determining whether the registered investment adviser is subject to the higher reporting standards of a large private fund adviser.

The deadlines for initial filings of Form PF will vary among advisers. The first annual filings for smaller advisers will be within 120 days of the fiscal years ending on or after December 15, 2012 (or April 30, 2013 for advisers with a December 31st yearend). Larger advisers subject to quarterly reporting may need to file initial reports as early as August 29, 2012. Later filing deadlines may apply to newly registered advisers. Advisers should confirm the applicable deadlines based on their particular circumstances.

1. See Section 406 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376 (2010).

2. Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Investment Advisers Act Release No. IA-3308 (Oct. 31, 2011).

3. See Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, Investment Advisers Release No. IA-3145 (Jan. 26, 2011), 76 FR 8,068 (Feb. 11, 2011).

4. Comment letter of TCW Group, Inc. (Apr. 12, 2011), available at

House Republicans Gear Up for Volcker Rule Fight

After the Federal Deposit Insurance Corporation released its proposed “Volcker Rule,” Republicans on the House Financial Services Committee were quick to announce hearings on the proposed regulations.

It’s a Dodd-Frank paradigm that we have come to know all too well: regulators continue to make slow progress to implement the many rulemakings required under the financial reform law, and with each new regulation, Republicans haven’t been far behind, working to repeal, scale back or defund every move the regulators have made. The hotly-contested Volcker Rule has proven to be no exception.

A House Financial Services Committee spokesman said the hearing will look at the economic impact and competitiveness of the proposed rule. The hearing will likely take place in early November.

The draft rule, which was formally released by the FDIC on October 11th and was approved by the Securities and Exchange Commission this morning, is 205 pages and seeks to ban banks or institutions that own banks from engaging in proprietary trading that isn’t at the behest of their clients and from owning or investing in hedge funds or private equity funds. The rule would also limit the liabilities the largest banks could hold and preclude those banks from gaining from or hedging against short-term price movements in the securities and derivatives markets. The proposal includes exceptions for market making for customers and for hedging against risky trades made on customers’ behalf.

Proponents say that the rule will eliminate the need for future bailouts, though some are already making the case that the rule doesn’t go far enough, and it defined proprietary trading too narrowly. Major financial firms, including Goldman Sachs, JPMorgan Chase and Bank of America have already closed their proprietary trading desks in anticipation of the rule, though firms continue to argue that the rule is unnecessary, difficult to implement, and will harm their ability to compete in the global market. The GAO released a report this past summer on the Volcker Rule, noting the difficulty in detecting proprietary trading and calling it “cumbersome” and “difficult to enforce.”
The rule will be open for comment until January 2012 and would take effect on July 21, 2012 – the second anniversary of Dodd-Frank; though some say certain banks would have until 2017 to fully comply.

The Volcker Rule is a proposal by former Federal Reserve Chairman Paul Volcker to restrict U.S. banks from making certain kinds of speculative investments that do not benefit their customers. Volcker argued that this kind of proprietary trading, where deposits are used to trade on the bank’s personal accounts, played a key role in the 2008 financial crisis.

The Commodity Futures Trading Commission has said that it may put forth its own version of the Volcker rule. Scott O’Malia, a Republican commissioner at the CFTC, said he spoke to CFTC Chairman Gary Gensler on Friday and quoted the chairman as saying, "We might, if it's the will of the commission, put forward ... a virtually identical proposal with the other regulators, or we could go it alone." O’Malia continued, "He's not committing either way."

Rep. Barney Frank (D-MA), for whom Dodd-Frank is named, as well as Sens. Jeff Merkley (D-OR) and Carl Levin (D-MI), who first introduced the Volcker rule during the Dodd-Frank debate last summer, have yet to publicly comment on the proposed rule.

House Republicans Blast Schapiro on...Fracking?

In the year since the passage of Dodd-Frank, House Republicans have launched a number of attacks against the Securities and Exchange Commission (SEC), calling it wasteful, inefficient, and incompetent and blaming it for problems ranging from the Madoff Ponzi scheme to the 2008 financial crisis. The SEC has been called anti-free market, anti-business and anti-Main Street, but during yesterday’s day-long House Financial Services Committee hearing on SEC Oversight, Rep. Bill Posey (R-FL) came up with a new one; saying, “The SEC is fracking crazy!”

SEC Chairman Mary Schapiro has plenty of experience being on the defensive, but yesterday even she appeared stunned as legislators asked her why the SEC is overstepping the EPA’s authority and regulating hydraulic fracturing, or fracking, a process used to access underground reserves of natural gas and oil. Shapiro insisted that the SEC’s questions about fracking have been strictly limited to assessing the actual value of oil and gas reserves as printed in investor disclosure documents. However, several reports now claim that the SEC has asked for specific information regarding the chemicals being used as well as companies’ efforts to minimize environmental impacts, asserting that those inquiries cannot reasonably relate to valuing the assets. Further, many companies are now alleging that the SEC is requiring them to disclose proprietary information which could harm their ability to compete.

Rep. Steve Pearce (R-NM) asked Ms. Schapiro about the sources of payments to defrauded Madoff investors as well as the details of several bankruptcy cases where millions of dollars of state and federal funds were lost in bankruptcy. When Ms. Schapiro said that she was not familiar with those cases, Rep. Pearce responded that he was confused as to why the SEC is focusing its energies on regulating fracking while complaining that it lacks the resources to perform its basic duties.

While the true details of the SEC’s interest in fracking may never come to light, House Republicans are conducting vigorous SEC oversight and holding the agency to a standard that it has never in its very mixed history proven it is able to meet. Members continue to argue that the SEC will not receive more funding until it becomes more effective, and the SEC continues to insist that it cannot become more effective until it receives more funding. It’s a Catch-22 without an obvious solution.

Sections 913 & 914: Winners and Losers

For one of the first times in the Dodd-Frank debate, House Democrats and financial services industry leaders find themselves on the same side of the debate over harmonization of fiduciary standards for investment advisers and broker-dealers. Meanwhile, as the SEC opens the door for the designation of self-regulatory organizations, House Republicans appear to be at a turning point.

Fourteen months ago, banks were railing against the idea of adopting a single fiduciary standard for both investment advisers and broker-dealers, saying that it paints two very different services with the same brush and harms U.S. firms’ ability to compete worldwide. But in a hearing yesterday, stakeholders appear to have reached a compromise, following the publication of the SEC study, mandated under Section 913 of Dodd-Frank, which called for the development of a fiduciary standard for broker-dealers. The SEC staff recommended harmonizing regulation of investment advisers and broker-dealers and establishing a fiduciary duty for both, but does not subject them both to the Investment Advisers Act of 1940 (“the ’40 Act”), as industry feared. The study also suggests three possible approaches to regulatory reform, including designating self-regulatory organizations (SROs) to oversee broker-dealers.


  • Banks, for their part, got most of what they wanted. The SEC report failed to show any empirical evidence demonstrating a need for the change, and it concluded that subjecting broker dealers to the ’40 Act would be inappropriate, as banks have maintained from the offset.
  • House Democrats appeared pleased with the proposals, which will increase regulation of financial professionals and could open the door for additional funding for the cash-strapped SEC. Further, industry called for any regulatory actions to be performed with strict Congressional oversight, preserving a strong government role in the financial sector for the foreseeable future.


  • The SEC’s report has been criticized by stakeholders on both sides of the debate for failing to include enough empirical evidence of a problem, opening the door for many to criticize regulators for, once again, regulating for regulation’s sake. Further, the commission was lambasted throughout the hearing for its demonstrated inability to carry out its many new responsibilities under Dodd-Frank. When faced with a choice between ceding some authority to FINRA or being tasked with additional regulatory responsibilities it cannot afford, it is tough to see an upside for the agency.
  • The Department of Labor’s proposal to broaden the definition of fiduciary standard to more financial professionals, including those who oversee IRAs, drew criticism from all sides as being ill-conceived and damaging to those who are already struggling to save for retirement in a volatile economic climate.


  • FINRA’s request to be designated as an SRO has the support of House Republicans as well as industry and could be an opportunity to scale back, even slightly, the growing government role in the financial sector and demonstrate that self-regulation can work. On the other hand, as House Democrats appear determined to paint the organization as “the ones that missed Madoff,” regulation could end up in the hands of the SEC.
  • House Republicans maintain that there has not been a demonstrated need for reform and are using the Department of Labor’s proposal as evidence of the Obama Administration’s desire to over-regulate and expand the size of government. However, the reforms seem to be moving forward regardless of the criticisms. The House GOP could score a big win if Financial Services Committee Chairman Spencer Bachus’s (R-AL) proposal to designate FINRA as an SRO becomes law and the private sector is able to regain some autonomy. If not, the SEC’s role will continue to grow and Republicans will face renewed pressure to increase its funding.

The SEC has yet to propose rules related to its study, and Rep. Bachus has not said when his legislation, still in draft form, will be introduced.

Dodd-Frank at One Year: Growing Pains

This article [PDF] was originally published in the Harvard Business Law Review on July 28, 2011.

Addressing a joint session of Congress for the first time in February 2009, President Obama asked Congress to “put in place tough, new common-sense rules of the road so that our financial market rewards drive and innovation, and punishes short-cuts and abuse.” [1] Nine months later, on November 3rd, then-Financial Services Committee Chairman Barney Frank (D-MA) introduced the Financial Stability Improvement Act.[2] The bill grew exponentially throughout the month of November, and by the time H.R. 4173 came before the full House of Representatives on December 10th, Rep. Frank’s 380-page bill had expanded to 1,279 pages. When the final conference bill was signed into law on July 21, 2010, not only was it the most significant regulatory overhaul since the New Deal, but at almost 2,400 pages,[3] it was more than twice the length of the three previous regulatory bills – the Securities Act of 1933, the Securities Exchange Act of 1934 and Sarbanes-Oxley – combined.

In the year since Dodd-Frank was enacted, Republicans have launched countless attacks against it, claiming that it is too costly and unnecessarily increases the size of government.[4] They have argued that the Volcker rule and derivative regulations harm U.S. competitiveness overseas, that regulatory agencies are overfunded, and that the Consumer Financial Protection Bureau (CFPB) and Office of Financial Research (OFR) have too much power and are not subject to enough oversight.[5] Republicans, especially those in the House, have introduced bills to repeal Dodd-Frank in its entirety or scale back, defund, delay or otherwise prevent regulators from implementing individual provisions.

Given the rules of the House and the strength of the Republican majority, House Democratic proponents of Dodd-Frank have little recourse but to criticize attempts to overturn Dodd-Frank or portions of it. The Democratic-controlled Senate is another story. In the upper chamber, some have described Senate Banking Committee Democrats as circling the wagons around Dodd-Frank and fending off any and all attempts to amend or repeal it.[6] The committee’s oversight agenda has been noticeably less active than in past years, and some claim the reason is that the new Senate Banking Committee Chairman Tim Johnson (D-SD) is trying to refute Democratic colleagues’ criticisms that he has been too ‘pro-bank’ in the past.[7] 

Most of the Republican arguments fall into one of two categories: Dodd-Frank will cost too much and its regulatory requirements will create too much uncertainty for businesses to function properly and plan for the future. Dodd-Frank created thirteen new regulatory agencies, while only eliminating one: the Office of Thrift Supervision. The Congressional Budget Office estimates that it will cost $2.9 billion over the next 5 years to implement Dodd-Frank,[8] and some claim there could be up to $1 trillion in broader economic costs resulting from the Act.[9] The Act also creates more than 2,600 new positions at regulatory agencies, with some agencies, like the Office of Financial Research, lacking any size limitations on their budgets or staffs.[10]

Congressional Republicans have taken on some of the cost issues by using the annual appropriation process to impose deep cuts in agency budgets for the 2012 fiscal year. The 2012 Financial Services Appropriations Bill includes $12.2 billion for the Treasury Department, which is $929 million below last year’s level and nearly $2 billion below the president’s request. The bill also limits mandatory funds for the Consumer Financial Protection Bureau (CFPB) to $200 million and subjects it to annual appropriations, giving the House more oversight capability. In addition, the bill limits funding to the Office of Financial Stability to $200 million. The bill provides $1.2 billion for the Securities and Exchange Commission (SEC), which is equal to last year’s levels and $222 million below the president’s request.[11] The 2012 Agriculture Appropriations Bill includes $172 million for the Commodity Futures Trading Commission (CFTC), a 15 percent cut from last year and nearly half of the $308 million the President requested.[12]

The regulatory uncertainty has been harder to tackle. The sheer volume of deadlines contained in the almost 400 rulemakings required by the Act is overwhelming the regulatory agencies as well as the private sector. The CFTC announced in June that it will miss the July 16th deadline for its rules on derivatives and extended the rulemaking period until December 2011. [13] The Securities and Exchange Commission (SEC), which shares the CFTC’s responsibility for promulgating new derivative rules, has extended its deadlines as well.[14] While some welcome the delays – like Senate Minority Leader Mitch McConnell (R-KY), who recently said that "anything we can do to slow down, deter or impede" these regulations would be "good for our country"[15] – others, like some in industry who view the rules as inevitable, want the SEC and CFTC to finalize the rules as soon as possible so that firms have adequate time to implement them.[16]

Adding more drama are studies and analyses of various aspects of Dodd-Frank. The Government Accountability Office (GAO) released a study in early July 2011 saying that the U.S. regulators do not yet know enough about Wall Street’s proprietary trading to effectively police it.[17] This study pertains to the Act’s Volcker Rule, named after the former Federal Reserve Chairman Paul Volcker and which restricts banks, their affiliates and holding companies from engaging in proprietary trading and sponsorship of hedge funds and private equity funds. The original rule was proposed by Senators Jeff Merkley (D-OR) and Carl Levin (D-MI) as an amendment to the Senate bill, but Sen. Richard Shelby (R-AL), Ranking Member of the Senate Banking Committee, blocked it from coming to a vote.[18] Ultimately, the House-Senate conference committee passed a strengthened Volcker rule by adopting the language offered by Senators Merkley and Levin. However, conferees changed the proprietary trading ban to allow banks to invest up to three percent of Tier 1 Capital in hedge funds and private equity funds at the request of Sen. Scott Brown (R-MA), whose vote was needed in the Senate to pass the bill.

House Republicans have used the non-partisan GAO report to argue that the new requirements put American companies at a competitive disadvantage compared to foreign firms. "The GAO report confirms that neither European nor Asian regulators or legislators will establish similar proprietary trading restrictions that the Dodd-Frank Act imposed on U.S. financial institutions," said House Financial Services Committee Chairman Spencer Bachus (R-AL). "This will unquestionably harm the ability of American companies to compete and create jobs. Once again, the rhetoric of Dodd-Frank supporters that the world would follow the U.S. lead on financial regulatory reform is shown to be a myth."[19] At the same time, Senate Democrats have been quick to criticize the report, calling the study "woefully incomplete."[20] Neither the House nor the Senate has taken any recent legislative steps to further scale back the Volcker Rule, and many large U.S. banks are actively divesting their proprietary trading businesses to prepare for the July 21, 2012 compliance deadline.

Congress continues to debate Dodd-Frank’s costs and regulatory deadlines, but the U.S. Treasury Department’s Assistant Secretary for Financial Markets Mary Miller recently warned that, "Scaling back or repealing major parts of the Dodd-Frank Act or not providing regulators with the funds they need to implement the Act will leave our economy exposed to a cycle of collapses and crises."[21] In anticipation of the one-year anniversary, House Republicans gave the Dodd-Frank Act a failing report card in mid-July, saying that Dodd-Frank has failed in five categories, including its impact on strengthening the economy, streamlining financial rules and stabilizing the housing market.

At Dodd-Frank’s passage last year, then-Senate Banking Committee Chairman Sen. Chris Dodd (D-CT) said, "No one will know until this is actually in place how it works."[22] In the year since, there is still little understanding of when most of Dodd-Frank’s extensive provisions will actually be in place and how they might affect the nation’s financial systems and economy. The only certainties are that the hearings will continue, the partisan battles will rage on, and for better or worse, many of the Act’s requirements could remain in limbo until well into the future.


[1] Remarks of President Barack Obama – As Prepared for Delivery Address to Joint Session of Congress (Feb. 24, 2009)

[2] H.R. Res. 4173, 111th Cong. (2010) (enacted).

[3] H.R. Rep. No. 111-517 (2010).

[4] See, e.g., Phil Mattingly, Republicans Would ‘Remedy’ Unwanted Dodd-Frank Effects, Bloomberg, Feb. 1, 2011,

[5] See id.; Victoria McGrane, Dodd-Frank-Created States Office Comes Under Fire, Wall St. J. Washington Wire Blog, July 14, 2011,

[6] Victoria McGrane, Senate Democrats: Still Making the Case for Dodd-Frank, Wall St. J. Washington Wire Blog, May 11, 2011,

[7] See Fight Over Dodd-Frank Headlines U.S. Senate Panel, Reuters, Feb. 17, 2011,

[8]Press Release, Representative Barney Frank, Frank statement on the cost of Dodd-Frank implementation (Mar. 30, 2011),

[9] Daniel Indiviglio, Dodd-Frank’s Derivatives Rules Could Cost Main Street $1 Trillion, The Atlantic, Jun. 30, 2010,

[10] House Financial Services Committee, One Year Later: The Consequences of the Dodd-Frank Act,

[11] Press Release, House Appropriations Committee, Appropriations Committee Releases Fiscal Year 2012 Financial Services Appropriations Bill (Jun. 15, 2011),

[12] House Appropriations Committee, Summary: Fiscal Year 2012 Agriculture Appropriations Bill (Jun. 13, 2011),

[13] Press Release, Commodity Futures Trading Commission, CFTC Clarifies Effective Date for Swaps Regulation Under the Dodd-Frank Act (Jul. 14, 2011),

[14] Press Release, Securities and Exchange Commission, SEC Provides Additional Guidance, Interim Relief and Exemptions for Security-Based Swaps Under Dodd-Frank Act (Jul. 1, 2011),

[15] Tom Braithwaite and Richard McGregor, McConnell attacks financial regulators, Financial Times, Jun. 23, 2011,

[16] This viewpoint was expressed by witnesses at the June 29, 2011 Senate Banking Subcommittee on Securities, Insurance and Investment Hearing which included several derivatives industry executives. See, e.g. Testimony of Neal B. Brady, CEO of Eris Exchange, available at

[17] U.S. Gov’t Accountability Office, GAO-11-529, Proprietary Trading: Regulators Will Need More Comprehensive Information to Fully Monitor Compliance with New Restrictions When Implemented (2011).

[18] P.K. Semler, Volcker rule unlikely to move forward in Senate, lawmakers say, Financial Times, Feb. 1, 2010,

[19] Peter Schroeder, GAO: Regulators need more info before curbing proprietary trading, Financial Times, Jul. 13, 2011,

[20] Alan Zibel, Senate Democrats Criticize GAO Study Related to Volcker Rule, Wall St. J. L. Blog (Jul. 13, 2011, 3:59 PM),

[21] Cheyenne Hopkins and Ian Katz, Treasury’s Miller Warns Against ‘Scaling Back’ Major Parts of Dodd-Frank, Bloomberg, Jul. 13, 2011,

[22] David Cho, Jia Lynn Yang & Brady Dennis, Lawmakers guide Dodd-Frank bill for Wall Street reform into homestretch, Washington Post, Jun. 26, 2010,

Preferred citation: J.C. Boggs, Melissa Foxman, & Kathleen Nahill, Dodd-Frank at One Year: Growing Pains, 2 Harv. Bus. L. Rev. Online 52 (2011),

Happy Birthday Dodd-Frank, Part III

It’s been called the birthday; the anniversary; the implementation deadline; the day the doors open; the transfer date; the rulemaking deadline; and more. By whatever terminology, July 21, 2011, Dodd-Frank’s first birthday, should have been a big day. When the countdown ended, however, and Thursday finally rolled around, it all began to feel a bit anti-climactic.

The Rulemakings: Of the 163 required rulemakings that had to be finalized by July 21, only 33, a mere 20 percent have been completed. Overall, only 51, or 13 percent of the total rulemakings required by Dodd-Frank have been finalized. Between the two key deadlines – July 16 (360 days after passage) and July 21 (one year after passage) – there were 117 rulemaking requirements, only 13 of which were actually met. There remain 104 requirements, or 88 percent, that have yet to be fulfilled.

The Studies: Dodd-Frank also requires a multitude of studies, and on the whole, agencies have been more successful in completing those on time. Regulators only failed to complete 3 of the 17 studies required this quarter.

The Agencies: The CFPB, the most anticipated of the new agencies, officially opened on Thursday, but has limited authority until it has a confirmed director. The SEC has missed the most deadlines, at 54, followed closely by the CFTC, which has missed 39. Both SEC Chairman Mary Shapiro and CFTC Chairman Gary Gensler have blamed the delays on limited resources, saying that unless they receive considerable funding increases, the delays will only continue. Regulators will spend $400 million implementing Dodd-Frank in 2011. That number is expected to triple to $1.2 billion in 2012, as regulatory agencies continue to add staff and increase oversight efforts. The House Appropriations Committee passed bills imposing deep cuts in the regulators’ budgets. Those bills have yet to come to a vote before the full House and are unlikely to pass the Senate. Under statute, regulators are also empowered to assess fees to the firms they regulate to bring in additional revenue.

The Leadership: Four regulatory agencies lack key leadership personnel, and all have significant staffing left to do. The president’s nominees for chairman of the FDIC, Comptroller of the Currency and a Member of the Financial Stability Oversight Council are set to appear before the Senate Banking Committee tomorrow. A hearing date has yet to be set for the president’s most controversial nomination, that of director of the Consumer Financial Protection Bureau. Senate Republicans have vowed to block any nominee for CFPB director, but have not vocally opposed the other nominations.

By all accounts, the first year of Dodd-Frank was just the beginning, but as Republicans in Congress continue their efforts to chip away at financial reform, it remains to be seen how many anniversaries it will take for Dodd-Frank to become a reality.

CFPB, House Republicans Hit the Ground Running - In Opposite Directions

The Consumer Financial Protection Bureau (CFPB) officially opened its doors yesterday and wasted no time before assuming its duties. The bureau sent letters to the CEOs of the financial institutions that fall under its supervision and opened its new consumer complaint hotline. In the coming week, it is expected to issue three reports to Congress: one examining the differences between credit scores sold to consumers and scores used by lenders to make credit decisions; one recommending a strategy for maximizing transparency and disclosure of exchange rate information; and one outlining the recruitment, training, benefits and retention plans for CFPB staff. The CFPB will also issue several interim rules, outlining protocols ranging from record-keeping to investigation and enforcement.

The House celebrated Dodd-Frank’s birthday by voting to change the structure and oversight authority of the Consumer Financial Protection Bureau (CFPB). By a count of 241-173, the House voted to replace the CFPB director with a five-person board, making it more similar to the leadership structures of the other financial regulators. The bill also empowers the Financial Stability Oversight Council (FSOC) to overturn CFPB regulations with a simple majority vote. Under Dodd-Frank, the FSOC needs a two-thirds vote to overturn any CFPB rulings. The House bill also requires that the CFPB have a Senate-confirmed director before it takes on any of its authority, not simply its authority over non-banks, as the Act requires. Ten Democrats voted for the measure, and one Republican, Rep. Walter Jones (R-NC), voted against it.

Most Democrats say the House bill is yet another attempt to undermine the CFPB’s authority. The bill now heads to the Senate, where it is unlikely to garner sufficient Democratic support to pass.

Happy Birthday, Part II - Top Regulators Make Case for Funding Increases

The nation’s leading financial regulators took their battle for more implementation and enforcement funding to Capitol Hill Thursday. Their testimony was offered on the first anniversary of the signing of the Dodd-Frank Act.The witness panel at the Senate Banking Committee consisted of Rep. Barney Frank (D-MA), for whom the Act was named; Deputy Treasury Secretary Neal Wolin; Federal Reserve Chairman Ben Bernanke; Securities and Exchange Commission Chairman Mary Shapiro; Commodity Futures Trading Commission Chairman Gary Gensler; Federal Deposit Insurance Commission Acting Chairman Martin Gruenberg; and Acting Comptroller of the Currency John Walsh. Not represented was the agency whose funding is most controversial – the Consumer Financial Protection Bureau. The CFPB opened its doors for business today.

The witnesses met with the mixed response they must have expected . Senate Banking Committee Chairman Tim Johnson (D-SD) opened the hearing by applauding the regulators for their work over the past year and emphasized that “Congress must do its part” to actively oversee the implementation of Dodd-Frank in the years to come. Ranking Member Richard Shelby (R-AL), on the other hand, expressed his frustration with the law, saying that it “provides little comfort to millions of Americans who are facing harsh economic realities.” Sen. Shelby went on to say that when Dodd-Frank was being considered in the Senate the-Senator Chris Dodd (D-CT), for whom the bill is also named, assured him that there would be strong oversight and accountability in the regulatory agencies. Shelby said he regrets that that hasn’t been the case.

Each of the regulators devoted his or her testimony to justifying the regulatory delays and petitioning for increased funding from Congress. Gensler said that regulations have been delayed because “It is more important to get it right, than to work against the clock.” Shapiro argued that the regulators cannot possibly fulfill all of their new responsibilities without increased resources.

Regulatory agencies have taken a hit in House Republicans’ latest attacks on Dodd-Frank. The House Financial Services Appropriations bill slashed several regulators’ budgets to levels at or below their pre-Dodd-Frank budgets, when they had far fewer responsibilities. Frank criticized the cuts during his testimony, saying that Congress can’t argue that it can’t afford to fund regulatory agencies when it continues to spend billions of dollars in overseas conflicts. It should be noted, the Senate Banking Committee is not the venue to battle the funding cuts suggested by the House Appropriations Committee. The Senate Appropriations Committee will take up the spending plan for most of these agencies later this year.

On the Occasion of Its First Anniversary - Dodd-Frank by the Numbers

Ever since the earliest whispers of Dodd-Frank, it’s been all about the numbers. From the $648 billion the Congressional Budget Office estimates the September 2008 economic collapse cost the United States, to the 1,010.14 points the Dow swung in a matter of minutes during the infamous May 6, 2010 Flash Crash, the financial crisis of the late 2000s has given the global financial markets more numbers to contend with than anyone could be expected to digest. With the passage of Dodd-Frank, the federal government’s legislative reaction to the crisis, the U.S. Congress has given us a few more:

  • $1,000,000,000,000+ the broader economic costs of Dodd-Frank, according to some estimates.
  • $19,000,000,000 the size of the bank tax that Sen. Scott Brown (R-MA) successfully removed during the conference process
  • $2,900,000,000 the cost of Dodd-Frank implementation over the next 5 years
  • $1,800,000,000 the implementation cost for commodities traders
  • 383,013 words in Dodd-Frank
  • 100,000 non-banking firms that could be regulated by the Consumer Financial Protection Bureau (CFPB)
  • 2,600 new positions at regulatory agencies
  • 2,319 pages in the final bill (vs. 2,409 for health care reform).
  • 533 new regulations
  • 243 rules created by Dodd-Frank (Sarbanes-Oxley created 16)
  • 94 reports
  • 88 hearings held on Dodd-Frank during the Act’s passage and first year of implementation
  • 67 studies required by Dodd-Frank (Sarbanes-Oxley required 6)
  • 44 Republican Senators who have vowed to block any candidate for director of the CFPB
  • 13 new federal government agencies created by Dodd-Frank

As Dodd-Frank rolls into its second year, much remains to be seen, but what is clear is that the numbers will continue to increase. The implementation costs will continue to rise, the agencies will hand down more and more regulations, and Members of Congress will introduce even more bills to scale back the Act. At this rate Dodd-Frank itself may be getting too big to fail.

EVENT: The Impact of Dodd-Frank on the Loan Market: Broad Principles and Practical Implications

Blank Rome joins the Loan Syndications and Trading Association (LSTA) and Morrison & Foerster to present a program on “The Impact of Dodd-Frank on the Loan Market: Broad Principles and Practical Implications” on July 12, 2011.

Blank Rome partners, J.C. Boggs and Marianne Caulfield, join the panel to discuss:

  • Dodd-Frank one year later, the current state of play on the Hill and the regulatory agencies
  • Major regulatory activities of interest to the loan trading market (Volcker, derivatives, capital and risk management)
  • Dodd-Frank and the Loan Market: The Future of CLOs, Derivatives and Loan Participations
  • How Dodd-Frank derivatives  rules affect risk participations (including LMA funded participations) and what alternatives are available

This presentation will be held:


July 12, 2011
4:00 p.m.–6:00 p.m.
Morrison & Foerster LLP, 2000 Pennsylvania Avenue, NW, Washington, DC


To register, please click here

House Financial Services Committee Continues Efforts to Chip Away at Dodd-Frank

The House Financial Services Committee voted Wednesday to approve several measures that would scale back provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

As lawmakers prepare for the bill’s July 21, 2011 implementation date, House Republicans passed several measures narrowing the scope of the bill, including a measure that would exempt companies that manage up to $50 million in securities from having to register with the Securities and Exchange Commission; a bill exempting most private equity fund advisers from having to register with the SEC; a bill repealing the provision in Dodd-Frank requiring publically-traded companies to disclose their employees’ median compensation separately from their CEO pay packages; and a bill creating a legal framework for the use of covered bonds.

House Financial Services Committee Chairman Spencer Bachus (R-AL) said that all of the bills were designed to create jobs. Reps. David Schweikert (R-AZ), Robert Hurt (R-VA) and Nan Hayworth (R-NY), who introduced three of the provisions, said their bills remove burdensome regulations that are both costly and unnecessary for small businesses.

Throughout the markup, Rep. Barney Frank (D-MA), ranking member of the committee and one of the architects of Dodd-Frank, expressed his frustrations with the various new provisions and made several failed attempts to amend them. When House Republicans said that they were concerned about finding sufficient funding for the SEC to fulfill all of its new regulatory obligations, Frank said that Congress should not scale back regulation because of budgetary limitations, citing the cost of the war in Afghanistan, and saying that the Congress can certainly find the necessary funding for the regulatory agencies. He went on to say that the costs of failing to regulate the financial markets are significantly higher.

A Ship Without A Captain: What Director-less CFPB Will Actually Look Like

As the July 21, 2011 Dodd-Frank implementation date rapidly approaches, it is becoming increasingly likely that the Bureau of Consumer Financial Protection will not have a Senate-confirmed director by the time its new authority begins. While some have tried to downplay the significance of the CFPB assuming authority without a director, it could seriously hinder the bureau’s ability to do so much as open its doors, let alone effectively regulate.

According to Title X of Dodd-Frank, the director is appointed by the President with the advice and consent of the Senate. Once confirmed, the director serves as the sole head of the CFPB. Dodd-Frank enumerates the director’s responsibilities clearly: appointing and directing all bureau employees; establishing all offices within the bureau; reporting to Congress; submitting budget requests to the Federal Reserve; requiring reports of covered firms; and prescribing rules and issuing orders and guidance, among others.

Additionally, there are a number of responsibilities assigned to “The Bureau,” though Dodd-Frank does not establish who has authority over The Bureau, if not the director. Assuming a case can be made for some other leadership structure, however, The Bureau is tasked with exclusively enforcing federal consumer financial law. The Bureau also may take action against those participating in unlawful acts, engage in joint investigations, conduct hearings and adjudication proceedings, and commence civil action against those who violate federal consumer financial law.

While this would suggest that The Bureau would have some capabilities absent a director, it may not be quite that easy. First, Dodd-Frank at times fails to clearly delineate where the exclusive authority of the director begins and ends as opposed to The Bureau as a whole. While this could arguably help The Bureau perform its duties without a director, there’s a second, stickier problem. The director has the sole authority to staff The Bureau, as well as to request and budget funding from the Federal Reserve. Consequently, even if The Bureau could find the statutory authority to perform some regulatory functions, it would be hard-pressed to do so without funding or personnel.

If a director is not confirmed by July 21, Dodd-Frank permits two courses of action. First, the Secretary of the Treasury may submit a request to Congress to delay the implementation date. The law requires that implementation cannot be delayed for more than 18 months, meaning that the Administration would only gain 6 months to get a nominee confirmed. Alternatively, Dodd-Frank states that the Secretary of the Treasury is authorized to perform the functions of The Bureau until the director is confirmed by the Senate, though it is unclear whether this authority expires on July 21.

Secretary Geithner has not yet announced plans to take either of these steps, but with only a month to go and Republicans in the House and the Senate vowing that they will go to any means necessary to block the confirmation of presumptive nominee Elizabeth Warren, delaying the implementation may be the Secretary’s only option.

Banks To Challenge Interchange Fees in Court

After an oh-so-close loss in the Senate last week, the banking industry is now planning to take the fight over debit card interchange fees to court.

The Federal Reserve has yet to issue a finalized rule, but once it does, the banking industry is likely to file suit, claiming that the Fed has misinterpreted the Dodd-Frank Wall Street Reform and Consumer Protection Act. The industry claims that the so-call Durbin Amendment, which imposed the cap, allows banks to make a “reasonable and proportional” profit. The industry also claims that the Fed is not taking into account the various costs associated with operating a debit card network.

Minnesota-based TCF National Bank sued the Federal Reserve in October 2010, challenging the constitutionality of the rule. The first hearing is set for this week.

Under the Dodd-Frank Act, debit card fees, which currently average about 44 cents per transaction, are capped at about 12 cents per transaction. Sens. Tester (D-MT) and Corker (R-TN) introduced an amendment that would have delayed the implementation of the fee cap, but it failed to pass the Senate by a six vote margin. The final count was 54-45, with 60 votes needed for passage.

If You Can't Beat 'Em - Cut Their Funding

In yet another attempt to hinder the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the House Appropriations Committee passed two measures this week to dramatically cut the budgets of key regulatory agencies.

The 2012 Financial Services Appropriations Bill includes $12.2 billion for the Treasury Department, which is $929 million below last year’s level and nearly $2 billion below the President’s request. The bill also limits mandatory funds for the Consumer Financial Protection Bureau (CFPB) to $200 million and subjects it to annual appropriations, giving the House more oversight capability. In addition, the bill limits funding to the Office of Financial Stability to $200 million. The bill provides $1.2 billion for the Securities and Exchange Commission, which is equal to last year’s levels and $222 million below the President’s request.

The 2012 Agriculture Appropriations Bill includes $172 million for the CFTC, a 15 percent cut from last year and nearly half of the $308 million the President requested. Subcommittee Chairman Jack Kingston (R-GA) said the bill takes spending to pre-stimulus, pre-bailout levels while ensuring that the CFTC and other agencies “are provided the necessary resources to fulfill their duties.” CFTC Chairman Gary Gensler has been saying for over a month that the CFTC cannot possibly fulfill its new role under Dodd-Frank without additional resources, but Republicans counter that the CFTC has been granted too broad authority and has been overstepping its role.

Some members are taking it even further, with Rep. Scott Garrett (R-NJ) introducing an amendment yesterday which prohibits the CFTC to use appropriated funds to promulgate any final rules until 12 months after the final swaps rules are completed. The swaps rules are slated to be finalized in December 2011, which means the CFTC would be at a standstill until at least December 2012.

CFTC Gary Gensler told the Agriculture Committee yesterday that these budget cuts will stymie the agencies’ ability to enforce Dodd-Frank, which appears to be what the Republicans are banking on.

A Tale of Two Regulators...And Missed Deadlines

What a difference a year makes. In July 2010, one year seemed to be a perfectly reasonable timeframe for regulators to develop more than 150 rules, conduct 47 studies, create several new government offices, and engage in extensive hiring and agency reorganization. With the first anniversary of the Dodd-Frank Wall Street Reform and Consumer Protection Act rapidly approaching, however, it is becoming increasingly clear that more time will be necessary in order to implement the financial reform law’s sweeping provisions.

In particular, when it comes to derivatives regulations, it appears that Congress bit off more than either the CFTC or SEC could chew. On Friday, the SEC announced that it would delay implementation of some of the new derivatives regulations that were set to take effect next month, while the CFTC voted on Monday to delay certain swaps rules until Dec. 31, 2011, in anticipation of missing the July deadline for completing the rules.

SEC officials said they are taking the additional time to ensure the clarity of the new rules and minimize market disruption. However, some lawmakers on Capitol Hill believe that such delays—which have yet to be specified—may cause as much disruption by preventing market participants from planning accordingly.

On Friday, House Agriculture Committee Chairman Frank Lucas (R-OK) sent a letter to CFTC Chairman Gary Gensler calling on regulators to reduce market uncertainty by clarifying various definitions, including the definition of a swap, which becomes effective on July 16, though it has yet to be finalized. The CFTC and SEC have recourse under a provision in Dodd-Frank to delay implementing regulations for no more than 60 days after they are finalized.

Delays and missed deadlines are certainly not exclusive to the SEC and CFTC. More broadly, as of June 1, of the 87 total studies required under Dodd-Frank, 24 have been completed and two deadlines have been missed. Of the 385 total rulemakings required, 115 have been proposed, 24 have been finalized and 28 deadlines have been missed. With 17 studies and 109 rulemakings due in July 2010 alone, the coming month will be the true test of regulators’ progress—and it is a test they are not likely to pass.

DOWNLOAD:  CFTC Swap Regulation Factsheet (PDF)

Bipartisan Alarm Sounds on Capitol Hill over Proposed Derivatives Rules

Federal regulators are continuing to field an array of questions and concerns from lawmakers surrounding the implementation of Dodd-Frank’s derivatives provisions (Title VII) – and it’s not just coming from House Republicans.

In a letter sent on Tuesday to Federal Reserve Chairman Ben Bernanke, Federal Deposit Insurance Corporation (FDIC) Chairwoman Sheila Bair, Commodity Futures Trading Commission (CFTC) Chairman Gary Gensler and acting Comptroller of the Currency John Walsh, New York’s two Democratic Senators and 16 of New York’s 29 Representatives expressed concerns that a proposed rule applying margin requirements to derivatives between non-U.S. subsidiaries of U.S. entities and non-U.S. counterparties would create a significant competitive disadvantage for U.S. firms operating internationally.

The letter, signed by 12 Democrats and 6 Republicans, went on to state that “disparate treatment of U.S. firms will only encourage participants in the derivatives markets to do business with non-U.S. firms,” and asked that U.S. regulators work with their international counterparts to ensure that the international regulations “perfectly mirror the U.S. rules.” Senate Agriculture, Nutrition and Forestry Committee Chairwoman Debbie Stabenow (D-MI) expressed similar concerns during a Senate hearing on March 3, stating that “having a different set of rules that govern similar transactions [internationally] could have negative impacts in the markets.”

The New York delegation letter is just the latest in what has been an ongoing congressional debate over Title VII.

Earlier this month, House Republicans introduced H.R. 1573, which would delay any new derivatives rules from going into effect before December 2012. The bill’s chief sponsor, House Agriculture Committee Chairman Frank Lucas (R-OK) said the proposal – which passed the Agriculture Committee early last week, and is expected to go before the House Financial Services Committee when it returns from recess next week -- aims to grant regulators sufficient time to properly impose the new regulations. House Democrats contend that the GOP effort is an attempt to derail Dodd-Frank in case Republicans regain the Senate, the White House, or both following the 2012 elections.

Responding to the House GOP efforts, CFTC Chairman Gary Gensler testified before the Senate Committee on Banking, Housing and Urban Affairs last week that his agency was well on its way towards implementing Dodd-Frank. Gensler said that the proposal phase of the rule-writing is nearly completed, and that the public comment period on the proposed derivatives rules has been extended by thirty days, giving the public the opportunity to comment on the “whole mosaic of rules.” Acknowledging that there have been discussions of altering the implementation timeline for certain provisions of Dodd-Frank, Gensler reaffirmed his and the Obama administration’s view that “the public will not be adequately protected until the agency completes final rules.”

Concerns that the many of the proposed derivates rules could negatively impact commercial “end-users” – businesses who use derivatives contracts to hedge against anything from interest rates and gas prices to crop yields – have been ongoing since the early debates surrounding Dodd-Frank, but Gensler has repeatedly said that the CFTC, which has considerable latitude in determining which businesses will be exempted under the law, does not intend to target legitimate commercial end-users who are making healthy contributions to the market.

House GOP Makes the Next Move on GSE Reform

The Obama administration’s February report that outlined a series of near-term and long-term proposals for reforming Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac provided a starting point for Congressional debate—and now House Republicans appear ready to act.

This afternoon, Republicans on the House Financial Services Committee held a press conference to unveil eight separate proposals for providing near-term reforms to Fannie and Freddie. Several of the GOP proposals mirror those made by the Obama administration, including an increase in Fannie and Freddie’s guarantee fees and a winding down of both GSE’s investment portfolios, which currently hover around $1 trillion. Of particular significance, however, is the GOP’s omission of a long-term proposal for replacing Fannie and Freddie, highlighting the difficulty in significantly decreasing the GSE’s outsized role in the U.S. housing finance market.

Below is a summary of each GOP proposal: 

Executive Compensation—Introduced by Chairman Spencer Bachus (R-AL), the Equity in Government Compensation Act of 2011 would suspend current compensation packages for Fannie and Freddie’s senior executives and replace them with compensation packages on par with current pay rates for senior employees in the Executive Branch of the Federal Government.

Congressional Oversight—Introduced by Rep. Judy Biggert (R-IL), the Fannie Mae and Freddie Mac Accountability and Transparency for Taxpayers Act of 2011 would require the Inspector General of the Federal Housing Finance Agency to submit quarterly reports to the Congress during the conservatorship of Fannie and Freddie.

Risk Retention—Introduced by Rep. Scott Garrett (R-NJ), the GSE Credit Risk Equitable Treatment Act of 2011 would prohibit mortgages held or securitized by Fannie or Freddie from being exempted from the risk retention rules established under Dodd-Frank and currently being proposed by the FDIC.

Investment Portfolio—Introduced by Rep. Jeb Hensarling (R-TX), the GSE Portfolio Risk Reduction Act of 2011 would incrementally impose caps on Fannie and Freddie’s investment portfolios so that it reaches $250 billion after five years.

Guarantee Fees—Introduced by Rep. Randy Neugebauer (R-TX), the GSE Subsidy Elimination Act of 2011 would increase the guarantee fees over two years that Fannie and Freddie charge investors in exchange for a guarantee of the timely payment of interest and principal on Mortgage Backed Securities (MBS).

Debt Issuance—Introduced by Rep. Steve Pearce (R-NM), the GSE Debt Issuance Approval Act of 2011 would prohibit Fannie or Freddie from issuing any new debt without approval from the Secretary of the Treasury.

Affordable Housing—Introduced by Rep. Ed Royce (R-CA), the GSE Mission Improvement Act of 2011 would repeal Fannie and Freddie’s congressionally-mandated affordable housing goals.

Lending Markets—Introduced by Freshmen Rep. David Schweikert (R-AZ), the GSE Risk and Activities Limitation Act of 2011 would prohibit Fannie and Freddie from approving any new financial products while in conservatorship or receivership.

The House Financial Services Subcommittee on Capital Markets & Government Sponsored Enterprises will consider the eight GOP proposals during a hearing on Thursday, as Federal Housing Finance Agency Acting Director Edward DeMarco is slated to testify.

The piecemeal approach to GSE reform is a continuation of House Republicans’ legislative strategy in the 112th Congress, aimed at avoiding comprehensive proposals that are more liable to political attack and getting bogged down in the legislative process.

The fast-track approach, however, will only go so far in the Senate. During a GSE reform hearing on Tuesday, Banking, Housing and Urban Affairs Committee Ranking Member Richard Shelby (R-AL) made clear in his opening statement that housing finance reform will require a long and protracted congressional debate that may last beyond 2012.

“Before Congress can consider legislation, this Committee needs to do its homework,” said Shelby. “The Committee needs to thoroughly examine Federal housing policy and identify the problems with our current system. Accordingly, I believe this hearing is premature.”

Shelby, one of the leading critics of Dodd-Frank, warned his colleagues that hastily crafted GSE reform legislation would lead to “unintended consequences,” citing the financial reform legislation as an example.

One Down, Two to Go: Treasury Announces FIO Chief

Since President Obama signed Dodd-Frank into law on July 21, 2010, the financial industry has been anxiously awaiting the appointments of the key individuals to lead the newly-created offices of Financial Research (OFR) and Federal Insurance (FIO), along with the Consumer Financial Protection Bureau (CFPB). But now the wait is over—at least for the one director position that doesn’t require Senate confirmation.

Treasury Secretary Tim Geithner announced on Thursday that Michael McRaith, the director of the Illinois Department of Insurance, will assume the helm of the new FIO. Under Dodd-Frank, the Treasury-housed office will be charged with collecting, analyzing, and disseminating data and information gathered from the insurance industry in order to help coordinate federal insurance policy. (Health insurance and long term care insurance are excluded from the FIO’s purview).

In an effort to preserve the longstanding state-based regulatory structure for the insurance industry, Congress crafted language that explicitly prohibits the FIO from exercising regulatory or enforcement authority. However, voices on Capitol Hill and within the financial industry have expressed concerns with the FIO’s sweeping authority to collect data and how that may impact business compliance costs and data security.

One of McRaith’s primary functions as FIO director will be to serve as a non-voting member on the Financial Stability Oversight Council (FSOC)—a council of regulators charged with monitoring the broader financial system—requiring consultation with the Treasury Secretary as to whether certain insurers or insurance practices may pose systemic risk.

As the FSOC continues to issue proposed rules that will ultimately determine how regulators designate non-bank financial companies for heightened supervision, a bipartisan group of lawmakers—including Reps. Barney Frank (D-MA) and Ed Royce (R-CA)—have been urging the Obama administration to quickly fill the FIO director position in order for the insurance industry to have a voice at the table during the FSOC’s rulemaking process.

Under Dodd-Frank, the FIO Director is also empowered to negotiate—along with the U.S. Trade Representative—all international insurance agreements on behalf of the U.S.

Mr. McRaith has served as secretary/treasurer of the National Association of Insurance Commissioners (NAIC) and has represented state regulators in negotiations with the International Association of Insurance Supervisors and the international Organization for Economic Cooperation and Development.

CFPB Director or CFPB Commissioners? House Republicans Prefer the Latter

Coinciding with Elizabeth Warren’s inaugural testimony before Congress in her capacity as Special Advisor to the Secretary of the Treasury for the Consumer Financial Protection Bureau (CFPB) on Wednesday, House Financial Services Committee Chairman Spencer Bachus (R-AL) revived a dormant proposal that would decentralize the leadership of what Bachus calls the “most powerful agency that’s ever been created in Washington.”

Joined by 26 GOP colleagues, Bachus introduced H.R.1121, the Responsible Consumer Financial Protection Regulations Act, legislation that would replace the position of CFPB Director with a five-member Commission consisting of members that are nominated by the President and confirmed by the Senate. In addition, H.R. 1121 requires the commission to be comprised of no more than three members of the same political party—a bipartisan structure similar to that of the FTC, FDIC and SEC. According to Bachus, Dodd-Frank consolidates too much authority in the hands of a single CFPB director.

The commission structure—an idea first proposed in Congress by former Rep. Walt Minnick (D-ID) during the initial stages of the Dodd-Frank debate in 2009—has long been under discussion on Capitol Hill and was ultimately included within the financial reform legislation that first passed the House in December of 2009. (The commission language was ultimately scrapped during the House-Senate conference negotiations.)

Although no Democrats have signed onto H.R. 1121 thus far, House Republicans view the commission proposal as perhaps the most palatable CFPB reform option for Congressional Democrats, who have remained unified in resisting recent GOP efforts to slash the agency’s budget.

When pressed by Rep. Sean Duffy (R-WI) during a House Financial Services Subcommittee hearing yesterday, Ms. Warren testified that Congress made the “right decision” in choosing a consolidated directorship in favor of a five-member board. Warren cited the OCC and OTS as examples of single director agencies that Congress centralized in order to create “a more efficient operation.”

Responding to Republican arguments during the hearing that the CFPB possesses unchecked and unprecedented financial regulatory authority, Warren reminded lawmakers that CFPB rules can be nullified by the newly-created Financial Stability Oversight Council (FSOC) if the council determines that such rules may affect the safety and soundness of a particular financial institution. “That is not true for any other agency,” said Warren.

In addition to H.R. 1121, a handful of GOP freshmen in the House have also introduced legislation to amend or repeal certain sections of Dodd-Frank as part of a broader GOP effort to tie the financial regulatory environment to U.S. job creation and economic competitiveness. The bills include the following:

  • Chief Executive Officer (CEO) Compensation Disclosures—Rep. Nan Hayworth (R-NY) introduced H.R.1062, the Burdensome Data Collection Relief Act, which would repeal Section 953(b) of the Dodd-Frank Act that requires all public companies to disclose the ratio of the median annual “total compensation” of all company employees to the annual “total compensation” of the CEO within all of the company’s SEC filings.
  • SEC Registration—Rep. Robert Hurt (R-VA) introduced H.R.1082, the Small Business Capital Access and Job Preservation Act, which would exempt advisors to Private Equity Funds from new SEC registration and reporting requirements under Dodd-Frank.
  • Public Offerings—Rep. David Schweikert (R-AZ) introduced H.R. 1070, the Small Company Capital Formation Act of 2011, which will increase the SEC’s Regulation A exemption for the public offerings of small companies from $5 million to $50 million. In addition, the bill requires the SEC to revisit the exemption ceiling every two years.

These bills were reviewed on Wednesday during a House Financial Services Subcommittee on Capital Markets and Government-Sponsored Enterprises—chaired by Rep. Scott Garrett (R-NJ)—that focused on “job creation, capital formation and market certainty.” The subcommittee also reviewed two yet-to-be introduced bills by freshman Reps. Michael Grimm (R-NY) and Steve Stivers (R-OH). Grimm’s proposal would amend the definitions of ‘‘major swap participant’’ and ‘‘major security based swap participant,’’ while the Stivers bill would repeal section 939G of Dodd Frank that related to the legal liabilities of credit rating agencies.

GOP Members of HFSC to Dodd-Frank Regulators: SLOW DOWN

Led by House Financial Services Committee Chairman Spencer Bachus (R-AL), 34 of the committee’s Republicans sent a letter to the six agency heads charged with implementing the Dodd-Frank Act stating that the members are “troubled by the volume and pace of rulemakings” under the Act. Citing the sheer number of rules, the diverse array of issue areas, and the truncated comment periods, the members are concerned that businesses and consumers will not have adequate opportunity to provide meaningful input into the process. The current comment periods are averaging 30-45 days as opposed to the typical 60 day periods that agencies usually allow for significant rules. The rushed time frames also cause the lawmakers to worry that the “consistency of rules across agencies” will be compromised and that the rules will not contain adequate regulatory flexibility for small businesses. The letter poses eight detailed questions to the financial regulators – the Treasury, Federal Reserve, Commodity Futures Trading Commission, Securities and Exchange Commission, Federal Deposit Insurance Corporation, and Comptroller of the Currency – and asks for their responses no later than March 25, 2011.

Click here for the full text of the letter.

High Stakes Budget Battle for Financial Regulators and Dodd-Frank Proponents

In an abrupt and somewhat anti-climactic fashion, House and Senate Congressional leadership temporarily averted the first government-wide shutdown since 1996 this week, agreeing to a two-week extension of a Continuing Resolution (CR) that will fund government operations through March 18.

With recent public polls showing that neither Democrats nor Republicans would benefit from a protracted budget stalemate, the White House is now ramping up its engagement, as Vice President Joe Biden and Congressional leaders are in the middle of behind-the-scenes negotiations to hammer out a long-term agreement to fund government operations for the remaining seven months of Fiscal Year 2011.

The recent budget deal and the White House’s active engagement may provide relief to some of the roughly 2 million civilian employees on Uncle Sam’s payroll, but don’t tell that to the folks at the Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC). Despite substantial new regulatory responsibilities granted to the agencies under the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111-203, H.R. 4173), both the SEC and CFTC budgets for FY11 and FY12 are under attack.

In February, House Republicans passed an FY11 spending bill that would slash a whopping $56.8 million from the CFTC's current funding levels of $168.8 million; and $25 million from the SEC’s $1.1 billion levels. Aiming to significantly cut federal expenditures and slow down the implementation of Dodd-Frank, GOP lawmakers view these cuts as the best of both worlds.

During Congressional testimony in February, CFTC Chairman Gary Gensler and SEC Chairwoman Mary Shapiro warned that even current funding—FY10 levels due to the passage of CRs—is already forcing their agencies to limit hiring, travel and technology improvements. Both Gensler and Shapiro then testified that the GOP-proposed cuts may even compromise the function of day-to-day operations, let alone the implementation of Dodd-Frank.

As a likely attempt at preempting the FY11 budget discussions, SEC Chairwoman Mary Shapiro is slated to testify in front of the Senate Banking, Housing and Urban Affairs Committee on Thursday to discuss the FY12 budget. President Obama’s FY12 budget proposal calls for the CFTC budget to nearly double from $168 million to $308 million; and the SEC budget to increase from $1.1 billion to $1.4 billion.

The White House and Congressional Democrats are bound to fight proposed cuts to the financial regulators’ coffers tooth and nail. But even if they succeed, Republicans in both the House and Senate will be eager to leverage the power of the purse to influence the regulators’ rules, enforcement actions, and Dodd-Frank implementation efforts moving forward.

Airing of Grievances: Banking Association Heads Continue to Blast Proposed Rule On Interchange Fees

Entitled "The Effect of Dodd-Frank on Small Financial Institutions and Small Businesses,” Wednesday afternoon’s hearing before the House Financial Services Subcommittee on Financial Institutions & Consumer Credit was intended to provide a venue for banking industry leaders to decry the oft-maligned Consumer Financial Protection Bureau (CFPB) and other potential regulatory hurdles stemming from the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111-203, H.R. 4173).

Interchange fees, however, appeared to be all banking industry leaders wanted to talk about—providing the latest signal that the Congressional debate over the controversial “Durbin Amendment” is far from over.

In 2010, the National Association of Federal Credit Unions (NAFCU), the Independent Community Bankers of America (ICBA) and other influential banking industry groups waged a full-scale—albeit unsuccessful—lobbying effort to strip from the Dodd-Frank legislation an amendment offered by Sen. Richard Durbin (D-IL) that would require the Federal Reserve to enact rules to limit the interchange fees paid by retailers and merchants for the acceptance of debit card payments. Although the Durbin amendment attempted to limit the exposure to credit unions and community banks through the inclusion of an exemption for banks with assets of $10 billion or less, witnesses at Tuesday’s hearing say a proposed rule issued by the Fed in December limiting fees from the current 44-cent average to 7-12 cents per transaction would have a “potentially devastating” effect on small financial institutions and consumers.

NAFCU representative John P. Buckley Jr., President and CEO of Gerber Federal Credit Union in Michigan, joined other witnesses in repeating comments made by Fed Chairman Ben Bernanke during a Senate hearing in February that despite the exemption, the new interchange fee limits may force small banks to lower such fees charged to merchants and retailers in order to compete with large banks that will face fee restrictions under the Fed’s rule.

"It is possible that exemption may not be effective in the marketplace," Bernanke told Senate lawmakers last month. At the same hearing, Federal Deposit Insurance Chairwoman Sheila Bair echoed Bernanke’s concerns, stating that she is “skeptical” that small banks will be shielded from the rule.

According to Buckley, President and CEO of Gerber Federal Credit Union in Michigan, the proposed rule is projected to cost Gerber FCU $210,000 per year in lost revenues. For the broader industry, Credit Union National Association President O. William Cheney estimated an annual effect of $1.5 billion in lost revenues.

The Financial Institutions & Consumer Credit subcommittee dedicated an entire hearing on February 17 to the Durbin amendment, in which Fed Governor Sarah Bloom Raskin testified. Raskin acknowledged the potential unintended consequences of the proposed rule and suggested that the final rule—slated for April—may be modified.

If last year’s Dodd-Frank debate proved anything, it’s that the credit union and community banking lobbies have a broad and influential reach in all 50 states and all 435 congressional districts. This issue should receive continued bipartisan attention in the days ahead.

The Impact of Dodd-Frank's "Incentivized" Whistleblower Provisions on Corporate Compliance Programs

Anecdotally, the Securities and Exchange Commission is receiving one or two "high value" whistleblower tips and complaints a day since the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank) statute was signed into law in July 2010. The statute, which enacts sweeping financial regulatory reforms, establishes an expansive whistleblower program. The program provides that a whistleblower, who voluntarily gives “original information” to the SEC that leads to a successful enforcement action with penalties exceeding $1 million, will receive a reward between 10 to 30 percent of the total recovery. To further incentivize whistleblowers, the Act allows for whistleblowers—who can be “any individual,” including corporate insiders, consultants, and service providers—to remain anonymous and cooperate with the SEC through an attorney. The Act also provides robust anti-retaliation protections, which permit federal lawsuits for wrongful termination, suspension, harassment, or other discrimination resulting from the whistleblower’s reporting to the SEC.

In enacting this whistleblower program, Congress sought “to motivate those with inside knowledge to come forward and assist the government to identify and prosecute persons who have violated securities laws and recover money for victims of financial fraud.” But, how does this expanded SEC whistleblower program impact corporate compliance programs, many of which were enacted to combat bribery and corruption in the wake of Sarbanes-Oxley?

Last November, the SEC proposed regulations to implement Dodd-Frank. Although the proposed rules make clear that they are not intended to discourage corporate whistleblowers from first availing themselves of their company’s compliance program, many companies nonetheless fear that the average employee has little or no incentive to provide his or her employer with an opportunity to investigate, and, if necessary, correct and self-disclose alleged wrongdoing. Doing so, after all, likely would eliminate that employee’s prospects of receiving a significant award.

Prior to the passage of Dodd-Frank, the SEC was empowered to reward whistleblowers that helped the government prosecute successful enforcement actions. However, the SEC was not legally obligated to do so. With little incentive to bypass corporate compliance programs, whistleblowers availed themselves of such programs in hopes of motivating the company to address possible wrongdoing. But now, prospective whistleblowers are motivated to do just the opposite, to take advantage of the potential payday that lies ahead.

Those who fear that whistleblowers will now proliferate believe that the SEC should require whistleblowers, in order to be eligible for an award, to use available internal reporting procedures before going to the government. The SEC is not likely to warm to this position, because of the concern that such a requirement will have a chilling effect on the number of legitimate tips. Possible retaliation by employers is very much at the heart of the SEC’s concerns about such an approach.

In response to corporate concerns about Dodd-Frank rendering compliance programs ineffective, the SEC has proposed two rules:

First, the SEC has proposed a 90-day reporting window, which allows an employee to report complaints to internal compliance personnel and still be eligible for the reward if the company, in the whistleblower’s estimation, fails to properly address the complaint. This 90-day grace period also may serve to limit the number of allegations ultimately brought to the SEC, by allowing a company’s internal compliance program time to investigate and possibly ferret out meritless claims.

The challenge, however, is that this grace period may not be enough to temper those who aspire to a big payday and, thus, are less motivated by a desire to see wrongdoing addressed internally. Moreover, 90 days may not be enough time for a company to conduct a thorough investigation, particularly in instances where the allegations implicate a statute such as the Foreign Corrupt Practices Act. Thus, the grace-period proposal ultimately may do little to stem the undermining of corporate compliance programs.

Second, the SEC proposes to take into account, when determining the award amount, whether a whistleblower reported the violation through internal compliance mechanisms before approaching the government. The SEC will consider higher percentage awards for whistleblowers who first report violations through these programs. In effect, then, the SEC seeks to counter any disincentive to internal reporting arising from the prospect of a significant award. (Under this proposed rule, however, whistleblowers who fail to avail themselves of these programs before going to the government will not be penalized, provided that they have a “fear of retaliation or other legitimate reasons.”)

Here, too, skeptics abound. Some commentators on the proposed rules take the position that whistleblowers may opt to “leave money on the table” by bypassing their internal compliance program rather than use those procedures, for fear that the employer might otherwise address the problem altogether or in a manner that minimizes the whistleblower’s potential award. This view hews closely to the position that the SEC mandate use of internal compliance programs in order for whistleblowers to be eligible for an award. Because that position might discourage potential whistleblowers, however, a middle road may be necessary.

One possible solution that has been put forth by some commenting on the proposed rules is to require whistleblowers to report allegations of wrongdoing simultaneously to the government and to the company, assuming the company has implemented and advertised an internal compliance program. Simultaneous reporting would allow the company to investigate the matter, while the SEC defers action until it hears back from the company. A whistleblower would be permitted to bypass reporting to the employer in instances where a legitimate reason, as determined by the SEC, exists.

This middle-of-the-road deferral approach acknowledges the government’s interest in encouraging valid tips and the interests of well-intended companies in being afforded an opportunity to conduct internal investigations that might, where appropriate, stave off unnecessary expenditure of corporate and public resources. Furthermore, because of the simultaneous-reporting requirement, whistleblowers can take comfort in knowing that the government, and not just the company, is aware of their allegations of wrongdoing. Presumably, an employer will think twice about retaliating against a whistleblower, whose identity—or, at a minimum, their legal counsel’s identity—is known to the government. This might very well prove to be a workable, win-win approach.

Absent such an approach, companies can best protect themselves by identifying any potential issues as early as possible through internal audits. Once identified, companies must then respond quickly and definitively to address the problem. Anything short of early and prompt response places the company at risk of government action initiated by a heavily-incentivized whistleblower.

In the Shadow of a Shutdown, the Beat Goes On

Resolving a Federal budget impasse that threatens the first government-wide shutdown since 1995 will undoubtedly be Congress’s top priority when it returns on Monday following a week-long President’s Day recess. But who says lawmakers can’t walk and chew gum at the same time? Below is a preview of next week’s critical financial services hearings on Capitol Hill, as both chambers continue to oversee the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 and discuss various proposals for reforming the housing finance sector.

GSE Reform

Treasury Secretary Timothy Geithner will make his first appearance of the year before the full House Financial Services Committee (HFSC) on Tuesday to discuss the Obama Administration’s long-awaited report to Congress—unveiled on February 11—that details both short-term administration initiatives and long-term options for reforming Government-Sponsored Enterprises (GSEs) Fannie Mae and Freddie Mac. House Republicans have targeted GSE reform as a key agenda item for the 112th Congress, as the HFSC has already conducted three separate hearings related to housing finance this Congress.

In addition, HFSC Chairman Spencer Bachus (R-AL) announced yesterday that his committee will be marking up four separate bills that will seek to terminate Obama administration foreclosure and housing assistance programs that Bachus argues are “doing more harm than good for struggling homeowners.” The Home Affordable Modification Program (HAMP), the Neighborhood Stabilization Program, the FHA Refinance Program, and the Emergency Homeowner Relief Program would all be terminated under the GOP proposals.

Republicans have been particularly critical of HAMP, a program spearheaded in March of 2009 by the Obama administration to assist struggling homeowners avoid foreclosure by providing federal incentives for borrowers, servicers and investors to modify delinquent home loans. HAMP has led to over 500,000 permanently modified home loans, yet has fallen far short of the Obama administration’s initial goal of 3 to 4 million modifications.

Consumer Financial Protection Bureau (CFPB)

On Wednesday, the House Financial Services Subcommittee on Financial Institutions and Consumer Credit – chaired by West Virginia Republican Shelley Moore-Capito – will conduct a hearing entitled "The Effect of Dodd-Frank on Small Financial Institutions and Small Businesses.” The CFPB’s potential impact on U.S. job creation and commercial credit access are likely to dominate the discussion.

The hearing follows the House’s passage on February 19 of a Continuing Resolution (CR) – a bill to fund government operations through September 30, 2011—that would cap the Federal Reserve’s funding for the CFPB at $80 million, representing a steep cut from the $134 million the White House requested for the agency’s FY11 start-up costs. Under the Dodd-Frank legislation, once the CFPB is officially established in July 2011, its funding will derive from the Federal Reserve’s operating expenses budget and could be as high as $500 million in FY12.

During the House budget debate, Chairwoman of the Appropriations Subcommittee on Financial Services Jo Ann Emerson (R-MO) defended the hefty cuts. "Providing half a billion dollars a year without any congressional oversight to the bureau is, I believe, a very irresponsible abdication of a constitutional check and balance," said Emerson.


Newly-minted Chairwoman of the Senate Agriculture, Nutrition and Forestry Committee, Debbie Stabenow (D-MI) will hold a hearing on Thursday to review agency implementation of Dodd-Frank’s provisions related to the regulation of over-the-counter swaps markets.

The hearing will primarily focus on Dodd-Frank’s imposition of enhanced regulatory requirements on the derivative market and its participants, including a requirement for stringent margin and capital requirements for all derivative market participants. During a HFSC oversight hearing on February 15, Commodity Futures Trading Commission Chairman Gary Gensler attempted to alleviate lawmaker and industry concerns that the new derivatives regulations will negatively impact so-called commercial “end-users” – those businesses ranging from farm equipment manufacturers to breweries -- who seek to hedge against interest rates and raw material prices through derivatives contracts. Gensler testified that the CFTC, which has been given broad leeway in determining the businesses who will be exempted under the law, does not intend to target legitimate commercial end-users.

Stay tuned for hearing updates next week.

SEC Rules on Say-on-Pay Votes, Frequency of Say-on-Pay Votes and Votes on Golden Parachute Arrangements Are Effective for the 2011 Proxy Season

On January 25, 2011, the Securities and Exchange Commission ("SEC") adopted amendments to its proxy rules1 to implement the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act relating to the approval by shareholders of executive compensation and "golden parachute" compensation arrangements. Section 951 of the Dodd-Frank Act amended the Securities Exchange Act of 1934 by adding Section 14A, which requires public companies to conduct a separate shareholder advisory vote to approve the compensation of executives (the "say-on-pay" vote), as disclosed pursuant to Item 402 of Regulation S-K, and to permit shareholders to weigh in on how often a company should conduct a shareholder advisory vote on executive compensation (the "frequency of say-on-pay" vote). The SEC's new rules related to "say-on-pay" and "frequency of say-on-pay" votes are effective April 4, 2011. Companies that qualified as "smaller reporting companies"2 as of January 21, 2011 and newly public companies that qualify as smaller reporting companies after January 21, 2011 will not be subject to "say-on-pay" and "frequency of say-on-pay" votes until the first meeting of shareholders at which directors will be elected occurring on or after January 21, 2013.

The Dodd-Frank Act requires separate resolutions subject to a shareholder vote to approve executive compensation and to approve the frequency of say-on-pay votes in proxy statements relating to a public company's first annual or other meeting of the shareholders occurring on or after January 21, 2011. Any proxy statement that is required to include executive compensation disclosure pursuant to Item 402 of Regulation S-K, even if filed prior April 4, 2011, must include the separate resolutions for shareholders to approve executive compensation and the frequency of say-on-pay votes. Public companies will not be required to file proxy materials in preliminary form if the only matters that would require a filing in preliminary form are the say-on-pay vote and frequency of say-on-pay vote.

In addition, the new SEC rules require companies soliciting votes to approve a merger, acquisition, sale of all or substantially all of the assets provide disclosure of certain "golden parachute" compensation arrangements and conduct a separate shareholder advisory vote to approve these golden parachute compensation arrangements. The golden parachute compensation arrangements disclosure and a separate resolution to approve golden parachute compensation arrangements pursuant to new Rule 14a-21(c) are required in merger proxy statements for meetings of shareholders occurring on or after April 25, 2011

Say-on-Pay and Frequency of Say-on-Pay Votes

Approval of Say-on-Pay and Frequency of Say-on-Pay Resolutions

Under new Rule 14a-21(a), a public company is required, not less frequently than once every three calendar years, to provide for a separate shareholder advisory vote to approve the compensation of its named executive officers, as disclosed pursuant to Item 402 of Regulation S-K, including the Compensation Discussion and Analysis ("CD&A"), compensation tables and narrative discussion3.

The final SEC rule does not require companies to use any specific language or form of resolution to be voted on by shareholders. The resolution should indicate that the shareholder advisory vote is to approve the compensation of the company's named executive officers as disclosed pursuant to Item 402 of Regulation S-K. A vote to approve a proposal on a different subject matter, such as a vote to approve only compensation policies and procedures, would not satisfy this requirement. The instruction to Rule 14a-21(a) provides the following non-exclusive example of a resolution that would satisfy Rule 14a-21(a):

RESOLVED, that the compensation paid to the company's named executive officers, as disclosed pursuant to Item 402 of Regulation S-K, including the Compensation Discussion and Analysis, compensation tables and narrative discussion, is hereby APPROVED.4
The compensation of directors is not subject to the shareholder advisory vote. In addition, if a company includes disclosure about its compensation policies and practices as they relate to risk management and risk-taking incentives, these policies and practices will not be subject to the shareholder advisory vote. However, to the extent that risk considerations are a material aspect of the public company's compensation policies or decisions for its named executive officers, then the public company is required to discuss these policies in its CD&A. If this is the case, such disclosure would be considered by shareholders when voting on executive compensation. Finally, in addition to the required say-on-pay and frequency of say-on-pay votes, companies may solicit shareholder votes on a range of compensation matters to obtain more specific feedback on the company's compensation policies and programs.

In addition, under new Rule 14a-21(b), public companies are required, not less frequently than once every six calendar years, to include a separate resolution, subject to shareholder advisory vote, to determine whether the shareholder vote on the compensation of the company's executives should occur every 1, 2, or 3 years. The separate shareholder vote on executive compensation and frequency of say-on-pay votes are required only when proxies are solicited for an annual or other meeting of security holders at which directors will be elected and for which the SEC rules require the disclosure of executive compensation pursuant to Item 402 of Regulation S-K.

Public companies are required to disclose in a proxy statement for an annual meeting (or other meeting of shareholders at which directors will be elected and for which the SEC rules require executive compensation disclosure) that they are providing a separate shareholder say-on-pay and the frequency of say-on-pay votes pursuant to the Dodd-Frank Act and to briefly explain the general effect of the vote, such as whether the vote is non-binding. Companies should also provide disclosure of the current frequency of say-on-pay votes and when the next scheduled say-on-pay vote will occur in their proxy materials. Public companies are not expected to disclose either the current frequency or when the next scheduled say-on-pay vote will occur in proxy materials for the meeting where a company initially conducts the say-on-pay and frequency votes.

The SEC rules also provide requirements as to the form of proxy that public companies are required to include with their proxy materials with respect to the frequency vote. The amended rules require proxy cards to reflect the choice of 1, 2, or 3 years (or every year, every other year or every three years), or abstain, for the frequency of say-on-pay vote.

Amendments to Compensation Discussion and Analysis Requirements

The SEC amended the CD&A requirements to clarify that one of mandatory principles-based topics to be discussed in the CD&A should be the company's consideration of the most recent say-on-pay vote. Such mandatory topic should focus on whether, and if so, how the public company has considered the results of the most recent say-on-pay vote in determining compensation policies and decisions, and how that consideration has affected the company's executive compensation policies and decisions. Public companies should address their consideration of the results of earlier say-on-pay votes to the extent such consideration is material to the company's compensation policies and decisions discussed.

Smaller reporting companies are subject to scaled disclosure requirements in Item 402 of Regulation S-K and are not required to include a CD&A. Smaller reporting companies are required to provide a narrative description of any material factors necessary to an understanding of the information disclosed in the Summary Compensation Table. If the consideration of prior say-on-pay votes is such a factor for a particular public company, disclosure of this fact would be required in the narrative description accompanying the Summary Compensation Table.

Shareholder Proposals

Rule 14a-8(i)(10) permits a public company to exclude a shareholder's proposal if the company has already substantially implemented the proposal. Under certain conditions, a public company may exclude subsequent shareholder proposals that seek a vote on the same matters as the shareholder advisory votes on say-on-pay and frequency of say-on-pay. The SEC added a note to Rule 14a-8(i)(10) to permit the exclusion of a shareholder proposal that would provide a say-on-pay vote, seeks future say-on-pay votes, or relates to the frequency of say-on-pay votes if, in the most recent shareholder vote on frequency of say-on-pay votes, a single frequency (i.e., one, two or three years) received the support of a majority of the votes cast5 on the matter and the company adopted a policy on the frequency of say-on-pay votes that is consistent with the shareholders' choice. For example, if in the first vote under Rule 14a-21(b) a majority of votes were cast for a two-year frequency for future shareholder votes on executive compensation, and the public company adopts a policy to hold the vote every two years, a shareholder proposal seeking a different frequency could be excluded so long as the company seeks votes on executive compensation every two years.

A shareholder proposal that would provide an advisory vote or seek future advisory votes on executive compensation with substantially the same scope as the say-on-pay vote should also be subject to exclusion if the company adopts a policy that is consistent with the majority of votes cast. Like additional frequency votes, the note to Rule 14a-8(i)(10) conditions exclusion on the public company implementing the frequency favored by a majority of shareholders.

Amendment to Form 8-K

Item 5.07 of Form 8-K currently requires a public company to disclose the results of its shareholders' meeting and to indicate the number of votes cast for, against, or withheld, as well as the number of abstentions and broker non-votes as to each matter on which shareholders voted at the meeting. Under the amended Item 5.07, with respect to the vote on the frequency of say-on-pay votes, the company is required to disclose the number of votes cast for each of 1 year, 2 years, and 3 years options, as well as the number of abstentions.

Amended Item 5.07 of Form 8-K also requires each public company to disclose its decision regarding how frequently it will conduct shareholder advisory votes on executive compensation. To comply with this new requirement related to the Board's decision regarding the frequency of the shareholder vote on executive compensation, a public company will have to file an amendment to its prior Form 8-K filing under Item 5.07 that disclosed the results of the shareholder vote on frequency no later than 150 calendar days after the date of the end of the annual or other meeting at which such vote took place, but in no event later than 60 calendar days prior to the deadline for the submission of shareholder proposals under Rule 14a-8 for the coming annual meeting.

Item 5.07 is not among the list of items subject to the safe harbor from liability under the Exchange Act. Companies that fail to file a timely report required by Item 5.07 will lose their eligibility to file Form S-3 registration statements.

Filing a Preliminary Proxy Statement for Say-on-Pay and Frequency Votes is Not Required

The SEC amended its rules to exclude shareholder votes to approve executive compensation and the frequency of shareholder votes on executive compensation, from the preliminary proxy statement filing requirement.

Approval and Disclosure of Golden Parachute Arrangements

Approval of Golden Parachute Arrangements

The SEC adopted new Rule 14a-21(c), pursuant to which a public company is required to include a separate resolution, subject to shareholder advisory vote, in a proxy statement for a meeting at which shareholders are asked to approve an acquisition, merger, consolidation, or proposed sale or other disposition of all or substantially all assets of the company, to approve any agreements or understandings and compensation disclosed pursuant to Item 402(t) of Regulation S-K (referred to as golden parachute arrangements). Any agreements or understandings between an acquiring company and the named executive officers of the registrant, where the registrant is not the acquiring company, are not required to be subject to the separate shareholder advisory vote.

Generally, the disclosure of golden parachute arrangements under Item 402(t) is not required to be included in annual meeting proxy statements. However, some public companies may choose to include this information because such companies will not be required to include in the merger proxy a separate shareholder vote on the golden parachute compensation if the same golden parachute compensation was included in the executive compensation disclosure that was subject to a prior say-on-pay vote.6

New golden parachute arrangements and any revisions to golden parachute arrangements that were subject to a prior say-on-pay vote require a separate merger proxy shareholder vote.7 However, changes that result only in a reduction in value of the total compensation payable would not require a new shareholder vote. Examples of changes requiring a new vote include: changes in compensation because of a new named executive officer, additional grants of equity compensation in the ordinary course, and increases in salary.

Companies providing for a shareholder vote on new arrangements or revised terms will need to provide two separate tables in merger proxy statements. One table will disclose all golden parachute compensation, including both arrangements and amounts previously disclosed and the new arrangements or revised terms. The second table will disclose only the new arrangements or revised terms subject to the vote, so that shareholders can clearly see what is subject to the shareholder vote. Similarly, in cases where Item 402(t) requires disclosure of arrangements between an acquiring company and the named executive officers of the soliciting target company, companies will need to clarify whether these agreements are included in the shareholder advisory vote by providing a separate table of all agreements and understandings subject to the shareholder advisory vote, if different from the full scope of golden parachute arrangements disclosed under Item 402(t).

Disclosure of Golden Parachute Arrangements

The SEC adopted the new Item 402(t) of Regulation S-K to require disclosure of named executive officers' golden parachute arrangements in both tabular and narrative formats. The required table is included as Exhibit A hereto. In the event uncertainties exist as to the provision of payments and benefits, or the amounts involved, a public company is required to make a reasonable estimate applicable to the payment or benefit and disclose material assumptions underlying such estimate in its disclosure. Item 402(t) does not permit the disclosure of an estimated range of payments.

The tabular disclosure required by Item 402(t) requires quantification with respect to any agreements or understandings, whether written or unwritten, between each named executive officer and the acquiring company or the target company, concerning any type of compensation, whether present, deferred or contingent, that is based on or otherwise relates to an acquisition, merger, consolidation, sale or other disposition of all or substantially all assets.

Item 402(t) also requires companies to describe any material conditions or obligations applicable to the receipt of payment, including but not limited to non-compete, non-solicitation, non-disparagement or confidentiality agreements, their duration, and provisions regarding waiver or breach. Public companies are also required to provide a description of the specific circumstances that would trigger payment, whether the payments would be lump sum, or annual, and their duration, and by whom the payments would be provided, and any material factors regarding each agreement. Such material factors would include, provisions regarding modifications of outstanding options to extend the vesting period or the post-termination exercise period, or to lower the exercise price.

Item 402(t) does not require disclosure or quantification of previously vested equity awards because these award amounts are vested without regard to the transaction. Also, the SEC rules do not require tabular disclosure and quantification of compensation from bona fide post-transaction employment agreements to be entered into in connection with the merger or acquisition transaction. However, information regarding such future employment agreements is subject to disclosure pursuant to Item 5 of Schedule 14A to the extent that such agreements constitute a "substantial interest" in the matter to be acted upon.

A public company may choose to include the disclosure in the annual meeting proxy statement to qualify for the exception from the separate merger proxy vote. If the golden parachute disclosure is included in an annual meeting proxy statement, the price per share amount will be calculated based on the closing market price per share of the company's securities on the last business day of the public company's last completed fiscal year. In a proxy statement soliciting shareholder approval of a merger or similar transaction, the tabular quantification of dollar amounts based on the company's stock price will be based on the consideration per share, if such value is a fixed dollar amount, or otherwise on the average closing price per share over the first five business days following the first public announcement of the transaction.

In addition, a company seeking to satisfy the exception from the separate merger proxy shareholder vote by including Item 402(t) disclosure in an annual meeting proxy statement soliciting the say-on-pay vote will be able to satisfy Item 402(j) disclosure requirements8 with respect to a change-in-control of the public company by providing the disclosure required by Item 402(t). The public company must still include in its annual meeting proxy statement disclosure in accordance with Item 402(j) about payments that may be made to the named executive officers upon termination of employment.

EXHIBIT A: Golden Parachute Compensation

  1. See SEC Release No. 34-63768, Shareholder Approval of Executive Compensation and Golden Parachute Compensation (Jan. 25, 2011) at and SEC Compliance and Disclosure Interpretations dated February 11, 2011 at
  2. A smaller reporting company is generally a company that had a public float of less than $75 million as of the last business day of its most recently completed second fiscal quarter.
  3. Smaller reporting companies are not required to provide a CD&A in order to comply with this requirement. Smaller reporting companies may include supplemental disclosure to facilitate an understanding of their compensation arrangements in connection with say-on-pay vote.
  4. The SEC has provided guidance that the following plain English version of the resolution is also permissible:   RESOLVED, that the compensation paid to the company's named executive officers, pursuant to the compensation disclosure rules of the Securities and Exchange Commission, including the compensation discussion and analysis, the compensation tables and any related material disclosed in the proxy statement, is hereby APPROVED.
  5. In light of the nature of the vote—with three substantive choices—it is possible that no single choice will receive a majority of votes and that, as a result, there may be companies that may not be able to exclude subsequent shareholder proposals regarding say-on-pay matters even if they adopt a policy on frequency that is consistent with plurality of votes cast. In addition, for the purposes of this analysis, an abstention would not count as a vote cast. This voting standard applies only to determine whether the exclusion of the proposal is appropriate under Rule 14a-8(i)(10) and not to determine whether a particular voting frequency was adopted pursuant to state law.
  6. The exception will be available only to the extent the same golden parachute arrangements previously subject to an annual meeting shareholder vote remain in effect, and the terms of those arrangements have not been modified subsequent to the say-on-pay shareholder vote.
  7. If the disclosure pursuant to Item 402(t) has been updated to change only the value of the items in the Golden Parachute Compensation Table to reflect price movements in the company's securities, no new shareholder advisory vote will be required. Any change that would result in an IRC Section 280G tax gross-up becoming payable would be viewed as a change in terms triggering such separate vote, even if such tax gross-up becomes payable only because of an increase in the company's share price.
  8. Item 402(j) requires this disclosure of potential payments upon termination of executive's employment or change-in-control of the company.

The CFPB Versus Congressional Appropriators: Round One

In prepared remarks before the 75th anniversary celebration of the Consumers Union on Tuesday, the Assistant to the President and Special Advisor to the Secretary of the Treasury on the Consumer Financial Protection Bureau (CFPB)—Elizabeth Warren— took the opportunity to counter ongoing attacks levied on the new agency from Congressional Republicans who, as Warren says, “are still trying to chip away at its independence.”

Warren’s comments yesterday specifically referenced the escalating efforts by House Republicans’ to strip the CFPB of its independent funding through the Federal Reserve, moves that appear to be the GOP’s most potent tools at increasing Congressional oversight of the CFPB and curbing its wide-ranging regulatory authority over both banks and non-banks.

As signed into law, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Pub.L. 111-203, H.R. 4173) contains provisions intended to insulate the CFPB politically by funding it outside of the Congressionally-approved discretionary spending process. Instead, the CFPB, once fully established on July 21, 2011, will possess a dedicated funding source through a set percentage of the Fed’s operating budget – resulting in an annual budget as high as $450-$500 million, or nearly double the Federal Trade Commission’s (FTC) budget for Fiscal Year 2010.

Last week, Rep. Randy Neugebauer (R-TX), Chairman of the Financial Services Subcommittee on Oversight and Investigations and one of the most ardent CFPB critics on Capitol Hill, introduced H.R.557, the Consumer Financial Protection Oversight Act of 2011, which would remove the CFPB from the Fed and transfer it over to the U.S. Treasury Department. According to Neugebauer, “Given the significant and perhaps over-regulating powers the CFPB has been given by the Obama Administration, Congress must have a say on the appropriation of taxpayer money funding this agency’s operation.”

As shorter-term strategy, House Republicans have also included a provision within H.R.1, the Full Year Continuing Appropriations Act —a must-pass piece of legislation that will fund government operations through FY11—that would limit the initial funding for the CFPB to $80 million, which represents a steep cut from the $134 million the White House requested for the agency’s start-up costs.

However, Warren warned during her Consumer Union remarks that such efforts to weaken the CFPB’s independence would diminish the agency’s ability to perform its regulatory functions.

“Politicizing the funding of bank supervision would be a dangerous precedent, and it would deprive the CFPB of the predictable funding it will need to examine large and powerful banks consistently and to provide a level playing field with their nonbank competitors,” said Warren. “While the banking regulators charged with preserving the safety and soundness of financial institutions and ensuring consumer protection compliance by smaller banks would continue to receive independent funding, the agency in the financial regulatory system with lead responsibility for protecting consumers would face a different set of rules - rules that threaten its independence.”

Although the CFPB funding debate is currently drawn on strictly partisan lines, the issue touches on a larger debate surrounding Congress’s oversight role over federal agencies and its inherent powers over the federal purse. The GOP’s position may appeal to moderate Democratic appropriators –particularly those on the Senate side – who could support a larger Congressional role in the CFPB budget process in order to preserve Congress’s spending prerogatives.

It’s still too early to tell where this debate will go – but one thing is certain: Congressional Republicans are on the attack, and Elizabeth Warren and the Obama administration will be forced into playing defense in the critical days ahead for the CFPB.

HR 557 - Consumer Financial Protection Bureau Funding (PDF)

The Impact of the Dodd-Frank Bill on Corporate Governance

DealFlow Media’s 2nd Annual Activist Investor Conference
New York City
January 27, 2011
9:00 a.m.-9:50 a.m.

Keith E. Gottfried, partner in Blank Rome's shareholder activism group, will be speaking on a panel at DealFlow Media’s 2nd Annual Activist Investor Conference on "The Impact of the Dodd-Frank Bill on Corporate Governance" on Thursday, January 27, 2011, from 9:00 a.m. to 9:50 a.m. at the Westin Times Square in New York City.

Mr. Gottfried's panel will discuss the Dodd-Frank legislation—including the changes it has created in the regulatory landscape—and its vast and evolving importance for activists and other investors. The panel will also examine how new rules bring new responsibilities, and liabilities, to management and directorships.

DealFlow Media is the publisher of the Activist Investor Alert and its 2nd Annual Activist Investor Conference, held January 27 and 28, brings together corporate managers, investors, proxy advisors, and legal representatives from all sides for a 360 degree view of activist investment strategies and their impact on corporate performance and returns. The event examines topics vital to both investors and corporate boards, including the following panel presentations:

  • A Review of the Objectives and Tactics of Hedge Fund Activists
  • Responding to Investor Activism: Running a Successful Proxy Response Campaign
  • Valuations & the Cost of Investing: Are Stocks Still Cheap?
  • Assessing the Vulnerability of a Board of Directors
  • Case Studies: Examining Campaigns against Nabors, Abercrombie & Fitch and Dell
  • Proxy Fights in Canada: Activism North of the Border
  • Executive Compensation: How Much is Enough?
  • The Perils of Being a Lone Dissident Board Member
  • Retail Investor Targeting
  • Who Wants to Be an Activist Millionaire?
  • Closed End Fund Activism
  • The Poison Pill: Examining Successful Corporate Defenses Using Good Corporate Governance to Affect Your Strategy

More information about DealFlow Media’s 2nd Annual Activist Investor Conference is available at

Meet the Next Chairman

At a closed-door House Republican conference meeting today, nine-term Congressman Spencer Bachus (R-AL) was selected by his colleagues to chair the House Financial Services Committee when Republicans assume power come January.

In the 112th Congress, Bachus will likely continue his conservative voting record and fulfill his stated intentions to make GSE reform and the reexamination of the Dodd-Frank Wall Street Reform and Consumer Protection Act (H.R. 4173) —particularly the provisions related to the newly-established Consumer Financial Protection Bureau (CFPB) and derivatives regulation—his top priorities.

Bachus has reserved some of his most pointed criticism for the CFPB, which he fiercely opposed during the congressional Dodd-Frank debate, and has often referred to as the “Credit Allocation Bureau.” In late November, Bachus joined fellow committee colleague, Rep. Judy Biggert (R-IL), in sending letters to the inspector generals of both the Treasury Department and the Federal Reserve, directing them to conduct an investigation and issue reports to Congress regarding the work currently being done by Treasury, the Fed and White House special advisor, Elizabeth Warren, to establish the CFPB. The letters cite "a clear absence of accountability and transparency" regarding the CFPB’s implementation and thus requires "rigorous" administration oversight. Bachus’s recent letters are part of a broader effort to “reinvigorate the committee’s oversight role,” in the next Congress. Bachus is expected to join with fellow Republican Darrell Issa (CA), the incoming chairman of the House Oversight and Government Reform Committee, to quickly initiate Dodd-Frank oversight hearings in 2011.

Although Bachus has served as the committee’s top Republican since beating out Howard Baker (R-LA) in 2006 and was considered the leading contender for the chairmanship, he was challenged this week by senior committee member Ed Royce (R-CA). However, Bachus was assisted by significant support from his senior Republican colleagues, as six senior Financial Services subcommittee members and the vice chairman all signed a letter on November 5 supporting his candidacy.

Bachus will replace outgoing Chairman Barney Frank (D-MA), who is expected to reassume the role of ranking member, a position he last held in 2006.

The View from November 3rd

The results of the 2010 mid-term elections are now in, meaning it’s time to begin analyzing what a new Republican House majority and a more narrowly divided Democratic Senate majority will represent for financial reform efforts in the 112th Congress.

Speaking to reporters this morning, House Minority Leader and likely the next Speaker of the House, John Boehner (R-OH), appeared to tone down previous calls by him and fellow GOP colleagues for a repeal of the Dodd-Frank Wall Street Reform and Consumer Protection Act, instead expressing his caucus’s intention to begin closely scrutinizing the implementation of the sweeping financial reform legislation through aggressive oversight. The GOP is expected to focus its sights on the following—the newly-created Consumer Financial Protection Bureau (CFPB); FDIC resolution authority that allows the agency to wind down failing financial institutions; and new rules governing financial derivatives. Republican gains in both the House and Senate will almost assuredly nix President Obama’s ability to usher through the Senate a potential nomination of Elizabeth Warren as a permanent director of the CFPB.

Despite the GOP’s renewed focus on overseeing and potentially repealing certain provisions of Dodd-Frank, a Democratic-controlled White House and Senate will still significantly hamper Republicans’ ability to pass any broad or sweeping changes. The most viable tool at Republicans’ disposal will be the power of the purse, as attempts could be made to prevent Dodd-Frank’s implementation through the withholding of federal appropriations to certain agencies. However, from a political standpoint, it remains to be seen whether the new House majority will risk being viewed by the electorate as proponents of Wall Street deregulation when looking ahead to 2012.

In addition to the oversight of Dodd-Frank, the looming congressional battle and the top legislative priority for the House Financial Services and Senate Banking Committees will be the reform of the U.S. housing finance system, particularly the Government Sponsored Enterprises (GSE), Fannie Mae and Freddie Mac.

In terms of key committee leadership posts, the top contender for the chairmanship of the House Financial Services Committee appears to be current ranking member Spencer Bachus (R-AL), who has served as the committee’s ranking Republican since beating out Howard Baker (R-LA) in 2006. Bachus possesses a conservative voting record and has stated his intention to make GSE reform and the reexamination of the Dodd-Frank bill—particularly the provisions related to the CFPB and derivatives regulation—his top priorities. The other potential contenders for the chairmanship include Ed Royce (R-CA) and Scott Garrett (R-NJ), although Garrett told reporters today that he expects Bachus to be chairman. Top Democrat Barney Frank (D-MA) is also expected to reassume the role of ranking member, a position he last held in 2006.

Aside from the transition in leadership, the committee will also lose at least 16 of its members due to reelection losses or retirements (13 Democrats and 3 Republicans). Of those 16, the most prominent committee member that will not be returning in January is the chairman of the Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, Paul Kanjorski (D-PA), who lost his bid for a 14th term on Tuesday. Currently, Gary Ackerman (D-NY) is next in line to assume the ranking member position on the subcommittee, which will play an outsized role in the pending GSE debate. Garrett—a vocal critic of the GSEs in their current form—is next in line to chair the subcommittee.

Joining Kanjorski, the following Democratic committee members also lost their races for reelection: Ron Klein (FL), Charlie Wilson (OH), Bill Foster (IL), Travis Childers (MS), Walt Minnick (ID), John Adler (NJ), Mary Jo Kilroy (OH), Steve Driehaus (OH), Suzanne Kosmas (FL) and Alan Grayson (FL).

Over in the Senate, three members of the Senate Banking Committee will be retiring at the end of 2010, including committee Chairman Christopher Dodd (D-CT), subcommittee chairman Evan Bayh (D-IN) and subcommittee ranking member Jim Bunning (R-KY). In addition, Robert Bennett (R-UT) lost his Republican primary for reelection in May. With Dodd’s pending departure, Tim Johnson (D-SD) appears slated to assume the chairmanship, with Richard Shelby (R-AL) retaining the ranking member post. Although Johnson’s chairmanship in the Senate appears secure, senior committee member Jack Reed (D-RI) has also been named as a potential contender. The narrowed Democratic majority of one or two seats on the committee will heighten the need for bipartisanship and ultimately grant moderate members such as Mark Warner (D-VA) and Bob Corker (R-TN) with greater influence moving forward.

Stay tuned in the days ahead as Financial Reform Watch continues to make sense of Tuesday’s historic election results.

Retiring Senate Banking Committee Chairman Predicts Tough Road Ahead for a Director-Less CFPB

Perhaps no section of the sweeping Dodd-Frank Wall Street Reform and Consumer Protection Act is more controversial on both Capitol Hill and within the financial industry than that which creates an independent Consumer Financial Protection Bureau (CFPB)—and according to the outgoing Senate Banking Committee Chairman, until the President nominates and the Senate confirms a permanent CFPB director, the entire bureau may be at risk in the next Congress.

“Look, this was a controversial section of the bill—don’t have any illusions,” said Chairman Christopher Dodd (D-CT) in reference to the CFPB during a Banking Committee hearing yesterday that received testimony from the heads of the various financial regulatory agencies. “Regardless of the outcome of the election in November, there are going to be people trying to get rid of this bureau, and it’s going to be a lot easier to get rid of it if it hasn’t gotten up and gotten started demonstrating the value and importance of it. So it’s at risk in my view, until we get someone in running the place and demonstrating what it can do and the kind of rules it’s going to develop.”

President Obama’s decision on September 16 to temporarily appoint Elizabeth Warren as "special adviser" to the President and the Treasury Secretary for standing up the CFPB has failed to appease Chairman Dodd, who has repeated such ominous warnings to the administration over the past few months. When taking the newly emboldened GOP and their recent rhetoric into account, Dodd’s sentiments don’t appear to be overstated.

During yesterday’s hearing, Ranking Member Richard Shelby (R-AL), stated his belief that changes to Dodd-Frank are “inevitable” as lawmakers, “when necessary, visit the law and make changes consistent with our findings and the demands of the electorate.” More directly, at a Reuters Washington Summit last week, Shelby referred to the CFPB as a “mistake” and stated his intention to revisit the issue if he assumes the committee chairmanship with a Republican takeover of the Senate in November.

The feelings appear to be mutual for Shelby’s counterpart in the House and the potential Financial Services Committee Chairman in waiting, Spencer Bachus (R-AL), who has continued to lob sharp criticism at the CFPB, referring to it in speeches as the “Credit Allocation Bureau.” In mid-September, GOP leaders even sent a pre-election signal that January can’t come soon enough for their caucus, as House Appropriations Committee Ranking Member Jerry Lewis (R-CA) led an unsuccessful GOP attempt to block funding for the Treasury to implement the Dodd-Frank provisions.

Responding to Dodd’s call for action, Deputy Treasury Secretary Neal Wolin attempted to underscore the administration’s sense of urgency yesterday, testifying that President Obama will formally nominate a CFPB Director “soon” and that “he’s reviewing candidates right now.”

Top Financial Regulators Set to Begin Examining Systemic Risk

Treasury Secretary Tim Geithner announced this morning that the newly-created Financial Stability Oversight Council (FSOC) will hold its inaugural meeting on October 1 at the U.S. Treasury Department.

A centerpiece of the Dodd-Frank Wall Street Reform and Consumer Protection Act (H.R. 4173), the FSOC consists of the nation’s top financial regulators and is charged with identifying and responding to systemic risks posed by large and interconnected bank holding companies and non-bank financial companies to the broader U.S. financial system. Proponents of the legislation believe that the FSOC’s broad oversight authority is necessary in order to eliminate the reoccurrence of “too-big-to fail” in the U.S. financial and political arenas.

Geithner, who will serve as the FSOC chairperson, will be joined in the meeting by seven voting members and three non-voting membership. Conspicuously absent from the list is Elizabeth Warren, who is serving in her new role as “Special Advisor” to the White House to help stand-up the Consumer Financial Protection Bureau (CFPB), and who presumably, cannot participate in the FSOC without the formal title of CFPB Director. Once a CFPB director is nominated and confirmed by the Senate, he or she will be voting member of the FSOC as pursuant to H.R. 4173. The law also states that the FSOC will meet at least on a quarterly basis.

Many in the financial industry are continuing to express significant concerns surrounding the powers of the FSOC’s research and analysis arm—the Office of Financial Research (OFR)—which is granted broad authority to collect information, including sensitive data, from regulatory agencies, bank holding companies, and non-bank financial companies to help the FSOC assess various risks to the U.S. financial system. The OFR will be led by a director appointed by the president and confirmed by the Senate, who will serve a six-year term. The OFR is bound to be a topic of discussion during next week’s FSOC meeting.

Below is a list of the FSOC’s voting and non-voting members that are expected to participate on October 1:

Voting Members
Ben Bernanke — Chairman of Federal Reserve
John Walsh — Acting Comptroller of the Currency
Mary Schapiro — Chairwoman of the U.S. Securities and Exchange Commission
Sheila Bair — Chairwoman of the Federal Deposit Insurance Corporation
Gary Gensler — Chairman of the Commodity Futures Trading Commission
Edward J. DeMarco — Acting Director of the Federal Housing Finance Agency
Debbie Matz — Chairman of the National Credit Union Administration

Non-Voting Members
John M. Huff — Director of the Missouri Department of Insurance, Financial Institutions, and Professional Registration
William S. Haraf — Commissioner of the California Department of Financial Institutions
David S. Massey — Deputy Securities Administrator of the North Carolina Department of the Secretary of State, Securities Division

Dodd Frank Act Means Major Changes for Public Companies

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). The Act provides the most sweeping overhaul of the regulation of the U.S. financial services industry and financial markets since the aftermath of the Great Depression. The Act represents Congress’ attempt to address the myriad of issues arising out of the financial crisis and marks the conclusion of over a year’s effort to craft a legislative solution designed to avoid another financial crisis. The legislation requires an overhaul of the regulatory landscape and establishes a new regulatory scheme to govern certain public companies, banks, insurance companies, hedge funds, as well as other companies in the financial services industry.

The new legislation is designed to address systemic risk in the U. S. financial system and remediate the “too big to fail” issues which required government bailouts of several large financial services companies during the financial crisis. The legislation also implements new corporate governance and disclosure requirements applicable to public companies, increases the regulatory requirements applicable to banks, insurance companies and hedge funds and subjects certain large financial services companies to regulation by the Federal Reserve Board (the “FRB”).

The new legislation adds several new corporate governance and disclosure requirements applicable to companies listed on U.S. stock exchanges and in some instances, other publicly-traded companies, including:

  • a requirement for having a non-binding shareholder vote on compensation of specified executive officers and in certain instances golden parachute provisions;
  • a requirement for more stringent rules and disclosure applicable to compensation committees;
  • a requirements for additional disclosure requirements related to executive compensation;
  • the elimination of discretionary voting by brokers in connection with the election of directors, executive compensation issues or other significant matters;
  • authorization for the SEC to adopt rules related to proxy access; and
  • a requirement to adopt clawback policies with respect to employment arrangements of executives of companies seeking to list on a U.S. stock exchange.

In most instances, the foregoing regulatory requirements, which are discussed in greater detail below, require additional rule making by the SEC or the national securities exchanges to fully implement these changes.

The Act imposes enhanced regulation on the derivatives market, and the participants in this market, including public companies and requires approval of the appropriate committee for derivative activities will be required. The Act also provides for additional changes impacting public companies, including new benefits for whistleblowers, expanded liability for securities violations, increased restrictions on short sales, relief for non-accelerated filers and smaller reporting companies from obtaining auditor attestation of internal controls, disclosure of votes by institutional managers, requirements related to credit rating agencies and committee approval for derivative activities.

This post highlights certain of the more significant changes resulting from the new legislation generally applicable to public companies. These changes will impact disclosure and other requirements, many of which will be applicable for the 2011 proxy season. This post does not cover changes in banking law, hedge fund requirements and requirements applicable to derivatives and credit unions affected by the Act that may indirectly impact public companies. Changes to SEC Regulation D which impact private offerings of securities by public companies are discussed in more detail in our previous post on July 26.

Regulatory Changes Impacting Proxy Statement Disclosures and the Annual Meeting Process

Say-on-Pay and Golden Parachute Proposals. Beginning six months after the enactment of the Act, public companies will be required to provide in their annual proxy statement, at least once every three years, a non-binding shareholder vote approving executive compensation. The non-binding shareholder vote on this proposal, which has been called a “say-on-pay” proposal, does not override board decisions in this regard, does not create or imply any change to fiduciary duties of the board of directors, and will not preclude shareholder compensation proposals1. In addition, at the first shareholders’ meeting to which this requirement will apply, each public company must include another shareholder proposal in its proxy materials which permits shareholders to determine the frequency of the inclusion of a “say-on-pay” proposal, in its proxy materials (i.e., every year, every two years, or every three years). Companies must also provide a vote, at least every six years, on whether the “say-on-pay” vote will occur every one, two or three years.

In addition to the say-on-pay proposal, whenever shareholders are asked to approve an acquisition, merger, consolidation or sale or other disposition of all or substantially all of a company’s assets at a meeting occurring six months after the enactment of the Act, the company or the person soliciting proxies must disclose in the related proxy statement or information statement any agreements or understandings concerning compensation payable to named executive officers as a result of such transaction, referred to as a “golden parachute payment,” and shareholders will have a separate non-binding vote to approve such payments2. The disclosure must include the aggregate total of all such compensation and the conditions upon which it may be paid to, or on behalf of, an executive officer of the public company. Similar to the “say-on-pay” proposal previously described, the results of this vote do not override board action or affect the board’s fiduciary duties under state law.

New Compensation Committee Requirements. Within 360 days of enactment of the Act, the SEC is required to instruct the exchanges to adopt rules that, in effect, mandate that compensation committees consist only of independent directors3. “Independence” is to be defined, but such definition must take into consideration any consulting or other fees paid by the issuer to a committee member and whether the committee member is an affiliate of the issuer. Compensation committees will also have the authority to engage independent consultants and counsel at the issuer’s expense, but must first consider factors to be identified by the SEC affecting independence4. These factors must include the following:

  • the provision of other services to the public company by the person that employs the advisor;
  • the amount of fees received from the public company by the person that employs the advisor and the percentage such fees represent of the person’s net total revenue;
  • the policies and procedures of the person that employs the advisor, which are designed to prevent conflicts of interest;
  • any business or personal relationships between the advisor and any member of the compensation committee; and
  • any stock of the public company owned by the advisor.

Proxy statements for meetings occurring one year after enactment of the Act will have to disclose whether a compensation consultant was engaged, whether there were any conflicts of interest and how they were addressed. These new requirements will place more emphasis on director independence and highlight conflicts of interests occurring with compensation consultants.

Additional Executive Compensation Disclosures. Public companies will be required to disclose in annual proxy statements the relationship between executive compensation and financial performance, taking into account any change in stock value and dividends paid (which may be done in a graph), and also must disclose (i) median compensation of all employees (excluding the CEO); (ii) CEO compensation; and (iii) the ratio of median employee compensation to CEO compensation. This provision will be implemented by amendment to the SEC’s rules but the Act does not specify any timeframe required for the SEC’s adoption of such amendments.

Disclosure Related to the CEO/Chairman Structure. The SEC must issue rules that require public companies to disclose in annual proxy materials sent to shareholders the reasons why the company chose:

  • to have the same person serve as Chairman of the Board of Directors and CEO; or
  • different individuals to serve as Chairman of the Board of Directors and CEO5.

The SEC previously promulgated similar disclosure requirements related to this issue and many companies have already addressed this disclosure. Other companies separated these two positions or have elected a lead director as this has long been considered a best practice in corporate governance.

Limits on Discretionary Voting by Brokers. The Act requires that the national securities exchanges adopt rules prohibiting brokers from voting shares held in “street name” on the election of directors, executive compensation or any other “significant matter” as determined by the SEC by rule unless the brokers have received voting instructions from the beneficial owner of the securities. The Act does not specify a timeframe for the adoption of rules related to this requirement, however, it is anticipated that these rules will be adopted and effective for the 2011 proxy season.

Proxy Access. The Act provided the SEC with the authority to adopt rules permitting shareholders of a public company, under specified circumstances, to utilize the company’s proxy solicitation materials to nominate directors submitted by the shareholders.6 The SEC has the discretion to determine the eligibility requirements shareholders must meet to utilize the company’s proxy statement to nominate directors. Given that the shareholder proxy access debate has raged for years, this requirement of the new law should come as no surprise as the SEC, on several occasions, has previously proposed rules addressing this issue, including proxy access rules proposed as recently as June 2009. Accordingly, SEC Chairman Mary Schapiro has indicated in a recent speech that the SEC intends to adopt rules related to proxy access that will be in effect for the 2011 proxy season.

New Hedging Disclosure. Public companies will be required to disclose in their annual proxy statements whether any employee or director is permitted to purchase financial instruments that are designed to hedge or offset any decrease in the market value of the company’s securities (i) granted to the employee or director by the company as compensation or (ii) otherwise held directly or indirectly by the employee or director. Although the Act requires the SEC to adopt rules on hedging disclosures, no timeframe for the adoption of such rules was specified in the Act.

Additional Changes Impacting Public Companies

Amendments to Regulation D Governing Private Offerings. Rules under the Securities Act of 1933, as amended (the “Securities Act”), provide for a series of tests to determine whether an investor is an “accredited investor.” The legislation requires the SEC to amend any of the net worth standards to exclude the value of the investor’s primary residence from the calculation of net worth7 and to provide for a periodic adjustment of the $1 million threshold beginning four years after the date of the legislation’s enactment. These changes which are effective immediately are discussed in detail in Blank Rome Corporate and Securities Alert No. 4.

The law also authorizes the SEC to undertake a review of the accredited investor tests that apply to natural persons, other than the net worth standard, to determine whether the requirements of the definition should be adjusted in light of the public interest, the protection of investors and the economy. The SEC may make changes to the rule, other than the net worth standard, as it deems appropriate, taking these considerations into account.

Beginning four years after the date of the Act’s enactment, and at least every four years thereafter, the SEC must review the definition of “accredited investor” set forth in Rule 215 under the Securities Act (or any successor rule) to determine whether the definition in its entirety should be amended for the protection of investors, in the public interest or in light of the economy. While the accredited investor test set forth in Rule 215 is identical in all material respects to the definition applicable to Rule 506 offerings, it is unclear whether the amendment of Rule 215 pursuant to the Act will affect the definition of accredited investor that is applicable to Rule 506 offerings.

Within one year after the law is enacted, the SEC must amend Rule 506 to include specified “bad boy” disqualifications for offerings exempt under that rule. First, the SEC must enact rules that provide for disqualifications under Rule 506 that are “substantially similar to” the provisions under Rule 262 of the Securities Act. Under Rule 262, an issuer is disqualified from relying upon that exemption if the issuer (or its predecessors or affiliated issuers), or its officers, directors, promoters, 10% or greater stockholders, or underwriters (and their affiliates) meet any one of several “bad boy” disqualifications.

In addition to these disqualifications, the legislation will require the SEC to adopt rules disqualifying an offering or sale of securities under Rule 506 if a person is subject to a final order of a state securities commission; a state insurance commission; or a state or federal authority supervising banks, savings associations or credit unions, including the National Credit Union Administration, that is issued within 10 years of the filing of the offer or sale and is based upon a violation of any law or regulation prohibiting fraudulent, manipulative or deceptive conduct, or that bars the person from:

  • associating with any regulated entity;
  • engaging in the business of securities, insurance or banking; or
  • engaging in savings association or credit union activities.

Reliance on Rule 506 would be prohibited for any person that has been convicted of any felony or misdemeanor in connection with the purchase or sale of any security or involving the making of a false filing with the SEC, no matter when the conduct occurred.

While Rule 262’s “bad boy” provisions had been currently applicable to offerings of securities under rarely-used Rule 505, the imposition of these requirements to Rule 506 offerings will serve to lessen the ability of some issuers to rely upon this widely-used exemption to raise capital. This amendment will also require an additional layer of due diligence for issuers relying upon Rule 506 in these transactions, especially necessitating deeper scrutiny into the background of the issuer’s controlling persons, 10% or greater beneficial owners, promoters, underwriters and related persons.

Enhanced Clawback Requirements for Executives. Public companies will be required to adopt and disclose clawback policies requiring current and former executive officers to repay any incentive compensation (including options) received during the three-year period prior to an accounting restatement, due to material non-compliance with financial reporting requirements, in excess of what they otherwise would have been paid. This provision significantly increases the clawback provisions currently contained in Section 304 of the Sarbanes-Oxley Act of 2002 which provide for a one-year clawback of compensation in the event of the restatement of financial statements due to material noncompliance with the financial reporting requirements under the securities laws where the executive was engaged in misconduct which resulted in the erroneous financial statements. These requirements will be implemented through the adoption of rules by the national securities exchanges which will prohibit the listing of the securities of any company which does not adopt such clawback policies.

Benefit for Whistleblowers. The Act adds a new benefit for whistleblowers8. Under this new provision, subject to certain exceptions, the SEC will have the authority to pay to a whistleblower who provides “original” information leading to an enforcement of a judicial or administrative action where the monetary sanctions recovered exceed $1.0 million, 10–30% of any monetary sanctions the SEC or other agency collects. Such payments will be in the SEC’s sole discretion. This provision does not apply to whistleblowers that are members or employees of a self-regulatory organization (for example, a securities exchange), the Department of Justice, the Public Company Accounting Oversight Board or a regulatory or law enforcement agency. Additionally, a whistleblower will be denied an award if such whistleblower is convicted of a criminal violation related to the judicial or administrative action for which the whistleblower provided original information, or if the whistleblower gained the original information through the performance of the audit of the company’s financial statements. Whistleblowers will also receive payments if their information leads to a successful related action by another governmental agency. Additionally, the federal whistleblower protection provided by the Sarbanes-Oxley Act was extended to prohibit retaliation or discrimination by subsidiaries or affiliates of a public company. Under the Act, public companies, including their consolidated subsidiaries or affiliates, may not discharge, demote, suspend, threaten or otherwise discriminate against a whistleblower.

Expanded Liability for Securities Violations. The legislation also expanded the Securities Act which governs securities offerings to add “aiding and abetting liability” for any person that “knowingly or recklessly” provides substantial assistance to another person in violation of the Securities Act. Section 20(e) of the Securities Exchange Act of 1934 was amended to enhance the current “aiding and abetting” liability to include “reckless” acts.

Increased Restrictions on Short Sales. The Act also requires the SEC to adopt rules requiring financial institutions to disclose information regarding short sales. Brokers will also be required to notify customers that such customers may elect not to allow their shares to be lent to third parties by the broker. Brokers are also required to notify their customers if the customers’ securities are used in short sales and indicate that the broker may receive a fee in connection with lending the customers’ shares. These are helpful provisions in that they enable retail brokerage customers to be put on notice of their rights with respect to the short sale of their securities held in brokerage accounts. Given the excessive and prolonged short sales have the effect of decreasing the market value of the affected publicly traded securities, investors in the affected securities, have an interest in limiting these activities as opposed to facilitating these short sales. The new SEC rules will likely reduce short selling problems plaguing certain public companies.

Enhanced Regulation of Swap Transactions and Committee Approval for Swap Transactions. The Act imposes enhanced regulatory requirements on the derivative market and its participants as well as public companies. Such enhancements include a broader definition of regulated financial instruments included as derivative instruments, and new requirements applicable to exchange trading and central clearing of derivative instruments. In addition, more stringent margin and capital requirements will be required for derivative market participants The Act also requires that the appropriate committee of any public company that engages in derivative activities approve the decision to enter into covered “Swap transactions” that rely upon commercial “end-user” exemptions from the new clearing requirements in the Securities Exchange Act of 1934 and the Commodity Exchange Act. The approval provision was effective upon enactment of the Act.

Relief from Section 404’s Requirement for Independent Auditor Attestation of Internal Controls for Small Public Companies. One of the positive elements of the Act for public companies was the relief provided for non-accelerated filers9 from Section 404(b)10 of the Sarbanes-Oxley Act which requires the company’s independent public accountants to attest to management’s assessment of the effectiveness of the company’s internal controls. Under the Act, companies that are not large accelerated filers or accelerated filers will be exempt from the requirement to provide such auditor attestation report. The SEC is also required to conduct a study on reducing the burden on companies with market capitalization between $75 million and $250 million of complying with Section 404(b) of the Sarbanes-Oxley Act.

Disclosure of Votes by Institutional Managers. The Act requires institutional investment managers to disclose at least annually how they voted on say-on-pay proposals and golden parachute proposals. It is anticipated that the SEC will issue rules related to the location and timing of this disclosure.

Credit Rating Agencies’ Consent and Disclosures. Many issuers refer to the ratings of their debt and preferred securities in their registration statements and in other SEC filings which are incorporated by reference into their registration statements. Rule 436(g) of the Securities Act historically allowed issuers to include or incorporate such credit ratings into their registration statements without obtaining the rating agencies’ consent. The Act repeals Rule 436(g). As a result of the provisions of the Act, certain rating agencies have said that they will not furnish consents for the time being. The SEC has set forth the following guidelines with respect to the disclosure of ratings information for non-asset backed securities offerings:

  • no consent is required where an issuer includes disclosure about its credit ratings in a filing with the SEC in the context of a discussion of changes to a credit rating, the liquidity of the registrant, the cost of funds for a registrant or the terms of agreements that refer to credit ratings (collectively, “disclosure-related ratings information”);
  • no consent is required where an issuer includes disclosure about its credit ratings in a free writing prospectus that complies with Rule 433 or in term sheets or press releases that comply with Rule 134;
  • except as provided below, issuers may continue to use currently effective registration statements without the credit agency’s consent to any information regarding ratings included or incorporated by reference therein until the next post-effective amendment to such registration statement;
  • a consent must be filed in connection with a prospectus or prospectus supplement that is first filed on or after July 22, 2010 that includes ratings information (other than disclosure-related ratings information as noted in the first bullet above);
  • a consent must be filed if a subsequently incorporated periodic or current report contains ratings information (other than disclosure-related ratings information as noted in the first bullet above); and
  • registration statements and post-effective amendments to registration statements (note that the filing of the issuer’s next annual report is deemed to be the post-effective amendment of a registration statement) that become effective on or after July 22, 2010 must include an appropriate consent if the registration statement includes or incorporates by reference any ratings information (other than disclosure-related ratings information as noted in the first bullet above).

Amendments to Regulation FD regarding Disclosure to Credit Rating Agencies. The Act requires the SEC to amend Regulation FD within 90 days of enactment of the Act to remove the exemption for communications with entities whose primary business is the issuance of credit ratings. Therefore, unless another exemption applies, public companies will not be able to provide material non-public information to credit rating agencies.

Establishment of a Risk Committee by Certain Publicly-Traded Bank Holding Companies. The FRB must require publicly traded nonbank financial companies that it regulates and publicly-traded bank holding companies with assets in excess of $10 billion, and may require smaller bank holding companies, to establish a risk committee responsible for the oversight of enterprise-wide risk. The committee must include such number of independent directors as the FRB determines appropriate (based on the nature of operations, size of assets, etc.) and at least one risk management expert. The FRB is required to issue final rules regarding this requirement not later than two years after the enactment of the Act, to take effect not later than 15 months after the one year anniversary of the enactment of the Act.

Application of the Act to Foreign Private Issuers. Although a majority of the provisions of the Act do not apply to foreign private issuers11, there are a couple of provisions that will impact foreign private issuers. For instance, a foreign private issuer with a security listed on an exchange will be required to adhere to the new compensation committee requirements unless the foreign private issuer provides in its annual report on Form 20-F the reasons why the foreign private issuer is not in compliance. In addition, as the enhanced clawback provisions for executives applies to all public companies with a security listed on an exchange, the clawback provisions for executives will apply to foreign private issuers unless the SEC in implementing regulations regarding the clawback provisions provides for a foreign private issuer exemption. The Act itself provides for no such exemption. As is the case with U.S. public companies, foreign private issuers that are non-accelerated filers will not be required to have the company’s independent public accountants attest to management’s assessment of the effectiveness of the company’s internal controls. Finally, the added whistleblower benefits and expanded liability for securities violations have the potential to impact foreign private issuers.

Action Items for Public Companies—Preparing for the 2011 Proxy Season and Beyond

In light of the Act’s new disclosure and corporate governance requirements, many of which take effect six months after enactment of the Act, public companies should consider taking the following actions prior to the 2011 proxy season:

1.  Plan Ahead for the 2011 Annual Meeting. The elimination of discretionary voting by brokers will undoubtedly create issues for companies with obtaining a quorum for the annual shareholders meeting or the vote for specific proposals requiring majority or super-majority votes. As a result, it will be important to review the company’s charter document or bylaws well in advance of the meeting to determine what the quorum requirements are for annual meetings and consult with counsel regarding whether amendments to modify these requirements are recommended. In addition, companies should plan on allowing extra time between the meeting and mail dates for the 2011 annual meeting or consider the retention of a proxy solicitor. These solicitation services will likely be in high demand in 2011 as a result of the elimination of broker voting and the other shareholder proposals required by the Act. Subject to the provisions of the final rules, if a company is only electing directors by a plurality vote, the company should also consider adding a proposal where directors have discretionary authority, such as the ratification of auditors. Thus, the addition of a proposal where discretionary voting is permitted will ensure the company meets its quorum requirements for the annual meeting.

2.  Anticipate Mandatory “Say-on-Pay” Proposal and Other New Compensation Disclosures. Given the mandatory “say-on-pay” proposal which will be effective for the first meeting of shareholders occurring six months after the enactment of the Act and other new disclosures related to compensation, the compensation committees will want to carefully consider how to address executive compensation disclosures in the company’s compensation discussion and analysis (“CD&A”) or elsewhere in the proxy statement. This will likely require a careful review and a potential rewrite of last year’s CD&A. It is suggested that companies attempt to streamline and clarify compensation policies for the benefit of shareholders reviewing this information. Since the vote on this proposal will likely set the stage for what will happen in future years, the presentation and content will be of critical importance this year.

Given the Act also requires disclosure of the relationship between compensation of executives and enhancing shareholder value (i.e., appreciation in the value of the company’s publicly traded equity), shareholders will continue to pay particular attention to how successfully the company aligned executive compensation with increasing value for shareholders as well as the combination of stock-based compensation and cash. It is anticipated that this disclosure will have to be more transparent with respect to executive compensation decision-making and the financial and other measures utilized to determine performance-based compensation. The financial crisis also focused attention on the compensation mix as contributing to the overall level of risk undertaken by executives. This Act provides incentive for compensation committees to review the interplay between risk and executive compensation and address any compensation policies or practices that encourage excessive risk-taking.

3. Evaluate Independence of Compensation Committee Members Under New Criteria. Given the new requirements applicable to compensation committees under the Act, as well as the new considerations applicable to the independence determination, the board should consider whether the composition of the compensation committee will meet the more stringent requirements of the Act and it should be noted that other requirements could be added by the SEC in the final rule when adopted. This review process should include the board’s evaluation of the relationships that exist with compensation committee members based upon these new requirements articulated in the Act. If the board determines that there are not an adequate number of compensation committee members that will meet the new requirements, it will be necessary to add new board members to this critical committee. Although it may be premature to embark on the process of adding new directors prior to the review of the SEC proposal, the company should have as a top priority the evaluation of the existing composition of this committee.

4. Reevaluate Clawback Provisions in Existing Compensation Arrangements. The expanded clawback provisions of the Act will likely require the amendment of existing company policies, as well as changes to compensation arrangements as well as plan documents and model agreements related to equity and other awards. This exercise will undoubtedly take some time to effect and may prove difficult with respect to implementation related to former officers. Prior to the adoption of SEC rules in this area, companies should include language compliant with the Act in new arrangements.

5. Analyze the Use of Compensation Committee Consultants. The changes in the Act with respect to compensation committee consultants will require a thorough evaluation of the selection process as well as a review of existing relationships and policies related to the solicitation of compensation consultants. It may be necessary to utilize a questionnaire for existing or new consultants for gathering the information necessary for the compensation committee to evaluate the consultants under the requirements of the Act. These requirements may also necessitate the implementation of policies similar to those used with the retention of a company’s independent auditors, including pre-approval policies. Companies should also consider adopting policy regarding the retention of consultants, counsel and advisors and the related procedures applicable to the retention of such advisors.

6. Determine How to Disclose and Calculate the Median Compensation Numbers. One of the most troubling aspects of the Act is clearly the disclosure of the ratio of the median of total annual compensation of all employees to the total annual compensation of the CEO. This requirement will be difficult (if not impossible) to calculate for many companies. Since the parameters are set forth in the law and the SEC rule cannot deviate from these parameters, companies will need an early start to gather the necessary data and draft disclosure to quantify and explain these numbers.

7. Amend Insider Trading Policy to Address Hedging. Hedging activities can often result in adverse effects and require specific policies to address these activities. Many public companies have policies addressing hedging, which are typically reflected in companies’ insider trading policies12. For companies that do not have such policies, consideration should be given to the adoption of such policies in anticipation of the issuance of disclosure rules on this topic by the SEC. In this regard, the board should consider whether these restrictions should apply only to directors and executive officers or to a broader group of employees. Additionally, consideration should be given to whether hedging activities should be prohibited or subject to an established pre-approval policy.

8. Rationalize Board Management Structure. The Act’s requirements regarding disclosure of the rationale for the company’s board management structure, as well as existing SEC disclosure requirements on this topic, will necessitate a review of the structure currently utilized. Companies with a combined chairman and CEO position will undoubtedly have to rethink this combination or provide additional support for continuing the combination of these two critical roles.

9. Review and Revise Key Corporate Governance Documents. Changes to the whistleblower provisions of the Sarbanes-Oxley Act as well as other corporate governance requirements of the Act necessitate the review and revision of the company’s whistleblower policies and procedures as well as other key corporate governance documents such as the code of conduct and committee charters. At a minimum, the whistleblower policy must be revised to include employees of the public company’s subsidiaries and affiliates whose financial information is included in the company’s consolidated financial statements. Further, this presents a good opportunity to review other documents as part of the company’s compliance review and assess the effectiveness of these documents.

10. Take Action with Respect to New Swap Approval Requirements. The Act’s new Swap approval requirements will require the Board to designate a committee to review and approve Swap transactions. An appropriate amendment to the selected committee’s charter will also be necessary. Finally, consideration needs to be given to what procedures need to be put in place to insure compliance with the new requirements applicable to Swap transactions.

11. Consider Establishing a Risk Committee. The requirement of the Act related to risk committees for non-bank financial companies and certain bank holding companies will undoubtedly affect best practices in this area for all public companies. Given the recent focus on risk-related issues particularly in light of the financial crisis, boards of public companies may consider establishing a risk committee to be responsible for the oversight of company-wide risk management practices. Whether this committee has a “risk management expert” as required for nonbank financial companies and certain bank holding companies will depend upon the complexity of organization, as well as other factors.

12. Educate the Board and Committees on the Act’s New Requirements. Given the myriad of changes required by the Act, it will be necessary to educate the board and affected committees regarding the Act’s requirements as well as the changes impacting the board and specific committees. For example, the Swap transaction approval requirements of the Act will also require the implementation of a new approval process as well as the education of the Board and the appropriate committees regarding the new approval requirements applicable to Swap transactions.

13. Develop and Implement Internal Controls to Ensure Compliance with the Act. In light of the numerous changes required by the Act, many of which will be implemented over a several year period, it will be necessary for public companies to develop and implement the appropriate internal controls and procedures to ensure compliance with the Act’s requirements on a timely basis. These controls will require a certain degree of flexibility given the manner in which the Act’s requirements will be implemented


  1. See generally section 951 of the Act
  2. This separate approval of the golden parachute payment is not applicable if the golden parachute payment was previously the subject of a prior “say-on-pay” vote.
  3. Generally does not apply to controlled companies.
  4. Generally does not apply to controlled companies.
  5. See generally, Section 972 of the Act.
  6. See generally, Section 971 of the Act.
  7. The SEC has indicated in a recent Compliance & Disclosure Interpretation that the amount of any indebtedness secured by the primary residence may be excluded from the value of the residence (where the amount of the debt exceeds the fair market value of the residence and the lender has recourse to the investor personally for such excess, such excess liability should be deducted from net worth calculation).
  8. See generally, Section 922 of the Act.
  9. A non-accelerated filer is a company with less than $75.0 million of public float held by non-affiliates on the last business day of the second fiscal quarter of the company’s fiscal year.
  10. See generally, Section 989G of the Act.
  11. Since the SEC’s proxy rules do not apply to foreign private issuers, provisions of the Act requiring additional proxy statement disclosure are not applicable.
  12. Certain hedging transactions are prohibited by Section 16(c) of the Securities Exchange Act.

Watch the FRW Webinar: Adapting to the New Normal

On July 16, 2010, Blank Rome presented a webinar on The Dodd Frank Wall Street Reform and Consumer Protection Act of 2010.

This legislation will affect everyone, from financiers working on Wall Street to publicly-traded companies in all industries to consumers on Main Street. To view a video presentation of the topics discussed during the webinar please click on the individual links below.

The Blank Rome team addressed the following provisions of the financial reform bill:

To download a PDF copy of the presentation, please click here.

Recently Enacted Dodd-Frank Financial Reform Legislation Has Immediate Effect on Private Offerings of Securities

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), which was signed into law on July 21, 2010, has an immediate effect on many private securities offerings. Specifically, the Act revises the net worth test for determining whether an individual investor is an “accredited investor” for purposes of Regulation D and Section 4(6) of the Securities Act of 1933 (the “Securities Act”).

Regulation D is the exemption under the federal securities laws that many issuers, including venture capital firms and real estate and private equity funds, rely upon to raise capital from investors in non-public offerings. This exemption is also often relied upon in many non-public M&A transactions in which the acquiror uses its stock as acquisition consideration. Section 4(6) is a statutory exemption available for private placements solely to accredited investors.

Section 413 of the Act requires the SEC to make a change to the net worth test contained in the definition of “accredited investor” that is applicable to all offerings exempt under Regulation D (especially Rule 506) and Section 4(6) of the Securities Act. Under the net worth test, an investor must have (either individually or together with the investor’s spouse) more than $1 million of net worth at the time of the purchase. As amended by Section 413 of the Act, the value of the investor’s primary residence is now excluded from the calculation of net worth. The SEC has indicated in a Compliance & Disclosure Interpretation (“C&DI”) dated July 23, 2010 that the amount of any indebtedness secured by the principal residence should be netted from the value of the residence (except where the amount of the debt exceeds the fair market value of the residence and the lender has recourse to the investor personally for such excess, in which case such excess liability is deducted from net worth).

The SEC has clarified in a 2009 C&DI that the net worth test is only applicable to individual investors and not to entities. The SEC has also indicated in the July 2010 C&DI that this change was deemed to have taken effect on July 21, 2010 upon the enactment of the law. Thus, public companies, as well as private companies or other entities, currently conducting an offering pursuant to Regulation D or Section 4(6) of the Securities Act to accredited investors are immediately affected by this change.

Any issuer that is currently relying on these exemptions should immediately reflect this change in the terms of the private placement and the related offering documents, including but not limited to, making the appropriate modifications to subscription or purchase agreements, investor questionnaires or other disclosure documents to adequately reflect this change prior to closing.

Furthermore, issuers conducting a private offering in reliance on Regulation D or Section 4(6) should reassess the accredited investor status of all individual investors under the new net worth test if the old net worth test was relied upon. If an investor fails to meet the amended net worth test and does otherwise qualify for accredited investor status, the issuer would need to determine whether the investor’s participation in the offering as a non-accredited investor would result in a loss of the exemption or whether another exemption from registration may be available. If no exemption is available, the investor would need to be prohibited from purchasing securities in the offering.

Further, for continuous offerings to accredited investors that have already commenced, issuers should determine whether they need to supplement their offering materials and reassess investors’ compliance with the new net worth standard, where such standard was originally relied upon.

The change in the definition of “accredited investor” may also affect compliance with state securities laws for states that rely upon or incorporate the federal definition in state law or regulations.

Section 926 of the Act also requires the SEC to issue rules amending Rule 506 to impose a number of “bad boy” disqualifications in relying upon the exemption. These disqualifications would bar reliance of Rule 506 by an issuer if, among others, the issuer (and its predecessors or affiliated issuers), as well as its officers, directors, 10% or greater stockholders, promoters and underwriters (and affiliates of underwriters), have been convicted of certain crimes or subject to certain legal and other proceedings stemming from activities in the securities, banking, insurance or credit union industries. This change to Rule 506 must be implemented by July 21, 2011 by SEC rulemaking. Additional information will be provided on those changes when such rules are made available, but when adopted, these changes will require issuers to undertake significant additional due diligence of their own principals and others associated with a private offering before relying on the Rule 506 exemption.

DOWNLOAD: Dodd Frank Wall Street Reform and Consumer Protection Act

To download the final, enrolled version of the Dodd Frank Wall Street Reform and Consumer Protection Act, please click here.

Finale - President Obama Signs the Dodd Frank Wall Street Reform and Consumer Protection Act into Law

Earlier today, President Obama signed into law the Dodd Frank Wall Street Reform and Consumer Protection Act—marking the completion of the legislative road and the beginning of the regulatory road for the financial reform bill that is now the law of the land.

In his remarks at the bill signing, the president thanked congressional leaders, praised the effort, and described the package as a "...set of reforms to empower consumers and investors, to bring the shadowy deals that caused this crisis into the light of day, and to put a stop to taxpayer bailouts once and for all."

The 2,300 page bill now falls into the hands of the Treasury Secretary and other financial regulators to execute. In the coming days and weeks, Financial Reform Watch will be "watching" for many things including whom the president nominates to be the head of the new Consumer Financial Protection Bureau; when the first meeting of the Financial Stability Oversight Council will be scheduled; and which proposed rules begin to flow from the financial regulators tasked with implementing the mandates of the Dodd Frank Act.

WEBINAR: Financial Reform Watch - Adapting to the New Normal

Date:  Friday, July 16

Time:  12:00 noon - 1:30 p.m. EST

Registration: Click here to register by July 15


The Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 brings the most ambitious reform to the financial industry in 70 years. This legislation will affect everyone, from financiers working on Wall Street to publicly traded companies in all industries and to consumers on Main Street.

Join the Financial Reform Watch team for a complimentary webinar that will address the overall provisions of the financial reform bill, including:

  • Political Overview—the Evolution of the Financial Reform Legislation
  • Executive Compensation and Shareholder Rights—New Rules for "Say-on-Pay" and Independent Compensation Committees
  • New Rules for Banks—Capital Requirements, Bank Fees and "the Volcker Rule"
  • Hedge Funds—SEC Registration, Providing Systemic Risk Data, and Expanded State Supervision
  • Derivatives—Central Clearing and Trading, Increased Market Transparency, and Regulating Foreign Exchange Transactions
  • Funeral Plans and Restructuring—Periodic Reporting for Rapid Shutdown and the Consequences of Non-compliance


For more information, please contact Alexandra Sevilla at [email protected]